Yes, but (even though, as you point out, both are often true) I would be extremely leery of basing my own financial health for the next n years on these assumptions. It’s also important to note that (as you also point out) while they’re almost always true in the long term, in the short term things can get much dicier, and the fact that I’ll get another job or my house’s value will appreciate in six months doesn’t help a whole lot if the sheriff is at the door this minute.

When you talk about personal fiscal responsibility, not overextending yourself and not buying fancy stuff you don’t need, you are actually singing out of my hymnal (as it were). I do think the responsibility should be a two-way street between lenders and borrowers. The irony is that I clearly recall that when we bought our second house the mortgage banker we worked with made sure that we could do the down payment with a pretty comfy cushion, which I think we needed to qualify for the type of mortgage we were getting.

People who have the cushion and can do a traditional 20-percent-down mortgage get offered the best rates; the people who are living closest to the edge are the ones who can only get riskier loans at higher rates. Now, I do understand why this is, that the higher the number of people in a given pool who statistically will default, the higher the interest rate on loans to that pool needs to be in order to make a profit on that group of loans as a whole. But it does seem like a self-fulfilling prophecy: if you’re one or two paychecks from insolvency to start with, and you have to pay higher rates, and your interest rates on your credit cards suddenly double because you miss one payment, of course you’re more likely to default. And after a certain point I have trouble with the ethics of it. Not everyone is pathologically risk-averse (I’m not labeling anyone else that, just myself), and I don’t think lenders should encourage people to bet the farm.

Lenders figure that a house’s value will either stay the same or increase. Borrowers figure that their income is going to go up in time. Usually, they’re both right. But not always, and a downturn in the economy can create a lot of problems.

There have been a lot of new houses built in my area in the last decade. They’ve been getting bigger and more elaborate as the years go on. My son sold pancake breakfast tickets and Christmas wreaths every year for his Boy Scout Troop, and things being the way they are these days I didn’t just kick him out the door with a fistful of tickets or an order book like my parents did, I walked around with him.

It was very instructive. We would walk up to the front door of this 2500+ square foot home made of brick with nice landscaping, fancy masonry, etc. I’d look in the windows (from an appropriate distance, mind you) and see … nothing. No curtains, no rugs, no furniture. House after house people were putting all their money into the house itself. There’d be some toys around and about, but that was it. Oh, and the $30,000+ cars. The idea is that “Oh, we’re young, our salaries will go up and we can afford to buy furniture then.” Then they get laid off, or raises are down or flat (hell, one year I had to take a CUT). If one of them loses their job, they’re in deep doo-doo.

Me, I paid $90,000 for my 1700 sq. ft. house on 3/4 of an acre (for you metric folks, my house is on a lot 39 m x 85 m) twenty years ago, and it’s covered with aluminum siding, not brick (siding is considered much less desirable in the Chicago area). My lot is at least 3x the size that these larger houses are on, and unlike them is covered with trees and plants. If I sold tomorrow I’d get about $350,000 for the house, and the new owner would knock it and most of the trees down the next day and either build a much larger house on it or try to figure out how to split it up into 3 lots and build a house on each. I’d never sell, because I’d never be able to get equivalent housing for $350,000 anywhere nearby. I’ll only sell when I’m too damn old and feeble to take care of myself and the house anymore.

But the point is that I’m not house poor; even when I bought it I paid a much smaller multiple of my then annual income than these folks have, because I was afraid to commit more money than that. I also got a deal because the owner, whom my wife was distantly related to, gave us a $20,000 break on the price. We were renting a house in the neighborhood when she called us up one day; her husband (70+ years old) was in great pain and she wanted to take him to the hospital. Her son couldn’t be bothered, so we took him. He thought he was dying, but it turned out to be a kidney stone. This was remembered in our favor 5 years later when we looked to buy her home (which was not at all something we had anticipated at the time). But without that break we’d have bought another property in our price range. I’m also fortunate that over the 20 years after that I have gotten a reasonable raise almost every year.

1) why anyone would take out a loan they couldn’t afford 2) why any financial institution would make such a loan.

Assuming that there’s no misrepresentation involved the obvious answer is that something changed. Maybe the borrower lost their job, had a child, had a lot of home repairs to make or lived beyond their means and got into credit card debt.

