The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
F ~ S[ ,\ 11 CH LI iJ 11 ,'. fIY
Federal Reserve Bank of Atlanta
Volume 10, Number 2
Predatory Lendin g
Pred atory lending practices are real.
There is no mistake that it occurs,
and based on anecdotal infom1ation
and most surveys or reports so fa r,
it appears that the victims are typica lly old er, lower-income, and
minori ty. It is offensive, and it is
wrong. But as you might expect,
there is more to stopping it than
"just say no."
Many of our constituents have
worked long and hard to ensure
equal and fair access to credit, and
the results are impressive. We now
boast the highest home ownership
rate in our nation's history.
Nontraditional underwriting,
including higher debt ratios or
lower down payments, for exa mple,
has revolutionized the home mortgage lending industry. Teclmology
changes that alJow more efficient
underwriting and the adven t of
credit scoring have also allowed
market penetration like never
before. And risk-based pricing has
certainly fueled lender ,villingness
to assume higher risks.
Predatory lending practices th mselves may not be new, but the stories of abuse have become too common. And public outcry is appropriate. Everybody is speaking out
against it and looking for ways to
fight back.
Parh1ers is compeIJed to dedica te
this issue to the fight against predatory lending. We begin with a discussion of predatory lending practices. Flipping. Packing. Targeting.
Su mmer 2000
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Stacking. While ind ividual actions
may not be illega l, many of these
practices are unjustified and inappropriate at best.
We present a regulatory anal ysis of
the subject of predatory lend ing,
and feature perspectives fro m the
Federal Reserve, Office of the
Comptroller of the Currency (OCC),
Office of Thrift Institutions (OTS)
and the Federal Deposit lnsurance
Corporation (FDIC). We include a
nationally recognized consumer
advocate's testimony to Congress
(Bill Brennan, Atlanta Legal Aid
Society), and the Mortgage Banker's
Association of America's "Seven
Point Plan" for mortgage reform.
Everybod y agrees: these practices
must stop. But definitions are hard
because nobody wa nts to cut the
fl ow of cred it to u nd er-served markets. One theme is common
throughout the industry - the line
between predatory and subprime
lending is difficult to define, and
stopping predatory lending must
not reduce access to credit through
appropriate risk-based pricing, or
"responsible subprime lending."
While this issue of Partners can't
resolve the issues surrounding predatory lending, we hope to add additional light on the subject and join
fo rces towa rd seekin g solutions.
Along those lines, we fea ture a
summary of the Home Ownership
Equity Protection Act and a
Consw11er Corner on education.
We welcome the opportuni ty to join
your organiza tion in spea ki ng out
against predatory lending practices.
Together we have made grea t
strid es in providi ng fair and equal
access to credit, almost to the point
that we take it for gra nted. We
have penetrated markets like never
before, reaching goals that seemed
unimagi nable just 10 or 20 yea rs
ago, and developing new and
improved loan and investment
products that knock down old barriers. We must not let unscrupu lous lenders damage the progress
we have made. In the end, we all
have an interest in stopping abusive practices and putting predatory lenders out of business.
-Ed itor
In This Issue
What is Predatory Lend ing?
The definition remains elusive .
.... 2
Consumer Advocate Pe rspective ..
......... 3
William J. Brennan , Jr., of Atlanta Legal Aid
Society's Home Defense Program .
Trade Associat ion Perspective
MBAA's "Seven Point Plan"
.............. .4
Regulatory Perspectives :
Federal Reserve
....... 5
FD IC
...... 7
OCC ...
. ..... 8
OTS ..
.... ......... .................. .. 9
Federal Law ................ .
. ............ 10
Home Ownersh ip Equity Protection Act
Consumer Corner...
... ....... 11
Education is a key to avoiding the predatory lending trap.
Fedeml Reserve Bank of Atla11ta
2
What is Predatory Lending?
By Wayne Smith
We have all hea rd of situ a tions
where lenders targe t morevu lnera ble borrowers who have
sig nifi ca nt equity in th eir home,
with th e ultimate intention of
seizi ng the property. The borrowers
a rc typica lly saddled wi th excessive
costs, often clandestinely. The loans
a rc booked based o n the equi ty in a
house, not on the inco m e ava ilable
to repay the loa n . Foreclosure
becomes inevitable. But is pred a tory le ndin g always that clear cut?
Unfortunately, no.
Subprime Lending
In order to defin e predatory lend ing, o ne must s ta rt with a n und ers tand ing of subp rim c le nding.
"Subprimc" refers to lending w here borrowers have
some fo rm of credit impa irm ent. The term applies to
borrowers who do not qualify for the "prim e market"
and is a lso known as "B, C,
or D paper" - contras ting
with the prime market's "A
paper.
A bo rrower 's credit his tory
determines his / her cred it sco re as
assigned by a cred it rati ng agency.
A credit score ca n be adversely
im pacted for reasons such as a histo ry of late payments or previous
defaults. Whether fair or unfair,
such blemishes rep resen t hi g her
ri sk to a lend er in future borrowing
req uests. To compensate fo r ta king
such risks, a lend er w ill typically
charge a hig her interest rate a nd / or
added fees.
The industry practice of risk-based
pricing is nothing new. In fa ct, it
usua ll y represents a pos itive thin g,
when done fairly, because it enables
a borrower to obta in th e cred it they
m ay need and work their way back
to "A" status. Therefore, responsible
subprime le nding represents a way
for borrowers to m a inta in access to
cred it despite past im pairment.
Wh ere is tha t line drawn before
ri sk-based pricing goes too far and
becomes preda tory? There is no
m agic answer, largely because sta te
ilnd federal lmvs il re rather broad
concerning agreem ents between
hvo parties. Consensus towil rd a
workable definitio n seem s to lie in
predatory !e ndin g's a ttributes - the
list o f practices tha t can be co nsidered abusive.
