Oh, Not Just the Subprimes, Folks

In DFE’s continuing coverage of the Subprime mess, we take you now to an article in the NYT which has the appearance of informing the public, but does not.  Or at least, it buries the truth towards the bottom of the article where most people probably won’t see it.  So, I’ll help fill in the gaps.

The article starts out thus:

Mortgage Crisis Spreads Past Subprime Loans – New York Times

As home prices fall and banks tighten lending standards, people with good, or prime, credit histories are falling behind on their payments for home loans, auto loans and credit cards at a quickening pace, according to industry data and economists.

Hmm. .  You may be wondering how banks tightening their lending standards would affect people who already have loans.  Well, it doesn’t.  But the banks jacking up your interest rates?  That does.

Altogether too often in the discussion of the current housing crisis, the subject has been those pesky poor people, living beyond their means.  All too often, the story has been about those “subprime borrowers.”  But in actual fact, the problem has nothing so much to do with “prime” versus “subprime,” but rather with the ARM mortgages that banks have been giving out.

ARM stands for Adjustable Rate Mortgage, and it means that the rate of interest charged on the loan can change as the bank sees fit.  Generally, ARMs are taken out at interest rates below the prime (or typical) rate on the bet that a person can refinance later on if needs be.  It’s a way of gambling that you can find a way, somewhere down the line, of affording a house much more expensive than you might otherwise get.  True, those with bad credit were often sold on ARM mortgages, but many more people of greater means also got conned into these schemes, and now they’re in trouble as well.

The trouble is when rates go up and you cannot refinance your house nor sell it, as is the case in the currently depressed housing market.  When the interest rate goes up, unpaid interest is tacked onto the principle of your mortgage.  The principle is the original borrowed value of the mortgage (say, a $95,000 house gets a $95,000 mortgage) and it’s the part that you pay interest on.

Many of us know that when you repay a loan, the first payments you make are primarily on the interest, and very little principle.  We also know that if you pay just a little more to the bank every payment than they require, that overage is paid against the principle, which is then recalculated, and you end up saving yourself tons of money on interest rates.  Unfortunately, ARM borrowers are finding out that the opposite is also true: when your interest rate goes up and the unpaid interest gets tacked on to the principle, that means much, much more to your bottom-line monthly payment.  In short, your payments balloon out of control until you can’t afford them.

So, if there’s a reason that subprime borrowers are in default in one out of four cases, it’s because the banks willingly gave out loans they knew could blow out of proportion to people they knew couldn’t afford such a thing.

And car loans and credit cards are also going into default.  Again, this is not just because of tightening of lending practices, and this is not just the po folks.  Bank are jacking up interest rates and payments are skyrocketing.  I damn-sure know my credit card rate has gone up with Citibank, surprise, surprise.

And when the Fed lowers interest rates but the credit industry keeps jacking them up, that’s a scam.  Even if, incredibly, there are those who are willing to defend the credit industry for this travesty.