Making Sense of the Sub-Prime Housing Market

It was another rollercoaster week for the stock market, and many analysts are blaming the continuing turbulence on the sub-prime mortgage market.

Sub-prime lenders have been in the headlines a lot this week, but it can be difficult to understand exactly who they are, and why they have caused such fallout on Wall Street.

Who Are Sub-Prime Lenders?

Sub-prime lenders are companies that provide loans to home buyers who either don't have good credit histories or, because of their income, are considered riskier candidates for loans.

These are home buyers who, in the past, might not have been able to get a mortgage loan. But as part of the housing boom over the last several years, the requirements for borrowers lessened, and more and more houses were sold to sub-prime buyers.

Buyers in the sub-prime mortgage market were often enticed by Adjustable Rate Mortgages that offered lower monthly payments to start. Some of these mortgages are known as 2/28's, where the first two years have a low monthly payment, and then the payments adjust for the remainder of the loan.

After the period of low monthly payments expires, monthly payments can spike much higher even than what a prime homebuyer would be paying -- to make up for the poor credit history of the sub-prime buyer.

Often, the sub-prime home buyer would try to refinance their mortgage to continue their low monthly payment, and would continue to try to refinance each time the lower rate expired. As a result of refinancing, many homeowners got trapped in their loans.

Because the value of houses in some areas of the country has been decreasing, sub-prime borrowers are having a tougher time keeping their low payments. When the value of their home is less than what they purchased it for, the loan becomes worth more than the house. The borrower now has a monthly payment that they simply cannot afford. As a result, many sub-prime borrowers are going into foreclosure.

Number Of Foreclosures Going Up

Foreclosure is a last resort for mortgage companies and the banks that finance them. Prior to foreclosure, many of these mortgage loans are going into delinquency, meaning the borrower can't pay their loan payment for a given month, or they can only pay a portion of it.

According to the Mortgage Banker's Association National Delinquency Survey, released on Tuesday, 13.3 percent of sub-prime mortgage loans, and 4.95 percent of mortgage loans overall, were delinquent in the last quarter of 2006.

The survey also showed that 4.53 percent of sub-prime loans were in foreclosure from October to December 2006. That's compared to 3.33 percent during the fourth quarter a year ago. 2006 had a record number of foreclosures for a three-month period.

Moody's estimates those percentages equal 400,000 foreclosures for 2006. But the numbers aren't expected to get better. That number is expected to double to 800,000 foreclosures for 2007.

What Does This Mean For The Housing Market?

The troubles plaguing sub-prime mortgage lenders and buyers could trickle into the broader economy. Delinquency and foreclosures are bad news for the housing market, which will have to absorb 800,000 more houses to sell. That's on top of an estimate by the U.S. Department of Commerce that there are a record four million homes currently sitting on the market unsold.

This means it's probably going to take longer to sell a house, especially in certain parts of the country. Many analysts think this added glut of unsold homes will push home prices down further.

Of course, a home price going down is good news if you're looking to buy. Houses had gotten very expensive during the housing boom.

What Does This Mean For The Stock Market?

The problems in the housing sector could create more volatility in the market, as there's a chance that more lenders are going to get into trouble. There's a growing fear that what's going on in the sub-prime market will affect other lenders.

The lenders who are concerned could tighten up their standards on who they give mortgage loans to. Someone who would have been a candidate for a prime loan may now have to look in the sub-prime market. That could create problems for the economy, much of which relies on credit.

More and more, economists are worried that problems in the sub-prime market could be spiraling into the economy overall, and consumers could cut back on their spending. But others believe that this will be a rocky period through 2008, after which the housing market will stabilize.