The economic slowdown, as mild as it appears, will be the first stress test of subprime mortgage lending. Subprime loans carry higher rates. Three questions arise:
Will more than the usual number of people default on their loans and lose their homes?
Did you accidentally take a subprime loan when you qualified for something better? As many as one-third of all subprime borrowers could get cheaper loans at traditional banks, according to an estimate by the Federal Home Loan Mortgage Corp.
How much high-rate lending went beyond subprime and turned predatory, raking consumers with abusive interest rates and fees?
Subprime mortgage lending expanded during the second half of the 1990s. The loans come mainly from finance companies and mortgage banks for borrowers with credit problems.
Before the business got started, these people might not have gotten a mortgage at all. Or they might not have qualified for a large enough loan to buy the house they wanted. Now, they have a chance -- at a high price.
An average mortgage rate last week, for people with acceptable credit, was 7.14 percent on 30-year fixed-rate loans, according to Freddie Mac, the mortgage company. On one-year adjustable loans were at 5.82 percent.
A subprime loan runs at least 2 percentage points higher and possibly more, depending on your credit profile, says HSH's Keith Gumbiner. There's usually a penalty for repaying early.
But hear this! People with modest credit problems may still qualify for standard rates. To know where you stand, you have to discover your "credit score."
The online lending company E-Loan offers consumers a one-time, free look at their current credit score. Go to www.eloan.com.
People with scores of 660 and up can get the best rate available. So can most people who score as low as 620, says E-Loan's CEO, Chris Larsen.
If you score 620 or higher, you should always apply first at a traditional bank or a mortgage bank that does prime lending. Larsen calls it abusive for subprime lenders to foist high-rate mortgages on people who could qualify for standard rates.
Subprime lending helps create homeowners. It's evil twin, "predatory" lending, wipes out borrowers and takes their homes away.
A predatory lender looks for people with financial problems who have a lot of equity in their homes. That includes many older people. You'll get a phone call or a letter in the mail, promising low interest rates. Not likely. The salesperson's job is to hide the loan's true cost.
You might be charged a huge 15 percent to 20 percent up-front fee, which is added to the loan itself. The salesperson's patter, however, keeps you focused only on monthly payments, which appear low.
They do indeed start low. But they rise rapidly -- something else that borrowers aren't told.
A year or two later, when monthly payments have shot up, you might not be able to afford them. So the lender will restructure the loan, for another round of fees.
The same thing might happen five or six times. That's called "loan flipping." When you can't possibly pay any more, the lender forecloses. You lose your home.
You might also owe a big payment (a "balloon") at the end of the loan. That might force you to borrow again.
The AARP has brought several lawsuits against predatory lenders. In one case, says Nina Simon, an attorney for AARP Foundation Litigation, First Alliance Mortgage (now bankrupt) flipped a couple who "thought they were paying less than 7 percent. But they ended up with over 11 percent."
Under federal law, the true cost of the loan has to be disclosed before you sign. The disclosure form, however, will be stacked with a lot of other papers and the salesperson won't point it out. If you complain, you'll be told that you had all the facts.
Big names are no guarantee of consumer protection. In March, the Federal Trade Commission brought a predatory-lending lawsuit against Associates First Capital Corp., which was recently acquired by Citibank. Citibank says it hopes to settle the case.
For information on how to protect yourself from predatory lending, get the AARP Borrowers Kit free at www.aarp.org/homeloans. Or call the AARP at (800) 424-3410 and ask for a kit to be mailed.