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The credit crunch is becoming a pressing issue not just in the UK but globally, and this article seeks to shed a little light on what it actually is and the impact it has on every one of us. Although this article is directed at the UK market, we are becoming more and more a global economy, and it helps to know what the credit crunch means to all of us as borrowers.

So what exactly is the definition of the credit crunch? As many people may already be aware, the credit crunch started in the United States. It’s arrival was principally caused by two factors. The first was the methods employed by companies when lending money to borrowers and the second factor dealt with how these companies went about obtaining the finance for these loans in the first place.

The majority of lenders lend money which they don’t actually have. Nowadays, strictly speaking, they can’t lend money they don’t have, but they can lend money which isn’t entirely their own. They lend what is called securitised money. Securitised money is the name given to money which is borrowed from elsewhere and then passed on to the borrower. This money is normally sourced from what are called the money markets. Lending companies will borrow huge amounts of money at a time from these money markets, in some cases many millions at a time. These amounts of money are referred to as a tranch of money.

Once the money in these tranches of money has been divided out amongst the lending company’s borrowers, the lender goes about getting more money to subsequently lend again, but the money that they have already given out is thereafter called the lending book. This lending book then has a value to investors. In a nutshell, institutional investors are looking to buy a loan so that they can cash in on the interest payable, but they don’t want the hassle of borrowing the money and giving out the loans in the first instance. These are normally pension companies or large investors, and certain lending books of high quality can be very valuable to them.

Quality plays a very large part in the credit crunch and leads us onto the other reason that we actually have a credit crunch in the first place. In a perfect world a lender borrows a tranch of money at a set rate and then sets about lending it out to their clients at a percentage slightly higher and it is this margin that there is profit. It all comes unstuck if one of two things happens, the money that the secondary lender lends out to the general pubic is poor quality ie one or more people do not pay their instalments or indeed the whole amount back, the other one is were the primary lenders in the market place that lend the huge amounts to the secondary lenders in the first place dry up.

Both these events have taken place in the US. Secondary lenders have lent to poorer quality borrowers and as such have ended up with bad debts and in addition primarily because of the first situation the lenders that lend the huge sums to the secondary lenders have pulled out of the market. This has left the secondary lenders with no means to raise more money to lend but also they are finding it increasingly harder to sell on their mortgage books, once completed, as they carry such bad paying customers and are deemed poor quality lending books. Poor quality lending books carry a lower value to institutional investors due to the fact that they could lose money.

This whole situation has affected the UK in so much as some of our major lenders use securitised lending as their main source of business and even though in the UK we are very much more conservative in our lending practises the international money markets still don’t want to lend the amounts they once use to.

This whole situation has left the UK lending industry in significant turmoil and some of our major institutions on the brink of collapse. This in turn affects every singly borrower such as you and me as lenders tighten up their lending criteria even more to ensure that their respective lending books stay as clean as they can be.

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