Questions and Answers About Predatory Lending
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Q. What is a subprime loan?
A. The word "subprime" describes the borrower's supposed credit quality. Subprime means that, according to the lender, the borrower's credit rating is impaired to the extent the borrower cannot get a conventional loan. Subprime loans typically have slightly higher interest rate & closing costs.
Q. What is a predatory loan and how is that different than subprime?
A. Predatory loans are a subset of subprime loans with features that significantly increase the likelihood of borrower failure. Moreover, they are specifically marketed to those who are vulnerable. While the distinction is not always clear because of the lack of reporting requirements, the recent explosive growth in the subprime market suggests that the growth is due to the predatory-type loans that first appeared in the mid-90's.
Q. What features do the predatory loans contain?
A. Extraordinarily high interest rates; excessive origination and other loan fees; loan amounts exceeding the value of the home; single premium credit life, disability or unemployment insurance added to the loan principal; credit insurance that expires well before the loan does; needless refinancing or loan flipping; balloon payments; negative amortization; partnerships with shady home improvement contractors; switching of loan terms at signing.
Q. What are the marketing strategies of predatory home lenders?
A. Predatory lenders aggressively market their loan products through mailings, telephone sales, going door-to-door and partnering with home improvement contractors. It is often difficult to get information about the true costs of their loans. They target borrowers who can least afford their loans. There is evidence that predatory lenders are engaged in reverse redlining; that is, they aggressively market in city areas that have traditionally found it difficult to obtain financing from conventional lenders. So while people in these areas once could not obtain any loans, now they are exposed to expensive and dangerous loans.
Q. Aren't subprime loans made to people who don't otherwise qualify for a mortgage, thereby giving them a chance to own a home?
A. The fact is, most predatory loans are made to people who already own their homes, and up to half of all subprime loans are made to borrowers who do qualify for traditional mortgage loans. Also, not all credit is good; an unaffordable loan, secured by the borrower's home is not good for the borrower.
Q. If the problem is so bad, why haven't we heard more about predatory mortgage lending?
A. For several reasons:
1. It's a fairly recent problem. The subprime market exploded in the 1990s.
2. It's a reporting problem. There are few reporting requirements for lenders so it is difficult to collect and report the extent of these abusive loans.
3. It's a human problem. Frankly, many victims of predatory lending are afraid to come forward because they feel ashamed and embarrassed, thinking they have done something wrong. Their self-esteem is at stake. Moreover, many victims of predatory home loans are poor, elderly or part of a minority community - groups that are traditionally underrepresented in public discourse.
4. It's a problem of complexity. Predatory lenders work the system using a myriad of tricks and gimmicks designed to induce the homeowner to take a bad loan.
Rest assured, predatory home lending is a problem.
Q. Why should we be concerned about predatory home loans?
1. These are unconscionable loans, leaving defeated borrowers and broken dreams.
2. For every unaffordable mortgage that is later foreclosed, a family has been ousted from their home.
3. Failed loans result in empty homes - attracting bad elements, diminishing the quality of neighborhoods.
Q. Don't predatory lenders face pressure from the communities where they do business?
A. Not much. Most of them are not located in communities where they do business. They are corporations hidden away in far-off cities who do most of their contact by mail or phone.
Common Predatory Lending Practices
Inflated appraisals
The lender partners with an appraiser to overstate the value of the home. By doing this the lender can loan you more money, charge you more fees, and make sure that no other lender can refinance you. In short, you are trapped with the predatory lender because there is negative equity in the home.
Bait & switch
A lender offers you one set of loan terms when you apply, but pressures you to accept worse terms at the closing when you feel you have no other options.
Home improvement scam
A home improvement contractor arranges the mortgage loan for your repairs, receives the payment directly from the mortgage lender and provides you with incomplete or shoddy work.
Packing
The lender secretly includes overpriced insurance such as credit life, disability, and unemployment insurance in your loan. The insurance is paid upfront out of the loan principal.
Flipping
Lenders encourage frequent and unnecessary refinancing of a loan with no benefit to you.
High Fees
Iowa Citizens for Community Improvement has seen fees as high as 20% of the loan amount.
This information was prepared by Iowa Citizens for Community Improvement and is reprinted with permission. Their website is http://www.iowacci.org
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