Anti Predatory Lending Toolkit

Transcription

1 Anti Predatory Lending Toolkit March 2002 Second Edition

2 NATIONAL COMMUNITY REINVESTMENT COALITION We strongly support the anti-predatory bills introduced in Congress. These bills provide comprehensive protections against predatory lenders by prohibiting abusive practices such as single premium credit insurance, prepayment penalties, balloon payments on high cost loans, and lending without regard of the borrower s ability to repay. At the same time, NCRC urges members of Congress to avoid reform efforts that only end up aiding and abetting predatory lenders. - John Taylor, President & CEO, National Community Reinvestment Coalition The mission of the National Community Reinvestment Coalition (NCRC) is to increase fair and equal access to credit, capital, and banking services and products because discrimination is illegal, unjust, and detrimental to the economic growth and well-being of our society. NCRC seeks to support long-term solutions which provide resources, knowledge and skills to build community and individual net wealth. More importantly, NCRC is at the vanguard of a growing economic justice movement in which community leaders across the nation, in urban and rural areas, are becoming educated about, and active in, efforts to affect the flow of capital and the provision of fair housing and fair lending services in their neighborhoods. NCRC has worked to make fair housing prevalent in all communities, to increase the capacity of neighborhood-based organizations, and to promote community-lender partnerships. The Board of Directors would like to express their appreciation to the NCRC professional staff who contributed to this publication and serve as a resource to all of us in the public and private sector who are committed to responsible lending. For more information please contact: : John Taylor, President & CEO David Berenbaum, Senior V.P. - Program & Director of Civil Rights Joshua Silver, V.P. Policy & Research Lynn King, Director of Legislative & RegulatoryAffairs Samir Parikh, Policy Analyst Soyong Cho, Research Analyst Mark Treskon, Research Analyst Zorana Hudnell, Fair Housing Assistant Lloyd London, Fair Lending Specialist Robert Levenson, Esq., Law Extern 2002 by the National Community Reinvestment Coalition. Reproduction of this document is permitted and encouraged, with credit given to the National Community Reinvestment Coalition. NATIONAL COMMUNITY REINVESTMENT COALITION th Street, NW, Suite 540, Washington, D.C (202) National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 2

3 Table of Contents Sub Prime & Predatory Lending Defined 4 Predatory Lending Scams A Primer 5 Building Consensus 6 National Anti-Predatory Lending Policy Is Good For America 7 Best Practices & Responsible Lending 13 The Legal Tool Box 14 NCRC HOEPA Fact Sheet 17 Casenotes 19 CRA & Predatory lending 28 Who Are The Regulators and How Do They Enforce Anti-Discrimination Laws? 29 The NCRC Fair Lending Consumer Rescue Fund 31 Legislative Developments 32 NCRC Model Legislation 33 Legislative Analysis 35 Glossary of Legislative Terms 187 NCRC Anti-Predatory Lending Model Bill 189 NCRC Board of Directors 204 National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 3

4 Sub-prime and Predatory Lending Defined Sub-prime Lending: A sub-prime loan is a loan to a borrower with less than perfect credit. In order to compensate for the added risk associated with sub-prime loans, lending institutions charge higher interest rates. In contrast, a prime loan is a loan made to a creditworthy borrower at prevailing interest rates. Loans are classified as A, A-, B, C and D loans. A loans are prime loans that are made at the going rate while A- loans are loans made at slightly higher interest rates to borrowers with only a few blemishes on their credit report. So called B, C, and D loans are made to borrowers with significant imperfections in their credit history. D loans carry the highest interest rate because they are made to borrowers with the worst credit histories that include bankruptcy. Predatory Lending A predatory loan is an unsuitable loan designed to exploit vulnerable and unsophisticated borrowers. Predatory loans are a subset of sub-prime loans. A predatory loan has one or more of the following features: 1) charges more in interest and fees than is required to cover the added risk of lending to borrowers with credit imperfections, 2) contains abusive terms and conditions that trap borrowers and lead to increased indebtedness, 3) does not take into account the borrower s ability to repay the loan, and 4), often violates fair lending laws by targeting women, minorities and communities of color. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 4

5 Predatory Lending Scams A Primer "It is clear that we need to focus a spotlight on predatory lenders whose sole purpose is to hijack the American dream from unsuspecting borrowers. We should leave no stone unturned to find and crack down on predatory lenders and Congress must pass the strongest legislation possible to end this pernicious practice." Marketing: Aggressive solicitations to targeted neighborhoods Home improvement scams Kickbacks to mortgage brokers (Yield Spread Premiums) Racial steering to high rate lenders Sales: Senator Charles Schumer Purposely structuring loans with payments the borrower can not afford Falsifying loan applications (particularly income level) Adding insincere co-signers Making loans to mentally incapacitated homeowners Forging signatures on loan documents (i.e., required disclosure) Paying off lower income mortgages Shifting unsecured debt into mortgages Loans in excess of 100% LTV Changing the loan terms at closing The loan itself: High annual interest rates High points or padded closing costs Balloon payments Negative amortization Inflated appraisal costs Padded recording fees Bogus broker fees Unbundling (itemizing duplicate services and charging separately for then) Required credit insurance Falsely identifying loans as lines of credit or open end mortgages Forced placed homeowners insurance Mandatory arbitration clauses After closing: Flipping (repeated refinancing, often after high-pressure sales) Daily interest when loan payments are late Abusive collection practices Excessive prepayment penalties Foreclosure abuses Failure to report good payment on borrower s credit reports Failure to provide accurate loan balance and payoff amount i National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 5

