Imagine paying credit-card fees higher than your credit line, or getting a mortgage loan with an interest rate twice the national average.
Sound outrageous? Maybe so. But when it comes to the exploding “subprime”-lending market, the Wild West of consumer lending, almost anything goes.
Just look at the newest credit card being touted to high-risk borrowers by First Alliance Mortgage Corp. of Irvine, Calif. In addition to annual interest of up to 24.8 percent, borrowers pay a $179.50 sign-up fee and a $38.50 annual fee.
Worse, their credit is tied to equity in their home. The penalty for non-payment: foreclosure. “This is for borrowers who otherwise wouldn’t have access to this kind of credit,” says Mark Mason, executive vice president of First Alliance.
Thousands of consumers are signing up for high-priced deals with subprime lenders, and they’re not just people with low incomes and dismal credit histories. “It is increasingly a broader spectrum of American households that qualify as subprime,” says Mark Zandi, chief economist of Regional Financial Associates Inc., a West Chester, Pa., consulting firm. “Some have bad credit and others may just be overindebted.”
To be sure, most people with troubled credit histories or heavy debt burdens are happy to get a loan or credit at all. But financial advisers and other experts say that in many cases borrowers are paying more than they have to, sometimes far more. Worse, some lenders in this market use pricing techniques that consumer advocates say are designed to veil the true cost of a loan or credit lines.
In a recent hearing before the U.S. Senate Special Committee on Aging, Ford’s majority-owned Associates First Capital, the nation’s largest home-equity lender, came under attack for alleged practices such as extending loans based on borrowers’ home equity, rather than their ability to repay, or packing fees and insurance products in with a loan, increasing total costs.
Dallas-based Associates says it is concerned about abusive lending practices and urges consumers to educate themselves when considering a loan, according to a statement released in response to the Senate hearings.
“The subprime market provides a lot of flexibility for the consumer and the lender, but it’s those same attributes that provide the opportunity for abuses,” says William Anderson, president of Bank Rate Monitor in North Palm Beach, Fla.
Mortgage loans, combined with home-equity lines of credit, account for about 60 percent of the high-risk-lending market. One costly hidden danger that experts cite when it comes to mortgage loans is the “average daily balance,” or “simple interest,” method of accounting, which means the principal and interest payments are calculated on a daily, rather than monthly, basis.
Normally a borrower has a 15-day grace period before late charges are assessed, and it makes no difference when the payment is made within that period. With the “simple interest” method, if a borrower makes a payment after the due date–but within the grace period–the loan accrues daily interest charges.
Say a borrower has a $100,000 balance on a mortgage loan with a fixed interest rate of 7 percent. Paying on the last day of his grace period would mean an additional $291 for that month.
The pitfalls of subprime lending can be more difficult to detect when it comes to used-car loans, which can have interest rates of up to 30 percent. “Many times the true price of financing is disguised by the increases to the price of the car,” says Anderson. “So a dealer can do a loan at what appears to be a market rate, but inflate the price of the car.”
In the credit-card industry, risk assessment tends to be more standardized. Even so, there are still cost-saving choices consumers can make.
In many cases for high-risk borrowers, it’s wiser to get a secured credit card rather than an unsecured card with high fees. Take an unsecured credit card offered by First Premier Bank in Sioux Falls, S.D. It carries fees of $278 on a credit limit that may be as low as $250 for customers with seriously impaired credit. In addition to charging annual interest of 21 percent, it levies a $119 acceptance fee, a $49 processing fee, a $50 annual membership fee and a $5 monthly participation fee. The company didn’t respond to requests for comment.
Secured cards require you to make a deposit equal to the desired credit line, says Robert McKinley, president of RAM Research in Frederick, Md. For instance, Community Bank in Parker, Colo., has a 15.9 percent interest rate and charges a $29 annual fee. Minimum deposits are $300. The deposit is returned with interest when the borrower is upgraded to unsecured.
Even though high-risk pricing is all over the map, many industry experts say consumers should expect more consistency in the next couple of years. “The introduction of larger, more sophisticated players is going to have the effect of improving rates for borrowers,” says Bob Meceda, managing director of a San Francisco consulting firm.
Indeed, driven by juicy profit margins, several large lenders have recently taken the plunge into the high-risk market. Recently, First Union Corp. in Charlotte, N.C., acquired Money Store Inc., of Union, N.J., one of the largest subprime lenders. And last year, KeyCorp, based in Cleveland, bought Champion Mortgage Co., a subprime lender in Parsippany, N.J. The Federal National Mortgage Corp., or Freddie Mac, also entered the high-risk-mortgage market last year by purchasing a total of $1.5 billion in subprime loans.
Meantime, here are some tips from experts to help you find the best deal:
– Check your credit report for accuracy. According to a study released recently by U.S. Public Interest Research Group, a consumer-advocacy group in Washington, a third of credit reports contain errors. This suggests many people are classified as high-risk borrowers when they shouldn’t be.
– Don’t assume you’ll get shut out by a traditional lender. Indeed, according to Freddie Mac, 35 percent of borrowers who have obtained mortgages in the subprime market could have qualified for a conventional loan at a lower rate.
– Request a list of all fees and expenses. A lender may advertise no “application fee” but charge a hefty fee by a different name.
– Ask what the annual percentage rate will be on your loan. The APR, as it is known, is your interest rate, after all fees and other expenses have been included.
– Do your research. “Don’t take the loan from someone who calls you on the phone,” says Norma Garcia, a staff attorney at the Consumers Union in San Francisco. “Compare the rates of at least three lenders.”
