Low interest rates and aggressive marketing campaigns have driven home lending to record levels. But increasingly Americans with good credit are being saddled with loans designed for high-risk borrowers.
These higher-cost loans have been the fastest-growing segment of the mortgage market -- accounting for 20% of the home loans issued last year, up from 10% a decade ago.
Freddie Mac, the government-sponsored mortgage finance giant, estimates that more than 20% of people who get these so-called sub-prime loans could have qualified for more-conventional prime loans.
Consumer advocates say it's a "borrower beware" market. Companies and independent brokers generally are not legally required to tell customers that they might get a better deal elsewhere, and regulations have not kept pace with the booming mortgage refinancing market and skyrocketing home prices.
"The reality is, if you happen to walk into the wrong door, you can be trapped," said Kathleen Keest, senior policy counsel at the Center for Responsible Lending, a nonprofit advocacy group in Durham, N.C.
The National Home Equity Mortgage Assn., which represents sub-prime lenders, disputes the notion that large numbers of their customers could find better loans elsewhere. There are legitimate reasons, the association says, why lenders make sub-prime loans to borrowers with good credit. Self-employed people, for example, don't have regular paychecks to document their income.
"People have a lot of choices these days, and everything doesn't come in one package," said Jeffrey Zeltzer, the association's president.
Used properly, sub-prime loans can help people with spotty credit and a large amount of debt, or others who simply want to tap their equity to pay off expensive credit cards. But they also can allow loan agents and brokers to earn high commissions at the expense of people with solid credit.
Loren and Rebecca Oldham say they thought they were getting a good deal when they refinanced their mortgage at 5.25% interest, cutting their monthly payment by $150 a month. But when they sold their house outside Louisville, Ky., less than a year later, they discovered a clause that forced them to surrender nearly $16,000 as a penalty for paying off the loan early.
Prepayment penalties are usually for borrowers with bad credit, not folks like the Oldhams, who say their high credit score should have landed them a loan without the provision. They plan to seek a refund, and are kicking themselves for not taking enough time to spot the penalty.
"You know how closings are: You sign so many documents, you kind of trust what they're saying," Loren Oldham said.
Freddie Mac estimates that during the last two years more than 1 in 5 borrowers who got these higher-cost loans could have qualified for less-expensive prime loans.
That estimate is based on computer analyses of hundreds of thousands of sub-prime loans, taking into account factors including credit history, home value and the ability to pay, said Peter Zorn, the company's vice president for housing analysis and research.
The number of borrowers improperly stuck in sub-prime loans is on the rise, Zorn said; until about two years ago, it was only 10% to 15%. One reason, he said, is that lenders have relaxed their standards for approving prime loans, making them easier to get than people may realize.
At least one mortgage company executive says he has also seen evidence supporting Freddie Mac's analysis.
IndyMac Bancorp Inc. of Pasadena was considering acquiring several sub-prime mortgage specialists about two years ago, and reviewed the loans that they had made, said Chief Executive Michael Perry.
The data, including credit scores and borrower incomes, showed that about 40% of the customers of the other companies qualified for lower-cost prime loans, Perry said.
That led IndyMac to rule out the acquisitions, he said, because prime loans aren't as profitable. His company makes both types of loans, and Perry says IndyMac's computers automatically steer qualified customers to prime loans.
Based on estimates from Freddie Mac and the Center for Responsible Lending, as many as 1 million borrowers are paying too much for their loans. Such customers paid an estimated $3 billion in excess interest in 2001 alone, the consumer group said in a study that year.
Prime, fixed-rate loans currently charge interest of about 6% a year, along with upfront charges known as points that typically run 1% or less of the loan amount. To cover their higher risk, sub-prime loans carry interest rates averaging about 7.5% a year and upfront points of about 3% of the loan value.
For a $300,000 loan, an extra 1.5% in interest costs the borrower nearly $11,000 in additional monthly payments in the first three years, or more than $25,000 extra over seven years. The two additional points upfront translate to $6,000 more at closing.