While these types of home equity loans can, in theory, help individuals consolidate their debts and pay off credit cards at a lower interest rate, they often end up costing borrowers tens of thousands of dollars over the course of the new loan—which is always longer and at a much less favorable rate than the original. Many borrowers are replacing loans originally issued by Habitat for Humanity, with interest rates as low as 1 or 2% over 20 years. The new loans are often issued at 12% or higher, with terms of 30 years. As a result of a recent swell in this activity, many low-income borrowers cannot meet their new debt service and face the risk of losing their homes to foreclosure.
Why are lenders doing this? Because they have developed sophisticated algorithms that accurately predict the default rates of “sub-prime” borrowers. Since the companies know the probability of their financial loss, they can hedge against it and continue to make money by exploiting the least affluent (and often least financially sophisticated) members of our society. Hence the term “predatory lending.”
The National Community Reinvestment Coalition, a non-profit citizen group, is fighting this trend, and the Federal Reserve Board is currently examining various courses of action to cure the problem. So, next time you see that television commercial urging you to consolidate your debts, think twice.