Jonathan and Darlene and their two children had lived in their home since 1995, which had risen in value since then; Jonathan works as a carman for the railroad. They had bought the house with a 7% interest rate mortgage and later took out a 12% second mortgage. After another few years, they started receiving phone calls and solicitations in the mail from Beneficial, a part of Household Finance. In August 2001, Beneficial pressured them to consolidate debts into a third lien for $23,000 at a 21.9% interest rate. The mailings and phone calls kept coming, and three months later Beneficial convinced them to consolidate their three mortgages and pay off some other debts.

 

Beneficial never told Jonathan and Darlene that it had financed nearly $18,000 in 7.0 discount points into their loan, increasing the principal to over $248,000. The loan amount was also inflated by a single-premium credit life insurance policy for almost $8,000, despite Jonathan’s telling the loan officer to not include it because he has a much less expensive term life insurance policy. And despite all the discount points, their history of never missing a home or car payment, and the fact that nearly two-thirds of the loan amount went toward the 7% first lien, fees, and credit insurance, the new loan contained an interest rate of 10.4%. Beneficial never told them that the new payments would not cover taxes and insurance, and the loan did not pay off all the debts Beneficial had promised. They were told the loan had a three-year prepayment penalty but not that the amount was over $6,000. The high monthly payments forced them to cut back on other expenses, and the high loan-to-value ratio plus the prepayment penalty prevented them from refinancing to a more reasonable rate. In the end, they had little choice but to sell their house and buy a less expensive one; they’ll never get back the $26,000 of equity Beneficial stripped away, but their new mortgage with another lender will have an interest rate of 7.5%.

 

Mason and Josie are an elderly African-American couple who have excellent credit and whose primary source of income is Mason’s veteran’s benefits. Their mortgage was at a 7% interest rate when a broker convinced them to consolidate some credit cards into the mortgage. While the new mortgage for $99,000 had a reasonable interest rate of 8.4%, the broker also slipped in a second mortgage for $17,000 at an interest rate of 13.0%. The first loan for $99,000 also financed in nearly $6,000 in broker and third-party fees, and both loans contained prepayment penalties – lasting for three and five years, respectively. The broker used a series of payment schedules to confuse them, and they didn’t realize that both loans had balloon payments after 15 years. After making monthly payments of nearly $950 over the next fifteen years, Mason and Josie will face a balloon payment for $93,000.¹

The above families are just two of the millions of unsuspecting homeowners and homebuyers who have been robbed by predatory lenders – mortgage and finance companies that make loans with high interest rates, exorbitant fees, and harmful terms, often through fraudulent and deceptive methods. Elderly homeowners, communities of color, and low-income neighborhoods are the most severely impacted by these practices.

Despite increased awareness of the issue and some progress over the last year in combating the problem, predatory lending has continued, as these modern day loan sharks sink their teeth into new prey every day. In 2001, for the eighth consecutive year, home prices nationally rose at a greater rate than general inflation, exacerbating the problem by making more homeowners targets for predatory lenders intent on stripping their equity.²

Nationally, the number of subprime loans has skyrocketed since the early 1990s. In 1993, just over 100,000 subprime refinance and home purchase loans were originated, compared to over a million subprime loans in 2001. The proportion of subprime loans compared to all home loans fell somewhat from 2000 to 2001, but this was primarily a reflection of the growth in prime refinances due to historically-low interest rates. Even then, however, the growth in prime refinances for African-Americans (131%) and Latinos (231%) substantially trailed the increase for whites (294%). The subprime industry’s tremendous growth has continued through the first half of 2002, as the volume of subprime originations rose to $106 billion, an increase of 19% compared to the first half of 2001 and the highest figure since the data started being collected a decade ago.³

The rise in subprime and predatory lending has been most dramatic in minority communities. Subprime lenders account for half, 51 percent, of all refinance loans made in predominantly black neighborhoods, compared to just 9 percent of the refinance loans made in predominantly white neighborhoods.⁴ Subprime lending, with its higher prices and attendant abuses, is becoming the dominant form of lending in minority communities. But while minority communities suffer from an extreme concentration of higher cost, harmful loans, the problem should not be viewed as one that only affects minorities, since the vast majority of borrowers in subprime loans – and thus the vast majority of predatory lending victims – are white.

