Define the following terms and explain why they were important during the housing and credit crisis of 2007-2009.
a. Mortgage
b. Subprime loan
c. Asset write-down
Answer:
Mortgage – is a contract whereby a borrower provides a lender with a lien on real property as security against a loan. Mortgage is important during the housing credit crisis because it is one of the major causes of the problems that financial institutions are facing during the crisis. The financial institutions (lenders) that owned subprime loans/ mortgage were in trouble because a lot of borrowers/home owners are defaulting on their loans because they are unable to meet the payment amount. In addition, the housing prices are deceasing compared to the original loan amount.
Subprime loan – are loans made to borrowers with low credit scores and thus a higher-than-average risk of default. Subprime loan is the mortgage approved to the borrowers that did not truly earn enough to be able to make the payment amount that would have repaid the obligated principal and interest. The financial institutions were offering such loans because they were making money by charging higher fees and rates. However, since the borrowers were just paying interest, the loan amount increased every month, while the housing price was decreasing. Thus the borrowers owed more than the house was worth. These subprime borrowers were the hardest hit and the main reason for the 2007-2009 credit crises.
Asset writedown – is the writedown of loan amount due to a loss of asset values, that is the balance amount are worth less than the original funds advanced. In this case, the housing value was decreasing and financial institutions were recording a large amount of asset writedown around the world. These writedowns, depleted the lenders’ capital and forced them to either sell assets or obtain external capital to replace capital lost from writedowns.
