Predatory Mortgage Lending Abuses
PREDATORY MORTGAGE LENDING ABUSES
Atlanta Legal Aid Society
Last Revised: June 15, 2005
This document describes the different ways that mortgage lenders can trick homeowners into giving up their homes.
I. ORIGINATION OF THE LOAN
Solicitations. Predatory mortgage lenders target low-and moderate-income and minority neighborhoods for extensive marketing. They advertise through direct mail, telephone and door to door solicitations, flyers stuffed in mailboxes, and highly visible signs in these neighborhoods. They advertise on radio stations with a large minority audience and employ television commercials that feature celebrity athletes. Many companies deceptively tailor their solicitations to resemble Social Security or other government checks to prompt homeowners to open the envelopes and otherwise deceive them about the transaction.
Home Improvement Scams. Predatory mortgage lenders use local home improvement companies essentially as mortgage brokers to solicit loan business. These companies target homeowners and solicit them to execute home improvement contracts. The company may originate a mortgage loan to finance the home improvements and sell the mortgage to a predatory mortgage lender, or steer the homeowner directly to the predatory lender for financing of the home improvements. There are many scams involving home improvements.
With FHA Title 1 home improvement loans, sometimes the contractor falsely claims that HUD will guarantee that the work will be done properly and/or that HUD will pay for the home improvements. In reality, HUD only guarantees to the holder of the mortgage that HUD will pay the mortgage if the homeowner defaults. HUD then pursues the homeowner for payment.
The homeowners are often overcharged for the work, which the contractors often perform poorly and fail to complete as agreed. They sometimes damage the homeowner's personal property in the process. In other cases, the contractor fails to obtain required city or county permits, thereby making sure that local code officials do not inspect the work for compliance with local codes and do not require that the shoddy work be corrected.
Some predatory mortgage lenders issue payments to the home improvement contractor without ensuring that the work has been properly completed according to the terms of the contract. Some predatory mortgage lenders issue checks payable solely to the contractor, thereby bypassing the homeowner.
Some home improvement companies solicit home improvement contracts with the intent to have the work financed and immediately begin the work prior to the expiration of the homeowner's three-day right to cancel the transaction.
Some home improvement contractors have the homeowner sign a cash home improvement contract for an amount the homeowner cannot afford in a lump sum. When the contractor arranges financing with the predatory mortgage lender and the homeowner objects to the terms of the predatory loan, the contractor threatens to place a lien on the property and sue the homeowner unless the homeowner goes through with the financing.
Predatory mortgage lenders deny responsibility for the overpriced, shoddy and incomplete work, even though they previously arranged for these home improvement companies to solicit loan business for them, and sometimes referred the homeowner directly to the unscrupulous contractor.
Mortgage Broker's Fees and Kickbacks. Predatory mortgage lenders also originate loans through local mortgage lenders who act as "bird dogs", or finders for the lenders. These brokers represent to the homeowners that they are working for them to help them obtain the best available loan, and the homeowners usually pay a broker's fee. In fact, the brokers are working for predatory lenders, who pay brokers kickbacks to refer borrowers to them. Mortgage brokers steer borrowers to the lender who will pay him or her the highest fee, not to the lender who will give the borrower the lowest interest rate and fees. Without the borrower's knowledge, the lender charges an interest rate higher than that for which the borrower would otherwise qualify in order to pass on to the borrower the cost of the kickback. On loan closing documents, the industry uses euphemisms or their abbreviations for these kickbacks: yield spread premiums (YSP) and service release fees (SRF). The industry also calls this bonus upselling or par-plus premium pricing; we call it paying unlawful kickbacks.
Steering to High Rate Lenders. Banks and mortgage companies steer customers with less than perfect credit to high rate lenders, often a subsidiary or affiliate of the bank or mortgage company. Some banks and mortgage companies steer customers - especially minorities - who may have good credit and would be eligible for a conventional loan to high cost lenders. Sometimes the customer is steered away even before completing a loan application. Kickbacks or referral fees are paid as an incentive to steer the customer to a higher rate loan. This practice of steering these applicants to high rate lenders is called downstreaming. On the other hand, when people with good credit go to predatory mortgage lenders, the lender does not upstream the applicant to a bank or conventional mortgage company for a low cost mortgage loan.
