|Understanding the Credit Crunch
At the moment it seems like everyone is worried about the so-called ‘credit crunch’ or ‘credit crisis’ that we are going through in the US and whether it will lead to full-blown recession. The world seems to be teetering on the edge of a major credit crisis, and its effects are starting to have very real effects on consumers as well as on financial institutions. So, why did this credit crunch happen in the first place?
Where did the credit crisis begin?
Many financial experts believe that the current global financial situation came about as a result of US banks and ‘sub-prime’ lending. In a previously buoyant housing market, many banks opened up the way that they gave out credit and started lending to ‘sub-prime’ applicants; to put it simply, they allowed virtually anyone to take out a mortgage on the basis that housing prices were so high that they could get their money back easily if the people to whom they gave mortgages couldn’t pay them back.
So, for example, in recent years you could get a mortgage even if you technically couldn’t afford it. 100% (or even higher) mortgages were common, and you could borrow up to seven times your income. But then, as housing prices dropped and banks stopped lending money to each other to cover the costs of sub-prime lending, things all went a bit pear-shaped! In the US, Bear Stearns ended up belonging to somebody else.
What does the credit crunch mean to you?
The current credit crunch or credit crisis simply means that financial institutions have put themselves in credit crisis mode. They are all trying to protect their money, so they charge more to lend money to other institutions or charge higher rates for doing so. They are looking to protect their assets and to minimise the risk of losing money. The effects to consumers include:
- Banks are far less likely now to give out certain types of lending products. 100% mortgages have virtually disappeared, for example, and you’ll only be able to borrow a sensible multiple of your income.
- Deals have started to disappear from the lending table and interest rates have started to rise. It’s estimated that half of the mortgage deals that were on offer less than a year ago are around at the moment. And, good deals are no longer on offer forever; banks and other lenders will put them out for a while and then will withdraw them so that they don’t become over-subscribed.
- Lenders are being far more stringent when it comes to giving out money in any form. Just a few months ago you were probably inundated with pre-approved credit card offers. Bet you aren’t getting so many through the door anymore! It’s becoming harder and harder to get approved for any kind of credit at the moment, especially if you have a less than perfect financial track record.
And, one of the biggest problems with the credit crunch is that it is forcing many individuals into their own credit crisis. The interest rates that they may have to pay on borrowings that they made pre-credit crunch may be rising and they may now be discovering that they over-extended themselves in the first place. So, it can be harder for them to meet their repayment obligations given the current credit crisis.
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