During the subprime problem the U.S. press and finance news channels was pretty active in using the term called “toxic assets” in many of their press releases and other articles. If you have often wondered what these are and how they were responsible for many banks and financial institutions to tighten up their lending, then read on to understand more about them.
Impact on mortgage loans
Toxic assets are those financial investments backed by unsafe subprime home mortgages. You can recognize them as you drive around and see many properties with foreclosure signs on them. They are the ones that have proved to be “toxic assets” to the lending institutions who lent money in the first place to borrowers who have not been able to repay the mortgage and have been forced to put up foreclosure notices.
These toxic assets are held by sizable U.S. financial institutions and are dragging down their net worth as they are not giving them the return on the investment or loan that they had advanced to their borrowers. Moreover, the cost or value of these properties has also dropped significantly. This means that these lending institutions cannot even sell them at a price higher to be able to recover their losses to some extent.
It also led to other problems. The lending institutions now had much less cash to be able to lend to borrowers with healthy credit rating and from whom there was no danger of default. Many finance news reports alluded to this problem as being totally unfair and not appropriate for the real estate economy as genuine home buyers were not able to buy their dream homes.
The road to healthy properties becoming toxic assets starts with lending institutions extending home loans to people with subprime status. Such indiscriminate lending meant that those with very less capacity to repay took those loans and consequently started defaulting on the repayments landing the lending banks with “toxic assets” that had shed its value and individuals who were in no position to make any repayment.
In the past times, purchasing a house involved substantial commitment and one that typically lasted for a life time. A house was typically the biggest property most Americans ever before possessed. It was typically fairly tough to apply for a home mortgage financing. Many financial institutions and home mortgage business needed the house loan borrower to place at least 20% of the house value down prior to a home mortgage financing approval to be given. There was other due diligence procedures followed by banks to ensure they gave mortgage loans only to the right individuals. This was seen as a major deterrent by many.
But from the beginning of this decade, many of these rules were not followed and subprime mortgages became very common with many of the banks bundling them and selling to other bigger banks. These big banks then sold them as mortgage backed securities and that was the beginning of the various problems that were so wonderfully highlighted by finance news channels post the crisis.