Predatory lending
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Predatory lending is the practice of using a borrower’s ignorance against them for profit. It is often referred to as an affliction that only strikes racial minorities, women, and the elderly. While these groups are certainly prone for victimization, for which the ramifications cut far deeper and are often life-altering, predatory lending runs silently unregulated amongst all demographics.
Predatory lending can be identified by deceptive marketing and sales practices, non-disclosure of all terms that relate to the qualification and payback of the loan, and falsifying documentation to gain otherwise unattainable loan approvals, although the actual term is an umbrella to numerous specific scenarios.
The majority of all government and government agency citations of the phrase "predatory lending", define the term as "granting loans without regarding the borrowers ability to repay". This definition thus seems to imply that the lender is granting a loan very well secured by some sort of collateral such as a car or a house, so that if the borrower doesn't repay the lender can still profit from selling the forclosed property. If the loan was not secured, it would be difficult for a lender to make a profit by lending money and not getting repayment. In fact, this strict definition of predatory lending leaves out the many forms of loans commonly called predatory, such as payday loans, consumer finance unsecured and mortgage loans, etc. The industry which would come closest to this strict definition is known as hard money lenders, who grant mortgage loans only if there is a large amount of equity in a home and without any verification of repayment. This is a marked difference to consumer finance mortgage lenders, who, while charging high interest rates, often lend more money then a home is worth. However,there are middlemen known as loan brokers, these persons can attempt to lie to the lender regarding the borrowers ability to repay, and while the lender believes they will repay, and the borrower cannot, the loan broker gets a fee for simply initiating the loan, regardless if the loan goes into default later on. Although this doesn't fall under the strictest definition of predatory lending, since the lender has been misled about the borrowers ability to repay, nevertheless it causes problems for the borrower and profit for the loan originator.
However the term has evolved and is used to describe any lending practice that someone might judge to be unfair or deceptive.
History
Historically, loan fees and interest rates were regulated. In the United States, deregulation starting at Citibank's urging in South Dakota, led to the effective elimination of usury lawshttp://www.pbs.org/wgbh/pages/frontline/shows/credit/more/rise.html in 1980.Profits as indicators of Predatory Lending
Large up-front fees and back-end rebates called Yield spread premium (YSP) often result in extraordinary profits to lenders without borrower awareness. YSP has maintained a rather secretive status in the mortgage and finance industries due to the relative identity protection it receives from Federal (RESPA) law. In 2002, The Secretary of HUD, now Senator Mel Martinez, R-Florida, tried and failed to pass sweeping RESPA (Real Estate Settlement Procedures Act) reform legislation that would have further put mortgage brokers at a disadvantage by requiring mortgage brokers to credit borrowers the amount of Yield spread premium that they earned, and then charge the borrowers a fee to recover the yield spread premium. Lenders would have still been exempt from that requirement.Today, a Mortgage broker must disclose YSP on the Good Faith Estimate and on the HUD-1 settlement statement, although exactly how it must be disclosed is ambiguous at best. A Mortgage banker is not required to disclose any YSP they make.
Some lenders target elderly homeowners who have considerable equity in their homes, and who might be more easily deceived or coerced into taking out a mortgage loan that they cannot afford to pay back.
A broker may originate a loan to a borrower knowing they do not have enough cash flow to make the monthly payments and then immediately sell the loan to a secondary market investor. When the borrower defaults, they and the funding lender are damaged, not the broker.
Sadly, in many cases where a person with large credit card debt (i.e. unsecured), no assets beyond the equity in their home, and no cash flow to cover the minimum monthly payments, a better option for them may be to work out a payment plan with the credit card companies covered by the cash flow they do have, or even to declare bankruptcy so that they do not lose their home in a foreclosure sale.
Another far more complex, very innovative (but allegedly criminal) predatory tactic involves predators creating and exploiting conflicts of interest among the various purchasers and servicers of a pool of mortgages, through frivolous foreclosures of performing loans, and legal barratry contrary to fiduciary duty that are extremely profitable for the predators. http://www.predatorix.com particularly "Super Future Equities vs. ORIX", SFEvsORIX.pdf sections:
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Abusive or unfair lending practices
There are many lending practices which have been called abusive and labeled with the term "predatory lending." There is a great deal of dispute between lenders and consumer groups as to what exactly constitutes "unfair" or "predatory" practices, but the following are sometimes cited.
- Risk-based pricing. This is the practice of charging more (in the form of higher interest rates and fees) for extending credit to borrowers identified by the lender as posing a greater credit risk. The lending industry argues that risk-based pricing is a legitimate practice; since a greater percentage of loans made to less creditworthy borrowers can be expected to go into default, higher prices are necessary to obtain the same yield on the portfolio as a whole. Some consumer groups argue that risk-based pricing is an excuse for price gouging vulnerable consumers. They argue that higher prices paid by more vulnerable consumers cannot always be justified by increased credit risk.
- Single premium credit insurance. This is a purchasing of insurance which will pay off the loan in case the homebuyer dies, this is more expensive than other forms of insurance because it does not involve any medical checkups, but customers almost always are not shown their choices—because usually the lender is not licensed to sell other forms of insurance. In addition, this insurance is usually financed into the loan which causes the loan to be more expensive, but at the same time encourages people to buy the insurance because they do not have to pay up front.
- Any situation where the loan price is negotiable, but the buyer is not aware of this. Many lenders will negotiate the price structure of the loan with borrowers. In some situations, borrowers can even negotiate an outright reduction in the interest rate or other charges on the loan. Consumer advocates argue that borrowers—especially but not only unsophisticated borrowers—are not aware of their ability to negotiate, and might even be under the misapprehension that the lender is placing the borrower's interests above its own. Thus, many borrowers do not take advantage of their ability to negotiate.
