What is sub-prime and what does it mean for me?

balancing the books

The sub-prime crisis that has been hanging ominously over the world economy for a number of months now is showing no signs of abating. We all know it is bad, but what is it really? What has caused it? And what does it mean for you? Read on to find out more.

The origins of the current sub-prime crisis, or so called global credit crunch, go back around four years when the United States economy was booming. This healthy economy and the historically low interest rates of the time prompted banks there to offer mortgages to people who had previously been refused. These are known as sub-prime mortgages.

In 2005, interest rates began to rise and the rise in the cost of repayments forced many borrowers to default on their mortgages. As rates continued to rise more people defaulted and US banks realised that they had a serious situation on their hands.

So, how can this affect us here in Britain? First, banks' debts are packaged and traded on the global market, so damage caused by money lost on US sub-prime loans is being borne worldwide. Second, because banks' debts are packaged and traded, nobody really knows where the sub-prime debts lie, or their extent. This has led to mass uncertainty among the financial institutions. Everybody knows that huge losses have been incurred, but no one knows for sure how much or who will be affected.

For this reason banks have tightened their belts and are unwilling to lend money to each other, and this means that there are less funds available to provide credit to businesses and consumers. The results? Economic uncertainty, the Northern Rock crisis, high credit costs, and more.

That is the background, and if you haven't felt the fallout from the sub-prime crisis already it probably won't be long before you do. So, what are the affects likely to be for the man on the street?

Tougher to get loans

As mentioned, lenders to not have access to huge amounts of funds for loans, and they are wary of people defaulting on loans. The upshot is that loans are now much harder to get than they were a year ago. If you are looking for any kind of substantial loan or a mortgage this year you will need to have a good credit rating and a stable income.

Costly credit

The simple rules of supply and demand dictate that the cost of loans will go up, indeed they already have. With less funds available to banks, the cost of credit is going up. So as well as being harder to get, loans are now more expensive than they were before. Mortgage seekers are also finding that LTV (loan to value) rates are decreasing.

Safe and secured

We think 2008 will be the year of the secured loan. The lenders don't want to take risks at the moment so you have a much better chance of getting a loan if you are willing to secure it against your home. However, if you go down this road be sure you can keep up with repayments on your secured loan or you could lose your home altogether.

House prices

One of the tell-tale signs of economic uncertainty is a dip or a slowdown in house prices. In Britain, this is already under way. While it is impossible to predict the extent of the slowdown at this stage, there is little doubt that it is linked to the sub-prime crisis.

Stock market uncertainty

If you have investments in stocks in Britain or abroad you will be well aware that the global markets are shaky at best. The last two weeks have been worrying for stock market investors with many now looking for safer places to put their money.

Bad for debt

This is not the time to get into financial difficulty. If you get into trouble with debt in the current economic climate, you will find it very difficult to get a debt to consolidate loans and banks might not be as sympathetic as they could be. If you fall seriously into the red you could be looking at a debt management plan, an IVA, or even bankruptcy.

Although these are tough times for consumers, some analysts are saying that it could be a lot worse and the end of the current crisis may be in sight. For the time being, our advice is to be prudent with your finances. Keep your credit rating clean, do not overspend and try to concentrate on clearing existing debts.

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