Predatory lending

Predatory lending describes unfair, deceptive, or fraudulent practices of some lenders during the loan origination process. While there are no legal definitions in the United States for predatory lending, an audit report on predatory lending from the office of inspector general of the FDIC broadly defines predatory lending as "imposing unfair and abusive loan terms on borrowers."^[1] Though there are laws against many of the specific practices commonly identified as predatory, various federal agencies use the term as a catch-all term for many specific illegal activities in the loan industry. Predatory lending should not to be confused with predatory mortgage servicing which is used to describe the unfair, deceptive, or fraudulent practices of lenders and servicing agents during the loan or mortgage servicing process, post loan origination.

One less contentious definition of the term is "the practice of a lender deceptively convincing borrowers to agree to unfair and abusive loan terms, or systematically violating those terms in ways that make it difficult for the borrower to defend against."^[2] Other types of lending sometimes also referred to as predatory include payday loans, credit cards or other forms of consumer debt, and overdraft loans, when the interest rates are considered unreasonably high.^[3] Although predatory lenders are most likely to target the less educated, lowest incomes, racial minorities, the elderly, victims of predatory lending are represented across all demographics.^[4][5]

Predatory lending typically occurs on loans backed by some kind of collateral, such as a car or house, so that if the borrower defaults on the loan, the lender can repossess or foreclose and profit by selling the repossessed or foreclosed property. Lenders may be accused of tricking a borrower into believing that an interest rate is lower than it actually is, or that the borrower's ability to pay is greater than it actually is. The lender, or others as agents of the lender, may well profit from repossession or foreclosure upon the collateral.

Abusive or unfair lending practices

There are many lending practices which have been called abusive and labeled with the term "predatory lending." There is a great deal of dispute between lenders and consumer groups as to what exactly constitutes "unfair" or "predatory" practices, but the following are sometimes cited.

• Unjustified risk-based pricing. This is the practice of charging more (in the form of higher interest rates and fees) for extending credit to borrowers identified by the lender as posing a greater credit risk. The lending industry argues that risk-based pricing is a legitimate practice; since a greater percentage of loans made to less creditworthy borrowers can be expected to go into default, higher prices are necessary to obtain the same yield on the portfolio as a whole. Some consumer groups argue that higher prices paid by more vulnerable consumers cannot always be justified by increased credit risk.^[6]

• Single-premium credit insurance. This is the purchase of insurance which will pay off the loan in case the homebuyer dies. It is more expensive than other forms of insurance because it does not involve any medical checkups, but customers almost always are not shown their choices, because usually the lender is not licensed to sell other forms of insurance. In addition, this insurance is usually financed into the loan which causes the loan to be more expensive, but at the same time encourages people to buy the insurance because they do not have to pay up front.

• Failure to present the loan price as negotiable.^[6] Many lenders will negotiate the price structure of the loan with borrowers. In some situations, borrowers can even negotiate an outright reduction in the interest rate or other charges on the loan. Consumer advocates argue that borrowers, especially unsophisticated borrowers, are not aware of their ability to negotiate and might even be under the mistaken impression that the lender is placing the borrower's interests above its own. Thus, many borrowers do not take advantage of their ability to negotiate.^[6]

• Failure to clearly and accurately disclose terms and conditions, particularly in cases where an unsophisticated borrower is involved. Mortgage loans are complex transactions involving multiple parties and dozens of pages of legal documents. In the most egregious of predatory cases, lenders or brokers have been not only misled borrowers but also actually altered documents after they have been signed.

• Short-term loans with disproportionally high fees, such as payday loans, credit card late fees, checking account overdraft fees, and Tax Refund Anticipation Loans, where the fee paid for advancing the money for a short period of time works out to an annual interest rate significantly in excess of the market rate for high-risk loans. The originators of such loans dispute that the fees are interest.

