Predatory Lending Practices Predatory lending was once a major problem in the United States. This was one of the reasons for the credit crisis in 2008. Unfortunately there were a few companies that were involved in these illegal practices which will be discussed in further detail later. There are different tactics used in predatory lending and several laws were developed to help prevent future predatory lending issues. What is predatory lending?
Predatory lending is any lending practice that imposes unfair or abusive loan terms on a borrower. It is also any practice that convinces a borrower to accept unfair terms through coercive, deceptive, exploitative, or unscrupulous actions for a loan that a borrower can’t afford, doesn’t need, or doesn’t want. Predatory lending benefits the lender, not the borrower by ignoring or hindering the borrower’s ability to repay the debt. These lending tactics attempt to take advantage of a borrower’s lack of understanding about loans, terms, or finances in general (Krulick, 2014). Who can be targeted in these illegal practices?
Predatory lenders typically target minorities, poor, elderly, and less educated people. People who need immediate cash are also targeted. For example people that need to pay medical bills, need to make a home repair, or someone that needs help making a car payment. People with credit issues or people who recently lost their jobs can be targets as well. The credit issues often disqualify borrowers from conventional loans or lines of credit but yet they have substantial equity in their homes. Predatory lending can take place in many forms including payday loans, car loans, tax refund anticipation loans, or any type of consumer debt. Over the past several years, predatory lending practices were prevalent in the area of home mortgages. Since home loans are backed by a borrower’s real property, a predatory lender can profit not only from loan terms stacked in his or her favor, but also from the sale of a foreclosed home, if a borrower defaults. While not all predatory lending practices are illegal, they can leave borrowers with unmanageable debt, ruined credit, or even homeless (Krulick, 2014)
There are several types of predatory lending practices which include: inadequate or false disclosure, risk-based pricing, inflated fees and charges, loan packing, loan flipping, asset-based lending, reverse redlining, balloon mortgages, negative amortization, abnormal prepayment penalties, and mandatory arbitration (Krulick, 2014). The several different types vary in definition. Inadequate or false disclosure means the lender hides or misrepresents the true costs, risks and/or appropriateness of a loan’s terms or the lender changes the initial terms after the offer. Risk based pricing is depended on by lenders which is tying interest rates to credit history; however, predatory lenders abuse this practice by charging very high interest rates to high risk borrowers who are most likely to default. Inflated fees and charges are when the lender’s fees and costs are much higher than those charged by reputable lenders and are usually hidden within the fine print. Loan packing is unnecessary products added into the cost of the loan. An example of this is credit insurance which pays off the loan if a borrower dies. Loan flipping is where the lender encourages a borrower to refinance an existing loan into a larger one with a higher interest rate and additional fees. In asset-based lending borrowers are encouraged to borrow more than they should when a lender offers a refinance loan based on their amount of home equity, rather than on their income or ability to repay. Reverse redlining is where the lender targets limited-resource neighborhoods that conventional banks may shy away from. Everyone in the neighborhood is charged higher interest rates to borrow money regardless of credit history, income, or ability to repay. A borrower is convinced to refinance a mortgage with one that has lower payments upfront but excessive (balloon) payments later in the loan term. When the balloon payments can’t be met the lender helps to refinance again with another high-interest, high-fee loan. Negative amortization occurs when a monthly loan payment is too small to cover even the interest, which gets added to the unpaid balance. It can result in a borrower owing substantially more than the original amount borrowed. Abnormal prepayment penalties is where the borrower tries to refinance a home loan with one that offers better terms can be assessed an abusing prepayment penalty for paying off the original loan early. Up to 80% of subprime mortgages have abnormally high prepayment penalties. In mandatory arbitration the lender adds language to a loan contract making it illegal for a borrower to take future legal action for fraud or misrepresentation. The only option then for an abused borrower is arbitration, which generally puts the borrower at a disadvantage (Krulick, 2014).
The U.S. mortgage market of recent years shows a high rate of both originations and foreclosures, especially in the riskier subprime sector. This trend, which has emerged as major economic event, has provoked significant discussion of how it occurred and how regulation might prevent its occurrence (Bond et al, 2009). All of the federal banking regulators, members of Congress, and many state and local jurisdictions are now addressing this issue, and different approaches have been presented which will be discussed further later. Bankers and mortgage lenders must act reasonably, and work with community advocates to formulate common sense rules. Otherwise, resulting legislation might as well be unworkable (Obara, 2001). How can people protect themselves from predatory lending?
