Today million are still jobless with an unemployment rate at 9.7%, credit is tight, and businesses are slowly building back up. The sub-prime financial crisis of 2007 and 2008 financially destroyed the lives of many, but how could this have happened?
So what is a sub-prime mortgage anyways? According to investopedia.com, a sub-prime mortgage is, “a type of loan granted to individuals with poor credit histories (often below 600), who, as a result of their deficient credit rating, would not be able to qualify for conventional mortgages. Because sub-prime borrowers present a higher risk for lenders, sub-prime mortgages charge interest rates above the prime lending rate.”
Our credit rating is called our FICO score, which is simply a
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Unfortunately, the bank does not have all the information on every borrower needed to choose who is the least risk. With the assumption that many are seeking a loan for assistance in tough times are most probable to be ones who are to be considered a high-risk borrower the banks are now provoked to be more conservative and become more restrictive on the loans they allow, regardless if a few of the borrowers could be low-risk. For instance, I am approached by two different people, one is known to go to work everyday, pay their bills on time, and is very responsible with their money, the other is the exact opposite, cannot hold a job, is always broke, and basically owes everyone. Now the first person tells me that they need to use the money because they want to take a well-deserved vacation and the other just was offered a new job, but needs to purchase a vehicle. The first person, although most deserving of a vacation, is requesting a loan for personal pleasure; the other has a very justified reason, yet cannot be trusted due to previous recorded. As the lender, I choose not to loan my money to either person, due to the uncertainty of use and ability to pay back my money.
Moral hazard, on the other hand, is the effect of after-the-fact possibilities, meaning if the loan can be justified and the risk is low the loan would make sense to give, but the chance or moral hazard that the borrower may take the money and use it for a purpose other