The Typical Borrower
Before discussing abusive practices,
it's a ppropriate to provide an
exa mpl e of how the predatory
process usu all y begins. The profile
of il typical "victi m " is an individua l (often minority or elde rl y) in a n
o lder home w ith a lcgitimiltc need,
such as a new roof. A disproporti onate pcrccntilgc a lso seem s to be
African Amcric,1n or Hispa ni c,
a lthough targets arc not confined to
these groups. Both urban ilnd rural
a reas arc susceptible, a nd many
middle-incom e populations a rc ta rgets due to hilving problems with
past credit histories.
With limited cas h fl ow, but with
accu mulc1tcd eq uity in their hom e,
the borrower is c1 pproachcd by a
lend er w ith il loiln to repa ir the
roof. Throug h co nfusion or fin e
print, the borrower often find s out
a fter it's too liltc th a t their loc1 n contains added costs tha t have cscillated the monthl y pa y m ent to the
point of unma nc1gca bili ty. Even if
suspicion is raised at the time of
loan closing, bo rrowers m ay go
throug h with the deal because of
the overwhelming need as w ell c1s
Pnrt11crs i11 Co1111111111ity n11d Eco110111ic Oevelop111c11t
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
the perception that they hc1ve no
other options.
Abusive Practices
Hc1ving noted the positive aspects
of subprime lend ing a nd the typical
borrowing situa tion, w ha t exactl y
m c1kcs a loan predatory? The line
is usua ll y crossed w ith a series of
prc1cticcs that hc1vc com e to be
v iewed as abus ive. A sam ple of
so m e of the m o re common adverse
practi ces include the following:
• "Tilrgctin g" vu lne rable hom eowners (e.g. seniors, lcss-edu rn tcd)
w ho have substanti a l home equi ty;
• Lendin g on a home's eq uity
rc1thcr thiln the borrower's rnsh
flow capacity;
e "Packing" unn ecessa ry
items such as hi g h-cost
sing le-premium life and
o th er ins urance prod ucts on
top;
• "Stacking" hi g h origina ti on
and other fees that are rolled
into th e note;
• "Flipping" -- frequent rcfina ncings with c1dditiona l
fees that strip equity;
• Requiring a ba lloon payment
after 5 ycc1 rs on a 30-ycar
inte rest-onl y note; ilnd
• Imposing a n excessive prepc1ym e nt penalty.
Conclusion
The definition of predatory lending
rcm c1 ins rather elus ive because of
gray areas within ec1ch of the
c1dvcrsc practi ces lis ted above, a nd bccil use ta ken by them selves, they
m ay not be illega l. Misre presentiltions, including fraud , are clear
cut predatory practices and are
illcgc1 l. Ot her practices cross the
line c1s predatory w hen the basic
tenets of sa fe and soun d lending
arc not upheld, especia ll y with
rega rd to Fair Lend ing laws and a
borrowe r 's ability to service an
obligation o ut o f inco m e.
3
Based on 111y 32 ym rs at the Atlanta
Lega l Aid Society, 12 ym rs as director of the Ho111e Defense Progrn111,
and hundred s of subpri111c lending
rnscs thilt have co111e th rough 111y
progrn m, I have never seen a subprime mortgage lend er not engage
in one or more of three distinct rn tegori cs of predatory practices.
They overcharge on interest and
points. Since these co111panics onl y
lend a t 70-80o/c loan-to-value ratios,
they h;ive il 20-30% cushion to protect them if they have to foreclose.
They perpetrate other profitable
abuses. They purposely engage in
other abusive lending prac tices that
effectively allow the lenders to collect hidden, indirect interest a nd
thereby increase profits. Exa 111ples
are loa n flippin g; packing the loa n
with overpri ced single prc111iu111finan ccd credit life, disability and
une111ploy111ent insurance; balloon
payments; hig h prepay111cnt penalties; using sca m home i111 provement companies to generate ori ginations; paying kickbacks to 111ortgage brokers to generate originations; and paying off low cost or
forgivable mortgage loa ns.
It is crnci;il to understand th;it the
profitability of the subprime mortgage lending business is derived
not just fro111 overcharging on interest and points, but also fro111 engaging in the listed abusi ve lending
practices set out above. The profitability is inextricably intertwined.
While the price of the loan product
should be related to actual risk, the
abusive practices listed have nothing to do w ith risk and ca nnot be
justified.
They target groups based on age,
race, income, and sex. Predatory
S 11111111 er 2000
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
mortgage lenders purposely target
vulnerable elderly, minority, low
a nd moderate income, and women
homeowners with high cost abusive mortgage loans. Eld erly
homeowners, who tend to have
su bstantial eq uity but li ve on fi xed
incomes are perhaps the principal
targe ts. Some banks and other
mortgage lenders engage in redlining by d esignating entire com munities as bad financial risks and refusing to make the111 prime rate loans.
Redlining crea tes a credit vacu um
filled by the preda tory lend ers.
These pred ators t;irgct these s;i me
areas with overpriced loan products, knowing that the residents arc
a ca ptive market wi th no access to
reasonably-priced credit. This is
c;i lled reverse redlining. Finally, a
disproportionate number are
women. Most of these are eld erly,
Afri can American, ;i nd widowed.
Although most banks have played
no role in the subprime lending
business, so111e ba nks have played
il very significant role. We have
numerous cases involving these
bank-owned subprime entities. In
these cases, we ha ve seen countless
exa mples of abusive lending practi ces, including hig h interest ra te
and points, loan flip ping, home
improvement scams, cred it insurance packing, high prepaym ent
pena lties, etc.
