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I'm reading about Household International's fraudulent mortgage interest rate. According to Michael Lewis, Household disguised a 15 year, fixed-rate loan as a thirty-year loan. The sales would offer to replace a client's existing $67,300 mortgage (8.5% interest rate) with a bigger but seemingly cheaper one: $86,300 at an “effective rate” of 7.6%. The sales pitch goes something like this: “If I can put together a loan that pays out like a 7.579%-a-year loan, but has a total term of 18.63 years … would you be interested?”

Can someone explain how exactly does the trick work? How did the sales misrepresent the 7.6% interest rate, which is seemingly lower than the client's existing 8.5% interest rate?

Source: https://www.forbes.com/forbes/2002/0902/062.html

Dheer
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user59667
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3 Answers3

36

A loan with a term of 18yrs 8mo on initial principal of $86,300 at an annual rate of 12.2% would require 224 payments of $979 for a total of about $219k, of which $133k interest (rounding to the nearest 1k).

A loan with a term of 30yrs on initial principal of $86,300 at an annual rate of 7.6% would require 360 payments of $608 for a total of about $219k, of which $133k interest.

Household was claiming that because the total amount of interest paid was the same on this ~19yr loan as on a standard 30-yr fixed loan at 7.6%, the rate was "effectively" 7.6%.

If the rate were truly 7.6% on a loan term of 18yr 8mo, the amortization table would call for 224 payments of $721 for a total of about $162k, of which $75k interest, quite different from the loan offered.

Martin Argerami
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user4556274
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The short answer is that they made up a new rate called it "effective" rate, and presented it as if it were the APR. AFAIK, creditors are supposed to disclose APR of a loan. Thus the situation presented would be fraud.

Xalorous
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Household was offering 19-year loans at an interest rate of 12.2%. They showed potential clients worksheets with an "effective interest rate" of 7.6%. If the client took out a 30-year loan at the effective interest rate then they would pay the same amount of interest.

Nosrac
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