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Mortgage bank backlash is here. The fear of sub-prime lending has thoroughly gripped many major banks, leaving future borrowers out in the cold. With so many dooms day stories out there, it’s hard for consumers to get the real facts.

How has Sub-prime Lending Affect Major Banks?

Many smaller mortgage loan companies have found themselves in bankruptcy because of the sub-prime lending fallout. Sadly, this is simply a result of bad business practices, too aggressive lending, and a residential slowdown.

During the rise of the residential real estate market, banks saw a great opportunity to increase their margins. For many smaller banks and mortgage companies, this would prove to be devastating. For larger banks the sub-prime lending fallout is a wake up call.

Traditionally, large banks are the most conservative types of corporations because of heavy regulation and their long memories. In the 1980’s banks experienced a much larger fallout that threaten to bring the entire United States banking system to its knees. After a governmental bailout, banks implemented stringent lending legislation and positioned themselves to be very conservative lenders.

How will Major Lenders React?

Much like a stretched rubber band that snaps backward, banks will become even more conservative than they were before the entire situation began. New Century Financial, a major mortgage lender to low credit score borrowers (sub-prime lender) attempted to buck the system by taking on more risk. Becoming the number two lender in this market essentially showed other banks that it was possible to make larger margins by taking more risk. Unfortunately for New Century Financial, their run ended in bankruptcy for the company and probably jail sentences for some of the top brass.

This bankruptcy has struck fear into other major lenders across the country. Some major banks have completely pulled out of the market by putting a hiatus on all sub-prime lending. Other banks have put so many restrictions on lending, that most buyers who need these loans will no longer qualify. Additionally, the areas where sub-prime lending is most needed (California, New York, Florida) has experienced these withdrawals and a lot of mortgage banking bankruptcies. This has created a vacuum for low income families in need of these loans in these areas.

The unfortunate reality of this entire situation is that the people, who most need these loans, will now be out of the market for at least five years. Most of the small lenders will either be bankrupt from their previous loan behavior or take on a more conservative stance minimizing these types of loan products in their portfolio. Major Banks will revert back to using these loans solely for diversification purposes, if they continue to use them at all.

The unfortunate victim of the sub-prime lending fallout will be the low income and the people who have had credit missteps. Furthermore, in markets where real estate has appreciated beyond the means of many will be forced to rent.

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