The difference between sub-prime and predatory loans

Sub-prime loans are loans extended by banks to customers at rates and conditions that are inferior to prime loans. These loans are given to customers, who may have a poor credit history or are in the low income bracket or are not eligible for prime loans due to other reasons.

Since the financier considers that it is riskier to lend to such groups, it wants a higher return and it charges a higher interest rate. The loans may also be accompanied by stiffer penalties and charges. Predatory loans on the other hand are different. They may be veiled under the garb of sub-prime loans, but they are offered by financiers, who are termed as loan-to-own lenders. They structure the loans with the objective to finally acquire the property. Their loans usually carry high interest rates, stiff prepayment penalties and high upfront fees, but are well devised so that they stipulate to regulations. These financiers often target older people, who eventually loose the ability to repay and forfeit the property to the lender.

Various states are now in the process to implement laws to curb such predatory practises.

Sub-prime to the rescue

If you are unable to get a regular loan to buy a home, don’t be disheartened. There is something called a sub-prime loan that is usually give to borrowers who are unable to raise prime loans due to problems with their credit history, income levels or age. Sub-prime loans carry a higher rate of interest and may have other accompanying charges that may not apply to a prime-loan.

Under ideal circumstances, if you were able to secure a prime loan, you would have been able to buy the property of your choice. But, if you are willing to compromise a bit, you can actually buy a property that is a little smaller that the one of your choice against a sub-prime mortgage. Since this loan will carry a higher level of interest rate, your monthly outflow will be higher and if you bought the smaller property it would fit into your budget. But, all the same you can become a homeowner.

Rising interest rates and falling realty prices

The US realty market seems to be in for a bad time. Both interest rates and realty prices are moving in unfavourable directions after having been favourable for a few years. The chief reason that has led to firmer interest rates is successive hikes in interest rates made by the US Fed. This hike has led to short term interest rates becoming almost aligned with long term interest rates and taking the steam out of ARMs.

Under a low interest rate regime and rapidly appreciating real estate prices, people could keep borrowing against their home and cashing out home equity. That time seems to be over for now. High interest rates on the one hand imply higher monthly outflows and softer property prices imply that additional borrowing is quite impossible. Both factors are working in tandem to cool the markets.

Long term rates creep up

Interest rates on long term mortgages crawled up to a new high for both 15 year and 30 year mortgages. The 30 year rate was up to 6.28% and the 15year rate rose to 5.91%. While the rates have risen only marginally compared to December levels, they are leading to discomfort in the market as long term mortgages were becoming a popular refinance choice. With these rates beginning to crawl up as well, the overall impact on the already flattened realty market will not be conducive.

Long term rates are expected to firm up further and experts believe that the 30 mortgage rates could be close to 7% by the end of the year on the back of the US Fed’s expected increases in interest rates in the next two quarters.

With this scenario in the offing, one can expect stagnation in the US realty markets if not an actual downturn.

Click here to read further on interest rates.

Home equity cash out skewing national savings rate

The savings rate in the US is abysmally low; in fact it is negative for the nation as a whole. In 2005, the savings rate was (negative) 0.5%. Americans spent $ 41.6 billion more than they earned. According to economists, this is an unsustainable paradigm and once the economy starts to slow down or goes into recession, bad debts will start to pile up and an economic implosion may occur.

Economists have identified cashing out of home equity as one of the key reason for the low savings rate. In the past few years, rising realty prices and low interest rates have encouraged homeowners to borrow against their homes and utilize the money for consumer spending. However, low interest rates leading to availability of easy money has led to rising realty prices. The recent reversal in the interest rate trend can lead to dip in property prices and panic selling of realty, setting in motion a vicious cycle that may initiate the accumulation of bad debts.

Median home prices in the US rose 24% between 2001 and 2004 with the rate being over 11% in 2004. It has been estimated that consumers pulled out nearly $ 243 billion in home equity in 2005.