Sub-prime
What is it?
Sub-prime is the term given to mortgages extended to borrowers with less than perfect credit histories. Sub-prime mortgages were particularly prevalent in the US, where many lenders made so-called 'ninja' loans to people with no income, no job, and no assets.
In the years between 1995 and 2006, the share of new mortgage lending that went to sub-prime borrowers in the US rose from nothing to more than 20%, according to the Center for Responsible Mortgage Lending.
Sub-prime mortgages are to be distinguished from prime and Alt A mortgages.
What's it got to do with the financial crisis?
The realisation that there had been reckless lending to homeowners who took out sub-prime mortgages and would never be able to pay them back was at the heart of the credit crunch.
In the US, many homeowners with poor credit histories and low incomes had been persuaded to take out sub-prime mortgages with so-called 'teaser rates'. These were very low interest rates that made the loan appear affordable. But after two or three years, the initial rates came to an end and borrowers were forced to pay much higher interest rates which they often couldn't afford.
The banks which had originally offered the sub-prime mortgages sold them to other investors via the process of securitization. Sub-prime loans were therefore repackaged in complicated financial products like CDOs and permeated the entire financial system.
By the time it became apparent that anything linked to sub-prime debt might be worthless, the sub-prime bug was impossible to contain: investors didn't want to buy anything that might be linked to sub-prime debt and those products became effectively worthless. Banks holding those products on their balance sheets were therefore forced to make huge writedowns.
Last updated on 26 September 2008.
