Let's say a subprime couple buys a $300,000 house they cannot afford.
To lure the couple in, the bank offers them a $330,000 loan, financing for 110 percent of the home's value, at a ridiculous teaser rate of 2 percent. Sometime later, the loan resets to a higher interest rate of 5 percent, and then still later at 7 percent.
With each reset, the monthly mortgage payment becomes more expensive, and soon the couple defaults, the mortgage is foreclosed, and the couple loses their house. In recent cases, the house has probably fallen in value, as much as 50 percent of the mortgage amount.
So, in this example, the house might now be worth only $150,000, but still have a loan of $330,000.
The bank has to write down the losses of $180,000, causing havoc in the banking sector and major losses for shareholders as more and more foreclosures stack up.
