How Lenders Are Reacting to Subprime Mortgage Delinquency Rates

Lenders react in two primary ways to high mortgage delinquency rates: first, they raise rates on variable-rate loans; second, they refuse high-risk loans in the near future. Both of these actions are in effort to prevent the bankruptcy or insolvency of the lending institution. Unfortunately, however, they end up harming the potential clients of the lenders, resulting in lower profits and greater challenges to the lending institution as a whole.

Raising Variable Loan Rates

Whenever a loan goes into delinquency, the bank loses a funding source. The lender immediately needs to find a way to supplement that funding on its own balance sheet, or it will net a loss in a given period. The fastest way to increase profits is not to issue new loans, which can take weeks to originate and represent up-front costs to the bank. Instead, lenders look for quick profits by raising existing rates on variable-rate loans. It is important to remember that few mortgage lenders are in the mortgage business alone. Most offer personal loans, equity loans, auto loans and credit cards. Rates on these debts can rise as quickly as mortgage rates if delinquencies are high on home loans.

Refusing High-Risk Loans

Barring unusual circumstances, low-risk loans rarely go delinquent. This is why they are "low-risk"; the borrowers value their credit, have good incomes and will typically avoid delinquency through careful planning. The loans that slip into problems are usually high-risk loans. These were extended to individuals who did not qualify for low rates. They were offered less favorable loan options, and the lenders took a chance the borrowers would pay. The chance did not pay off. Now, the lenders are scared off from these loans at least temporarily. You will find lenders fear high-risk loans in a period of high delinquency.

Increasing Lending Standards

To stay away from high-risk loans, lenders begin increasing lending standards. For example, they will require a much higher down payment, sometimes as high as 30 percent on a mortgage loan. The banks will tighten credit requirements as well. A borrower will need to have stellar credit in order to qualify for a fixed-rate loan. The lenders may also shrink limits if job security is questionable in the given marketplace. The result is, while most low-risk borrowers will continue to get loans, even borrowers in the middle ground will start seeing denials of financing.

Shrinking the Credit Market

The credit market is circular. What happens on one end affects another. When fewer people are given home equity loans, fewer people use those loans for a down payment on an automobile, so fewer auto loans are taken out. When fewer auto loans are taken out, auto lenders lose income sources, and auto dealers lose their jobs. When auto dealers lose their jobs, they may allow their mortgages to slip into delinquency. Each event creates a result somewhere down the line. When delinquencies are high, the credit market shrinks as a whole, and this is exactly what happened in the late 2000s. Getting any loan, regardless of credit, is now much more challenging than it was 5 years ago.