Last year we saw the fall of the Mortgage business and with it we slid to the brink of recession. What caused this movement to the brink of recession? It is not just the subprime mortgage loans handed out. I believe it is more than that. Lets look into some major the reasons:
1. Subprime mortgage loans (most widely known reason)
I understand that all lenders want to get more customers. More the customers, more the business and hence more the profits. However, what happened here was that due to the rising Real Estate value, many banks and lenders started to lend money out to all people who wanted to purchase home. Banks adjusted for people's low income and bad credit with changes in the loan package. End result, many people with bad credit had received loans for huge amount. As business see profits rising, the costs will rise too. Its how economy works. Demand pushes the price. Here, in the lending business, price is the interest. As more people stated to take loans, Fed and bank interest rates started to rise.
Many subprime loans were not on Fixed interest. Result, the rise in interest rates, started to push their payments high, so high that many could no longer afford to pay the monthly payments. In some cases, it went higher that the individual's monthly income.
The moment people started to default in payments, banks started foreclose procedures. They had the number of active customers as a fuel to foreclose initial defaults (early 2007). Little did they realize that more people will follow suit and default in payments.
I was surprised why banks did not negotiate a lower fixed rate interest with those who were in danger of foreclosure. Only recently did they start active negotiations.
If banks and lenders had not given so many subprime loans, we may have been far away from recession than we are today.
2. Faulty American Credit System (lesser known culprit)
The American Credit System is to be partially blamed for this mess. I guess not just partially but to an equal level as the subprime Loans. Let me explain why I believe in blaming the Credit System.
American Credit System largely depends on the Credit Score of individuals to determine if an individual can be given credit/loans or not. This is very much acceptable. But the bad part of this is that if an individual has low credit score, his interest rate is high.
Be realistic, if a person has bad credit, it means he may or may not be able to replay the loan. If you give him a large loan at a high rate of interest, he mostly will not be in the mind to stick to the huge monthly payments.
I believe, instead of helping the individual move out of the bad credit, this credit system is pushing more people into bad credit.
If you look at many other countries (like India with a huge population), why is it that a higher percentage of people are not defaulting in payments, as compared to US. The reason is simple - the credit system. In those countries, they give loans at a single rate to all, irrespective of what their credit history is (they do not have credit score system). What changes based on the credit history is the amount of loan they will provide (also takes into consideration the current debt which also includes the credit card limits). So, if a person bad credit history, he may not get the amount of loan he is looking for even though he may have very good and capable income. This will force him to limit his present dream and be realistic on selecting what he can afford. He will be able to payback in time.
Be realistic, if a normal person has a credit card, and he uses more than 80% of his credit amount, due to which the card company raises his interest rate, he may not be able to fully pay the new monthly installment. That can then result in late payments and then in no payments. But he can get new credit card with a good credit limit if he has not defaulted in any payment, irrespective of how many credit cards he has with high credit limits.
The same is the case with mortgages. For subprime mortgages, banks gave the loan at a very high rate to the individuals, due to their credit score. And then, the interest rates started to climb and most people did not have enough leg room to adjust comfortably to the increase in the rate. To begin with, most had taken the loan at the maximum rate they could afford. They gave huge loans at high interest rate and then increased the rates only to see many could not afford to payback.
Now, the more low your credit score is, the more you will not be able to pay back debts due to the high interest rates which will climb more if you don't pay on time. This way, you will suddenly find you are not able to pay back money in time, even though you want to, because credit card companies and home interest rates are climbing every month.
In countries like India, if you default in paying one card, you will not get another card till you clear the first one off in good time, but the amount of debt will increase only marginally (at the original interest rate). This give him a good chance to pay back the debt faster.
It is time the Government and people stand up to change the credit system of America. Put a halt to the interest rate based on Credit Score. Force banks and lenders to change only the Loan amount based on the credit score and current debts. This way, America will soon see that many people are able to pay back their loans.
At the least, to move the country very far away from recession, government should ensure that credit card companies do not increase rates, but decrease them to a reasonable extent, thus helping many clear debts faster.
Right now, many are paying back credit card debts and have less to spend on regular food & clothing, due to the increasing credit card and loan interest rates.
Remember, faster the debts are cleared, more money people will spend on new goods. More the money people spends on goods, further the economy will be from recession. I wish the government would understand this and do this, instead of giving small tax amount for spending. It will have a better effect as nearly all families in America, have multiple credit cards.
No comments:
Post a Comment