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| City
of Piqua Ohio |
Predatory Lending:
Tricks of the Trade &
How to Recognize Them
(From the Ohio
Department of Commerce -
Division of Financial Institutions and the
Ohio Office of Consumer Affairs |
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| Predatory
Lending & Its Tricks |
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| In today's lending market, more and more
people can qualify for a home loan or equity line of
credit. However, some unscrupulous lenders and brokers
have taken advantage of the situation to place borrowers in
unnecessarily costly and inappropriate loans for their own
financial gain. This is known as predatory lending.
While predatory lending can be found in all types of loans, it
generally happens in the subprime loan market. |
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| Subprime lending involves loans to
consumers who do not meet standard lending criteria, either
because of previous late payments, bankruptcy filings or an
insufficient credit history. These loans are priced
according to risk, with higher interest rates or higher fees
than standard credit products. This lending market allows
individuals who would not otherwise be able to purchase a home
to find financing. While subprime lending is not bad in
and of itself, it becomes a problem when predatory lending
practices or "tricks" become part of the
deal. |
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| Some of the main tricks of the trade are: |
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| Selling
the Monthly Payment |
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| Flipping by Repeated
Refinancing |
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| Growing the Debt |
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| Equity Stripping |
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| Over-Inflating the
Appraisal |
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| Insurance Packing |
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| Trapping the Mark |
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| Here's how they work ..... |
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| Trick
#1: Selling the Monthly Payment |
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| When dealing with loans, it is a mistake to
focus exclusively on the monthly payment - it's not the whole
story. Of equal or greater significance are - What is
the loan's interest rate and other finance charges as shown by
its annual percentage rate (APR)? How long will it last
and how much will it cost in total payments? Will the
regular monthly payments pay it off, or is there one large
balloon payment at the end? Is the a risk of the interest
rate going up, and how will it affect the monthly payment?
In addition, when comparing claims of savings over your current
mortgage payments, include the cost of setting aside the
property taxes and home insurance if these costs are currently
part of your monthly payments. Otherwise, it's comparing
apples to oranges. |
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| Trick
#2: Flipping by Repeated Refinancing |
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| This trick usually targets a person
who has already been overcharged by the same lender or
broker. It is an offer to refinance a high cost/high rate
loan at a slightly lower rate than the one they arranged
for the borrower within the past year or so. Since the
initial loan's interest rate is needlessly higher than the one
the borrower could qualify for, the borrower is soon contacted
and urged to refinance. The catch is that the borrower is
again charged, or more likely overcharged, for all the loan
origination fees, broker fees, points, and other closing
costs. The effect is that the consumer, who initially
sought to borrow, for example, $50,000, and ended up borrowing
$55,000 in order to finance the $5,000 in fees associated with the
first loan, is now borrowing $60,000 since the same $5,000 in
loan costs are again being charged. The consumer is now
carrying an additional $10,000 in debt just to get the loans. |
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| Trick
#3: Growing the Debt |
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Upstreaming and wrap-arounds are efforts by
lenders to grow the debt. Having borrowed a small amount
to purchase an appliance or another consumer good, consumers are
approached by the lender about borrowing more money. This
usually ends up in the lender having the consumer refinance
their mortgage and add in all their consumer debt for one loan payment
secured by their home. While debt consolidation can have advantages,
there are often serious risks as well. First, changing
regular consumer debt into a mortgage loan means non-payment can
now result in foreclosure and the loss of your home.
Second, the monthly "savings" from a lower payment as
a result of a mortgage consolidation or equity consolidation
loan will be quickly lost if you run up debt on the credit cards
you paid off.
Home improvement schemes also can lead to growing the
debt. High pressure door-to-door salespersons urge
homeowners to make expensive home improvements, which are funded
through a connected lender. But instead of financing only
the cost of the home repair, they seek to refinance the whole
mortgage and add in the cost of the repair. The reason is
that a loan origination fee of, for example, 2%, is worth a lot
more if the loan is for $55,000 than for $5,000. The
problem is that this "growing the debt" can result in
situations where, for example, you are paying $6,000 in points
and other loan fees to refinance the whole loan in order to get
the $5,000 you need to pay for the home improvement. Suddenly,
a $5,000 project costs $11,000. |
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| Trick
#4: Equity Stripping |
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| Equity stripping is where the lender is
depending more upon the value of the property to repay the loan
than on the borrower's actual income or ability to repay the
loan. As long as the value of the home at a foreclosure
sale exceeds the amount of the loan, the lender will be made
whole. Meanwhile, you as the borrower will be left without
a home when you default. Sometimes, borrowers are encouraged
to overstate their income in order to qualify for the
loan. This is illegal, and cannot change the fact that the
loan payments remain beyond the borrower's ability to repay. |
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| Trick#5:
Over-Inflating the Appraisal |
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| Appraisals are undertaken by the lender to
make sure that the value of the property will likely pay off the
loan in case the borrower defaults. Their purpose is to
protect the lender, not necessarily you as the borrower.
If the initial appraisal indicates the home does not have enough
value to support the loan, the mortgage broker might suggest
that another more "friendly" appraiser come in to take
a second look. While it might seem like an inflated
appraisal is to your benefit, it does have its downside,
particularly in the subprime market. First, the greater
the alleged value of the property securing the loan, the greater
the ability of the broker or lender to suggest or obtain higher
fees. (i.e. Five percent of $55,000 is greater than five
percent of $45,000.) Similarly, if a broker can get a lender
to loan $60,000 when you are only seeking $45,000, the extra
cash can be used as an inducement to go forward with the loan
while being a vehicle to pay additional fees, in effect
splitting the "windfall." You, for example, get
an additional $7,500 in money to do what you like, while $7,500
in fees is tacked on to the loan to be financed. Second,
an over-inflated appraisal makes it difficult to refinance the
loan later through a lower-rate mortgage. Then, if your
credit improves or rates drop and you wish to refinance, it may
be impossible to find another lender. Thus, you become
locked into a subprime loan. |
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| Trick
#6: Insurance Packing |
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| Credit insurance is a highly profitable
product for most mortgage lenders; therefore, some lenders push
borrowers to buy such products. Consumers need to shop
around and see if other lenders offer better terms, or determine
if existing insurance coverage they may have would already accomplish
the same purposes. Multiple credit insurance products may
be offered to some consumers where they are unneeded or
unsuitable. Credit life insurance, credit disability
insurance and credit unemployment insurance are the most common
forms of credit insurance. For example, it would be wholly
inappropriate for a nonworking retired senior citizen who is
refinancing his or her house to purchase credit unemployment
insurance. |
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| Trick
#7: Trapping the Mark |
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| For a borrower in the subprime loan market,
the goal should be to re-establish one's credit and, if
possible, refinance the loan at a much lower rate. Large
prepayment penalties can hinder refinancing, as can borrowing
based on an inflated appraisal. A subprime consolidation
loan with a balloon payment can also be a credit trap if
borrowers fail to change their spending habits and run up the
same credit card debts they had initially paid off. The
effects of these loan terms, especially when combined with
unreformed spending habits on the part of the consumer, ensure
the consumer will remain trapped in the subprime,
high-rate/high-cost mortgage market. |
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| If You Need Assistance
Please Contact: |
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Office of Consumer
Affairs
Consumer Lending Toll-Free Hotline
1-866-278-0003 |
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Division of Financial
Institutions
Office of Consumer Affairs
77 South High Street
21st Floor
Columbus, OH 43215-6120
www.com.state.oh.us |
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Housing Rehab
201 W Water St.
Municipal Government Complex - 2nd Floor
Piqua OH 45356
937-778-2062
e-mail
Housing Rehab
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