Benefits of Subprime Lending - Paper Example

Abstraction

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The subprime loans are given to borrowers who usually expect low credit rating and those who can highly default in paying in payment. This is done to take care of everyone within a country without discrimination. The main aim of this study basically was to show the impacts of the subprime borrowing on the minority community in the US. The study utilizes hypothesis testing so as to determine whether there is enough statistical evidences to prove whether the minority community who use subprime borrowing system benefit from the loans despite the higher risks involved. This paper is a review research paper that looks at the data of a population within a period of time lasting from 2006 to 2009. Questionnaires and previous research papers help in the process of data collection since information about lenders and borrowers of this loan are kept in US banking data base. The research instruments used in this research are the question guides and interviews. These are tailored to target both lender and borrower.

Basically, the people who are not whites makes part of the US population and form part of most important Citizens of the US. Most of these people live middle or poor lives. The government has therefore provided means by which these people can be well absorbed and taken care of financially. The major challenge is with receiving loans that can elevate their states of lives. This is especially because of the high interest rates charged on the loans offered by these banks. The subprime lending system of the loans was brought so as to care for the people who are part of the US population and cannot afford the current loan rates. The subprime lending system is seen by many analysts as a biased process and should be scrapped off.

However, this hot debate still remains without reliable solutions as both the criticizers and proposers believe that they are both right in their arguments. The question remains: if the banks and other financial institutions are exploiting subprime loan borrowers, then why are they still existing and still manage to make huge profits? This was once considered to be one of the greatest money inventions at the time of its conception three decades ago. It managed to include the oppressed, low income earners and the low credit rated individuals in the financial market. They were allowed to borrow subprime loans which had different borrowing terms and conditions as opposed to prime loan borrowing.

Most individuals have confirmed their satisfaction and directed their gratitude to the subprime lenders for improving their standards of living.

Chapter One:

Introduction

Subprime lending has been on the increase with the rising diversification of financial services aimed at catering all groups in the society. Near-prime or second-chance lending has been used to give second chances to loan defaulters and other people with low financial credit score to better their lives. Setbacks in paying loans, conditions like divorces, natural disasters, and medical emergencies among other challenges make loaned defaulters making the industry vulnerable hence the need of subprime lending. High unemployment cases among the minorities calls for specialized treatment to uplift their lives. Badger (2013) argued that subprime lending during the housing boom was ignoring the minority communities thus creating a divide in sharing of wealth. The high-income African-American individuals and households were the perfect targets of the housing booms as they could afford to pay the loans and take more. The minorities and especially the blacks were ignored by major banks to their disadvantage. There was a void for those pedaling subprime lending services to the blacks and this created much riskier lot to loan. Badger (2013) observed that the loans were tremendously profitable for the financial providers especially when the homeowners did not foreclose due to the high fees and interest rates charged (Peterson-Withorn, 2015).

It has been envisioned that giving a black family a subprime loan while it qualifies for a prime loan amounts to high profits since the family would repay the loan fully and the bank would benefit from the interests and repayments. The housing crash was defaced with lots of injustice where several discriminating lawsuits were filed to challenge the mistreatment to the blacks (Karikari, Voicu, & Fang, 2011). During 2006 and the years following the crash, Black and Hispanic households earning above $200,000 annually were more likely to obtain subprime loans as compared to white families earning less than $30,000 annually. This indicates the level of discrimination that was and continues in the financial lending and high rates of discrimination. Badger (2013) continued to argue that banks that were previously ignoring minority communities, rushed to give them loans to reap big indicating their core interest-making profits from the minorities and the disadvantaged (Eriksen, Kau and Kenan, 2013). A closer look at the 2006 Home Mortgage Disclosure Act indicated that out of the 3,819,923 loan applications that were made, over 2 million were given at prime rates while 5.4% (200,000) were given at subprime rates, mostly to the minorities. The data further argued that Blacks and the Latinos were 2.8 and 2 times more likely to be denied loans by the mainstream financing facilities and institutions. The subprime disparity grows wider with growing income as minorities are viewed as targets for high rates as compared to their white sup remises. It is foreseen that families with difficulties tend to struggle more to pay their monthly loans despite their challenges.

Problem Statement

The recent rise in subprime lending and the high foreclosure rates in the last four decades could be expounded by a mix of profit-alienated lenders, well-informed borrowers, tax regulators, greedy investors as well as fraudulent appraisers among other financial stakeholders. Financial institutions have re-engineered subprime lending in a bid to drive economic growth in the United States. Increasing subprime lending is an indication of financial challenges associated with low wages as well as high income volatility (Taub, 2016). The increasing option by the minority groups to have subprime loans should be researched and ascertained whether the loan facilities have alleviated poverty among beneficiaries through facilitating home ownership.

Background

Taub (2016) also indicated that the US economy could be influenced by higher wages as well as increased federal spending on basic amenities. Provision of basic amenities directly affects the minority groups translating to higher economic freedom, better credit scores and decreased subprime loans. Adam (2007) observed that the total non-housing debt increased from $2.71 trillion in 2008 to $3.17 trillion at the close of financial year 2015. Most of the debts are asset-backed securities and a sizeable portion is owned by the minorities. Hwang, Hankinson, and Brown (2015) indicated that there were high levels of black-white segregation increased rates of subprime lending and foreclosures in major US metropolitan areas. There was a high concentration of subprime loans among the minority neighborhoods in 100 largest US cities as the study indicated.

Subprime lending, also termed as second class, or chance lending, non-prime or near prime lending, is the process of lending borrowers with low credit ratios (Smith & Hevener, 2014). It also involves risking loans to people experiencing difficulties in maintaining or keeping up to date with the scheduled repayments as a result of setbacks like divorce, unemployment, health and medical emergencies, among other things. Traditionally, qualified borrowers were those with FICO scores of over 750. The changing economic circumstances have elicited further reviews on the credit scores and rating to match the changing times. Gerardi (2009) indicates that the changes and considerations of lower FICO scores resulted from aspects like Great Recession and other major economic storms over the four decades. Many lenders have different FICO levels as minimum for borrowing thus a lender could consider FICO score of 650 suitable while another would consider 700 as the minim. The FICO levels may change based on the prevailing market conditions.

Subprime loans are offered to individuals who have not qualified for prime rates. This could be due to poor credit history or low credit or FICO scores of about 640 and below. They are often charged high interest fees and rates of interest than those who have qualified for prime rates (Smith & Hevener, 2014). According to Adams (2007), subprime loans are characterized by higher interest rates, poor collateral quality and unfavorable terms and conditions so as to compensate for the high risk of credits. Initially, subprime loans were packed as Mortgage Backed Securities (MBS). The MBS acted as loan collateral which was to be taken by the financial institution in case the borrower was unable to repay the loan.

Proponents of subprime lending practice have, however, maintained that the practice of lending involves extending credit to individuals or people who...