Sub prime mortgage crisis

The economic woes hitting the U.S started due to its sub prime mortgage crisis but has moved further a field and hit financial markets all over the world, but many people do not understand why this is. First you have to understand the sub prime mortgage process compared to the traditional one seen elsewhere to better appreciate its failings.

Traditional Mortgage Model

Under the traditional model the bank grants a home owner a mortgage and lends them the money (dependant on circumstances) and the home owner pays the bank their monthly fee with interest to pay off the mortgage. The banks make all checks on circumstances before lending the money in this model.

Sub Prime Mortgage Model

Under the sub prime model in the United States the bank sells mortgage bonds to those who wish to purchase them then they grant a home owner a mortgage and lend them the money via a home appraiser, the home owner then makes payments back to the bank via a mortgage broker. The bank then uses a rating agency to determine the amount of money a bondholder should get and makes a payment to the bondholder. All the checks made in this model are done by independant companies, not the bank itself.

The Sub prime model grew rapidly due to the Mortgage bond market which flourished. As you can imagine the banks were making alot of money, because of this they started pushing mortgage brokers to sell more Sub prime mortgages.

The mortgage brokers who wanted to make money and felt pressured by the banks started selling these sub prime mortgages to people in poor low income areas. They mis sold these mortgages to the lower income people by advising them that they could unlock some cash out of their property by refinancing but neglected to tell them that after two years the interest on these Sub prime mortgages would double.

After the two years were up many poor families found the interest doubled on their Sub prime mortgages and suddenly couldn't afford to make their mortgage repayments causing mass repossessions of properties.

The huge amount of repossesions hit the property market hard with a massive crash in property prices, this in turn has hit the United States building industry which represents 15% of the total US economy. Due to this slump in a large portion of the economy it has had a knock on affect across other industries, which in turn is affecting many economies across the globe.