The Check's in the Mail

Roll those credit cards into your mortgage, urge the ads, and your overall monthly bills will plummet. Sound too good to be true? It is.

The day that Thomas Patterson received his umpteenth mailer announcing his eligibility for an "instant" loan, water was pouring from the upstairs bathroom into the kitchen below. Strapped for cash and having exhausted his line of credit, Patterson--not his real name--called the number listed on the faux check. Within a few hours, $40,000 had been deposited into his bank account for home repairs and debt consolidation. Six months later, however, Patterson is deeper in debt than ever, and this time he's at risk of losing his home.

According to financial experts, he's one of an increasing number of unsuspecting borrowers who have been seduced by a new kind of loan allowing homeowners to borrow up to 125 percent of the value of their house. And within the year, they predict that this new lending instrument will dramatically increase the number of foreclosures.

Last summer, a new job enabled the Patterson family to move from its small rambler into the home of their dreams--a four-bedroom, 3,100-square-foot house located in a quiet, middle-class suburb northwest of the Twin Cities. The house cost $170,000, but since Thomas Patterson would be pulling in $70,000 a year in his new sales job, he was confident that he could swing the $1,200 monthly payment while letting his wife stay home with their three small children. However, he now concedes, he should have seen that his budget was already stretched to the breaking point. "I also had $20,000 in credit-card debt," he admits, "and I'd maxed out my $15,000 express line of credit with the bank."

Shannon Brady

So when the bathroom floor threatened to spill into the kitchen, Patterson picked up one of the mailers that had been lying around the house. He contacted Pacific Prime Mortgage, a privately owned brokerage firm based in California, and applied for what's known as the "125-percent" loan. Consumers with "unblemished credit" are able to get up to 100 percent of the value of their homes plus an additional 25 percent to use at their discretion. In Patterson's case, he says, he planned to use the money for home repairs and other "necessities."

Prior to 1979, the federal government set limits on the amount of interest banks and savings and loans could legally charge and pay customers. While savings-and-loan institutions were allowed a bit more leeway, in order to qualify for federal insurance on deposits, both types of institutions had to toe the government line. But at the end of the Carter administration, the federal government deregulated the banking industry, in part in the name of free-market competition. One result was that in an attempt to get an edge on competitors, banks began making it increasingly easy to borrow money, offering a steady stream of new types of loans. For example, homeowners used to have to put up substantial down payments. But faced with competition for mortgage lending, banks have steadily lowered the amount a buyer must produce.

Within the past year or so, explains Dan Hardy of the Minnesota Mortgage Bankers Association (MMBA), some savvy financiers realized that a growing number of homeowners were carrying substantial credit-card debt and were looking for ways to consolidate their bills, preferably at lower interest rates. Although consumers in this group tend to have a lot of debt compared to their income, they also have sterling payment records. No matter how onerous, most always pay their bills on time.

The combination of these two elements--a large debt load coupled with a diligent payer--is particularly alluring to lenders, especially as the likelihood that they'll pay off early is slim to none. "Financial institutions make their money off the servicing of the loan," or interest, says Hardy. "They lose money when people prepay." From a consumer's point of view, a home-equity loan is the best kind of debt to carry. Unlike credit-card interest, the interest paid on such loans is usually tax-deductible, making them cheaper in the long run.

Plus, says Patterson, there's the "lure of easy money": "You can get thousands of dollars within a few hours, and you can do it all from your home." This is due, in part, to the fact that the bulk of these kinds of loans aren't made by banks. Should a firm like Pacific make bad loans and consequently go belly-up, it answers only to its stockholders. But should a bank shut down as a result of these risky loans, it has to answer to the federal government because tax dollars are used to reimburse account-holders for their losses. And as the S&L crisis of the '80s taught us, the taxpaying public ultimately bears the bailout burden.

At the time of his loan, Patterson had paid off $24,000 on his home, so Pacific offered him $60,000. He opted to borrow $40,000 at 13.5 percent interest. "Part of my rationale was that I could get some things done around the house that I couldn't otherwise afford." Plus, he reasoned, since the term of the loan was more than 10 years, the monthly payments would be low.

That's true, say debt counselors, but Patterson had nonetheless fallen into the same thinking that drives millions of consumers into bankruptcy each year: "If it's being offered, then I must be able to afford it."

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