Some banks make ca pital loa ns to
support the operations of subprime
mortgage co111panies. Other banks
support subprimc mortgage companies by acting as trustees in the
securiti za tion process. Some banks
down strea m !prime credit! potential customers to their subprimc
mortgage subsidiaries where they
arc subjected to high cost, abusive
mortgage lending practices. Some
banks engage in red lining practices. In sum, the involvement of
these banks w ith subprimc lending
has been a devastating development in terms of the expa nsion of
abusive, predatory 111ortgage practices in low and mod era te income
and 111i nority communities.
The fact tha t these banks are federall y regu lated has made little difference. So fa r, the bank regulators
have done little to stop the overcharging on cost and the other abusive practices. ow, to my dismay,
Fannie Mile and Freddie Mac have
announced they arc getti ng into the
subprimc mortgage lending business. Unfortunately, self-reform
docs not sec111 to be occurring.
Lenders might very well refrain
from the few prohibited practices,
but would si mpl y expa nd into the
permissible abuses beca use they
are so closely tied to profitability.
A ll the abuses must be stopped.
HOEr>A shou ld be ame nd ed by
substantiall y lowering the interest
rate a nd points and fees triggers.
Further, illl of the abuses discussed
above should be prohibited. In
addition, H UD and / or Congress
s ho uld require tha t F,1n ni e Mae
and Freddie Mac expa nd their support fo r conventional 111ortgage
lending in minority and low and
mod criltc-incomc communities,
and prohibit the111 from entering
into subprime 111ortgagc lending.
For a full text, refer to www. housc.
gov / banking/ 52400brc.hh11.
Fcdernl Reserve Bn11k of Atln11tn
4
When used appropriately, subprime lending makes homeow nershi p possible for famili es w ho
might not otherw ise have access to
fina ncing. While the vas t majori ty
of lenders w ho make subprime
loans provide a valuable service, a
few unscru pulous operators take
advantage of vulnerable consumers by charging excessive fees,
using deceptive practices, and
imposing debt that the borrower
will never be able to repay.
TI1e Mortgage Bankers Association
of America (MBAA) is an active
participant in the dialogue
with Congress, federal
agencies, and consumer
advocates concerning abusive lending. As a member
of the HUD / Treasury Joint
Task Force on Predatory
Lending, the MBAA is
working closely with all of
these parties to formu late
solutions that work.
The MBAA believes that the
heart of the problem is the
complexity of the mortgage transaction, which allows unscrupu lous
operators to exploit the process
and take advantage of consumers.
That is why the MBAA has developed a seven-point comprehensive
approach to reform the mortgage
process and increase consumer
protections.
This approach combines increased
disclosures to borrowers, a simplified mortgage transaction, more
consumer education and cou nseling, a commitment to fair lending
practices, and increased enforcement authority.
Pnrt11c:rs in Co1111111111ity
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
"I. Fully Enforce Consumer
Protection Laws
Most cited abuses are illega l under
current federal and state law.
Consumer pro tection agencies
should be full y fund ed and given
the resources necessa ry to enfo rce
these laws effectively.
2. Simpli fy the Mortgage
Transaction to Protect
Consumers: The Loan Closing
Costs Guarantee
Pass legislation to establish a
"Closing Costs Gua rantee" program, w hich wou ld require lenders
to provide mortgage applicants
with an up-front loan closing price
guarantee. The lender 's gu aranteed ma ximum loan closing price
would be binding from the time of
disclosure (prior to application)
through the actual closing. The
approach will enhance shopping
w hile protecting from "bait and
switch tactics."
3. Increased Disclosures for
Consumers
Required disclosures wou ld
include a mortgage in formation
booklet detailing the process, protections, warni ngs on common
abuses, information about mort-
n11d £co110J11ic OevelopJ11ent
gage coun seling, and a loan closing
costs guarantee d isclosure.
4. Enhance Enforcement
Tools/Provide Effective Remedies
For Consumers
Identify, strengthen and enforce
federal penalties against prohibited
practices, such as steering borrowers to high-rate lenders, intentionally structuring high-cost loans
with payments the borrower can
not afford, requiring credit insurance, fail ing to report good payment on borrowers' credit reports,
etc. Also, provide and facilita te
remedies for consumers,
under law incl uding the prohibition of final foreclosure
without first ensuring the
right of the consumer to list
and make a good faith effort
to sell the property [some
exceptions apply !.
5. Increase Availability and
Quality of Counseling for
Prospective Borrowers
The Federa l Reserve and
HUD shou ld lead an effo rt to
develop a uniform counseling program. The America n Homeowner
Education and Counseling Institute
(AHECI), the MBA, and others
should be involved .
6. Increase Consumer Education
Programs
Support increased education,
including fin ancia l literacy in the
schools, to help potential borrowers make infom1ed decisions.
7. Industry Commitment to Fair
Lending Practices
Support fair lending initiatives,
including a fair lending training
program.
5
This should be a time of great satisfaction for the advocates of lowincome and minority borrowers
because various technologica l
changes and innovative financial
products have caused an upsurge
of cred it to this market segment.
Much of this expansion a ppears to
be in the subprime lending market,
which has opened up the possibility for many borrowers to realize
their drea m of owning a home and
to have a chance for acqu iring the
capital gai ns that ha ve increased
the wealth of upper-income
households.
But with the good news there is
also bad news, or at least sobering
news. Just as the expansion of
subprime lend ing has increased
access to cred it, the expa nsion of
its unfo rtunate counterpa rt,
predatory lending, has made many
low-income borrowers worse off.
Subprime Vs. Predatory Lending
The distinction between subprime
and predatory lending is
important. Subprime lending
involves borrowers who do not
qualify for "prime" rates - those
rates reserved fo r borrowers with
virtually blemish-free cred it histories. Premiums range from about
l point over prime for "A-minus"
loans to about 6 points over prime
for "D" loans. While these premiums have been questioned, longnm market forces work to minimize spreads.
