Consumer Federation of California

FACT SHEET: Predatory Mortgage Lending

Special Note: For
those individuals needing assistance with a predatory loan contact a
HUD-certified mortgage counselor for assistance at 800-569-4287 or the
Home Ownership Preservation Foundation at 888-995-HOPE (4673).

Background: Homeownership, Predatory Lending and the Subprime Market

Low-income consumers have a huge disadvantage when it comes to buying a
home. Denied conventional home loans – the most important
wealth-building tool in this country – their only avenue is the
‘sub-prime’ credit market. These ‘predatory lenders’ target people with
impaired credit records – typically offering to refinance an existing
loan with initial ‘teaser’ rates often with no down payment, no income
verification required, no credit checks, yet include adjustable rate
mortgages with steep built-in rate and payment increases with excessive
or unnecessary fees, and more onerous prepayment penalties.

Predatory mortgage lending drains family savings, eliminates
the benefits of homeownership for a growing number of Americans, and
often leads to foreclosure. According to the Center for Responsible
Lending (CRL), from 1994 to 2005, the subprime home loan market grew
from $35 billion to $665 billion, and is on pace to match 2005’s record
level in 2006.

By 2006, the subprime share of total mortgage originations reached 23
percent, including 354,554 new foreclosure filings for the fourth
quarter alone, 47.5 percent higher than the fourth quarter of 2005.
Recent studies estimate that predatory market lending costs Americans
$9.1 billion each year.

The Big Lie: Subprime Loans DON’T Increase Home-ownership

According to CRL, in California, ‘subprime adjustable rate products
with discounted initial payments made homeownership temporarily
accessible, but didn’t increase long-term home ownership or necessarily
make homeownership any more affordable. Over the past nine years, the
subprime market has produced more than two trillion dollars in home
loans, but only a relatively small portion of these loans have
supported first-time ownership’the majority of subprime loans are
refinance loans.’

In other words, between 1998 and 2006, only about 1.4 million
first-time home buyers purchased their homes using subprime loans, yet
over 2.4 million borrowers who obtained subprime loans will lose or
have already lost their home to foreclosures in that same time period.
This means that since 1998, subprime lending has led to a net loss of homeownership for almost one million families ‘ with a net loss occurring in every one of the past nine years

California’s Foreclosure Crisis

A recent CRL analysis projects that 21.4 percent of all subprime loans
initiated in California in 2006 will result in foreclosure. Taking into
account the rates at which subprime borrowers typically refinance from
one subprime loan into another, this translates into foreclosures for
more than one-third of subprime borrowers.

Recent data compiled by DataQuick Information Systems in January 2007,
indicates that default notices jumped 145% in the last three months of
2006, accelerating a trend that began in late 2005 as home sales
started to cool.

Nine of the nation’s 15 metro areas with the highest projected
foreclosure rates for subprime loans originated in 2006 were in
California. Similarly, from 1998 to 2001, California metro areas had
the top 14 largest increases in home losses due to the subprime loan
industry.

Thousands of California consumers that were suckered into these
agreements with initially fixed interest rates are now seeing their
loans reset to a much higher level. Foreclosure activity soared an
annual 172.8 percent in California during the first quarter of 2007,
totaled 80,595 foreclosure filings in the January through March period,
the most in the country, according to RealtyTrac.

The impact on minority communities is even more concentrated in
California’s urban neighborhoods. The California Reinvestment Coalition
recently found that in most large cities in California, more than half
of African-American and Latino purchase borrowers received subprime
loans in 2005.

