Lee’s Notes: Found this while finishing up some training for my recertification. Figured I would share.
Seven Signs of Predatory Lending
Predatory mortgage lending involves a wide array of abusive practices. Here are brief descriptions of some of the most common.
1. Excessive Fees & Insurance: Points and fees are costs not directly reflected in interest rates. Because these costs can be financed, they are easy to disguise or downplay. On competitive loans, fees below 1% of the loan amount are typical. On predatory loans, fees totaling more than 5% of the loan amount are common.
These “fees” go by a variety of terms (mortgage broker fees, origination fees, servicing release fees, processing fees, discount fees, etc.) Regardless of the name, they have two common characteristics:
a. fees are significantly higher b. fees are not paid by the borrower at the time of loan closing, but are instead financed as part of the loan.
Predatory lenders get consumers to accept this insurance by automatically including it in the loan without the borrower’s knowledge, and threatening to delay a loan closing if the borrower tries to decline the coverage.
Other abuses include selling credit insurance on an amount greater than the loan balance and calculating insurance premiums based on the maximum allowable amount under state law.
Again, because these premiums are financed as part of the loan amount, the borrower loses even more home equity.
These insurance coverages are very profitable for predatory lenders or brokers, who capture 40%-50% of the total premiums.
If a mortgage lender owns an affiliated insurance agency, the percent of premiums retained jumps to 70% or more. Generally, none of these arrangements are disclosed to the borrower.
2. Abusive Prepayment Penalties: Borrowers with higher-interest subprime loans have a strong incentive to refinance as soon as their credit improves.
However, up to 80% of all subprime mortgages carry a prepayment penalty — a fee for paying off a loan early. An abusive prepayment penalty typically is effective more than three years and/or costs more than six months’ interest.
In the prime market, only about 2% of home loans carry prepayment penalties of any length.
A prepayment penalty is a fee required by the lender when borrowers pay off a mortgage loan early. In the subprime mortgage market, where borrowers tend to have less-than-perfect credit, an abusive prepayment penalty can trap them in a high-interest loan even after they improve their credit rating.
This penalty is seldom imposed in the conventional mortgage market.
3. Kickbacks to Brokers (Yield Spread Premiums): When brokers deliver a loan with an inflated interest rate (i.e., higher than the rate acceptable to the lender), the lender often pays a “yield spread premium” — a kickback for making the loan more costly to the borrower.
“Yield-spread premiums” is what lenders call them. Consumer groups call them kickbacks.
They’re the cash that mortgage brokers get for steering a borrower into a home loan with a higher interest rate.
They’re everywhere – even though prominent academics, state attorney’s general and even some lenders say that often they’re an invitation to steal.
Kickbacks can cost homebuyers thousands of dollars extra on their mortgages. “Consumers,” Iowa Attorney General Tom Miller said recently, “are paying more than the fair market price of their loan.”
4. Loan Flipping: 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.
Flipping occurs when a lender induces a borrower to refinance a loan with a new larger loan designed to both pay off the previous loan and finance the fees and costs of the new loan.
As the initial loan is extended over a longer period of time and the loan balance increases, a borrower is exposed to greater risk of losing his home through foreclosure.
The frequency of flips is not just the result of borrowers wanting to borrow more money, it has been designed and encouraged by finance companies, as well as brokers who try to earn more fees by “churning” their portfolio of customers.
5. Unnecessary Products: Sometimes borrowers may pay more than necessary because lenders sell and finance unnecessary insurance or other products along with the loan.
6. Mandatory Arbitration: 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 wrong-doing.
Most people assume they can take their grievances to court if a lender violates the law. Unfortunately, many borrowers are denied that option through “binding mandatory arbitration” (BMA), a common clause in loan contracts.
Barred from bringing claims to court, victims of abusive lending practices frequently find that their loan contracts require them to go through arbitration: proceedings conducted in secrecy, with limited evidence and documentation.
All too often, borrowers pay excessive costs and receive unfair results.
7. Steering & Targeting: Predatory lenders may steer borrowers into subprime mortgages, even when the borrowers could qualify for a mainstream loan.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.
According to a government study, over half (51%) of refinance mortgages in predominantly African-American neighborhoods are subprime loans, compared to only 9% of refinances in predominantly white neighborhoods.
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