[Senate Hearing 107-774]
[From the U.S. Government Publishing Office]
S. Hrg. 107-774
PREDATORY MORTGAGE LENDING:
THE PROBLEM, IMPACT, AND RESPONSES
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
ON
THE EXAMINATION OF THE PROBLEM, IMPACT, AND RESPONSES
OF PREDATORY MORTGAGE LENDING PRACTICES
__________
JULY 26 AND 27, 2001
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PAUL S. SARBANES, Maryland, Chairman
CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii JOHN ENSIGN, Nevada
Steven B. Harris, Staff Director and Chief Counsel
Wayne A. Abernathy, Republican Staff Director
Patience Singleton, Counsel
Jonathan Miller, Professional Staff
Daris Meeks, Republican Counsel
Geoff Gray, Republican Senior Professional Staff
Joseph Cwiklinski, Republican Economist
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
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THURSDAY, JULY 26, 2001
Page
Opening statement of Chairman Sarbanes........................... 1
Prepared statement........................................... 51
Opening statements, comments, or prepared statements of:
Senator Gramm................................................ 2
Senator Johnson.............................................. 5
Senator Reed................................................. 6
Senator Schumer.............................................. 6
Senator Miller............................................... 7
Senator Carper............................................... 8
Senator Stabenow............................................. 9
Senator Bennett.............................................. 11
Senator Dodd................................................. 12
Senator Bayh................................................. 14
Senator Allard............................................... 14
Prepared statement....................................... 52
Senator Corzine.............................................. 20
Senator Bunning.............................................. 53
WITNESSES
Carol Mackey, of Rochester Hills, Michigan....................... 12
Paul Satriano, of Saint Paul, Minnesota.......................... 14
Leroy Williams, of Philadelphia, Pennsylvania.................... 17
Mary Ann Podelco, of Montgomery, West Virginia................... 18
Thomas J. Miller, Attorney General, of the State of Iowa......... 29
Prepared statement........................................... 53
Stephen W. Prough, Chairman, Ameriquest Mortgage Company,
Orange, California............................................. 31
Charles W. Calomiris, Paul M. Montrone Professor of Finance and
Economics,
Graduate School of Business, Columbia University, New York, New
York......................................................... 35
Original prepared statement.................................. 81
Revised prepared statement................................... 101
Martin Eakes, President and CEO, Self-Help Organization
Durham, North Carolina......................................... 40
Prepared statement........................................... 120
Additional Materials Supplied for the Record
Letter to Senator Paul S. Sarbanes from Paul Satriano, dated
August 9, 2001................................................. 143
Statement of Elizabeth Goodell, Counsel, Community Legal Sevices
of Philadelphia, on behalf of Leroy Williams, dated July 26,
2001........................................................... 147
Statement of Daniel F. Hedges, Counsel, Mountain State Justice,
Inc., on behalf of Mary Podelco, dated July 26, 2001........... 147
Ameriquest Mortgage Company Retail Best Practices, submitted by
Stephen W. Prough.............................................. 149
Statement of America's Community Bankers, dated July 26, 2001.... 154
Letter to Senator Paul S. Sarbanes from Fred R. Becker, Jr.,
President and CEO, National Association of Federal Credit
Unions, dated July 24, 2001.................................... 163
Statement of Gale Cincotta, Executive Director, National Training
&
Information Center, National Chairperson, National People's
Action,
dated July 25, 2001............................................ 166
Statement of Allen J. Fishbein, General Counsel, Center for
Community Change, dated July 26, 2001.......................... 173
Letter to Senator Paul S. Sarbanes from Gary D. Gilmer, President
and CEO, Household International, Inc., dated July 26, 2001.... 179
Letter to Senator Paul S. Sarbanes from Susan E. Johnson,
Executive
Director, RESPRO', dated August 2, 2001............. 184
Letter to Senator Paul S. Sarbanes from Tom Jones, Managing
Director
and Amy Randel, Director of Governmental Relations, Habitat for
Humanity International, dated August 13, 2001.................. 190
``A Prudent Approach To Preventing `Predatory' Lending'' by
Robert E. Litan................................................ 193
Statement of Bruce Marks, Chief Executive Officer, Neighborhood
Assistance Corporation of America.............................. 210
Letter to Senator Paul S. Sarbanes from Richard Mendenhall,
President, National Association of Realtors', July
25, 2001....................................................... 224
Letter to Senator Paul S. Sarbanes from Jeremy Nowak, President
and CEO, and Ira Goldstein, Director, Public Policy & Program
Assessment, The Reinvestment Fund.............................. 226
Statement of Jeffrey Zeltzer, Executive Director, National Home
Equity Mortgage Association, dated July 26, 2001............... 232
----------
FRIDAY, JULY 27, 2001
Opening statement of Chairman Sarbanes........................... 241
Prepared statement........................................... 288
Opening statements, comments, or prepared statements of:
Senator Miller............................................... 243
Senator Stabenow............................................. 243
Prepared statement....................................... 288
Senator Corzine.............................................. 244
Senator Carpo................................................ 254
Senator Dodd................................................. 259
Senator Carper............................................... 259
Senator Santorum............................................. 267
WITNESSES
Wade Henderson, Executive Director, Leadership Conference on
Civil Rights................................................... 244
Prepared statement........................................... 289
Judith A. Kennedy, President, The National Association of
Affordable
Housing Lenders................................................ 247
Prepared statement........................................... 294
Response to written questions of Senator Miller.............. 416
Esther ``Tess'' Canja, President, American Association of Retired
Persons........................................................ 249
Prepared statement........................................... 296
Response to written questions of Senator Miller.............. 417
John A. Courson, Vice President, Mortgage Bankers Association of
America, President and CEO, Central Pacific Mortgage Company,
Folsom, California 250
Prepared statement........................................... 311
Irv Ackelsberg, Managing Attorney, Community Legal Services,
Inc.,
testifying on behalf of the National Consumer Law Center, the
Consumer
Federation of America, the Consumer Union, the National
Association of
Consumer Advocates, U.S. Public Interest Research Group........ 252
Prepared statement........................................... 317
Response to written questions of Senator Miller.............. 420
Neill A. Fendly, CMC, Immediate Past President, National
Association of
Mortgage Brokers............................................... 254
Prepared statement........................................... 340
Response to written questions of Senator Miller.............. 425
David Berenbaum, Senior Vice President, Program and Director of
Civil
Rights, National Community Reinvestment Coalition.............. 257
Prepared statement........................................... 344
Response to written questions of Senator Miller.............. 428
George J. Wallace, Counsel, American Financial Services
Association.................................................... 259
Prepared statement........................................... 378
Lee Williams, Chairperson, State Issues Subcommittee, Credit
Union
National Association, and President, Aviation Association
Credit Union,
Wichita, Kansas................................................ 262
Prepared statement........................................... 384
Response to written questions of Senator Miller.............. 438
Mike Shea, Executive Director, ACORN Housing..................... 264
Prepared statement........................................... 398
Additional Materials Supplied for the Record
Statement of the American Land Title Association................. 440
Statement of the Consumer Bankers Association, dated July 27,
2001........................................................... 441
Statement of the Consumer Mortgage Coalition, dated July 27, 2001 445
Letter to Senator Paul S. Sarbanes from Brian A. Granville,
President
Appraisal Institute, dated July 27, 2001....................... 468
Letter to Senator Paul S. Sarbanes from Maude Hurd, National
President, ACORN, dated August 9, 2001......................... 481
Statment of Richard Stallings, President, National Neighborhood
Housing Network................................................ 489
Statement of Marian B. Tasco, Councilwoman, Ninth District, City
of Philadelphia, Pennsylvania.................................. 492
PREDATORY MORTGAGE LENDING:
THE PROBLEM, IMPACT, AND RESPONSES
----------
THURSDAY, JULY 26, 2001
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:05 a.m., in room SD-538 of the
Dirksen Senate Office Building, Senator Paul S. Sarbanes
(Chairman of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES
Chairman Sarbanes. The hearing will come to order.