6 Building Consensus Many of the people in the sub-prime market are unsophisticated in financial matters and easy victims for sleazy sales practices. They deserve better legal protection. - Editorial, The New York Times, March 18, 2000 Advocates for economic justice, consumer issues, regulators and legislators alike have begun a private and public sector colloquy of great importance to our nations communities and homeowners. In a recent HUD- Treasury Task Force on Predatory Lending report entitled Curbing Predatory Home Mortgage Lending, the authors suggested a four point approach to the problem, including: Improving consumer literacy and disclosures. For example, suggesting that creditors should be required to recommend that high-cost loan applicants avail themselves of home mortgage counseling, disclose credit scores to all borrowers upon request and give borrowers more timely and more accurate information as to loan costs and terms. Prohibiting harmful sales practices in the mortgage market. For example, banning practices such as loan "flipping" and lending to borrowers without regard to their ability to repay. Suggesting new requirements that should be imposed on mortgage brokers to document the appropriateness of a loan for high-cost loan applicants, and requiring lenders who report to credit bureaus should be required to provide "full-file" payment history for their mortgage customers. - Restricting abusive terms and conditions on high-cost loans. For example, recommending that Congress increase the number of borrowers in the sub-prime market covered by legislative protections; further restricting balloon payments on high-cost loans; restricting prepayment penalties and the financing of points and fees; prohibiting mandatory arbitration agreements on high-cost loans; and banning lump-sum credit life insurance and similar products. - Improving market structure. By awarding Community Reinvestment Act (CRA) credit to banks and thrifts that promote borrowers from the sub-prime to prime mortgage market, and by denying CRA credit to banks and thrifts for the origination or purchase of loans that violate applicable lending laws. This was an important first step to examine the issue. However, it is only a first step. Subsequent inquiries by Senator Sarbanes and the Senate Committee on Banking, Housing & Urban Affairs have continued the dialogue. Questions abound concerning definitions, evidence, the role of Wall Street, regulators and the GSE s, and the expanded use of existing law plus the creation of new Federal State and local protections. How can we leverage greater accountability and protect those currently being victimized by predatory lenders in our society while celebrating good business practices, financial institution profitability and community investment? The legislation enacted North Carolina and Chicago, Illinois establish State and local models for discussion. The purpose of this tool kit is to affirmatively further the dialogue in order to provide support for those considering new or existing policy, research, consumer action, civil rights initiatives and to move us all to a pro-active position where the community, individual consumer and corporation alike all celebrate a healthy lending market were everyone treated fairly and has equal access. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 6

7 National Anti-Predatory Lending Policy Is Good For America "We must target not just the predators themselves, but the conditions that allow them to flourish. That means encouraging responsible competition in the same markets in which the predators operate. It means helping low and moderate-income Americans to gain a better understanding of their financial obligations and options." - John D. Hawke, Jr., Comptroller of the Currency Regulating Sub-prime Lending Prevents Abuses and Would Not Cut Off the American Dream of Homeownership In recent years, sub-prime and predatory lending has exploded. Sub-prime lending specialists are not new; sub-prime lending has been a part of consumer and automobile finance for decades. Sub-prime lenders, however, have reoriented their focus towards home refinance lending. Sub-prime lenders convince consumers to take out home equity or home refinance loans to consolidate consumer debts by using the tax advantages associated with home loans. While some maintain that sub-prime lending has been responsible for the surge in homeownership among minorities and low- and moderate-income borrowers, NCRC believes that increased prime lending by CRAcovered banks has played the major role in the increase in homeownership. Proponents of sub-prime lending caution against aggressive anti-predatory lending regulation and legislation, saying that such efforts will choke-off credit in under served communities. NCRC, in contrast, asserts that anti-predatory legislation and regulation will not constrain home mortgage lending to traditionally under served communities and is needed to protect communities from unscrupulous actors. This position paper distinguishes sub-prime from predatory lending and outlines NCRC s proposed policy responses to the scourge of predatory lending. Sub-prime and Predatory Lending Defined Sub-prime Lending: A sub-prime loan is a loan to a borrower with less than perfect credit. In order to compensate for the added risk associated with sub-prime loans, lending institutions charge higher interest rates. In contrast, a prime loan is a loan made to a creditworthy borrower at prevailing interest rates. Loans are classified as A, A-, B, C and D loans. A loans are prime loans that are made at the going rate while A- loans are loans made at slightly higher interest rates to borrowers with only a few blemishes on their credit report. So called B, C, and D loans are made to borrowers with significant imperfections in their credit history. D loans carry the highest interest rate because they are made to borrowers with the worst credit histories that include bankruptcies. Predatory Lending: A predatory loan is an unsuitable loan designed to exploit vulnerable and unsophisticated borrowers. Predatory loans are a subset of sub-prime loans. A predatory loan has one or more of the following features: 1) charges more in interest and fees than is required to cover the added risk of lending to borrowers with credit imperfections, 2) contains abusive terms and conditions that trap borrowers and lead to increased indebtedness, 3) does not take into account the borrower s ability to repay the loan, and 4), often violates fair lending laws by targeting women, minorities and communities of color. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 7

