- How the credit crunch affects you
- Are your savings safe
- What needs to be done next?
- Personal loans
- Take control of your finances
- Mortgage rates
- Secured loans

The term credit crunch – means credit is no longer freely available because there is a shortage of funds for lending.

The problems which led to the current credit crunch actually began back in 2004 in the US when homeowners began to default on their mortgages. The reason for this was that US mortgage lenders sold home loans to customers on low income and poor credit. This market is referred to as the sub-prime market because by definition it is higher risk lending. As a means to sell more profitable sub-prime mortgages, mortgage companies bundled the debt into consolidation packages and sold the debt on to other finance companies. What this meant was mortgage companies were borrowing in order to lend mortgages, so the lending was not financed out of the companies own assets.

This is where things got messy. Normally sub-prime mortgages would have a high risk assessment rating however when the mortgage bundles got passed onto other lenders, rating agencies gave these sub-prime mortgages a low risk rating. Therefore, the financial system denied the extent of risk on their balance sheets. So long as homeowners continued to service their loans the risk factor was kept in check but eventually something had to give and it did.

Many of these mortgages had an introductory period of 1-2 years of very low interest rates. At the end of this period, interest rates increased.

In 2007, the US had to increase interest rates because of inflation. This double whammy on interest rates made mortgage payments even more expensive.

Rising living costs put even more pressure on struggling homeowners and mortgage default rates increased further. These defaults in turn signalled the end of the US housing boom. As US house prices started to fall so the problem of negative equity started to rear its ugly head and it meant that many loans were no longer secured. If homeowners defaulted, the bank couldn’t guarantee to recoup the initial loan.

A widespread picture of bad debt emerged but the losses weren’t confined to mortgage lenders, many banks also lost billions of pounds in the bad mortgage debt they had bought off US mortgage companies. As banks wrote off large losses, they became far more stringent in their lending. The picture in the UK was not that dissimilar – Northern Rock had to go cap in hand to the UK government because it had a high percentage of loans financed through reselling in the capital markets. When the subprime crisis struck, Northern Rock was unable to raise sufficient funds in the capital market as it would typically have done, so the government had to provide a rescue plan.

The upshot of all this irresponsible lending is that across the world it has became very difficult to raise funds and borrow money.

And when individuals or companies can’t borrow, cash flow issues that ordinarily wouldn’t be a problem, suddenly become very serious indeed.

So what is likely to happen next? It is hoped that government intervention either side of the Atlantic will see confidence return to the banking system. Providing a degree of stability is what everyone needs at the moment – not least the stock market which has seen share prices plummet and investors lose billions in the process. The next few years are likely to be very tough – house prices are likely to fall further and rising unemployment is liable to put even greater pressure on those struggling to pay mortgages. At least inflation looks like it has peaked and governments already seem prepared to lower interest rates to alleviate some of the pain.