Never have I received more e-mails or telephone calls about what has been going on in the sub-prime mortgage market in the United States than in the past month or so. Let me try to put things in simple English.
First, what is sub-prime mortgage lending? Simply, it is the lending to borrowers who do not qualify for loans from traditional mortgage lenders, typically banks. In the US, the use of consumer credit bureaus is quite advanced and transparent.
The use of consumer credit data determines the amount of loans available to a borrower and the risk-adjusted level of interest rate. The most commonly used credit scoring system is called Fico (Fair Isaac Corp).
A Fico score is a number typically between 300 and 850 which is based on a statistical analysis of a person's credit files. This represents a person's creditworthiness - the likelihood that a person will pay his or her bills. Using Fico, a borrower with a score below 620 would be considered higher risk.
The US sub-prime mortgage market is not a new phenomenon. Since the mid-1990s, sub-prime lending has increased in popularity and its growth represents a natural evolution of credit markets.
This evolutionary process was encouraged by various government actions, in particular, incentives to make loans to low and moderate-income borrowers or areas.
While I do not believe that the sub-prime mortgage market will mirror the US savings and loans crisis in the late 1980s, the knock-on impact on the overall US economy cannot be understated. The housing market has been one of the primary drivers of consumer spending in the past decade. Any property market slowdown (prices or new home starts) will inevitably have an adverse impact.