We’re at the early stages of a subprime crisis. The number of people getting kicked out of their homes for missing loan payments is rising. Since home ownership is every politician’s favorite talking point, it’s no wonder that we’re seeing presidential hopefuls like Senator Clinton taking the evil eye off of oil companies, and pointing fingers at the subprime loan business.
As the real estate mess should be peaking right before the next presidential election, expect the subject to increasingly dominate the news and talking points.
"Something must be done to ensure honest hardworking Americans don’t get kicked out of their homes,” they say. Some of the policies proposed to “fix” the system will do exactly the opposite of the intended result: they will hurt lower income Americans by restricting access to home loans.
The coming crisis isn’t in subprime loans so much as subprime politicians.
Now that the real estate market has stopped its meteoric rise, the questionable loan practices and buyers’ logic that was once the foundation of the late stages of the boom is starting to crack. Double-digit home price gains year-after-year hid a whole bunch of mistakes.
Home buyers and lenders were both duped into the belief that home prices always go up, so putting very little money down and “buying as much home as you could possibly afford” is always a sound investment strategy, regardless of the entry price.
The pending doom was no secret. In this column last year I noted how buying can be a bigger mistake than renting, how the real estate market can crumble if home prices stop going up thanks to speculative borrowing, and how big foreclosures were right around the corner.
You’ll notice I never worried about so-called “predatory lenders” leading to people getting kicked out of their homes in great numbers. Predatory lending is not even in the top 10 reasons the American dream will end up being the American nightmare for some. The irony is that it wasn’t that long ago that politicians accused lenders of “redlining” — not making loans to certain minority groups and demographics.
As politicians try to redefine predatory lending, as they did with “price gouging,” it’s useful to know what predatory lending really is.
Predatory lending means that making a loan that the lender knows will have little chance of getting paid off without a host of penalties, and a high likelihood that the asset backing the loan will get confiscated at a nice profit for the lender.
If somebody with low income and mediocre credit gets a loan to buy a $200,000 house with no money down — it is not predatory lending, it's just stupid lending. The lender is the one making the bigger mistake.
When the borrower misses payments, the lender is not making any money because they will be foreclosing on a house with zero equity. If the lender is lucky, they will be able to wrap the foreclosure sale up within a year of default by the borrower. If the lender is really lucky, the home will be worth at least $200,000. Make enough of these mistakes, and the lender will be in bankruptcy — which has been the trend recently. The unfortunate borrower would have been kicked out of their rental home even more swiftly for missing rent payments — and there is no law preventing a renter from renting more home than they can afford and getting into trouble down the road.
The above example – which has become much more common in recent years — could be predatory lending if the borrower had 10 percent or more down on the home. In such a case, the predatory lender would effectively say, “this guy has no chance of making these loan payments, when they default we’ll get the home, flip the house, and pocket the $20,000 - $40,000 down payment less missed payments and other fees.”
As the bubble deflates there will certainly be some examples of this predatory formula. But in the majority of cases, the lender (or those that bought the loans from the lender after the loan was made) could be worse off than the borrower.
It is far more likely that the lender was trying to rip off the investor by buying the loans from the bank — the borrower buying the home was a mere pawn in the game. The lender, or perhaps the commission fueled mortgage broker, lied about the lender's income and ability to pay, in order to move the process along, get paid, or unload the loan to another buyer. In many cases, the borrower buying the house was the liar, hence the industry term “liar loans”.
There is more predatory lending going on in consumer purchase finance than in home purchase finance. Used cars are sold with usury interest rates off lots with the full intention of repossessing the car for a profit later. But without “the American Dream” getting repossessed, politicians stay quiet. Nobody cares if a truly poor hardworking individual loses his transportation to work, but if a higher income condo flipper in Miami gets stuck holding title to a few properties when the music stops, the villains who financed the no money down speculator must be shackled on the public square.
Credit card companies make the typical subprime lender look like Mother Teresa Savings & Loan. While there may be some lesser known, questionable lenders making predatory home loans, big credit card companies like JPMorgan Chase routinely send Americans into bankruptcy by increasing the interest rates on their cards to “default rates” of around 30 percent, because the borrower missed some payments to another creditor — even a utility or medical bill.
In all of the articles bashing subprime lenders, there is very little mention of the actual interest rates charged — just the “payments doubling” or “teaser rates expiring.” The entire credit card industry is built on teaser interest rates of 0 percent, that can ultimately go to 30 percent. You are told to use these 0 percent loans to “take a vacation,” or “buy an HDTV.”
By and large, the interest rates charged in the subprime loan business were surprisingly low, given the minimal down payments and spotty credit records. I wish somebody would have lent me money to buy my first apartment in New York City, with no money down and an interest rate just a few percentage points above a prime buyer with 20 percent down.
Today’s lenders have put more lower income and minorities into the American dream — too many perhaps — than all the politicians combined could ever take credit for. While adding disclosures that could simplify understanding mortgages and future payments is fine, political meddling in the mortgage market will cut off those most in need of money. Worry more for those who won’t be able to borrow tomorrow than those who are getting kicked out of their homes today.
“Get rich in real estate with no money down using other people’s money” charlatans will lead more to bankruptcy court than today’s predatory lenders.
Bottom line, 99 percent of the time, the lenders want borrowers to make the payments and stay in their homes. They don’t want to foreclose on a home that was bought with little to no money down, especially now that home prices are sinking in many areas with rising foreclosure rates.
Predatory lenders make money when borrowers lose their home. Ordinary lenders just go bankrupt.
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