Today is the first of two initial hearings on predatory
mortgage lending: the problem, the impact, and the responses.
This morning, we will first hear from a number of families that
have been victimized by predatory lenders. Later this morning,
and again tomorrow morning, an array of public interest and
community advocates, industry representatives, and legal and
academic experts will discuss the broader problem and the
impact that predatory lending can have not only on families,
but also on communities.
Homeownership is the American Dream. It is the opportunity
for all Americans to put down roots and start creating equity
for themselves and their families. Homeownership has been the
path to building wealth for generations of Americans. And in my
view, it has been the key to ensuring stable communities, good
schools, and safe streets.
Predatory lenders play on these homes and dreams to
cynically cheat people of their wealth. These lenders target
lower income, minority, elderly, and often unsophisticated
homeowners for their abusive practices.
Let me briefly describe how predatory lenders and brokers
operate. They target people with equity in their homes, many of
whom may be feeling the pinch of consumer and credit card
debts. They underwrite the property, often without regard to
the ability of the borrower to pay the loan back. They do not
use the normal underwriting standards. In fact, they ignore
them altogether. They make their money by charging extremely
high origination fees and by packing other products into the
loan, including upfront premiums for credit life, disability,
and unemployment insurance, and others, for which they get
significant commissions right at the outset, but for which
homeowners continue to pay for years since it is folded into
the mortgage.
The premiums for these products get financed into the loan,
greatly increasing the loan's total balance amount. As a
result, and because of the high interest rates being charged,
the borrower is likely to find himself in extreme financial
difficulty.
As trouble mounts, the predatory lender will offer to
refinance the loan. Unfortunately, another characteristic of
these loans is that they have high prepayment penalties. So, by
the time the refinancing occurs, with all of the fees repeated,
the prepayment penalty included, the lender or broker makes a
lot of money from the transaction and the owner finds that they
are being increasingly stripped of their equity and, in the
end, it may well be their home.
Nearly every banking regulator, Federal and State, has
recognized this as an increasing problem. And I believe,
predatory lending really is an assault on homeowners all over
America.
Now I want to make one thing clear. These hearings are
directed toward predatory lending practices. There are people
who have credit problems who still need and can justify access
to affordable mortgage credit. They may only be able to get
mortgage loans in the subprime market, which charges higher
interest rates. Clearly, to get the credit, they will have to
pay somewhat higher rates because of the greater risk they
represent.
So, we make the distinction. We recognize that there is a
subprime lending industry that is performing an important
function. But we are concerned to get at those within that
industry who are engaging in these abusive practices. Families
should not be charged more than the increased risk justifies.
Families should not be stripped of their home equity through
financing of extremely high fees, credit insurance, or
prepayment penalties. They should not be manipulated into
constant refinancings, losing more and more of their equity and
of their wealth that they have taken a lifetime to build up,
but which is consumed by each set of new fees by each
transaction. They should not be stripped of their legal rights
by mandatory arbitration clauses that block their ability to
appropriate legal redress.
Some argue there is no such thing as predatory lending
because it is a practice that is hard to define. Perhaps the
best response to this was given by Federal Reserve Board
Governor Edward Gramlich, who said earlier this year:
Predatory lending takes its place alongside other concepts,
none of which are terribly precise--safety and soundness,
unfair and deceptive practices, patterns and practices of
certain types of lending. The fact that we cannot get a precise
definition should not stop us. It does not mean this is not a
problem.
Others, recognizing that abuses do exist, contend that they
are already illegal. According to this reasoning, the proper
response is improved enforcement.
I support improved enforcement. The FTC, to its credit, has
been active in bringing cases against predatory lenders for
deceptive and misleading practices. However, because it is so
difficult to bring such cases, the FTC further suggested last
year a number of increased enforcement tools that would help to
move against the predators. I hope that we will get an
opportunity to discuss those proposals as these hearings
progress.
I also support actions by regulators to utilize the
authority under existing law to expand protections against
predatory lending. That is why I sent a letter signed by my
colleagues on the Committee strongly supporting the Federal
Reserve Board's proposed regulation to strengthen consumer
protections under current law.
Campaigns to increase financial literacy and efforts within
the industry to engage in best practices are also important
parts of any effort to combat this problem. Many industry
groups have contributed time and resources to educational
campaigns of this sort or developed practices and guidelines,
and I welcome this as part of a comprehensive reform to the
problem of predatory lending.
Neither strong enforcement, nor literacy campaigns are
enough. Too many of the practices we will hear outlined this
morning and in tomorrow's hearings, while extremely harmful and
abusive, are technically within the law. And while we must
aggressively pursue financial education, we also recognize that
education takes time to be effective.
Again, I want to reiterate that subprime lending is an
important part of the credit markets. But such lending needs to
be consistent with and supportive of the efforts to increase
homeownership, build wealth, and strengthen communities. And in
the face of so much evidence of abuse and of so much pain, we
must work together to address this crisis and that is what we
are setting out to do by launching these hearings this morning.
