What To Do About Predatory Loans
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Predatory loans are the new horror of mortgage lending, a subject getting much attention in the media and with good reason.
In general terms predatory loans can be seen as financing which the borrower does not understand, cannot repay, or includes terms so onerous even loan sharks would be embarrassed. Such loans harm consumers, generate grossly high foreclosure levels and hurt legitimate lenders.
Sometimes predatory loans are confused with flipping, buying a home and quickly selling for a higher value.
Flipping — by itself — is neither wrong nor disturbing. Consider the parallel: if someone buys a stock Tuesday for $10 and sells it Wednesday for $15 no one gets distressed. Where flipping goes wrong is when it relies on pay-offs to appraisers, crooked loan applications, dishonest loan officers, cheating lenders, and fraudulent contracts. We don’t need further protection against unlawful flipping, all we need is to enforce the rules now on the books.
Predatory loans are troublesome because they may not be illegal today. Instead, they’re often loans made to those who are poor, sick, uneducated, ignorant or elderly — people who pay far more than they should for financing secured by real estate.
If you look at the Home Ownership Equity Protection Act of 1994 (HOEPA — Section 32 of Regulation Z, part of the Truth in Lending Act) you can see the problem: According to the Federal Trade Commission, a loan is covered by the law if it meets the following tests:
- For a first-lien loan, that is, the original mortgage on the property, the annual percentage rate (APR) exceeds by more than eight percentage points the rates on Treasury securities of comparable maturity;
- for a second-lien loan, that is, a second mortgage, the APR exceeds by more than 10 percentage points the rates in Treasury securities of comparable maturity; or
- the total fees and points payable by the consumer at or before closing exceed the larger of $561 or eight percent of the total loan amount. (The $561 figure is for 2008. This amount is adjusted annually by the Federal Reserve Board, based on changes in the Consumer Price Index.) Credit insurance premiums for insurance written in connection with the credit transaction are counted as fees.
There are three problems with Section 32.
First, Section 32 requires disclosure for onerous loan terms, it does not ban such financing.
Second, as I read Section 32 it allows loans with awful terms and no disclosure, say 7.99 percentage points above the rates on Treasury securities of comparable maturity — plus 7.99 points.
Third — and you’ll love this — a huge percentage of all real estate loans are excluded from Section 32 regulations! As the FTC states, “The rules do not cover loans to purchase or initially construct your home, reverse mortgages, or home equity lines of credit (similar to revolving credit accounts).”
What to do?
Look at the money.
Predatory lenders are motivated by money. The way to stop predatory lending is to cap the money that can be made and impose significant consumer protections.
For instance, a $100,000 mortgage at 6.5 percent and no points (par pricing) over 30 years yields interest worth $127,545. But not all loans are available at 6.5 percent because not all borrowers have pristine credit.
Okay, let’s say that 6.5 percent is the base rate for loans originated today but that rates as high as 12 percent and no points (50 percent greater) will be allowed. That means a $100,000 loan over 30 years would have a projected interest cost of $270,300. Any loan with a higher projected yield — including interest, points, loan discount fees, origination fees, and other payments to a lender (or any party related to or controlled by the lender) — will be defined as “predatory.”
And what state or federal penalties should we have for predatory lenders? How about a mandatory 50 percent reduction in the principal amount and an interest rate no greater than half the highest allowable charge at the time a predatory loan was originated? Why golly, in the example above we would have a $50,000 loan at 6 percent — less any fees or excess interest paid to date, of course.
We can debate the percentages and penalties, but the principle concern is that we should be able to easily determine what is or is not a predatory loan — and then do something about it.
Foreclosures for predatory loans with less than six months notice should be made illegal.
Late fees of any sort for predatory loans should be banned.
Predatory rates that escalate from initial levels should be forbidden.
In the event of a dispute predatory lenders must be required to bear their full legal costs. If a predatory lender loses a court case, mediation or arbitration, it should also be required to pay the borrower’s legal fees and costs.
Related costs for loan “insurance” should be included within the yield computation (don’t worry, FHA, VA, and private mortgage insurance companies want nothing to do with predatory loans).
Borrowers should have the right to pay off predatory loans at any time and without penalty.
No cash from predatory loans should be provided to consumers for “home repairs” during the first three years of the loan term This would impact “contractors” who offer to both fix the property and provide cash to owners — but forget to mention that the deal is powered by a predatory loan.
A 30-day mandatory disclosure period would be established for predatory loans — and consumers would not be allowed to waive their disclosure rights. Borrowers would have the right to withdraw from the loan without cost or penalty during the disclosure period for any reason — or for no reason.
And, of course, such rules should apply absolutely and equally to purchase money mortgages, first trusts, second loans, refinancing, construction financing, reverse loans, and home equity lines of credit — any financing secured by a prime residence.
HUD, the Federal Reserve, or the FTC can publish a daily base rate that borrowers and attorneys can check to see which loans are predatory and which are not. Such rates can be drawn from data developed by an accepted financial publisher, such as HSH Associates, a company that surveys thousands of lenders each week.
The lending industry is filled with people who are just like the rest of us — they want to earn a fair profit from the provision of a legitimate service. But predatory lending hurts consumers and damages lenders, it’s a loser for everyone and it’s long past the right time to get it stopped.
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Published originally by Realty Times on June 20, 2000 and posted with permission.
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