Here's a Little Story You All Might Like

A young couple bought a house about 5 years ago. Credit wasn't all that great. Their agent told them to get qualified with a lender....gave them a couple of reputable names in the area. They used a friend of a parent instead. That should have been okay. They should have gotten a good deal. Well, the deal wasn't so good. They ended up with an interest-only loan that couldn't be refinanced for 24 months.

That type of loan is exactly what it sounds like. All the money you are paying every month covers only the interest on the money you borrowed. You aren't paying down your principle at all. The agent and the title company were alarmed because this wasn't a loan either saw here in the Midwest very often....not five years ago. We're too conservative for loans like these.

Interest-only loans work fine, if real estate is appreciating. The borrower is stil
getting the increased value of the home, so it's not a huge deal if he isn't paying down his original loan. He's still increasing his equity in the home.

Fast forward. Kids refinance....probably with the same kind of company a couple of years later....another adjustable rate....maybe even paid all their closing costs on the new loan by rolling those costs into the new loan. More debt. Interest rate went from 6.5 percent to 11 percent when loan adjusted last year. The family lost the house this month. They couldn't make the new payments and didn't ask for help in time.

Result: They are going to be in a credit mess for 7 years.

You can bet that some financial institution made good upfront money on those two loans because the credit involved was not so great. The loan was then sold off in a package to a hedge fund or bank that bought riskier loans because they are lucrative and give their investors a good return. Loans get bought, repackaged and sold over and over, each entity taking a cut of the profit. The purchaser of the loan is willing to take the risk because the return is so good, unless it all hits the fan. It did.

The bank that forecloses will spend thousands of dollars to execute that foreclosure, and will try to stick it to the family whose house they just took. In this case the loan holder wanted an additional 40K from this family, until the family got a lawyer. The foreclosure went through, but the 40K was waived.


This is one case. One little house. One little family.

Many wouldn't think of the little family down the street with two incomes and a nice car as victims of predatory lending. Most of the people in the lending industry would have thought of these loans as a good way for young people to get started on the American dream of home ownership. The lender involved in this second adjustable rate mortgage that broke the bank would have said that the borrowers saw the "Truth in Lending" statement and knew exactly what they were getting involved in, and all of that would have been correct. Yet, something went terribly wrong.

A couple of very important factors were at work against these and lots of other homebuyers. One, was a real estate bubble that they couldn't imagine bursting, and the other was the symbiotic relationship between banks, their lobbyists, and the government.

In the spirit of full disclosure, let me say that I sold houses for over 20 years in the midwest.
I saw good markets and bad. Mostly good ones, though. The market in my town flattened out a few times, but home values never went down....not in 20 years. I, myself, couldn't have imagined this downturn, and I really tried to make sure my clients didn't get in over their heads by using the many good conservative lenders who want clean transactions, not mess.

Over the last few years that I sold homes, though, I saw some weird new "loan products." There were 105% loans, which are beyond scary. There were 80% first mortgages tied with 10 and 15% seconds so that buyers didn't have to pay private mortgage insurance to better qualify for more expensive homes. There were a lot of variations on these risky deals that only work in a market that is constantly appreciating. It's hard to believe that none of us in the housing industry, no one in the banking industry, and no one in government could see this coming.

This mess was built from the ground up from greed, unfounded optimism, and a total lack of oversight. Greed on the part of lenders for the big interest rates they would receive for taking the risk of lending to risky borrowers.....unfounded optimism on the part of buyers and their agents that the boom would never end.....and lack of oversight from a government where the banking industry's lobbyists succeeded in persuading regulators to cut all that nasty red tape that keeps banks from making freaky loans like these.

Now the financial industry will get bailed out. Even though lenders knew there were risks, they will get bailed out. Even though they fought hard to relax the rules of lending the government will bail them out, which means you and I will be doing the bailing. We pretty much have to if our economy is ever to get back on track, I guess.

However, I don't think that the few dollars the government is going to throw at the thousands and thousands of families who were in over their heads will even compare to the need. I also don't think that we will ever know the true extent of the government's complicity in writing this nightmare scenario to please the financial sector. And I don't think that a lot of these borrowers have any idea how long the seven years that they are stuck with crappy credit is going to seem. Unfortunately, they are going to find out.