The rise in interest rates on these loans resulted in a credit crunch, which is likely to continue. This credit crunch will hit middle-class homeowners who took out risky loans with adjustable-rate mortgages during the recent housing boom. Increases in rates of interest have hit borrowers hard, and they are finding it difficult to continue to make their mortgage payments.
This issue affects not only those with low incomes and poor credit but also all those with subprime loans. Adjustable-rate mortgages reset at higher rates also affect those with good credit who could qualify for prime loans.
The downturn of the housing market will result in less consumer spending, which, in turn, will have a domino effect on the economy. Resets of adjustable-rate mortgages will continue to occur for the next three to four years, resulting in large numbers of defaults and foreclosures on mortgages.
The easy availability of loans was one of the factors fueling the housing boom during the last decade. This led to a huge supply of homes that exceeded demand, and inventories of unsold homes eventually rose. The resetting of interest rates also affects housing demand; housing sales fell in the last quarter.
Furthermore, this recent turn of events will shake out some of the subprime lenders, and the marketplace will change. Only a few larger subprime lenders will survive.
The subprime-loan meltdown has begun. What major effects can be expected?
Housing prices will fall. Demand for housing will also fall. Mortgage underwriting standards will be tightened, and as a result, fewer people will qualify for loans. Foreclosures, unsold inventory, and defaults will increase the supply of homes. Prices will fall further, depressing the housing market in a vicious downward spiral.
During the boom, due to equity increases, homeowners felt less need to save, and expenses rose. With the collapse of the subprime lending market, consumer spending will decrease.
So when will things brighten up for the housing sector?
The housing sector will be revitalized once the mortgage meltdown has been arrested.
The growing number of foreclosures will offer excellent investment opportunities. Wealthier buyers will purchase properties, hold onto them for a short time, and then sell. Alternatively, buyers may rent out their properties for short periods of time before selling them or rent them out indefinitely. Institutions and other powerful players in the housing sector stand to benefit in a depressed market.