Making Unaffordable Loans. Some predatory mortgage lenders purposely structure loans with monthly payments that they know the borrower cannot afford so that when the homeowner is led inevitably to the point of default, she will return to the lender to refinance the loan, and the lender can impose additional points and fees. Other predatory mortgage lenders, called hard lenders, intentionally structure the loans with payments the homeowner cannot afford in order to lead to foreclosure so that they may acquire the house and the valuable equity in the house at a foreclosure sale.
Falsified or Fraudulent Applications. Some predatory mortgage lenders knowingly make loans to unsophisticated homeowners who do not have sufficient income to repay the loan. Often such lenders plan to sell the loan on the secondary market, especially through a process of securitization. This process generally involves oversight and due diligence by the purchaser to ensure that each borrower appears to have sufficient income to repay the loan. Knowing that these loan files may be reviewed at a later date by subsequent purchasers, such lenders have the borrowers sign a blank application form and then insert false information on the form, claiming that the borrower has employment income that she does not, so it appears that she can make the payments.
Adding Inappropriate Cosigners. This is done to create the false impression that the borrower can afford the monthly payments, even though the lender is well aware that the cosigner has no intention of contributing to the payments. Often, the lender requires the homeowner to transfer half ownership of the house to the cosigner. The homeowner thereby loses half the ownership of the home and is saddled with a loan she cannot afford to repay.
Incapacitated Homeowners. Some predatory lenders make loans to homeowners who are clearly mentally incapacitated. They take advantage of the fact that the homeowner does not understand the nature of the transaction or the papers that she signs. Because of her incapacity, the homeowner does not understand that she has a mortgage loan, does not make the payments, and is subject to foreclosure and subsequent eviction.
Forgeries. Some predatory lenders forge loan documents. In an ABC Prime Time Live news segment that aired April 23, 1997, a former employee of a high cost mortgage lender reported that each of the lender's branch offices had a "designated forger" whose job it was to forge documents. Forgeries are used to refinance a customer into another high cost mortgage with the same lender, to show apparent approval for payouts to home improvement contractors when the work is shoddy and/or incomplete, and to show apparent approval for such charges as credit insurance premiums.
High Annual Interest Rates. Because the purpose of engaging in predatory lending is to reap the benefit of high profits, these lenders always charge extremely high interest rates. This drastically increases the cost of borrowing for homeowners, even though the lenders' risk is minimal or nonexistent. Predatory lenders may charge rates of 10% and more, substantially higher than the rates of 7% to 8% on conventional mortgages.
High Points. Legitimate lenders charge discount points to borrowers who wish to buy down the interest rate on the loan. Predatory lenders charge high points, but offer no corresponding reduction in the interest rate. These points are imposed through prepaid finance charges (or points or origination fees), which are usually 3% to 10%, but may be as much as 20%, of the loan. The borrower does not pay these points with cash at closing. Rather, the points are always financed as part of the loan. This increases the amount borrowed, which generates more actual interest to the lender.
Balloon Payments. Predatory lenders frequently structure loans so that the borrower's payments are applied primarily to interest, and at the end of the loan period the borrower still owes most or all of the principal amount borrowed. The last payment balloons to an amount often equal to 85% or so of the original principal amount of the loan. The homeowner cannot afford to pay the balloon payment, and either loses the home through foreclosure or is forced to refinance with the same or another lender for an additional term and additional points, fees, and closing costs.
Negative Amortization. This involves structuring the loan so that interest is not amortized over the term. Instead, the monthly payment is insufficient to pay off accrued interest and the outstanding loan balance therefore increases each month. At the end of the loan term, the borrower may owe more than the amount originally borrowed. With negative amortization, there will almost always be a balloon payment at the end of the loan.
Credit Insurance - Insurance Packing. Predatory mortgage lenders market and sell credit insurance as part of their loans, often without the knowledge or consent of the borrower. Typical insurance products sold in connection with loans include credit life, credit disability, credit property, and involuntary unemployment insurance, and debt cancellation and suspension agreements. Lenders frequently charge exorbitant premiums, which are not justified based on the extremely low actual loss payouts. Frequently, credit insurance is sold by an insurance company which is either a subsidiary of the lender or which pays the lender substantial commissions. They over-insure borrowers by providing insurance for the total indebtedness, including principal and interest, rather than merely the principal amount of the loan. They also under-insure borrowers by providing insurance for less than the outstanding principal balance and less than the full term of the loan. In short, credit insurance becomes a profit center for the lender and provides little or no benefit to the borrower.
