Subprime lending became popular in the first decade of the 2000s.
Subprime lending wasn't always the ubiquitous term that it has become in the first decade of the 2000s. What started as a rare, and sometimes shady, lending practice became a popular mortgage lending vehicle. According to the Federal Reserve Bank of Dallas, subprime mortgages made up about 9 percent of all U.S. mortgage loans in 2001 and 40 percent in 2006.
Prime Rate
The prime rate is used to calculate bank interest rates.
The U.S. prime rate, as defined by the "Wall Street Journal," is the interest rate commonly used by banks. The prime rate is used as the base lending rate by consumer and commercial lenders, who then add a profit margin based on the riskiness of a loan.
Subprime Loans
Subprime loans are given to risky borrowers.
Traditionally, lenders would make loans below the prime rate only if the loan was secured with something highly valuable, such as a home. However, that began to change in the 1990s with the rise of what is better described as "nonprime" loans. According to the Federal Reserve Bank of Dallas, lenders began to make high interest loans for cars, cash and mortgages to borrowers with no credit or bad credit histories. The mortgage loans, for example, were often given with little or no down payment and borrowers were allowed to make interest-only payments or receive loans for greater than the value of the home.
Regulations
Government deregulation made subprime loans more popular.
According to "A Short History of Subprime" published on Allbusiness.com in 2006, changes in government regulations are at the heart of the rise in subprime loans. Until adoption of the Depository Institutions Deregulatory and Monetary Control Act in 1980, usury laws restricted lenders from charging the high-interest rates that would offset the risk of subprime loans. Then the Tax Reform Act of 1986 allowed interest deductions on mortgage loans, thus making them a popular form of lending.
Housing Boom
A housing boom increased subprime loan growth.
According to National Public Radio's "The Mortgage Market: What Happened?" the rate of U.S. home ownership hit a record high 69 percent in 2004. Home prices were rising along with home ownership, while interest rates were historically low. This environment made fertile ground for the proliferation of subprime mortgage loans to risky borrowers.
Lending Institutions
Lending institutions of all sizes make subprime loans.
Throughout the rise and subsequent fall of subprime mortgage loans after the swift decline in the U.S. housing market in 2007, major banks and private mortgage brokers were making subprime loans. As Congress and the Federal Reserve Bank began to scrutinize the banking business, the practice of subprime mortgage loans fell dramatically. However, according to the March 11, 2010, "Time" magazine article titled "The Subprime-Lending Business Survives, Even Thrives" by Stephen Gandel, the business of subprime lending by smaller lending institutions to risky borrowers for credit cards and car loans is going strong.
