Risk aversion and loan rates
A classist, racist, ableist pile of BS.
Q: What is shared by just about every kind of loan—from payday to mortgage and credit card to equity?
A: Different rates for different people.
Q: What’s the reason people get these different rates?
A: The “risk” associated with their ability to pay back the loan.
Let’s break this down:
- The riskier the person is who’s applying for the loan, the worse rates they get.
- Someone who can easily pay a $10,000 loan could get a 2% interest, $200 per month loan.
- Someone who might have more trouble paying could get a 4% interest, $400 per month loan.
Seems like what you’ve seen before, right? Anyone who’s trying to get a loan tries to seem as un-risky as possible because they certainly don’t want those terrible rates. You have to pay more every month and end up paying more total over time as well. So if you’re poor, you have to pay more. That’s a rotten deal. That’s classist and functionally racist. It also doesn’t really make sense overall.
So the story lenders tell is that you get that rotten deal because they think you can’t pay it back. How is that supposed make sense? Let’s actually think about that a second.
Suppose I’m a lender and I’m worried someone won’t pay back the money I loan them. Why might I be worried?
- Low income
- Unstable income
- History of unreliable payment (possible because of 1 and/or 2)
Okay, so this person has these difficulties listed out in either their loan application or a credit report. I can scrutinize them in great detail. What could I do to lower my risk of not getting my money back?
- Deny the loan
- Require a less risky co-signer
- Require them to front property of equal value
- Make the loan terms align with what they can likely pay
Hmm. I just got to the end of my list and guess what I didn’t include: terrible rates and terms.
Why didn’t I list a terrible rate? Well, if I want them to be able to pay me and then I make it MORE DIFFICULT for them to pay me—what does that do to risk? It raises the risk!
Terrible rates make a higher risk. Worse rates? Even higher risk.
With terrible loan rates I’m not averting risk, I’m manufacturing risk!
I’d be actively preventing them from returning my investment. Remember I’m a lender, I like money. I want to keep getting it. I want the whole amount back plus interest.
- When I make it harder to pay, they’re far more likely to fail. Then I don’t get my money back and most importantly, I don’t get that sweet, sweet interest as profit. So clearly, I shouldn’t make it harder to pay for someone who is already likely going to have trouble paying.
- When I make it easier to pay then I’ve lowered the risk I’m taking on the loan. They’re more likely to be able to pay it, all of it. They’re also more likely to be a repeat customer, and refer others to me. More juicy profits and I don’t have to lift a finger.
So what I should be doing
- Low income = Lower payments over longer time.
- Unstable income = Flexible schedule.
- History of unreliability = Have a conversation to figure out if there are any other solutions like co-signers, increments, lower total, etc.
It’s not about risk
So if it’s not about risk, what IS it about?
How failure effects lenders
Still roll-playing as a lender, let’s first look at what happens after someone fails from the terrible loan rates I give them:
- If it’s a loan without equity I pass it all to a collection agency. If I’m lucky, I might eventually get the remaining money back but it will be a lot slower. The agency will dock their pay, take their cut, and we’ll be harassing this person possibly for the rest of their life.
- Additionally I might have loan insurance included in the cost of their terms, so when they fail it’s then the insurance company that harasses the person instead of me. Then I get the loan amount back all at once. This is better but it effects my taxes and it removes any chances of more interest profits.
- If it’s an equity loan, I take possession of their property and resell it. If it’s their house, their car, their business… it’s no longer theirs. I do get my money back but not as planned, over the repayment period. I get it all at once when I sell the property. But that’s not supposed to be my business. I’m a lender, not a seller of property. That changes my taxes and makes a lot more work for me. I don’t like working. That’s why I’m a lender in the first place.
Neither of these situations return my investment as planned and they turn me from a helping hand into an oppressor.
How failure effects borrowers
What happens after a “risky” person fails?
- When someone is financially struggling, lowering their income further serves to make them struggle that much more. If they’re poor, they become poorer.
- If they lose their home that can be a huge and lasting hit. Home ownership has repeatedly been calculated as the most significant factor in first achieving long term financial stability. Particularly intergenerational stability.
- Business ownership is a path to greater financial progress than most work as an employee. Taking away such property often takes away that stability or that potential for the rest of that person’s life.
- Docked pay and losing property can lead people to take on more jobs, stay at worse jobs, turn to crime, attempt gambling, or just give up. This gives them less time for themselves and their family, increases the danger of everyday life, turns them into a burden on society, or makes them a tragic statistic.
- Taking away someone’s house who’s struggling is the quickest way to make them homeless. With homelessness comes a litany of other barriers to stability.
- Increased poverty can easily spans generations. It can create a bleaker outlook for that person and their whole family. It can make them sicker and less able to seek medical help. Members of poor families that gain some financial stability end up having less of it because they need to support the rest of their family, still in poverty. It’s like an extra tax that established families don’t have to pay or even know about.
Lenders must know about these effects, right?
Can plausible deniability be so strong that they literally have no idea what damage they’re doing? Or is it the more likely case that they do know?
So with this in mind—is my real motivation to be an oppressor, get cash quicker, or a nasty soup both?
Those effects don’t sound to me like something a normal, reasonable person would want. Not for themselves or to inflict upon members of their community. But since worse loan rates manufacture risk (even to the point of inevitability) and they must realize what happens after failures—that HAS to be what current lenders want to do to people they call “risky”.
So if that’s what they want, why would they want that for only “risky” people? Remember this isn’t applied to rich borrowers. This is being targeted, intentionally, groups who are already marginalized. Groups who are separated along lines of race, class, gender, and ability. These are the folks who are regularly deemed as “risky”.
It’s not about risk but it sure is about being a bigot.
Lenders might not consider themselves sociopaths but they are certainly using a framework seated firmly in racism, sexism, classism, and ablism. I mean, you’re either a sociopath or not, right? This doesn’t seem to have any gray area and it’s certainly not about reducing risk.