A Huge Reason For the Subprime Mess

I came across a couple of interesting articles yesterday regarding subprime mortgages. The first article, Wow, I Could’ve Had a Prime Mortgage, was enlightening. It seems that people who didn’t know any different were given subprime mortgages even though they qualified for a prime mortgage. OUCH! Why would such a thing happen? Well, this portion of the article explains why (bold emphasis mine):

Some consumer advocates blame loan officers and mortgage brokers who steer borrowers away from prime loans because they can make much more money from the subprime market.

“Dollar for dollar, it is much more lucrative for a broker to sell subprime loans,” said Allen Fishbein, a director of credit and housing policy for the Consumer Federation of America.

“I have a friend who interviewed for a job with my company,” said Hardester. “He told me, ‘I’m not coming to work for you. I can’t make enough money.'”

The friend, who had been working in the subprime industry, told Hardester he was used to getting an average of five points-plus for each loan he originated; that’s more than $10,000 on a $200,000 mortgage. Hardester’s company writes mostly prime loans, where the margins are much thinner – around 1 percent or less.

There’s your motivator right there: money. When a broker can make $8,000 more by selling a crappy product than he can make selling a decent product, he’s gonna sell the crappy product. Forget about doing what’s best for the client. Sell the product first and then justify it later. Most of the brokers who sold these subprime mortgages did nothing wrong legally. However, one has to question their ethics, especially if the client qualified for a prime mortgage but was sold a subprime mortgage.

The second article I read was a front-page story in the Wall Street Journal titled ‘Subprime’ Aftermath: Losing the Family Home($). The article profiles several families from a neighborhood in Detroit. The article made me angry for two reasons:

1. How could people be so stupid (or niave)? and…

2. How can lenders justify these types of loans?

Here’s the story of one lady and her husband:

April Williams was feeling the pain of the downturn back in 2002, when she saw an ad from subprime lender World Wide Financial Services Inc. offering cash to solve her financial problems. At the time, production slowdowns at Ford Motor Co. were squeezing her husband’s income from an assembly-line job, and they’d heard rumors that more cutbacks were coming. Still, after a loan officer from World Wide paid a visit, they became convinced they could afford stainless-steel appliances, custom tile, a new bay window, and central air-conditioning — and a $195,500 loan to retire their old mortgage and pay for the improvements. The loan carried an interest rate of 9.75% for the first two years, then a “margin” of 9.125 percentage points over the benchmark short-term rate at which banks lend money to each other — known as the London interbank offered rate, or Libor. The average subprime loan charges a margin of about 6.5% over six-month Libor, which as of Tuesday stood at 5.38%.

“I knew better than to be stupid like that,” she says. “But they caught me at a time when I was down.”

It would be nearly impossible for most people to afford that! According to Bankrate, the current six month Libor rate is 5.38%. So, after two years, this lady was going to be paying around 14.51% interest on her mortgage (9.125 + 5.38 = 14.505). For the first two years she would be paying over $1,679 per month, which would jump to $2,376 per month (that’s over $28,000 per year)!

Something I would like to know is whether or not she knew all of this information? I can’t imagine anyone signing up for something like this if they knew these numbers. Regardless, she was incredibly niave to get suckered into this deal.

That’s just one of the many stories regarding this mess. I have a feeling that we are only seeing the beginning of this.

Oh, and here’s a little message for the mortgage brokers who hawked these loans: Enjoy it while you can because everyone knows that a man reaps what he sows.

11 thoughts on “A Huge Reason For the Subprime Mess”

  1. This all boils down to people buying more house than they can afford. If your husband’s income is going down at his job and there is a possibility of a layoff, why the heck are you buying new appliances and such. Helllooo, news flash your income is going down while your expenses are going up.
    There was a times article in the real estate section on foreclosure in NY. It showed a lady in Queens, NY who bought a $515,000 home on her salary of $40,000. WTH??? I make more than that in the NY area and still know I cannot afford to buy any home, much less one that is half a million dollars.

  2. Check out the picture of Ms. Williams in front of her house in the WSJ article. She’s got a Lincoln Navigator parked in the driveway. If you can’t afford the house, the LUXURY appliances and the LUXURY car, then you don’t deserve a break when the spending catches up to you.

    The scary thing is that this is not an isolated incident. The debt funded spending binge the consumers in this country have been on over the last ten years can only foreshadow serious problems as the real estate market slows down and a major source of people’s liquidity is turned off.

