Subprime Mortgage

What Is Subprime Mortgage?

A subprime mortgage is a home loan extended to a borrower with a weaker credit history, lower income documentation, or a higher likelihood of default than a prime borrower. To compensate for that added risk, subprime loans often carried higher interest rates or adjustable terms that reset upward over time. During the U.S. housing boom of the mid-2000s, relaxed lending standards and low interest rates fueled a surge in subprime lending, and many of these loans were bundled together and sold to investors. When home prices stopped rising and borrowers began to default, the subprime market collapsed, and the 2008 financial crisis is most closely associated with that collapse.

Why It Matters

Subprime mortgages matter because they were the fault line along which the 2008 crisis spread. Lenders like Countrywide Financial wrote enormous volumes of these loans; when defaults mounted, losses rippled through the securities built on top of them and into banks and insurers worldwide. Investors who had bet against subprime, profiled in Michael Lewis's The Big Short, profited enormously as the market fell. The episode prompted the 2010 Dodd-Frank Act and the creation of the Consumer Financial Protection Bureau to tighten lending standards and disclosure. The term endures as shorthand for how risky lending, once packaged and spread through the system, can threaten the entire economy.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• The 2008 financial crisis is most closely associated with the collapse of which type of home loan market?
  Subprime mortgages
• What securitized financial products, backed by pools of home loans, were central to spreading subprime mortgage risk through the financial system?
  Mortgage-backed securities (and collateralized debt obligations)
• What major subprime mortgage lender was acquired by Bank of America in 2008 as its losses mounted?
  Countrywide Financial