8 Sub-prime Lending Trends According to the Department of Housing and Urban Development s (HUD) recent study, Unequal Burden: Income and Racial Disparities in Sub-prime Lending in America, sub-prime refinance lending, which constitutes 80 percent of all sub-prime lending, increased almost 1000 percent from 1993 to In 1993, sub-prime lenders made 80,000 refinance loans; by 1998, they made 790,000 loans! ii Given the huge increase in sub-prime lending, the next question is whether minority communities receive a disproportionate amount of sub-prime lending. The same HUD study found that borrowers in black neighborhoods were five times more likely to receive sub-prime refinance lending than those living in white neighborhoods. NCRC research has found similar disparities. For example, major sub-prime and manufactured home lenders made 47 percent of the refinance loans in predominantly African American and Hispanic neighborhoods in the District of Columbia in 2000, a significant increase from 39 percent of the loans in 1999 and 25 percent of the loans in In contrast, sub-prime and manufactured home lenders made less than 4 percent of the loans in predominantly white neighborhoods in the three years of the study. iii Substantial evidence suggests that sub-prime borrowers in minority communities experience price discrimination. Over the last several years, HMDA (Home Mortgage Disclosure Act) data has indicated that Black applicants are denied twice as often as whites. NCRC believes that it does not necessarily follow that Blacks are twice as likely to have bad credit. But given that Blacks are denied twice as often for conventional loans as whites, it does not follow that minority communities should be five times as likely to receive sub-prime loans. And in some geographical areas, the disparity is much greater than five to one. The major secondary market institutions have found pricing inefficiencies in sub-prime loans. Freddie Mac states that up to 30 percent of sub-prime borrowers were creditworthy for prime loans. Fannie Mae s CEO, Franklin Raines, is quoted as saying that half of all sub-prime borrowers could have received prime loans. iv A study by the Research Institute for Housing America (RIHA) concludes that minority borrowers are more likely to receive sub-prime loans after controlling for credit risk factors. RIHA cautions against a conclusion that price discrimination alone explains this since minority borrowers may have different techniques of searching for lenders. However, when one considers the totality of the research by NCRC, HUD, Fannie Mae, Freddie Mac, RIHA, and others, it seems fair to say that the burden of proof lies with those who assert that discrimination does not occur in the sub-prime market. v How Necessary is Sub-prime Lending in Serving Minority and Low- and Moderate-Income Borrowers? In late October of 2000, the incoming chairman of America s Community Bankers told an American Banker reporter that We need to be very careful that sub-prime lending, which has a useful place, does not get confused with predatory lending because lending to borrowers with imperfect credit history is one of the reasons we ve increased homeownership to record levels in the U.S. vi The home mortgage lending data does not support the contention that sub-prime lending has driven the surge in homeownership for traditionally under served populations. NCRC calculates that in 1990 low- and moderate-income borrowers (LMI borrowers have up to 80 percent of area median income) received 18.5 percent of all home mortgage loans made in the country. By 1995, LMI borrowers received 26.9 percent of all home mortgage loans, or 8.4 percentage points more than they had in By 2000, LMI loan share had increased to 29.6 percent or only 2.7 more percentage points than in The surge in sub-prime lending occurred from 1995 to 1999, yet LMI borrowers experienced the largest gains in home mortgage lending from 1990 to The first part of the decade witnessed a tremendous increase in conventional and affordable prime loans as depository institutions worked in partnership with community organizations to make CRA-related home mortgage loans. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 8

