Final answer:
A subprime mortgage is a loan given to individuals with poor credit scores at higher interest rates to offset lender risk. The practice of securitizing these loans, and making risky NINJA loans, contributed to the housing bubble and financial crisis due to widespread defaults when housing prices stopped rising and refinancing options disappeared.
Step-by-step explanation:
The concept of a subprime mortgage refers to a type of mortgage that is provided to borrowers with lower credit ratings, which results in higher interest rates compared to conventional mortgages. The riskier nature of lending to individuals with a poor credit history is offset by these higher rates, and often, these loans have adjustable rates that can increase over time. Subprime lending was particularly prevalent during the housing boom, when banks were flexible in their lending practices.
During the mid-2000s, lending institutions began to securitize mortgage loans, selling them as bonds, which created a disconnect between the origination of the loan and the lender's financial stake in the borrower's ability to repay. This facilitated the proliferation of subprime loans, including NINJA loans, which did not require proof of income, employment, or assets from the borrower. This more lenient approach to lending was predicated on the expectation that housing prices would continue to rise, allowing borrowers to refinance before higher payments were due.
However, these practices contributed significantly to the financial crisis, as many borrowers were unable to refinance or keep up with payments once the initial low-payment period ended, leading to widespread defaults and foreclosures. The impact of subprime lending on the larger economy was devastating, culminating in the 2007-2008 financial crisis.