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Credit Crunch Definition We've all heard about the credit crunch, but do you really understand the credit crunch definition? Simply put, a credit crunch is when banks pull back from extending lines of credit and become stricter on qualifications for the few loans they do hand out. In a serious credit crunch it can be nearly impossible to secure a loan without a sizable bank account, full proof income, and a perfect credit rating. In our current credit crunch lenders are reducing the subprime loans they extend, but it is still likely that many people can find a loan if they have a decent credit rating and can prove their ability to pay with a secure employment history or a large down payment. So what exactly are subprime loans? Subprime Lending Definition A subprime loan is one extended to a person who does not qualify for prime (lower) interest rates. The interest rate on a subprime loan can be rather high, depending on the circumstances of the borrower. Most subprime loans are made to people with bad credit scores, a lot of flaws on their credit reporting, or who cannot prove adequate income to make the loan payments long term. For one reason or another, a subprime candidate is seen as risky to the lender and therefore must pay more interest for the lender to extend a line of credit. Subprime lending is nothing new. It first became popular back in the 1990s when it was seen as a way for borrowers to improve their credit. After making timely payments for awhile on a subprime loan they could then refinance into a prime rate. Unfortunately, lenders began extending these loans rather loosely, especially for home loans, and the end result was a high percentage of the loans going into default. This is largely what has resulted in millions of homes going into foreclosure today. So what would encourage banks to be so free with their money? Take a look at the next credit crunch definition. Mortgage Backed Securities Definition Have you heard of this one in news reports lately? Probably so, considering it is what made banks feel so secure extending credit lines totaling trillions of dollars to people who could not afford to pay them back long term. Here is what it means. Banks take a group of loans that they have extended to various people and sell them as one package to an investor. This creates free money that the bank can use before the loans are actually paid off, and the investor has all of the property attached to those loans as collateral. This did work while the housing market was booming in the late 1990s and prices were rising, but the banks saw dollar signs and started extending credit to large numbers of risky borrowers. They would collect the fees from originating the loans, then bundle them up and sell them off to investors. The problem came when a large percentage of those subprime loans turned bad and the loans were worth far more than the property held as collateral. You can see here how all of these credit crunch definitions connect together to deliver the global crunch that is in effect right now. Banks around the world are trying to stay afloat and undo the damage that years of loose subprime lending created. |
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