Borrower beware: a look at predatory lending

After Chris and Shannon Mitchell (their names have been changed for this story) took out a home equity loan from a local, reputable bank two years ago, they felt their most valuable asset rested in good hands.

"Our loan officer was friendly. She said that she could help us out and we believed her," Chris said.

The Mitchells, who already had a loan with another local bank at the time, sought the additional financial assistance to pay off credit card bills. The home equity loan provided them with a $25,598 second mortgage at 14.1 percent interest, a 16.9 percent APR (annual percentage rate) and a $399 monthly payment. The loan also included $3,021 in fees and closing costs and $4,225 in credit insurance.

It all looked legit to the Mitchells. Then their loan officer bought them a new car, sort of.

The couple said after they inquired about a car loan, the loan officer took it upon herself to finance a 2000 Chevy Silverado by paying off their preexisting loan with the other bank.

"I said, 'Youve got to be kidding me.' I just thought we'd agreed to a home equity loan. I didn't think they would touch the [other] mortgage," Chris said.

The Mitchells found themselves saddled with a new mortgage for $162,651 as well as $8,577 in closing costs and monthly payments of about $2,000 -- not to mention an unwanted pickup truck with no paperwork, no warranty and a faulty engine. The couple said they felt pushed into a hole of insurmountable debt.

Then, this spring, the couple received a mailing from the Minnesota Don't Borrow Trouble campaign that listed the warning signs of predatory lending. Shannon realized they'd been scammed.

"All the signs were there," Shannon said. "I was so embarrassed." Eventually, the couple's worked up the courage to visit the advocacy group listed on the mailing, ACORN, the Association of Community Organizations for Reform Now in St. Paul.

Program Director Jordan Ash helped them refinance with Ameriquest. The new loan has a 7 percent interest rate with monthly payments of less than $700.

Today, the Mitchells are back on more stable financial footing, but many other borrowers are not. According to a November 2002 report by Minnesota ACORN, predatory lending in refinance loans alone affects more than 1,000 Minneapolis homeowners every year.

What is predatory lending?

The federal department of Housing and Urban Development defines predatory lending as a practice in which the lender "provides misinformation, manipulates the borrower through aggressive sales tactics, and/or takes unfair advantage of the borrower's lack of information about the loan terms and their consequences."

Most commonly, predatory lenders bury prepayment penalties in their mortgage contracts. Penalties -- sometimes as high as $10,000 -- are built in for paying off all or some of a loan in advance, effectively preventing consumers from refinancing into a lower interest loan. Predatory lenders use vaguely worded contracts to mislead their customers.

Some predatory lenders practice "loan flipping" -- repeatedly refinancing borrowers' loans over a short period of time. With each successive refinancing, the broker imposes expensive fees that reduce the borrower's home equity.

Under the federal Real Estate Settlement Procedures Act (RESPA), mortgage brokers must give the borrower advance notice if they intend to service the loan or transfer it to another lender. However, some lenders do not make their intentions clear until it is too late. Predatory lenders do not follow the traditional ethical practices most lenders do.

In another predatory lending practice, lenders give loans without regard for the borrower's ability to repay. In April of 2000, a task force assembled by the U.S. Department of Housing and Urban Development reported several instances in which high-cost loans were issued to senior citizens living off of modest, fixed incomes. "Such loans quickly led borrowers into default and foreclosure actions," the report stated.

Perhaps most disturbing is the predatory lending practice of "asset flipping." In such instances, an unscrupulous investor purchases a run-down house, makes cosmetic repairs, and conspires with an appraiser and a mortgage broker to inflate the property's value. Upon selling the home, the investor refers the buyer to his cohort, the mortgage broker. The homeowner's property value quickly plummets and he is forced to foreclose when he cannot repay the fraudulent mortgage price.

Hurting homeowners, and good businesses

"Elderly people are targets because they tend to be house-rich and cash-poor, which means they have home equity and need money," said Ash of ACORN. "In minority neighborhoods, predatory lenders are taking advantage of the years of discrimination that kept minorities from getting loans from mainstream banks."

Minnesota ACORN estimates that predatory lending costs Minneapolis homeowners $10 million in drained equity and excess interest every year.

But borrowers are not the only ones feeling the effects of predatory lending. Jeff Galban-Skenes, a US Bank loan officer, said predatory lenders hamper honest lenders' ability to do business. That's why US Bank, along with Bremer, Wells Fargo, TCF and members of the Minnesota Bankers Association, the Minnesota Credit Union Network and the Mortgage Association of Minnesota are funding the "Don't Borrow Trouble" campaign (see below) to decrease predatory lending.

"[Predatory lending] gives the lending industry a bad name. You have people who don't trust loan officers because of what they've heard about or experienced with predatory lenders," Galban-Skenes said.

Because predatory loans erode borrowers equity and decrease their credit rating, traditional lenders have trouble refinancing them. In the past year, Galban-Skarenes said he has been able to refinance just four or five victims of predatory lending. "But they were the lucky ones. Most aren't so lucky," he added.

Galban-Skarenes asserts that steps must be taken to clean up the subprime lending industry.

"There will always be a need for subprime lending. It allows people who fall below the standards of prime lending to get the loans they need. I'd like to see laws passed at the state and federal levels to regulate banks' lending practices," he said.

However, not all brokers agree. Steve Hartman of Loanpros Financial, 3010 Hennepin Ave. S., Ste. 274, said the existing legislation is excessive.

"The industry is so competitive that it polices itself," Hartman said. "Consumers have a responsibility, too; it shouldn't be all about policing the brokers."

Protecting yourself, the borrower

Although many banks and grass-roots groups alike agree that existing state and federal laws do not adequately regulate lending practices, passing legislation to clean up the lending industry has proved to be an elusive task.

In February, the United States Congress voted down the Responsible Lending Act, which intended to protect borrowers in the subprime market by establishing nationwide standards for lending.

This spring, the Minnesota House of Representatives rejected the Home Loan Protection Act of 2003. Sponsored by Senator Sandy Pappas and strongly backed by advocacy groups, the Home Loan Protection Act proposed explicit measures to forbid all predatory tactics and impose a criminal penalty for lender violations.

The city of Minneapolis' Public Safety and Regulatory Services Committee is presently looking into a strategy to combat predatory lending, and Mayor R.T. Rybak supports legislation at the state level as well.

How to avoid trouble In March, a coalition of over 50 organizations including banks, Realtors, law firms and nonprofit groups throughout the Twin Cities, including several organizations and banks in Southwest -- launched the "Don't Borrow Trouble" campaign to raise consumer awareness about predatory lending. The campaign operates a free advice hotline to educate borrowers about the lending industry, promoted through mailings and advertising, mostly on city buses and billboards.

Here are a few tips from Freddie Mac, a company created by Congress to facilitate home ownership and to help consumers avoid bum deals.

  • Do the homework. Shop around and compare different lenders' products. Ask for written estimates that include all points and fees.

  • Avoid solicitations for loans that sound too good to be true. If it sounds too good to be true, it probably is. If a solicitation is really interesting, get it in writing.

  • Use a home's equity carefully. Homeowners may be able to get some cash by repeatedly refinancing their homes, but they will lose equity in their homes. A loss of equity also occurs each time homeowners finance new points and fees.

  • Don't borrow more than needed. When refinancing, borrow only what is needed so the home's equity is protected.

    For more information, call the Don't Borrow Trouble line at 312-2020 or go to www.dontborrowtroublemn.org. for additional resources, go to http://www.freddiemac.com/corporate/consumers/antipred/.