After 30 years of falling interest rates, Americans have become addicted to cheap credit and personal Ponzi schemes. People have learned they can take on large debts, consolidate them at lower and lower interest rates, and service that debt with a portion of their income. It’s a bit like learning to live with a lamprey slowly sucking your financial juices. Often it’s not enough to kill, so it’s a parasite people learn to live with.
Oftentimes when people get in trouble with debt, they stop using it. As Jesus would say, “sin no more.” Through falling interest rates, loan consolidations, and other methods of “working with borrowers,” lenders have learned out not to kill their hosts. Lenders have intentionally fostered moral hazard by teaching people to live with their parasites rather than learning how to get rid of them.
After the crescendo of credit craziness that culminated with the 2008 financial collapse, I hoped a few people would have learned the perils of excessive debt. Not so. The federal reserve lowered interest rates to zero to keep millions of hosts from experiencing a cleansing financial death. As a result, people are becoming accustomed to a life with debt, sometimes very high cost debt.
High-cost borrowing through payday loans, pawn shops, auto title loans and others is no longer on the margins of U.S. consumer behavior — about 1 in 4 Americans have tapped this kind of financing, new research shows.
A new study by the National Bureau of Economic Research finds high-cost lending is now firmly rooted in the American financial system after two decades of strong growth.
“High-cost borrowing cannot be considered a ‘fringe’ behavior that is limited to a specific and small segment of the population,” economists Annamaria Lusardi and Carlo de Bassa Scheresberg wrote in their study. “Rather, it is firmly rooted in the American financial system and is common even for households who are generally referred to as ‘middle-class families.’”
High-cost borrowing is a cancer. It’s a sickness that should be eradicated before it kills Americans financially. People who work in the PayDay loan industry or any of the related high-cost borrowing rip-offs are selling their souls like those who work for big tobacco.
The new research comes amid a renewed regulatory focus on this type of lending, particularly the payday loan industry. A recent report by the Consumer Financial Protection Bureau found that payday loans were essentially a “debt trap.”
The average payday-loan consumer took out 11 loans during a 12-month period, paying a total of $574 in fees — not including loan principal, according to the study by that federal agency. A quarter of borrowers paid $781 or more in fees.
PayDay loan fees are so high that once a borrower uses one, their next paycheck is consumed by the fees, so then they need another loan. Once they start, they can never stop. It is a financial death spiral.
The study also found that about 34% of young adults have used a payday loan, pawn broker or some other form of high-cost financing. A low level of financial literacy correlated highly to the use of these loan products.
The second cousins to PayDay loan sharks are subprime lenders. The worst part about their customers is that rather than recognizing their financial illiteracy, these people believe they are sophisticated borrowers displaying creativity in their financing. Idiots.
Lenders are reemerging to offer the classic subprime trade-off: high-priced loans for high-risk customers. This time, though, the standards are more stringent.
Michele and Russell Poland’s credit was shot, but they managed to buy their suburban dream home anyway.
After a business bankruptcy and a home foreclosure, they turned to a rare option in this era of tightfisted banking — a subprime loan.
The Polands paid nearly $10,000 in upfront fees for the privilege of securing a mortgage at 10.9% interest. And they had to raid their retirement account for a 35% down payment.
$10,000 in fees?
35% down — which they got by raiding their retirement?
Tony Soprano would have given better terms. As one commenter pointed out, there are hard-money lenders providing loans to flippers under better terms.
The contention that they bought their dream home with a 10.9% interest rate is quite a stretch. These people were competing with others borrowing at 3.5%. That’s a huge advantage in leverage. Whatever these people bought, it was far less than what others with their income are getting.
Most borrowers would balk at such stiff terms.
Anyone with a brain would balk at those terms.
But with prices rising, the Polands wanted to snag a four-bedroom home in Temecula near top-rated schools for their 5-year-old son. By later this year, they figure, they’ll be able to refinance into a standard loan.
“The mortgage is a bridge loan,” said Russ Poland, now working as an insurance investigator. “It was expensive, but we think it’s worth it.”
Didn’t people learn that’s a road to destruction during the bubble? If you can’t sustain ownership on the purchase loan, the hope of subsequent refinances won’t make ownership tenable.
In the aftermath of the housing crash, there’s no shortage of Americans who, like the Polands, are eager to rebuild their shattered finances. In response, lenders are emerging to offer the classic subprime trade-off: high-priced loans for high-risk customers. …
The idea of charging higher interest rates for higher risk customers could work for a few on the fringe. However, that’s not what subprime lenders do. They typically go well past the fringe and start loaning money to anyone.