While not all subprime lenders are predatory, just about all predatory loans are subprime, and the subprime industry is a fertile breeding ground for predatory practices. Subprime loans are intended for people who are unable to obtain a conventional prime loan at the standard bank rate. The loans have higher interest rates to compensate for the potentially greater risk that these borrowers represent. There is a legitimate place for flexible loan products for people whose credit or other circumstances will not permit them to get loans on ‘A’ terms. Predatory lending occurs when loan terms or conditions become abusive or when borrowers who should qualify for credit on better terms are targeted instead for higher cost loans.

Fannie Mae has estimated that as many as half of all borrowers in subprime loans could have instead qualified for a lower cost mortgage.⁵ Freddie Mac suggested a somewhat lower, but still extremely large figure – that as many as 35 percent of borrowers who obtained mortgages in the subprime market could have qualified for a prime loan.⁶ The difference this could make is enormous: borrowers can easily pay $200,000 more in payments on a subprime loan over its 30 year life.

Too often higher rate subprime loans are also loaded with abusive features – high fees, large and extended prepayment penalties, financed single premium credit insurance – which cost borrowers even more money, and can lock them into the higher rates. When a borrower with good credit in a high rate loan is also charged inflated up front fees, assessed a prepayment penalty, and/or sold financed single premium credit insurance, it often leaves them without enough equity to refinance into a loan at a more reasonable rate.

Those borrowers who are not in a position to qualify for an ‘A’ loan are also routinely overcharged in the subprime market, with rates and fees that reflect what a lender or broker thought they could get away with, rather than any careful assessment of the actual credit risk. These loans too are often loaded with additional abusive features like financed credit insurance, hidden balloon payments, and mandatory arbitration clauses. As a result, such borrowers also find themselves trapped in high rate loans even once they have improved their credit. Many borrowers are also repeatedly solicited, and repeatedly refinanced into high rate loans, losing equity through every transaction.

Unfortunately, these problems pervade too much of the subprime industry. Just in the past few months, two of the largest subprime mortgage lenders – Household International and The Associates, which is now owned by Citigroup – announced respective settlements of $485 million and $240 million for engaging in predatory lending practices. While these are the largest settlements in American history for any type of consumer complaints, the dollar figures are well below the financial damage these companies have inflicted on their borrowers. Abuses are also widespread among unscrupulous mortgage brokers, who convince consumers they are acting to secure the lowest-priced loan when they are actually taking kickbacks from lenders to jack up interest rates, in addition to their standard origination fees.⁷

Predatory lending practices are even more insidious because they specifically target members of our society who can least afford to be stripped of their equity or life savings, and have the fewest resources to fight back when they have been cheated. Subprime lending is disproportionately concentrated among minority, low-income, and elderly homeowners.⁸ Over 1.8 million lowest-income senior citizen homeowners pay more than half their incomes for housing, leaving them with little room to make increased mortgage payments.⁹

Many in the lending industry argue that the disproportionate concentration of subprime loans among low-income and minority borrowers is only a reflection of the greater risk that these borrowers represent based on their lower credit ratings. However, Fannie Mae has stated that the racial and economic disparities in subprime lending cannot be justified by credit quality alone. According to Fannie, loans to lower-income customers perform at similar levels as loans to upper-income customers; indeed, some recent research suggests that mortgages to low- and moderate-income borrowers perform better than other mortgages when the lower prepayment risk is taken into account.¹⁰ In addition, the level of disparity presented in studies which showed that black households had more credit problems than white households was not even close to the levels of disparities seen in subprime lending.¹¹

Predatory lending threatens to reverse the progress that has been made in increasing homeownership rates among minority and lower income families. Many in the subprime industry like to portray their primary role as helping families realize the American dream of homeownership. But the vast majority of subprime loans are refinances and home equity loans to existing homeowners, not purchase loans; last year, more than 65% of the reported home loans made by subprime lenders were for refinances, and an additional 6% were home-improvement loans.

While it is important for homeowners to be able to use the equity in their homes to meet financial needs, predatory lenders bombard homeowners in many communities with refinance offers that lead to loans at high rates, with inflated fees, and other abusive terms. By stripping equity, increasing indebtedness, and even costing families their homes, these practices cause homeowners to lose their equity, rather than use it for their benefit.

