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What is it?

Prime is the term given to mortgages that are extended to borrowers with good credit histories. Prime mortgages are clearly distinct from sub-prime and Alt A mortgages, which are extended to borrowers with poor or incomplete credit histories respectively.

Prime mortgage borrowers pay lower interest rates on their mortgages than sub-prime borrowers because it's seen as less of a risk that they will fail to pay.

What's it got to do with the financial crisis?

Prime mortgage lending had very little to do with the start of the credit crunch - except for the fact that there wasn't enough of it, particularly in the US. Between 1995 and 2006, the share of new mortgage lending that went to sub-prime borrowers in the US rose from nothing to more than 20%, according to the Center for Responsible Mortgage Lending.

For the first six months of the credit crunch, prime mortgages were seen as relatively safe investments. However, as the crunch continued it became increasingly apparent that prime mortgage borrowers - both in the US and overseas - were also at risk of defaulting on their mortgage payments. This risk increased as the crunch spread to the broader economy, raising the spectre of redundancies.

In mid-2008, data from Federal Deposit Insurance Corp. showed that 0.91% of US prime mortgages from 2007 were seriously delinquent after 12 months (ie, in foreclosure, or at least 90 days late in payment). The equivalent figure for prime mortgages made in 2006 was just 0.33% after 12 months.

If a high proportion of prime mortgage borrowers are unable to meet their repayments, the credit crunch is likely to worsen. Lending banks would make big losses and be forced to raise additional capital and further cut the amount of credit they're willing to extend.

Last updated on 26 September 2008.

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