The best defense against predatory lending pertains to people becoming educated about deceptive practices and specific items to watch for. Beware of loan officers through the mail, telephone, or door-to-door. Reputable lenders normally don’t work in that way. Make sure every lender is licensed. Stay clear of lenders who promise that the loan will be approved regardless of credit history or rating. Get a copy of current credit report to help be aware of what the person would actually qualify for. Don’t be rushed to sign the paperwork. Study the paperwork, and don’t sign until everything is fully understood. Always be aware of the interest rates and fees. Question anything that looks too high. Refuse to accept anything that doesn’t seem affordable. Decline any additional services “packed” into the loan like credit or health insurance. Don’t sign any documents with blank spaces. Read all documents carefully and have them checked by a trusted friend or reputable lawyer (Krulick, 2014).
Several financial institutions that target subprime market were pursued by federal and state authorities for predatory lending violations. For example, Household International agreed to pay $484 million in fines to consumers who were victims of alleged illegal lending practices. The New York State Attorney General accused Household management of failing to disclose material information to consumers and misrepresenting loan terms. As part of the settlement, Household management agreed to reduce the number of points charged for new loans, reform and improve disclosures to consumer, reduce flipping of outstanding loans, and provide loan closers with no financial interest to ensure compliance. In another example, the Federal Trade Commission filed a complaint in federal court charging the corporations collectively known as “The Associates” with systematic and widespread abusive lending practices. To go along with this complaint were allegations that the lenders victimized consumers who borrowed to meet emergency needs without access to other capital; induced consumers to refinance existing debts into home loans with high interest rates, costs, fees, and unnecessary credit insurance; concealed essential information from consumers; misrepresented loan terms; and packed optional fees to raise the cost of loans. Other allegations were that employees rushed consumers through the closing process to avoid explaining loan terms, employed unfair and aggressive tactics to collect payments, and bothered consumers with repeated and continuous phone calls to homes and places of work. The parent company Citigroup paid $215 million to settle and agreed to modify their marketing tactics consistent with ethical industry practices (Hill & Kozup, 2007).
Federal laws protect consumers against predatory lending. Main one among them is the Equal Credit Opportunity Act. This law makes it illegal for a lender to impose a higher interest rate or higher fees based on a person’s age, race, color, religion, sex, marital status, or national origin. The Home Ownership and Equity Protection Act protect consumers from excessive fees and interest rates. Loans that are considered “high cost” are subject to additional disclosure requirements and restrictions (Krulick, 2014). The Act only applies in certain cases, when the interest rate is 8% or higher. Prepayment penalties are forbidden. If the homeowner comes up with the remainder of the loan before an introductory period ends when the lender can’t charge a fine. The borrowers’ ability to repay the loan must also be considered before being approved (Hamilton, n.d.). In addition, 25 states have added anti-predatory lending laws and 35 states limit the maximum prepayment penalty that a homeowner is required to pay (Krulick, 2014).
The credit crunch of 2007 hit everyone hard; however, those that were victims of predatory lending were hit harder. Predatory lending resulted in several people having credit they can’t afford. Others were hit with high interest rates and penalty charges so that repaying the debt was nearly impossible. There is more legislation in place to protect consumers against predatory lending practices. The Truth in Lending Act is federal legislation created to help stop predatory lending practices. This act demands that credit card and loan companies fully disclose to consumers the true costs of their loan agreements. This includes costs such as interest rates and any penalty charges must be made clear under this act. As of Feb. 22, 2010, credit card companies had their policies drastically changed by the government when President Obama signed the Credit Card Accountability Responsibility Disclosure Act into law. This act brings several advantages to the consumer and limits credit card companies’ ability to practice predatory lending. Under the new law, interest rate hikes are illegal in the first year unless an introductory period has come to an end. Only one penalty charge per billing cycle is allowed. Credit card companies are also no longer allowed to issue a line of credit to anyone under the age of 21 without a co-signer or proof of adequate income. Finally, credit card companies are forbidden to offer promotions within 1,000 feet of a university campus (Hamilton, n.d.).
