The idea was to refinance before the rate reset, but many homeowners never got the chance before the crisis began and credit became unavailable. After two years, the interest rate “reset” to a higher rate, which often made the monthly payments unaffordable. It gave borrowers a below-market “teaser” rate for the first two years. The most notorious of these loans was the 2/28 subprime adjustable-rate mortgage (ARM). Soon, there was a flood of risky types of mortgages designed to get people into homes who couldn’t typically afford to buy them. Lenders began turning a blind eye to income verification. Down payment requirements gradually dwindled to nothing. Subprime mortgages, or mortgages to people with low credit scores, exploded in the run-up to the crisis. Mortgage lenders, which make money by charging origination fees and thus had an incentive to write as many mortgages as possible, responded to the glut by trying to put buyers into those homes.īut mortgage lenders ran out of qualified buyers-who, in most cases, make a 20 percent down payment and have a high enough income to cover the monthly mortgage payments, with an interest rate determined by the borrower’s credit score-and still had a ton of homes to fill, so they started cutting corners. The result was an oversupply of single-family houses for sale. These companies built homes so quickly they outpaced demand. Historically, the home-building industry was fragmented, made up of small building companies producing homes in volumes that matched local demand.īut in the 1990s, the industry started to consolidate, and by 2005, one in three homes was built by a large public home-building company. That burst had no single cause, but it’s easiest to start with the homes themselves. But in the mid-2000s, lending standards eroded, the housing market became a huge bubble, and the subsequent burst in 2008 impacted any financial institution that bought or issued mortgage-backed securities. This “mortgage securitization chain” keeps money flowing into the mortgage market, making credit available to anyone who wants to purchase their piece of the American dream. A homeowner’s monthly mortgage payment then goes to the bondholder. They sell these bonds to investors-hedge funds, pension funds, insurance companies, banks, or simply wealthy individuals-and use the proceeds from selling bonds to buy more mortgages. Then, they use the proceeds from the sale to originate another mortgage.įannie, Freddie, Ginnie, and investment banks buy thousands of mortgages and bundle them together to form bonds called mortgage-backed securities (MBSs). ![]() After the savings-and-loan crisis of the late 1980s, the originate-and-hold model turned into the originate-and-distribute model, where lenders issue a mortgage and sell it to a bank or to the government-sponsored enterprises Fannie Mae, Freddie Mac, and Ginnie Mae. ![]() ![]() When lenders and banks extend a mortgage to a homeowner, they usually don’t make money by holding that mortgage over time and collecting interest on the loan. How did this happen? Start with shady mortgages
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