No Money Down! A Lifetime to Pay!

Welcome, friend, to the booming field of "subprime" mortgages. Think you can't afford a house? You're probably right, but that won't stop us from putting you in one!

In an effort to keep the money churning, and despite warnings from federal officials, even old-school mainstream lenders have loosened the terms on which they extend credit in recent months. Bankruptcies and foreclosures are no longer an obstacle to getting a credit card--just to getting one with an affordable interest rate. This year two-thirds of new mortgages are either interest-only loans, in which the borrower pays nothing toward the principal until a balloon payment for the entire amount comes due, or feature an adjustable rate, which delivers sticker shock, albeit in smaller increments.

As program manager for Lutheran Social Services Financial Counseling, Darryl Dahlheimer is described by local debt counselors as the Twin Cities' credit guru. "Lenders have never seen a loan they didn't want to make. They get fees and costs," he says. "Ford Motors made more money on their loans than by selling cars. Sears makes more on its Mastercard than from its stores. It's very profitable and tempting for mainstream financial institutions to get involved in this."

Which is very bad for consumers, he adds. "These loans are like Band-Aids on a burning garbage can."

 

In 1978, the U.S. Supreme Court handed down Marquette vs. First Omaha Service Corp., allowing banks to charge customers whatever interest rate was allowed by the laws of the bank's home state, not the borrower's. Quickly, first South Dakota and then Delaware eliminated their "usury laws," rules capping what interest lenders could charge. As banks rushed to relocate their credit card subsidiaries to those states, others followed.

From the consumer's standpoint, the move was a mixed bag. The good news was that people who hadn't previously qualified for credit cards could enter the market. If they managed their cards well, they could qualify for car loans and mortgages. If they didn't, however, they could expect to pay not the state-mandated 9 or 10 percent in interest, but 15, 20, or sometimes even 30 percent in interest. (Minnesota caps interest at a relatively business-friendly 18 percent.)

As the market opened up, lenders were pleased to discover that when they encouraged people to take on more debt, they made more money. First credit card issuers discovered that people spent more when lenders raised credit limits and lowered minimum monthly payments. That led to the realization that the customers who pay their bill in full every month might be the best risk, but not the most profitable mark; better are the so-called revolvers, the 35 million Americans who, according to an investigation by PBS's Frontline, make only minimum payments. In 1996, another Supreme Court decision eliminated many restrictions on the fees lenders can charge. Before long, many credit card issuers were making more money on late fees and overage penalties than on interest.

Today 144 million Americans have credit cards, which they use to charge $1.5 trillion a year. Between 1990 and 2003, household debt, adjusted for inflation, rose more than 80 percent, according to the Federal Reserve. From 1945 to 2003, it rose 30-fold.

The credit card industry's discovery of profit in debt did not go unnoticed by other sectors of the financial services industry, and in the mid-'90s lenders began loosening the terms on mortgages and home equity loans. In 1996 alone, for instance, the number of home equity loans made rose by 22 percent, according to American Banker. While the loans had long been used for new roofs and remodeling, lenders began to urge consumers to use home equity loans to deal with their burgeoning credit card debt. Why pay 12 or 15 percent interest on a credit card when you can pay 8 percent and, because it's a second mortgage, write off interest paid on your taxes?

Mortgage terms were changing, too. Home ownership rates soared as the down payments required to finance the purchase of a house fell from 20 to 10 percent, and then to 5 percent, and finally to zero. For those who still found buying a house too expensive, the adjustable rate mortgage offered lower-than-normal interest rates for a few years--usually three--after which, consumers were counseled, they could simply refinance. And with each transaction, of course, the mortgage broker made a tidy commission and the lender raked in fat fees.

The bursting of the tech bubble a few years ago left a lot of investment dollars looking for a new home and accelerated the explosion in housing prices, which in turn stimulated more interest from Wall Street investors. Vast amounts of capital became available to companies specializing in giving mortgages to people with no credit, bad credit, or tarnished credit. These so-called subprime lenders charge interest rates and fees far higher than those offered to more desirable "prime" customers. The loans are then packaged in big pools and sold as securities to investors.

A growing pool of people like the Marolts, with blemished credit and a well-founded fear of getting priced out of the housing market, has meant boom times for subprime mortgagors. Subprime loans made up 5 percent of mortgages issued in 2000 and 28 percent of the total so far this year. In the three years ending in June 2004, revenue at New Century grew 651 percent, from $180 million to $1.4 billion, according to the Orange County Business Journal. During that same time period, Ameriquest's mortgage production grew more than 12-fold to $82.7 billion, according to American Banker magazine.

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