Predatory Mortgage Lending

For the average consumer who is contemplating buying a house or refinancing an existing home loan, the credit marketplace appears to be highly competitive. Mortgage loan rates are published weekly in most newspapers, making comparison shopping easy. Home loans are available through a wide variety of sources, including banks, credit unions, savings and loan associations, mortgage brokers, financed companies and specialized mortgage lenders.

It is a different story for consumers with low or irregular incomes, with blemished credit records, or with limited education or financial sophistication. Many of these consumers believe they are excluded from the credit mainstream and turn to more marginal or "sub-prime" sources for their credit. Home loans are readily available in the subprime market but borrowers pay much more. There are subprime mortgage lenders who charge points and origination fees in excess of 10% of the loan amount, and then finance those fees at high interest rates. In addition to paying more, the subprime borrower may be subject to predatory practices, such as flipping, packing, and equity stripping. The stakes are especially high in these loans because the borrower's home is at risk if he cannot maintain the monthly payments.

Here are some examples of specific predatory practices in home mortgage lending:

Excessive Mortgage Broker Compensation. Most consumers who contact a mortgage broker expect the broker to arrange a loan with the best terms and at the lowest possible rate. Most mortgage brokers do just that, and charge a reasonable fee for their services. However, in the subprime market, there are mortgage brokers who do just the opposite. That is, the broker will attempt to sell the borrower on a loan with the most fees and highest rate possible so that the broker will get more compensation. Some of these brokers may charge fees of 8 to 10 points. On a $100,000 loan, that means the borrower is paying and financing an additional $8,000 to $10,000. In addition, the broker may get additional compensation from arranging a higher than necessary interest rate for the consumer. For example, the consumer may qualify for an 8% interest rate, but if the broker can sell the consumer a 9% rate, he can keep the differential. This method of indirect payment is commonly referred to as a "yield spread premium." Before contracting with a mortgage broker, the consumer should understand how the broker is going to be paid.

Excessive Points and Fees. Most borrowers can expect to pay a 1% origination fee and possibly another 1% of the loan amount in points, as well as basic closing costs which would include appraisal and attorney's fees. Some predatory lenders load up loans with these up-front charges and charge additional "junk fees" to pad the closing costs. As a real life example, a broker recently arranged a $48,000 home loan for a borrower in Fayetteville which included a $4352 origination fee, $1089 in points, a $175 "underwriting" fee, a $200 "processing" fee and a $175 "document prep" fee, in addition to standard closing costs. These fees are then rolled into the loan and financed at a high rate of interest along with the loan principal. Even if the borrower may be able to refinance the loan later at a lower interest rate, he cannot get any rebate on the fees because they are earned as soon as the loan is closed.

Sell the Monthly Payment. Many brokers and lenders advertise "bill consolidation" home equity loans. They encourage consumers to pay off credit card, retail and motor vehicle debt by consolidating them all into one home loan and promise to reduce the monthly debt payment. Monthly payments can be lowered this way but the problem lies in the fact that the consumer is trading short term debt for long term debt. Instead of paying off consumer credit bills in 3 to 4 years, the new consolidation loan will take 15 to 30 years to pay off. And the total amount paid out in interest will be much greater. Predatory lenders love to sell loans based on the monthly payment. Consumers must look beyond the monthly payment and analyze all the terms of the loan if they want to avoid being victimized.

Balloon Payments. Another way for a predatory lender to reduce the monthly payment on a home loan is to have the borrower pay off only the accrued interest each month. This method of financing will result in a huge balloon payment at the end of the repayment term, usually after 15 years. The borrower, who believes he is paying down the loan after making all the payments, is in for an unpleasant surprise. He may owe almost as much as he originally borrowed 15 years earlier. If the borrower is elderly, it will be very difficult to refinance the loan, and foreclosure may become inevitable.

Equity Stripping. If the consumer has a significant amount of equity in his home, he could be a target for the predatory practice of equity stripping. An unscrupulous lender may lend an amount that is more than the borrower can financially handle, knowing that the borrower is likely to default. The lender can then foreclose and sell the house, stripping the homeowner of all the equity he has earned over the years.

Flipping. Flipping is the repeated refinancing of the consumer's loan. When the consumer has paid down the loan slightly, a predatory lender may encourage the consumer to refinance and get a little more cash out of the available equity in his home. Each time the loan is refinanced the lender charges more fees, placing the borrower further in debt over a longer period of time.