Benefits with Commonwealth of Virginia Members

Predatory Lending

The practice of offering dishonest, improper, or deceptive loans has become known as predatory lending. The term is generally used to refer to a variety of specific unethical or fraudulent lending techniques. It occurs primarily during collateral-secured transactions like home loans, but car loans, credit cards, and payday loans are also susceptible. Borrowers are convinced to accept financing that is unwanted, not beneficial, not affordable, or all of the above. Overall, common practices can include a combination of the following:

• High fees
• High interest rates
• Unclear loan terms
• Undisclosed or poorly disclosed loan terms
• Short or variable loan terms
• Additional, uncommon insurance premiums
• Balloon payments
• Unwarranted risk-based pricing
• Usury
• Prepayment penalties
• Targeted discrimination
• Steering

Many of the previously mentioned terms are not necessarily predatory by design, and legitimate loans may include their use. It is important to understand how the different terms can work together and how they can potentially create an abusive or unfair scenario for borrowers. Standard closing costs in the United States can range from two to five percent of the sales price.¹ It may be wise for cautious home buyers to double-check scenarios that exceed this general rule.

In addition there can be junk fees. Look for names like broker rebate, loan processing fee, application fee, mortgage rate lock fee, or underwriting fee. These fees are very common and are mostly above board, but this is an area where excessive fees can pile up.

Protection

The good news is that there are some common tools that can help consumers identify predatory lending practices. The Truth in Lending Act (TILA) requires the use of the annual percentage rate (APR), disclosure of fees via a good faith estimate, and more. These tools help to normalize the terms and expenses between different financial structures and can help consumers to compare offers made by lenders. The U.S. Department of Housing and Urban Development form HUD-1 or corresponding final closing statement is the final opportunity to see everything, but it is recommended that borrowers do their own review prior to the closing. Although many of the practices discussed here are not illegal, their unethical use can create significant financial handicaps for consumers.

Examples of Predatory Lending

Abusive methods that predatory lenders use cover wide range. Here are several categories:

Examples of Predatory Lending

Abusive methods that predatory lenders use cover wide range. Here are several categories:

• Inadequate or false disclosure—The lender hides or misrepresents the true costs, risks, or appropriateness of a loan's terms, or the lender changes the loan terms after the initial offer.
• Risk-based pricing—While all lenders depend on some form of risk-based pricing—tying interest rates to credit history—predatory lenders abuse the practice by charging very high interest rates to high-risk borrowers who are most likely to default.
• Inflated fees and charges—Fees and costs (such as appraisals, closing costs, and document preparation fees) are much higher than those charged by reputable lenders, and are often hidden in fine print.
• Loan packing—Unnecessary products like credit insurance which pays off the loan if a homebuyer dies—are added into the cost of a loan.
• Loan flipping—The lender encourages a borrower to refinance an existing loan into a larger one with a higher interest rate and additional fees.
• Asset-based lending—Borrowers are encouraged to borrow more than they should when a lender offers a refinance loan based on their amount of home equity, rather than on their income or ability to repay.
• Reverse redlining—The lender targets limited-resource neighborhoods that conventional banks may shy away from. Everyone in the neighborhood is charged higher rates to borrow money, regardless of credit history, income or ability to repay.
• Balloon mortgages—A borrower is convinced to refinance a mortgage with one that has lower payments upfront but excessive (balloon) payments later in the loan term. When the balloon payments cannot be met, the lender helps to refinance again with another high-interest, high-fee loan.
• Negative amortization—This occurs when a monthly loan payment is too small to cover even the interest, which gets added to the unpaid balance. It can result in a borrower owing substantially more than the original amount borrowed.
• Abnormal prepayment penalties—A borrower who tries to refinance a home loan with one that offers better terms can be assessed an abusive prepayment penalty for paying off the original loan early. Up to 80 percent of subprime mortgages have abnormally high prepayment penalties.
• Mandatory arbitration—The lender adds language to a loan contract making it illegal for a borrower to take future legal action for fraud or misrepresentation. The only option, then, for an abused borrower is arbitration, which generally puts the borrower at a disadvantage.

Specific Terms

Rescission—Three-day period after loan signing that gives the borrower the ability to decline the loan. It only applies to owner occupied refinances.

APR—Annual Percentage Rate is the expression of the interest rate and certain loan fees.

GFE—Good Faith Estimate is a document that lenders must provide within three business days after application. It gives the details of the proposed transaction including fees, rates, and loan amounts.

HUD 1—Closing statement that has the final, combined costs of the real estate transaction.

Adjustable rate loans—Loans with short term fixed periods followed by variable rate periods.

Tips & Best Practices

• Ask escrow for a preliminary HUD 1 statement so that you have an approximation of the costs. If there are significant discrepancies or omissions, you will have an opportunity to challenge the lender and/or have them make corrections.
• On owner occupied refinances, utilize your three-day right of rescission to review terms, fees, and even get second opinions on your closing statement.
• Make sure the benefit is clear to the borrower. Does this financing make sense? Are you saving on your monthly payment, getting cash to consolidate debt, financing a home improvement project, etc.?
• Borrowers should be wary of lenders that rush them to make a decision, unless it makes sense. Some examples that make sense: Expiring locks, Contracted closing dates, Expected large rate increases like the Fed going up significantly (uncommon), or discontinued programs.
• Make sure your home loan payment includes EVERYTHING. The Good Faith Estimate will include the base loan terms and the corresponding payment. Does it include your property taxes, homeowners insurance, flood insurance (uncommon), homeowner's or condo association dues? You need the real payment to plan your new budget.

Reference

1. Investopedia. (2012, April 22). 11 hidden costs of owning a home. Retrieved on August 17, 2023, from https://www.investopedia.com

Workplace Options. (Revised 2023). Predatory lending (B. Schuette, Ed.). Raleigh, NC: Author.