• Servicing agent and securitization abuses. The mortgage servicing agent is the entity that receives the mortgage payment, maintains the payment records, provides borrowers with account statements, imposes late charges when the payment is late, and pursues delinquent borrowers. A securitization is a financial transaction in which assets, especially debt instruments, are pooled and securities representing interests in the pool are issued. Most loans are subject to being bundled and sold, and the rights to act as servicing agent sold, without the consent of the borrower. A federal statute requires notice to the borrower of a change in servicing agent, but does not protect the borrower from being held delinquent on the note for payments made to the servicing agent who fails to forward the payments to the owner of the note, especially if that servicing agent goes bankrupt, and borrowers who have made all payments on time can find themselves being foreclosed on and becoming unsecured creditors of the servicing agent.^[7] Foreclosures can sometimes be conducted without proper notice to the borrower. In some states (see Texas Rule of Civil Procedure 746), there is no defense against eviction, forcing the borrower to move and incur the expense of hiring a lawyer and finding another place to live while litigating the claim of the "new owner" to own the house, especially after it is resold one or more times. When the debtor demands, under the best evidence rule, that the current claimed note owner produce the original note with the debtor's signature on it, the note owner typically is unable or unwilling to do so, and tries to establish his claim with an affidavit that it is the owner, without proving it is the "holder in due course", the traditional standard for a debt claim, and the courts often allow them to do that. In the meantime, the note continues to be traded, its physical whereabouts difficult to discover.^[8]

Disputes over predatory lending

The organization ACORN claimed that predatory loans are usually made in poor and minority neighborhoods where better loans are not readily available.^[9] Organizations such as AARP, Inner City Press, and ACORN have worked to stop what they describe as predatory lending. ACORN has targeted specific companies such as HSBC Finance and H&R Block, successfully forcing them to change their practices.^[10]

On the other side of the issue are various subprime lending advocates, such as the National Home Equity Mortgage Association (NHEMA), which say many practices commonly called "predatory," particularly the practice of risk-based pricing, are not actually predatory, and that many laws aimed at reducing "predatory lending" significantly restrict the availability of mortgage finance to lower-income borrowers.^[11] Such parties consider predatory lending a pejorative term.^[who?]

Some subprime lending practices have raised concerns about mortgage discrimination on the basis of race.^[12] African Americans and other minorities are being disproportionately led to sub-prime mortgages with higher interest rates than their white counterparts.^[13] Even when median income levels were comparable, home buyers in minority neighborhoods were more likely to get a loan from a subprime lender, though not necessarily a sub-prime loan.^[12]

In addition, studies by leading consumer groups have concluded that women have become a key component to the subprime mortgage crunch. Professor Anita F. Hill wrote that a large percentage of first-time home buyers were women, and that loan officers took advantage of the lack of financial knowledge of many female loan applicants.^{[14] [15]} Consumers believe that they are protected by consumer protection laws, when their lender is really operating wholly outside the laws. Refer to 16 U.S.C. 1601 and 12 C.F.R. 226.

Media investigations have disclosed that mortgage lenders used bait-and-switch salesmanship and fraud to take advantage of borrowers during the home-loan boom. In February 2005, for example, reporters Michael Hudson and Scott Reckard broke a story in the Los Angeles Times about “boiler room” sales tactics at Ameriquest Mortgage, the nation’s largest subprime lender. Hudson and Reckard cited interviews and court statements by 32 former Ameriquest employees who said the company had abused its customers and broken the law, “deceiving borrowers about the terms of their loans, forging documents, falsifying appraisals and fabricating borrowers' income to qualify them for loans they couldn't afford.”^[16] Ameriquest later agreed to pay a $325 million predatory lending settlement with state authorities across the nation.

Underlying issues

There are many underlying issues in the predatory lending debate:

• Judicial practices: Some^[who?] argue that much of the problem arises from a tendency of the courts to favor lenders, and to shift the burden of proof of compliance with the terms of the debt instrument to the debtor. According to this argument, it should not be the duty of the borrower to make sure his payments are getting to the current note-owner, but to make evidence that all payments were made to the last known agent for collection sufficient to block or reverse repossession or foreclosure, and eviction, and to cancel the debt if the current note owner cannot prove he is the "holder in due course" by producing the actual original debt instrument in court.^{[citation needed]}

