Lenders' Woes with Delinquent LoansAccording to an article in Toronto's Globe and Mail, the two biggest lenders in the subprime mortgage market are reporting much bigger losses caused by delinquent loans. Both HSBC Holdings PLC of Europe and New Century Financial Corp are having to increase their bad loan provisions to deal with anticipated problems caused by lending to the riskiest segment of the lending market.
The warnings from these two big players are sending shock waves through the lending community, affecting the stock market as well.
HSBC has a substantial portfolio of what is called "second-lien" mortgages. A second-lien mortgage means that the borrower already has a first mortgage on a home, and this first mortgage will be paid before any other debt in the case of the sale of the home. This type of loan is much riskier than a first mortgage.
The news of lending problems comes on the heels of an economy that has been benefiting substantially from steady economic growth and high housing value appreciation over the past few years. In response to the booming economy, stiff competition in the subprime market led to a loosening of lending requirements. In fact, borrowers were often encouraged by lenders to take advantage of equity in their homes in order to get other consumer goods or to renovate homes.
The line between "responsible" lending practices and "predatory" lending practices became more and more blurred. We've been following this story for some time. Lenders encouraged borrowers into homes, using US tax breaks on mortgage interest payments as a rationale. Lenders defend their actions by pointing to the high levels of homeownership. However, if these subprime lenders now collapse, homeownership could be facing a much graver threat.
Canadians have some good news in this area: Canadian lenders have little apparent exposure to the building crisis in the US.
There is another aspect to this trend beyond blatantly predatory loan practices: lenders have been offering 40 year terms on loans in order to lower payments and entice the buyer into a bigger home. Unfortunately, the new trend to 40 year mortgage loans is not a good move for the consumer. While it lowers payments now, it means tens of thousands (if not more) in interest paid over the life of the mortgage. So the cost to the consumer is very high.
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