Home Loans: Journey to the present mortgage crisis

There were large inflows of foreign funds a couple of years earlier. The rate on interest was low and this foreign money along with low rates created easy credit conditions. The resultant was a housing boom. There was encouragement of debt- financed consumption. US citizens became proud owners of their homes. This home ownership was largely fuelled by sub prime lending. There was an increase in home ownership rate. There was created a demand for housing, which in turn drove the prices higher.

There was an increase in price of homes by an amazing 124%. Resultantly the median household income to median home price increased to 4.00 from a meager 2.9. Many home owners refinanced their home loans at lower interest rates or went on to take second and third mortgages. The annual household debt percentage increased to 139% at the end of 2008 as compared to 77% in 1990.

Thus common man was saving less, spending more and borrowing more. Thus consumerism culture took roots. American households have been spending almost 99.5% of their disposable personal income on interests on debts or consumption. Household debts have increased from 60% in 1974 to 134% in 2008. A typical USA house hold owned 13 credit cards in 2008. Among these almost 40% of house holds were carrying a balance from 1970 at a 6% interest rate.

A combined burden of credit and explosion of house prices led to construction boom and eventually to a surplus of unsold homes. The house prices reached a peak and began their descent by mid 2006. Low rates, easy credit and speculations leading to the belief that house prices would continue to appreciate had led to many sub prime borrowers to opt for ARM (Adjustable rate mortgages). The below market rates of interest for an initial brief period of time, to be followed by market interest rates for the remaining time were the conditions for ARMs.  Borrowers who were unable to pay the market rate after the completion of the grace period looked for refinancing their home loans.  As the prices of homes declined, refinancing became more and more difficult. Thus started default of payments ultimately leading to foreclosures.

More foreclosures led to increased availability of homes for sale. This led to a negative pressure on the prices of houses indicating a reduction in home equity. Negative home equity meant that homes cost more than the mortgages. Borrowers began to abandon and walk away from their homes. This damaged their credit rating for many years. December 2007 saw nearly four million houses for sale of which 2.9 were vacant. The surplus unsold houses led to the decline of home prices. The free fall in home prices is still continuing. Defaults and decline in mortgage payments reduced the value of MBS (mortgage backed securities). Thus the financial health of banks and other financial institutions were getting affected. Thus the housing crisis ultimately led to the economic slow down and financial crisis that the world is witnessing at present. Many such bubbles in different countries have led to this global credit crisis.