Senator Gramm.
STATEMENT OF SENATOR PHIL GRAMM
Senator Gramm. Mr. Chairman, thank you for holding these
hearings.
Let me say that one of the blessings of living in a strong
economy, with a healthy savings rate that is made considerably
better by the Federal Government running a surplus, is that for
the first time in American history, we have an active outreach
program by private lenders to lend to people who, under
ordinary circum-
stances, would have a difficult time borrowing money, people
who would end up borrowing from other sources such as, kinfolks
or in the backstreet market where abuses would be substantial.
Let me assure you, Mr. Chairman, that I am committed to
cracking down on crooks and people who abuse the system and who
abuse borrowers.
I want to be absolutely certain that in trying to get at
the bad guys we do not put into place policies that destroy a
market that is serving an increasing number of people.
We will hear later today that the default rate in some
areas of subprime lending is as much as 23 percent. That is a
massive default rate, the good news is that 77 percent of those
borrowers did pay the loan back, and they, in doing so,
established good credit.
This is something that I feel very strongly about. Fifty-
two years ago, my momma bought a house. She had three children
and no husband. She was a practical nurse who worked in a
system that when your number came up, you got to take the job.
And so, she did not have, for all practical purposes, a
full-time job. She borrowed for a house that cost $9,200. She
borrowed this money from a finance company, and she paid 50
percent more than the market rate for that loan. Now some
people would say, prima facia, that was an abusive loan, that
it was predatory lending. I would beg to differ.
First, my mother was the first person that I am aware of
since Adam and Eve, in our branch of the human family, who ever
owned the dwelling where she lived. She paid off that loan, and
52 years later, her credit is golden. Any bank in Columbus,
Georgia would lend my momma money because in all her 52 years
of record there was never a time when she has ever borrowed a
penny that she has not paid back.
Now my point is the following. We have to be very careful
in trying to deal with an abuse that exists so that we do not
create a situation where credible lenders, non-abusive lenders,
good lenders will get out of the subprime market.
If we end up doing that, if we end up falling victim to
this rule or law of unintended consequences, the problem will
be that the 77 percent of the people that are now paying these
loans back will not get the loans. People will end up being
forced to borrow in a more informal market. People will not be
able to buy their own homes, and I think that this is something
that we have to measure. All good public policy is based on
cost and benefits, the intended consequence versus the
unintended. This is something that I am going to try to watch
very carefully because, again, subprime lending I view as a
very good thing.
I never will forget when I was a Member of the House of
Representatives, and someone came up to me and said, ``Do you
think 6 percent is a fair interest rate?'' And I said, ``Fair
to whom?''
He said, ``Well, fair to the borrower and fair to the
lender--Do you think we ought to have a law that says the
interest rate is 6 percent?''
Well, I said that would be great, but if the market did not
produce more than a 6 percent interest rate, then you would
have massive shortages of credit and you would disrupt the
credit markets. In fact, I think zero interest would be a great
rate. I would borrow a lot at it. But no one would lend me the
money.
We have to be sure that we know what we are doing, not just
focusing on the evil we hope to drive out of the system, but
also take care that the good is not driven out of the system.
Finally, it is hard to define many things in the world,
hard to define pornography, as they say, I agree with the old
adage--I know it when I see it.
But I think when you are making law it is important to try
to define what you are doing. My guess is if you ask 100 people
in America to define predatory lending, you are going to get
100 different definitions.
Many people define predatory lending as lending at above
prime. I am sure what is predatory lending to one person is not
the same thing to another.
But it is important that we know what we are doing and that
we know what we are trying to eliminate, and that we are aware
of what the unintended consequences might be.
And, again, I want to thank you, Mr. Chairman. I have a
Finance mark-up, and then we have a big trucking dispute on the
floor, as all my colleagues know. So, I will be in and out.
But I am going to read the testimony that is given today.
This is an area that I am very interested in, and I want to
thank all of our witnesses for participating.
Chairman Sarbanes. Thank you very much, Senator Gramm.
Senator Johnson.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Well, thank you very much, Mr. Chairman I
appreciate your leadership in calling today's hearing on
predatory lending. I look forward to hearing from the witnesses
who will come before this Committee both today and tomorrow.
Today's testimony, I am sure, will be moving. Nobody likes
to hear that vulnerable members of our society have been taken
advantage of. No one should be preyed upon to borrow money they
do not need on terms that they do not understand.
We in Congress are in a unique position to shine some light
on shady practices and to think through the best way that we
can, in a constructive way, bring an end to those practices.
At the same time, Mr. Chairman, I urge caution that we not
generalize the practices of a subset of lenders to an entire
sector.
As we will hear today, predatory lending occurs in the
subprime market. But as you wisely emphasized in your
statement, only a fraction of subprime lending is predatory.
Subprime is not, in and of itself, predatory lending. The
subprime market provides a critical source of credit to many
Americans who struggle to find economic opportunity in our
country. To be sure, lenders can and do charge a higher rate to
account for the higher risk associated with those borrowers.
When it is done right, subprime lending gives people what they
need, and that is more, not less, opportunity.
I have been encouraged by some noteworthy improvements in
the subprime marketplace in recent weeks. A number of key
players have announced new practices which I hope will have a
salutary effect on the subprime sector.
We want to encourage lenders with household names who have
every incentive in the world to protect their good reputations
to remain in the subprime marketplace. We need to give their
initiatives a chance to have an impact.
So, I would offer a word of caution, that while we should
be vigorous in our efforts to eliminate the ugly instances of
predatory lending, that we take care not to institute a policy
that is in fact counterproductive, that would increase the cost
of credit and, indeed, cut off critical sources of credit to
the very members of society who need it most.
I look forward to today's hearing and hope that we can have
a balanced and thoughtful discussion of how we can best
accomplish our common goal of making credit available under
fair terms to a broad segment of our society, keeping in mind
that we have already a substantial level of law pertaining to
these issues from HOEPA legislation to Truth-in-Lending to the
Real Estate Settlement Procedures Act, to the Federal Trade
Commission, and the Federal Credit Opportunity Act legislation.
That is not to say that there is not room for further
Federal legislative action. It is to say that there is a
context that this has to fit into and that we need to, on the
one hand, address the abuses, but on the other hand, make it
very certain that we do not pursue public policy that in fact
is counterproductive.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you, Senator Johnson.
Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. Thank you very much, Mr. Chairman.
I want to commend you for holding this hearing. This
hearing will shine a light on one of the dark corners of the
financial markets. And in doing that, it will be helpful in and
of itself.
