5. Lending More Than a Borrower Can Afford.
You�ve seen the ads in your email box or on late night television: �Borrow 125% of your home�s value.� �Use your home to buy a new car (boat, a fabulous vacation, etc.) While these can be classified under Predatory Lending Practice #1, aggressive solicitation, they are also part of a more devastating practice, purposely granting and/or structuring a loan with monthly payments in excess of what the borrower can reasonably be expected to pay.
Beyond loaning at an over-the-top LTV (loan to value), there are other ways to structure a loan guaranteed to get a borrower in trouble:
- Disregarding income and debt. Predatory lenders ignore conventional guidelines regarding the borrower�s ratio of debt to income, or the level of income itself. If a borrower is obligated to pay 55% of his monthly income to principal, interest, and property taxes and another 20% to installment loans, medical, or other expenses, he is nearly bound to fail.
- Negative amortization. This is now illegal in many states and should be in all of them, but lenders can usually get away with selling �neg ams� to uninformed borrowers with little risk of prosecution. With a neg am, the borrower is required to pay less than the amount due each month, the balance being tacked on to the principal. Obviously, at some point, that swollen principal will come due.
- Interest only loans. Zero amortization is only slightly less dangerous than �neg ams.� The borrower makes a minimum payment for a period of time, that amount covering the interest, but paying nothing toward principal. After five or ten years, payments are accelerated to cover both interest and principal. This is usually legal and some bank home equity loans are structured along these lines.
A lender usually does this to virtually insure that the borrower will fall into default. When this happens, the lender is the first to know and can approach its customer to offer bailout refinancing, with more fees and probably yet a higher rate attached.
Under any of these scenarios, a borrower might refinance two or three times before ultimately losing the house to foreclosure or being forced to sell and, with the equity stripped from his home, walk away virtually empty handed.
Some lenders, usually called �hard money lenders�, grant a loan with the sole purpose of foreclosing. These guys usually lend no more than 50% of the value of the home (the 50% equity will ultimately be their profit) and tend to prey on the elderly who have owned their home for many years, or on formerly credit worthy homeowners suffering financial distress. We will talk about how these hard money lenders (and many other only slightly more reputable folks) get away with keeping all of a home�s equity when we discuss predatory loan servicing practices.
It is important to note that there are legitimate uses for a 125% home loan.
6. Loan Steering
This happens when a bank or mortgage company notifies a qualified borrower (we will call him Tom) that he is not, by reason of income, credit, or a host of other causes, some of which may, on their own, violate fair credit laws, qualified for a loan from that institution. This may be done as a routine practice by a predatory institution, or an honest bank may be the totally innocent instrument of a renegade employee. In the latter situation, the rejection is conveyed by a trusted loan officer (Bill) acting totally on his own. AND, it just so happens, Bill has a friend, �Joe� who might be able to help Tom with a loan.
Of course, the loan that Joe is able to arrange is quite different from what Tom imagined when he started the process. The interest rate is higher, usually much higher, than the rate offered by mainstream lenders, and the fees are a shock. But rejection by the bank has shaken him. Bill told Tom that, not only would his bank not lend to him, but neither would any bank or thrift, so Tom, who really wants to buy a house or desperately needs to consolidate his debts, is reluctant to approach and be embarrassed by yet another institution. While Tom is still thinking about it, Joe calls again, and promises to make it easy.
Then a host of the other predatory practices we have talked about come into play.
- Joe is aggressive, calling Tom every night to push the benefits of his product.
- The fees are to be wrapped into the loan amount, driving monthly payments up even further, perhaps beyond what Tom can reasonably afford.
- Tom has already been victim of one form of �bait and switch,� when he was handed off to Joe, but now Joe does it again, promising that �after a period of time� paying on the high interest loan, Tom will be refinanced into a better deal.
Of course you realize that Bill, the bank�s loan officer, and Joe are partners. Joe gave a kickback to Bill from the proceeds of Tom�s loan and, maybe even promises another down the line when Tom can no longer keep up the payments and must refinance with Joe, or loses his home to Joe�s �company.� The bank was probably as much a victim as Tom, losing his business and probably his good will.
Real life story. In the early 1990�s the Federal Deposit Insurance Corporation closed a $500 million dollar bank in Boston. In those days $500 million in assets did not indicate a huge bank, but it was a respectable size. It was, however, not a respectable bank. The local papers had long referred to it as �the mob�s favorite bank� and, indeed, it did have some interesting customers on its Christmas card list.
But the real story centered on a member of its Board of Directors. This gentleman, a building contractor by trade, ran a loan sharking operation out of one of the bank�s branches. He had access to all of the bank�s files (technically he shouldn�t have, but the employees were scared to death of him.) When he found an application that had been rejected by The Board of Directors (do you sense a pattern here � this guy did not need a partner) he contacted the borrower and, giving his title and claiming to represent a subsidiary of the bank, offered a loan at twice the going interest rate. When all of the paperwork was done, the director actually kicked the branch�s manager out of his office and used the office as a place to close the loan.
The director even had his own collections department although, by the time the bank was closed by the Feds, Frankie was serving life without parole for murder.
Let�s hope it wasn�t a hapless borrower.