The most egregious examples of predatory lending occurred when interest-only loan products where offered to subprime borrowers whose income only qualified them to make the initial minimum payment (assuming the borrower actually had this income). This loan program was commonly known as the two-twenty-eight (2/28). It has a low fixed payment for the first two years, then the interest rate and payment would reset to a much higher value on a fully amortized schedule for the remaining 28 years.
Seventy-eight percent of subprime loans in 2006 were two year adjustable rate mortgages. Anecdotal evidence is that most of these borrowers were only qualified based on their ability to make the initial minimum payment. The low starting payment rate is often called a "teaser rate" because it is a temporary inducement to take on the mortgage. There was a widespread belief among borrowers that one could simply refinance from one teaser rate to another forever in a process known as serial refinancing.
This practice did not fit the traditional definition of predatory lending because the lender was not planning to profit by taking the property in foreclosure. However, the practice was predatory because the lender was still going to profit from making the loan through origination fees at the expense of the borrower who was sure to end up in foreclosure.
There were feeble attempts at justifying the practice through increasing home ownership, but when the borrower had no ability to make the fully amortized payment, there was no chance of sustaining those increases. In many ways, people were more stable in their homes prior to the financial innovations. Long-term renters can stay in their rentals for extended periods, particularly if private landlords are more concerned with vacancy than with collecting top dollar for their rental. Renting from the bank for two years prior to a foreclosure hardly seems a beneficial move.
The advantage of interest-only, adjustable-rate mortgages (IO ARMs) is their lower payments. Or put another way, the same payment can finance a larger loan. This is how IO ARMs were used to drive up prices once the limit of conventional loans was reached.
Subprime borrowers took out 2/28 loans in large numbers. The majority of these borrowers defaulted on their loans because they could not afford the payment recast. This was predatory lending. Despite the fact that lenders lost a great deal of money on these loans, they wrote the loans to profit from origination fees. Lending for a profit at the expense of borrowers is the definition of predatory lending, and many lenders were guilty of it during the Great Housing Bubble.
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: [http://www.thegreathousingbubble.com/]
Read the author's daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/
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