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Asset Securitization: Theory and Practice by JOSEPH C. HU

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Chapter 10

Subprime Mortgage-Backed Securities

Subprime mortgage-backed securities made their capital-market debut only in the late 1980s, but became one of the fastest growing sectors of the asset securitization market in the late 1990s. Before their debacle in late 2006, subprime mortgages were generically referred to as home equity loans (HELs) among the participants in the residential mortgage market. In fact, HELs were originally second-lien mortgages originated for homeowners to borrow against the accumulated equity on their houses. However, as originations expanded quickly with the rapid pace of securitization, HELs began to represent more subprime mortgages than a true second-lien mortgage secured by the home equity.1

A subprime mortgage refers to a borrower who in the recent past has turned delinquent on paying scheduled interest and even defaulted (chronically delinquent) on consumer loan(s). By contrast, a prime mortgage describes a borrower who has an unblemished credit history with no delinquencies and defaults. From a cash-flow point of view, a subprime mortgage is no different from a prime mortgage. They are all single-family mortgages. In the securitization market, however, subprime mortgage-backed securities are viewed as a part of the ABS, not RMBS, market.2 This arbitrary distinction, gradually established during the 1990s, was made primarily because the origin of subprime mortgages was HELs, which were not full fledged first-lien mortgages.

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