In this space, we recently initiated a series of articles on mortgage fraud,
which the FBI says is now rampant. We began with a discussion of one aspect
of this broad crime, predatory
lending practices, by describing two of the more common predatory practices:
aggressive solicitation by the lender, and home improvement
scams. We continue today with a discussion of two more common techniques
used by the predatory lender.
Just a note about sub-prime lenders, a term we will use a lot. These are companies or individuals who are willing to assume a greater risk than a bank, credit union, or thrift institution in return for a larger, often excessive, profit. The risk might relate to a buyer with a higher level of consumer debt, less than perfect credit, or hard to verify or inconsistent income (self employment or lots of overtime). It could be a risky property, one in need of rehab or in a neighborhood being (illegally) shunned by traditional lenders. It could be the loan itself that is risky. Many conventional lenders won�t touch a cash-out refinancing, certain types of construction or rehabilitation loans, or one with a very high loan to value (LTV).
Not all sub-prime lenders are bad. They can serve a useful purpose as long as a borrower is alert and informed. We are concerned here with the lending practices of the ethically challenged, those who often prey on vulnerable borrowers. Many sub-prime lenders flock to the industry in when home sales are skyrocketing and refinancing is the hot topic at every suburban cocktail party. Once the market cools, they crawl back under their rock.
Now, more about predatory lending practices.
3. Pushing for refinancing a lower interest rate mortgage. An unethical mortgage lender, once he has sold the buyer on a new loan, will start pitching a refinance of the first mortgage rather than granting the second mortgage the borrower originally sought. The lender argues for the convenience of a single mortgage payment or promotes the potential savings. The lender may, for example, initially promote a second mortgage at 10% but reduce that to 8% if the borrower agrees to a total refinance of the first mortgage loan.
The borrower will probably save on his monthly payment. A second mortgage is usually for a term of 10 or 15 years, a first mortgage is typically amortized over 30 years. Wrapping both into a total refinance of a first mortgage that may have only 20 years left to run, and amortizing the total amount over 30 years will usually result in a substantially reduced monthly payment, even if at a higher interest rate. In the long run, however, the borrower will pay tens of thousands of dollars in additional interest (plus the initial loan fees, usually wrapped into the loan) over the life of the loan and will strip much of the equity out of his home.
The lender, of course, did not just fall off of the turnip truck. In addition to the immediate profit from a larger loan, his real goal is to gain a first mortgage position on the home. A second mortgagee is always behind the first in the case of a foreclosure or bankruptcy, and may have to pay off the first mortgage in order to recover on its loan. A borrower who develops financial problems can default on a second mortgage with little fear of foreclosure if there is a substantially larger first mortgage in place and he continues to make payments on it. The second mortgagee will get paid eventually, but might have to wait until the property is sold.
4. Bait and switch. You know the term. It is most commonly used when a retailer advertises a great sale on a large screen television or new car. When the buyers flock to his store, that item is sold out or the ad was a mistake. However, the retailer has something �almost as good� that he will let go at a steal to make up for the confusion. Well this practice is rampant in lending as well.
Here are two examples of mortgage bait and switch.
A borrower commits to a mortgage under a set of terms: a certain interest rate, a fixed or adjustable mortgage with a specified frequency and method of adjustment; length of loan; and so forth. Then, at the closing table, the borrower realizes that the loan documents specify a higher rate, more frequent adjustment, a five year note with a balloon or other terms to which he was sure he had not agreed.
The loan originator does not answer his cell phone, the moving van is loaded, and the sellers are beginning to look real unhappy. Under such pressure, the borrower signs the documents while swearing to get the mess straightened out. But with a signed note and mortgage, it is now a legal issue that will take time and money and perhaps the courts to sort out.
Lest you think this could never happen to you, in a California study of 125 persons who borrowed from sub-prime lenders, 70% reported that a key element or elements of their loans changed negatively at closing.
Let me illustrate a second form of bait and switch with a true story.
Pam, a single mother (and ironically a woman with considerable experience in the mortgage field) was struggling with credit card debt and an increasing number college loans. She had an adjustable rate mortgage that had tumbled as far as it could, to a remarkable 5.25%, but it was unlikely to stay there and she know her well-paying job would probably end in less than a year.
She had toyed with the idea of a home equity loan, so when a mortgage company called her at home, she was curious enough to give them her financial information and allow them to run her credit, which she knew was excellent. They were back the next evening with a proposal, a two-stage deal. Since this was a cash-out refinance of her existing mortgage, it could not be a conventional Fanny Mae or Freddie Mac product. Instead, she would be simultaneously approved for the cash out at 10.5% through a sub-prime lender and for a 6% conventional loan with a well known nationwide lender. She would close on the higher interest loan first and then on the conventional refinance after the first loan had �aged� for a few months. Both transactions would, of course, carry broker fees and closing costs, but the end result would be manageable payments that would allow Pam to keep her house even if she eventually had to take a lower paying job.
Pam agreed to the proposal. Her house appraised higher than she had anticipated (another predatory practice), high enough to allow her to also pay off her auto loan. The 10.5% loan closed in May, and, even with the higher interest rate, her payment was several hundred dollars less than she had been paying on the old mortgage and installment loans. In July she inquired when she could move on to phase two, the conventional loan, that would drop her payments another $600 per month. She was told that her current loan would have to age another four months, into late November. By then she had received a date certain for a corporate-wide layoff, and began an increasingly frantic series of calls to the mortgage broker. How soon could they close on the new loan? After a few frustrating conversations, the office manager even intimated that she was making things up, her calls were no longer taken or returned.
Pam was laid off as scheduled; and, after weeks of searching, ended up with a commission-based job. Without verifiable income she could not qualify for a better loan. Within 18 months she had run through her modest savings and her 401K and lost her home to foreclosure.
Oh, by the way, she never heard from the mortgage company again.
We will continue with this series in the near future. In the meantime, if you have a story about mortgage fraud or predatory lending to share, please email contact us.