What Does The Credit Crunch Mean To You? | Mortgage

By ChrisClare
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The aim of this article is to define the credit crunch and explain how it may have an affect on you as a borrower. Although it is compiled with the UK market in mind, due to similarities between the different countries within the European and world markets, the effect it may have on the individuals within these markets will likewise be similar.

First of all lets discuss what is the credit crunch? The credit crunch that most people have heard about first started in the US. It was primarily bought about by two situations, the first of which was the way in which money was being lent and secondly how the money was derived by the lenders making the loans.

Most lenders lend money they don't have, now of course they can't lend money they don't actually have but they can lend money that is not exactly their own. A lot of lenders lend what is called securitised money this is where they borrow money from another source and then lend it to you and I. Securitised money is generally sourced from what is known as the money markets. Lenders basically go to these money markets and borrow vast amounts of money at a time, millions in some cases. The amount that they borrow in any one time is also known as a tranch of money.

Once that tranch of money has been lent to borrowers, they then set about borrowing more but what has already been lent is known as a lending book. That lending book has a value to institutional investors. Institutional investors are people such as pension companies or large investors who want to own loans lent to others that are going to be repaid but don't want to go through the hassle of actually lending it in the first place and dealing with the end user. Lending books depending on their quality can have quite a high value.

Indeed one of the main reasons that we have a credit crunch in the first place is down to the quality of the accounts contained in the lending books themselves. The ideal scenario would be that the lender would borrow a tranch of money, set at a certain rate, which they loan on to the public, and obtain their profit, by setting their percentage rate on the loan slightly higher. And this is where things become unstuck. For example what happens if some members of the public are unable to pay some or even the entire loan they obtained from the secondary lender. Not only that but what happens to the secondary lenders if the primary lenders, ie the institutional investors decide that they want to get out of the marketplace. Limited institutional investors means less money available to the secondary lenders.

Both these scenarios have occurred in the United States. Erratic payment and non payment of loans obtained by the public have left the secondary lenders with a trail of bad debt on their lending books which have in turn led the institutional investors to leave the markets. This has a subsequent effect on the secondary lenders in that there are less institutional investors to borrow money from and the ones that remain will be far more scrupulous in scrutinising the loan books before putting their money forward, and so continues the downward spiral. The secondary lenders need money to borrow and continue on but the investors are not willing to invest in what they can perceive from the loan books to be bad debt and therefore bad investment opportunities.

This situation has made a huge impact on lending and borrowing in the UK insofar as that the majority of lending companies in the UK operate on the securitised money method of doing business. Although we are much more restrained with regards to our money lending/borrowing practises, the international money markets simply aren't lending money like before and we are all feeling the effects of that.

This whole situation has left the UK lending industry in significant turmoil and some of our major institutions on the brink of collapse. This in turn affects every singly borrower such as you and me as lenders tighten up their lending criteria even more to ensure that their respective lending books stay as clean as they can be.

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