The Sub-Prime Mortgage Fiasco and What it Means to You

The “sub-prime” mortgage fiasco which has been leading the financial news headlines for much of the past few weeks have led many people to ask “what does it mean to me?” I have read dozens of articles on the subject, and listened to many financial pundits. Following is my take away of what it may mean to you.

The general economy - The risk of loss has been spread over many institutions, hedge funds, and portfolios. While some financial companies will be hurt, the effect on the overall economy will not be severe. However, if the downstream effect of housing sales and home values are hindered considerably by the fall out, a further slow down in the housing market may lead to an economic downturn. Please see below for more details.

Mortgage Rates - The bloom is off the rose for mortgage backed securities, as well as other asset backed securities. Therefore, in order to attract buyers to mortgage backed securities rather than the safe haven of US Treasuries, mortgage backed securities yields and hence, mortgage interest rates have to be higher. These higher yields are already built into current mortgage rates. Without the problems created by sub-prime loans, current rates would probably have dropped lower.

Credit. –

1. “A” Credit – Those who continue to pay there bills on time, and have a credit score of over 660 will continue to be able to borrower without a problem.
2. “Alt-A” – For those whose credit may not be perfect and/or need to use alternative income, asset, or no documentation status, I envision a small change. Mostly a tightening of credit score minimums and/or loan to value minimums.
3. Sub-prime borrowers will have far less access to credit.
4. Government Intervention – Could have an effect

Home Values – The effect of the sub-prime market on home values should be fairly negligible overall, but is driven by locale. For instance, the overall number of sub-prime loans in the North East is far smaller than in other areas of the country. The effect of both foreclosures and the reduction of the sub-prime purchase borrowing pool will not have as much impact as in other parts of the country. In other region, a higher percentage of sub-prime loans and foreclosures will put more houses on the market – again with a smaller purchase base. More supply and less demand could force down already falling prices in these areas. If this spirals too deeply, it could affect the general economy as well.

I would enjoy hearing your thoughts on the fall out from the sub-prime defaults.