9 The story is similar for home mortgage lending trends to Blacks and Hispanics. Blacks and Hispanics received 9.7 percent of the home mortgage loans in 1990 made to Blacks, Hispanics, Whites, American Indians, and Asians. The Black and Hispanic loan share climbed to 13.9 percent in 1995 and to 16.6 percent in The share of home mortgage loans made to Blacks and Hispanics increased by 4.2 percentage points from 1990 to 1995, but only 2.7 percentage points from 1995 to Pundits and proponents of sub-prime lending talk about how it has made homeownership accessible, but the statistics show the biggest gains for Blacks and Hispanics occurred in the first part of the decade when CRA-related lending surged - as opposed to the second part of the decade when sub-prime lending soared. NCRC acknowledges that responsible sub-prime lenders play a role in the marketplace. However, these lenders are primarily consumer lenders and should not be confused with CRA-covered lenders that have done the most work in making the American Dream of homeownership possible. In addition, a portion of subprime lending is predatory since it involves price discrimination, or charging higher interest rates than is necessary to cover risk. Abusive Terms and Conditions in Predatory Loans While price discrimination is insidious, it is often combined with abusive terms and conditions that compound the evils of predatory lending. Overpriced loans with abusive terms and conditions strip equity out of borrowers homes and often lead to foreclosure. This following list is not meant to be exhaustive; it includes the major abuses associated with predatory lending. Prepayment Penalties A lender assesses prepayment penalties when a borrower either pays the remaining loan balance before the end of the loan term or refinances with another bank. In the case of prime loans, borrowers sometimes agree to prepayment penalties in exchange for a lower interest rate or lower loan fees. In the case of predatory loans, prepayment penalties become a trap, preventing many borrowers from shedding a high interest loan in favor of a prime loan and/or a lower interest loan. NCRC recently represented a couple in the District of Columbia who was almost unable to sell their home and nearly suffered foreclosure due to a prepayment penalty of several thousand dollars. According to the HUD and Department of Treasury Task Force report on sub-prime lending, about 70 percent of sub-prime loans contain prepayment penalties. Only one to two percent of prime loans includes prepayment penalties. vii Balloon Payments A balloon payment is a loan payment that can equal all of the remaining loan balance or a large fraction of the remaining balance. In prime lending, balloon payments can be used on second mortgages and other instruments to help finance the loan by making monthly payments lower. It is anticipated that a borrower s income will increase, making it feasible for the borrower to pay the balloon when it is due or to refinance the loan. In predatory lending, a balloon payment is another type of trap. Borrowers with high cost loans cannot pay the balloon when it is due and usually end up refinancing their loans. Predatory lenders will then often increase their interest rates and fees on the refinanced loans. Flipping Flipping refers to the practice of repeated loan refinancings with little or no benefit to the borrower. NCRC s Consumer Rescue Fund program assisted a borrower who originally obtained a home improvement loan in Different lenders convinced the borrower to refinance his loan twice within six months during One lender charged more than $5,600 in fees. After the second flip, the borrower was paying almost 60 percent of his monthly income on mortgage payments. viii Credit Insurance If a borrower dies or becomes unemployed, credit insurance pays the outstanding loan balance. Borrowers of prime loans sometimes decide to obtain credit insurance after they close on their loans, and may or may not obtain credit insurance through their lender. Borrowers of prime loans also usually pay for credit insurance on a monthly basis. In contrast, predatory lenders persuade borrowers to pay for all of their credit insurance up-front via a single premium payment. In other words, the premium for credit insurance is added to the loan amount. Credit insurance is much more expensive when it is added to the loan amount than when a consumer pays for it on a monthly basis outside of the loan. For instance, a National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 9

10 $10,000 policy paid for on a monthly basis would cost a consumer $37,000 when financed into a thirty-year loan with a 12 percent interest rate. Fee Packing Predatory lenders will pack loans with unnecessary fees. In the case of Delta Funding, the Attorney General of the State of New York found that the lender paid brokers fees that added 10 percent to the loan amount simply for inducing borrowers to accept excessive, above-market interest rates. ix In industry parlance, the practice of paying brokers kickback fees to induce borrowers to accept higher interest rates than the lender would normally offer is called yield spread premiums. In the summer of 2001, Senator Paul Sarbanes, Chairman of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, held a hearing on predatory lending, which featured testimony from victims. One victim testified that she was persuaded to refinance a $74,000 loan at an interest rate of 7.5 percent into a new $100,750 loan at an interest rate of percent. She paid fees of $8,105 for a loan that amounted to only $18,645 in additional funds. The fees are 43 percent of the additional funds. Sum Total of Abuses - The abusive terms and conditions on predatory loans can be so harmful that after several years of paying on time, the borrower still owes almost the entire principal on the loan. This is systematic equity stripping in its most perfect and insidious form. For example, the Federal Trade Commission documents in their suit against the Associates that the entire principal on $24,000 home equity loans remained after ten years of borrowers payments. x Why Stronger Regulation and Legislation is Needed Opponents of additional regulation and legislation of sub-prime lending state that these steps will turn-off the flow of credit to minorities and low- and moderate-income borrowers. As demonstrated above, however, subprime lending has not been a major factor expanding homeownership opportunities for traditionally under served populations. In addition, opponents of tighter control of sub-prime lending suggest that improved disclosure of terms and conditions of loans will provide the needed protections against predatory lending. This argument brushes aside the fact that a loan transaction is an exceedingly complex transaction, making it difficult for sophisticated borrowers to understand loan terms, let alone borrowers that are not familiar with financial institutions. Comparing lending trends in states with and without anti-predatory laws effectively refutes the notion that anti-predatory statutes choke off credit. The first state to pass an anti-predatory law was North Carolina. The law was passed in the summer of 1999 and became effective in the summer of An NCRC analysis of the time period before and after the law from 1998 through 2000 reveals that lending trends in North Carolina closely resemble those in states, like Ohio, where anti-predatory laws were not discussed and debated during the same time period. In both Ohio and North Carolina total single family lending (especially refinance lending) declined over the three years because of higher interest rates in 2000 than in xi In Ohio, prime and sub-prime single family lending declined 41 percent and 20 percent, respectively, from 1998 through In North Carolina, prime and sub-prime lending decreased 38 and 21 percent, respectively, during the three years. In contrast to refinance lending, sub-prime home purchase lending even increased in North Carolina by 31 percent over the time period. The specter of credit constriction in the wake of an anti-predatory law remains a figment of imagination and a scare tactic only, not a reality. NCRC believes that current law and regulation are weak and err on the side of allowing exploitative practices that are not economically justified in terms of being necessary to make loans profitable. Steep prepayment penalties on high interest loans, high balloon payments, repeated flipping, credit insurance, and fee packing were not necessary for profitable home mortgage loans made to first time homebuyers during the tremendous homeownership expansion in the 1990 s, especially in the first half of the decade. Instead, these abusive terms and conditions trap and exploit unsophisticated borrowers. Their unsuitability to the borrower and lender is demonstrated by higher foreclosures associated with predatory lending as documented by NCRC and other research. xii Indeed, the FDIC has found that although sub-prime lenders constitute about 1 percent of National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 10

