For most people, the purchase of a home requires financing. As a consumer, you'll want to obtain the best loan possible at the most reasonable terms. If your credit history is sparkling, you should have no trouble obtaining the loan you desire. However, if your credit score is not favorable, you may be forced to accept terms that are not as advantageous. No matter what your credit history is, you must be treated fairly.
What is predatory lending? It is defined as the use of abusive lending practices. Most often associated with lower credit scores, minority purchasers, elderly purchasers and lesser-educated consumers, predatory lenders takes undue advantage by engaging in deception or fraud.
There is a difference in predatory lending and sub-prime lending. Sub-prime lenders offer appropriate, legal lending solutions to borrowers who do not qualify for prime rates.
Predatory lenders manipulate borrowers through aggressive sales tactics and take unfair advantage of his or her lack of understanding of the financing process.
There are specific categories of abuse of which consumers should be aware:
- Loan Flipping
- Charging Excessive Fees and "Packing"
- Lending Without Regard to Ability to Repay
- Outright Fraud and Abuse
- Overdraft Loans
Loan Flipping is defined as "Repeated refinancing without benefit to the borrower." You typically see high fees charged in association with each refinance. Pre-payment penalties are also employed to keep the borrower engaged in a long repayment process. If the borrower wants to get out of the loan early, he or she will be charged a significant sum to end the loan. The cycle of loan flipping depletes the equity already built up in the home by successively increasing the amount of the loan and charging fees.
CHARGING EXCESSIVE FEES AND PACKING
Another category of predatory lending is charging excessive fees. High closing costs,
requiring high cost credit life insurance, high loan origination fees, high cost appraisals and other abnormally high fees are "packed" onto the amount needed for the actual purchase.
ABILITY TO REPAY
Lending without regard to the ability to repay the loan is not allowed. When a lender makes the decision to lend on the basis of the equity in the property and not on the ability of the purchaser/borrower to repay the loan, it is considered to be predatory lending. Would you lend money to a stranger, knowing that he couldn't pay you back? Then, decide that since he didn't have the money to pay you, you would just take away his home? (If the answer is "yes" - you would be a predatory lender!) Reasonable mortgage lenders base decisions for loan approvals on the person's ability to repay the funds. Consideration is given to income from employment and other sources, such as alimony, rental income, government pensions, etc. It is not acceptable to fund a loan with the idea that the collateral will be taken because the borrower cannot show any income for possible repayment.
FRAUD & ABUSE
This category is often employed with minority, elderly and under-educated borrowers. Tactics used include document switching, bullying, demanding acquiescence, threatening to ruin the credit of the borrower, and just plain lying.
With overdraft loans, high fees are charged for things such as a returned check. There may be hidden daily fees from $2 to $5. Daily interest may also be charged on the unpaid balance.
The effects of predatory lending can be devastating. Victims of this unsavory practice may face foreclosure and the loss of their home and possible bankruptcy. Mortgage investors also experience a loss. Legitimate lenders are forced to adhere to stringent underwriting and appraisal requirements. Real estate values may also decrease and cause instability in the neighborhood.
Both federal and state government authorities have taken steps to respond to predatory lending practices and prevent instances from happening in the future. Rules and legislation enacted to protect consumers include:
1. HOEPA (Home Ownership and Equity Protection Act - 1994)
- Federal Legislation
- Prevents predatory lending & increases borrower protections
- Focuses on regulating high-cost segment of sub-prime market
- Defines high cost in terms of rate, points, fees
- Covers certain closed-end refinance and home equity loans
- Applies to:
- Creditors originating two or more HOEPA loans in any 12-month period, or
- Creditors originating one or more HOEPA loans through a mortgage broker in any 12-month period.
- Restrictions for high cost loans:
- no balloon payments in first five years
- no prepayment penalties during first five years
- prohibits "asset based" lending
- requires additional disclosures three days prior to closing
- Consumer is not required to complete loan application agreement
- Loan on consumer's home could result in loss of home and any equity in home if loan is not paid
- If the loan uses a variable rate, sets a maximum monthly payment
- Further defines "high cost" loans by
- lowered APR trigger to 8% for first liens
- established APR trigger of 10% for second liens
- amended "points & fees test" for first liens
- Restricts frequency of refinancing to one year unless clearly in borrower's best interest
- Requires creditors to verify & document borrower's repayment ability
2. TILA (Truth in Lending Act)
- Provides consumers with meaningful information about credit transactions
- Requires three-day Right of Rescission (means that the consumer can decide within three days of signing the loan document that he or she doesn't want to accept the loan)
- Required disclosure of finance charge, APR, amount financed & total of all payments
3. RESPA (Real Estate Settlement Procedures Act)
- Requires Good Faith Estimate disclosure of estimated settlement costs within three days of application
- Prohibits kickbacks, referrals & unearned fees
- Permits bona fide compensation for goods, facilities, services provided
4. SC HIGH COST AND CONSUMER HOME LOANS ACT
- Effective January 1, 2004
- Defines "high cost loans"
- Sets fee limitations, defines prohibited loan provisions and prohibited practices
- Requires mortgage brokers to work in borrower's "best interest"
- Requires "high cost loan" borrowers to attend a state-approved consumer credit counseling session
- Requires homeowner and contractor be named on loan proceeds checks issued to pay off home improvement loans
- Prohibits balloon payments on high cost loans
- Prohibits prepayment penalties on loans of $150,000 or less
- Requires written disclosure of amount earned on the loan at time of Good Faith Estimate and before closing
- Requires loan term disclosure at least 48 hours prior to closing for non-real estate secured manufactured housing (mobile homes)
- Prohibits loan flipping within 3-1/2 years of loan start date without net tangible benefit to borrower
- Prohibits lenders from charging points or fees if refinancing a high cost loan for an existing borrower
- Limits points and fees on high cost loans to 2.5% of total loan amount
- Prohibits financing of prepaid, single premium life, disability or unemployment insurance
- Sets limits on lenders who make car title loans. Maximum annual rate of 300% and amount owed may not be renewed more than six times
RESOURCES FOR ADDITIONAL INFORMATION ON PREDATORY LENDING
- U.S. Department of Housing and Urban Development/Department of Treasury Joint Report (June 2000)
- Mortgage Bankers Association of America web site
- HMDA Data per Fed Reserve Board Gov. Gramlich - Remarks to Housing
- U.S. Department of Treasury 2003 MMSA
- Testimony of Eric Stein, Senior VP-Center for Responsible Lending (March 30, 2004) to the Joint Hearing of the Subcommittee on Financial Institutions and Consumer Credit and Subcommittee on Housing and Community Opportunity
- Center Responsible Lending web site