Predatory Lenders

By Rick Stuart, CAE

A November article in USA Today titled, “More U.S. home buyers fall prey to predatory lenders”, made me think that I have not seen much on this topic recently. It still exists, unfortunately, but perhaps state legislation has slowed or controlled the abuse. For some, this is old hat, but for others this may be a practice you have seen happen to friends or a family member.

Information in this article is not suggesting that all lenders or mortgage bankers are predatory lenders. There are ‘bad apples’ in every profession. It was noted in the USA Today article that mortgage brokers now originate about 50% of the loans and “the number of mortgage brokerage firms has climbed to 44,000 last year from 7,000 in 1978”. ¹

The website for the National Mortgage Bankers Association (www.mbaa.org) has a section dedicated to predatory lending. On their website, choose Resource Centers and then Predatory Lending Resource Center.

“Interagency Guidance on Subprime Lending issued by the federal bank agencies on March 1, 1999, defines subprime lending as extended credit to borrowers who exhibit characteristics indicating a significantly higher risk of default than traditional bank lending customers. Subprime lending is linked to the credit status of the borrower. That is, subprime lending serves the market of borrowers whose credit history would not permit them to qualify for the conventional prime loan market”. ² “While most subprime loans are not predatory, consumer advocates caution that all predatory loans are subprime”. ¹

“Practices and terms that in combination are commonly found in predatory lending, principally home equity lending, include:

· High-pressure and/or misleading marketing and sales efforts;

· Excessive fees and interest rates at levels well beyond those appropriate or necessary to cover risk and a profitable return;

· Excessive origination fees and/or excessively priced or unnecessary products, such as can be the case with single premium credit life insurance, that are included in the loan balance;

· Large prepayment penalties that are intended to trap borrowers in an unfavorable or unaffordable loan;

· Balloon payments that have unrealistic repayment terms and often result in foreclosure;

· Loan flipping, or frequent refinancing, with fees folded into the loan balance repeatedly, resulting in rising loan balances and the stripping of equity; and

· Aggressive, often abusive, collection practices”. ²

Not only are home equity loans a good avenue for predatory lenders, but refinancing is also. Refinancing transactions involve fewer people and thus it is easier to cover up any hidden fees.

Those borrowers who have few credit choices and are less financially sophisticated are one target for predatory lenders. “Subprime lenders provide mortgages or home equity loans to people, including high-income borrowers, who don’t qualify for conventional financing. Such lenders accept credit scores below the 620-660 threshold generally needed for prime financing and require less-stringent income documentation”. ¹

Over the last few years, a large target has been minorities and the large number of immigrants that continue to flow into the United States. Predatory lenders prey on those who have a low-level of education or do not seek help in reading or reviewing loan documents.

Of course, the elderly are always a target for any type of scam and the elderly continue to grow in numbers. You can read multiple stories where an elderly person signs a loan for some minor remodeling and then refinance after refinance and suddenly their equity is gone in their house.

The AARP has several articles on their website (www.aarp.org) relative to this topic that gives good advice for all ages with some of the advice shown below.

“Avoiding Predatory Lenders: Lots of dishonest, aggressive, lenders advertise their loans to homeowners in financial need – people who have fallen behind on property taxes, need money for medical bills or need costly home repairs. Instead of offering a fair loan, these lenders use smooth-talking salespersons whose loans carry high interest rates, outrageous fees, and unaffordable repayment terms. They can trick you into taking our loans that you cannot afford to repay. Some people even lose their homes to foreclosure. That’s a high price to pay for choosing the wrong lender.

Spotting a Dishonest Lender: Be suspicious of anyone who offers you ‘bargain loans’, whether they mail or email you an offer, call you on the phone, or come to your door. Avoid salespeople who promise ‘No Credit? No Problem’. A bad loan is a costly mistake. Beware of offers that are only ‘good for a very short time’. Be suspicious of anyone who contacts you first – most good mortgage lenders or credit companies don’t solicit business over the phone or just show up on your doorstep.

Avoid lenders who call you and promise guaranteed, low-interest loans, who take application over the phone, or who offer next-day approval if you pay them some money today. Say ‘No’ to lenders who ask for up-front fees to cover the first payment and other expenses. Why? Because they never intend to give you the actual loan – they just take the up-front money and run.

Avoid ‘balloon’ payments: One way that lenders make loans sound very good is to make the monthly payment small but then require a big balloon payment at the end of the loan period. Some loans have you wait to repay the entire loan amount until the loan term ends. Dishonest lenders may promise to help you refinance when it comes time to pay it off, but watch out! This promise may be just a way for the lender to charge you higher fees and closing costs. Predatory lenders make money by charging excessive fees every time they refinance the loan and they’ll encourage you to refinance often.

