What is sub-prime lending and how has it affected the housing crisis - Essay Example

nd the nature of subprime lending, this paper also provides a background of the subprime lending which gained popularity in the 1990’s, and also a comparison with other forms of mortgages like the prime lending. Subprime lending is a type of granting loans in which the client’s ability to pay is questionable. Kenneth Temkin et. al (2002) add that subprime lending mortgage originations are more inclined to risky borrowers. According to the U.S. Department of Housing and Urban Development, subprime loans are given to individuals with limited credit histories.

One reason for this is the lack of background check on the borrower. In order to compensate for the higher credit risk, the loans that are given have higher interest rates.1 The U.S. Department of Housing and Urban Development presents three (3) truths about the subprime lenders: (1) the increased shares of subprime lenders’ overall origination as compared to the prime lenders’ originations are due to home refinance loans; (2) they occupy a bigger percentage in total originations in black-predominated communities than prime lenders; and (3) terms like “consumer, finance, and acceptance” are seen more in their lender names.

2 Temkin et al. (2002) find out that subprime borrowers have lower incomes or belong to minority groups than their primary counterparts. They have less information financially on the bank mechanisms. They are also less sophisticated and less comfortable in dealing with banks. Danielle DiMartino and John Duca (2007) add that the prime or the traditional mortgages are offered to borrowers with good credit histories and can make down payments and document their income entirely. Whereas the subprime or the nontraditional mortgages, are extended to borrower applicants who are less credit-worthy as reflected by their low credit scores and unsure income forecasts which “reflect the highest default risk and warrant the highest interest rates”.

They also introduce the near-prime