Predatory lending, however, is
difficult to quantify because the
practices are shady, and information is incomplete or anecdotal.
Abusive prilctices include outrigh t
fraud, excessive fees ilnd interest
S11111111cr 2000
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
rates, hidd en costs, unnecessary
insurance, and deceptive uses of
balloon pilyments.
The ultimate difference between
subprime and predatory lending
comes back to the competitive
assumptions. If one is a market
optimist and believes tha t both
lenders and borrowers are rational
and well-informed, then subprime
credit markets with proper rate
differentials will open up. If one is
a market pessimist and believes
that borrowers ilre not wellinformed and may not be fully
rational, then some lenders will
have opportunities to exploit
these borrowers with pred atory
practices.
Distinguishing positive subprime
lending from negati ve predatory
lending is obviously importan t,
pilrticularly for regulators trying to
encourage one type of lending and
discourage the other.
Who Are the Subprirne and
Predatory Lenders?
Subprime lending tends to be
done primilri ly by nondeposi tory
institutions, either fi nance
companies or mortgage
companies thilt arc not subject to
routine regu latory compliance
audits and connected with
regulated financial institutions.
In the mortgage market, relil ti vcly
fe w of these loilns ilre for first-time
home-bu yers - mostly they ilre for
mortgilge refin ilnci ngs, second
mortgages, or consolidilting
debt. Often these loans arc
securitized ilnd sold to investors
such as insurance companies il nd
pension fu nds.
As mentioned, one d istinguishes
prcdil tory lending from subprime
lending by the fea tures of the loa n
ilnd, importa ntly, by w hether the
borrower understands the tem1s of
the loil n. TI1us, there is no ready
way to distinguish predatory from
subprime lending, to id enti fy
preda tory lend ers, or to measure
ilmounts. Yet most a necdotal
reports or legill cases aga inst
prediltory lenders hilve involved
subpri me lenders, and it is
certa inly logical to expect these
practices to flourish in entities
w here regulil tors arc remote.
Predatory lending is made possible
by inadequate information. The
hmdamentill weakness is the
desire of uneducated borrowers for
cash up front, typiCillly refl ecting il
need for home repairs. Couple this
with a lilck of understilnd ing of
complex credit terms or conditions,
and a resulting bargili ning imbalance will often subject borrowers
to outright fraud, falsifications, and
even forgery. Apart from ou tright
frilud , however, regulators ilnd
legislators feel reluctm1t to outlaw
potrntinlly abusive practices if these
practices have legitimacy most of
the time.
What Can be Done?
TI1e Home Ownership Equity
Protection Act (HOEPA) defines a
clilss of "high cost" home purchase
loilns. While most ilnil lysts
consider HOEPA to hilve been
effective, milny lenders reportedly
skiltc just below the HOEPA
requirements and sti ll engage in
egregious practices.
Most present attempts to deill w ith
prediltory lending try to brOilden
Fcdan l Rcsave Bn11k of Atln11tn
6
the I IOEPA net by lowering the
threshold cost levels and by
preventing abusive practices.
Many states have also attempted
legislative remedies. In Jul y 1999,
orth Carolina enacted laws that
prohibit prepayment penalties,
loan-flippin g, and single-premium
cred it life insura nce on most home
loa ns.
Other federal sta tutes address
predatory lending less di rectly.
The Tnith in Lending Act requires
all creditors to calculate and
disclose costs in a uniform ma tter.
Under this statute,
lenders must disclose
informa tion on payment
schedules, prepayment
penalties, and the total
cost of cred it, expressed
as a dolla r amount and
as an AP R.
The Rea l Estate
Settlement Proced ures
Act prohi bits lenders
from paying fees to
brokers that are not
reasonabl y related to
the va lue of services
performed by the
broker. The Equal
Cred it Opportwuty Act prohi bits
discrimination in lending on the
basis of a number of "prohibited
basis characteristics" such as age
a nd race. The Federa l Trade
Comm ission Act prohibits unfriir
and deceptive practices.
And yet, with all this legisla tion,
preda tory lending may still occur.
To address this issue, the Federa l
Reserve joined a nine-agency
working group in the fall of 1999
to develop solutions. The agencies
include fi ve that regulate
depository institutions (Federal
Reserve, OCC, FDIC, OTS, and
NC UA), two tha t regu late housing
(H UD and the Office of Federa l
Housing Enterprise Oversight),
and two that regulate or prosecute
deceptive trade practices in general
(Doj and the FTC). The complete
regulatory net of these agencies
would cover all predatory lending.
The aim s of the group arc to tighten enforcement of existing sta tutes,
to identify those predatory practices tha t might be limited by tightened regulations or legislative
changes, and to establish a coordinated attack on predatory practices.
Secondary mortgage institutions
such as Famue Mac and Freddie
Mac have a role. If Fannie and
Freddie were merel y to buy
subprime loa ns without add ed
inspection, these secondary mclrkct
institutions cou ld actually
subsidize pred atory lending. But
if Fcl mue and Fredd ie were to
inspect the practices of subprime
lenders from w hom they purchase
loa ns, or to limit purchases of
certain types of loa ns, they might
effecti vely extend the domain of
subprime regulations.
A fina l factor is consumer education. Predatory lending wou ld not
exist, or would be relatively rare,
if prospecti ve borrowers
understood the true nature of
their loa n contracts. The
Neighborhood Reinvesh11ent
Corpora tion (NR ) has an acti ve
borrower ed uca tion program to
promote just that type of understanding, and many other public
and quasi-public agencies arc
thinking of fo llowing suit.
