Many of you may be scratching your heads when you hear the term subprime loan. What exactly is a subprime loan? It is a loan that is given out to people who have poor credit and need the bank to take a chance on them. As stated in an article by Joseph Gilbert (2011), subprime loans are given to people who cannot get a prime rate for a loan. A prime rate is a lower interest rate. Some people have little or bad credit, which makes it tougher to get approved for loans. Subprime loans’ higher interest rates serve as a buffer for the increased risk that the lenders are taking on from the borrower. Mortgages are one kind of subprime loan. Unfortunately, what seemed like a good idea has burned Americans and lenders several times. In 2007, about 1.5 million Americans sadly watched their homes go into foreclosure. People with subprime loans experienced over half of all foreclosures (Gilbert, 2011).
While many people and stock brokers may be quick to blame the borrowers for not paying their bills, the real reasons are more complicated and seemingly unethical. 10 years ago, approximately 66% of subprime loans were classified as an Adjustable Rate Mortgage (ARM). While these rates can seem great in the beginning of the loan due to an initial lower rate, many subprime loans jump to higher rates per month (Gilbert, 2011). In essence, what may have begun as a great deal of $650 per month for a mortgage payment is now $825 a year later. The ARM combined with job loss, no raises, and inflation created a financial nightmare for many mortgage owners, who could no longer afford to keep their homes. Hence, a mortgage crisis occurred.
There are several reasons that the mortgage crisis occurred and why borrowers defaulted on their loans. One problem could have been that borrowers lied on their applications, i.e. income, bills, outstanding debt (Gilbert, 2011). However, it seems to me that the real problems are due to borrowers not understanding the ARM and what they are getting themselves into financially. I have known people who have taken out ARM subprime loans without understanding that their monthly loan rate could increase per month. One couple that I know was forced to file bankruptcy when their monthly loan payment increased by $400. I have also known lenders who have been right on the line of lying by downplaying how much subprime loans could rise per month. This not ethical leadership or decision making. There is a major difference between a $50 increase versus a $350 increase. Many Americans live check to check and need to know the reality of the situation up front before they find themselves in a financial pit in which they cannot escape.
Gilbert, J. (2011). Moral duties in business and their societal impacts: the case of the subprime lending mess. Business and Society Review 116 (1), 87-107.