I spoke with Beatrice Scott, a Vancouver mtg. broker with Invis about the whole subprime mess. What is a subprime mortgage? Why did it cause my portfolio to tank? (grrrrrr….). Here’s what I learned.
When a person qualifies for a mortgage, the bank of course looks at the person’s credit, profession, income and downpayment. When a person doesn’t qualify for a mortgage (usually because their credit rating indicates they struggle to make their debt obligation payments) they can sometimes turn to other companies for a sub-prime mortgage.
A sub-prime mortgage is one that charges higher interest rates (sometimes significantly higher) in exchange for taking the risk with the individual. They are usually floating interest rates, that started at 4%, but now with interest rates having risen in the States are at 8%. You can imagine the pain of having your mortgage payments double, in under 5 years!
Note: I (Nancy) personally nearly got sucked into one of these when my mtg was up for renewal. I had just started my new business 4 years ago, and (erroneously) figured a bank wouldn’t be interested in me. I saw a couple very attractive sounding adverts on TV by non-bank mortgage companies who pretty much guaranteed I’d get my mortgage. It sounded reasonable, until (money coach that I am) I read the fine print carefully. OUCH! It was, in my opinion, nearly criminal. There were all kinds of hidden fees and the way the interest was structured would have left things pretty shaky for me. Thankfully, I got a mortgage broker and discovered I would indeed qualify for a terrific mortgage through a bank.
Not everyone was so lucky. In the US 20% of all people who have mortgages had a subprime mortgage as compared to 5% in Canada. There are some significant differences in the US and Canada in terms of qualifying for a subprime mortgage. The differences are the tighter rules in Canada for this type of mortgage.
In the US last year, subprime mortgages accounted for 1 Trillion dollars. These subprime Mortgages were sold to different companies all around the world. Now, those companies are in dire straights because their clients are not able to meet their payments and are defaulting. It also means the US housing market has deflated significantly, and caused a global credit crunch – ie., institutions are less likely to lend out money, since they can’t recoup their previously loans.
Case in point: The US Federal Reserve Board decreased their lending to commercial banks by half a percent.
What is surprising is that the effect on the stock markets world wide isgreater than the actual financial implication. Investor’s emotions have played a key in their reaction to the collapse of the US subprime Mortgages.
An interesting effect here in Canada was the increase in the dollar. We had our biggest gain in the Canadian dollar since June 2006. It increased all the way to 94.22 cents.
Currently Canada’s prime lending rate is at 6.25%. Before the US subprime collapse, Canadian economists were predicting that the Bank of Canada would increase it to 6.50% in September. It is now predicted that we may not see that quarter point increase.