Skirting the Law: How Predatory Mortgage Lenders Are Destroying the American Dream

• Publication year: 2010

Skirting the Law: How Predatory Mortgage Lenders are Destroying the American Dream

Anne-Marie Motto

Introduction

Subprime lenders provide loans to people with cash flow problems and blemished credit, often charging high fees and interest in order to compensate for added risk.[1] In the last decade, subprime lending was handled mainly by finance companies that did not fund their high-risk mortgages with federally insured bank deposits.^[2] However, the market has since expanded, with big banks now controlling "five of the nation's top ten subprime [lenders]," and several other prominent national banks investing in the subprime market either by extending lines of credit to subprime lenders, or by purchasing subprime loans.^[3] These big banks then refer potential customers to their subprime affiliates.^[4]

While access to credit through the subprime lending market is necessary and appropriate, the deregulation of the banking industry, the absence of mainstream lenders in low-income neighborhoods, tax breaks for interest on second mortgages, and "appreciating real estate values" have made conditions ripe for many subprime lenders to engage in predatory practices.^[5] These predatory practices include using high-pressure tactics such as door-to-door solicitation and repeated phone calls in order to intimidate homeowners into acquiring high-cost loans.^[6] In addition, some subprime lenders urge borrowers to "sign loan documents without reading them or with key terms left blank."^[7] Moreover, even if borrowers had read the loan documents carefully, the documents were "usually complex enough to make an attorney's eyes cross, leaving little hope that a consumer can wade through the legal double talk."^[8]

Subprime lenders who engage in these types of abusive practices are commonly called predatory lenders.^[9] Predatory lenders actually target the elderly, who have typically amassed considerable equity in their homes, yet have limited funds to cover repairs or personal expenses, such as medical bills.^[10] This process of targeting low-income borrowers for high-cost loans is sometimes called "reverse redlining."^[11] However, some predatory lenders crudely refer to their practice of targeting elderly widows as "granny shopping."^[12] For example, a seventy-six-year-old woman "fell behind on her mortgage payments" after a sudden illness left her with excessive medical bills.^[13] A mortgage broker persuaded the woman to refinance her mortgage by promising her "a lump sum of $10,000."^[14] What the woman actually received was less than $500 and an adjustable rate mortgage that increased her previous monthly mortgage payments from $664 to $1300.^[15] Because the woman was unable to pay her new mortgage payments, she and her 101-year-old mother were evicted from their home.^[16]

In 1995, "2.89 million households [were] headed by persons" aged sixty-five or older, with median incomes of only $18,500, but average home values of $70,000.^[17] Although elderly homeowners may have accumulated substantial home equity, they often need extra cash for home repairs, medical bills, or property taxes.^[18] Because many such homeowners want to remain in their homes but live on fixed incomes, they become victims of predatory lenders when they inevitably cannot meet their expenses.^[19] Unfortunately, it is highly unlikely that these elderly homeowners will pursue legal relief because they lack financial sophistication, awareness of available remedies, or resources to initiate litigation.^[20] Further, the onset of dementia may have left these seniors with diminished mental capacity.^[21] This places predatory lenders in a "win-win situation," allowing lenders to foreclose when borrowers fail to pay the requisite high interest rates.^[22]

This Note analyzes the success of various avenues of redress currently available to victims of predatory lending, emphasizing the unique effect of predatory lending on the elderly. Part I explains the types of predatory lending practices subprime lenders employ and explores the common defenses predatory lenders offer.^[23] Part II examines federal statutes and case law addressing various predatory practices, while Part III considers the state-level options available to predatory lending victims. Part IV reviews federal, state, and local efforts to curb predatory practices, including laws specifically aimed at predatory lending, consumer education, and industry self-policing. The Note concludes that current federal and state law provides insufficient protection against predatory lending, and that state and local efforts to halt abusive lending practices have fallen short when met with resistance from a wealthy and powerful mortgage lobby. Thus, federal and state lawmakers must work with both the mortgage industry and consumers to enact federal predatory lending laws, increase enforcement of existing laws, and improve consumer awareness.

