The US subprime crisis has brought subprime loans under the scanner. What exactly is a subprime loan? How different is it from a normal loan? Subprime loans are granted to borrowers with bad credit history, who do not qualify for the best market interest rates. This is a very risky form of lending because of the adverse fi nancial situation of the applicants, their bad credit history, and the high interest rates of the loans. As of March 2008, the value of US subprime mortgages was estimated at $1.3 trillion. But what led to the subprime crisis, and what was its effect on other fi nancial institutions?

One of the main reasons for the crisis was the inability of the subprime homeowners to pay back their loans as interest rates rose – and monthly mortgage payments along with them. Those who were unable to pay back their mortgage had their homes repossessed. Until 2007, housing prices were high and many borrowers could only afford homes of lower re-sale value. The increase in the number of repossessions had an overwhelming effect on the housing market, leading to a decline in housing prices. In turn, as a ripple effect, the crash in the real estate market has affected the economy. Smaller builders went out of business. Larger ones suffered huge losses. This, in turn, affected other industries, such as durable goods manufacturing. The banks have not been spared by this crisis.A credit crunch amongst banks developed as they hesitated to lend to one another, for fear of subprime exposure. This has led them to reject more credit card and personal loan applicants. The bond market also suffered with bond holders incurring huge losses. The losses suffered by fi nancial institutions are valued between $220 billion and $450 billion. On the whole, the spreading of risk in this case remains an effective force for stability.