Shake-ups in the sub-prime lending market in the US and soon the UK bring to light the problems of consumers having faith in lenders. Many assume that if they are approved for a loan or mortgage that it means that someone responsible felt they could afford it. Nothing could be further from the truth.
Consumers are mistaken about the motives of many lenders, especially the sub-prime lenders that extend credit to people with less than perfect credit. Lenders are businesses that make money by originating loans on behalf of others. An average loan broker is not a financial planner nor providing you with financial advice. They are trying to get your application to tick all the boxes to be approved by the lender so the mortgage broker can get paid a commission for finding you and generating the loan.
The issue of affordability hardly even comes into the equation when approving a loan application. With lenders offering no documentation or self-certifying loans can we be surprised when a consumer might bend the truth a bit to get the money they think will save them from a difficult financial situation or the house they want.
The loan originators sell their loans to a loan company that will often bundle a bunch of loans together and sells them up the food chain. It is not unusual for a new loan to pass through two or three hands until it lands in some bigger fish loan warehouse.
During the stage when you would hope that a sub-prime loan is screened for appropriateness what is happening in many cases is that everyone is looking the other way. The borrower is fudging the numbers a bit, the lender is pushing the envelope a bit and everything is getting pushed upstream.
Currently, in the United States, a crisis of sorts is brewing in the mortgage market with sub-prime loans going bad faster than milk in the sun. In 2000 approximately 3% of the loans originated in the United States were sub-prime mortgages. In 2006 that number was only around 13%.
Over the past six years, lenders have smelled blood in the water and sought to exploit an area of the lending market that they felt would make them a lot of money. And I guess they were right as long as the US economy remained strong and growing.
But with the housing market cooling and loans originated in the past year or so going bad as fast as they are written, some lenders that have enjoyed strong growth in the sub-prime market are now finding that as many as 19% of those loans are delinquent and in default.
And now, some of the lenders behind the sub-prime market have found themselves insolvent. Waves of these smaller companies have been going bankrupt, with as many as 22 just last week seeking protection through bankruptcy.
What makes this situation particularly scary is that many of these newly originated loans are interest-only or adjustable interest rate loans and if interest rates creep up even just a bit, many will find themselves in a situation where they are losing their homes.
The lesson to be learned from this story is that the consumer should not rely solely on the approval by a lender. They should make certain that the proposed monthly loan payment will fit within the budget with room to spare.