Predatory Lenders and Students

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy.

It turns out that banks consider students to be great customers for their credit cards. I learnt this from James D. Scurlock’s book Maxed Out: Hard Times, Easy Credit and the Era of Predatory Lenders, which gives a fascinating look into the world of lenders and their hapless customers.

So why are students good customers? When you think of the old style bank that only lends to people with steady income to pay off a loan, lending to students makes no sense. Students usually have little income, and many of them will run up bills on their cards that they can’t pay off.

It turns out that students have something else that makes them great customers: parents. According to Scurlock, parents will almost always bail their children out of debt problems. And the attitude of banks has changed dramatically over the years.

Students run up debts and pay interest for as long as they can. When things finally fall apart, their parents pay off the debts. The situation is perfect for the bank: they charge high interest rates with very little risk of default.

Other great customers are people who can’t handle money properly, but have a valuable asset such as a home. The strategy here is to offer this person some unsecured credit, and when they become unable to make payments on the debts they run up, get them to reorganize the debt with the home as collateral. As the debt continues to grow, and the borrower can’t make the payments, the bank can seize the home.

In this scenario, the bank’s goal isn’t so much to seize the home as it is to collect interest on its loans. The home serves as protection against default making the loan safe. Profitability comes from maximizing interest rates and minimizing the risk of default.

When you think in generalities about debt, it is hard to argue with the idea that people should be responsible for their debts and should pay them back. But, when confronted with the particular case of an illiterate woman being forced from her modest trailer home over a snowballing small debt combined with some papers she signed, but didn’t understand, things become less clear.

I’ve done my best to educate my sons about the problems with debt. I’ve also tried to convince them to talk to me before the first time they get a credit card or borrow money in any other way. But, I don’t have any particular insight into the best way to protect young people from the debt trap.