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What
is a Predatory Lender and How Are They Different From Other Lenders?
Indicators
of a Predatory Lender
What
is a Predatory Lender and How Are They Different From Other Lenders?
A Fact Sheet by the Ohio Coalition for Responsible Lending
In recent years, there has been a tremendous increase in the number of
mortgage loans made by lenders specializing in lending to borrowers with
sub-par credit histories. These lenders, known as “subprime lenders,”
are often times independent mortgage or finance companies, but they can
also be thrifts or even banks. Some larger banks have affiliate mortgage
companies that are subprime lenders. Subprime lenders typically charge
borrowers higher fees and interest rates than “prime” lenders,
based upon the risk of the loan. By providing loans to borrowers who do
not meet the credit standards in the prime market, subprime lenders can
and do play a critical role in this economy. These borrowers may have
what is often referred to as “bruised” credit histories, they
may have insufficient credit histories, or non-traditional credit sources.
Through the subprime market, these borrowers can buy a new home, improve
their existing home, or refinance their existing mortgage to increase
their cash on hand.
According to The Woodstock Institute in Two Steps Back: The Dual Mortgage
Market, Predatory Lending, and the Undoing of Community Development,
from 1993 to 1998, loans made by prime lenders rose substantially slower
than those by subprime lenders, with a 38 percent increase in home purchase
loans and a 2.5 percent increase in refinance loans. Corresponding increases
among subprime lenders were 760 percent and 890 percent respectively.
One possible reason for this dramatic increase in loans made by subprime
lenders pertains to the increasingly segmented system of consumer finance,
with higher-income communities as the main target of more highly regulated
banks, thrifts, and their affiliates who seek to cross-sell account and
investment products. At the same time, lending to lower-income and minority
communities is often viewed as an isolated line of business, in which
the focus is on the short-term transaction and associated fees. Lenders
active in these communities tend to be mortgage and finance companies
subject to substantially less regulation than banks and thrifts.
The overall growth of the subprime market as evidenced by the explosion
of loans made between 1993 and 1998, combined with the almost hyper-segmentation
of mortgage lending markets by race and neighborhood, has created opportunities
for abuse. This dual finance system has fueled the rise of subprime firms
and has increased the “room for abuse” within the market,
especially for less sophisticated homeowners. Abusive mortgage lending,
or what has been dubbed “predatory lending,” often leaves
homeowners with substantial debt that they cannot afford or are unwise
to take on.
What makes a sub-prime lender different from a predatory lender? While
most sub-prime lenders serve a need by targeting borrowers with sub-par
credit histories, some go too far. Those that go too far are know as predatory
lenders. Lending practices become predatory when lenders target specific
populations (usually low-income, minority, and/or elderly homeowners)
with high pressure marketing techniques, charge excessive fees, frequently
refinance or “flip” the loan, and often times mislead the
borrower. Ohio is not immune to this practice. In low-and moderate-income
and minority communities throughout the state, one or two predatory lenders
often dominate the market, while prime lenders are nowhere to be found.
These predatory lenders are literally harvesting the equity that homeowners
have built up over the years. By loading the loan with excessive fees,
high interest rates, and pricey insurance premiums on the front end, predatory
lenders are all but ensuring themselves a pay-off. In many ways, it’s
a win-win situation for the lender and a lose-lose situation for the borrower.
If the borrower makes the monthly loan payments, which are often times
inflated (excessive fees, high interest rates, and pricey insurance premiums),
the lender is making a profit. If the borrower is unable to make the monthly
payments, the lender forecloses and sells the house for a profit.
Predatory
lenders go beyond risk-based pricing, and instead set loan terms high
above what they need to offset costs and earn a return that compensates
for the increased risk. This is typically done through high interest rates,
high points, high origination fees, unnecessary credit life insurance,
and other additions to the loan. While many of the loan terms described
below may not be predatory on their own, the failure of the lender to
fully disclose to the borrower the risk or cost associated with each individual
term can make the loan package more problematic, especially if the borrower
is unaware that better terms may be available. Many of these terms, in
and of themselves, may not be fraudulent, unethical, or prohibited by
law, but thrive because there is a lack of competition in the marketplace
and a lack of information for consumers.
By structuring the debt with excessive fees and interest rates (beyond
those needed to cover costs and reasonable, risk-adjusted returns), by
“packing” and financing these excessive fees, and by “flipping”
or frequently refinancing with fees being rolled back into the loan, some
lenders are able to exploit low-income, minority, and elderly homeowners.