  3. Is this typical of the subprime problem we’re seeing. 2 purchases, 5 refinances.

    New kitchens, marble floors, department store bills, etc. Ridiculous. Home equity loans are absolutely a bad idea, there is little reason to risk your home for any kind of debt repayment. You may have bad credit because you bought a bunch of furniture you couldn’t afford, but Dillard’s can’t come and take your house.

    New roof? Roofs don’t just explode one day, and any inspector can usually tell you far in advance when you need to replace your roof, and how much it will cost. Didn’t any of these people think “gee, I want a new kitchen, I should start saving for it”?

    One guy had a fixed rate loan of 86k (from 1997) and cashed out to a variable 112k loan. What are people thinking when they buy a house, spend 10 years paying it down, and then borrow AGAIN. Do people just like paying interest? I can only assume they do, if they pay interest not once but TWICE on the same house.

    I understand the frustration of someone new, buying their first home, being sold inflated loans with complex terms. Mortgages are complicated and can be overwhelming, especially if your lender dances around the negative aspects of such loans. Many people depend on their broker to understand the loan, they can’t understand by reading it themselves.

    But refinancing to cash out and pay for a new kitchen or credit cards? Sorry, you gambled with your most important asset, you lost.

  4. I think that a lot of people are subjectively bad at math. You would think that if your mortgage payment was more than your monthly income it would set off alarm bells, but many see what they want to see. This is rampant in our society and not only in financial matters (look at the obesity epidemic). JLP if you’re interested in hearing a firsthand account of the mortgage madness you might want to check out SoCalMtgGuy’s site (www.housingbubblecasualty.com). He’s a (former) mortgage broker who talks about how people were preyed upon, high rates, high prepays, etc. and how much money the brokers stood to gain from each with real inside data. It’s a real eye-opener.

  5. I recently blogged that the greed, the shameless unabated grab for money by these unscrupulous loan officers is nothing short of a crime. Fraud? Robbery? Both? The people that have created this catastrophe have tarnished the reputations of the professionals in the industry. How long will it take before people trust the true and professional mortgage loan officer again? Check out the interview that NPR had with an Ameriquest loan officer. You can listen to it at http://www.npr.org ……

  6. I read the same article and it is distressing that some people get taken for these kind of loans when they could qualify for something better. You have to wonder though, how many of these people did not go into the process with the education to make the right decisions. Some people are not concerned with how much they are paying overall, but how much their PAYMENTS are. It is the same thing with cars. Some people will take out a 6-7 year loan just to have a lower payment.

    If it is the loan officers telling them they only qualify for a sub-prime loan, then it is wrong on their part.

  7. I especially loved her quote earlier in that article. I don’t have it in front of me, but it was something to the effect of “They took away my dignity.” Really? Who did that?

    I pointed the Navigator out to my friend, too, after reading the article.

    Besides her husband facing fewer hours at his plant, did you catch her job? She’s a nursing home aid. Do you know what those people get paid? Like nothing. (Which is ironic since nursing home care costs a fortune).

    The bottom line is, this was greed all around. The mortgage brokers, CMO purchasers, homeowners – all of them.

  8. Doesn’t a 1600/mo payment seem like a lot to most people? Especially if your factory job is in jeopardy. 1600/mo is the payment on 275000, with nothing down and 6%. They financed 200K for the same payment. My spouse and I ran the numbers on everything until we got the payment where we wanted it just in case one of us was out of work (or on purpose, so one of us could stay home with children). These financial calculators have been around for decades, and even buying a handheld calculator would have been a sound investment for these two idiots.

  9. In regards to what Patrick said about the car loans, I have this to offer.
    Granted, our situation isn’t the typical situation, but here’s what we did.
    – Got a 6 year loan for our vehicle (after putting 20% down)
    – Maxed some of our credit cards at very low rates (highest was 1.99%), BUT PUT THE BORROWED MONEY INTO OUR EMIGRANTDIRECT savings account (at 5.05%)
    – Use the borrowed money in the savings account to make the minimum payments on the credit card
    – Use the interest earned in the savings account to help offset the car payment

    This effectively brought our average monthly car payment down to $95/month or less, even though the “real” car payment is $173/month. So the interest we’re earning on the credit cards is more than the interest we’re paying for the car loan. And if all goes well, we’ll be able to do this for another 4 years, at which point the car note will be paid in full.
    Whoever said you can’t borrow money to make money, wasn’t quite right 🙂

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