Pnrt11ers i11 Co1111111111ity n11rf Eco 110111ic Oevelop111 e11t
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Conclusion
Preda tory lend ing causes obvious
difficulties for borrowers, is
difficult fo r enforcers to track
down, a nd is difficu lt to regula te.
So far as we ca n tell, predatory
lend ers generally operate ou tside
the main fina ncial regulation
netwo rk. These lenders are
sometimes fraudulent, but
probably more often they take
advantage of low-income and
less-ed uca ted borrowers who need
cash up front and are unlikely to
full y understa nd the loan
provisions. When mid if borrowers
defa ult, they ca n either lose their
house or be induced to
sig ning up fo r sti ll
more exploitative
terms.
Because preda tory
lenders are less
regulated, and because
predatory loans are
often difficult to
id entify and d efine,
it becomes both a
regu latory and an
enforcement cha llenge
to stop preda tory
practices. Currently,
nine agencies are
meeting to design a
coordinated attack on the problem,
and a number of legislative options
are under considera tion in both the
federal and sta te legislatures. The
goa l is to eliminate or limit bad
practices that are the unfortunate
byproduct of recent efforts to
democrati ze credit markets.
For a full text of Gov. G ramlich's
speech, refer to www.
fedcralrcscrvc.gov / boarddocs /
speeches/ 2000 /
7
Although a precise definition of
"subprime" lending remains subject
to debate, the "Interagency
Guidance on Subprime Lending"
issued by the federal banking
agencies on Ma rch 1, 1999, defines
subprime lending as "extending
credit to borrowers w ho exhibit
characteristics indicating a
significantly higher risk of default
than traditional bank lending
customers."
Subprime lending serves the
market of borrowers w hose cred it
history would not permit them to
qualify for the conventional
"prime" loa n market. Therefore, a
well-managed subprime lending
program provides an important
source of credit in a manner
consistent with safe-and-sound
banking, and the FDIC does not
wan t to inhibit subprime lending
that meets these criteria . While
most predatory Joans are made to
subprime borrowers, predatory
lending is product-driven exhibiting certain marketing tactics,
collection practices, and loan terms
that, w hen combined, deceive and
exploit borrowers.
While the FDIC has not uncovered
evidence that insured depository
institutions are acti vely originating
loans with predatory fea tures,
concern exists that banks and
thrifts, like other instih1tional
inves tors, may be involved in the
predatory loan market in an
indirect way. One indirect forn1 of
funding preda tory loa ns is through
the relationships that banks may
have with mortgage brokers.
Another involves banks and thrifts
purchasing loans or securities
Summer 2000
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
backed by predatory loans, or by
offering credit lines to nonbank
predatory lenders. These indirect
means may subject an institution
to increased credit, reputation,
and legal risk because the
institution does business with
predatory lenders or mortgage
brokers.
The FDIC is addressing the issue of
predatory lending in a number of
ways, including:
• Writing guidance for insured
depository institu tions describing
effective practices to keep them
from inadvertently acquiring loans
(or securities backed by loans) that
ha ve predatory features;
• Working on an interagency basis
to revise CRA examination
practices so that a bank's purchase
of loans (or securities backed by
loans) that ha ve predatory terms or
features cannot be used to improve
the bank's CRA rating;
• Giving positive CRA consideration to bank-sponsored programs
that combat predatory lending by
fostering financial literacy;
• Working on an interagency basis
to review other consumer laws
and regulations to determine
whether regulatory changes may
be warranted;
• Working on a financial literacy
campaign to educate consumers
about the risks of predatory
lenders.
A number of laws and regula tions
prohibit fra ud and certain
misleading or deceptive sales and
marketing practices by providing
disclosure requirements and
limitations. However, current law
does not fully address a number of
predatory practices found in some
loans, especially in the markets for
refinancing and for home equity
loans. But w hile banning certain
practices (e.g. balloon payments
and prepaym ent penalties,) may be
well-intended, outright prohibitions of such practices could
w1duly limit credit availability.
In eva luating alternatives that
might curb predatory lending, the
FDIC is applying a framework of
allowing continued access to credit
for the widest range of qualified
customers; protecting against the
abuse of vulnerable individuals;
and allowing sufficient return for
lenders to provide credit on a riskjustified basis.
For a full text of Chairman
Ta noue's testimony, refer to
www.fdic.gov/ news/ news/index.
hhnJ
• Holding several public fomms
across the country in which
community organizations,
government officials, and members
of the financial communi ty can
meet and explore effective means
to protect consumers; and
Federa l Reserve Ba nk of Atlnntn
8
The competiti ve market works
best when consumers have a
wide array of choices and, importantl y, the necessary information
about price, other terms and conditions, and their available
options to m ake well-advised
decisions. Furthermore, many
practices that have been characteri zed as predatory tend to strip
away borrowers' equity in their
homes, and to m ake foreclosure
m ore likely, if not inevitable.
Thus, some forms of preda tory
lending und ermine a centra l
objective of our national socia l
and economic policies: the prom o tion of home ownership a nd
its attenda nt virtues of neighborhood stability, decreased crime,
and the building of wealth for a
broad spectrum of famili es. These
practices should be condemned.
I do not think it's necessary, however, or even particul arly helpful,
to arrive a t a general d efinition of
predatory lending. Attempts to
But loans predicated on real
estate collateral where the borrower does not d emonstrate the
capacity to repay the loan as
structured w ill be ad versely classified, and, depending on the circumstances, furth er accru al of
interest may not be allowed. In
addition, if examiners fin d loan
terms, lending practices, or other
factors that ma y indica te a higher
risk of problem s in this area, we
w ill take a closer look, from both
safety a nd soundness and other
appropriate perspectives. We
will bring enforcem ent action
w here we find viola tions.
