Washington — It has been said that those who understand interest earn it, and those who don't pay it. Subprime banks -- the newest legal incarnation of loan sharking -- were created for people with less than perfect credit, but they often are being misused to prey on those who don't understand the concept of interest. While there is a place for subprime banks -- for people who are willing to bite the bullet and pay exorbitant interest rates (between 12 and 40 percent) until they get their credit rating back on track -- the subprime market mainly targets unsophisticated, low-income people in poorer neighborhoods.
Last spring, the Senate held a hearing on unconscionable lending techniques in the subprime market. A seven-year veteran from the industry addressed the committee with a paper bag over his head (to avoid retribution) and told the banking committee just how the burgeoning subprime industry makes a buck.
"Finance companies try to do business with blue-collar workers, people who haven't gone to college, older people who are on fixed incomes, non-English-speaking people and people who have significant equity in their homes," the witness referred to as "Jim Dough" said from behind his paper bag. "In fact, my perfect customer would be an uneducated widow who is on a fixed income -- hopefully from her deceased husband's pension and Social Security -- who has her house paid off, is living off of credit cards, but having a difficult time keeping up her payments, and who must make a car payment in addition to her credit-card payments."
The equity "Jim Dough" speaks of is important. Many shady subprime companies seek out unsophisticated homeowners and put them into loans designed to fail, and secure the loan with the house. The loans are made without regard for the income of the mortgagee, and all sorts of hidden costs are tucked into the loan and financed over the life of the loan.
Jim Dough tells how he was supposed to refinance all loans before the customer got to the point that they would be paying down the principle of the loan. Refinancing, is called "up-selling" because the bank folds all sorts of costs into the new loan every time the loan is refinanced.
Lenders, Jim Dough testified, are supposed to up-sell at least two loans a day and call every borrower at least once a month and ask them if they need more money and then push to refinance.
"We were trained to sell the monthly savings." Jim Dough said. "That is, how much less per month the customer would be paying if we flipped the loan. In reality, the 'savings' were just an illusion. The uneducated customer would jump for the 'savings' thinking that he would have money to buy other things. What the customer wouldn't figure out and what we wouldn't tell him is that he would be paying for a longer period of time and in the end would pay a whole lot more."
The problems with the industry have not escaped notice. Bad press and lawsuits, however, have done little to push the bad lenders out of business.
"I have seen endless creativity in the direction of trying to deceive people," says Earl Peattie, president of Mortgage News Company, a California consulting firm. "They are getting people to refinance who don't need to, attaching extremely expensive balloon payments to a loan, switching loan papers, paying kick-backs to banks that deny prime loans but then refer the consumer over for a subprime loan." Shady lenders are able to do this, Peattie says, because many people are financially ignorant. "A good percentage of people who get subprime loans actually qualify for a prime loan," he said.
-- Jack Anderson and Douglas Cohn are columnists for United Feature Syndicate.
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