I hear these lurid tales of people who gross $5000 a month taking out loans with payments of $2000 a month increasing to $6000 a month after two years — those numbers are exaggerated, of course, but you get the idea.

well, three years ago I bought a house on a 3 year ARM, with 10% of the down payment on a 15 year interest only loan. I’d been planning to move in three years so at the time it made sense. But if things hadn’t worked out the way I was planning I’d have been in a difficult situation. I basically had to move when I did no matter what, or watch my mortgage payment balloon. I wasn’t exactly walking on the edge, but I could have bought more house. Lenders are willing to assume the buyer will be house poor to a shocking extent.

these people crunch numbers for a living, so the only explanation I can think of is that they’ve figured out how to do OK even if the debtor goes bust. Or maybe, as Ron said, they think the taxpayers will bail them out.

well, there’s money to be made in lending money and a lot of people want a piece of it. So we get lot’s of lenders and lots of competition. People take more and more chances and eventually a company or two goes too far and goes out of business. Believe me, they screw up just like everyone else. You’ll see a lot of them go out of business or be bought out soon enough.

If the loan is unsecured, yes, it would be stupid. If the loan is secured by collateral that’s appreciating, you get whatever payments you’re able to collect before the balloon payment comes due, plus you get to resell the collateral and at least break even. If you can pass the collateral (house) off to the real-estate arm of your company, a sweet deal indeed.

It rarely works this way for houses. The foreclosure process is both long and public. It’s very hard to ‘surprise’ someone with the sale of their house. In a normal scenario there’s no equity left in the house. The owner has borrowed as much as they can get. Think about it, if you owed 10K on a 80K house and couldn’t make the payments you’d sell or refinance.

Most banks would rather sell short, (sell the house for less then the debt and either write of the loss or take a promissory note) than take ownership of the house. They have transaction costs associated with the sale just like we do. Most houses that go into foreclosure aren’t in great shape and often have tax bills that have to be paid off. Not slamming people that have lost their homes, but if you were struggling to make the house payment how much time and money would you put in curb appeal? If you knew you were being thrown out, what condition would you leave the property in? This makes it very hard for the bank to make back what was owed on the house

If the loan is unsecured, yes, it would be stupid. If the loan is secured by collateral that’s appreciating, you get whatever payments you’re able to collect before the balloon payment comes due, plus you get to resell the collateral and at least break even. If you can pass the collateral (house) off to the real-estate arm of your company, a sweet deal indeed.

If OTOH you raise the interest rate on a credit card by 50 percent or more soon as a debtor misses one payment, you are indeed very likely making an unsecured loan that the debtor can’t pay.

And, yes, if a lender who failed in due diligence were required to compensate the debtor more than the value of the loan, some people would try to get such loans — which would put more of the burden back on lenders to minimize risk. I agree that a lot of people wouldn’t be in over their heads if they’d read the fine print, and that they should read the fine print, but why should ALL of the responsibility be on the debtor to avoid being screwed, and not on the lender not to screw people?

I also agree that if lenders made fewer risky loans, more people would be unable to get credit, but I think that would be as it should be.

This argument presumes that the practice of reselling loans as described is the product of a declining market as opposed to being a pre-existing pattern of business. Is that your contention?

That is not my contention. There can be many reasons to sell a loan. The value of a loan is give by present value of the future payments. This present value is determined by a discount rate that incorporates all risk associated with the loan. The current value off a loan can go up or down depending on interest rates, the value of the collateral, and the risk of default. Basically, they’re just another investment. Banks will buy or sell them for a variety of reasons. Well mostly just to make a profit. But the specific strategies can be complicated.

It’s debatable who’s doing the selling and who’s doing the buying in the home mortgage market. In practice the home owner feels like the buyer but that’s psychological. I’m offering you 500$/mo for 30 years in exchange for $85,000 today. Does it matter if I rewrite the sentence as You’re offering me $85,000 today in exchange for 360 monthly payments of 500$? I suppose if you call me you’re selling, but if I call you I’m selling. If you put an add in the paper does that make you the seller? What if I call every lender I can find? In principle a home mortgage and a corporate bond are the same thing. Does that mean that GE isn’t selling bond anymore?

I think both parties have an obligation to honestly represent all relevant information. If the loan originator obscures the fact that payments might change, or how this would be governed I think they’re guilty of fraud. If they create a loan they expect not to be paid back in anticipation of colleting fees and penalties (e.g. check cashing) I think they’re engaging in predatory lending.

If the loan originator acted as an agent of the lending institution there is the question of negligence as well as active participation.

True. But in that case you’d have to show both that the loan originator was a cooked and that the bank was negligent.

If you sell a substandard or injurious product, you cannot escape culpability by citing the fact that someone else sold it to you first. You must demonstrate that you satisfied the requirements of due diligence, Otherwise you are liable through negligence.

