As a reaction to problems in the subprime area, lenders tightened lending standa

Question

As a reaction to problems in the subprime area, lenders tightened lending standards. What effect do you think this had on the housing market?
• What is an adjustable rate mortgage (ARM)? Do you think this type of mortgage is more attractive to new homebuyers than traditional mortgages? Explain with reasons.
• Which of the following factors was most influential in the crisis: low interest rate environment, loose underwriting standards, or innovations in mortgage financing? Select one and explain why.

Explanation / Answer

1.As a reaction to problems in the subprime area, lenders tightened lending standards. What effect do you think this had on the housing market?

Yes, It may dissuade potentially eligible borrowers from applying- and gradually they will serve to restrain housing demand, although the real magnitude and dimension of these effects is difficult to quantify. Purchase homes appear to have peaked in late 2005 where there is a good boom in real esate and declined substantially since then, and by more ( considering even in absolute terms) than prime mortgage originations. Thus, some part of the effect on housing demand (on borrowing) of the retrenchment in the subprime area has likely already been felt.

2.What is an adjustable rate mortgage (ARM)? Do you think this type of mortgage is more attractive to new homebuyers than traditional mortgages? Explain with reasons.

Interest rate of ARM varies over time.Initially the interest rate will be below market rate and then gradually it will keep on rising if the ARM Is held for long time.ARM has fixed time duration to keep the interest constant. This type of mortages is more attractive because of non floating interst for a constant years. This will help them to pay constant interest rate for fixed years. In normal mortage interest rate is floating and this will become more burden to the buyers while comparing to ARM.

3. Which of the following factors was most influential in the crisis: low interest rate environment, loose underwriting standards, or innovations in mortgage financing? Select one and explain why.

Loosened Under writing standards : Proper under writing standards helps to analyse the loan repayable capacity and credit trustworthiness of the person who has applied loan. Thus during crisis time it was evident that in order to increase teir loan sales and popularity bank used to give loans to the borrowers without proper documentation and under writing formalities. Many part time workers used to get loans with least formalities and they gradually couldnt able to repay the loans as many would have lose their jobs in crisis. Thus under writing has to be tightend enough to control the fraudulence in loan and to have a proper grip on the given loan by the bank.

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