Factors Driving Foreclosures in the Subprime Market

According to CRL, mortgage brokers, who are responsible for
originating over 70 percent of loans in the subprime market, have
strong incentives to make abusive loans that harm consumers. Unlike
other similar professions, mortgage brokers do not believe they have a
fiduciary responsibility to the borrower who employs them. In most
states, they have no legal responsibility to refrain from selling
inappropriate, unaffordable loans, or not to benefit personally at the
expense of their borrowers

Michael Calhoun, President of CRL, stated, ‘The market, as it
is structured today, gives brokers strong financial incentives to
ignore the best interests of homeowners. Brokers and lenders are
focused on feeding investor demand, regardless of how particular
products affect individual homeowners. Moreover, because of the way
they are compensated, brokers have strong incentives to sell
excessively expensive loans ‘

In recent years, brokers have flooded the subprime market with
unaffordable mortgages, and they have priced these mortgages at their
own discretion. Given the way brokers operate today, the odds of
successful homeownership are stacked against families who get loans in
the subprime market. A report issued by Harvard University’s Joint
Center for Housing Studies, stated, ‘Having no long term interest in
the performance of the loan, a broker’s incentive is to close the loan
while charging the highest combination of fees and mortgage interest
rates the market will bear

Thus, lenders have been able to pass off a significant portion
of the costs of foreclosure through risk-based pricing, which allows
them to offset even high rates of predicted foreclosures by adding
increased interest costs. Further, the ability to securitize mortgages
and transfer credit risk to investors has significantly removed the
risk of volatile upswings in foreclosures from lenders. In other words,
high foreclosure rates have simply become a cost of business that is
largely passed onto borrowers and sometimes investors.

State Laws Against Predatory Mortgage Lending Work

According to another recent study by CRL, states that have implemented
strong consumer protections have enjoyed a significant drop in abusive
loans, with growing access to responsible subprime mortgages;
comparable or even lower interest rates; and the spread of better
lending practices nationwide. In fact, states with the strongest laws –
Massachusetts, New Jersey, New Mexico, New York, North Carolina, and
West Virginia – showed the largest declines in loans with predatory
terms. Predatory loans in many of the 28 states with some kind of
reforms against predatory lending dropped by almost a third. In
Massachusetts alone, that meant almost 600 fewer abusive loans a month.

These figures refute industry claims that tough anti-predatory loan
laws will decrease people’s access to credit. Data also shows that
borrowers in states with predatory lending regulations pay about the
same or even lower interest rates for subprime mortgages.

California has no laws protecting borrowers against predator lenders and
the Department of Corporations has never examined the underwriting
criteria used by state-regulated mortgage originators. The Department’s
25 mortgage licensee examiners simply can’t monitor the activities of
some 4,800 licensees originating $150 billion in mortgages each year.

Time for the California Legislature to Act

This foreclosure epidemic threatens not only individual families and
homeowners in California, but entire communities, neighborhoods and
local economies. Until recently, homeownership has served as a lifeline
for families to gain security, financial stability and wealth, but
high-risk nontraditional mortgage products and the lack of appropriate
regulation and oversight of the subprime industry are seriously eroding
the traditional benefits of owning a home.

It is imperative that California act to address the foreclosure
crisis and the collapse of the subprime market. Current borrowers
caught in the dept trap must be helped and tough regulations of the
subprime market must be enacted to prevent future foreclosure crises.

Helping Current Borrowers Caught in the Dept Trap: California
could take a number of positive actions, including: converting loans to
fixed-rate mortgages with affordable interest rates, writing down
principal loan balances, and waiving prepayment penalties.

Strengthening Mortgage Laws to Prevent Reoccurrence of Foreclosure Crises:
Suggested reforms CFC supports advocated by CRL include: Prohibit
exorbitant and abusive fees; ensure families get loans they can afford
to repay; eliminate kickbacks that reward brokers for steering
homeowners into unnecessarily costly loans; prohibit abusive prepayment
penalties on subprime loans; require counseling for high-cost loans;
limit the financing of fees in high-cost loans; prevent loan ‘flipping’
by requiring all refinance loans to provide homeowners with a
reasonable net benefit; protect homeowners’ ability to protect their
homes from foreclosure; and ensure homeowners have full access to the
court system to settle conflicts with lenders.

For more information (and a special thanks to), see Center for
Responsible Lending at https://www.responsiblelending.org/index.html and
the California Reinvestment Coalition at https://www.calreinvest.org/