Padding Closing Costs. In this scheme, certain costs are increased above their market value as a way of charging higher interest rates. Examples include charging document preparation fees of $350 or credit report fees of $300, which are many times the actual cost.
Inflated Appraisal Costs. In most mortgage loan transactions, the lender requires an appraisal. Most appraisals include a detailed report of the condition of the house, both interior and exterior, and prices of comparable homes in the area. Others are "drive-by" appraisals, done by someone simply looking at the outside of the house. The former naturally costs more than the latter. However, in some cases, borrowers are charged for a detailed appraisal, when only a drive-by appraisal was done.
Inflated Appraisals. In order to make large loans, predatory mortgage lenders arrange for appraisals that inflate the true value of the house. The homeowner is then stuck with the new mortgage, unable to sell the house or refinance in the future because the mortgage balance exceeds the true value of the home.
Padded Recording Fees. Mortgage transactions usually require that documents be recorded at the local courthouse, and state or local laws set the fees for recording the documents. Predatory mortgage lenders often charge the borrowers a recording fee in excess of the actual amount established by law.
Increased interest rate after default. Some predatory mortgage lenders make loans that allow the interest rate to increase if the borrower defaults on the loan, which makes it even more difficult for the homeowner to catch up the payments when they recover from a temporary financial loss.
Advance Payments from Loan Proceeds. Some predatory mortgage lenders make loans in which more than two monthly payments are consolidated and paid in advance from the loan proceeds. The payments can be used to mask a loan that is being made to a borrower who has no reasonable prospect of paying the loan. By creating this initial reserve of advance payments, the lender can use this reserve to keep the loan current for a period and make the loan appear justified. In addition, the lender's deducting these payments from the loan proceeds gives the lender free use of the borrower's money that the borrower is paying interest on.
Bogus Mortgage Broker Fees. In some cases, predatory lenders finance mortgage broker fees when the borrower never met or knew of the broker. This is another way such lenders increase the cost of the loan for their own benefit.
Unbundling. This is another way of padding costs by breaking out and itemizing charges that are duplicative or should be included under other charges. An example is charging a loan origination fee (which should cover all costs of initiating the loan) and then imposing separate, additional charges for underwriting and loan preparation.
Prepayment Penalties and Fees. Predatory lenders often impose exorbitant prepayment penalties. This is done in an effort to lock the borrower into the predatory loan for as long as possible by making it difficult for her to refinance the mortgage or sell the home. For example, a homeowner has a high cost mortgage loan with a balance of $132,000 which she is unable to refinance at a lower rate because there is a $6,200 prepayment penalty due at the end of her fifth year paying this mortgage. Predatory mortgage lenders often charge a fee for informing the borrower or a lender of the balance due to pay off the existing mortgage loan. The loan documents almost never authorize such a fee. These practices provide back end interest for the lender if the borrower does prepay the loan.
Mandatory Arbitration Clauses. Pre-dispute, mandatory, binding arbitration clauses limit the rights of borrowers to seek relief through the judicial process for any and all claims and defenses the borrower may have against the mortgage lender, mortgage broker, or other party involved in the loan transaction. By inserting these clauses in the loan documents, some lenders attempt to obtain an unfair advantage by relegating their borrowers to a forum perceived to be more favorable to the lender. This perception exists because discovery is not a matter of right, but is within the discretion of the arbitrator; the proceedings are private; arbitrators need not give reasons for their decisions or follow the law; a decision in any one case will have no precedential value; judicial review is extremely limited; and injunctive relief and punitive damages are not available. Furthermore, the lender is not required to arbitrate claims it may have against the borrower. If the borrower defaults on the loan, the lender proceeds directly to foreclosure.
