How Investors Should View the Subprime Mortgage Troubles

Stockholders do have some reason to be concerned over delinquent junk mortgages. But it's hard to see how the subprime problems will contaminate large swaths of the economy.

You expect stocks to suffer if interest rates soar or inflation spins out of control. That's not happening, but for much of 2005 and 2006, escalating oil prices spooked the financial markets until wiser heads figured out that America's efficient economy isn’t defined by prices at gas pumps. Inflation fears eased, and you and your portfolio reaped the benefits.

Now, after almost a year of bull-market bliss, fear is back. Stocks lost 5% over a couple of weeks, all of it in two bad days. The fuss is over something that until recently you probably had never heard of: "subprime" mortgages and, more particularly, a growing number of defaults on homeowners who had taken out subprime mortgages. Freddie Mac describes these as loans that charge high -- typically adjustable -- interest rates, a high number of points and fees, and high prepayment penalties. Lenders extend them to people who lack cash for a down payment or who have spotty job and credit histories. These loans are difficult or impossible to refinance. Yet the interest rates adjust more quickly and more sharply than do other kinds of ARMs.

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Jeffrey R. Kosnett
Senior Editor, Kiplinger's Personal Finance
Kosnett is the editor of Kiplinger's Investing for Income and writes the "Cash in Hand" column for Kiplinger's Personal Finance. He is an income-investing expert who covers bonds, real estate investment trusts, oil and gas income deals, dividend stocks and anything else that pays interest and dividends. He joined Kiplinger in 1981 after six years in newspapers, including the Baltimore Sun. He is a 1976 journalism graduate from the Medill School at Northwestern University and completed an executive program at the Carnegie-Mellon University business school in 1978.