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Subprime mortgage loans contributed significantly to the 2008 financial crisis and a long recession. The significant and growing number of mortgage failures/foreclosures in 2007, which economists believe was the beginning of the long recession, were mostly on subprime mortgages. In 2007, less than 20% of all outstanding mortgage loans in the US were subprime loans, but more than half of the foreclosure initiations were on subprime loans.

A subprime mortgage loan is a mortgage loan for persons who present more risk because they have a less than desired credit score (there is more risk that the loan would not be repaid). In the U.S., the number of subprime mortgage loans by banks, mortgage brokers, and other financial institutions increased from $35 billion in 1994 to more than $600 million in 2005. The majority of the $600 million + of subprime mortgage loans (84%) were for the refinancing of existing mortgages and for second mortgages. Many consumers used high home values to obtain additional loans (effectively borrowing against the increased value of their homes).

In 2006, more than two-thirds of the subprime mortgage loans were adjustable rate mortgages (ARMs), which means that the interest rate of the mortgages would adjust or change over time. Some were balloon mortgages and other types of mortgages. Subprime loans were risky for the borrower. ARMs had the risk that the interest rate would adjust to a rate that made the mortgage unaffordable. For balloon mortgage loans, there was the risk that when the (large) balloon came due in a future year, the borrower who could not afford the balloon payment would not qualify for a new mortgage loan for the balloon amount.

For lenders, the loans were considered risky and therefore had a higher interest rate/return for the increased risk of non-payment or default on the loans. However, lenders usually sold the loans to intermediaries in the secondary mortgage market – institutions that created mortgage-backed securities or collateralized mortgage obligations – at a profit. When the loans were sold, the risk transferred to institutions that purchased the loans.  When the institutions pooled the mortgages and sold as securities in the financial market, the risk transferred to security holders. It is believed that the increase in the secondary mortgage market or securitization of mortgages was one reason for the growth in subprime loans.

Gilbert, J. (2011). Moral Duties in Business and Their Societal Impacts: The Case of the Subprime Lending Mess. Business & Society Review, 116(1), 87-107. doi:10.1111/j.1467-8594.2011.00378.x

Pajarskas, V., & Jočienė, A. (2014). Subprime Mortgage Crisis In The United States In 2007-2008: Causes and Consequences (Part I). Ekonomika / Economics, 93(4), 85.

Ross, L. M., & Squires, G. D. (2011). The Personal Costs of Subprime Lending and the Foreclosure Crisis: A Matter of Trust, Insecurity, and Institutional Deception. Social Science Quarterly (Wiley-Blackwell), 92(1), 140-163. doi:10.1111/j.1540-6237.2011.00761.x