On Personal Finance | Take the pain out of subprimes

We've all been reading stories about the subprime-mortgage meltdown for months, but last week it came home to Philadelphia with the release of a comprehensive study by the Reinvestment Fund, a nonprofit group that works to stimulate growth in low- and moderate-income neighborhoods.

The Inquirer's front-page story on the study offered some heartbreaking cases of Philadelphians likely to lose their homes, and perhaps tumble into bankruptcy. It's a tragedy, an outrage . . ..

To be precise, TRF's study was on predatory lending - selling high-risk mortgages to people who cannot afford them. That's not quite the same as subprime mortgages, which are loans to people with poor credit. Not every subprime mortgage is predatory.

But most predatory loans are subprime mortgages.

The first homeowner described in the story bought a $66,900 house in 2003 with plans to fix it up and rent it out. Two years later, her monthly payments jumped to $514 from $387 when her interest rate adjusted, as most subprime rates do after two or three years.

She also lost her job, which might have been enough to cost her the house even if the rate had not increased.

In the second case, the homeowner took out a succession of loans to fix up an inherited house, raising the debt from $13,000 to $90,000. The bigger debt and a jump in interest rates produced a huge increase in monthly payments.

Who gets the blame?

There's plenty to go around. The stories of subprime loans we're hearing now are like the stories on obesity. Yes, the lenders and mortgage brokers are at fault, just like the fast-food chains offering ever-larger portions.

But, after all, no one puts a gun to your head to make you drink a 64-ounce soda - or to get a subprime loan.

TRF's study found that 3.1 percent of owner-occupied houses in Philadelphia appeared to have been touched by predatory lending. But the figure was 14.1 percent for houses whose owners had taken out at least three home-equity loans.

The study found that many subprime loans exceeded the value of the house and that many were used to pay off other loans such as credit card debt.

In other words, these borrowers were engaging in high-risk financial behavior.

Why do people get into these messes?

Many borrowers use poor judgment in their eagerness to own a home or extract cash from it. But with its accounts of heavy promotion by lenders in less-affluent neighborhoods, the study makes it clear that borrowers are being lured into this trap with visions of easy money and low starting payments, and no clear disclosure of how those payments can rise.

It's easy to shrug and say, "Well, buyer beware." But that's a cop-out. It's not realistic to expect people to understand the nuts and bolts of these complicated products.

Most subprime borrowers are ordinary folk with little experience buying houses and shopping for mortgages. Many already are in financial straits, or they wouldn't need to resort to subprime loans. They don't have fallback funds to carry them through a financial setback, such as a job loss or illness.

To make the problem worse, the mortgage broker and real estate agent have no incentive to wave the red flag. They get paid only if the deal goes through - and they don't have any financial stake in what happens later.

TRF joined with other consumer groups in calling for a federally mandated "suitability standard" that would prohibit a lender or broker from selling a loan that's too risky for a particular borrower. Like stockbrokers who already live under a similar rule, violators could be fined, or even kicked out of the business.

That's a good idea, but I'd go a step further and make the real estate agents accountable, as well. How many times has a real estate agent sat silently at a closing table, knowing the buyer she spent days with is walking off a cliff?

Current laws make the agent responsible for warning the buyer about flaws in the property, such as leaks, termites or cracks in the foundation. Why shouldn't they address mortgage flaws, too?