A New Slant on Predatory Lending

You have probably read about predatory lending, where unscrupulous lenders prey on disadvantaged borrowers.   Many states have recently enacted legislation to effect standards to help prevent consumer abuse, and properly so.   The laws typically define as predatory any loan with an interest rate higher than a set standard, usually in the 10 to 12 percent range.

But there is a little known aspect of A-paper lending, lending to those borrowers with excellent credit, that in my view also should fall under the definition of predatory lending.   I have written my views to the U.S. Department of Housing and Urban Development, which has regulatory authority over many aspects of mortgage lending, but it is not likely that any change will come as a result of my views.   However, I still want to warn consumers, lest they become victims to this abusive practice.

The issue is zero-point loans.   Now your first reaction to this might be, “Wait a minute! I think not having to pay those nasty old points is a good thing, not bad!” Well, let’s go through an example and let’s see what you think then.

You know perfectly well that there some costs associated with originating your loan, and that someone has to pay them.   In spite of how it might look or feel at the time you are signing documents, you are not getting something for nothing.   None of those people you interface with are engaging in a hobby.   It’s their business and they are getting paid.   So, if you don’t pay them upfront, how do they get paid?   Well, you probably remember words something like, “Your interest rate will be slightly higher.”   Sound familiar?

The reality of the marketplace is that the “slightly” is one-eighth of a percent in interest rate for every half point in fee.   That means that if a lender wanted to make one point as an upfront fee, you’d have to pay one-quarter percent more.   Make sense?

Let’s go through the numbers on a simple example.   On a $100,000 loan, instead of paying 1 point and 6 percent, you’d pay no points and an interest rate of 6.25 percent.   Now that additional quarter percent amounts to $250 per year, $100,000 times .0025.   So the lender advanced the $1,000 to their employees in lieu of you paying them, and you pay them $250 per year in interest to pay them back.   OK?

But wait a minute! $250 per $1,000 is equivalent to an interest rate of twenty-five percent! Holy cow!   That’s about twice the rate that lawmakers think is predatory!   Even worse,   in the event you kept this loan for the full 30 years, that additional quarter percent would add up to a total of over $5,000.     The lender fronted $1,000 for you and got back $5,000 for their trouble.   You’d be better off getting a $1,000 cash advance on your credit card and paying 18 percent interest.   Do you still feel that no-point loans are a good deal?

You can also see why the mortgage industry is so anxious to do a no-point loan for you. In fact, according to industry sources, over 50 percent of consumers choose this option, at a cost to them of billions of dollars every year. Millions of people are, in my view, getting ripped off.

So if your co-worker or your neighbor or you kid tells you, “I’m not going to have pay any points on my loan,” whip out this article and give it to them. And of course, when you refinance, if you haven’t done it yet, find an honest lender and have them work through various scenarios with you.

If this situation upsets you and you’re feeling especially civic minded, cut out this article and mail it to HUD Secretary Mel Martinez, 451 7 th St SW, 10 th Floor, Washington DC 20410. Maybe he’ll listen to all of you.