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Credit Crunch in the UK - Case Study Example

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This paper "Credit Crunch in the UK" discusses mortgages that are difficult to get, demand for houses has slumped. Therefore, house prices have fallen. Lower house prices mean many face negative equity. Therefore, mortgage defaults now cost banks even more…
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Credit Crunch in the UK
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Download file to see previous pages To sell more profitable subprime mortgages, mortgage companies bundled the debt into consolidation packages and sold the debt on to other finance companies. In other words, mortgage companies borrowed to be able to lend mortgages. For example, the lending was not financed out of saving accounts (Mortgage Guide).

These mortgage debts were bought by financial intermediaries. The idea was to spread the risk, but, actually, it just spread the problem. Usually, subprime mortgages would have a high-risk assessment rating. But, when the mortgage bundles got passed onto other lenders, rating agencies gave these risky subprime mortgages a low risk rating. Therefore, the financial system denied the extent of risk in their balance sheets (Mortgage Guide).

Many of these mortgages charged a balloon interest rate in which, they charge low-interest rates in the initial period, but at the end of the introductory period interest rates rise rapidly (Mortgage Guide).

In 2007, the US had to increase interest rates because of inflation (BBC). This made mortgage payments more expensive. Furthermore, many homeowners who had taken out mortgages two years earlier now faced ballooning mortgage payments as their introductory period ended. Homeowners also faced lower disposable income because of rising health care costs, rising petrol prices and rising food prices.

This caused a rise in mortgage defaults, as many new homeowners could not afford mortgage payments. These defaults also signaled the end of the US housing boom. US house prices started to fall and this caused more mortgage problems. For example, people with 100% mortgages now faced negative equity (Mortgage Guide). It also meant that the loans were no longer secured. If people did default, the bank couldn’t guarantee to recoup the initial loan.

The number of defaults caused many medium-sized US mortgage companies to go bankrupt. However, the losses weren’t confined to mortgage lenders, many banks also lost billions of pounds in the bad mortgage debt they had bought off US mortgage companies.  ...Download file to see next pagesRead More
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