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Subprime Mortgages and Home Equity Loans

By Charles Hopkins Published 10/26/2007 | Loans
Anyone who's dealt with the money market lately has heard of -or worse, experienced - the recent subprime loans fiasco that sent dozens of firms to the bottom after a salvo of boom-wrecking reverses in the housing market.  A combination of low interest rates, new financial products, low housing prices, loans to high-risk borrowers, over-aggressive lenders, and starry-eyed would-be homeowners resulted in a monetary crisis that is still not over and whose effects for the future are still uncertain.

What are Some of the Effects of the Subprime Crash?

It isn't the direct losses caused by the subprime loan disaster that concern investors.  According to 2007 report from AMP Capital Investors, the total amount of subprime loans is worth about 1.4 trillion dollars, of which only one-third of the outstanding loans could default.  The loss is mitigated by the banks' ability to sell the foreclosed properties to recoup some of their money.  Still, this means that approximately 200 billion dollars are going to be unrecoverable - a staggering amount indeed but which is insignificant compared to the GDP of the United States alone (13 trillion in 2006).  The subprime market losses alone probably won't have a major impact on the overall economy.  It's the potential carry-over effects on other markets that have investors and other people worried.

How are Home Equity Loans Affected?

Already, there is an about-face in investors' willingness to extend credit, especially to high-risk borrowers.  A heightened perception of the risks involved leads them to ask for higher rates of returns, which raises interest rates and overall costs of obtaining loans and owning homes.  The credit crunch also reaches into the home equity loan market.  With the decline in real estate values, lenders are reluctant to originate equity loans, given the depressed values.  Given today's more restricted market, it's more important than ever to select the right equity loan and use the cash wisely.  Not every package is the right one for every borrower.  One should pick a deal that offers competitive repayment terms, fees and rates for them.

Home Equity Loan Security

Home equity loans still present an easy way for the owner to cash in on the value contained in their property.  There are two main types - fixed-rate loans are similar in structure to mortgages (in fact, both types are also called second mortgages), wherein the borrower receives a lump sum and pays it back in installments within five to fifteen years, while lines of credit are based on variable-rate interest and act more like credit cards, some of them being issued with and accessed through special cards and checks.

In fact, the ease with which homeowners can obtain the cash in equity loans and the amount they can borrow - up to 125 percent of the property value in some cases - can lead to certain pitfalls.  The first is what is known as reloading, where the borrower is simply taking out a loan to pay off another loan, freeing up credit and spending it again and not taking steps to reduce their cash outflow.  The second problem involves predatory lenders who use various schemes to scam money from their customers.