Tilted Forum Project Discussion Community - View Single Post - What Happened to Personal Responsibility?

Yakk · 10-14-2008, 08:28 PM

People who borrowed 400,000$ using NINJA balloon loans, paying less per month than they where in rent for a larger, better house, with the loan guaranteed only against the price of the house ... where doing something smart.

If the house price went up, they got to keep the money.

If the house price went down, they could walk away from it after having spent less on the interest payments than they would have on rent.

The people who made those loans? They screwed up.

Now, the problem is, the banks where so desperate for yield (any yield) that they where willing to lend to anyone, even if the default rates where expected to be high. These are products that are not designed to be repaid: they are designed to get the person to pay high interest rates, with increasing principle, until the person goes bankrupt. With a high enough rate, you can make this profitable -- more importantly, you can make it look profitable to your shareholders even easier than you can make it profitable.

Should that kind of lending be encouraged? Ie, you lend money to someone at a 50% annual rate, where you work out that they can afford at most 20% of your starting loan value per year, and that they'll go bankrupt in about 5 years and, with an expected reduction the amount they owe you down to 20% of the total value with a 20% per year over 5 year repayment plan...

This loan starts at 1000$.
After 1 year: +200$ paid, +500$ interest: 1300$ balance.
After 2 years: +200$ paid, +650$ interest: 1750$ balance.
After 3 years: +200$ paid, +875$ interest: 2425$ balance.
After 4 years: +200$ paid, +1212.5$ interest: 3437.5$ balance
After 5 years: +200$ paid, +1718.75 interest: 4956.25 balance

Borrower goes bankrupt. Debt reduced by a factor of 5 down to ... about 1000$. Person owes you 200$ per year for 5 years and then the debt is cleared.

They paid you 200$ per year over 10 years -- but they also went bankrupt.

That works out to an effective 15% interest rate you actually got from the deal. Pretty sweet return! And all you had to do was find someone with bad credit to sign a loan guaranteed to drive them to bankruptcy.

What is better is that in the short term, you can make it look like the loan is even better than 15%! Pretend that the chance of it going upside down is even less...

Do you see anything wrong with this kind of business model? Where you make a loan to someone with the expectation that they cannot repay you, and the nominal interest rate simply exists in order to boost the amount of debt they will owe you when they eventually go bankrupt, so your share of the amount collected at that point is higher?

10-14-2008, 08:28 PM	#14 (permalink)
Yakk Wehret Den Anfängen! Location: Ontario, Canada	People who borrowed 400,000$ using NINJA balloon loans, paying less per month than they where in rent for a larger, better house, with the loan guaranteed only against the price of the house ... where doing something smart. If the house price went up, they got to keep the money. If the house price went down, they could walk away from it after having spent less on the interest payments than they would have on rent. The people who made those loans? They screwed up. Now, the problem is, the banks where so desperate for yield (any yield) that they where willing to lend to anyone, even if the default rates where expected to be high. These are products that are not designed to be repaid: they are designed to get the person to pay high interest rates, with increasing principle, until the person goes bankrupt. With a high enough rate, you can make this profitable -- more importantly, you can make it look profitable to your shareholders even easier than you can make it profitable. Should that kind of lending be encouraged? Ie, you lend money to someone at a 50% annual rate, where you work out that they can afford at most 20% of your starting loan value per year, and that they'll go bankrupt in about 5 years and, with an expected reduction the amount they owe you down to 20% of the total value with a 20% per year over 5 year repayment plan... This loan starts at 1000$. After 1 year: +200$ paid, +500$ interest: 1300$ balance. After 2 years: +200$ paid, +650$ interest: 1750$ balance. After 3 years: +200$ paid, +875$ interest: 2425$ balance. After 4 years: +200$ paid, +1212.5$ interest: 3437.5$ balance After 5 years: +200$ paid, +1718.75 interest: 4956.25 balance Borrower goes bankrupt. Debt reduced by a factor of 5 down to ... about 1000$. Person owes you 200$ per year for 5 years and then the debt is cleared. They paid you 200$ per year over 10 years -- but they also went bankrupt. That works out to an effective 15% interest rate you actually got from the deal. Pretty sweet return! And all you had to do was find someone with bad credit to sign a loan guaranteed to drive them to bankruptcy. What is better is that in the short term, you can make it look like the loan is even better than 15%! Pretend that the chance of it going upside down is even less... Do you see anything wrong with this kind of business model? Where you make a loan to someone with the expectation that they cannot repay you, and the nominal interest rate simply exists in order to boost the amount of debt they will owe you when they eventually go bankrupt, so your share of the amount collected at that point is higher? __________________ Last edited by JHVH : 10-29-4004 BC at 09:00 PM. Reason: Time for a rest. Last edited by Yakk; 10-14-2008 at 09:05 PM..