True, but there’s nothing wrong with the loan itself, the structure of the loan is fine it’s the way it was created that was the problem.
Say you sell me a sup-prime loan in Atlanta. (Let’s assume that you did so to collect origination fees. Let’s assume that you intentional obscured the terms of the loan from me. And that you strongly suspected that I would default. Let’s also assume that you leave a paper trail so there’s no doubt as to what you did. The bank you work for (Bank 0) takes that loan and 1000 others of similar risk and sells them to Bank A. (lets assume Bank A buys them and 9000 more because Bank A expect that housing prices will appreciate and thus the loans will become more valuable). Interest rates go up. Bank A decides it can get a better rate of return on it’s 8.6million dollars in the stock market and sells the loans to Pension Fund B. (Let’s assume that Pension Fund B expects interest rates are too low due to all the recent stock buying. So they want to get something that will go up in value quickly as bond prices rise.) Mutual Fund C comes along and offers to buy the loans from Pension Fund B at a slight premium. (Mutual Fund C is a publicly traded fund that specializes in the housing market, but they’ve accidentally concentrated too many loans in California and want to hedge against regional variation.
Now I find out that the loan you wrote has an interest rate that goes up every year. I know I asked you about that. I have notes of what you said. My lawyer finds your paper trail. But like many con artists you’ve left town and I can’t get any money from you.

Do you really think I have a claim of negligence against Bank C? If you do, and if you the courts agree with you I predict one of three things. Lawyers will find a way out of it, there will be less capital available to poor (risky) people, the interest rates for risky borrowers will go up to reflect the new risk. Most likely some of all three.

Few financial institutions are in business for the short term. Yeah, you can turn around your portfolio of crappy loans…once. The next cycle, who’s going to buy from you? The other players in the loan buying market (unlike the poor folks that predatory lenders target) have access to good information - like, the performance of the loans they bought from you last year. If the performance is lower than what the estimates of same predicted…you don’t have a customer any more.

Go to the next buyer? Sure…but eventually people start to wonder why you never get any repeat customers for your loan sales, and you’re out of luck.

I don’t doubt that there are a fair number of predatory lenders out there, but it really isn’t possible for a company to stay afloat making bad loans unless a government, or some other discretionless agent that can’t engage in commonsense declining to trade, is involved.

Creditors don’t make loans they know the debtor can’t pay back. That would be stupid.

Only stupid if the creditor has no means of realizing a profit short term by offloading the liability onto someone else.

The value of a bond is determined by the discounted value of it’s future payments. That discount rate is based on the risk associated with the loan. It includes not just the present value of the future payments but also the risk associated with inflation and default. The risk of default depends on both the liquidity of the borrower and the future value of the collateral. So in a falling housing market with rising foreclosures the value of the loan is going to decrease and the company that’s holding it now will have to sell it for less than they paid. In other words, they’ll loose money.

This argument presumes that the practice of reselling loans as described is the product of a declining market as opposed to being a pre-existing pattern of business. Is that your contention?

Sub-Prime loans were made more possible by the housing bubble. Since the future value of the collateral was expected to rise the discount rate was assumed to fall and the loan became more valuable. Sine this isn’t true anymore there aren’t as many places willing to buy the loans and the companies that originated them don’t have the capital they need to keep making loans. So they go out of business, or at least leave the Sub-Prime segment of the market.

You now appear to be arguing that the pattern of reselling was a product of the boom rather than the bust. In which case your previous explanation loses its credibility. Further, if the origin of the loan lies in boomtimes and the boom produced the cycle of reselling, then the likelyhood is that the majority of bad loans are no longer held by the originating lender. That such lenders will change business practice in light of the bust does nothing to deter them in future and it certainly doesn’t insure that they will go out of business, since they have already taken the greater part of their profits.

The person you want to ‘hold accountable’ is the loan originator, not the company that lent the money. Loans are products like anything else. As someone pointed out up-thread Sub-Prime loans have done some positive things. It’s the salesman that mis-represented the terms and risks of the loan. This assumes that the lending institution wasn’t involved in trying to defraud the borrower. If they were, they’re also liable.

If the loan originator acted as an agent of the lending institution there is the question of negligence as well as active participation. The question of negligence pervades the entire chain of reselling. If you sell a substandard or injurious product, you cannot escape culpability by citing the fact that someone else sold it to you first. You must demonstrate that you satisfied the requirements of due diligence. Otherwise you are liable through negligence.

People default on credit cards and bank loans all the time - and yet, credit card companies are turning incredibly high profits.

How high?

Lu:

It should be illegal for a lender to make a loan they know the debtor can’t pay back, and if they are found to have made such a loan they should be required to compensate the debtor to the tune of, say, three times the original or current value (whichever is greater) of the collateral. That would end predatory lending in a hurry.