I hope when we do that, we can not only identify and point
out to the American public abuses, but we also can identify
those companies that have high standards that should be
emulated by all their colleagues, and at the end of the day, we
can move all companies to the best practices that we will find
in the financial services industry.
And in doing that, I think we can both allow for the
continuation of credit for individuals that may have credit
problems, and avoid the abuses that we will hear about today.
I welcome the witnesses. Your testimony is vitally
important because you put a human face on what can be a lot of
numbers, graphs, and statistics.
Again, let me thank you, Mr. Chairman, for holding this
hearing and sending a very strong signal that we want to have a
robust financial service industry, but one that certainly
respects consumers and respects their clients.
Thank you.
Chairman Sarbanes. Thank you, Senator Reed.
Senator Schumer.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Well, thank you, Mr. Chairman. I want to
add my voice in thanking you for making this an early topic in
your Chairmanship.
Our Committee is off to a great start under your leadership
and we are doing a lot of good things. And this is at the top
of the list. Thank you for that. I would like to make just
three points.
One--two are a little bit in counter to what my colleague
and friend from Texas, Senator Gramm, said. It is easy to talk
about this stuff in the abstract. I hope, and one of our goals
should be that Senator Gramm not only reads your stories, but
hears it and just goes through what some of us have gone
through when we meet people who are victims of predatory
lending, the horror of it.
It is people who have lived by the American Dream. They are
often people of color. They are often people who buying the
home is the first time in their whole family that they have
ever bought a home, and they live by the rules. They save their
$25 and their $50 every month, did not serve meat on the table
so they could achieve their piece of the American Dream and own
a home.
And some bottom crawler comes in and not only sells them at
a higher interest rate--that is what subprime is--but says, I
will get you the right appraiser, I will get you the right
lawyer, I will get you the right this and that. And what are
they left with?
They end up buying a home where the boiler might break
down, even though they were certified. Someone came in and
said, this is a good boiler. Or the roof leaks the minute they
move in.
They end up often paying with a balloon payment they cannot
pay off, or the interest rates goes from 4 percent the first
year to 12 percent the second and they have to give up their
home. And these people are crushed for the rest of their lives,
most of them, because they played by the rules and scrounged
and then nothing happened. I have sat in my State of New York
and listened to these folks. That is what motivates us, and I
believe it is really important to remember that.
Second, also in reference to Senator Gramm and you,
Chairman Sarbanes. You are both right to emphasize that the
subprime market is a good market. And I know there is a
tendency of people just to say anything above conventional
mortgage is bad.
Well, that is not true. We want to give people the ability
to buy a home when their credit is not so good that they would
get a conventionally rated loan. And I agree with Phil that the
free market has to help govern here.
There is a little statement that we make to remind
ourselves of this. And that is, not all subprime loans are
predatory, but all predatory loans are subprime.
Why? How come no conventional loans are predatory? You
could have the same practices at a lower interest rate.
It is because we regulate the conventional market. And
conventional lenders cannot get away with doing this. If
someone tries to set up a little shady bank in the conventional
way, regulators will come down on them.
Regulation makes a big difference. And the idea that we
should shy away from any regulation when it has been so
successful at keeping the conventional market on the up and up,
does not make sense to me.
I want to commend some of the banks, for instance, that
recently changed the way that they issued insurance on their
own. They deserve credit. And all too often, I think many in
the community lump everybody together and we have to separate
the good ones from the bad ones. But we are not going to get
rid of the bad ones unless we regulate. And just one quick
final point.
Part of this is created because there is a vacuum of
conventional lending in the inner city. All I want to say is we
can make a large difference today where we could not 20 years
ago, in getting conventional mortgages into working-class and
middle-class neighborhoods of people of color which we could
not before.
CRA has done that. Banks are eager to make those loans. But
they do not have the ins. And we have to explore ways to get
them the ins there. We are doing that in New York and I will
share that with my colleagues later.
Thank you, Mr. Chairman. Sorry I went on too long.
Chairman Sarbanes. Thank you, Senator Schumer.
Senator Miller.
STATEMENT OF SENATOR ZELL MILLER
Senator Miller. I will take only a minute.
Thank you very much, Mr. Chairman, for holding this
hearing. This is a very serious matter. This is an important
topic and I commend you for holding this hearing. And I want to
welcome all of the witnesses here this morning. I look forward
to hearing from you. I look forward to listening to the debate
on this issue.
In the State of Georgia, we just got through a debate that
raged for a long time and very heatedly, in the State
legislature, where a predatory lending law was passed in the
State Senate, but then died in the house.
So, this is a topic that I am very interested in hearing
from the witnesses on, and I thank you for holding this
hearing.
Chairman Sarbanes. Senator Miller, thank you. We have had
some good discussions between ourselves about this issue and I
appreciate that very much.
Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Mr. Chairman, thank you.
To our witnesses, I want to echo the words of welcome from
Senator Zell Miller. We are glad that you are here. Thank you
for taking time out of your lives to share this part of your
day with us.
Mr. Chairman, and my colleagues, I am struck sometimes by
how helpful simply scheduling a hearing on a particular subject
can be.
[Laughter.]
I just want to point to a couple of examples.
One, I serve on the Energy Committee where Chairman
Bingaman invited folks who serve on the Federal Energy
Regulatory Commission to come and testify earlier this month.
Two or 3 days before they testified, they took some remarkably
positive steps to help alleviate the energy crisis in
California.
Just yesterday, Chairman Joesph Lieberman held a hearing on
legislation that he and others have sponsored dealing with the
entertainment industry and questions about the quality of the
entertainment that is provided to us from the music industry,
the video game industry, the television industry, and the movie
industry.
I found the comments from some of the industry
representatives, talking about things that they had done
voluntarily, were willing to do even more and better
voluntarily, coming out of that hearing were encouraging.
Others of my colleagues have spoken here today about some
of the very positive steps that some who are represented in
this room have taken to make sure that some of the questionable
practices they were involved in have been stopped or will be
stopped. I join my colleagues in applauding those of you who
have taken those steps or will take those steps.
I read an interesting piece by Robert Litan, whom some of
you may recall. He used to be the number-two guy at OMB when
Alice Rivlin was the head of OMB, and he is now over at the
Brookings Institution. He has a very thoughtful piece that some
of you may have seen. It is too long for me to go into at any
length, but I think the points that he makes are good. They
reflect the concerns that we have already heard that we want to
make sure that the steps that we take here in this Committee
and in this body, that we do no harm, that we make sure that
those who are riskier borrowers still have access to credit,
but they are not exposed to the kind of predatory practices
which in many cases are already illegal.
