Boom in Subprime Loans has Downside

DES MOINES, Iowa – Michael A. Knox thought he had run out of ways to pay off his credit card bills when he got the salesman’s call two years ago. To wipe out his nearly $20,000 debt, he was told, all he had to do was take out a new, bigger mortgage on his house.

Knox, then 60 and on disability, signed up. The mortgage broker sent him eight checks already made out to his creditors, and Knox dashed to the post office the day they arrived to mail them.

But the bigger house payment devoured 75 percent of his income. He quickly fell behind. And the full meaning of what he had done suddenly became clear.

By using his mortgage to pay off his credit card debt, Knox had avoided the humiliation of filing for bankruptcy. But he had put at risk something much more important to him than his pride. In late January, with Knox in arrears, the Wall Street firm that had bought his mortgage informed him that it was taking away his home.

“They’re going to have to carry me out of here,” he told a lawyer in early March. Days later, Knox, who had suffered for years from depression, was found dead of carbon monoxide poisoning in his sealed-up car.

Encouraged by low interest rates and rising home values, millions of Americans have been using their homes to pay off credit card bills. One-fourth of homeowners who refinanced their mortgages took out larger loans on their homes in order to pay off credit cards and other debts, according to a recent study by the Federal Reserve.

The maneuver is known as debt consolidation, and mortgage lenders are using national campaigns — from prime-time advertising to e-mail spam — to pitch it as a sound way to ease the sting of credit card debt, which averages $13,000 for people who don’t pay off their balance each month. For many, probably a vast majority, it has been a boon. Experts say the device is a factor in a recent leveling off of credit card debt and a drop this year in personal bankruptcies.

But each year, tens of thousands of people — not just the poor — lose their homes after trying to cope with their debts this way, industry figures show, and their heart-rending tales are raising alarm among consumer advocates, federal regulators and some mortgage-lending officials.

While anyone can encounter problems with debt consolidation, much of the booming business of debt consolidation is concentrated in what is known as the subprime market, which caters to traditionally poor credit risks.

The industry, which has an estimated 4 million outstanding loans, has enabled many people with modest incomes to enjoy the advantages of homeownership.

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