• Risk-based pricing: The basic idea is that borrowers who are thought of as more likely to default on their loans should pay higher interest rates and finance charges to compensate lenders for the increased risk. In essence, high returns motivate lenders to lend to a group they might not otherwise lend to -- "subprime" or risky borrowers. Advocates^[who?] of this system believe that it would be unfair—or a poor business strategy—to raise interest rates globally to accommodate risky borrowers, thus penalizing low-risk borrowers who are unlikely to default. Opponents argue that the practice tends to disproportionately create capital gains for the affluent while oppressing working-class borrowers with modest financial resources.^[17] Some^[who?] people consider risk-based pricing to be unfair in principle.^[6] Lenders^[who?] contend that interest rates are generally set fairly considering the risk that the lender assumes, and that competition between lenders will ensure availability of appropriately-priced loans to high-risk customers. Still others^[who?] feel that while the rates themselves may be justifiable with respect to the risks, it is irresponsible for lenders to encourage or allow borrowers with credit problems to take out high-priced loans.^[6] For all of its pros and cons, risk-based pricing remains a universal practice in bond markets and the insurance industry, and it is implied in the stock market and in many other open-market venues; it is only controversial in the case of consumer loans.^{[citation needed]}

• Competition: Some^[who?] believe that risk-based pricing is fair but feel that many loans charge prices far above the risk, using the risk as an excuse to overcharge. These criticisms are not levied on all products, but only on those specifically deemed predatory. Proponents^[who?] counter that competition among lenders should prevent or reduce overcharging.^{[citation needed]}

• Financial education: Many observers^[who?] feel that competition in the markets served by what critics describe as "predatory lenders" is not affected by price because the targeted consumers are completely uneducated about the time value of money and the concept of Annual percentage rate, a different measure of price than what many are used to.^{[citation needed]}

• Caveat emptor: There is an underlying debate about whether a lender should be allowed to charge whatever it wants for a service, even if it seems to make no attempts at deceiving the consumer about the price. At issue here is the belief that lending is a commodity and that the lending community has an almost fiduciary duty to advise the borrower that funds can be obtained more cheaply. Also at issue are certain financial products which appear to be profitable only due to adverse selection or a lack of knowledge on the part of the customers relative to the lenders. For example, some^[who?] people allege that credit insurance would not be profitable to lending companies if only those customers who had the right "fit" for the product actually bought it (i.e., only those customers who were not able to get the generally cheaper term life insurance).^[6]

OCC Advisory Letter AL 2003-2 describes predatory lending as including the following:

• Loan “flipping” – frequent refinancings that result in little or no economic benefit to the borrower and are undertaken with the primary or sole objective of generating additional loan fees, prepayment penalties, and fees from the financing of credit-related products;
• Refinancings of special subsidized mortgages that result in the loss of beneficial loan terms;
• “Packing” of excessive and sometimes “hidden” fees in the amount financed;
• Using loan terms or structures – such as negative amortization – to make it more difficult or impossible for borrowers to reduce or repay their indebtedness;
• Using balloon payments to conceal the true burden of the financing and to force borrowers into costly refinancing transactions or foreclosures;
• Targeting inappropriate or excessively expensive credit products to older borrowers, to persons who are not financially sophisticated or who may be otherwise vulnerable to abusive practices, and to persons who could qualify for mainstream credit products and terms;
• Inadequate disclosure of the true costs, risks and, where necessary, appropriateness to the borrower of loan transactions;
• The offering of single premium credit life insurance; and
• The use of mandatory arbitration clauses.

Predatory borrowing

In an article in the January 17, 2008 New York Times, George Mason University economics professor Tyler Cowen described "predatory borrowing" as potentially a larger problem than predatory lending:^[18]

"As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default. Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers."

It should be noted that mortgage applications are usually completed by mortgage brokers, rather than by borrowers themselves, making it difficult to pin down the source of any misrepresentations. The only situation in which the application would not be done by the broker, but rather the borrower, would be in a "stated income loan."

A stated income loan application is done by the borrower, and no proof of income is needed.^[18] When the broker files the loan, they have to go by whatever income is stated. This opened the doors for borrowers to be approved for loans that they otherwise would not qualify for, or afford.

Several commentators have challenged the notion of "predatory borrowing," accusing those making this argument as being apologists for the lack of lending standards and other excesses during the credit bubble.^[19]

Although the target for most scammers,^[20] lending institutions were often complicit in what amounted to multiparty mortgage fraud. The Oregonian obtained a JP Morgan Chase memo, titled "Zippy Cheats & Tricks." Zippy was Chase's in-house automated loan underwriting system, and the memo was a primer on how to get risky mortgage loans approved.^[21]

United States legislation combating predatory lending

Many laws at both the Federal and state government level are aimed at preventing predatory lending. Although not specifically anti-predatory in nature, the Federal Truth in Lending Act requires certain disclosures of APR and loan terms. Also, in 1994 section 32 of the Truth in Lending Act, entitled the Home Ownership and Equity Protection Act of 1994, was created. This law is devoted to identifying certain high-cost, potentially predatory mortgage loans and reining in their terms.