When confronted w ith proposa ls
involving subprime lending tha t
require our approva l, we have
acted to ensure that any such
lending ac ti vity by national
banks or their subsidiaries will be
conducted responsibly, and w ith
appropriate consumer protections, in accordance with the
applicable lega l criteria.
Finally, many have raised a significant regul atory concern about
the appropriate considera tion
under the CRA of loans -w hether m ad e or p urchased -that can be characterized as abusive or predatory. I welcome the
opportunity to work with our fellow regulators on an interagency
ba sis to achieve a consistent interagency approach to this issu e.
I urge the Congress to consider
all the potential consequences of
the different proposa ls for
reform. For example, a t some
point, lowering the interest rate
and fee thresholds for loans subject to the HOEPA restrictions
risks li miting credit access for
subpri me borrowers. Further, a
general ban on prepa ym ent premiums could limit a consumer's
produ ct choices and ability to
negotiate other concessions, su ch
as a reduced interest rate, in
exchange for accepting the risk of
a prepayment premium .
attack a n abstract conception of
predatory lending ma y tend to
focus on broad classes of lending
acti vity, and to distrac t us from
the particular troubling practices
we wish to address.
For exampl e, the idea that predatory lending is a unified problem,
capable of being generally
defined, ma y have contributed to
a tend ency to equa te predatory
lending w ith subprim e lending.
The OCC, in fact, encourages
responsible, risk-based subprime
lending. Lending to subprime
credit applicants, w hose credit
histories, or lack thereof, indicate
a higher than normal risk of
default, can be conducted in a
fair and responsible m anner.
Partners
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
We also exa mine ba nks for com pliance with sp eci fi c laws tha t
ma y be relevant to predatory
lending practices, particularly the
provisions of the Truth in Lending Act ("TlLA") and the provisions for high-cost home loans
included as part of the HOEPA.
Our examina tion and other ac tivities relating to the CRA are
designed to p romo te competitive
alternatives for low- and moderate-income borrowers. We will
continue to explore, both on our
own and on an interagency basis,
how we might be able to make
more effecti ve use of these and
other tools to enhance competition in financial services.
in Commun ity and Economic Development
Thus, wh ile we clearly need to
address the real abuses that exist,
particula rl y in connection with
home loans, we also need to preserve and encourage consumer
access to credit, mea ningful consumer choice, and competition.
For a full text of Chairman
Hawke's remarks, refer to www.
house.gov / banking/ 52400.htm
9
A discussion of predatory lending
must start with the frank admission that defining it is not easy. In
Deborah Goldstein's predatory
lending stud y, "Understanding
Predatory Lending: Moving
Towards a Common Definition
and Workable Solutions," 1 the
au thor states that "predatory
lending describes a set of loan
tern1s and practices tha t fall
between appropriate risk-based
pricing by subprime lenders and
blatant fraud ."
Ms. Goldstein suggests that loans
become predatory when they
target a particular population
(most frequ ently low-income
minorities and the elderly), taking
adva ntage of the borrower's
inexperience and lack of information to manipulate a borrower into
a loan the borrower cannot afford
to pay.
Risks
In addition to risks to consumers
and communities, predatory
lending can present safety and
soundness risks such as "legal" and
"reputatio n. " A second major risk
involves market liquidity with
hig h loan-to-value loans. Finally,
there are opera tional and credit
problems w hen borrowers are
strai ned in servicing their debt.
OTS's Advance Notice of
Proposed Rulemaking (ANPR)
As concerns intensified about
predatory lending practices, the
OTS decided to review its own
regulations to detern1ine their
effect in today's market on thrifts
and their customers and, under the
S11111111er 2000
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Alternative Mortgage Transaction
Parity Act of 1982, on state housing
creditors. TI1e ANPR sets forth the
following six goals:
1. Encourage safe and sound
lending.
2. Encourage innovation in
identifying potential customers
and meeting their needs.
3. Discourage lending that preys
upon cu stomers' lack of
knowledge or limited options.
4. Enable thrifts to compete wi th
other types of lenders.
5. Maintain the uniform system of
regulation that applies to federal
thrifts.
6. Minimize regulatory burden on
thrifts.
The Three "E's" of Combating
Predatory Lending
In fighting against abusive predatory lending practices, the OTS is
taki ng a three-prong approach.
The emphasis is on three "E's."
• Examination for enforce ment of
applicable laws and regulations;
• Encou ragement of responsible
subpri me lending; and
• Education of consumers and
investors.
Responsible Subprime Lending
Subprime lending refers to lendi ng
to borrowers who do not qualify
for the most favorab le interest
rates and other loan terms because
they are not among those with the
best credit histories and most
stable employment. Responsible
subprime lending means making
those loa ns at a price and with
terms that appropriately
compensate the lender for any
enhanced risk, including a reasonable return, and marketing the loan
in a maimer that is fair to, and
understandable by, the borrower.
Freddie Mac has estimated that
from 10 to 35 percent of borrowers
w ith subprime loans could have
qualified for a prime loan, but were
steered to a higher-cost loa n
anyway- a practice that clearly
conflicts with responsible subprime
lending.
In working to curtail predatory
lending, the flow of credit to
low- and moderate-income
families, elderly individuals, and
their communities must not be
impeded. Lending to underserved
communities and individuals,
w hether prim e or responsibly
d one subprime lending, provides
necessary credit safely and soundl y.
For a full text of Director Sied man's
testimony, refer to W\-VW.ots.treas.
gov/ docs /87077.html
1This ::,fudy was written ,mder the ;:;11pporf of the
Ncishl10rhood Rcill'Pl'SIJJU'llf Corporntio11';:;
Emerging L.·adcr::, i11 Co1111111mity Ecm10111ic
OC1. 1elop111c11t Fellmcs/Jip and il't1s is~ucd i11
October 1999.