Flipping. Loan flipping happens when mortgage lenders and mortgage brokers aggressively try to persuade homeowners to refinance repeatedly when the new loan does not have a reasonable, tangible net benefit to the borrower considering all the circumstances, including the terms of both the new and refinanced loan, the cost of the new loan, and the borrower's circumstances. Reduction of monthly payments alone is not a tangible benefit to the borrower. Predatory mortgage lenders and brokers hook the borrower into refinancing by offering lower monthly payments and lower interest, refinancing out from under a balloon payment or variable rate mortgage, or by offering additional cash. Each time the borrower refinances, the amount of the loan increases to include additional origination fees, points, and closing costs. Also, the term of the loan is extended. If the loan amount is increased and the term is extended, the borrower will pay much more interest than if the borrower had kept the original loan. If the borrower actually needs more money, it would be better if the lender made a second, separate loan for the additional amount needed. A powerful example of the exorbitant costs of flipping is the case of Bennett Roberts, who had eleven loans from a high cost mortgage lender within a period of four years. See Wall Street Journal, April 23, 1997. Mr. Roberts was charged in excess of $29,000 in fees and charges, including 10 points on every financing, plus interest, to borrow less than $26,000. The purpose of flipping is to keep the borrower in a constant state of indebtedness. To paraphrase from the famous Eagles' song, "Welcome to the Hotel California, you can check in but you can never check out."
Recommending Default in connection with a Refinance. Predatory mortgage lenders and brokers often recommend or encourage the borrower to stop making payments on their existing mortgage loan and other loans or debts because they will refinance "soon." However, the closing on the refinance is delayed and sometimes never happens. If the refinancing occurs, the borrower feels compelled to go through with the closing despite the high interest rate, points, and fees and other abusive features of the loan because the other creditors are demanding payment on their loans, possibly threatening foreclosure or other legal action. Also, the new lender charges an interest rate higher than originally promised, and justifies the higher rate by telling the borrower that their credit records now show no or slow payments on their bills.
Modification or Deferral Fees. Some predatory mortgage lenders charge borrowers a fee or other charge to modify, renew, extend or amend a mortgage loan or to defer any payment due under the terms of the mortgage loan, even though the contract does not authorize such a fee.
Spurious Open End Mortgages. In order to avoid making required disclosures to borrowers under the Truth in Lending Act, many lenders are making "open-end" mortgage loans. Although the loans are called "open-end" loans, in fact they are not. Instead of creating a line of credit from which the borrower may withdraw cash when needed, the lender advances the full amount of the loan to the borrower at the outset. The loans are non-amortizing, meaning that the payments are interest only, so that the balance is never reduced.
Paying Off Low-Interest Mortgages. A predatory lender usually insists that its mortgage loan pay off the borrower's existing low- cost mortgage. Instead of lending the borrower only the amount he actually needs in a second, separate loan, the lender makes a new loan paying off the current mortgage. The homeowner loses the benefit of the lower interest rate and ends up with a higher interest rate and a principal amount that is much higher than necessary.
Paying Off Forgivable Loans and No-interest Loans. Many low income homebuyers obtain down payment assistance grants from state and local agencies. These grants are made in the form of second mortgages that are forgiven as long as the homebuyer remains in the home for five or ten years. Other government programs allow low income and elderly homeowners to obtain grants for necessary home improvement work to bring homes up to code standards. These grants are also made in the form of mortgage loans that are forgiven as long as the homeowner remains in possession of the home for five or ten years. When many predatory mortgage lenders make loans to these homeowners, they insist that these forgivable loans be paid off (to increase the amount borrowed) even though these loans would be forgiven in a matter of a few short years. Habitat for Humanity provides home purchase mortgage loans on which no interest is charged to low-income homebuyers. Predatory mortgage lenders have targeted Habitat for Humanity homebuyers in Georgia and North Carolina for high-cost mortgage loans, offering "cash out" loans to entice them and then requiring them to paying off their no-interest Habitat mortgage loans.
