The Subprime Trap: How Predatory Lending Engineered the 2008 Housing Collapse

The caps on interest for credit cards have been removed, which not only affects credit card customers but also homeowners as well. It used to be that to buy a home, one had to put down, on average, 18 percent of the home's value. Today, that figure has shrunk to 3 percent. This small down payment may sound appealing, but the less money put down is more money because the base, as well as interest, must be paid back. The lower the payment one must pay every month, the longer and more expensive it is to pay off that loan. 

"According to one study, families that make a down payment of less than 5 percent of the purchase price are fifteen to twenty times more likely to default than those who put down 20 percent or more. The obvious would be to reimpose some standards in the mortgage market, but deregulation continues to reign supreme. Even as defaults are rising, President Bush argues that the federal government should work to reduce families down payments even further – with no thought about how those low down payments may cost millions of families their chance at staying in their homes." 1

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A new industry has been born for those with bad credit. Subprime mortgage lenders are lenders that give loans to those who are unlikely to qualify for traditional, low-cost, regular prime loans. Subprime loans were unknown before the removal of market caps and relatively unheard of afterward. However, the big banks needed a new market to tap. Just as the credit cards, the banks applied the same principles that profited them so handsomely. They would charge high-interest loans for those on houses who couldn't afford them.

"To give a sense of how expensive subprime mortgages are, consider this: In 2001, when standard mortgage loan were in the 6.5 percent range, Citibank’s average mortgage rate (which included both subprime and traditional mortgages) was 15.6 percent. To put that in perspective, a family buying a $175,000 home with subprime loan at 15.6 percent would pay an extra $420,000 during the 30-year life of the mortgage – that is, over and above the payments due on a prime mortgage. Had the family gotten a traditional mortgage instead, they would have been able to put two children through college, purchase half a dozen new cars, and put enough aside for a comfortable retirement." 2

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Banking interests will often cite that they are helping more people afford homes. This is often not the case. Lenders that offer subprime mortgages often prey on pre-existing homeowners and not new homeowners. “Fully 80 percent of subprime mortgages involve refinancing loans for families that already own their homes.” 3 For these families/home owners, the subprime mortgage does nothing but raise the amount of money they owe. This also makes it more likely that, if anything goes wrong, those people will lose their homes.

Most people who end up with subprime mortgages are those in the middle-class who can get regular prime mortgages. However, many customers are ignorant of such predator schemes and fall into the subprime trap. And, banks do this because it makes them (a lot) more money! 

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"At Citibank, for example, researchers have concluded that at least 40 percent of those who were sold ruinous subprime mortgages would have qualified for prime-rate loans. Nor is Citibank an isolated case: A study by the Department of Housing and Urban Development revealed that one in nine middle-income families (and one in fourteen upper-income families) who refinanced a home mortgage ended up with a high-fee, high-interest subprime mortgage. For many of these families there is no trade-off between access to credit and the cost of credit. They had their pockets picked plain and simple.

Many unsuspecting families are steered to an overpriced mortgage by a broker or some other middleman who represents himself as acting in the borrower’s best interests, but who is actually taking big fees and commissions from subprime lenders. In some neighborhoods these brokers go door-to-door acting as “bird dogs” for lenders, looking for unsuspecting homeowner who might be tempted by the promise of extra cash. Other families get broad sided by extra fees and hidden costs that don’t show up until it is too late to go to another lender. One industry expert describes the phenomenon: “Mrs. Jones negotiates an 8 percent loan and the paperwork comes in at 10 percent. And the loan officer or the broker says, ‘don’t worry, I’ll take care of that, just sign here." 4

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Every now and then, a case comes to the forefront that is particularly egregious. Citibank was recently caught in one of those cases. In 2002, Citibank’s subprime lending subsidiary was prosecuted for deceptive marketing practices, and the company paid $240 million to settle the case (at the time, the largest settlement of its kind). A former loan officer testified about how she marketed the mortgages: “If someone appeared uneducated, inarticulate, was a minority, or was particularly old or young, I would try to include all that CitiFinancial offered.” In other words, lending agents routinely steered families to higher-cost loans whenever they thought there was a chance they could get away with it." 5

Banking practices have become so predatory that they no longer just want customers' money but their homes as well. Banks have been caught deliberately loaning money to those who couldn’t afford another mortgage. The goal is for the bank to eventually own the homes due to foreclosure. This practice is known as “loan to own.” 

This was thought to be profitable before the financial collapse of 2009 because banks could put a stranglehold on homeowners and families, so they must pay the bank for a few years until they can no longer afford to do so. After the bank takes the home and resells it for more than the mortgage amount. The lender would win either way because even if the homeowner didn't manage to pay off the high payments, the lender would still have the home, which was always increasing in value.

What happened during the 2008 financial collapse was that all the subprime mortgages--which were bundled into Collateralized Debt Obligations (CDOs)--defaulted (meaning the homeowner couldn't pay for the home), and the price of homes in the housing market dropped. This created a situation where the lender had assets without any equity/value, rendering the (risky) mortgage worth only pennies on the dollar of its original worth with no way of increasing its value. That is what is often referred to as an "economic bubble," which was popped when the lender's lender called for their money back!      

1-5. Warren, Elizabeth and Tyagi, Amelia Warren. “’The Cement Life Raft’ (Chapter Six)” PBS Frontline. November 24, 2004. 

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