Top 10 Predatory Practices
Top 10 Predatory PracticesThe California Reinvestment Coalition (CRC) conducted a multi-city study of predatory mortgage lending. CRC interviewed subprime refinance borrowers in four California cities, reviewed their loan documents and conducted Home Mortgage Disclosure Act (HMDA) lending analysis and research. Based upon these findings, and other research in the field, CRC has identified the following as the top ten most predatory practices:
1. Targeting high cost products to vulnerable borrowers and neighborhoods:
Home Mortgage Data Act (HMDA) analysis reveals that subprime lenders originate a greater percentage of their loans to minorities than do the prime lending banks that often own, or are affiliated with, them. The HUD/Treasury Report confirms that “subprime lending is disproportionately concentrated in low-income minority neighborhoods” and that “in particular, borrowers in black neighborhoods rely heavily on subprime lending when refinancing their mortgages.”
People of color, the elderly, and their communities face intense marketing efforts by subprime lenders. In CRC’s study, thirty-eight percent of respondents reported that the idea to refinance came from their lender or broker, through mail, telephone or door-to-door solicitations.
2. Failure to refer qualified borrowers to prime products:
Up to 50% of subprime borrowers could have qualified for prime, low cost credit. This figure is consistent with statements by Fannie Mae and Freddie Mac, as well as research by the trade publication, Inside Mortgage Finance. CRC’s study confirms these figures, with 60% of subprime borrower respondents reporting that their credit is “good,” or “excellent.” Most of these borrowers reported that they viewed their credit reports or were aware of their credit scores.
This means that half of the hundreds of thousands of subprime loans in existence should not have been originated, and are by definition, predatory. This fact, coupled with the fact that minority borrowers are more likely to live in neighborhoods without a bank and to turn to the subprime market for financing, raises obvious and serious questions about the discriminatory impact high cost subprime lending has on protected classes. In CRC’s study, 72% of the respondents, most of them people of color, reported that they did not even seek financing from a bank or thrift, but instead were solicited by subprime lenders and brokers. This is particularly troubling where the subprime lender is a subsidiary of a bank or thrift that offers prime loans but does not refer prime borrowers up to the prime lender. This dynamic raises serious fair lending and equal access to credit concerns.
3. Prepayment penalties:
Prepayment penalties either lock borrowers into high cost loans or strip equity from their homes as they seek to escape a predatory loan through refinancing. If a borrower is able to graduate to a prime loan, she will lose equity as prepayment penalties are assessed. Prepayment penalties are not prevalent in prime loans, yet estimates by Standard and Poor’s suggests that 80% of securitized subprime loans carry prepayment penalties.
CRC analyses of interviews with subprime borrowers and review of loan documents suggests that these provisions are one of the least well understood in an otherwise complex home loan process. Approximately 59% of loan documents reviewed included prepayment penalty provisions lasting from 2 to 5 years. Nearly one quarter of these loans had prepayment penalty provisions that lasted longer than the initial interest rate of the loan, meaning that as these borrowers see a rise in their monthly mortgage payment obligations, they will be unable to refinance out of their loans without incurring a costly prepayment penalty.
Most borrowers reported finding out about prepayment penalties only at closing, were unsure if their loans included a prepayment provision or believed that they did not have prepayment penalties when, in fact, they did. Subprime borrowers are not bargaining for lower rates in exchange for prepayment penalty provisions, and they are vulnerable to being trapped in high cost loans.
Lenders need no more than 3% of the loan amount in up front fees AND prepayment penalties to cover the lenders' costs of making the loan. Any more than that is equity stripping, according to the National Consumer Law Center.
4. Flipping:
When loans are frequently refinanced, or flipped, borrowers are forced to pay high points, fees and/or prepayment penalties for loans they may not need and which may be on less favorable terms. Oppressive terms in these loans fuel a cycle of flipping whereby borrowers are unable to pay their loans and must refinance, again on unfavorable terms and with equity further stripped from their homes. HUD has called for flipping to be outlawed as a deceptive and abusive practice.
Borrowers who have low or no cost mortgages through special nonprofit and/or government programs are especially vulnerable to abusive flipping. Why would a borrower refinance a 0% interest mortgage from Habitat for Humanity with a high cost loan, unless tricked into doing so by a predatory lender, or unless done in light of no real or perceived legitimate finance options? This is a growing problem that is afflicting the rural and self-help housing movements.
