Select Page

What is the subprime market?

Ventsi Stamenov, portfolio manager and investment analyst at the Garrison Financial Institute in the Sam M. Walton College of Business, replies:

Subprime lending is the practice of making loans to borrowers with questionable or deficient credit history. To compensate the lender for the default risk associated with lending to borrowers with poor credit, subprime borrowers are charged a higher interest rate than borrowers with good credit ratings. Subprime lending is risky for lenders and borrowers due to the combination of high interest rates, poor credit history and adverse financial situations usually associated with subprime applicants.

The subprime mortgage financial crisis of 2007 was characterized by a rise in home foreclosures, which started in the United States during the fall of 2006. The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007. The share of subprime mortgages to total originations increased from 9 percent in 1996 to 20 percent in 2006. While U.S. housing prices continued to increase from 1996-2006, refinancing was available. However, once housing prices started to drop in 2006-2007 in many parts of the U.S., refinancing became more difficult. Mortgage lenders that retained credit or default risk were the first impacted, as borrowers became unable to make their mortgage payments.

Due to a form of financial engineering called securitization, many mortgage lenders had passed the rights to the mortgage payments and related credit risk to third-party investors via mortgage-backed securities. Investors holding these securities faced significant losses, as the value of the underlying mortgage assets declined and payment streams became unpredictable. In addition, legal entities designed to isolate this risk from the originating lenders, called collateralized debt obligations and structured investment vehicles, held substantial amounts of mortgage-backed securities. As the value of payments into these entities declined, their value also declined, forcing the sale of these securities, sometimes at fire-sale prices.

About The Author

Looking for an expert?

The University of Arkansas Campus Experts website is a searchable database of experts who can talk to the media on current events.

Trending Topics:
Mars
State and local economy
Environmental economics
Immigration politics

‘A House of the Ozarks’; Exploring Arkansas’ Most Important Architect

The University Relations Science and Research Team

Camilla Shumaker
director of science and research communications
479-575-7422, camillas@uark.edu

Matt McGowan
science and research writer
479-575-4246, dmcgowa@uark.edu

Robert Whitby
science and research writer
479-387-0720, whitby@uark.edu

DeLani Bartlette
feature writer
479-575-5709, drbartl@uark.edu

More on University of Arkansas Research

Visit The Office of Research and Innovation for more information on research policies, support and analytics.

a graph showing research expenditure rising from under $120 million to over $170 million over ten years

Connect with Us