What is Predatory Lending
A predatory home loan is typically a home equity loan or mortgage refinancing at a steep cost with no consideration to the homeowner’s ability to repay. There is no precise definition of a predatory loan, although many experts agree that it is the result of a company misleading and sometimes coercing someone into taking out a home loan. These lenders are usually non-bank companies and can include mortgage brokers, home improvement contractors and finance companies.
Predatory lending also has been associated with non-mortgage loans. Clearly, not every non-bank lender is unscrupulous, but consumers need to be informed of unethical practices and avoid predatory lenders. Predatory mortgage lenders essentially market their services to people with poor credit histories or who, they believe, are in need of cash or are otherwise vulnerable. Examples include the senior population who needs money for medical bills or home repairs, middle-income consumers who need to pay off credit card bills or consolidate other debts, or who want to make some dream purchase, lower-income or minority communities where there may be limited competition from more reputable lenders, and college students who are usually financially strapped. There are also those people who are impulse shoppers and don’t shop around for goods and services; making them more likely to be victimized by predatory lending as well.
Characteristics of Predatory Lending
Predatory mortgage lending involves a wide array of abusive practices. The Center for Responsible Lending gives brief descriptions of some of the most common.
Excessive fees. Points and fees are costs not directly reflected in interest rates. Because these costs can be financed, they are easy to disguise or downplay. On competitive loans, fees below 1% of the loan amount are typical. On predatory loans, fees totaling more than 5% of the loan amount are common.
Abusive prepayment penalties. Borrowers with higher-interest subprime loans have a strong incentive to refinance as soon as their credit improves. However, up to 80% of all subprime mortgages carry a prepayment penalty — a fee for paying off a loan early. An abusive prepayment penalty typically is effective more than three years and/or costs more than six months’ interest. In the prime market, only about 2% of home loans carry prepayment penalties of any length.
Kickbacks to brokers (yield spread premiums). When brokers deliver a loan with an inflated interest rate (i.e., higher than the rate acceptable to the lender), the lender often pays a “yield spread premium” — a kickback for making the loan more costly to the borrower.
Loan flipping. A lender “flips” a borrower by refinancing a loan to generate fee income without providing any net tangible benefit to the borrower. Flipping can quickly drain borrower equity and increase monthly payments — sometimes on homes that had previously been owned free of debt.
Unnecessary products. Sometimes borrowers may pay more than necessary because lenders sell and finance unnecessary insurance or other products along with the loan.
Mandatory arbitration. Some loan contracts require “mandatory arbitration,” meaning that the borrowers are not allowed to seek legal remedies in a court if they find that their home is threatened by loans with illegal or abusive terms. Mandatory arbitration makes it much less likely that borrowers will receive fair and appropriate remedies in cases of wrongdoing.
Steering & Targeting. Predatory lenders may steer borrowers into subprime mortgages, even when the borrowers could qualify for a mainstream loan. Vulnerable borrowers may be subjected to aggressive sales tactics and sometimes outright fraud. Fannie Mae has estimated that up to half of borrowers with subprime mortgages could have qualified for loans with better terms.