In the CRC predatory mortgage lending study, 72% of borrowers had refinanced their home loans from two to six times. Many refinance loans were used to pay off debt that was not secured by the borrower’s home, with some borrowers reporting that they were induced by their broker or lender to include these debts into the refinance loan. Even at closings, where 69% of borrowers reported they were first presented with changes in key loan provisions, many report that brokers or lenders recommended they refinance their loans again within a couple of years.
5. Financing of single premium credit life insurance:
Perhaps the most abusive of all loan products, credit insurance has come to symbolize predatory lending. These policies are often misunderstood by borrowers. Testimony by a finance company employee at the 1998 hearing of the Senate Special Committee on Aging was chilling. In describing how consumers are misled into buying insurance they do not need or do not understand, he stated, “customers were not aware, until closing (if at all), that the loan included insurance.”
Single premium credit insurance adds significantly to the costs of a loan. Estimates set the increased cost of credit insurance at 10% to 20% of the loan amount. HUD and the Department of the Treasury report that “low loss ratios in the industry imply that these products may be a bad deal for consumers.” Yet this business is booming. Self-Help of North Carolina estimates that 250,000 families will lose $5,000 to $10,000 in equity in their homes over the next five years due to credit insurance products. The evidence is in. These products are abusive and take advantage of unsuspecting borrowers.
6. Mandatory arbitration provisions:
As mandatory arbitration provisions are more prevalent in subprime loans, they create a two-tiered justice system for prime and subprime borrowers. Subprime borrowers should have the same due process rights as other borrowers, including rights to discovery, class action litigation, a hearing based on applicable law and appeal. Borrowers cannot vindicate any broker or lender wrongdoing, and cannot meaningfully seek redress if they cannot have their day in a court of law. Ensuring that predatory lending victims can pursue their rights in court also sends a strong message to would-be predatory lenders that there will be consequences for illegal and fraudulent conduct.
7. Failure to confirm ability to repay:
Predatory lenders seek to trap borrowers into collateral-based loans they clearly cannot repay, force them into foreclosure and create huge windfalls for those who purchase the home, often the unscrupulous lender. The Federal Reserve Board, through its regulation of HOEPA, prohibits lenders from engaging in a pattern and practice of lending without considering a borrower’s ability to repay the loan. Brokers and lenders of all loans must be mandated to ensure and document that a borrower has the ability to repay a loan. This predatory practice of asset based lending sets borrowers up to fail and to lose their homes. According to the National Consumer Law Center, the rate of foreclosure in the United States increased by 384% between 1980 and 1998, and the foreclosure rate is substantially higher for subprime loans than for prime loans.
8. High points and fees:
Much of the damage of predatory lending comes in the form of upfront points and fees charged that are not justified by the credit risk of the borrower. Given the secondary market’s current appetite for subprime mortgage loans, lenders can originate loans with less concern about the borrowers ability to repay the loan. The incentive is to gouge the borrower for as much as possible in the form of various points and fees, and sell the loan to other larger institutions or package the loan into a pool for sale to investors as mortgage backed securities. Points should result in reduced rates for the borrower. Prime loans normally carry one point or less, representing 1% or less of the loan amount. Fees charged must be reasonable. In the context of non-purchase subprime loans, borrowers typically finance most or all of the costs of the loan, resulting in borrowers paying high interest on the points and fees over the life of the loan.
9. Abusive and deceptive practices of under-regulated Brokers:
Much of the problem of predatory mortgage lending concerns the practices of loan brokers. CRC’s Predatory Mortgage Lending study findings are consistent with this. Most study participants reported that they had a broker and that: they faced heavy marketing and solicitation by brokers; brokers urged them to consolidate unsecured debt into their home loans; brokers allayed concerns about adjustable rates by advising borrower to refinance in two years when initial rates would go up, even if the loan contained a five-year prepayment penalty provision; brokers placed undue pressure on borrowers during loan closing; and borrowers were surprised by high broker fees that presented themselves only at closing.
10. Purchase of predatory loans:
Financial institutions and investors are the lifeblood of predatory lending. Much predatory lending is financed through the sale of predatory loans, as well as the securitization of pools of subprime and predatory loans that are sold as investments on Wall Street. This system of financing enables predatory lenders to continue their devastating work, with little if any concern for borrowers’ ability to repay their loans and to remain in their homes. If financial institutions, regulators and legislators are concerned about predatory lending, more should be done to ensure the secondary market for abusive loans dries up. When the purchases of, and investments in, predatory mortgage loans cease, so will predatory mortgage lending.
