The institution giving out the sub-prime loans takes the money that it gets by selling the financial securities and passes it on to the bank he had taken the loan from, thereby repaying the loan. And everybody lives happily ever after. Or so it would have seemed.
The sub-prime home loans were given out as floating rate home loans. A floating rate home loan as the name suggests is not fixed. As interest rates go up, the interest rate on floating rate home loans also go up. As interest rates to be paid on floating rate home loans go up, the EMIs that need to be paid to service these loans go up as well.
Image: Hundreds of people facing difficulties paying their mortgages wait in line in front of a hotel in Washington, DC to receive free financial counseling from the Neighborhood Assistance Corporation of America. | Photograph: Nicholas Kamm/AFP/Getty Images
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