August 10, 2007
The Psychology of Subprime Mortgages
Jonah Lehrer in The Frontal Cortex:
The shit is hitting the fan: all those sub-prime mortgages given out so recklessly over the past two years are getting their interest rates re-adjusted. And that, of course, is when the foreclosures begin.
By most measures, sub-prime loans are a bad idea. Look, for example, at the popular 2/28 loan, which consists of a low, fixed-interest rate for the first two years and a much higher, adjustable rate for the next twenty-eight. Most people taking out a 2/28 loan can't afford the higher interest rates that will hit later on. It's not unusual for interest payments on a 2/28 loan to double within four years. (That's why you're seeing such high foreclosure rates in the sub-prime market.)
So why do people take out sub-prime loans? Don't they realize that they won't be able to afford the ensuing 28 years of mortgage payments? I think a big part of the reason sub-prime loans remain so seductive, even when the financial terms are so atrocious, is that they take advantage of a dangerous flaw built into our brain. This flaw is rooted in our emotional brain, which tends to overvalue immediate gains (like a new house) at the expense of future costs (high interest rates). Our feelings are thrilled by the prospect of a new home, but can't really grapple with the long-term fiscal consequences of the decision. Our impulsivity encounters little resistance, and so we sign on the bottom line. We want the house. We'll figure out how to pay for it later.
The best evidence for this idea comes from the lab of Jonathan Cohen.
More here.
Posted by Abbas Raza at 03:43 PM | Permalink
Comments
What a misguided thesis--just another study psychologizing (and thus naturalizing) what is really a question of class resources. I mean, who is in a position to appreciate the implications of taking a sub-prime loan - a trust-funded MBA or a working, first-time home buyer? Which of these two figures would command the resources necessary to assess such a loan offer? Or is the better explanation that the former's "emotional brain" is better managed/developed? Face it, the sub-prime crisis stems from a predatory loan practice predicated upon the very disingenuous assumption that the parties on each side of the contract are equally apprised of the mystifying significations of legalese and likely operations of "the market." Find that with your MRI.
And claiming that this experiment somehow bears upon the process of taking out a home loan is the kind of argument by analogy that undergraduates are routinely and quite properly chastised for.
Posted by: Diamond Mike | Aug 10, 2007 5:19:32 PM
Yes, the basic reason for this mess is that we have a "market" economic system which allows a financial industry of this type, which in a more rational system would be outlawed. (This system, of course, would also include a rational housing system which would provide decent shelter for all.) But the psychology is probably also correct.
Posted by: JonJ | Aug 10, 2007 8:44:49 PM
I don't completely agree. The industry is to blame, of course, for marketing crazy loan packages. But the bottom line is yet another affirmation of the marshmallow test and the greater fool theory.
Look closely and you will find too many of these so called "investments" issued to people with no intention of using them as homes. In some cases they were trying to acquire second "homes" with a view of "flipping" them later at a profit. Greed is almost as irresistable as sex. What we are watching is the equivalent of an investment world's Girls Gone Wild.
Those who worship at the altars of free enterprise and market economics take note. The public sector is not all it's cracked up to be. Sometimes a little regulatory oversight goes a long way. Or doesn't...in this case.
Posted by: Hootsbuddy | Aug 11, 2007 7:38:20 AM
Nice information thanks for giving out
Posted by: Patchouli | Mar 27, 2008 2:30:43 AM
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