As the United States continued to face the worst financial crisis since the Great Depression, politicians in Washington focused on regulatory reform of the nation’s financial markets and institutions, including a new system for federal and state regulation of mortgages. On June 17, 2009, President Obama introduced the most comprehensive financial regulatory reform proposal in seventy-five years, which would overhaul the nation’s financial regulatory overnight structure. The Obama proposal includes a new plan to address systemic risk in the financial system, a new consumer watchdog for financial products, and an effort to reform the financial regulatory system (Caggiano et al, 2010).
The Obama proposal includes legislation that would create a Consumer Financial Protection Agency (CFPA), a powerful new agency that would set standards for all consumer financial products and services offered by any person who engages directly or indirectly in a financial activity, except for those investment products and services that the U.S. Securities and Exchange Commission or Commodity Futures Trading Commission already regulates. The CFPA would exercise the consumer protection authority now spread among all the federal financial institution regulators and would have full supervisory, examination, and enforcement authority. The proposal also includes appointing the Federal Reserve Board as the “systemic risk regulator” with new authority for regulating all large firms that pose a risk to the entire economy in the event of failure. A council of regulators would be created to guide the FRB in this area. The Office of Thrift Supervision would be eliminated along with the federal thrift charter. Supervision and regulation of national banks and federal thrifts would be consolidated under a new regulator, the National Bank Supervisor. All financial firms’ capital requirements would be increased (Caggiano et al, 2010).
The Secure and Fair Enforcement for Mortgage Licensing Act of 2008 was enacted as Title V of the Housing and Economic Recovery Act of 2008. The SAFE Act requires each state to have a system to license individual residential mortgage loan originators, including mortgage brokers and loan officers, that meets the SAFE Act minimum requirements. The U.S. Department of Housing and Urban development must develop a backup system for any states that didn’t have a system for licensing and registering loan originators in place by the effective date of July, 31, 2009. The Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators drafted model legislation to assist states in enacting laws compliant with the SAFE Act. The Model State Law delays the implementation date for loan originators operating within a state to be licensed to either July 31, 2010, or January 1, 2011, or such a later date approved by HUD. They announced that state legislation that follows the Model State Law will be deemed compliant with the SAFE Act (Caggiano et al, 2010).
On May 20, 2009, the Helping Families Save Their Homes Act of 2009 was signed into law. The Save Homes Act contains amendments to the HOPE for Homeowners Program, creates a safe harbor for mortgage loan servicers from investor liability when performing loan modifications, imposes a new Truth in Lending Act notice on purchasers of residential mortgage loans, and allows the Federal Housing Administration to give qualified borrowers the opportunity to reduce their monthly mortgage payment by modifying their mortgage. The American Recovery and Reinvestment Act, an $800 billion stimulus package that was signed into law on February 17, 2009, set the maximum Federal National Mortgage Administration (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) loan limit for mortgages originated in 2009 at $729,750 for certain areas, which is a return to the late-2008 level. HUD also temporarily increased until December 31, 2009, the loan limits for FHA loans in high cost areas to $729,750 and increased the national mortgage limit for home equity conversion mortgages from $417,000 to $625,500. On February 18, 2009, President Obama announced the Homeowner Affordability and Stability Plan to help families restructure or refinance their mortgages to avoid foreclosure. The administration announced all the details for this plan on March 4, 2009. Also on this date, the U.S. Treasury Department issued uniform guidelines for loan modifications under the Home Affordable Modification Program and as part of the program Fannie Mae and Freddie Mac both issued guidance on this program for loans they own or guarantee (Caggiano et al, 2010). Even though all of these acts were signed into law there has still been accusations made.
