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January 15, 2008

What are sub-prime loans?

We're hearing the term sub-prime loans used in connection with the turmoil in the housing and credit markets? Is there a precise definition of such loans, and just when did they become a major part of the mortgage market? Listen

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Well, this is one of those terms that is thrown around a lot. We hear it in the media all the time, but people may not know exactly what is meant. And unfortunately we don't have a formal definition of sub-prime loans. But in the lending industry it typically refers to a borrower that has very low credit score number one - who also may have become delinquent on some form of debt repayment in the past year or two, and who may actually have filed for bankruptcy.

"So traditionally these folks were not good credit risks, and they were actually shut out of the mortgage market. And they couldn't obtain a traditional home loan, and, therefore, most of them couldn't buy homes.

"But there were changes, first of all in regulations, then in credit instruments, and then with the expansion of credit availability such that the sub-prime mortgage market began to expand first in the mid 1990s and then even more so this decade. And importantly it has expanded to include borrowers who are making, for example, no down payments and who are providing little financial documentation.

"So this was all good at the time in the sense that this allowed more people, people who were considered very poor credit risks traditionally, to get into the home market and buy a home. But now as credit standards have tightened - interest rates have gone up - obviously many of those folks are finding that they are in financial trouble."

Posted by Dave at January 15, 2008 08:00 AM