Some predatory lenders dramatically change the loan terms at the last minute from what you thought you were promised. Before you sign the loan papers, ask a lawyer or trusted friend to go over them with you”. ³

“States that have cracked down generally bar or limit these practices: loans that carry excessive interest and fees, exceed a borrower’s ability to pay, include big balloon, or lump-sum, payments or penalties for early payoff or are subject to ‘flipping’ – repeated refinancing with fees that strip out home equity”. ¹

According to the website for the Mortgage Bankers Association,

45 states and the District of Columbia have passed legislation concerning predatory lending. Kansas is not one of those states. The very first state was North Carolina in 1999. This law has been effective according to a recent study by The University of North Carolina and shown on the Mortgage Bankers website.

“The nation’s first anti-predatory lending law – the North Carolina statewide measure that took effect nearly three years ago on July 1, 2000 – has significantly reduced harmful refinance loans containing abusive terms, while not limiting access to subprime credit for homebuyers and low-credit score borrowers, according to a report by the Center for Community Capitalism (CCC) at the University of North Carolina at Chapel Hill.

The UNC report revealed that loans in North Carolina containing prepayment penalties of three years or more) one of the most common characteristics of a predatory loan) dropped 72 percent in North Carolina after the law’s passage, while rising in neighboring states, and by more than 260 percent in South Carolina. On the crucial issue of credit availability, the report found that the total volume of loans to North Carolina borrowers with impaired credit actually increased by 31 percent since the state’s anti-predatory lending law was fully implemented, while subprime home purchase loans increased by 43 percent – keeping North Carolina on par with surrounding states, which did not have predatory lending curbs in place”. ⁴

A concept to stop predatory lending with less legislation was proposed in a paper presented by Jack Guttentag of The Wharton School at the University of Pennsylvania. His paper was titled, “Another View of Predatory Lending”, and he argues that predatory lending is the fault of market failure. Guttentag argues that every borrower is vulnerable because effective shopping for a mortgage is extremely difficult.

“Market failure is a single-market paradigm. It makes no sense that the same market structure would work for some borrowers but not for others. The borrower who pays $10,000 more on a $400,000 loan than he could have paid had he been more alert, astute and aggressive probably won’t lose his house as a result, and won’t find himself the subject of a news article. Yet he has been hoodwinked just as badly as the borrowers who populate the horror stories appearing in the press. If the causes of market failure can be removed, predatory lending will be eliminated, no matter how it is defined”. ⁵ According to his paper, the best way to stop predatory lending is to make mortgage shopping unnecessary by having mortgage brokers represent the borrower.

“Mortgage shopping is a highly-skilled professional service that should be purchasable in the market. I call the professionals providing this service “Upfront Mortgage Brokers’ (UMBs), to distinguish them from conventional mortgage brokers who are part of the problem.

UMBs act as agents of borrowers in shopping for mortgages, are paid a negotiated fee for their services, and disclose and pass through the prices they receive from lenders. In contrast, conventional mortgage brokers are independent contractors who mark up the prices they receive from lenders, which they do not disclose.

The global remedy to predatory lending is to require by law that all mortgage brokers operate as UMBs. Then borrowers would shop for mortgage brokers, not for mortgages, and need concern themselves only with price, quality and referrals – the same factors they look at when hiring a house painter or an electrician. Predatory lending would then disappear”. ⁵

“The FDIC recognizes that predatory lending practices raise a number of consumer concerns as well as safety and soundness issues. Predatory lending can:

· cause substantial harm to financially vulnerable and unsophisticated consumers and undermine the stability of the neighborhoods where the loans were made;

· lead to a high volume of foreclosures which are costly to the holder of the mortgage;

· undermine the reputation of individual financial institutions and the public’s trust in the financial services industry as a whole; and

· subject institutions that might unwittingly support predatory lending to the risk of costly litigation”. ²

Allowing predatory lenders to continue unabated, would have a much larger affect upon the economy than just some individuals becoming deeper in debt or losing their homes.

1 More U.S. homebuyers fall prey to predatory lenders, USA Today, November. 2004.

2 Testimony of Donna Tanoue, Chairman – Federal Deposit Insurance Corporation, U.S. House of Representatives, May 24, 2000.

3 AARP website, consumer protection/financing homes, September 16, 2002.

4 New Study Finds North Carolina Predatory Lending Law Cuts Abuses, Does Not Dry Up Credit For Borrowers, Mortgage Bankers Association website, June 25, 2003.

5 Another View of Predatory Lending, Jack Guttentag, The Wharton School, University of Pennsylvania, August 21, 2000.