Predatory Lending Practices
Predatory lending comes in a number of different forms. In each instance, however, a financial institution takes unfair advantage of a consumer’s financial needs by charging high interest rates and other unconscionable fees and charges.
Predatory Mortgage Lending drains wealth from families, destroys the benefits of homeownership, and often leads to foreclosure. It is estimated that predatory mortgage lending costs Americans more than $9.1 billion each year.
Predatory mortgage lending involves a wide array of abusive practices. Here are brief descriptions of some of the most common.
Excessive fees: Points and fees are costs not directly reflected in a mortgage’s interest rate. Because these costs can be financed, they are easy to disguise or downplay. On competitive loans, fees equaling less than 1% of the total loan amount are typical. On predatory loans, fees often total more than 5% of the loan amount.
Abusive prepayment penalties: Borrowers with higher-interest subprime loans have a strong incentive to refinance as soon as their credit improves. However, up to 80% of all subprime mortgages carry a prepayment penalty -- a fee for paying off a loan early. An abusive prepayment penalty is often effective for more than three years and/or costs the consumer more than six months’ interest. In the prime market, only about 2% of home loans carry prepayment penalties of any length.
Kickbacks to brokers (yield spread premiums): When brokers deliver a loan with an inflated interest rate (i.e., higher than the interest rate the consumer qualifies for), the lender often pays a “yield spread premium" -- a kickback for making the loan more costly to the borrower. This kickback goes directly in to the pockets of the broker and consequently incentivizes the broker to put consumers in higher interest rate loans.
Loan flipping: A lender "flips" a borrower by refinancing a loan to generate fee income without providing any net tangible benefit to the borrower. Every time a loan is refinanced the consumer has to pay out fees. These fees can amount to thousands of dollars. Flipping can quickly drain borrower equity and increase monthly payments -- sometimes on homes that had previously been owned free of debt.
Unnecessary products: Sometimes borrowers may pay more than necessary because lenders sell and finance unnecessary insurance or other products along with the loan.
Forced arbitration: Some loan contracts require "forced arbitration," meaning that the borrowers are not allowed to seek legal remedies in a court if they find that their home is threatened by loans with illegal or abusive terms. Because the arbitrator is often looking for the repeat business of the mortgage lender there is an automatic bias. Consequently, forced arbitration makes it much less likely that a borrower will receive a fair and appropriate remedy when they have been wronged.
Steering & Targeting: Predatory lenders may steer borrowers into subprime mortgages, even when the borrowers could qualify for a mainstream loan. Vulnerable borrowers may be subjected to aggressive sales tactics and sometimes outright fraud. Fannie Mae has estimated that up to half of borrowers with subprime mortgages could have qualified for loans with better terms. According to a government study, over half (51%) of refinance mortgages in predominantly African-American neighborhoods are subprime loans, compared to only 9% of refinances in predominantly white neighborhoods.
Short Term Predatory Lending
Payday Lending (sometimes called cash advance): is the practice of using a post-dated check or electronic checking account information as collateral for a short-term loan. To qualify, borrowers need only personal identification, a checking account, and an income from a job or government benefits, like Social Security or disability payments.
Overdraft Loans (also called "bounce protection" plans): are offered by banks to low-income consumers. In exchange for covering account overdrafts up to a set dollar limit, banks charge bounced check fees, ranging from about $20 to $35 for each transaction. Some banks also charge a per day fee of $2 to $5 until the consumer's account has a positive balance. In addition to writing checks, customers can borrow against their bounce protection limit using their debit cards and by making ATM withdrawals.
Car Title Loans: Like payday loans, car title loans are marketed as small emergency loans, but in reality these loans have extremely high annual interest rates that trap borrowers in a cycle of debt. A typical car title loan has a triple-digit annual interest rate, requires repayment within one month, and is made for much less than the value of the car. Car title loans put at high risk an asset that is essential to the well-being of working families -- their vehicle.
Tax Refund Anticipation Loans (RALs): are short-term cash advances against a customer's anticipated income tax refund. But the loans are offered at high interest rates, ranging from about 40% to over 700% annual percentage rate (APR). Also, they speed up the refund process by as little as one week, compared to what consumers can expect by filing online and having their refunds deposited directly into their banking accounts.
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