But the explosion of mortgage defaults that began in late 2006 vaporized an entire industry of subprime specialists. The Wall Street firms that had bundled the loans into securities soon began to implode as well. Little wonder that loans for the credit-challenged disappeared.
Today’s high-risk lenders differ from those during the housing boom in key ways. These lenders say the new subprime mortgages are actually old school — the kind of loans made in the 1980s and 1990s. In other words, a borrower’s collateral matters, down payments matter, income and ability to pay matter.
Subprime lenders care because they are holding the loans on their books rather than selling them to investors.
Based on the onerous terms given to these borrowers, the lender was matching the return to the risk. By demanding a large down payment, hefty up-front fees, and high interest rates, the lender has done everything possible to mitigate the risk. What’s amazing is the anyone would take out such a loan.
They hope a private securities market for subprime loans, also destroyed in the meltdown, will reemerge soon.
For now, the subprime and alt-A business remains small, maybe $8 billion total, estimated Inside Mortgage Finance Editor Guy D. Cecala. That’s less than half of 1% of the $1.8 trillion in U.S. home loans last year.
The market for subprime loans is nearly dead — as it should be given the enormous losses investors took on these securities.
John C. Williams, president of the Federal Reserve Bank of San Francisco, sees no reason that subprime mortgage bonds can’t reemerge in “plain vanilla” form, as opposed to the complex concoctions that ended up as “toxic assets” in the meltdown.
“I can’t understand why it hasn’t come back sooner,” he said, pointing out that there’s a strong market for bonds backed by subprime auto and credit-card loans.
“California has been famous for devising exotic mortgages,” Williams said. “But the reality is that they held up rather well until we started doing things like giving them to people with no jobs.”
I find ignorant statements like that from the president of a federal reserve bank shocking. He really believes the problem with subprime was the lowering of standards. That is not the case. The lowering of standards allowed lenders to keep the game going a little longer, but the real problem with subprime is with the business model itself. Subprime only works when prices are rising because otherwise the default losses are too large. Lowering standards kept the flow of customers coming in and helped perpetuate the rise of prices necessary to keep the business model alive. As soon as prices either stop going up or start going down, subprime no longer works.
I guess it’s not just borrowers who failed to learn the lessons of the housing bubble.
Late 2008 loans going bad?
After the credit crunch of August 2007, lenders were supposed to have cleaned up their act. We keep hearing that credit standards have improved and the new loan vintages since the bubble are much better. Is that really the case? If it were, we wouldn’t see foreclosures from late 2008 vintage loans, but here we are.
The former owners of today’s featured REO paid $398,000 on 11/20/2008. They put $39,800 down and borrowed $358,200. They quit paying in 2010, and they were allowed to squat for a little more than one year. The bank then sat on this property for 18 months waiting for prices to come back. I guess it finally reached the top of the queue because they are finally ready to sell it.
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Proprietary OC Housing News home purchase analysis
$425,000 …….. Asking Price
$398,000 ………. Purchase Price
11/20/2008 ………. Purchase Date
$27,000 ………. Gross Gain (Loss)
($34,000) ………… Commissions and Costs at 8%
($7,000) ………. Net Gain (Loss)
6.8% ………. Gross Percent Change
-1.8% ………. Net Percent Change
1.5% ………… Annual Appreciation
Cost of Home Ownership
$425,000 …….. Asking Price
$14,875 ………… 3.5% Down FHA Financing
3.47% …………. Mortgage Interest Rate
30 ……………… Number of Years
$410,125 …….. Mortgage
$106,570 ………. Income Requirement
$1,835 ………… Monthly Mortgage Payment
$368 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$89 ………… Homeowners Insurance at 0.25%
$461 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,753 ………. Monthly Cash Outlays
($378) ………. Tax Savings
($649) ………. Principal Amortization
$16 ………….. Opportunity Cost of Down Payment
$126 ………….. Maintenance and Replacement Reserves
$1,869 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$5,750 ………… Furnishing and Move-In Costs at 1% + $1,500
$5,750 ………… Closing Costs at 1% + $1,500
$4,101 ………… Interest Points at 1%
$14,875 ………… Down Payment
$30,476 ………. Total Cash Costs
$28,600 ………. Emergency Cash Reserves
$59,076 ………. Total Savings Needed