And as we face this challenge and listen to our witnesses,
we have to be smart enough and thoughtful enough to come up
with ways to better ensure, one, that the laws that already
make these predatory practices illegal are actually enforced,
at the Federal, the State, and the local level.
Two, I think there is a lot to be said for embarrassing
publicly those financial institutions who are actually
violating the law and to put them under a spotlight and glare
that they will not enjoy and will help to ensure that they and
others cease those practices.
Three, we have an obligation to work with the private
sector and others to better ensure that consumers are educated
and know full well what is legal and what is not, and that they
are better able to police those who are offering credit in ways
that are inappropriate or illegal.
And last, I understand in reading this piece by Robert
Litan that the Federal Reserve has undertaken the gathering of
a fair amount of data that deserve to be studied, scrutinized,
analyzed, as we prepare to take any action here in the Senate.
So let me conclude where I started, Mr. Chairman. Thanks
for bringing us together today. And to those who have joined us
to testify, both in this panel and other panels, we appreciate
very much your presence and your testimony.
Thank you.
Chairman Sarbanes. Well, thank you, Senator Carper.
Senator Stabenow.
And let me acknowledge Senator Stabenow's tremendous help
and support in helping to put these hearings together and
moving this issue forward and ensuring that it is high on our
priority list and our agenda.
STATEMENT OF SENATOR DEBBIE STABENOW
Senator Stabenow. Well, thank you, Mr. Chairman very much
for holding this hearing and for the witnesses that are here
today. This is an incredibly important issue and I hope that we
can come together and put forward a positive solution.
I know that there are literally thousands of horror stories
around the country and I have heard many of them personally
from my constituents in Michigan. Unfortunately, we do have
unscrupulous lenders that are in the subprime market, while we
also have ethical and responsible lenders in that market as
well. But I have been pleased to invite one of our panelists
today, Carol Mackey.
Carol Mackey is from Rochester Hills in the metro Detroit
area. She came to a hearing that I held in May on this very
issue, where I learned of her own difficult and tragic
experience. Ms. Mackey, I am very appreciative that you are
here with us today to share your experiences and help us to
learn from what happened to you.
Mr. Chairman, I also, would like to recognize a very
special friend and guest of mine who I have asked to attend
this hearing today--Rev. Wendell Anthony, who is the President
of the Detroit NAACP chapter, which I might brag is the largest
chapter in the United States.
Under the leadership of Rev. Anthony and the NAACP, they
have been working very hard to raise awareness and to combat
the issues of predatory lending, as well as increase affordable
housing.
There was a very successful hearing and conference that was
held on June 9 that I was pleased to be a part of in Detroit
under Rev. Anthony's leadership. He informed me last evening
there was a second follow-up meeting on issues of access to
affordable housing and predatory lending issues, where on just
a few days' notice, they invited people to come, expected 100
people and had 500 people show up. This is an example of how
important issues of affordable housing and fair lending
practices are, I believe, to the people that we represent.
I think, as this hearing gets underway, I would like to
underscore, Mr. Chairman, something that I said earlier that
many of my colleagues have said. And that is, subprime lending
is not predatory lending. In fact, subprime lending serves a
legitimate purpose in providing credit to consumers with risky
credit histories. We know that. A thriving subprime market can
serve higher credit risk communities well.
Our challenge is to focus on the bad actors, if you will,
without giving the entire industry a bad name. And I think that
is our challenge. And what we do not want to do is dry up
capital in the subprime market. We do want to stop predatory
lending practices.
I hope we are going to sort out these issues, and to
increase educational outreach, that we are going to make sure
that existing laws are enforced. I also hope we also will pass
new legislation that will make illegal what is now unethical.
I do not believe it is enough just to promote education and
enforcement without new legislation. Frankly, I think it is
extremely important, given the fact that we are talking about
thousands of dollars that have been taken from hard-working
Americans, as well as their dreams--the dream of homeownership,
the opportunity to build a secure future for themselves and
their families. And that is why this practice is absolutely
outrageous.
Again, Mr. Chairman, I want to thank you for your
leadership in calling this hearing. I want to thank Ms. Mackey
for being here, and Rev. Anthony for his leadership. I am very
anxious to move forward in a way that allows us to be
constructive and address what I believe is a very serious issue
for our families.
Senator Carper. Would the Senator yield for just a moment,
please?
Senator Stabenow. Yes, I would be happy to yield.
Senator Carper. Mr. Chairman, I misspoke earlier. I
mentioned the hearings involving the Federal Energy Regulatory
Commission and I gave the credit to the Energy Committee for
holding them. Those were actually hearings called by Senator
Lieberman, also, before the Governmental Affairs Committee. He
held the hearings on the entertainment industry yesterday, the
Federal Energy Regulatory Commission a week or two earlier.
He is probably going to have hearings now on predatory
lending. I do not know what he is running for, but----
[Laughter.]
--he is a busy boy. But I want to give him the credit for
it, and his staff.
Thank you.
Senator Stabenow. Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Bennett.
COMMENTS OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman. I do not have an
opening statement, but I have read through the statements of
the witnesses here and appreciate their willingness to come
share their experiences with us.
I know it has to be a painful experience to come before the
public and admit that you have gone through something like this
and that you have been taken advantage of. Many people would
prefer to simply hide and live with the sense of outrage that
comes. We are very grateful to you for your willingness to
expose yourselves to the lights and the heat of this kind of a
circumstance because your information is very helpful. Once
again, my gratitude to you. Thank you, Mr. Chairman
Chairman Sarbanes. Thank you, Senator Bennett.
Our first panel consists of four individuals who have
suffered from predatory lending practices. I am very quickly
going to touch on each of the witnesses before I recognize
them.
Carol Mackey is a retired substitute teacher who, as
Senator Stabenow indicated, lives in Rochester Hills, Michigan.
Her monthly mortgage payment doubled after she was encouraged
to refinance her mortgage to pay off debt and undertake repairs
to her condominium. And we will hear more about that in some
detail.
Paul Satriano is a retired steel worker from St. Paul,
Minnesota. He was solicited for a loan with high points and
excessive fees, including single premium credit life insurance
and prepayment penalties as well.
Leroy Williams is a retired shoe store assistant manager
from Philadelphia, Pennsylvania. Mr. Williams received three
mortgages, including two refinancings by three separate lenders
over a 15 month period and he is currently fighting off a
foreclosure.
