Predatory Lending: Don't Fall Victim!
Some mortgage lenders and others who extend credit may use unfair or illegal practices and offer inappropriate loan products to consumers to increase their own profits. Practices that have a disparate negative impact on members of protected classes may be illegal under the Fair Housing Act or the Equal Credit Opportunity Act. Some lenders target senior citizens and others who are likely to be less aware of questionable practices and potential scams. Descriptions of the most common follow. Please call Jay Stevens at 914-428-4507 ext. 339, if you would like more information or to set up an educational session for your group.
Charging Higher Interest Rates Than a Borrower’s Credit Justifies
Theoretically, a borrower with near-perfect credit would be able to borrow at the “A” or prime rate. Those with imperfect credit histories are usually charged higher interest rates by so-called subprime lenders. These rates are intended to compensate the lender for taking a greater credit risk. With some subprime lenders, however, there simply is no lower rate offered no matter how good a borrower’s credit. Very often, borrowers with perfect credit are charged interest rates 3 to 6 points higher than the prime rates. For borrowers with impaired credit, rates are frequently much higher than even somewhat blemished credit would reasonably deserve. An outright illegal practice would be charging higher interest rates for members of racial or ethnic minority groups compared to white borrowers with similar credit histories.
Making Loans without Regard to the Borrower’s Ability to Pay
Some predatory lenders create loans based purely on borrowers’ equity, even when it is obvious that homeowners will not be able to afford the payments. In these instances, the incentive for mortgage brokers to engage in this kind of practice is the desire for the fees generated by such loans. Loan officers at mortgage companies may have similar motivations based on earning commissions, regardless of the consequences for the lenders for whom they work. Some lenders, especially when there is a substantial amount of equity in particular homes, may be motivated by the possibility of foreclosing on houses, which can then be resold at a profit.
Mortgages with “balloon payments” are arranged so that after making a certain number of regular payments (often over five or seven years, or even fifteen), the borrower must pay off the remaining loan balance in its entirety, in one lump sum. About ten percent of subprime loans are structured this way. Many borrowers are unaware that their loan has a balloon payment, that their monthly payments are essentially paying only interest and not reducing the principal, and that the balloon will ultimately force them to refinance.
With a traditional mortgage, you pay enough each month to cover some interest and some principal and the principal gradually decreases With a “negative amortization” loan, despite regularly making the required monthly payment, the borrower’s loan balance increases every month. This occurs because the repayment amount is structured so that the borrower is not even paying the interest that would be charged under a regular mortgage, let alone a portion of the principal. The “unpaid amount” is instead added back into the total amount that the borrower ultimately needs to pay off. Instead of building equity, the borrower loses equity over time, and the borrower may not find that out until he or she calls the lender to inquire why the loan balance keeps increasing. Predatory lenders use negative amortization to win over borrowers with offers of low payments without making it clear that the principal balance will rise rather than fall and the required payment will increase substantially, typically after five years.
"Flipping" is a practice in which a lender, often through high-pressure or deceptive sales tactics, encourages repeated refinancing by existing customers without a true benefit to the borrowers and tacks on thousands of dollars in additional fees or other charges for each refinancing. Some lenders will intentionally start borrowers with a loan at a higher interest rate, so that the lender will then refinance the loan to a slightly lower rate. This kind of multiple refinancing is never beneficial to the borrower and results in a loss of equity.
Yield Spread Premiums
A “yield spread premium,” or YSP, is a fee paid by the mortgage lender to the mortgage broker for a particular home loan in exchange for the broker’s arranging a higher interest rate or an above-market mortgage rate. YSPs create an obvious incentive for brokers to make loans at the highest interest rates and fees possible regardless of whether borrowers could qualify for better terms. This practice was originally intended as a way to avoid charging the borrower any out-of-pocket fees, as brokers could earn their commission and cover closing costs with the YSP. However, many feel the intentions have been misdirected, with the premium ending up as just another fee borrowers must pay without any benefits.
Fraud and Abuse
Outright fraud or abusive practices are typically directed toward minority, elderly, and less knowledgeable borrowers. Methods include scare tactics, threats that the borrower’s credit will be ruined, bullying, document switching, and plain old lying.
Home Improvement Scams
Some home improvement contractors deliberately target lower income and elderly homeowners, using high pressure tactics to sell unneeded and overpriced contracts for so-called improvements. Often these scam artists charge more than their quoted prices, or their work does not live up to their promises. When a homeowner refuses to pay for shoddy or incomplete work, the contractor may threaten to put a lien on the home or even force the homeowner into foreclosure.