11 all insured financial institutions, they account for 20 percent of depository institutions that have safety and soundness problems. xiii In order to protect consumers and the lending industry from unsafe and predatory practices, NCRC favors federal anti-predatory legislation that builds upon the Homeownership and Equity Protection Act of 1994 (HOEPA). HOEPA defines loans that exceed a certain interest rate and fee threshold as high cost loans. It then outlaws various terms and conditions on high cost loans. The shortcoming with HOEPA is not its structure but its high interest rate and fee thresholds. The current interest rate threshold, for example, is 10 percentage points above Treasury bill rates which currently translates into interest rates of 16 percent and higher (the Federal Reserve Board lowered the threshold to 8 percentage points above Treasury securities; this change becomes effective in October 2002). The HUD/Treasury Task Force on Predatory Lending estimates that the current HOEPA interest rate threshold covers only about 1 percent of sub-prime loans. xiv Tighten Up HOEPA NCRC believes that HOEPA should be changed in the following manner. Local and state bills should also contain the following: Coverage HOEPA should be expanded to cover home mortgage lending, reverse mortgage lending, and open-ended transactions secured by real estate. Currently, HOEPA applies only to closed-ended consumer transactions secured by a borrower s home. In order for HOEPA s protections to be comprehensive, it is time to extend it to all lending secured by a borrower s principal dwelling. Interest Rate Threshold The interest rate threshold should be lowered from 10 percentage points above Treasury bill rates to 4 percentage points above Treasury rates. Using the figures in the HUD/Treasury report, NCRC estimates that this would cover about 70 percent of all sub-prime lending, or the percentage of sub-prime lending which is estimated to contain prepayment penalties. Fees NCRC believes that the HOEPA fee threshold should be lowered from 8 percent of the loan amount to 3 percent of the loan amount. Fannie Mae has indicated that it will not purchase loans with fees exceeding five percent of the loan amount. This is a significant policy statement from a major secondary market player indicating that Fannie Mae does not believe that fees above five percent are economically justified from a profitability point of view. xv The rationale for NCRC s suggested trigger of 3 percent of loan amount is that fees are usually only 1 percent of prime loans; we are thus allowing fees to be three times the average prime amount before the fee trigger is crossed. In addition, NCRC maintains that yield-spread premiums should be included in the calculation of the fee threshold. NCRC also agrees with the HUD/Treasury recommendation that for high cost loans, a ceiling should be established on the percentage of fees that are financed and added to the loan amount instead of being paid up-front. The HUD/Treasury recommendation is that fees exceeding more than 3 percent of the loan amount must not be financed. Flipping NCRC agrees with the HUD/Treasury recommendation that refinances of high cost loans that occur within 18 months of the original loan should be prohibited unless a tangible net benefit accrues to the borrower. Such a benefit should include a reduction in the loan interest rate. NCRC s model bill prohibits the refinancing of a high cost loan into another high cost loan when the lender finances points and fees into the new high cost loan. Prepayment penalties HOEPA currently allows prepayment penalties in the first five years. HOEPA must be changed to shorten the time period during which prepayment penalties can be assessed on loans that exceed the interest rate and fee threshold. The NCRC model bill includes a time period of three years; advocates and policymakers should assess economic conditions in their localities in deciding appropriate time periods. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 11

