New Century Case

The New Century Financial Corporation was once the second-largest subprime mortgage lender in the United States. Just two years after the company was founded, New Century recorded $17.7 million in net profit received countless awards for their rapid growth in such a short time. However, by 2007 New Century had filed for bankruptcy and was bombarded with lawsuits. New Century Financial Corporation had burst along with the housing bubble.

New Century and other subprime lenders provided loans to individuals with a rough financial past who were unqualified to receive funding from traditional financial institutions. During the early 2000s interest rates were extremely low and consumers were being offered new types of mortgages. These two elements plus the attractive promise of refinancing in the future, made consumers eager to take on the risk of buying too much house by borrowing too much money. In addition, the government had recently passed the Affordable Housing Act which required that 30% of all mortgages bought from lenders had to be to subprime borrowers.

A traditional mortgage is a loan from a bank. Banks gain money from their members' deposits and the bank has control over who they decide to loan it to. Borrowers would make monthly payments to the bank, including interest. Lenders who choose not to hold the mortgage in their portfolio can sell the mortgage to other banks. By selling the mortgage the lender gets cash to be able to make other loans. The mortgage is then pooled with other similar mortgages. This second bank then sells securities that represent an interest in the pool of mortgages they have obtained to investors called mortgage-backed securities (MBS). Borrowers make payments to the original lender, who takes a fee and sends it to the bank that purchased the mortgage. This bank takes a fee and passes the rest of the money on to the investors.

Many of the new mortgage options featured increased interest rates or payments. As the payments increased, more and more homeowners defaulted on their loans. The supply of empty houses increased and the value of houses dropped. Banks were unable to get the original loan amount back from the foreclosed homes.

As hundreds of thousands of borrowers defaulted on their loans MBSs become virtually worthless. Prior to 2006 MBSs had been considered solid and safe investments. Many large investment banks heavily invested in MBSs that now held little to no value. The huge increase in defaulted mortgages in the U.S. house market and the dependence on MBSs affected the global market. Thus, the bubble had burst.

Since subprime candidates had limited options for funding, many relied on subprime lenders such as New Century. Subprime lenders now have a negative association and are considered by some as predatory lenders. Subprime lenders have a reputation of taking advantage of borrowers with limited options and, commonly, limited financial knowledge. Subprime lenders required borrowers to pay a higher interest rate than prime borrowers because they were a higher risk. However, as history can show, these borrowers could not keep up with their payments.

New