Creditors don’t make loans they know the debtor can’t pay back. That would be stupid. They make risky loans which the debtor might not be able to pay back. So how sure should they have to be, and how would you determine when they weren’t sure enough? Doesn’t this create incentives for people to try to get loans they can’t pay off, or, having been issued a risky loan, get themselves into situations where they can’t pay it back?

Why are you treating the debtors as innocent victims, anyway? If it should be illegal to issue risky loans, why shouldn’t it be illegal to take them out?

The message I’m getting from the comments here is that the poor are just too stupid to be trusted with significant amounts of credit. If that’s what you really believe, fine. But how many of you would be slamming banks for denying the poor access to credit if they actually stopped engaging in “predatory lending?”

The value of a bond is determined by the discounted value of it’s future payments. That discount rate is based on the risk associated with the loan. It includes not just the present value of the future payments but also the risk associated with inflation and default. The risk of default depends on both the liquidity of the borrower and the future value of the collateral. So in a falling housing market with rising foreclosures the value of the loan is going to decrease and the company that’s holding it now will have to sell it for less than they paid. In other words, they’ll loose money.

Sub-Prime loans were made more possible by the housing bubble. Since the future value of the collateral was expected to rise the discount rate was assumed to fall and the loan became more valuable. Sine this isn’t true anymore there aren’t as many places willing to buy the loans and the companies that originated them don’t have the capital they need to keep making loans. So they go out of business, or at least leave the Sub-Prime segment of the market.

The person you want to ‘hold accountable’ is the loan originator, not the company that lent the money. Loans are products like anything else. As someone pointed out up-thread Sub-Prime loans have done some positive things. It’s the salesman that mis-represented the terms and risks of the loan. This assumes that the lending institution wasn’t involved in trying to defraud the borrower. If they were, they’re also liable.

Don’t forget that most mortgage loans are not held by the company that wrote them for more than a year; after that, the maker generally sells the loan to another company. I don’t know if sub-prime loans are different, mind you. But if not, if the writer qualifies someone for a loan when they were not in fact qualified and then sells that loan they’ve committed fraud against both the mortgagee and the company they sell the loan to.

Doesn’t this further undermine the argument that the initial lender will eventually go bankrupt from making bad loans, at least within a time frame that would limit the potential economic damage? Isn’t it also true that the secondary lender will likely sell the loan in turn? Can’t this process be repeated numerous times before the crunch comes? In the meanwhile, what’s to stop the initial lender from closing shop and starting up business under new articles of incorporation? How many homeowners in foreclosure are likely to pursue civil or criminal action rather than seeking relief through bankruptcy? How realistic is it to assume that every lender in the chain of reselling would be ignorant of the nature of such loans? How likely is it that any corporate entity other than the initial lender would be called to account?

The idea that somewhere, sometime down the road , someone might be held accountable isn’t much of a deterrent in such a setup.

The abstract theory of the self regulating market is wonderful, so long as you don’t take too close a look at reality.

Ours was sold 3 times in the first year of our mortgage. It’s crazy. We didn’t have a sub prime loan, but we did do an 80/20 split ( which in hindsight was stupid and I’ll never do it again). And the rate on our 20% loan is embarassingly high. EMBARASSINGLY high, and the rate on the 80% loan isn’t fabulous either. At least I made them fixed rates (thank god for small amounts of common sense).

We’ve hit some rocky times and the mortgage has been late multiple times. But, it’s still getting paid - trust me, the loan company is making PLENTY of money off of us. (So much so that it makes me angry), but in all honesty, ours is not a case of predatory lending - we had different information about annual salaries, etc at the time we bought and one month later my husband was laid off with no notice. But I digress.

I will agree with the poster who said that home ownership is not always in the best interest of poor people or working poor or even lower middle class folks. Part of the reason our situation has been so prolonged is because we are stuck in our house. We couldn’t resell it so soon after buying it and make back enough to pay real estate fees and the bank loan (especially since we had no money down, so there’s literally no equity in the house at all). In additon, we have been unable to do basic upkeep and repairs that are necessary. Thank goodness nothing disasterous has happened (knock on wood), but I’m sure our neighbors hate us - last year we had a tornado (which is crazy since this is the NE) and some large branches broke off the tree and fell into the yard. Thankfully, it didn’t damage anything, but the huge branches and brush are still sitting in our yard because we can’t afford to have it chopped up and disposed of properly… If anything, we are LESS invested in our neighborhood and city because we are fighting so hard to keep our heads above water I don’t have the time or resources for anything else. I have wished many times in the last 2 years that we were renting and could be in a cheaper place or at least FIND a cheaper alternative, as it is, my housing payment is fixed and fixed at as much as 50% of the monthly income at one point.