Twenty-five states have passed anti-predatory lending laws. Arkansas, Georgia, Illinois, Maine, Massachusetts, North Carolina, New York, New Jersey, New Mexico and South Carolina are among those states considered to have the strongest laws. Other states with predatory lending laws include: California, Colorado, Connecticut, Florida, Kentucky, Maine, Maryland, Nevada, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Utah, Wisconsin, and West Virginia. These laws usually describe one or more classes of "high-cost" or "covered" loans, which are defined by the fees charged to the borrower at origination or the APR. While lenders are not prohibited from making "high-cost" or "covered" loans, a number of additional restrictions are placed on these loans, and the penalties for noncompliance can be substantial.

Research has found ambiguous results of such legislation, including finding that high-cost mortgage applications can possibly rise after adoption of laws against predatory lending.^[22]

See also

• Consumer finance
• Poverty industry
• Loan sharking
• Overdraft protection loans
• Payday loan
• Refund anticipation loan
• Settlement (finance)
• Title loan
• Usury
• Mortgage discrimination
• Securitization
• Debt bondage
• Developing countries' debt

References

1. ^ http://www.fdicoig.gov/reports06/06-011.pdf
2. ^ Investor Dictionary
3. ^ "Loans to avoid at all costs". CBS Early Show. March 6, 2007
4. ^ Fannie Mae Overview of Predatory Lending
5. ^ Federal Trade Commission
6. ^ ^{a b c d e f} ACORN Reports
7. ^ Will My Mortgage Loan Be Sold?
8. ^ http://www.supreme.courts.state.tx.us/jfrtf/pdf/110707transcript.pdf
9. ^ ACORN campaign against predatory lending
10. ^ The Nation: Tax Refund Scheme Targets the Working Poor
11. ^ National Home Equity Mortgage Association Report
12. ^ ^{a b} Study Finds Disparities in Mortgages by Race The New York Times By Manny Fernandez Published: October 15, 2007
13. ^ NAACP Fights Loan Discrimination
14. ^ Women and the Subprime Crunch. Economica.
15. ^ Hill, Anita (October 22, 2007). "Women and the subprime crunch". Boston Globe. http://www.boston.com/bostonglobe/editorial_opinion/oped/articles/2007/10/22/women_and_the_subprime_crunch/. Retrieved 11 June 2010. 
16. ^ Mike Hudson and E. Scott Reckard, “Workers Say Lender Ran 'Boiler Rooms',” Los Angeles Times, Feb. 4, 2005. http://www.latimes.com/ameriquest
17. ^ In Defense of Payday Lending
18. ^ ^{a b} Tyler Cowen (13 January 2008). "So We Thought. But Then Again . . .". New York Times. http://www.nytimes.com/2008/01/13/business/13view.html. 
19. ^ Tyler Cowen, Apologist for Fraud?
20. ^ http://www.palmbeachpost.com/business/content/business/epaper/2007/10/28/m1a_MORTGAGE_FRAUD_MAIN_1028.html
21. ^ Jeff Manning (27 March 2008). "Chase mortgage memo pushes 'Cheats & Tricks'". The Oregonian. http://www.oregonlive.com/business/index.ssf/2008/03/chase_mortgage_memo_pushes_che.html. 
22. ^ St. Louis Federal Reserve Review, The Varying Effects of Predatory Mortgage Lending Laws on High-Cost Mortgage Applications

External links

• Don't be a victim of loan fraud from HUD.
• Protect yourself in the loan process from the California Department of Real Estate.
• Federal Citizen Information Center, site has links to state and federal regulatory agencies and other consumer information provided by the United States General Services Administration.
• Challenges in combating predatory lending from The United States General Accounting Office.
• Predatory lending article from Dollars & Sense magazine
• Alternatives to payday loans from Virginians Against Payday Loans (VAPL)
• Americans for Fairness in Lending (AFFIL), nonprofit consumer organization with news, articles and advice
• Capitalism without values, Clint Reilly on the predatory lending scandal.
• DoomsdayLoans.co.uk Non-profit consumer organisation campaigning for greater regulation of payday lending in the UK.