It’s Time to Recall the Sub-prime Loans
By Virginia Pratt
March 13, 2008
Recent reports on the rate of foreclosure are staggering. With the numbers rising so quickly, one has to ask why. Certainly the problem appears to be systemic. It may help to think about how the mortgage industry and process for getting a mortgage has changed over the last decade or two. There have been dramatic shifts in lending practices with the emergence of large national sub-prime lenders, as well as the use of the internet and computer programs. Prior to the wide use of the internet, applicants went to local banks and lending institutions to apply in person for loans. This application process was often lengthy and cumbersome. The applicant had to provide pay-stubs, W2s, tax returns, a credit reports, and proof of savings. Mortgage applications are now largely handled through a computer process or over the phone in a fraction of the time.
As the values of homes rose, real estate came to be viewed as a way to get rich quick. New loan products were developed. Application processes were streamlined and traditional requirements waived. Lenders competed for business by offering lower rates. Real estate agencies and brokers pledged to close deals quickly. Slogans such as “why rent when you can own” predominated. The general perception was that home values could only go up. With this perception came the belief that you couldn’t go wrong investing in real estate and that even if it was a stretch people should try to own as it would pay off in the end.
Traditional requirements, such as a down payment and saving came to be seen as stumbling blocks to the socially accepted goal of homeownership. Sub-prime lenders compensated for their risk by charging higher fees and interest. Mortgage brokers were compensated for generating business for the sub-prime market. Potential homeowners were urged to move quickly in the “red hot market.” Homeowners were also bombarded with offers to refinance. As home values climbed homeowners were encouraged to consolidate their debt, roll their credit cards and car loans into their mortgage, and get cash out for renovations, their children’s college education, and vacations. People in communities of color were targeted for abusive high cost sub-prime loans. Anyone questioning the terms of the loans was generally told not to worry as they would simply refinance before the interest rate rose. These same people and communities now face high rates of foreclosure and continued threat of foreclosure.
Wall Street investors were eager to back the sub-prime loan industry. The lenders were generally based in California with offices across the country. They operated under the laws of Delaware or New York, like the credit card companies. The mortgages, backed by “securities” were registered with the Mortgage Electric Registration System through a PO Box in Flint Michigan. The servicing on these loans was transferred as soon the documents were signed. These loans were made with very few consumer protections and little accountability.
For reasons we may not understand, the bubble has burst, and the party is over. Housing values have dropped. The market is in a slump. We now confront sober realities. Far too many people were approved for loans they could never afford. Far too many loans were made without ever determining homeowners’ ability to pay. Far too many loans were based on inflated income. Far too many loans were made with terms that had no sustainable features, such as interest only, adjustable rates, balloon payments, and negative amortization. Most homeowners got loans with terms and conditions they do not understand. Some of the blame can be attributed to mortgage brokers who received handsome compensation from sub-prime lenders for matching consumers with loans that were never in their best interest. However, they were not the only ones making money during the housing boom. Appraisers, real estate attorneys, loan officers, and mortgage companies benefited as well.
If a car maker puts out a new model with faulty features, do we blame the consumer? No, the industry is responsible for making the repairs, and the vehicles are recalled. The owner gets a notice to go to the dealer for the repair. It’s time for the investors and the lenders to have national recalls on sub-prime loans to rewrite them with reasonable terms. Let’s repair the loans rather than punish the homeowners.
(Virginia Pratt is a Foreclosure Prevention Counselor with 6 years of experience at ESAC’s Sustainable Housing Program. ESAC has HUD approval to provide foreclosure prevention counseling to area residents. ESAC receives funding by the City of Boston, Neighorworks, HUD, and the Mass Bar Foundation. ESAC is a member of the Massachusetts Alliance Against Foreclosure.)