Subprime Loan Sharks
Avoiding Predatory Mortgage Lending in Home Purchase or Refinancing
Just a few years ago, it was difficult for many people with imperfect credit to receive loans to purchase a home. However, the explosion of a subprime lending market with its higher-priced loans has suddenly made the dream of borrowing in order to buy a home a reality for many individuals. Along with this increased access to credit has come a wave of aggressive, predatory lending schemes that take advantage of less sophisticated borrowers by charging excessive fees and interest.
The Center for Responsible Lending estimates that predatory mortgage loans alone cost home owners $9.1 billion each year.
Predatory mortgage lending seems to be targeted towards the elderly, women, low income Americans, and minorities. These groups tend to qualify for prime lending rates less often or are perceived as less sophisticated by predatory lenders. According to statistics, race, gender, and age are often key factors in determining whether a borrower receives a prime or a subprime loan. In 2002, African Americans were 3.6 times as likely as whites to receive a home purchase loan from a subprime lender and 4.1 times more likely to receive a refinance loan from a subprime lender. Latinos were 2.5 times as likely as whites to receive subprime home purchase and refinance loans. According to the Federal Financial Institutions Examination Council, in 2004, high-cost loans represented 53.6% of the refinances to African-Americans, 24.4% of those to Latinos, and 15.7% of refinances to whites.
Subprime mortgages go into foreclosure ten times more often than prime mortgage loans and as many as one in five borrowers in the subprime market end up loosing their homes.Predatory Mortgage Lending Techniques
There are seven basic ways that predatory lenders try to take advantage of vulnerable borrowers:
Such fees include costs associated with the loan that are not directly reflected in the interest rates. As these fees are often financed rather than having to be paid up front, they are frequently disguised or downplayed and borrowers often do not notice that these charges have been added to the total cost of their loan. With competitive loans, typically fees are less than 1% of the loan amount. With predatory loans, fees often total more than 5% of the loan amount.
Abusive Prepayment Penalties
If you obtain a subprime loan with a high interest rate and your credit improves enough to obtain a more favorable loan, you will want to refinance your original loan. However, predatory lenders are aware of this, and up to 80% of subprime mortgages carry a prepayment penalty. This is a fee charged for paying off your loan early. Predatory prepayment penalties often are effective for over three years and cost more than 6 months’ interest. Keep in mind that only about 2% of home loans in the prime market carry prepayment penalties of any length.
Kickbacks to Brokers (yield spread premiums)
On as many of 90% of subprime mortgage loans, brokers receive a kickback from the lender known as a ‘yield spread premium’. The higher the interest rate, the more the more the broker gets paid. The brokers are thus rewarded for making a loan more expensive to the borrower – and unscrupulous brokers take advantage of this in making predatory loans.
Loans that include yield spread premiums cost borrowers and additional $800 to $3,000 per loan. The average amount of a yield spread premium is $1,850 per loan, making these payments the largest part of a broker’s compensation. On average, mortgage brokers earn $1,046 more on loans with yield spread premiums.
It’s estimated that more than 75% of borrowers with loans that include yield spread premiums could have used a less expensive method to help pay closing costs.
A lender “flips” a borrower by refinancing a loan to generate fee income without providing any net tangible benefit to the borrower. Flipping can quickly drain borrower equity and increase monthly payments -- sometimes on homes that had previously been owned free of debt.
These mortgage originators refinance borrowers’ loans repeatedly in a short period of time. With each successive refinancing, these originators charged big fees, sometimes including repayment penalties.
Unscrupulous lenders tempt borrowers to refinance loans based upon a small reduction in interest rates. This may appear to be a good idea until one considers the fees charged for the refinancing.
Sometimes borrowers may pay more than necessary because lenders sell and finance unnecessary insurance or other products along with the loan.
Some loan contracts require “mandatory arbitration,” meaning that the borrowers are not allowed to seek legal remedies in a court if they find that their home is threatened by loans with illegal or abusive terms. Mandatory arbitration makes it much less likely that borrowers will receive fair and appropriate remedies in cases of wrongdoing.
Steering & Targeting
Brokers and lenders frequently overcharge through ‘interest rate steering’ – setting rates on the basis of perceived financial sophistication rather than risk. Elderly, minority, and low-income homeowners are prime targets. Vulnerable borrowers may be subjected to aggressive sales tactics and sometimes outright fraud. Fannie Mae has estimated that up to half of borrowers with subprime mortgages could have qualified for loans with better terms.
The Department of Housing and Urban Development (HUD) points out that predatory lenders also sometimes make loans without regard to the borrower’s ability to repay. This involves lending based upon a borrower’s home equity, where the borrower clearly did not have the capacity to repay the loan. In the extreme, sometimes elderly people living on fixed incomes had monthly payments that equaled or exceeded their monthly incomes, which quickly leads borrowers into default and foreclosure.Other Techniques Used by Predatory Lenders
Other signs of predatory lending include creditors who:
How to Avoid Being Victimized by Predatory Mortgage Lenders
The Department of Housing and Urban Development (HUD) recommends that home buyers follow the following steps to avoid falling prey to predatory lenders when obtaining a mortgage:
Laws to Protect Borrowers
Among the federal laws designed to protect consumers in mortgage lending are the Truth in Lending Act (TILA), the Home Ownership and Equity Protection Act (HOEPA), and the Real Estate Settlement Procedures Act (RESPA). In connection with transactions such as mortgages on a personal residence, TILA requires disclosure of essential terms, including the finance charge, the finance charge expressed as an annual percentage rate, and the total of loan payments.
For a subset of refinancing and closed-end equity loans that are particularly high-cost, HOEPA requires additional disclosures and restricts some loan agreement provisions (e.g., prepayment penalties, balloon payments, and negative amortization) that can cause unique hardships to high cost loan borrowers. Private remedies for violations of TILA and HOEPA include, when appropriate, rescission and damages.
RESPA requires disclosure of settlement costs; bars payment by settlement service providers for business referrals and unearned fees; limits amounts that can be held in borrowers’ escrow accounts; and requires that borrowers be informed of mortgage servicing transfers and of lender’s business arrangements with affiliated settlement service providers.
A number of states have enacted anti-predatory mortgage lending laws in response to predatory lending that falls just below the thresholds set in 1994 in the HOEPA. North Carolina was the first state to enact anti-predatory lending relating to mortgages in 1999. Since then, about 30 states have enacted similar laws. However, these state laws are in danger of being preempted by weaker national legislation, and several proposals to do so were introduced into Congress in 2005.
HUD has a very good summary of predatory lending in the home market on its website and provides links to local organizations which can provide assistance if you have been victimized by predatory lenders. By understanding the risks in advance, borrowers can avoid predatory lending scams and keep their finances protected.
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