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What Does The Credit Crunch Mean To You?

Feb 22, 2008
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.

So what exactly is the definition of the credit crunch? As many people may already be aware, the credit crunch started in the United States. It's arrival was principally caused by two factors. The first was the methods employed by companies when lending money to borrowers and the second factor dealt with how these companies went about obtaining the finance for these loans in the first place.

The majority of lenders lend money which they don't actually have. Nowadays, strictly speaking, they can't lend money they don't have, but they can lend money which isn't entirely their own. They lend what is called securitised money. Securitised money is the name given to money which is borrowed from elsewhere and then passed on to the borrower. This money is normally sourced from what are called the money markets. Lending companies will borrow huge amounts of money at a time from these money markets, in some cases many millions at a time. These amounts of money are referred to as a tranch of money.

The lenders then proceed to borrow more money but the tranch of money that they have already borrowed is accounted for in what is known as a lending book. This lending book attracts great interest from institutional investors. Institutional investors can vary from single large investors to pension institutions who are keen to own repayable loans but would rather use intermediaries than deal with the people requiring the loans themselves. The value of these loan books to both the lender and the investor is dependent both on their size and the quality of the loans within.

Quality plays a very large part in the credit crunch and leads us onto the other reason that we actually have a credit crunch in the first place. In a perfect world a lender borrows a tranch of money at a set rate and then sets about lending it out to their clients at a percentage slightly higher and it is this margin that there is profit. It all comes unstuck if one of two things happens, the money that the secondary lender lends out to the general pubic is poor quality ie one or more people do not pay their instalments or indeed the whole amount back, the other one is were the primary lenders in the market place that lend the huge amounts to the secondary lenders in the first place dry up.

Both these events have taken place in the US. Secondary lenders have lent to poorer quality borrowers and as such have ended up with bad debts and in addition primarily because of the first situation the lenders that lend the huge sums to the secondary lenders have pulled out of the market. This has left the secondary lenders with no means to raise more money to lend but also they are finding it increasingly harder to sell on their mortgage books, once completed, as they carry such bad paying customers and are deemed poor quality lending books. Poor quality lending books carry a lower value to institutional investors due to the fact that they could lose money.

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.
About the Author
Advice on mortgages from specialist Independent Mortgage Advisers guidance information and free to use mortgage calculators please visit Mortgage Route
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