Key to the understanding of the current issues facing the mortgage lending industry is the distinction between “subprime” lending and the oft-unmentioned “predatory” lending. A subprime loan, also known as a “second chance” loan, is tailored to borrowers with “less than perfect credit,” credit problems, or who are less likely to qualify for conventional home loans. Many times, it is the only option for home & mortgage loans philadelphia Pennsylvania home ownership that the borrowers have. The loans are typically short term, and generally extend over a two to four year period. The loans come with higher interest rates and fees, which is standard for any line of credit approved for higher-risk borrowers. Most important, however, is the fact that these loans are intended to allow the borrowers a chance to pay back debts and clean up their credit. At the end of the lending period, the borrowers should be able to qualify for or refinance into a loan with a lower rate and risk from a major bank.
Predatory lending involves engaging deception or even fraud, through misinforming and manipulating the borrower. This often involves pushing aggressive sales tactics onto naïve consumers, and taking advantage of any lack of understanding. The predatory lender does not care about the borrowers’ ability to repay. It occurs in both the prime and subprime market, but thrives in the latter due to the greater amount of oversight that prime lenders (typically banks or credit unions) provide. Predatory lenders use abusive loan practices that generally involve one or more of the following problems:
The Coalition for Responsible Lending recently estimated that predatory lending alone costs borrowers in the U.S. over $9 billion every year. A prominent indicator of the rise of predatory lending is the unprecedented increase in foreclosures across the United States. While interest rates were dropping from 1990 to 1998, the home foreclosure rate increased massively – rising 384%.
Why the differentiation? For starters, many consumer advocates and hard-line opponents of subprime lending have claimed that there was no distinction. This unfortunately blurred the line between lenders offering a second chance to the borrowers who need one and those lenders who target for the sole purpose of squeezing blood from the proverbial stone. While subprime lending creates homeowners, predatory lending eliminates them. Predatory lending is most prevalent in the subprime market, but occurs across the entire lending spectrum. It affects middle- and upper-class in the same destructive way as it does the lower-class. The only requirements for a predatory lender are that his victims must have two things: financial problems and a lot of equity in their homes.
A perfect example of predatory lending is found in the story of Ken and Pat Leahy, who live in the suburban Chicago town of Glenview, Illinois. The couple is currently fighting a business that conducted “mortgage rescue” operations, which is another term for one of the numerous predatory lending scams. The couple lived in the same house for forty-seven years, and had refinanced several times (as many Americans do) to build onto the house and send their daughters to college. In March of 2002, Ken lost his job. After struggling for a while to make their $1,700 mortgage payments and receiving numerous solicitations from lawyers and loan brokers, the couple decided to meet with Harrison & Chase. The business advertised itself as a “foreclosure mitigation firm,” and pledged that its services were provided “free and pro bono.” As the couple sat down to meet with Mr. Hantzakos, a company rep now named as a defendant in their lawsuit, he assured them that they should not worry because he “talk[s] to different people than [they] do.” The couple then hesitatingly signed two forms – one which authorized Harrison & Chase to negotiate on their behalf, and another that was an exclusive deal to help the Leahys sell their home.
The Leahys never received a copy of either form. After the supposed meetings with the couple’s lender failed, Mr. Foxx, the president of Harrison & Chase contacted the couple and offered them a new idea. Foxx told them that they could put their home in a “protected trust,” which would protect them from creditors while Ken found a new job, they improved their borrowing power, and refinanced. Though the trust would have the power to sell their home, the Leahys were assured that they would have the first chance to buy it back.
While the couple had not intended to give up the title to their home of nearly fifty years, they unfortunately did exactly that. They learned that they had sold their home for $230,000 in an area which they at the time could have gotten over $500,000 for the same property. After satisfying their mortgage with the $230,000 for which they sold the house to Harrison & Chase and paying property taxes, the Leahys walked away with only $10,361. Adding insult to injury was the fact that the couple would up paying $2,500 per month to rent their own home back from the “rescuers,” and agreed to pay nearly $300,000 to buy their beloved home back. Unfortunately, due to another series of unfortunate hospital visits, the Leahys cannot afford that.