Shifting Unsecured Debt Into Mortgage. Mortgage lenders badger homeowners with advertisements and solicitations that tout the "benefits" of consolidating bills into a mortgage loan. The lender fails to inform the borrower that consolidating unsecured debt such as credit cards and medical bills into a mortgage loan secured by the home is a bad idea. If a person defaults on an unsecured debt, they do not lose their home. If a homeowner rolls their unsecured debt into their mortgage loan and default on their mortgage payments, they can lose their home. Furthermore, since unsecured debt generally is paid off between three and five years, shifting unsecured debt into a mortgage loan extends the payoff period to 15 to 30 years. Paying off unsecured debt with a mortgage loan also necessarily increases closing costs because they are often calculated on a percentage basis, thereby increasing the loan balance. Whereas the old total monthly household debt payments may in some cases be less than the monthly payments on the new mortgage loan, the monthly mortgage payments are often more than the previous mortgage payments, thus exacerbating the risk that the homeowner will lose the home to foreclosure.
Making Loans in Excess of 100% Loan to Value (LTV). Some lenders are making loans to homeowners in amounts that exceed the fair market value of the home. This makes it very difficult for the homeowner to refinance the mortgage or to sell the house to pay off the loan, thereby locking the homeowner into a high cost loan. Normally, if a homeowner goes into default and the lender forecloses on a loan, the foreclosure sale generates enough money to pay off the mortgage loan and the borrower is not subject to a deficiency claim. However, where the loan is 125% LTV, a foreclosure sale may not generate enough to pay off the loan, and the lender may pursue the borrower for the deficiency.
II. SERVICING OF THE LOAN
Force Placed Insurance. Lenders require homeowners to carry homeowner's insurance, with the lender named as a loss payee. Mortgage loan documents allow the lender to force place insurance when the homeowner fails to maintain the insurance, and to add the premium to the loan balance. Some predatory lenders force place insurance even when the homeowner has insurance and has provided proof of insurance to the lender. The premiums for the force placed insurance are frequently exorbitant. Often the insurance carrier is a company affiliated with the lender, and the force placed insurance is padded because it covers the lender for risks or losses in excess of what the lender may require under the terms of the loan.
Daily Interest When Payments Are Made After Due Date. Most mortgage loans have grace periods, during which a borrower may make the monthly payment after the due date without incurring a late charge. The late charge often is assessed as a percentage of the late payment. However, many lenders also charge daily interest based on the outstanding principal balance. While it may be proper for a lender to charge daily interest when the loan so provides, it is deceptive for a lender to charge a late fee as well as daily interest when a borrower pays before the grace period expires.
Late fees. Some predatory mortgage lenders charge excessive late fees, such as 10% of the payment due. Sometimes they charge this fee more than once for only one late payment.
III. COLLECTION OF THE LOAN
Abusive Collection Practices. In order to maximize profits, predatory lenders either set the monthly payments at a level the borrower can barely sustain or structure the loan to trigger a default and a subsequent refinancing. Adding insult to injury, the lenders use aggressive collection tactics to ensure that the stream of income flows uninterrupted. The collection departments call homeowners at all hours of the day and night, including Saturday and Sunday, send late payment notices (in some cases, even when the lender has received timely payment or even before the grace period expires), send telegrams, and even send agents to hound homeowners, who are often elderly widows, into making payments. These abusive collection tactics often involve threats to evict the homeowners immediately, even though lenders know they must first foreclose and follow eviction procedures. The resulting impact on homeowners, especially elderly homeowners, can be devastating.
High Prepayment Penalties. See description above. When a borrower is in default and must pay the full balance due, predatory lenders will often include the prepayment penalty in the calculation of the balance due.
Flipping. See description above. When a borrower is in default, predatory mortgage lenders often use this as an opportunity to flip the homeowner into a new loan, thereby incurring additional high costs and fees.
Call provision. Some predatory mortgage lenders make loans with call provisions, which permit the holder of the mortgage, in its sole discretion, to accelerate the indebtedness, regardless of whether the borrower's payments are current and the homeowner is otherwise in compliance with the terms of the loan.
Foreclosure Abuses. These include persuading borrowers to sign deeds in lieu of foreclosure, giving up all rights to protections afforded under the foreclosure statute, sales of the home at below market value, sales without the opportunity to cure the default, and inadequate notice which is either not sent or backdated. We have even seen cases of "whispered foreclosures", in which persons conducting foreclosure sales on courthouse steps have ducked around the corner to avoid bidders so that the lender was assured he would not be out-bid. Finally, foreclosure deeds have been filed in courthouse deed records without a public foreclosure sale.
Atlanta Legal Aid Society
Last Revised: June 15, 2005