And Mary Ann Podelco is a widow who resides in Montgomery,
West Virginia. Mrs. Podelco's home was foreclosed upon in 1997,
after her mortgage was refinanced seven times in 16 months by
four separate lenders.
Let me say before we turn to you for your testimony, I want
to express my appreciation to all of you, as Senator Bennett
has just done, for your willingness to leave your homes and to
come to Washington and to speak publicly about what you have
been through. I know it must be very difficult for each of you.
But I hope you appreciate and understand and take some pride in
the fact that you will be contributing to a process that I
trust will lead to action to put an end to the kind of
practices that have caused each of you such heartache and such
trouble.
I hope you will draw some strength and comfort from
understanding that you are an important part of this process
that we are undertaking here to try to correct this situation
and to ensure that others do not go through the same experience
which each of you have suffered. And so we are deeply
appreciative to you for coming to be with us today.
Now Ms. Mackey, before I start with you, Senator Dodd has
joined us. I do not know what his schedule is, but I will yield
to him for just a moment for a statement.
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Thank you, Mr. Chairman. I will be very
brief. I apologize to my colleagues and the witnesses.
First, I want to underscore the comments just made by
Chairman Sarbanes. The admiration I have for people who step
out of private lives before a bank of microphones and cameras
to talk about very personal matters deserves a special
commendation. All of us are deeply appreciative of your
willingness to do this. I want to thank Senator Sarbanes for
holding this hearing. It is important.
But I think all of us up here, I hope, anyway, feel very
strongly that predatory lending is a cancer. There is no other
way to describe it in my view. Its causes should be catalogued,
its manifestations should be carefully studied, its victims
should be treated and made whole, and these practices should be
cut from the body of healthy mortgage lending so that more
people in our Nation can enjoy the American Dream of
homeownership.
This hearing is going to go a long way to help us do that.
We are already seeing reaction by the banking industry in this
country, responding to it. So, if nothing else happens, just
merely having these hearings has already had salutary effects.
And a great deal of credit for that goes to the Chairman of
this Committee, Senator Sarbanes, for insisting upon these
hearings, that they be held.
And so, I thank you, Mr. Chairman, for doing so, and I
thank our witnesses for your courage to be here with us this
morning.
Chairman Sarbanes. Thank you very much, Senator Dodd.
Ms. Mackey, we would be happy to hear from you now.
STATEMENT OF CAROL MACKEY
OF ROCHESTER HILLS, MICHIGAN
Ms. Mackey. My name is Carol Mackey. I am from Rochester
Hills, Michigan. I am a senior citizen and I am working. I was
substitute teaching. That was really my calling. But because of
retirement ages for teachers, I am now working as a secretary,
which I find to be an interesting and challenging occupation as
well.
I appreciate the opportunity to share my experience as a
victim of what I believe to be predatory lending practices of
American Equity Mortgage. I have been a stay-at-home mom most
of my life. I just recently in the last 12 years had to go back
to work full time.
I first heard about American Equity Mortgage in August
2000, from an advertisement on WJR radio in Detroit. Ray
Vincent, the President of American Equity Mortgage, was on
every morning as I was getting ready for work. I had been
considering a home equity loan so I called the Southfield
office of American Equity Mortgage and spoke with a loan
officer. I told him that I wanted to get a home equity loan to
pay off my debts and make some minor improvements to my condo.
According to the loan officer at American Equity Mortgage,
even though I wanted a home equity loan to pay off some bills
and do some minor home improvements, it was in my best interest
to do a consolidation, which meant refinancing my old mortgage
loan.
The mortgage loan officer of American Equity Mortgage
explained that it was best for me because I would only have to
make one payment instead of two, it would all be tax
deductible, and with my bills paid off, I should be able to
handle the new payment. In addition, he implied that I would
have difficulty getting a second mortgage because of my credit
history. Not being a financial whiz, I relied on his expertise.
My old mortgage loan had a remaining balance of about
$74,000, an interest rate of about 7.5 percent, and a monthly
payment of about $510. Based on the State Equalized Value used
for tax purposes, my home is worth about $151,000.
My new mortgage is for $100,750, has an interest rate of
12.85, an APR of 13.929 percent, a monthly payment of $1,103,
and a prepayment penalty of 1 percent.
The $100,750, new mortgage was comprised of the $74,000
payoff of the old mortgage, $18,645, in additional funds to pay
off bills and perform the minor improvements to my home, and
points and fees totaling $8,105.
I did not understand the full cost of the additional money
I received until several weeks later when I finally discussed
the situation with one of my sons. Based on my son's
calculations, American Equity Mortgage and their loan officer
thought it was in my best interest:
To pay $8,105 in points and fees to receive $18,645 in
additional funds; to pay an effective interest rate of 44
percent on the $18,645 in additional funds; to pay an extra
$593 a month for the $18,645 in additional funds; and to pay an
additional $201,608 in interest over the life of the loan for
the $18,645 in additional funds.
After funds were disbursed to pay off some of my bills I
ended up with just over $9,000 to spruce up my condo, but I had
to pay off a credit card debt of $1,200 out of that, leaving me
with $7,800. Since closing last September, I have had to dip
into the $7,800
to make the mortgage payments that American Equity Mortgage
arranged for me.
When my son and I discussed the outrageous cost of my
attempt to get a home equity loan, it was apparent to us both
that I had been victimized by a predatory lender.
My son contacted American Equity Mortgage on my behalf, and
was directed to the General Counsel of the company. He
explained to the General Counsel that he believed that I had
been a victim of predatory lending practices by American Equity
Mortgage.
Through a series of conversations, he discussed the facts
of the situation as I have outlined them here today, and
requested that American Equity Mortgage cancel the new mortgage
and replace it with a revised mortgage that reflected the
interest rate of my original mortgage, blended with what a
reasonable interest rate on a second mortgage would have been.
American Equity Mortgage refused, on the basis that the
mortgage loan officer stated that I had wanted to refinance my
original mortgage from the outset. That is absolutely false.
Why would I want to lose a perfectly good 7.5 percent mortgage?
If I had been able to get a home equity loan for $20,000,
as I had sought, all of my debts would have been paid and I
would still have the $10,000 that I wanted to spruce up my
home. And I most assuredly would not be paying more than double
what my mortgage payment was before this all started. All I
needed was $20,000.
