Friday, June 15, 2007

Subprime Lending Mess Good for America

Gadabout has been keeping his eye on the subprime leading headlines, and posits a polemic position on the matter. Okay, first, what is a subprime? Well, it is essentially lending to individuals with less than desirable credit ratings at higher interest rates under less than optimal terms. In the mortgage business, it is all about closing a deal, and making a killing with fees and so forth. Everyone makes a buck when a real estate deal is closed; real estate brokers and agents, attorneys, surveyors, title insurance companies and home inspectors. Since so much cash is distributed in the name of the buyer, it is important for the housing industry to keep the machine turning. And it turned so wonderfully from 2001-2006.

Subprime lending accounts for about 12 percent of the big picture in mortgages and the default rate (2.5 %) for these loans is 10 times the prime rate lending industry. Ten times the prime rate sounds scary, but in the big picture it is a relatively small segment of ownership. Sure, a few homeowners will default and lose their homes, but savvy investors are waiting in the shadows to gobble up these prizes and generate a profit. Who loses in this horse trading? The owners who default ruin their credit scores, and the lender will most likely lose a bit too.

Let’s look at an example:

Earl and Betty buy a $200,000 home with a zero dollar down payment. They take a teaser low interest rate ARM and after a couple of years the interest rate climbs from 4 % to 6.5 %. Tax assessments increase also so their initial monthly payment jumps from $1,200 to $1,800, and they start falling behind. Oh, don’t forget that they dumped several grand for furniture, landscaping and new curtains, so the credit cards are maxed out too. Anyway, they default and an investor picks up the property for $155,000, and flips it for a profit at a final sale price of $182,000. Every group makes money again through fees and taxes!

The final point is that the lower selling price helped BRING DOWN inflation, thus offering first time homeowners more choices and lower prices. Subprime lending is a small portion of the mortgage industry and regardless of the fact that lives are temporarily ruined, lots of others make a killing off these serial closings and turnovers.

Gadabout does agree that the housing market has taken a downturn and in some areas, like Las Vegas, prices have crumbled. There are problems out there and some people are hurt and will face a serious hit in the future, but the "bubble" never "popped." It may have deflated a bit, but it remains a bubble. And with the national unemployment rate at 4.5%, the country still has steam. As always, be cautious, read the fine print, and don't live beyond your means.


Bald Jack said...

"...don't live beyond your means." Amen Gadabout!

Gadabout Jack said...

bald jack,
Agreed, but it feels so GOOD to spend!