Furthermore, when we do examine the subprime industry’s role in the home purchase market, there is additional cause for concern. From 1993 to 1995 there was a substantial increase in prime home purchase loans to minorities. Since then, however, the number of prime loans has stagnated, while the number of subprime purchase loans has skyrocketed. From 1995 to 2001 the number of subprime purchase loans to African-American homebuyers rose 686%, while the number of prime conventional purchase loans to African-American homebuyers actually fell 5.7%. A huge homeownership gap remains, with over three-quarters of white households owning their own homes, compared to less than half of African-American and Latino families.

This, along with the data from Fannie Mae and Freddie Mac mentioned above, suggests that higher cost subprime loans are replacing rather than supplementing less expensive ‘A’ credit, with tremendous extra costs for borrowers who should be qualifying for, or previously were in, ‘A’ loans. When buyers who should be eligible for loans at good interest rates are instead steered towards subprime lenders, they end up paying hundreds of dollars more each month than they would with a prime loan, and the higher interest rates and added fees deprive these homeowners of a fair opportunity to build equity. In the worst cases, the high interest and fees are only the tip of a predatory lending iceberg in which the loan also contains harmful terms, and the combination of these factors greatly increase the likelihood of foreclosure. The prevalence of predatory lending abuses in the subprime market has been a major factor behind record-breaking foreclosure rates; the Mortgage Bankers Association’s survey of borrowers entering foreclosure and mortgages already in foreclosure for second quarter 2002 showed the highest percentages in each category since the statistics first started being tabulated in 1972.¹²

In addition, subprime purchase loans are the financing mechanism of choice for carrying out “property flipping” scams, which unfortunately have become all too common an occurrence in a number of cities. Property flipping involves the purchase of distressed properties at a negligible price, and then, after minimal cosmetic or even no repairs, the property is sold at prices far above their actual worth. The victims of property flipping are often unsuspecting low-income, minority first-time homebuyers.

The damage that predatory lending inflicts on our communities cannot be overestimated. Homeownership provides the major source of wealth for low-income and minority families, with around two-thirds of their wealth coming from home equity. Rather than strengthening neighborhoods by providing needed credit based on this accumulated wealth, predatory lenders have contributed to the further deterioration of neighborhoods by stripping homeowners of their equity and overcharging those who can least afford it, leading to foreclosures and vacant houses.¹³

The last few years have seen a growing recognition of the serious harm being caused by predatory lending, and federal and state regulators have begun to take modest yet significant steps against the abuses. The Office of Thrift Supervision moved forward in September with regulations that effectively restored consumer protection laws on late fees and prepayment penalties in about half the states. Last December, the Federal Reserve used its regulatory authority under the federal Home Ownership Equity Protection Act (HOEPA) to announce two significant changes that went into effect in October – counting single-premium credit insurance policies as a fee under the HOEPA test, and expanding HOEPA coverage to a few more first mortgages with very high rates. In May, the Federal Reserve also announced that it would require the collection of annual percentage rates on most high-cost home loans, although the data collection was disappointingly postponed until January 2004, meaning nothing will be publicly available until mid-2005.

As mentioned above, two major subprime lenders – Household and The Associates – have been forced into huge predatory lending settlements after extensive investigations by the state attorneys general¹⁴ and the Federal Trade Commission. The Household settlement’s two-year limit on prepayment penalties and the hundreds of millions of dollars in payouts coming from these subprime lending giants are clearly breakthroughs. But at the same time, many of their abusive practices remain in place, and the settlement amounts for individual borrowers will fall far short of how much wealth was stolen from families by these multi-billion dollar corporations, let alone providing any punitive damages, and will offer little solace to the countless Household and Associates borrowers who have already lost their homes.¹⁵ And of course, a substantial number of other subprime lenders and brokers have also engaged in widespread abuses without serious investigations into their business practices ever having been conducted.

While the settlements were on-balance positive, their limitations demonstrate the need for strong legislative protections in the subprime market. State legislatures and city councils around the country continue to debate anti-predatory lending bills, with victories of varying levels being won in just over the past year in Georgia, New York City and State, California, and Oakland. On the federal level, the Senate Banking Committee in the 107th Congress, under the leadership of Chairman Paul Sarbanes (D-MD), held a number of major hearings on predatory lending. Senator Sarbanes and Rep. John LaFalce, Ranking Democrat of the House Financial Services Committee, also introduced comprehensive anti-predatory lending legislation in the 107th Congress, S. 2438 and HR 1051. While much of the financial industry has desperately tried to hold off legislation through a combination of announcing insufficient “best practice” standards, hiring high-paid lobbyists, and making large campaign contributions, the actual experience with legislation has been that it works without reducing access to credit. North Carolina Governor Michael Easley recently announced that the state’s 1999 law had saved homeowners $100 million while borrowers with incomes below $25,000 received a higher share of subprime loans than in any other state in the country.¹⁶ Meanwhile, a huge fight looms in Congress as segments of the financial industry view the Republican takeover of the Senate as an opportunity to preempt state and local consumer protections against predatory lending without setting any new, meaningful safeguards for homeowners at the federal level.¹⁷ The fate of our country’s gains in homeownership over the last couple decades among people of color and low- and moderate-income Americans hang in the balance.

