To sell more profitable subprime mortgages, mortgage companies bundled the debt into consolidation packages and sold the debt on to other finance companies. In other words, mortgage companies borrowed to be able to lend mortgages. For example, the lending was not financed out of saving accounts (Mortgage Guide).
These mortgage debts were bought by financial intermediaries. The idea was to spread the risk, but, actually it just spread the problem. Usually subprime mortgages would have a high risk assessment rating. But, when the mortgage bundles got passed onto other lenders, rating agencies gave these risky subprime mortgages a low risk rating. Therefore, the financial system denied the extent of risk in their balance sheets (Mortgage Guide).
Many of these mortgages charged a balloon interest rate in which, they charge low interest rates in the initial period, but at the end of the introductory period interest rates rise rapidly (Mortgage Guide).
In 2007, the US had to increase interest rates because of inflation (BBC). This made mortgage payments more expensive. Furthermore, many homeowners who had taken out mortgages two years earlier now faced ballooning mortgage payments as their introductory period ended. Homeowners also faced lower disposable income because of rising health care costs, rising petrol prices and rising food prices.
This caused ...