Predatory Lending: The Sub-Prime Mortgage and Payday Industry
This paper was prepared for Markets and Institutions, Finance 323, taught by Professor Geyfman
Predatory lenders are growing at an alarming rate; in this paper I will provide an examination of predatory lending patterns and the effects on the markets and consumers. Predatory lending is defined as the practice in which a loan is made to a borrower in the hope or expectation that the borrower will default. (Predatory, N.D.) The market for short-term loans have only been around for the past twenty years, however, has expanded at such a rate that there are now more ...view middle of the document...
Before sub-prime mortgage lending, borrowers would often get turned down from companies and banks for mortgages because they simply did not earn enough income to afford the house in question. A sub-prime loan allowed borrowers to have the ability to buy the house of their dreams.
The danger in these loans is it tricks consumers into believing they can afford a house that is far out of their price range. The loans are made to be attractive and easy enough for anyone to be preapproved. Sub-prime mortgages are so attractive that in Atlanta, Georgia, the amount of sub-prime loans increased 500% from 1993 to 1998. (History, N.D.) The graph in the appendix shows across the nation the total monthly balance of sub-prime loans grew from $111.6 billion in 2000 to $840.8 billion at its peak in 2007 before the recession. (Fun, N.D.)
They accomplish this by offering what lenders call “affordability products.” (Reed, 2014) For example, a negative amortization loan allows a borrower to only pay the interest due on the loan each month then upon maturity, the full principal is due at once. These tactics use teaser costs that are low in the beginning but towards the end, are much higher than originally thought possible. Another tactic used by lenders is called “fee packing.” (Negative, 2011) This refers to hidden and often unnecessary fees tacked onto loans to make more profit for the lender.
A lender is able to hold onto mortgages to collect the interest payments and fees. They will continue to do this or they can drop all of their risk and bundle loans to sell to third parties. Most will decide to bundle and sell the loans because they know how risky these loans are and expect the borrowers to default upon the payments at some point. When the lender has sold your loan, the lender has no risk and simply accepts fees from the third party for collecting the borrowers payments and transferring the funds to the third party. This allows the lenders the freedom to create as many mortgages as possible while not having to consider the borrower’s credit risk. (Diaz, 2008) As I pointed out earlier in the graph in the appendix, the peak of the sub-prime mortgage industry was right before the recession in 2007. This is because when borrowers began defaulting on their payments, payments stopped being made which caused third parties to not receive their payments and the sub-prime lenders then were not receiving their fees. In order for borrowers to pay off their mortgages their houses would forced to be foreclosed and sold. Foreclosure is relevant even with prime mortgages, however, the rate at which properties bought with sub-prime mortgages were being foreclosed made the values of the properties drastically drop and made it near impossible for the houses to be sold. At the height of the recession in late 2008, the total monthly balance of foreclosures due to sub-prime mortgages hit $91.6 billion. This dwarfs the amount in 2000 when foreclosures were only at $4.7...