Take a deep breath. The market recovered from terrorist attacks, the falls of Enron, WorldCom and Arthur Andersen, soaring oil prices and one very expensive war. Can this sub-prime crisis really hold the market back? To answer this query, the cause must be examined.
Sub-prime loans are generally offered by lenders to customers with either no credit or a poor credit history. In most cases, these loans include adjustable interest rates. During the initial years of the loan, the interest rate will be low (as compared to fixed rate loans for the same customer) and fixed, effectively lulling the payer into a false sense of security. After this initial period, the rates generally revert to the prime rate plus a specified margin. The prime rate varies directly with the Federal Funds Rate set by the Federal Reserve. For example, for the first two years, the lender may offer the loan for 8.9 percent, and then the rate for the remaining years becomes the prime rate plus 6.5 percent. If the prime rate is 5.5 percent for year three of the loan, the payer is stung with a twelve percent interest rate. (more…)