The Leahys are not alone, either. Predatory lenders have been taking advantage of sentimentality and human attachments to property all over the country, using “sales leaseback” schemes like Harrison & Chase. All a potential victim needs is exactly what the Leahys had: financial problems and a lot of equity in their homes. Until these operations are squeezed out by the increase in oversight effectuated by the mortgage bust, borrowers must not make the same mistake as the Leahys. Both new and veteran homeowners who find themselves in financial trouble must sort through the frustration and educate themselves. Seeking independent legal and financial advice is paramount, and there are many private and public outlets in which to do so.
MERGING CRIME WITH CAPITALISM
In addition to highlighting the predatory lending that had been taking place, the bust in the real estate market turned the spotlight on potential criminal activity in the real estate market. For example, New York Attorney General Andrew Cuomo has filed suit against the real estate appraisal unit of First American Corporation – a Fortune 500 company. Attorney General Cuomo believes that the practice is “widespread” and has been a large contributor to the crash in the market.
The lawsuit against First American alleges that the company inflated the values of homes in order to get more loans approved. The mortgage companies were apparently pressuring the appraisers to do so. Such a practice makes it very easy for borrowers to either overpay for a home or borrow too much against their current home. Therefore, when home prices began falling, the borrower would be unable to refinance if his house ended up being worth much less then he had thought at the time of purchase.
More recently, mortgage lending fraud in Pittsburgh has been picked up by the national newswire. U.S. Attorney Mary Beth Buchanan announced on April 10, 2008 that two mortgage brokers pleaded guilty in federal court to mortgage fraud charges. The two brokers, Aaron Thompson and Randy Carretta, operated People’s Home Mortgage. While the stated purpose of the business was to “assist borrowers in obtaining financing to purchase homes,” the duo instead submitted for borrowers applications containing patent misrepresentations about the borrower’s financial condition. The applications also included inflated appraisals of the properties prepared by unlicensed appraisers and falsified employment documents. Sentencing is scheduled for September 2009, and the two are each facing the possibility of $250,000 in fines and twenty years in prison. The two convicts are only a drop in the growing pond, however, and are not the only ones to blame for the subprime lending crash.
Laissez-Faire lending oversight and standards also provided an avenue for “fraud for profit.” In one New York case, the FBI has charged twenty-six people for fraud. The defendants allegedly used stolen identities, invented buyers, and inflated appraisals in order to obtain over $200 million worth of properties. Several other similar operations have been eliminated by law enforcement – in an Ohio case, almost half of all the mortgages processed by a single broker did not make a single payment. Unfortunately, many other fraudulent borrowers and lenders will get away with it, because the money is “out of the door” and there is no recovery to be had.
For many investors, the growth and rapid bust of the lending industry reminds them of the savings and loan crisis of the early 1990s. That crisis ended with the federal government pumping the market with a bailout of $150 billion, and a small number of high-profile fraud convictions. Presently, however, the major losers in terms of real dollars have been the hedge funds. Though these funds are in theory only limited to the more wealthy investors, small business and borrowers alike could soon feel the famous “trickle-down” effect. The present administration is considering its available options and will probably end up pressured into out lending companies, the borrowers facing foreclosure, or both. In the meantime, class action litigation has begun, and will not end anytime soon.
ADDRESSING THE PROBLEM IN CONGRESS
On October 22, 2007, Representatives Brad Miller (D-NC), Mel Watt (D-NC), and Barney Frank (D-MA) introduced “The Mortgage Reform and Anti-Predatory Lending Act of 2007.” The stated purpose of the Act is to “reform consumer mortgage practices and provide accountability for such practices, to establish licensing and registration requirements for residential mortgage originators, to provide certain standards for consumer mortgage loans, and for other purposes.” The purpose of the Act, in summary, is to place a substantial burden on mortgage lenders while vaguely ignoring any irresponsibility in borrowing.
Title II of the Act is entitled “Minimum Standards for Mortgages.” Under this Title, no mortgage lender is allowed to make a residential mortgage loan unless it makes a “reasonable and good faith” determination that the borrower has a “reasonable ability to repay” the loan. The basis for such a determination would have to be the borrower’s credit history, current income, expected income, current obligations, debt-to-income ratio, employment status, and “other financial resources.” There is also a rebuttable presumption against the mortgage lender, under Section 203 of the Act.