12 Balloon payments HOEPA prohibits balloon payments on high cost loans within the first five years of origination. NCRC agrees with the HUD/Treasury recommendation that balloon loans must be prohibited until 15 years after the issuance of high cost loans. A shorter time frame invites flipping as predatory lenders convince borrowers facing steep balloon payments to refinance, usually at higher interest rates and added fees. NCRC s model bill actually prohibits all balloons on high cost loans; in some localities, however, NCRC is realistic that a straight-out prohibition will not be attainable. Single premium credit insurance This is an abuse that must be ended on all loans. Fannie Mae and Freddie Mac have indicated that they will not purchase loans with single premium credit insurance. xvi Congress should follow their lead and prohibit single premium insurance. If financial institutions wish to sell credit insurance, it should be on a monthly basis and must allow the borrower to cancel it at any time. On their part, many of the largest sub-prime lenders have stopped adding single premium credit insurance to their loans. This list of HOEPA changes is not intended to be comprehensive (NCRC s model bill contains more provisions). For example, additional reforms would be to outlaw mandatory arbitration clauses and prohibit high cost loans with negative amortization and/or with debt-to-income ratios that exceed 50 percent of the borrower s income. Instead, this list of NCRC recommendations is intended to illustrate how public policy should respond to the pervasive abuses occurring in the marketplace that cannot be addressed solely through improved disclosures or more extensive financial literacy counseling. The protections in a strengthened HOEPA statute or in a local statute ultimately aim at creating a banking system in which loans are made that meet the tangible net benefit standard. In other words, anti-predatory statutes would create a system in which loans are appropriately priced, affordably priced, and meet housing needs as well as urgent consumer needs such as financing a medical emergency. While this seems to be a straightforward proposition, it is in fact the anti-thesis of predatory lending, whose sole purpose is to harm, not benefit, the consumer. In conclusion, stronger legislation and regulation is needed to end the scourge of predatory lending. Noble attempts have been made at the state and local level to implement legislative and regulatory protections against predatory lending. NCRC applauds these initiatives and supports them. However, a comprehensive HOEPA statute, accompanied by stronger regulations, is needed to establish uniformity and prevent predators from preying upon borrowers in states with weak laws. A uniform national framework will promote competition from prime lenders and responsible sub-prime lenders. It will benefit communities and lenders alike by prohibiting unsafe and unsound lending that is designed to exploit borrowers and neighborhoods and strip them of their wealth. How this Paper Was Written The Board of Directors and the Legislative/Regulatory Affairs Committee (Leg/Reg Committee) establish NCRC s policy positions. The Leg/Reg Committee is chaired by two NCRC Board members, and consists of any NCRC member willing to participate in conference calls and policy development discussions. Typically, thirty to forty NCRC member organizations participate in conference calls five to six times a year. In between the conference calls, NCRC shares drafts of policy papers, Congressional testimony, and comment letters to members via an bulletin board or listserv for edits and suggestions. The listserv contains the s of over 200 member organizations. NCRC also mails out important policy papers to all 800 NCRC member organizations for their input, consideration, and action. Thus, this position paper on predatory lending is a dynamic and fluid policy paper that represents the input and collective wisdom of NCRC member organizations. It is subject to change as NCRC and its member organizations learn more about predatory lending and its devastating impact on communities. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 12

13 Best Practices & Responsible Lending "I have no illusions that the task of breaking down barriers that have produced disparities in income and wealth will be simple Although we have achieved much in this regard, more remains to be done.... Discrimination is against the interests of business - yet business people too often practice it." - Alan Greenspan, Chairman, Federal Reserve Fair lending is an integral part of a financial institution s legal responsibility to society. Although overt discrimination in mortgage lending is rare in today s market, unintentional or unauthorized discrimination may be found due to a continuation of standard practices of loan underwriting or appraisals. Challenges facing lending institutions may arise from review of the latest Home Mortgage Disclosure Act data or review of those standard practices which may be contrary to equal opportunity goals set by the institution. Check to see if the financial institution you are dealing with has adopted a mission statement pledging to make fair lending and responsible a significant goal of the company. If there is a goal established, the strategy to accomplish said goal should be in writing, available for the consumer to review. For example, it is (name of bank or mortgage company) s goal to eliminate discrimination based upon a characteristic of the applicant (race, color, national origin, marital status, sex, age, familial status, handicap, religion) and upon the racial composition of the community in which the property is located (redlining)? While best practices are not a substitute for sorely needed new consumer protections, they do expand access to credit and celebrate fair lending as a profitable business practice. Question the lender as to: Do they train the staff (including contracted appraisers and brokers) in the area of fair lending and equal credit opportunity laws? Do they have a review policy to ensure detection of discrimination? Is their advertising in compliance with federal, state and local fair housing laws? Are all loan products presented to prospective clients? Are products equally suited to majority and minority communities? Are there loan officers who speak foreign languages or sign language? Are offices and branches located equally in all communities and do they offer equal services, hours and types of facilities? Are there minorities at all levels of employment in the institution and on the Board of Directors? Do they have written and established underwriting standards and criteria with specific and objective terminology? If exceptions are made in the underwriting decision, what are the circumstances for the exceptions? Do they apply the same standards for all? Are debt-to-income ratios flexible underwriting tools or fixed standards? In the Neighborhood Analysis section of the appraisal report, are there references to the desirability of a neighborhood? Does the lender celebrate Responsible Lending and have a meaningful anti-predatory or responsible lending policy? National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 13

