Essays on Financial Distress Article

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Financial distress is a term in Corporate Finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. Financial distress is a term in Corporate Finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. Sometimes financial distress leads to bankruptcy. Financial distress at individual or household level, is simple insolvency, failure to repay the loans, to meet routine expenses and so on. In United States, the subprime mortgage financial crisis of 2007 consummated Financial distress at both organization and household. Let's see an example: ``A family, Husband-Wife both working, with their combined income around $65,000 a year, purchased a modest ranch house, say in Boston's Hyde Park neighborhood for $300,000, taken on loan. The family was paying it comfortably in installments.

After two years, they got it refinanced (on different terms) and got a fresh loan from a lender. But that lender has since gone under. In fact the lender had written too many loans that customers didn't or couldn't pay back. The monthly payment on $300,000 loan started at about $2,100.

Then, the payment was re-structured at an accelerating rate of more than $300 a month, and soon adjusted to about $2800 per month. In next six months, payments increased to even higher levels. Since nobody has any idea how much this monthly payments would go up and consequently the buyer found himself unable to afford his home. ''The subprime mortgageThat was the case of the subprime mortgage financial crisis of 2007. As per definition the overall conventional mortgage market includes two broad categories of loans, prime and subprime.

Prime mortgages is still the largest category, representing loans to those borrowers who are regarded as good credit, ``A'' quality, or investment grade. Everything else is called subprime – i. e. loans to borrowers who have a history of credit problems, insufficient credit history, or nontraditional credit sources. Subprime mortgages are rated by their perceived risk, from the least risky to the greatest risk. Amazingly the worst kind of borrowers account for 50 to 60 percent of the entire subprime market. Subprime lending is also described as high-cost lending.

Borrower cost associated with subprime lending is driven predominantly by two factors: credit history and down payment requirements. This juxtaposes with the prime market, where borrower cost is primarily driven by the down payment alone, as the prearranged that minimum credit history requirements are satisfied. Subprime lending is at the same time viewed as having great promise and great peril. The promise of subprime lending is that it can provide the opportunity for home ownership to those who could not easily qualify for a mortgage in the past. A large number of such people who fulfilled their life time ambition to own a house, were the people who paid too much or borrowed too much against their homes. If their payments are rising and the houses are worth less than they owe, expectedly they'll just walk away from the re-payment commitments. However, in 2006-2007, at the first minor jolt to housing prices in many parts of the U. S., refinancing became more difficult.

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