What you need to know about the cash crisis

The FTSE 100 Index plunged more than 2% yesterday as the fall-out from the cash crisis at troubled US investment bank Bear Stearns shook world markets.

Q: What has sparked the latest sell-off?

A: US investment bank Bear Stearns became the latest victim of the credit crunch when it was bought by JP Morgan Chase on Sunday for a cut-price $US236.2m (£116.4m) after being forced to seek emergency funding on Friday. The US Federal Reserve, in a rare Sunday meeting, cut its lending rate to banks to 3.25% from 3.5% and created another short-term loan facility for big investment banks in a bid to ease the pressure. Far from reassuring markets, the move was seen as further evidence that the financial crisis is deepening,

Q: What caused the credit crunch in the first place?

A: The credit crunch was sparked by high levels of defaults on sub-prime mortgages in the US. Banks sell mortgage packages on to investors in a process known as securitisation. The high level of defaults in the US has left investors with heavy losses, making them wary of mortgage-backed securities. So, the credit markets have dried up as financial institutions do not want to lend to each other and lenders are finding it harder to get mortgage debt off their balance sheets.

Q: What impact will yesterday's events have on mortgages?

A: No direct impact, but they are likely to exacerbate the trends that are being seen. The credit crunch has led to lenders becoming increasingly risk-averse. As a result, many products are being withdrawn, with no lenders offering 125% loans and only a handful offering 100% ones. Mortgage lenders are also want higher deposits from borrowers in order to qualify for their best rates. At the same time it has become more expensive for lenders to borrow funds themselves and this cost increase is being passed on to borrowers, with many firms increasing the tracker rates they offer to new customers outside of movements to the Bank of England base rate. The Council of Mortgage Lenders predicted at the beginning of the year that lenders would be unable to meet about a third of the demand for mortgages due to the problems they faced raising money.

Q: What should I do if I need to remortgage?

A: Start the process at least three months before the current deal expires. The mortgage landscape is very different now to what it was two years ago when many people last remortgaged, while interest rates are also considerably higher. Once people find a deal they should act fast to secure it, as huge demand for competitive rates is causing them to be pulled quickly as lenders struggle to keep up with processing applications, while the funding difficulties they face mean rates for new deals are being regularly increased, while firms also keep tightening their lending criteria.

Q: What is likely to happen to interest rates now?

A: The Bank of England is widely expected to cut rates at least twice more this year to 4.75%, while some commentators claim they could end the year as low as 4.25%.