Northern Rock was forced to knock on the door of the Bank of England in search of funds this week. This has caused disquiet as our central bank is the last resort for banks that find themselves unable to raise funds elsewhere. If the Bank of England had declined to lend it any money, Northern Rock could have faced insolvency.

The credit crisis, which has resulted in the first leading British bank being bailed out by the Bank of England for 34 years, has been brewing for more than a year.

Where did the problems start?

The buck belongs firmly with the US. Mortgage lenders there extended loans to people with weak credit histories. These sub-prime loans had low initial rates, making them attractive to new buyers. But as interest rates rose and house prices plummeted these homeowners were unable to meet monthly payments and defaulted on their loans.

Surely that’s just a problem for the mortgage lenders?

Unfortunately not. These banks raised money to lend to borrowers by selling the loans they had already agreed to other financial institutions, such as hedge funds and investment banks. The investment banks repackaged the debts, which they sold on to other investors.

So what happened next?

About 30 US mortgage lenders went bust and the ramifications of the problems radiated out across Europe. Germany was particularly badly hit. Two of its banks, Sachsen LB and IKB, collapsed.

But what has this got to do with Northern Rock?

Banks are always lending money to each other. When the sub-prime crisis arose, banks across the globe were left holding big chunks of debt. The banks became suspicious of each other’s exposure to the growing crisis, and stopped lending each other money. This freeze on lending between banks is known as a “credit crunch”. Northern Rock is affected particularly because it is structured differently from most other mortgage lenders, who fund their home loans from savings deposited by customers. Northern Rock, in contrast, borrows money from banks and other institutions cheaply, and then lends to homeowners at a higher rate. As the credit crunch deepened, the lender found it impossible to raise cash.

So why did Northern Rock go to the Bank of England?

Its problems in raising funding meant that the lender did not have the cashflow that would enable it to continue its business. So the Bank of England stepped in.

How much did it lend Northern Rock?

Northern Rock has an unlimited line of credit over the next few weeks, but it hasn’t taken any of the money yet.

Are there other lenders with the same structure as Northern Rock?

Yes. GMAC-RFC, which specialises in buy-to-let mortgages. Many sub-prime lenders, including Paragon Mortgages and Edeus, also rely on the financial markets to raise funds. Alliance & Leicester and Bradford & Bingley raise some of their money like Northern Rock, but insisted yesterday that they were not affected by the credit crunch.

GMAC-RFC says that it will not have to ask the Bank of England for money and that it has dealt with its funding issues by raising mortgage rates and tightening lending criteria.

But some other sub-prime lenders have had a torrid time lately. Only this week Victoria Mortgages, a small sub-prime lender, went into administration.

I have a Northern Rock mortgage. What should I do?

Nothing. The bank should continue to operate as usual and some brokers have indicated that they will continue to recommend the lender’s home loans. If the bank did get into further trouble it is likely another bank would take on its loan book.

Will mortgage rates rise for everyone?

Homeowners may find that rates continue to increase despite the base rate remaining at 5.75 per cent, as lenders try to recoup the cost of more expensive borrowing. Those with troubled credit histories will find it more difficult to secure a loan.

Should I take my savings out of Northern Rock?

The British Bankers’ Association says that customers’ deposits are safe and the Financial Services Authority was at pains to point out that Northern Rock was solvent and the Bank of England believed that Northern Rock can trade its way out of its problems. Independent financial advisers also told savers not to panic, although they added that savers should spread their money across several banks and building societies.

What happens if a bank goes bust?

The Financial Services Compensation Scheme guarantees to repay the first £2,000 of your savings and 90 per cent of the next £33,000. The maximum guaranteed amount you will receive is £31,700.

Is there anywhere my money is totally secure?

The only place which offers a cast-iron guarantee for savings is National Savings & Investments, the government-backed savings institution.

Should I sell my Northern Rock shares?

The share price dropped by more than 30 per cent yesterday from 638p to 438p, but analysts said that most private investors should hold on to the shares.

What happens now?

Experts say Northern Rock has become a bid target so it may be taken over by another company.