Confused Borrowers Can Make Easy Prey

Victims of predatory lenders are generally passive, allowing themselves to be solicited by those who prey on others.

Understanding the characteristics of victims can help you avoid becoming one.

Almost all of the case histories provided by the Assn. of Community Organizations for Reform Now, or ACORN, involved confusion by the borrower about one or more aspects of the transaction. In some cases, borrowers were under the impression that they were getting unsecured loans rather than mortgages.

In many cases, they purchased credit life insurance under the impression that it was required. Often, they thought that they were paying a lower interest rate than was the case. The total amount of fees packed into the loan balance usually surprised them. A large number did not know that their contract included a prepayment penalty until years later when they went to prepay.

Why so much confusion? Victims often don’t read documents, or if they do read they are afraid to ask questions about what they don’t understand. The “plain English” movement has not impacted mortgage documents, although there isn’t a segment of the economy that needs it more.

Not reading is not a major problem if the loan provider is honest and competent. Predators, however, thrive on confusion, which provides a smokescreen for their shenanigans. To a predator, a reading-challenged borrower is an invitation to take advantage in every possible way. And mortgages provide lots of ways.

Confusion and passivity go hand in hand, and must be overcome together.

Remember two things:

* Mortgages are so complicated even professors get confused.

* It is the loan provider’s responsibility to eliminate your confusion. If he doesn’t do it, walk out the door.

Another characteristic of predatory lending victims is that they are often heavily in debt, and therefore vulnerable to offers of debt consolidation. Debt consolidation was the primary motivation in about two-thirds of the ACORN cases.

The argument is compelling. Make one lower payment, and enjoy tax benefits besides. While these advantages can be real, they tend to disappear in dealing with a predator.

Sometimes the payment is higher rather than lower because of the stiff interest rate. Even if the payment is lower, the borrower’s equity is depleted by the inclusion of large upfront fees in the loan. Consolidate debts with a predator and you end up worse off than you were before.

Consumers who have accumulated too much short-term debt have an option other than debt consolidation. They can instead work out a debt management plan with a credit counselor.

In exchange for agreeing to take on no new debt and to pay off the old debt within a prescribed period, the counselor can get the creditors to agree to a reduction in interest rates. The consumer makes one payment to the agency, which in turn pays the creditors. This avoids one of the perils of debt consolidation, which is that it may encourage a new credit binge.

If the indebted consumer opts for debt consolidation, it can be done by taking a second mortgage for the amount of the debt, or by a cash-out refinancing of the first mortgage. In the refinancing, the new loan balance is large enough to cover the debt as well as the old balance.

Whether a second mortgage or a cash-out refinancing is less costly for the consumer is a tricky question that depends on a number of factors.

One of the calculators on my Web site was designed to answer this question. But you won’t find this (or any other) calculator being used by a predator.

Predators consolidate in the way that is most costly to the consumer, because that generates the most revenue for the predator.

Consumers with excessive short-term debt who are too passive or confused to use a calculator or shop alternatives will do better seeing a credit counselor rather than a loan provider. While not all counselors are great, the loss is small if you get a bad one. If you go to a loan provider who turns out to be a predator, the loss can be catastrophic.

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Jack Guttentag is a syndicated columnist and professor of finance emeritus at the Wharton School of the University of Pennsylvania. Questions or comments can be left at https://www.mtgprofessor.com. Distributed by Inman News Features.