Three Atlanta area counties have filed a lawsuit claiming that British bank HSBC cost them hundreds of millions of dollars in extra expenses and damage to their tax bases by aggressively signing minorities to housing loans that were likely to fail. The Georgia counties' failure or success with the relatively novel strategy could help determine whether other local governments try to hold big banks accountable for losses in tax revenue based on what they claim are discriminatory or predatory lending practices. Similar lawsuits resulted in settlements this year worth millions of dollars for communities in Maryland and Tennessee. The lawsuit says the banks violated the Fair Housing Act, which provides protections against housing or renting policies or practices, including lending, that discriminate on the basis of race, color, national origin, religion, sex, family status, or handicap. The lawsuit says predatory lending practices include: targeting vulnerable borrowers for mortgage loans with unfavorable terms; directing credit-worthy borrowers to more costly loans; putting unreasonable terms, excessive fees or pre-payment penalties into mortgage loans; basing loan values on inflated or fraudulent appraisals; and refinancing a loan without benefit to the borrower. The counties are asking the court to order the bank to stop its behavior and to take steps to prevent similar predatory lending in the future. They are also seeking financial compensation for the damages they've suffered and punitive damages to punish the bank for its "willful, wanton and reckless conduct." The counties say the financial injury they've suffered is in the hundreds of millions of dollars. A federal judge has given the bank until Jan. 25 to respond to the counties' complaint (Brumback, 2012).
A similar situation by the same company was brought up this year. HSBC was accused of targeting Chicago-area minority borrowers for high-cost home loans as Illinois’s Cook County followed other local governments trying to hold subprime lenders liable for urban blight. Cook County seeks unspecified compensatory and punitive damages for its alleged costs to police and maintain deteriorating neighborhoods and from lost tax revenue on vacant properties, according to a complaint filed against HSBC North America Holdings on March 21 in federal court in Chicago (Harris & Pettersson, 2014).
Deutsche Bank AG last year settled a lawsuit by Los Angeles alleging the bank had become the city’s biggest slumlord because, as trustee for mortgage-backed securities, it had acquired title to thousands of foreclosed properties. The bank said in June that servicers and securitization trusts would pay the $10 million settlement. Los Angeles City Attorney Mike Feuer in December filed new lawsuits against Citigroup Inc., Wells Fargo & Co. and Bank of America Corp. seeking to hold them liable for the high rate of foreclosures in the city’s minority neighborhoods after the collapse of U.S. housing market. Those banks have said the city’s claims have no merit. Wells Fargo and Bank of America had previously agreed to pay a combined $569 million to resolve the two biggest residential cases in the history of the Fair Housing Act and Equal Credit Opportunity Act. Borrowers with Wells Fargo and Countrywide Financial Corp., which had been the biggest U.S. mortgage lender before being acquired by Bank of America in 2008, were more likely to be put in subprime loans if they were black or Hispanic, even when they qualified for lower-cost loans, according to the federal government’s claims. Those lenders’ settlements didn’t include admissions of wrongdoing (Harris & Pettersson, 2014).
After all the research it proves that predatory lending has been an issue in the past and unfortunately continues to be an issue in the present. Even after all the regulations that have been put in place over the past several years it still continues to create more lawsuits as could be seen in the two HSBC examples. Predatory lending takes several different forms but it seems like the main issue is with the mortgage industry. It will be interesting in the future to see if there’s more regulations passed and if predatory lending will eventually become a thing of the past.

References
Bond, P., Musto, D.K., & Yilmaz, B. (2009). Predatory mortgage lending. Journal of Financial Economics, 94(3), 412-427.
Brumback, K. (2012). HSBC sued by Atlanta-area counties over predatory lending claims. Retrieved from http://www.huffingtonpost.com/2012/12/25/hsbc-sued-predatory lending_n_2362436.html?utm_hp_ref=@money123
Caggiano, J.R., Franzen, T.G., & Dozier, J.L. (2010). Developments in state and federal mortgage lending laws: Predatory lending and beyond. Business Lawyer, 65(2), 583-593.
Hamilton, R. (n.d.). Consumer laws on predatory lending. Retrieved from http://www.ehow.com/list_6835331_consumer-laws-predatory-lending.html
Harris, A. & Pettersson, E. (2014). HSBC sued for predatory lending by Cook County, Illinois. Retrieved from http://www.businessweek.com/news/2014-03-25/hsbc-sued-by-illinois cook-county-on-minority-lending-practices
Hill, R.P. & Kozup, J.C. (2007). Consumer experiences with predatory lending practices. Journal of Consumer Affairs, 41(1), 29-46.
Krulick, A. (2014). Predatory Lending. Retrieved from http://www.debt.org/credit/predatory lending/
Obara, P.E., (2001). Predatory lending. Banking Law Journal, 118(6), 541-553.