14 The Legal Toolbox If a consumer feels that they have been a victim of predatory lending and/or lending discrimination, here are some legal tools to redress the situation. The Federal Fair Housing Act: Title VIII is our nations primary civil rights law designed to ensure equal housing opportunity and fair lending. Congress intended this law to ensure equal access and nondiscrimination in lending on the basis of race, national origin, sex, disability, religion and familial status. It is unlawful for any person who engages in the lending, purchasing, selling, brokering, or appraising of residential real property to discriminate on the basis of the protected classes listed. Home Mortgage Disclosure Act (Regulation C): The intention of this Congressional Act enacted in 1975 and amended from is for lending institutions to provide the public with data to determine if the institution is serving the housing needs of all community residents. It was enacted to assist in identifying possible discriminatory practices in lending and to assist public officials in distributing public sector investments. HMDA requires most lenders to report the sex, race and income of mortgage applicants and borrowers. Regulation C requires lenders to report data regarding loan applications, including information on origination and purchases. Equal Credit Opportunity Act (Regulation B): ECOA was enacted to promote credit to applicants without regard to sex, race, color, religion, national origin, marital status, age, receipt of public assistance funds, or the exercise of any right under the Consumer Credit Protection Act in Under ECOA, Regulation B prohibits creditor practices that discriminate on the basis of these protected classes. Community Reinvestment Act: In 1977 the CRA was enacted to obligate depository institutions to meet the credit needs of low and moderate income neighborhoods. Truth In Lending Act (TILA): The liability of assignees is addressed under Section 131 of the Truth In Lending Act. 15 U.S.C. section Under this section, assignees are not immune from liability. An assignee will be liable for actual and statutory damages to the same extent as the originating lender if the Truth In lending violations is apparent on the face of the disclosure statement. 15 U.S.C. section 1641 (s). A Truth In Lending violation would include failure to properly designate a loan as a Section 32 high cost loan and make the relevant disclosure required by Regulation Z, section and the Home Ownership and Equity Protection Act of 1994 (HOEPA). Because of the exposure to assignee liability, assignees must exercise due diligence in purchasing loans. The Truth In Lending Act sets for the required level of due diligence. In the case of a mortgage loan, the assignee must review and compare the disclosure statement, any itemization of the amount financed, the note and any other disclosure of disbursements (such as the HUD - 1 Settlement Statement) to determine whether any errors were made by the originating lender. The assignee must also make certain that the disclosure statement follows the format and contains the terminology required by the Truth In Lending Act. Errors that are discoverable through due diligence are deemed apparent on the face of the disclosure statement. 16 U.S.C. section 1641 (e). Even if the Truth in Lending violation is not apparent on the face of the disclosure statement, a consumer who is entitled to an extended right of rescission under Section 125 of the Truth In Lending Act may assert that right against and assignee. 15 U.S.C. section 1641 c A servicer will not be subject to liability for a disclosure errors unless the servicer is or was the owner of the loan. 15 U.S.C. section 1641 (f)(1). Lenders should seek the advise of counsel with regard to potential assignee liability under those state high-cost loans laws which have been passed and become effective as of the date of this paper. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 14

15 Other protections include the Home Ownership and Equity Protection Act (HOEPA), the Fair Debt Collection Practices Act (FDCPA), and the Real Estate Settlement Procedures Act (RESPA), which are discussed extensively both earlier and later in this document. Factors to examine in assessing the merits of a consumer complaint: While price discrimination alone is insidious, it is often combined with abusive terms and conditions that compound the evils of predatory lending. Overpriced loans with abusive terms and conditions strip equity out of borrowers homes and often lead to foreclosure. Repeated direct mail solicitation, telephone marketing calls, adding requirements for co-signers, pre-payment penalties, inflated appraisal costs, to more technical issues such as negative amortization and even forging documents are all warning signs for a potential predatory loan. The following list is not meant to be exhaustive; it includes the major abuses associated with predatory lending. Prepayment Penalties A lender assesses prepayment penalties when a borrower either pays the remaining loan balance before the end of the loan term or refinances with another bank. In the case of prime loans, borrowers sometimes agree to prepayment penalties in exchange for a lower interest rate or lower loan fees. In the case of predatory loans, prepayment penalties become a trap, preventing many borrowers from shedding a high interest loan in favor of a prime loan and/or a lower interest loan. According to the recent HUD and Department of Treasury Task Force report on sub-prime lending, about 70 percent of sub-prime loans contain prepayment penalties. Balloon Payments A balloon payment is a loan payment that can equal all of the remaining loan balance or a large fraction of the initial balance. In prime lending, balloon payments can be used on second mortgages and other instruments to help finance the loan by making monthly payments lower. It is anticipated that a borrower s income will increase, making it feasible for the borrower to pay the balloon when it is due or to refinance the loan. In predatory lending, a balloon payment is another type of trap. Borrowers with high interest loans cannot pay the balloon when it is due and usually end up refinancing their loans. Predatory lenders will then often increase their interest rates and fees on the refinanced loans. Flipping Flipping refers to the practice of repeated loan refinancing with little or no benefit to the borrower. In a recent case, for example, a lender flipped a consumers loan five times in eight years, charging fees and points of about 10 percent on each refinancing. As a result, the loan amount increased from $26,000 in 1987 to $51,793 in Despite paying more than $100,000 over the life of the loan, the loan principal had increased, the lender commenced foreclosure proceedings against the homeowner. Credit Insurance If a borrower dies or becomes unemployed, credit insurance pays the outstanding loan balance. Borrowers of prime loans usually decide to obtain credit insurance after they close on their loans, and may or may not obtain credit insurance through their lender. Borrowers of prime loans also usually pay for credit insurance on a monthly basis. In contrast, predatory lenders persuade borrowers to pay for all of their credit insurance up-front via a single premium payment. Usually, the premium for credit insurance is added to the loan amount. Single premium credit insurance can equal as much as 20 percent of the loan amount. Fee Packing Predatory lenders will pack loans with unnecessary fees. In a recent case, the Attorney General of the State of New York found that the lender paid brokers fees that added 10 percent to the loan amount simply for inducing borrowers to accept excessive, above-market interest rates. In industry parlance, the practice of paying brokers kickback fees to induce borrowers to accept higher interest rates than the lender would normally offer is called yield spread premiums. Advocates and consumers should also be wary of shifting unsecured debt into mortgages, loans in excess of a loan-to-value of 100%, forced place insurance,compounding daily interest when payments are made after National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 15