I am sharing my bad experience because I believe that I
have been victimized. That American Equity Mortgage has
perpetrated a fraud and that they should be held accountable
for their actions. I hope that by sharing my experience, other
homeowners can recognize and avoid the predatory practices that
I fell victim to. Moreover, I hope that appropriate laws can be
put into place, at both the State and Federal level, to protect
homeowners from being victimized and to punish lenders engaging
in predatory practices.
Chairman Sarbanes. Let me interject to be clear. This is
the new mortgage the loan officer said that you should
consolidate.
Ms. Mackey. Yes.
Chairman Sarbanes. And when you sought an equity loan for
$20,000, just to pay the debts and fix up your condo, he
suggested, no, what you should do is consolidate that with your
old mortgage. So you, in effect, would get a new mortgage.
Ms. Mackey. Well, what he suggested was a consolidation,
yes.
Chairman Sarbanes. Right. And so, this new mortgage is the
result of that consolidation.
Ms. Mackey. That is correct. And the new mortgage is for
$100,750.
Chairman Sarbanes. Yes.
Ms. Mackey. The interest rate is 12.85 percent, with an APR
of 13.929 percent, and a monthly payment of $1,103, with a
prepayment penalty of 1 percent.
The new mortgage, which is $100,750, was comprised of
$74,000 that paid off the old mortgage, $18,645 in additional
funds to pay off the bills and do the spruce-up on my condo,
and points and fees totalling $8,105. I think I have everything
in there now.
Chairman Sarbanes. Well, thank you very much.
Ms. Mackey. Thank you. And I especially thank you for
asking me to testify. And Senator Stabenow, thank you so much
for taking an interest in my case. I appreciate that.
Chairman Sarbanes. Mr. Satriano, just before I turn to you,
we have been joined by Senator Bayh and Senator Allard. I do
not know whether either has a statement they may wish to make.
COMMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Mr. Chairman. I do not want to
interrupt our witnesses.
Thank you for the offer.
COMMENT OF SENATOR WAYNE ALLARD
Senator Allard. Mr. Chairman, I do have a statement.
I would just ask that it be made a part of the record. I
would agree that we go on and hear the testimony from the
witnesses.
Chairman Sarbanes. Fine. Of course, it will be included in
the record.
Mr. Satriano, we would be happy to hear from you.
STATEMENT OF PAUL SATRIANO
OF SAINT PAUL, MINNESOTA
Mr. Satriano. Thank you very much. Good morning. My name is
Paul Satriano and I am a member of Minnesota ACORN. Last
November, I got a terrible home loan from Beneficial, which is
part of Household, and over the last few months I have become
active in ACORN's campaign against predatory lending, so that I
can help make sure that more people do not have the same
problems that I do now.
For the last 8 years, I have been working as an auditor for
Holiday Inn, and before that, I was working for the steel
workers. I was also a member of the U.S. Air Force and I am a
disabled vet. My wife, Mary Lee, works as a customer service
representative for Road Runner Delivery Service and we have a
daughter and two children that live with us in our house.
My father-in-law built our house in 1947. Four years ago,
after my wife's mother passed away, we took out a mortgage to
buy the house. Interest rates were falling, so we refinanced
the following year. And then we found out that the windows,
which were original, had to be replaced, so we took out a
second mortgage for them. Our monthly payments were $791 on the
first mortgage and $166 on the second, and we never had a
problem with these loans, were never late on any payments.
A few years ago we dealt with Beneficial for the first
time. They refinanced our car loan. They were very friendly at
that time. Then they started sending letter after letter
telling us how we can get up to $35,000 in cash. We had some
credit card bills totalling $7,000, so we called and figured we
are take care of them. Once they have you calling back, they
had us. We were hooked.
We told the Beneficial representative that we just wanted
to pay off our credit card bills. She convinced us that we
should do that at the same time that we consolidate our first
and second mortgages with them.
But the loan they ended up giving us only paid off $1,200
of our credit card bills. To do that cost us $10,000 in fees,
plus almost $5,000 in credit insurance, and left us with a
higher total interest rate and a couple of hundred dollars more
each month to pay on our debts. We lost $15,000 in equity in
our home and now we are locked into the higher rate in
payments, both because the loan has a 5 year prepayment penalty
for about $6,000, and because we now owe much more on our house
than it is worth, and it is going to be harder to refinance it.
Let me tell you how it happened.
A few hours before we were supposed to go to the signing
for the closing papers, Beneficial faxed us the first written
information we ever received about the loan. The paper they
sent said the house was worth $106,000, and that would be the
maximum amount of the loan. They laid out what the $106,000
would go to and none of it was for points or fees to
Beneficial.
When my wife and I went in for the closing, they went
through all the paperwork so fast, it was like a barker in a
circus--they just keep talking, you put your money down, and
you try to find the two-headed boy and you never saw one. It
was over in less than a half hour.
During the closing, the branch manager said they could not
pay off all our credit cards with this loan. But because you
have a car loan with us and you are such a good person and you
paid every month, that we can get you more money on that and we
will pay off the credit cards. So, we thought that was okay.
When we got home later, we found out that there was a
letter in our mailbox that the change in our car loan to
include the credit card debt had been denied.
Beneficial implied that if we did not take our credit
insurance, we would not get the loan. So, they added $4,900 to
our loan amount for that. After talking with ACORN, I realized
that we could ask for a refund on this $4,900. With what we got
back, we paid off some of our credit card loans. But we are
going to be paying the $4,900 for the rest of the loan, so it
really does not matter at this point.
Also, the offer sheet Household sent us said our payments
would be $1,168 a month, which was already more than we were
paying before. But now we are paying them $1,222 a month, plus
we are paying another $49 a month on the bills the Beneficial
offer sheet said would be paid off, but were not. And despite
our history of not a single late mortgage payment, Beneficial
charged us an interest rate of nearly 12 percent. Standard bank
`A' rates were below 8 percent at the time.
Although we did not realize it, the fees and credit
insurance put our loan amount over $119,000. Even without the
prepayment penalty, the fact we owe more than the value of our
house means we might be stuck in this loan for a while. ACORN
was the one that really let us know that there was a prepayment
penalty. We did not even know that there was a prepayment
penalty.
Beneficial had also charged us 7.4 percent of the loan
amount as discount points, and that is close to $8,900 on top
of the $1,100 that they took out for third-party fees. Our loan
also contains a mandatory arbitration clause which says, we
cannot take Household to court.
After we sent in a complaint to the Minnesota Commerce
Department, we eventually got a district manager from Household
on the phone. But he told us everything was fine with our
paperwork and that he could not do anything and he sent all the
paperwork to the Commerce Department.
