Unsafe at Any Rate
If it’s good enough for microwaves, it’s good enough for mortgages. Why we need a Financial Product Safety Commission.
Even worse, consumers wary of creditor tricks may look for help, only to rush headlong into the waiting arms of someone else who will fleece them–and then hand them over to the creditors for further fleecing. In the mortgage market, for example, consumers may respond to advertisements for “a friend to help you find the best possible mortgage,” “someone on your side,” and “access to thousands of mortgages with a single phone call–do all your comparison shopping here.” When they call a mortgage broker, they may believe they will receive wise advice that will guide them through a dangerous thicket. Some mortgage brokers will do just that. But consumers are just as likely to encounter a broker who is working only for himself, taking what amounts to a bribe from a mortgage company to steer a family into a higher-priced mortgage than it could qualify for, all the while assuring the family that this is the best possible deal. For example, a family that might qualify for a 6.5 percent fixed-rate, 30-year mortgage could easily end up with a 9.5 percent mortgage because the broker can pocket a fee (what the industry calls a “yield service premium,” or YSP) from the mortgage company to place the higher-priced loan. High YSPs helped drive the wild selling that led to the recent meltdown in the subprime mortgage market.
Despite the characterization of YSPs by one Fannie Mae vice president as “lender kickbacks,” the practice of taking these fees is legal. Under pressure from the mortgage-broker industry, Congress and the regulatory agencies have generally approved of YSPs. In fact, mortgage brokers face few regulatory restrictions. It is no surprise, then, that mortgage brokers originate more than half of all mortgage loans, particularly at the low-end of the credit market. YSPs are present in 85 to 90 percent of subprime mortgages, which implies that brokers are needlessly pushing clients into more expensive products. And the costs are staggering: Fannie Mae estimates that fully 50 percent of those who were sold ruinous subprime mortgages would have qualified for prime-rate loans. A study by the Department of Housing and Urban Development revealed that one in nine middle-income families (and one in 14 upper-income families) who refinanced a home mortgage ended up with a high-fee, high-interest subprime mortgage. Of course, YSPs are not confined to subprime mortgages. Pushing a family who qualifies for a 6.5 percent loan into a 9.5 percent loan and pocketing the difference will cost the family tens of thousands of dollars, but it will not show up in anyone’s statistics on sub-prime lending.
Other creditors have their own techniques for fleecing borrowers. Payday lenders offer consumers a friendly hand when they are short of cash. But hidden in the tangle of disclosures is a staggering interest rate. For example, buried in a page of disclosures for one lender (rather than on the fee page, where the customer might expect to see it) was the note that the interest rate on the offered loan was 485.450 percent. For some families, the rates run even higher. In transactions recently documented by the Center on Responsible Lending, a $300 loan cost one family $2,700, while another borrowed $400, paid back $3,000, and was being hounded by the payday lender for $1,200 per month when they gave up and filed for bankruptcy. In total, the cost to American families of payday lending is estimated to be $4.2 billion a year. The Department of Defense identified payday lending as such a serious problem for those in the military that it determined the industry “undermines military readiness.” In fact, the practices were so outrageous that Congress banned all companies from charging military people more than 36 percent interest. This change in the law will protect military families from payday lenders, but it will leave all other families subject to the same predatory practices.
For some, Shakespeare’s injunction that “neither a borrower nor a lender be” seems to be good policy. Just stay away from all debt and avoid the trouble. But no one takes that position with tangible consumer goods. No one advocates that people who don’t want their homes burned down should stay away from toasters or that those who don’t want their fingers and toes cut off should give up mowing the lawn. Instead, product safety standards set the floor for all consumer products, and an active, competitive market revolves around the features consumers can see, such as price or convenience or, in some cases, even greater safety. To say that credit markets should follow a caveat emptor model is to ignore the success of the consumer goods market–and the pain inflicted by dangerous credit products.
Indeed, the pain imposed by a dangerous credit product is even more insidious than that inflicted by a malfunctioning kitchen appliance. If toasters are dangerous, they may burn down the homes of rich people or poor people, college graduates or high-school dropouts. But credit products are not nearly so egalitarian. Wealthy families can ignore the tricks and traps associated with credit card debt, secure in the knowledge that they won’t need to turn to credit to get through a rough patch. Their savings will protect them from medical expenses that exceed their insurance coverage or the effects of an unexpected car repair; credit cards are little more than a matter of convenience. Working- and middle-class families are far less insulated. For the family who lives closer to the economic margin, a credit card with an interest rate that unexpectedly escalates to 29.99 percent or misplaced trust in a broker who recommends a high-priced mortgage can push a family into a downward economic spiral from which it may never recover.
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