Subprime Meltdown

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DEFINITION of 'Subprime Meltdown'

The sharp increase in high-risk mortgages that went into default beginning in 2007, contributing to the most severe recession in decades. The housing boom of the mid-2000s – combined with low interest rates at the time – prompted many lenders to offer home loans to individuals with poor credit. When the real estate bubble burst, many borrowers were unable to make payments on their subprime mortgages. 

INVESTOPEDIA EXPLAINS 'Subprime Meltdown'

Following the tech bubble and the economic trauma that followed the terrorist attacks on the U.S. on September 11, 2001, the Federal Reserve stimulated the struggling U.S. economy by cutting interest rates to historically low levels. As a result, the housing market soared for several years. In order to capitalize on the home-buying frenzy, some lenders extended mortgages to those who couldn’t qualify for traditional loans because of a weak credit history or other factors. Investment firms were eager to buy these loans and repackage them as mortgage-backed securities (MBSs).  

Many subprime mortgages were adjustable-rate loans that were initially affordable, but which reset to a dramatically higher interest rate after a given period of time. This sudden spike in payments played a major role in the growing number of defaults, starting in 2007 and peaking in 2009. The ensuing meltdown caused dozens of banks to go bankrupt, and led to enormous losses from Wall Street firms and hedge funds that marketed or invested heavily in risky mortgage-related securities. The fallout was a major contributor to the global recession that followed.

In the wake of the subprime meltdown, myriad sources have received blame. These include mortgage brokers and investment firms that offered loans to people traditionally seen as high-risk, as well as credit agencies that proved overly optimistic about non-traditional loans. Critics also targeted mortgage giants Fannie Mae and Freddie Mac, which encouraged loose lending standards by buying or guaranteeing hundreds of billions of risky loans. 

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