I. Predatory Lending Exposed

Subprime lending is not always abusive; it offers a legitimate option to those with poor credit histories who would not otherwise be able to obtain loans.^[24] However, while "not all subprime lending is predatory . . . nearly all predatory lending is subprime."^[25]

While officials and commentators are unable to agree on a standard definition of predatory lending, several lending tactics carry inherently high potential for abuse.^[26] One such tactic is loan flipping, which involves repeated refinancing with no tangible net benefit to the borrower.^[27] Lenders argue that refinancing is not abusive per se, especially if the borrower wants lower rates or needs money for a financial emergency.^[28] However, some lenders do not notify credit bureaus of borrowers' positive payment histories, thus effectively preventing borrowers from obtaining better rates with their "rebuilt" credit.^[29] Lenders are also concerned that some borrowers might accuse the lender of flipping to defend against foreclosure.^[30] Another predatory practice is loan packing, which typically involves financing credit insurance premiums^[31] over the life of the loan.^[32] Many lenders overcharge for this coverage and do not inform borrowers that the insurance is included, or that it is optional.^[33] In fact, one noted subprime lender sets quotas on credit insurance, which is "pure profit," mainly because the lender itself often underwrites it.^[34] Moreover, although the cost of credit insurance is typically based on the total loan amount plus interest, the insurer "will only pay the actual cash value . . . of the collateral" if a claim is filed.^[35] In addition, insurers often deny claims by citing pre-existing conditions about which the lender never took the time to ask.^[36]

Some lenders also structure loans so that payments are applied primarily to interest, leaving a huge balloon payment due at the end of the loan.^[37] A related practice, negative amortization, also often results in a balloon payment due at the end of the loan.^[38] In a negatively amortized loan, the monthly payments are not even sufficient to cover the interest; thus, the principal loan balance increases each month.^[39] Both of these practices perpetuate the cycle of predatory lending, because by the time the balloon payments become due, the borrower must refinance with another predatory loan to avoid foreclosure.^[40] Industry professionals insist that balloon payment schemes, which offer lower initial payments, may be beneficial for some borrowers, such as those only intending to remain in their home for a short time.^[41] Nevertheless, subprime loans result in a disproportionate percentage of foreclosures.^[42] For example, in Atlanta, the volume of subprime foreclosures increased by 232% from 1996 to 1999.^[43] Moreover, "the subprime share of foreclosures (16 percent) is larger than the subprime share of originations (9 percent)."^[44] This disproportionality resulted in the Department of Housing and Urban Development (HUD) declaring a ninety-day moratorium on foreclosures in several metropolitan areas, including Atlanta.^[45]

Predatory loans frequently contain mandatory arbitration clauses, which force the borrower to seek relief in a forum that is often "more favorable to the lender" and may require the borrower to travel far from home at a considerable expense—a particular hardship for the elderly.^[46] However, arbitration may provide a faster, "more affordable alternative to litigation."^[47]

Other predatory practices include the use of high prepayment penalties, which make it difficult for the borrower to refinance the loan at a lower rate when his credit rating improves,^[48] and home improvement scams, in which lenders enter into agreements with contractors who strong-arm their elderly victims into taking out high-cost mortgages to pay for shoddy home repairs.^[49]

None of these practices, in and of itself, is inherently predatory.^[50] Whether a loan is predatory depends not only on the loan's terms, but also on the context in which the loan is made.^[51] In general, a loan is considered predatory when a lender's practices result in a borrower's loss of equity in a home, higher payments than initially promised, larger loan amounts than needed, emotional and social costs, or ultimately, foreclosure.^[52]

Regulators stress that it is difficult to define predatory lending in such a way as to curb it without also prohibiting legitimate high-interest loan programs.^[53] However, the incidence of predatory lending practices is considerably higher among subprime lenders than among prime lenders.^[54] Further, nearly half of all borrowers with high-cost loans could have qualified for lower-cost prime loans.^[55] Although lenders maintain that a greater risk of default justifies the higher rates and fees, that claim may be illusory due to the manner in which such loans are secured.^[56] Predatory lenders may actually configure the loan so that a borrower will default, ensuring foreclosure.^[57] Moreover, the fact that...