Main Report Table of Contents | Summary of Findings

1. All of the examples of predatory lending abuses on subprime loans cited in this study were made in 2001 or 2002. The one exception is the balloon payment example, which was originated in 1996 with the balloon coming due in 2001 (the second story in the introduction also provides an example of a balloon payment loan originated in 2001).

2. The State of the Nation’s Housing: 2001, Harvard University Joint Center for Housing Studies, p. 1.

3. “Subprime Volumes Keep Rockin’”, National Mortgage News, by Paul Muolo, September 16, 2002, p. 38.

4. Curbing Predatory Home Mortgage Lending: A Joint Report, June 2000, U.S. Department of Housing and Development and U.S. Department of Treasury, p. 47.

5. “Financial Services in Distressed Communities,” Fannie Mae Foundation, August 2001.

6. “Automated Underwriting,” Freddie Mac, September 1996.

7. See testimony of Harvard Law School Prof. Howell E. Jackson to the Senate Banking Committee hearing on "Predatory Mortgage Lending Practices: Abusive Uses of Yield Spread Premiums," January 8, 2002.

8. "We think [predatory lending is] at epidemic proportions, particularly in low-income, elderly and minority communities." Craig Nickerson, vice president of community development lending, Freddie Mac, as quoted in “Campaign to Help Buyers Avoid Predatory Loans”, Los Angeles Times, by Lee Romney, July 18, 2001, Business p. 1.

9. The State of the Nation’s Housing: 2001, Harvard University Joint Center for Housing Studies, pp. 26-27.

10. “Performance of Low-Income and Minority Mortgages,” by Robert Van Order and Peter Zorn, in Low-Income Homeownership: Examining the Unexamined Goal, ed. Nicolas Retsinas and Eric Belsky, 2002, p. 324.

11. “Financial Services in Distressed Communities,” Fannie Mae Foundation, August 2001.

12. “2nd Quarter Foreclosure Rates Highest in 30 Years,” Washington Post, by Sandra Fleishman, September 14, 2002, p. H1.

13. “Equity Strippers,” Pennsylvania ACORN, May 2000; “Preying on Neighborhoods,” National Training and Information Center, September 1999; “Unequal Burden in Baltimore,” HUD, May 2000; “The Expanding Role of Subprime Lending in Ohio’s Burgeoning Foreclosure Problem,” Ohio Community Reinvestment Project, October 2002.

14. A group of 20 state attorneys general began their joint investigation into Household’s lending practices within a year of ACORN launching a nation-wide effort in the summer of 2001 to file hundreds of consumer complaints with state AGs and state banking commissioners against the company. See http://www.naag.org/issues/20021011-multi-household.php.

15.To put these dollar amounts in context, Citigroup CEO Sandy Weill received $523 million in compensation from 1999 through 2001. A more accurate estimate of the actual direct damage inflicted by Household and Beneficial’s predatory lending abuses on home loans would range to around $8 billion. On Household’s practices, see “Home Wrecker”, Forbes, by Bernard Condon, September 2, 2002; and Washington State. Department of Financial Institutions report on Household’s predatory lending practices, April 30, 2002.

16. North Carolina’s Subprime Home Loan Market After Predatory Lending Reform, prepared by The Center for Responsible Lending, Durham, NC, August 13, 2002. See also “Predatory loan crackdown won't ruin the business; City, state laws raise howls of protest, but experience suggests limited impact,” Craine’s New York Business, by Heike Wipperfurth, October 21, 2002, p. 4; “Surprisingly Strong Subprime Growth,” Morgan Stanley, by Kenneth Posner and Athina Meehan, July 31, 2002.

17. “GOP Rout Means a Change in Committees,” National Mortgage News, by Brian Collins, Nov. 11, 2002, p. 2.