Recall that securitization is the process of turning a loan, such as a mortgage, into a bond that can be bought and sold in secondary markets. An article in the Economist noted: That securitization caused more subprime mortgages to be written is not in doubt. By offering access to a much deeper pool of capital, securitization helped to bring down the cost of mortgages and made home-ownership more affordable for borrowers with poor credit histories. What is a "subprime mortgage"? What is a "deeper pool of capital"? Why would securitization give mortgage borrowers access to a deeper pool of capital? Would a subprime borrower be likely to pay a higher or lower interest rate than a borrower with a better credit history? Under what circumstances might a lender prefer to loan money to a borrower with a poor credit history rather than to a borrower with a good credit history? Briefly explain.

Step by step solution

01

Define Subprime Mortgage

A subprime mortgage is a type of mortgage granted to borrowers with poor credit histories, who do not qualify for conventional mortgages because of higher risk of default. These are generally associated with higher interests to compensate for the higher risk.

02

Define Deeper Pool of Capital

A 'deeper pool of capital' refers to a larger amount of resources (especially financial) that are available for borrowing. This can include funds from various investors in the market, which is made accessible due to securitization.

03

Securitization and Access to Capital

Securitization allows an entity to convert assets into a security that can be sold on the market. This way, lenders can recoup their money faster by packaging their loans into bonds and selling them to investors. This opens up a 'deeper pool of capital' for mortgage borrowers.

04

Compare Interest Rates

A subprime borrower, having a poor credit history, is more likely to pay a higher interest rate than a borrower with a better credit history. This is done to cover the risk involved with lending money to customers more likely to default.

05

Reasons for Lenders Preferring Poor Credit History Borrowers

In specific circumstances, a lender might prefer to loan money to a borrower with a poor credit history rather than to one with a good credit history. This could be due to potentially higher returns from the higher interest rates charged to subprime borrowers or when they believe the borrower's credit rating underrates their creditworthiness.

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