Predatory lending practices

From Recessipedia

Generally, predatory lending practices refer to situations where the lender uses its superior knowledge or market power to defraud borrowers by charging them high interest rates, exorbitant fees, or by imposing upon them other onerous contract terms that purposely leave them worse off than if they had not taken out the loan.^[1]

Predatory lending practices were implicated in the subprime mortgage crisis of 2007 because many observers interpret interest-only (I/O), negative amortization (neg am), adjustable-rate (ARM), and a variety of other types of subprime mortgage as prima facie evidence of predation. Those mortgages were predatory and caused the crisis, the argument goes, ergo predatory lending practices caused the crisis.^[2]

In fact, subprime lending is not synonymous with predatory lending. The conflation is made primarily because subprime borrowers are at higher risk of being victimized. ^[3] Any type of mortgage can be beneficial to a borrower who fully knows and understands the terms and conditions of the loan. A type of interest-only loan known as a "ground rent," for example, greatly aided artisans (small manufacturers) in late eighteenth and early nineteenth century Philadelphia and Baltimore.^[4] Similarly, ARMs make sense for borrowers who plan to move in a few years but wish to own rather than rent. Such mortgages become predatory when mortgage brokers trick or cajole borrowers into taking them in order to increase their commissions.^[5]

Predatory lending predated the housing bubble ^[6] but the buoyant market hid its proliferation because victimized borrowers a) could easily refinance if necessary; b) benefited from rising home price levels. The collapse in housing prices and consequent tightening of the mortgage market eliminated both outlets, thereby rendering the problem more salient.

Notes

1. ↑ "Victimizing the Borrowers: Predatory Lending's Role in the Subprime Mortgage Crisis," Knowledge@Wharton.com (February 20, 2008): http://knowledge.wharton.upenn.edu/article.cfm?articleid=1901
2. ↑ John Atlas and Peter Dreier, "The Conservative Origins of the Sub-Prime Mortgage Crisis," American Prospect (December 18, 2007): http://www.prospect.org/cs/articles?article=the_conservative_origins_of_the_subprime_mortgage_crisis.
3. ↑ Ken Zimmerman, Elvin Wyly, and Hilary Botein, "Predatory Lending in New Jersey: The Rising Threat to Low-Income Homeowners," (February 2002): http://www.njisj.org/reports/predatory_lending.html.
4. ↑ Robert E. Wright, The First Wall Street: Chestnut Street, Philadelphia and the Birth of American Finance (Chicago: University of Chicago Press, 2005): http://www.amazon.com/First-Wall-Street-Chestnut-Philadelphia/dp/0226910261/ref=ntt_at_ep_dpi_3.
5. ↑ A. Philip Bond, David K. Musto, and Bilge Yilmaz, "Predatory Mortgage Lending," SSRN Working Paper (October 10, 2008): http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1288094.
6. ↑ For an example, see Jeanette Bradley and Peter Skillern, "Predatory Lending: Subprime Lenders Trick Homeowners into Expensive Loans," NHI (January/February 2000): http://www.nhi.org/online/issues/109/bradley.html