Also, while we touch lightly on some of the anti-predatory lending news that is out there, there are some real programs that are beginning to take hold. Freddie and Fannie each have nationwide efforts in place and there is a growing list of consumer protection activity at the state level. We will also take a look at some of these in the near future.
7. Prepayment Penalties
As the name suggests, these are extra costs written into the note which are triggered if the borrower pays of the loan before a specified date. The costs are usually a percentage of the amount borrowed and can be excessive. The usual time period is three to five years after origination of the note and can be a real deterrent to refinancing or even selling a property.
Prepayment penalties are, thankfully becoming rare (as evidenced by the refinancing mania of the last few years,) and a number of states have outlawed them completely. Still, it is always a good idea to check with your lender before signing the note.
8. Insurance Loading
Predatory lenders often market and sell various forms of credit insurance – credit life insurance, unemployment insurance, credit disability insurance – and some may insist that a borrower purchase one of more of these policies as a condition of the loan. The stated purpose, which may seem reasonable on its face, is that the lender needs to protect its investment against the possible death, disability, or involuntary unemployment of the borrower. Funny, isn’t that what the mortgage is supposed to do? The lender is already pretty well covered.
Even worse, some of these policies require a total payment up front and some are based, not on the amount borrowed, but on the total payments over the life of the loan (i.e. principal plus all interest payments,) which can easily quadruple the amount of insurance required.
Credit life insurance is a legitimate product although most experts will tell you there are a lot less expensive ways of protecting the roof over your families head. You may decide you want credit life, fine, as long as it is your decision. It would also be wise to buy your policy from someone other than your lender.
9. Mandatory Arbitration
This one is not as straightforward as padding closing costs or home improvement scams, nor is it necessarily always a bad thing. It is, however, a practice that is being banned, at least by the secondary market.
Arbitration clauses, inserted in the note, require borrowers to pursue any claims or grievances against a lender in arbitration, rather than in a court of law.
Arbitration can be a very good alternative in civil litigation, it is generally quicker and less expensive than a court suit, and frees up the legal system for other purposes, but it should be voluntary by both parties. The problems, from a borrower’s perspective, with forced arbitration are:
- The lender may use arbitration many times each year, the borrower only once, so the level of expertise is skewed, and the mediators who handle the cases may have a built in bias toward the lender.
- Mediators are usually lawyers but are not necessarily bound by the law nor do they always have to give reasons for their decisions.
- Proceedings are private and most decisions are not subject to appeal.
- Discovery (a demand that the other party provide documents or other evidence) is not necessarily a right but up to the mediator’s discretion.
- The aggrieved party may not be able to claim punitive or injunctive damages.
Both Freddie Mac and Fannie Mae have now recognized these problems and have
announced that they will no longer purchase mortgages containing mandatory arbitration
clauses. Freddie Mac’s ban on purchases went into effect on August 1,
Fannie Mae’s as of October 30.