Subprime mortgages are loans that are made to borrowers with poor credit histories, and make up approximately 13% of the $10 trillion mortgage market. Lenders have traditionally been more generous when it comes to house loans since they can be collateralized. And since property values have done exceptionally well during the past few years nobody had a problem. This changed, however, during the past year or so when the residential housing market began taking a downturn. Many people with poor credit who owned houses had mortgaged it to help pay off credit card bills, and found themselves in trouble when the appreciation on their house suddenly stopped. This caused a sharp increase in defaults on loans during the past few months.

Risky lenders like NovaStar (NFI) and New Century (NEW) saw their income erode as borrowers with poor credit found themselves unable to pay off their loans. Subprime lenders like these make a profit by making loans and then selling them to brokerages that resell pools of mortgages as securities in a process known as securitization. The problem is that with the increasing number of defaults, buyers of these loans began demanding that the lenders buyback bad loans. Shares in New Century and NovaStar each lost more than a third of their value in a single day earlier this month after the lenders warned of deteriorating lending conditions while three other subprime lenders have already declared bankruptcy.

The lesson? Make sure to only spend what you can afford. Don't take out mortgages on your house if it doesn't make sense. It may take awhile for lenders to dig themselves out of this hole as a result.