Lenders Entice Passive Borrowers
Victims of predatory lenders are often passive when solicited. They also tend to be confused about the transaction and frequently have substantial short-term debt. Two other traits usually characterize these victims:
* Many are cash-dazzled; the prospect of pocketing a significant sum of money causes a complete lapse of judgment. They ignore where the money is coming from and what it is costing them.
Predators love cash-dazzled borrowers because they are prime candidates for cash-out refinancing that results in loans that are larger than the outstanding balance of the old loans. Frequently, the new loan has a higher interest rate than the old one, and the refinancing fees are added to the balance. Some borrowers will refinance again and again, a practice known as “flipping,” until they have used up all their equity.
There are many legitimate cash-out refinance transactions. They become predatory when the cash-dazzled victim agrees to terms that are far more costly than the borrower could have obtained from alternative sources. The alternatives include home equity loans.
In many cases, a borrower who needs cash does much better with a home equity loan than with a cash-out refinance. Even when the rate on the home equity loan is high, that rate is paid only on the additional cash required. On a cash-out refinancing, the higher rate is paid on the old loan balance as well as the additional cash.
The worst rip-off is cash-out refinancing of zero-interest loans, a problem that has plagued the Habitat for Humanity program. The Coalition for Responsible Lending estimates that 10% of all Habitat borrowers between 1987 and 1993 subsequently refinanced their zero-interest loans into loans carrying rates of 10% to 16%. Borrowers who did this were paying interest costs of 60% and up for the cash in their pockets. The cash-dazzled don’t see it.
In the case histories of borrowers victimized by predators, a surprisingly large number had a previous satisfactory credit experience with a reputable lender. In some cases, they had paid off their mortgages. Then the prospect of cash in hand lured them to a predator.
* Victims often base decisions solely on the affordability of monthly payments; they are payment-myopic. They don’t consider interest costs or how the decisions will affect the equity in their homes.
Predators love payment-myopic victims because, like cash-dazzled victims, they offer little resistance to upfront charges that are included in the loan amount. An upfront fee of $2,500 reduces the borrower’s equity in his home by the same amount, but that doesn’t matter to the payment-myopic borrower. What matters is that at 10% and 30 years, the $2,500 converts into only $22 a month.
Here is the kind of deal that payment-myopic and cash-dazzled borrowers find irresistible. The borrower has paid down his 8% loan to $100,000 and has only 12 years to go. He is offered a 30-year loan for $110,000 at 9%. The monthly payment would fall from $1,082 to $885, and he puts $10,000 in his pocket tax-free. What a deal!
Of course, five years down the road, he would have owed only $69,449 had he stayed with his original mortgage. With the new mortgage he will owe $105,468, even more if there are upfront fees included in the new loan, which is almost always the case. Payment-myopic borrowers don’t look down the road.
People who are cash-dazzled or payment-myopic do not have to be victims. They can avoid victimization if you steer clear of temptation.
Alcoholics who are on the wagon have trusted advisors to call when they feel their control weakening. Impulsive borrowers can do the same. If all else fails, you can e-mail me, but expect a stern lecture.
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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://https://www.mtgprofessor.com .
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Distributed by Inman News Features.