Federa l Reserve Bn11k of Atln11 tn
IO
HOEPA
By Keenan Conigland
What is HOPEA?
The H ome Ownership Equity
Protection Act of 1994 (HOEPA)
is a federa l disclosure law
d esigned to address certai n
unfair le nding practices.
HOEPA, as im plemented
through Section 32 of the Federa l
Reserve's Regula tion Z, seeks to
protect homeowners ta rgeted by
predatory lenders that characteristica lly use high interest ra tes,
exorbita nt fees, a nd unreasonable repayment terms. HOEPA
does not prohibit creditors from
maki ng a particular type of
home-secured loan. Instead, the
law classifies groups of high-cost
mortgage loans throu gh rate and
fee triggers. Loans above the
triggers are subject to greater
disclosures and restrictions.
Covered Loans
HOEPA covers loa ns that have
(1) an annu al percentage rate
(APR) exceeding the rate on a
comparable-maturity Treasury
note by more than 10 percentage
points, and (2) total nondiscount
points and fees exceeding the
la rger of $451 (effecti ve 1-1-00,
adjus ted a nnual for changes in
the CPI) or 8 percent of th e total
loan amo unt. The rule does not
cover reverse mo rtgages o r
home eq uity lines of cred it.
Required Disclosures
For covered loans, a bo rrower
must receive a written disclosure
of the APR and regular payment
amount. For va riable rate loans,
the ma ximum monthl y payment
also mu st be presented .
The no tice must warn the borrower in plai n language that
becau se th e lend er will hold the
mortgage, the borrower could
lose the residence a nd any
mo ney put into it if the payments are not made. The lend er
mus t give the borrowe r a written
notice at leas t three bu siness da ys
before the loa n is finalized sta ting
that the loa n need not be completed, even though the agreement has
been signed , and the borrowe r
ma y resci nd the ag reement a t a ny
time during this period. These
HOPEA di sclosures are in addi tio n
to the other Truth in Lending Act
disclosures tha t must be made no
later than the closing of the loan .
Rule-Writing Authority
The Board of Gove rnors has rulew riti ng authority und er HOPEA
to lower the triggers for interest
rates and associa ted fees by two
percentage points, a nd m odify
the limita tins and prohibited
practices. HO EPA a uthorizes the
Board to hold hearings periodica ll y to keep ab reast of the home
equity credit ma rke t.
Limitations / Prohibited Practices
Under HOPEA, the following practi ces a re generally banned:
• Ball oon pa yments within 5 yea rs;
• ega tive a morti za tion;
• Advance payments (where two
or more payments a re paid in
advance from the proceeds);
• Increased interest rate (where
interest is higher upon d efault);
• Rebates (where a refund is ca lculated by a me thod less favorab le
than the ac tuarial method for
reba tes of inte rest ari sing from a
loa n acceleratio n due to default);
• Prepayment penalti es, except
within the first 5 yea rs of the loa n
if the source of the prepayment
fund s is not a refinancin g by the
sa me creditor and the borrower 's
total monthly debt-to-income ratio
is und er 50%;
• Extending credit without rega rd
to the payment ability of the borrower; a nd
• Disbursing funds for home
improveme nt loa ns directl y to the
contractor rather than directly to
the bo rrower, jointly to the borrower a nd the contracto r, or to the
escrow agent.
• Selli ng or otherwise assigning a
mo rtgage w ithout furnishing the
following statement to the purchaser or assignee: " otice: Thi s
is a mortgage subject to special
rules under the fede ral Truth in
Lending Act. Purchasers o r
assignees of thi s mortgage cou ld
be liable for all claims a nd d efenses
w ith respect to the mortgage tha t
the borrower could assert aga inst
the creditor."
In 1997, the Fed era I Reserve
Board held its firs t public hea rings concerning this subject. This
summ er, th e Board hosted fo ur
more public hea rings to ascerta in
w hether the HO PEA should be
changed to better speak to the
issue of pred a tory lending. The
Board invited a cross-sectio n of
consu mers, advoca tes, a nd
lend ers to participate in the hearings, w hich were held in
Charlotte (July 27), Bos to n
(August 4), Chicago (August 16),
a nd Sa n Francisco (Se ptember 7).
Pnrtners in Co111111u11ity nnd Eco110111ic Develop111e11t
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
The hea rin gs bore ou t the
complexity a nd enormity of the
issue and raised many suggestions that will be consid ered by
the Board. Any tig htening o f the
regulations imple menting the la w
would have to take into consid e ration the pote ntial effect on
respo nsible subprime lend ing .
Beca use HOP EA is but o ne tool
in ad dressing pred a tory lending,
broad er soluti ons mu st be multi faceted and incorpora te both a
regula to ry and non-regula tory
approach.
11
Consumer Corner
By Wayne Smith
Education of Consumers and
Investors
An important clement in combating predatory lending is edu ca tion
of bo th consumers w ho are
potential victims of predatory
lenders and of investors in
subprime mortgage loans and
securities backed by subprime
loans.
A well-informed consumer is better
equipped to avoid the predatory
lend er. Three basic considerations
in this regard includ e the followin g:
• Und erstanding one's
options fo r
obtai_ning credit;
• Using only responsible
lenders; and
• Being awa re of the
abuses used by those
w ho prey on the
vulnerable.
OTS Director Ellen
Siedman noted in her
Congressional testimony
that commtmi ty-based
orga ni za tions ca n play
a big role in helping to
bridge the ga p between
financial institutions and
communities vulnerable to predatory lending. Many alread y work
with homebu yer educa tion and
counseling and can expand into
post-pu rchase counseling to teach
clients about how to be discerning
homeowners and how to avoid
potential home equi ty sca ms.
and are not involved in existing
homeowner education and
cotmseling programs is difficu lt.
