Enticed by an offer of lower monthly payments and a chance to consolidate their bills, this couple refinanced their home mortgage with a subprime lender. Subprime lending, that is, lending to borrowers with marginal credit at higher than normal interest rates, is a skyrocketing business. It’s also rife with abuse: How can you consolidate a) a $91,000 mortgage, b) a $12,500 loan, and c) $1200 worth of credit card bills and come up with d) a loan principal of $119,726.15? Welcome to the shady world of predatory lending, where high interest rates, outrageous fees, and punitive terms are the norm.
1 Prime loans–traditional home loans from banks–typically have an interest rate in the ballpark of 7 percent, but this subprime loan comes with a whopping 11.9 percent interest rate. Why not an even 12.0 percent? Perhaps because under some state laws–including a new Texas law–lenders must advise borrowers about the availability of debt counseling for loans at a rate of 12 percent or higher. Another subprime lending reform recently adopted in Texas prohibits low-rate government and nonprofit loans from being refinanced at a higher rate for seven years–but it says nothing about private, for-profit loans like this one.
2 Back to that mysteriously growing principal: In a scam the Consumer Federation of America has called “the worst insurance rip off” in the U.S., this couple was aggressively sold single premium credit life insurance. Credit life insurance, which pays the holder’s mortgage payments in the event of his or her death, is not uncommon–it’s the deceptive way predatory lenders sell it that stinks. With single premium insurance, instead of making regular monthly or quarterly cash payments, the borrower is assessed one lump sum, which is financed immediately into the loan principal. Because of the interest payments the borrower will make over the life of the loan, these policies can cost as much as five times more than monthly credit insurance. Even worse, if these consumers later try to refinance through legitimate lenders, such as the Fannie Mae or Freddie Mac corporations, they may be out of luck, since both companies refuse to purchase loans with financed credit insurance.
3 In addition to higher interest rates, fees are what attract vultures into the subprime lending game. While prime lenders typically collect a 1-2 percent origination fee (known as the loan discount fee) at the time the loan is made, this couple found themselves with a fee of 7.4 percent, which is just under the maximum established by federal law. In this case, that’s over $8,500, added right to the principal! One motivation behind this couple’s decision to refinance was credit card debt, a typical trap that lenders set to draw in lower-income folks. While refinancing means some relief from the credit card companies, it means a higher loan principal and thus more money to be paid in fees. Any equity that the couple may have had in this home vanishes, since their new loan principal is so inflated. Once the paperwork is signed and the rescission period expires, there is no way to get that equity back.
4 The rise in subprime lending has skyrocketed especially in minority communities. In Houston, for example, whites only comprise about 5 percent of subprime borrowers, according to a recent report by Acorn, the low-income community advocacy organization. African Americans, meanwhile, purchased a whopping 32 percent of subprime loans, and Latinos account for 11 percent. Nationwide, Acorn found that from 1995 to 2000, the number of subprime loans to African-American homebuyers rose 714 percent, while the number of prime loans actually fell slightly. Subprime lenders go after folks with less-than-perfect credit, who are understandably dubious about their ability to get credit elsewhere at a better rate. But Fannie Mae estimates that about half of all subprime borrowers could have qualified for a lower-interest loan, thus saving thousands of dollars over the life of the loan.