Subprime loans are bad for most borrowers and a disaster for others. At best, these high-priced loans add substantial debt to already overburdened consumers.
At worst, they cost borrowers their homes or drive them into bankruptcy. No wonder one Wall Street executive called these loans an "evil creation."Subprime mortgage and auto loans are being marketed aggressively to low- and moderate-income households with less than an "A" credit rating. These loans are almost always "sold," not "bought." Sellers pitch relentlessly by mail, by phone and at the door.
All too often they succeed - last year, by most estimates, subprime lending exceeded $100 billion.
For these loans, consumers pay a high price. That cost begins with interest rates and fees. The most reputable subprime lenders charge a 10 percent to 16 percent rate and closing costs that are almost always much higher than those on conventional loans. Predatory lenders, however, assess charges that often escalate finance charges to 40 percent or more.
Recent research shows that a significant minority of subprime borrowers could obtain conventional loans at much lower prices. These consumers typically are victimized by a combination of aggressive lender selling and their own lack of financial sophistication.
A far higher consumer cost of subprime lending, however, is the personal financial crises they precipitate. There are two typical scenarios involving subprime mort-gage loans. The most common is experienced by consumers who refinance credit-card debts. Without lowering costs appreciably, they regain substantial lines of revolving credit. If they again run up sizable credit-card debts, they risk losing their homes through foreclosure or being driven into bankruptcy.
An even more troubling scenario is the targeting of low- and moderate-income homeowners, often elderly, by predatory lenders.
Through personal contacts and high-pressure tactics, these sellers consciously seek to skim home equity. They do so through oppressive loan terms that typically include high rates, excessive fees and points, huge brokerage commissions, overpriced credit insurance, unaffordable balloon pay-ments and draconian late payment penalties, which have included a foreclosure notice after one missed payment.
Borrowers who were counting on low housing costs in their retirement years end up saddled with expensive mortgage loans.
The subprime lending spurt has been fueled by financial institutions with money to lend who have saturated credit-card markets and have the ability to sell loans to investors (i.e., securitization). Yet, because of rising delinquencies, many of these institutions and investors have recently suffered losses. That has been made possible by mortgage loans often exceeding home value by 25 percent to 50 percent and by cars greatly overpriced. In both instances, the loan collateral does not come close to covering the loan amount.
While these losses normally would restrain future subprime lending, bankruptcy "reform" may ease this restraint. Congress is poised to restrict the ability of bankrupts to discharge many of their debts. Any significant reform could persuade lenders that even borrowers heavily burdened with debt would eventually be forced to make repayments. That could set off another surge of subprime lending.
As an alternate to being financially indentured to lenders for many years, consumers should "just say no" to almost every subprime loan. They will save lots of money. They will reduce the risks of foreclosure and bankruptcy. And as an added bonus, they will experience less-frequent and aggressive marketing by lenders.
If consumers need to finance a purchase, they should try to save enough money to qualify for a conventional loan. If they are burdened with huge debts, they should immediately contact their local nonprofit consumer credit counseling service (800-388-2227).