On the other hand, since we have certain things going for us, whiteness, education, etc, we have the potential to scrape out of this mess, but it’s gonna take a lot longer than it did to get into it. Although in hindsight, some of what we are dealing with is our own damn fault (we had no where near enough savings or cushion as an emergency fund and thus should have waited before jumping in to home ownership), some of it has just been unfortunate circumstances that are compounding over time.

I guess my point is that while it’s true that the individual buyers have to take some responsibility for their mistakes, there are some systematic problems that contribute to making those mistakes worse than they might otherwise be. It’s not always so simple of “personal responsibility.” I don’t have any solutions except to offer caution to anyone I see starting to follow in our footsteps!

Hm. Good point. Perhaps I did go a bit far. OTOH, don’t go too far on “all the people who are paying insanely high rates”, either. What fraction of mortgagees took out a sub-prime mortgage and are paying “insanely high” interest rates? It’s true that the makers won’t go bankrupt, but whoever is holding the loan at this point will take losses where they had budgeted for profits. Do that enough and you will go bankrupt, or at least lose your investors.

Not to mention that in the case of a secured loan (such as a mortgage) the creditor ends up with the collateral and can resell it and incur little if any loss,

Don’t be so sure. In the current market in the Chicago area, anyway, there’s lots of homes that are either just even with the market or even upside down, where the home is worth less than the loan balance. Home prices have slid, new construction is down. And then there’s the expenses that the loan company incurs in taking possession, cleaning the place up and repairing any damages, etc., and then selling the house. Loan companies don’t want to get into the real estate business; it limits their losses but is not a profitable business for them.

The bottom line is that the kinds of governmental intervention that I favor here would be to prosecute fraud where it has occurred and provide regulation where needed. If a company qualified someone for a loan by misstating their income or ignoring adverse information, then it seems to me they’ve committed fraud.

Don’t forget that most mortgage loans are not held by the company that wrote them for more than a year; after that, the maker generally sells the loan to another company. I don’t know if sub-prime loans are different, mind you. But if not, if the writer qualifies someone for a loan when they were not in fact qualified and then sells that loan they’ve committed fraud against both the mortgagee and the company they sell the loan to.

However, if the person was fairly qualified for a sub-prime loan and then fails to pay for whatever reason, that’s not a problem for the taxpayer, just as if someone is fairly qualified for any other kind of loan and then fails to pay it.

But, now that my interest rate has gone up 60 percent (which seems wildly disproportionate to the increased chance that I’ll default, but set that aside), the chance that I’ll be able to pay what I owe has gone down, even more if multiple creditors and/or insurers do it simultaneously. If the creditors want me to pay what I owe (or what I would have owed), jacking up my rates seems counterproductive.

It doesn’t, nor is it supposed to. Instead, it adjusts the credit companies’ return on its investment in you, on the not unreasonable grounds that the chance you’re going to rabbit or bankrupt has just gone up.

Not to mention that in the case of a secured loan (such as a mortgage) the creditor ends up with the collateral and can resell it and incur little if any loss, and the debtor forfeits any equity and ends up in a deeper hole than before. These days most creditors’ business plans are explicitly based on getting people too deep in the hole to climb out, but not so deep that they throw in the towel, and the change in the bankruptcy laws makes it harder to throw in the towel. (Contrary to the propaganda that the loan industry put out, most bankruptcies are and were due to catastrophic medical bills or similar unforeseeable disasters, not to irresponsibility.)

There’s a difference between predatory lending and fraud. As I said before, a lot of lending practices are legal but wrong. It should be illegal for a lender to make a loan they know the debtor can’t pay back, and if they are found to have made such a loan they should be required to compensate the debtor to the tune of, say, three times the original or current value (whichever is greater) of the collateral. That would end predatory lending in a hurry.

It’s also common practice nowadays for all of a person’s creditors and insurers to jack up their rates after one late payment. If you’re living on the edge and paying, say, 15 percent on three credit cards, how does having all those rates raised to 25 percent make you more likely to pay your debts? It’s normal to charge a higher rate to begin with to a riskier pool of debtors, but to apply that reasoning to an individual makes no sense at all.

The first part is already true. The second part (where the company making a loan that doesn’t get paid off) is highly unlikely to happen since they are able to make money on all the people who ARE paying and are paying insanely high rates, etc. People default on credit cards and bank loans all the time - and yet, credit card companies are turning incredibly high profits. Even as foreclosures and unpaid cc balances increase the banks and card companies are still getting filthy rich. So, the little guy still gets screwed no matter what, and the rich guys get richer no matter what.