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Subprime Lending

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Defining Subprime Lending The problem to be investigated is the effect of subprime mortgage loans on the economy. According to Merriam Webster subprime is defined as having or being an interest rate that is higher than a prime rate and is extended especially to low-income borrowers; extending or obtaining a subprime loan (Webster, 2012). Subprime mortgage loans are loans given to people with a low credit score. Subprime borrowers normally don’t qualify for prime loans or prime lending. According to Jennings, the subprime mortgage market is defined to include those borrowers with a FICO (Fair Isaac Co.) score below 570 (Jennings, 2012, p. 434).
The American Dream Home ownership has always been a big part of the “American Dream.” It allows you to have your piece of “the rock.” It gives one the ability to invest in your community. This need to have a piece of the American dream not only drives the average American to capitalize, it also drives mortgage lenders to take their portion of your dream as well. Initially, this relationship tends to have win/win connotations; however, true colors eventually prevail when dealing in subprime mortgage loans.
Subprime Lenders It seems subprime lenders never call themselves just that. You have to be aware of the enormously high prices; prices much higher than your prime lenders.
Subprime lenders based their rates and fees on the same factors as prime lenders. For example, rates were higher the lower the credit score and the smaller the down payment. However, the entire structure of rates and fees were higher at subprime lenders to cover the greatest risk and higher costs of subprime lending (The Mortgage Professor, June 2009).
Subprime loans tend to go into default at a higher rate than prime loans, because of the initial risks attached to the borrower. Subprime loans also have prepayments written into the loans; whereas prime loans rarely have prepayment clauses. According to Jennings, during its period of expansion, the subprime market was a source of great wealth for many lenders. “We made so much money, you couldn’t believe it. And you didn’t have to do anything. You just had to show up,” commented Kal Elsayed, a former executive at New Central Financial (Jennings, 2012, p. 434).
Predatory Lending When I first moved to Georgia, I worked for a company called Valued Services. Valued Services was the parent company for our “payday lending” operations. I remember seeing the words predatory lender in an article written about the company. Hindsight 20/20, predatory lending is exactly what we were doing. All of our stores were in low income neighborhoods. It was well know they were in “bad” areas because we had bars on the windows of every store we owned. Several of our stores required security during the day, and a police escort at night when the managers would leave with the daily deposit. Instead of the loan assisting the borrower, before it was over with they were in even deeper debt. The interest was at a rate of about 85%, and we would run the postdated check through the borrower’s checking account up to five times. Not only were they accruing large interest rates from the loan with Valued Services, but they were also getting insufficient fund fees. You have to ask the question how ethical was Valued Services. It’s like asking an alcoholic to work in a liquor store. We placed stores in low income areas, and gave consumers loans knowing they were not in positions to pay them back. This is exactly what subprime lenders do. Allow consumers to get loans so they can have a piece of the American dream knowing they won’t be able to pay the loans back. It seems, throughout my professional career, predatory lending has followed me. When I started working for Veolia Transportation I received court ordered bankruptcies every day. When I called the employees’ in, almost all of them had the same story….”I lost my house.” Each employee talked about how they had no problem paying the mortgage for the first few years; then their payments ballooned and they couldn’t make them.
The vast majority of subprime loans are now securitized; leading to claims that securitization facilitates predatory lending and should actively police lenders. New standards to protect borrowers against unfair practices were launched 1 July including requirements to ensure they are not lured into credit contracts they cannot afford to repay. The standards include provisions to stop predatory lenders from exploitative practices such as using household items as security for cash loans (Engel, K. & McCoy, 2007).
Lender and Incentives One has to wonder, why were subprime loans pitched to consumers? They weren’t pushed for altruistic purposes; not from the kindness of the heart. The results were inevitable. According to the readings, subprime loans ended with the same result. They were a risk for the consumer as well as the bank backing the loan. There had to be some incentive for the banks; some benefit that is reaped. In this case, it was a monetary benefit.
Yield-spread premiums is what lenders call them. Consumer groups call them legal kickbacks. YSPs are the cash that mortgage brokers or lenders get for steering a borrower into a home loan with a higher interest rate (Center for Responsible Lending, Yield Spread Premiums (YSPS).
However, the Federal Reserve stepped in and regulated these kickbacks.
New rules issued by the Federal Reserve Board mean that YSPs are no longer legal. The Fed rules ban brokers and loan officers from receiving extra pay based on a loan’s interest rate or other loan terms. Also, brokers can no longer receive “split” compensation, when payment comes from both borrower and lender—brokers must be paid by one or the other (Center for Responsible Lending, Yield Spread Premiums (YSPS).
With these rules in place that is a source of added protection for possible borrowers so that they aren’t victimized.
Lending Institutions after the Meltdown It is hard to imagine how so many risky mortgages could have been authorized by lending institutions. When the inevitable happened and the mortgage rate incentives went to the actual prices, many owners were unable to meet the new payment requirements. As the number of foreclosures became larger, many lenders began to suffer high losses. The effect of
Foreclosures; however, was not uniformed across regions and demographics and seemed to affect certain populations like low-income individuals and minorities more than others. This led to accusations of discriminatory behavior on part of lending institutions. As a result lending institutions were unable to recover their losses on defaulted mortgages.
Subprime wrap up
The subprime mortgage crisis, popularly known as the “mortgage mess” or “mortgage meltdown,” came to the public’s attention when a steep rise in home foreclosures in 2006 spiraled seemingly out of control in 2007, triggering a national financial crisis that went global within the year. Consumer spending is down, the housing market has plummeted, foreclosure numbers continue to rise and the stock market has been shaken. The subprime crisis and resulting foreclosure fallout has caused dissension among consumers, lenders and legislators and spawned furious debate over the causes and possible fixes of the “mess” (Blanco, K, 2008).

References
Jennings, M. (2012). Business ethics: Case studies and selected readings 7th Ed. Mason, OH: South-Western
Cengage Learning
Engel, K. & McCoy,P. (2007). Turning a Blind Eye: Wall Street
Finance of Predatory Lending. Fordham Law Review; March
2007, Vol. 75 Issue 4, p2039-2103, 65p
Subprime. 2012. In Merriam-Webster Online Dictionary. Retrieved
October 24, 2012, from http://www.merriam-webster.com/dictionary/information technology
Blanco, K. 2008. The Subprime Lending Crisis: Causes and Effects of the Mortgage Meltdown. Mortgage Compliance
Guide and Bank Digest

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