Community-based organiza tions
and financial institutions whose
constituents are likely to be
targeted by predatory lenders
need to reach out aggressively to
potential borrowers a nd a rm them
with valuable info rmation to give
them a shield aga inst the lies and
deceit of predatory lend ers. For
example, cornmtmity groups can:
• fdentify reliable home improvement contractors and home
equity lenders;
• Establish earl y warning networks and intervention ga me
plans for implementa tion when
unscrupulous contractors or
lenders invade a neighborhood ;
Learning what questions
to ask and how to evaluate the
answers---0r where to find help-is
critical to making informed choices.
So is d eveloping the discipline to
say "no" to dea ls that are just too
good to be true.
• Encourage commu nity
members to build broad-based
banking relationships with
federa ll y insured d eposito ry
institutio ns, including, for
example, electronic benefits
transfer prog rams and
first-time investor prog ram s;
a nd
Reaching community residents
who a lready own their own homes
• Work with loca l schools,
fai th-based organizations, and
S11111111er 2000
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
seniors groups to get out the
word about predatory lending
sca ms-how to avoid them,
where to report them, and how
to get answers to questions.
As fo r investors, they must be
more discerning in their purchase
of securities backed by high-cost
loans to avoid providing liquidity
to the unscrupulous. The acti vities
of large predatory lenders will
quickl y shrivel if they are denied
fin ancing. Participants in the
secondary market are beginn ing
to recogni ze that predatory loans
are not good business-not just
because they are unethical but also because
they can damage their
reputation and hurt
their stock price.
It is critical, however,
not to pursue this
in a manner that
threatens the viability
of responsible subprime
markets. There will still
be a vital and large
market for securities
backed by subprime
loans. TI1e well-oiled
machine of loa n
securitization will not
seize up when it ceases to accept
fraudulent or abusive loans. Fannie
Mae and Freddie Mac ha ve
respond ed not as regula tors, but as
investors who recogni ze the
hazards predatory loans bring to
their loan portfolios.
Together, lenders, borrowers,
secondary markets, and regu la tors
must work together to eliminate
these abusive practices.
Federnl Reserve Bnnk of Atlnntn
Community Forum on Predatory Lending
Lang-Carson Community Center in Reynoldstown , Atlanta, GA, September 16, 2000
This conference is sponsored by the Atlanta neighborhood Development Partnership {AN DP) and will help
community organizations and individuals identify and prevent predatory lending practices. For further information,
please contact Myke Harris Long, AN DP, at (404) 522-2637.
V ICE PRESID ENT
Minority Entrepreneurs' Conference
Federal Reserve Bank of Philadelphia Philadelphia, PA , September 27, 2000
Court 11cy Dufrics
Ko11 Zi rnrn e rrn an
ED ITOI~
The purpose of the conference is to inform existing or prospective entrepreneurs of the opportunities for businesses
in the Philadelphia area. Presenters will include venture capital firms and banks as well as representatives from city,
state, and nonprofit programs that offer special financing or technical assistance.
For further information, please contact Grace Theveny, Community and Consumer Affairs Department, Federal
Reserve Bank of Philadelphia, at (215)574-6457 or grace.theveny @phil.frb.org
Community and Economic Development Conference 2000:
Seizing Opportunities in a Changing Financial Landscape
The Westin Michigan Aven ue Chicago, Illinois, October 30 - November 1, 2000
Sponsored by the American Bankers Association and the Federal Reserve Banks of Chicago and St. Louis, the
conference will explore community and economic development with an emphasis on seizing financial opportunities
and growing institutions and organizations.
ASSO C IA T E E DITOH
w ay11c Srni tl1
Free s u1Jscrip1ion (Hld ciddilionu l copies ;-ire
u,·oila!Jl c upo n reque s t 10 Con1nH111i1y
.\floirs. Pcderal Hcscr\'(· B;:mk o f .\11 ..11110 .
104 i\. l i-Hic11c1 51. . N .\\ '. . . \tlania . c;c orgia
3030:3-271 :3.
or
('-llli-lil
llS
at
P artrl('fS (E\·111.trb.org or C~l !I 404/!JW)-7242:
F: \X 404/SSq-7:142 . Tile v iews e x p ressed
;ire no, necessari ly 11losc o f 1hc Fede ra l
H C'S(' IYl' l3i:.lll k o f ,\llcllll <I o r f ill' Fc cl cri\ l
l°lCSC l'\'l' S )'S l l'lll . ~ltll (' fi (ll may l)c rc prirned
or c1bs tranccl pro,·idc cl 1l 1c11 Ponncr!-. 1s c rc ditccl a nd pro \ ·idcd \\'itl1 r1 ropy o f tlH~ publl~
caIio I1
For further information, please contact Barbara Sims-Shoulders at (312) 322-8232 or
Barbara. E.Shoulders@chi .frb.org.
National Community Capital 2000 Conference
Philadelphia, PA November 1-4, 2000
National Community Capital's Annual Training Conference attracts more than 350 CDFI practitioners, investors,
funders, and policymake rs. The conference features training sessions specifically developed for CDFI investors and
funders.
For fu rther information, please contact Adina Abramowitz, National Community Capital
at (215) 923-4754, ext. 205.
Printed on recycled paper
For other events that may be of interest to you , visit www.frbchi.org/cedrjc.html.
The Federal Reserve System has a new national Community Affa irs website.
Please visit our national site at www.federalreserve.gov/communityaffairs/national .
lo conMUnli'J' uwd Mono le d•
l@p
OBI.I
Com muni ty Affa irs
Fed e ra l Heserve Bank of A tla nt a
10 4 Ma ri e tta S tree t. NW
A tla nt a, Georg ia 3030 3-27 13
Pa rtners in Community
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
and Economic Development
•
-
I
.
@FedFRASER