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Predatory lending in the subprime mortgage market covers a wide range of practices. (We would point out that, so far as we know, many if not most lenders do not engage in the activities described here.) While the practices are quite varied, there are common traits. They generally aim either to extract excessive fees and costs from the borrower or to obtain outright the equity in the borrower's home.
● Aggressive Marketing Practices and High-Pressure Sales Tactics. These include unremitting telemarketing and loan closings in unconventional settings like the homes of borrowers.
● Equity-Stripping and Asset-Based Lending. “Equity-stripping” often begins with a loan that is based on equity in a property rather than on a borrower's ability to repaythe loan -- a practice known as "asset-based lending." As a general rule, loans made to individuals who do not have the income to repay such loans usually are designed to fail. They frequently result in foreclosure.
● Packing. This is the practice of adding credit insurance or other "extras" to increase the lender's profit on a loan. Lenders often stand to make significant profits from credit insurance. The guidelines established by the National Association of Insurance Commissioners suggest that lenders and insurers may retain up to 40 cents on the dollar from premiums paid by borrowers, with 60% of premium payments paid out for claims. In some states, however, lenders retain up to 70% or 80% of the proceeds. See Jane Bryant Quinn, “Credit Life Insurance Often Overpriced,” Wash. Post, Feb. 9, 1997, at H2.
● Loan Terms that Inhibit a Borrower's Ability to Go Elsewhere for Credit. Prepayment penalties are an example.
● Flipping. Another practice is “flipping,” that is, inducing a consumer to refinance a loan repeatedly, often within a short time frame, charging high pointsand fees each time. One method of inducing a borrower to refinance is by issuing a balloon note -- particularly one in which the borrower is paying only interest -- where the note comes due in a relatively short period of time. When the note comes due and the borrower owes a substantial lump sum -- sometimes equal to the entire principal of the original loan -- the borrower must again obtain a loan in order to finance the balloon paymentthat is due at that time.
● Home Improvements. Another abuse is the targeting of borrowers by home improvement contractorswho are effectively working as agents of lenders. Lenders have several incentives to refinance a homeowner's existing mortgage rather than to merely originate a new loan for the home improvements.
First, lenders generally seek to originate one combined loan rather than only a second mortgage for the smaller cost of the improvements. This allows them to maximize fees that are obtained based on the loan principal. Second, lenders generally prefer the initial lien position because of the benefits that would accrue to them in the event of a borrower's bankruptcy. Third, under current federal law, state usury caps do not apply to first liens.
● Impermissible Loan Servicing Practices. After a loan is closed, borrowers may be subject to loan servicing practices that extract monies not owed under the loan terms or that inhibit refinancing options with another lender.
A lender may provide inaccurate monthly-payment demands, adding fees and charges that are not owed. Because of the complexities of loan terms, it is often difficult for the borrower to know whether the lender's payment demands are accurate.
A lender also may fail to provide the consumer with full or accurate pay-off information, and at the same time aggressively solicit the borrower to refinance with the lender. Consequently, the borrower becomes tied to a lender without a means of escape.
A borrower also may be tied to a lender if the lender's appraisal intentionally and significantly overvalues the property because the borrower's loan-to-value ratio may be too high for refinancing. This is known as a "bumped appraisal."
Probably the most frequent practice is interminable harassment by telephone calls and mail when delinquency occurs and, sometimes, even if it has not.
● The Reaction of Reputable Lenders and Government. Freddie Mac stated in February 2000 that it would not buy high-cost mortgage loans that are subject to the Home Ownership Equity Protection Act. The following month, it announced steps to protect borrowers from predatory practices, including a refusal to purchase mortgages with single-premium credit insurancepolicies.
In April 2000, Fannie Maelaunched its own campaign against predatory lending practices. Among other things, it has said it will not purchase subprime loans that: include single-premium credit life insurance; charge excessive fees; charge prepayment penaltiesthat do not benefit the borrower through, for example, a rate or fee reduction; or steer well-qualified borrowers to high-cost mortgages.
The American Bankers Association and the Mortgage Bankers Association of America, among others, have disassociated themselves from predatory lending.
Finally, the Federal Trade Commission, the Federal Reserve Board, and the U. S. Department of Housing and Urban Development have denounced these practices.
Most of this analysis is based upon the Prepared Statement of the Federal Trade Commission before the House Committee on Banking and Financial Services on Predatory Lending Practices in the Subprime Industry (Federal Trade Commission, May 24, 2000), http://www.ftc.gov/os/2000/05/predatorytestimony.htm, and Elizabeth Renuart, prin. ed., Stop Predatory Lending: A Guide for Legal Advocates, Boston: National Consumer Law Center, Inc., 2002. See also the Prepared Statement of the Federal Trade Commission before the Board of Governors of the Federal Reserve System on Predatory Lending Practices in the Home-Equity Lending Market (FTC, September 7, 2000). http://www.ftc.gov/os/2000/09/predatorylending.htm
See further the Remarks by Federal Reserve BoardGovernor Edward M. Gramlich at the Housing Bureau for Seniors Conference, Ann Arbor, Michigan, January 18, 2002). http://www.federalreserve.gov/boarddocs/speeches/2002/20020118/default.htm. Finally, see Curbing Predatory Home Mortgage Lending: A Joint Report, United States Department of the Treasury and United States Department of Housing and Urban Development, June 2000.