16 the due date, and after the borrower has closed on the loan, abusive collection practices. All loans should have a tangible net benefit to the consumer. David Medine, Associate Director for Financial Practices of the Federal Trade Commission s (FTC) Bureau of Consumer Protection testified before the House Committee on Banking and Financial Services regarding predatory lending practices affecting home equity borrowers. He described the practices that concern the Commission, including equity stripping, packing and flipping. Equity stripping occurs when a loan is made based on the equity in a property rather than on a borrower s ability to repay the loan. Such loans are often designed to fail and result in the lender acquiring the borrower s home and any equity the borrower had in the home. Packing is the practice of adding credit insurance or other often unnecessary or not useful services to increase the lender s profit on a loan such as credit insurance. Flipping occurs when a lender induces a borrower to repeatedly refinance a loan, often within a short time frame, charging high points and fees each time. According to the testimony, sometimes these practices constitute unfair or deceptive practices and may violate one or more federal or state statutes such as the Federal Trade Commission Act (FTC Act), Truth in Lending Act (TILA) or the Home Ownership and Equity Protection Act (HOEPA), an amendment to TILA, the Equal Credit Opportunity Act (ECOA), the Fair Debt Collection Practices Act (FDCPA), and the Real Estate Settlement Procedures Act (RESPA). The growth of the sub-prime mortgage industry has been accompanied by a rise in predatory lending practices. Therefore, the FTC urged the Committee to consider expansion of HOEPA protections in four specific ways: (A) prohibit the financing of single-premium, or lump-sum, credit insurance premiums (as well as other loan extras ) in loans covered by HOEPA; (B) count lump-sum financed credit insurance premiums (and other extras) toward HOEPA s fees-based trigger; (C) provide the Commission and other law enforcers with the power to impose civil penalties for HOEPA violations; and (D) prohibit mandatory arbitration clauses in loans covered by HOEPA. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 16

17 NCRC HOEPA Fact Sheet Amending the Truth in Lending Act (TILA), the Home Ownership and Equity Protection Act of 1994 (HOEPA) defines high-cost loans based on interest rate and point and fee thresholds. It then prohibits or limits various practices that are often abusive and trap borrowers into high-cost loans. HOEPA, however, does not cover many loans at this point due to the high interest rate thresholds and its restricted coverage (it does not apply to home mortgage lending, for example). In December of 2001, the Federal Reserve Board adopted changes to its Regulation Z that implements HOEPA and TILA. Lending institutions must comply with these changes on October 1, 2002 (the regulatory changes are indicated below). Annual Percentage Rate (APR) and Points and Fees Triggers: HOEPA applies to loans with an APR of 10 percentage points above Treasury rates, or with points and fees that are greater than 8 percent of the loan amount or $400, whichever is greater. The $400 limit is adjusted annually for inflation. For 2002, the amount is $480. The Federal Reserve Board has the authority to lower the APR trigger to 8 percentage points above Treasury rates, as well as to prohibit or restrict mortgage lending practices it deems unfair and deceptive. In December of 2001, the Federal Reserve lowered the APR trigger to 8 percentage points for first mortgages and 10 percentage points above Treasury securities with comparable maturities for second mortgages. Coverage: HOEPA applies to all consumer credit transactions secured by a borrower s principal dwelling, other than purchase money mortgages, reverse mortgages, or open-end credit transactions. Definition of Points and Fees: Points and fees include all items included in the finance charge, all compensation paid to mortgage brokers, and other charges that the Board determines to be appropriate through regulation. In December of 2001, the Federal Reserve required the inclusion of credit insurance and other debt-cancellation coverage in the points and fees trigger. Credit insurance pays the mortgage in the event of death, accident, health problems or unemployment. Financing of Points and Fees: There is no restriction on the financing of points and fees under HOEPA. Disclosures: HOEPA requires additional disclosures three days before closing to ensure that borrowers are aware that loans covered by HOEPA are high cost loans. These key disclosures include the APR, the monthly payment, the amount of any balloon payment, and the total amount borrowed including any premiums for credit insurance. Under TILA, a borrower can rescind and cancel a loan three days after closing. If a borrower has a high cost loan covered by HOEPA, the borrower thus has six days to carefully consider the loan and decide whether to cancel it. Due on Demand Clause or Call Provision: In December of 2001, the Federal Reserve Board prohibited the use of due on demand clauses on HOEPA loans. Due on demand clauses allow the lender to require payment on the entire outstanding balance of the loan at any time. Flipping: Predatory lenders encourage borrowers to refinance often and then add points and fees to the loan with each refinance. In December of 2001, the Federal Reserve Board prohibited the refinancing of a HOEPA loan within one year by the lender that made the original loan, but not other third party lenders. The anti-flipping prohibition also applies to a purchaser of a HOEPA loan, or an assignee, or servicer of the loan within one year of the original loan. Affiliates of the lender are exempt unless the lender engages in a pattern or practice of the affiliate flipping loans in order to evade the anti-flipping rule. A lender, however, can refinance a loan within a year if doing so is in the borrower s interest. National Community Reinvestment Coalition Anti Predatory Lending Toolkit - Page 17