Anti-predatory lending organizations such as ACORN argue that predatory loans are usually made in poor and minority neighborhoods where better loans are not readily available, and that the loss of equity and foreclosure can devastate already fragile communities.
Organizations such as AARP Inner City Press and ACORN have worked to stop what they describe as predatory lending. ACORN has targeted specific companies such as Household Finance and H&R Block, successfully forcing them to change their practices. Inner City Press and Fair Finance Watch continues watchdogging the practices of HSBC and Citigroup as they export their controversial subprime lending models beyond the United States. These groups have also spearheaded legislation that would make forms of lending deemed to be predatory illegal.
On the other side of the issue are various subprime advocates such as NHEMA, who say that many practices commonly called "predatory," particularly the practice of risk-based pricing, are not actually predatory.
Underlying issues
There are many underlying issues in the predatory lending debate on which there are many viewpoints:
- Risk-based pricing: The first issue is to whether risk-based pricing is fair in and of itself. Risk-based pricing is the universal practice of the bond markets and the insurance industry, and is implied in the stock market and in many other industries. The basic idea is that those who are more likely to default, or are deemed more risky, should pay more interest to avoid the tragedy of the commons, to avoid unfairly punishing those who have never defaulted and never will. This might be the reverse way of looking at it though, risk-based pricing can also be seen as a way for a lender to lend to a group they never have been able to previously, whereby the higher charge allows them to not lose money based on the higher than normal default rate. There is some debate as to whether this concept is fair. There is also some who, while agreeing that the rates are generally set fairly, relative to the risk the lender assumes, feel that it is not good to allow borrowers with credit problems to take out such a loan.
- Competition: Some of those who believe risk based pricing is fair, nevertheless feel that many loans which they deem predatory charge prices far above the risk, using the risk as an excuse to overcharge. Others counter that competition would reduce this possibility. These criticisms may be applied to certain products and not others.
- Financial Education: Many observers feel that competition in the markets served by what critics describe as "predatory lenders" is not affected by price because the targeted consumers are completely uneducated about the time value of money and the concept of APR, a different measure of price than what many are used to.
- Caveat Emptor: There is an underlying debate about whether a lender should be allowed to charge whatever it wants for a service, even if it seems to make no attempts at deceiving the consumer about the price. At issue here is the belief that lending is a commodity and that the lending community has almost a fiduciary duty to advise the borrower as to how to obtain funds more cheaply. Also at issue are certain financial products which appear to only be profitable due to anti-adverse selection, that is a lack of knowledge on the part of the customers relative to the lenders. For example, some people allege that credit insurance would not be profitable to a company if only those customers who had the right "fit" for the product actually bought it (i.e., only those customers who were not able to get the generally cheaper term life insurance).
- Discrimination: Certain groups feel that many financial institutions continue to engage in racial discrimination. Most do not allege that the loan underwriters themselves discriminate, but rather that there is a systemic discrimination. Loan brokers or other types of lending situations where the rate is negotiable or set by the salesman himself, however, have been seen as more ripe for discrimination (and in fact, certain lenders like Honda Auto Finance have had to pay settlements for alleged discrimination of their auto dealers). The discrimination that occurs in this scenario usually thought to be in this way: the loan broker would more often claim that a racial minorities' credit score is lower than it really is, justifying a higher interest rate charged, on the hope that the customer would assume that the lender was right because of an internalized bias that a minority group has a lower economic profile. It is also possible that any broker or loan salesman with some control of the rate charged would simply attempt to charge a race that he dislikes a higher rate. This is seen as being a less likely scenario, although the potential for this occurring causes some to call for the outlawing of interest rates being set by anything but non objective measures.
United States legislation combating predatory lending
Many laws at both the Federal and state government level are aimed at preventing predatory lending. Although not specifically anti-predatory in nature, the Federal Truth in Lending Act requires certain disclosures of APR and loan terms. Also, in 1994 section 32 of the Truth in Lending Act, entitled the Home Ownership and Equity Protection Act of 1994, was created. This law is devoted to identifying certain high-cost, potentially predatory mortgage loans and reining in their terms.Twenty-four states have passed anti-predatory lending laws. Arkansas, Georgia, Illinois, Massachusetts, North Carolina, New York, New Jersey, New Mexico and South Carolina are among those states considered to have the strongest laws. Other states with predatory lending laws include: California, Colorado, Connecticut, Florida, Kentucky, Maine, Maryland, Nevada, Ohio, Oklahoma, Pennsylvania, Texas, Utah, Wisconsin, and West Virginia. These laws usually describe one or more classes of "high-cost" or "covered" loans, which are defined by the fees charged to the borrower at origination or the APR. While lenders are not prohibited from making "high-cost" or "covered" loans, a number of additional restrictions are placed on these loans, and the penalties for noncompliance can be substantial.
See also
- Usury
- Payday loan
- Overdraft protection loans
- Subprime lending
- Title loans
External links
- [ACORN], neighborhood associations opposing predatory lending
- [Weekly report on predatory lending by Inner City Press], an organization combatting predatory lending
- [Center for Responsible Lending], an organization opposing predatory lending
- [National Home Equity Mortgage Association], an organization promoting subprime lending
- [Report Predatory Lending], a complete list of resources to report suspected fraud.
- [Predatorix], educates the public about certain complex predatory lending practices.
- [Banks Trick Poor Into Expensive Loans] from Dollars & Sense magazine
References
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