Predatory lending practices can and do include both specific types of
loan terms as well as overly aggressive marketing and deceptive or fraudulent
practices on the part of lenders. The Atlanta Legal Aid Society has identified
the following examples of predatory lending practices:
Examples of Predatory Lending Practices
Sales and Marketing
- high pressure, door-to-door sales
- targeting vulnerable populations (i.e. elderly, less educated)
- steering to higher-cost loans despite borrower qualifying for lower-cost
credit
- flipping - excessive refinancing
- home improvement scams, in which contractors act as loan brokers
Excessive Fees
- “packing” loans with unnecessary fees, which are often
financed into the loan
- padded closing costs of third party fees
- excessively high points or origination fees
- high broker fees, including yield spread premiums
Terms that Trap Borrowers
- balloon
payments, which conceal the true cost of financing and may force repeated
refinancing
- negative amortization, in which payments are less than interest, resulting
in an increase in the principal balance
- prepayment penalties
- “Asset-based” lending, ignoring repayment ability
Other Fraudulent Practices
- reporting inflated income figures
- forgeries
- insufficient or improperly timed disclosure
- inflated appraisals, in part to enable secondary market sale
While an instance of predatory lending could involve just one of the aforementioned
practices, more often than not, a number of these practices occur simultaneously.
These practices raise serious community reinvestment, fair housing and
fair lending concerns, largely because banks and their mortgage and/or
finance company subsidiaries appear to be representing the market and
targeting minority communities for higher priced, lower quality products.
As reported in The Subprime Market Share in Ohio, the share of
the mortgage market held by subprime lenders in minority neighborhoods
is significantly higher than the share of the mortgage market held by
subprime lenders in non-minority neighborhoods. The State of Ohio is third
in the country with respect to the number, and fifth in the country with
respect to the percentage of refinancing loans originated by subprime
lenders. According to 1999 Home Mortgage Disclosure Act (HMDA) data, more
than 63,000 refinancing loans were made by subprime lenders within the
state. The vast majority of these loans were made in substantially minority
census tracts. In some of these census tracts, as many as 80 percent of
all refinancing loans were made by subprime lenders.
While this information in and of itself is specific only to subprime lending,
it does offer some insight on what has come to be known as “predatory
lending.” While not all subprime lenders are predatory lenders,
all predatory lenders are in fact subprime lenders. That being said, an
increase in subprime lending activity throughout the State of Ohio correlates
directly with an increase in predatory lending practices.
Unfortunately, the situation in Ohio is representative of a larger epidemic.
According to the U.S. Department of Housing and Urban Development (HUD)
in Unequal Burden: Income & Racial Disparities in Subprime Lending
in America, subprime loans are five times more likely in minority neighborhoods
than in white neighborhoods, and three times more likely in low-income
neighborhoods than in high-income neighborhoods. Clearly there is a problem.
These factors combined with the literal explosion in the predatory lending
market over the past few years have created a situation within the State
of Ohio that must be addressed. The most vulnerable or traditionally underserved
populations (low-income, minority, or elderly homeowners) are being singled
out and taken advantage of by predatory lenders. This is a practice that
must stop. As long as predatory lenders go largely unregulated, as long
as they are allowed to take advantage of often times low-income, minority,
and elderly homeowners, and as long as we continue to sit idly by, they
will continue to destroy entire communities one block at a time.
Indicators
of a Predatory Lender
A Fact Sheet by the Ohio Coalition for Responsible Lending
Marketing:
- Aggressive solicitations to targeted neighborhoods
- Home improvement scams
- Kickbacks to mortgage brokers (Yield Spread Premiums)
- Racial steering to high rate lenders
Sales:
- Purposely structuring loans with payments the borrower cannot afford
- Falsifying loan applications (particularly income level)
- Adding insincere co-signers
- Making loans to mentally incapacitated homeowners
- Forging signatures on loan documents (i.e., required disclosures)
- Paying off lower income mortgages
- Shifting unsecured debt into mortgages
- Loans in excess of 100% LTV
- Changing the loan terms at closing
The loan itself:
- High annual interest rates
- High points or padded closing costs
- Balloon payments
- Negative amortization
- Inflated appraisal costs
- Padded recording fees
- Bogus broker fees
- Unbundling (itemizing duplicate services and charging separately for
them)
- Required credit insurance
- Falsely identifying loans as lines of credit or open end mortgages
- Force placed homeowners insurance
- Mandatory arbitration clauses
After closing:
- Flipping (repeated refinancing, often after high-pressure sales)
- Daily interest when loan payments are late
- Abusive collection practices
- Excessive prepayment penalties
- Foreclosure abuses
- Failure to report good payment on borrowers’ credit reports
- Failure to provide accurate loan balance and payoff amount
This information is from the Community Reinvestment Association Of
North Carolina (CRA*NC), Introduction to Predatory Lending Policy.
Ohio
Coalition for
Responsible
Lending
c/o COHHIO
35 East Gay Street, Suite 210
Columbus, Ohio 43215
(614) 280-1984 phone
(614) 463-1060 fax
www.cohhio.org/projects/ocrp/ocrp.html
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