Predatory Lending

Predatory lending has exploded in America, impacting many areas of daily life, from home mortgages to student loans to unauthorized lines of credit for small businesses. The result of predatory lending is families saddled with unmanageable debt, higher living costs, and damage to personal credit scores and business credit lines.

How can consumers protect themselves? This article will clue borrowers in to common predatory lender practices in real estate so home buyers and homeowners can steer clear of trouble.

What Is Predatory Lending?

According to the Office of the Inspector General “… Predatory lending typically involves imposing unfair and abusive loan terms on borrowers, often through aggressive sales tactics; taking advantage of borrowers' lack of understanding of complicated transactions; and outright deception."

Predatory lending imposes unfair and abusive loan terms on vulnerable people, usually those who are financially struggling, who have few loan options, who don't speak English as their first language, and who aren't financially savvy. Predatory lending disproportionately impacts people of color, immigrants, women, and older people.

While predatory lending can be criminal, that's not always the case. There are ways that mortgage brokers and unethical appraisers can legally take advantage of consumers.

If You Hear These Phrases, Proceed with Caution!

• “This is your only chance to get a loan to own a home."
• “We'll fill in the blank lines (on the sales contract or loan documents) later"
• “The Federal Housing Administration insurance protects you against loan fraud." (It does not.)
• “This refinance will solve your credit problems."
• You can get a good deal if you finance it with this particular lender."

Examples of Predatory Lending in Real Estate

The U.S. Department of Housing and Urban Development has provided guidance to prospective buyers who could be the victims of predatory lending or loan fraud. Their brochure, “Don't be a Victim of Loan Fraud" alerts buyers and sellers to the red flags that may signal they are working with a predatory lender, mortgage broker, or appraiser.

Borrower Beware

Encouraging Misrepresentation: Did a lender or broker encourage you to lie or misrepresent your income, expenses, or cash available for a down payment? An unscrupulous lender may encourage a potential borrower to provide a projected business income/expense sheet that projects a rosier financial picture than is reasonable for the borrower's business.

This rosy projection may not be an overt lie, but by pushing the bounds of what is realistic, it also pushes the bounds of what is ethical. If a lender is encouraging you to sign a self-attestation form that grossly exaggerates your anticipated cash flow, that is a red flag.

Knowingly Lending More than a Borrower Can Afford: A loan originator uses income information to determine loan eligibility and the applicant's ability to repay. They usually review two years' worth of pay stubs and tax returns to determine if there is a reasonable expectation that the borrower will continue to make enough income to pay on the loan. Is the income stable and dependable?

A lender may violate 7 CFR § 3550.53 by failing to consider all eligibility factors and failing to require full disclosure of a borrower's financial picture. That's a red flag that the lender doesn't care if you can afford the loan you will receive.

Balloon Loans and Interest-only Payments: There are several loan options that look good at the beginning and very bad by the end. For some buyers, these loans actually save money, but for most buyers, they can be burdensome. If your lender or broker is pushing you into a balloon mortgage or trying to entice you with interest-only payments without explaining all of the pros and cons, it's a red flag.

A balloon loan doesn't follow a consistent amortization schedule over the life of the loan. With a balloon loan, you make a balloon payment at the end. You may pay less at the beginning and more as you get closer to the maturity date. If your income is rising, that may be reasonable. If your income stagnates or you lose a job, you could find yourself in hot water.

Interest-only loans can be difficult to pay off because, during their "interest-only" phase, the principal remains the same. Until the loan is re-negotiated, none of the money the borrower has paid is applied to the principal. You owe as much as you did in the beginning, despite making timely and full payments.

Pre-payment Penalty: A pre-payment penalty punishes the borrower for paying off their loan early. It effectively locks the borrower into paying long-term interest. This is not a red flag. It's outright predatory lending and it's illegal unless the lender discloses this loan condition before the borrower signs the paperwork.

Discrimination: It's illegal under The Fair Housing Act (FHA) and The Equal Credit Opportunity Act (ECOA), but it still happens that some borrowers are offered higher interest loans because of their race or national origin and not their credit history. Your realtor or real estate attorney may be able to advise you of typical interest rates in your area. If the loan you are being offered is higher than that, you may want to speak to other lenders.

Charges for Nonexistent Products and Add-On Loan Services: When you are looking at the lengthy mortgage document that outlines all of the costs you will be paying to originate your loan, it's likely you will see many terms you don't understand, all of them with a dollar sign attached. If fees add up to more than 5% of your loan, you may want to question the loan officer.

Other “junk fees" that can sometimes be negotiated or removed entirely if you question them include application fees, underwriting fees, mortgage rate lock fees, loan processing fees, and broker rebate fees.

Consolidating Debt: The U.S. Department of Justice warns borrowers about the risk of home foreclosure if they agree to consolidate their home mortgage and credit card debt into a new loan with their home as collateral. It puts the family home on the line for repossession.

False Appraisals: A false appraisal can be an intentional act of fraud, such as when an appraiser deliberately overstates the value of a property in order to get more business from a realtor, seller, or buyer in the future.

An appraiser might just have “lax ethics" – selectively and deliberately choosing sales comparisons that come closer to the sales price the buyer wants to achieve. While this might help a borrower with their loan approval, the home buyer winds up with more debt than they needed to take on and the appraiser effectively becomes an accessory to a predatory lender. Due to their potential for intimate involvement in predatory lending, the appraiser might even be named as an additional defendant in a mortgage fraud lawsuit.

Homeowner Fraud Alerts

Cash-out Refinancing: This really egregious loan tactic targets vulnerable borrowers in need of cash, often due to medical issues, unemployment, or debt problems. When the borrower refinances, they receive cash in exchange for the equity in their home that they have painstakingly built over time.

The borrower can use that cash to pay down higher-interest debt, but their mortgage interest rate may be higher than what's available elsewhere. Worse yet, lenders may convince borrowers to do this again and again when they are once again in debt.

When the homeowner sells, they may see little gain for all of those years of payment. They can easily find themselves "underwater" on their mortgage, owing more than their home is worth.

Not all cash-out refinancing opportunities are predatory by default. In certain circumstances, cash-out refinancing can make financial sense.

Related Articles

• Mortgages and Your Rights to Fair Lending
• Mortgage Borrowers' Rights
• Fair Housing and Lending

Talk to a Real Estate Attorney

Unfortunately, predatory lending can turn the American dream of homeownership into a nightmare. To protect your interests before signing on the dotted line, do your research. See the related articles above for more information about your rights as a borrower.

If you believe you have been the victim of predatory lending, talk with a civil litigation attorney in your area. For cases of mortgage discrimination, contact a civil rights lawyer who handles discrimination cases.