Predatory lending has become a hot topic in recent years. State governments for
years have adopted policies aimed at getting lenders to provide loans to credit-
risky people. Indeed, expanding credit to low-income people has been the thrust
of many community redevelopment laws. In the 1990s, a now booming industry
began serving that niche, led first by consumer finance companies and later by
some of the nation's biggest banks. Also called subprime lending, high-risk lending
soared as home loan lenders became skilled at evaluating the risk posed by less-
than-prime borrowers. From 1994 to 1999, the number of loans to high-risk
borrowers increased sixfold to 856,000. It is now a $140-billion market, according to
Inside Mortgage Finance Publications.
Lending to high-risk borrowers is the consumer equivalent of junk-bond financing,
making credit available at higher-than-prime interest rates to borrowers who
otherwise wouldn't have access to credit. Such lending clearly can benefit people
with low incomes, bad-credit histories, no credit histories or high levels of debt,
who otherwise couldn't qualify for a loan to buy a home, refinance, make
improvements or take out equity. The borrowers, however, often include those
who are unsophisticated in their financial knowledge, making them susceptible to
swindlers and high-pressure sales--cold calling, direct mail and door-to-door
soliciting. Through the hard sell and hooks like too-good-to-be-true rates, some
lenders sucker home-owners with loans that advocates say they have no business
taking.
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Fed Chairman, Alan Greenspan, has had the Federal Reserve increase its scrutiny
of high-cost loans. Mortgage loan buyer Freddie Mac partnered with 12 cities on
a "Don't Borrow Trouble" education campaign to warn against double-digit
interest rates, high fees and harsh restrictions. Sometimes, the new loans--based
on the value of the home, rather than what borrowers can afford--carry payments
that homeowners can't meet. They can wind up losing their homes. Or they agree
to repeated refinancing, called flipping. The lenders then pocket more fees, and
the customer ends up no better off. Some borrowers who find better deals and
seek to refinance discover that they agreed to a prepayment penalty that locks
them into the loan for years. Many borrowers simply can't comprehend the loan
terms in adjust-able-rate and balloon-payment mortgages -- even when they're
spelled out in big type and given document after document at a loan closing.
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The complex debate over predatory lending has grown along with the subprime
lending market and the housing boom in the past decade. The debate has
moved in recent years into state capitals for lack of a federal law. So far, North
Carolina, Georgia, and New York have enacted such laws. In 1999, North Carolina
became the first state to pass a tough, anti-predatory lending law that aimed to
eliminate certain lending practices and hinder others. Provisions of the law include:
- A ban on prepayment penalties on loans under $150,000.
- Provisions for special handling of "high-cost" loans, defined as any loan
with an interest rate 10 percentage points above a Treasury index or
loans with upfront fees, points and charges that are more than 5% of
the loan amount.
- Lenders must show that customers have completed consumer counseling
and that the borrowers have the ability to repay the loan.
- Lenders on such loans can't pocket fees or points to refinance a high-cost
loan from an existing customer, and they can't direct loan proceeds solely
to a home improvement contractor.
- Penalties include forfeiting interest, paying back twice the interest paid
(the punishment for usury) or paying triple damages.
- Bans on the financing of upfront, single-premium credit insurance.
Advocates complain lenders soak borrowers by "packing" loans with
such charges.
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However, it isn't always clear what amounts to predatory lending. The industry
argues that some loan provisions, including prepayment penalties, that are
routinely labeled as predatory actually benefit some customers. High-risk lender
Citifinancial, for example, reports that 90% of its customers prefer taking a pre-
payment penalty when it means a half-point lower interest rate on their loan.
Some community reinvestment experts worry that high-risk borrowers won't get
credit if new legislation drives quality lenders from the market. The fear is that
people will turn to even higher-cost sources of credit, pawnshops, or even loan
sharks.
High-risk lending has already proven too risky for some in the business. Bank of
America, the nation's largest retail bank, last year quit the field -- and put its
EquiCredit unit based in Jacksonville up for sale. Such lending had become
unattractive from a “risk-reward standpoint.” Citigroup initially provoked a
storm of negative attention in 2000 when it bought Dallas-based The Associates,
"widely recognized as the most notorious predatory mortgage lender in the
nation, "in the words of Martin Eakes of the Coalition for Responsible Lending.
But Citigroup's ownership has had a salutary effect on The Associates' business
practices. Citigroup stopped the use of single-premium credit insurance, dumped
4,100 (nearly 70%) of the brokers with whom The Associates dealt, and suspended
1,379 proposed foreclosures over concerns about the original Associates loans.
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