So, we are left with a loan amount much higher than the
value of our home, higher payments, more debt staked against
our house, a higher interest rate than before, and they paid
off only a fraction of our credit card debt, which had been the
original reason to refinance. Plus a prepayment penalty and
Beneficial is protected from legal action by the mandatory
arbitration clause.
My wife and I have faced some difficult times this year,
and the financial stress caused by this loan has made things
worse. In January, my sister died and I had to travel out to
New Jersey, and I had to drive because my one sister could not
fly. On the way back, our brakes went out and I had to pay $500
to get new brakes. Three weeks ago, my daughter-in-law died,
and now my son and three children are going to need help.
This is not Beneficial's fault. But if we would have had
the right kind of loan, we would have been in a better position
to help these people now. Even without a predatory loan, we
would be in a tough spot. Now we have higher payments on our
debts each month and we owe more against our house. For the
first time, this month, we were not able to make our mortgage
payment.
What surprised me most in all of this is that I am not
alone in getting a predatory loan. In the last few months I
have heard from a lot of people who have also been hurt by bad
loans, from Household and from other lenders.
The basic problem is that when you sit down at that closing
table, the lender knows more than you do. You expect honest
dealings, like you have had on past loans. And with predatory
loans, that is just not what happens. That is why we are
counting on our Senators to support strong protection for
borrowers against abusive loan terms. And to say I am pissed is
an understatement.
Thank you.
Chairman Sarbanes. Thank you, Mr. Satriano.
Mr. Williams.
STATEMENT OF LEROY WILLIAMS
OF PHILADELPHIA, PENNSYLVANIA
Mr. Williams. Good morning. And thank you for inviting me.
My name is Leroy Williams. I am 64 years old. I live at
5617 Larchwood Avenue, Philadelphia, Pennsylvania. My income
from Social Security is $826 a month.
I bought my home in 1975 for $10,000. I had a mortgage with
payments of about $150 a month. The payments included my taxes
and insurance. I finished paying my mortgage in 1996, and I
retired the same year as an assistant manager of a shoe store.
Between October 1998 and January 2000, I ended up with
three different mortgages on my home. My taxes and insurance
were not included in the payments on any of the three loans.
In 1998, I was having trouble paying my gas bill. I was
behind in the payments and I did not want the city to dig up
the gas line in front of my home and turn off the gas. I saw an
ad in the paper about loans to pay off your bills and I called.
A man came out to my home and talked to me about getting a
loan. He brought loan papers to my home for me to sign. The
loan was with EquiCredit. The payments ended up being $215 a
month. The payments were higher than my gas bill had been and I
still had a high gas bill every month in the winter. My Social
Security income when I got the EquiCredit loan was $779 a
month.
The date I signed the loan was October 2, 1998. The loan
from EquiCredit was $19,000. They gave me $3,000 in cash that I
did not ask for. I used the $3,000 to pay the gas bill and
other bills and help my sister. Her husband had just died and I
used some of the money to go to the funeral in North Carolina
and to help pay some of the expenses and to help my sister in
general. I do not remember where the rest of the loan money
went, just that they told me that the loan had to pay all my
bills.
As far as I remember, I was making the EquiCredit payments
okay. I do not remember just how I got into the next loan, with
New Jersey Mortgage. There was a broker named Joe, but I do not
remember his last name or what company he worked for. I threw
out the papers from that loan because I was so mad about it. I
had to take a bus outside the city to go sign for the loan. The
date I signed for the loan was October 6, 1999, about 1 year
after the EquiCredit loan.
The loan from New Jersey Mortgage was $26,160. I do not
remember what all the loan paid for, but I think I received
$400. The payments ended up being $320 a month. I did not want
payments that high, so I cancelled the loan. But they called me
and told me I had to make payments or I was in jeopardy of
losing my home. I kept telling them that I cancelled the loan.
Right after I signed the loan from New Jersey Mortgage, I
got a card in the mail from someone named Keeler. The card said
I could get a better deal on my mortgage. I called Keeler and
he told me not to send payments to New Jersey Mortgage and he
would get me a better deal. Then it took a long time for him to
set up the loan, and I kept getting calls from New Jersey
Mortgage.
Keeler drove me to an office in New Jersey to sign for the
loan. He would not come into the office with me. He told me he
had to go get gas. The loan Keeler set up was from Option One.
The date was January 3, 2000. The loan was for $32,435. The
payments are $315, but I know now the payments can go up to
$348 or higher after 3 years because the interest rate will
change.
I signed for the Option One loan because I thought I was
going to lose my home if I did not, even though I told Mr.
Keeler that I needed payments around $240 a month. I tried to
make the payments at first, but I had too many bills to pay and
it was so hard. And it was making me more and more angry, so I
stopped making the payments.
I know now that Option One paid New Jersey Mortgage around
$2,300 more than the amount of the New Jersey Mortgage loan--
because of interest and a penalty of 5 percent of the loan if I
paid it off early. I have also learned that the New Jersey
Mortgage loan had a balloon payment. I understand now that
means I could have paid $320 every month for 15 years and still
owe most of the loan.
When you are a certain age and you have lived in a place
for 20 years, you just want to dwell there until your time
comes, but I do not have any peace because of all this.
Thank you again for inviting me to talk with you.
Chairman Sarbanes. Thank you very much, Mr. Williams.
Mrs. Podelco.
STATEMENT OF MARY PODELCO
OF MONTGOMERY, WEST VIRGINIA
Ms. Podelco. Mr. Chairman, thank you for the invitation to
speak here today. My name is Mary Podelco and I live in
Montgomery, West Virginia. I grew up in West Virginia and went
through the 6th grade. I moved to Indiana where my husband and
I worked in factories. I had four children with my husband of
19 years and was widowed for the first time in 1967. After I
was widowed the first time, I moved back to West Virginia and
worked as a waitress, paid all my bills and rent in cash. When
I remarried in 1987, my husband Richard and I were very proud
that we were finally able to purchase our own small home. He
worked as a maintenance worker and passed away in June 1994. I
became the sole owner. In July 1994, I paid off the $19,000
owed on the home from the insurance from my husband's death.
Before my husband's death, I had never had a checking account
or a credit card. I had always paid my bills in cash and tried
to be an upstanding, responsible citizen. I do not drive and
never owned a car.
In 1995, I received a letter from Beneficial Finance
offering to lend me money to do home improvements. I thought it
was a good idea to put some new windows and a new heating
system in my home. I signed a loan with Beneficial in May 1995.
This was the beginning of my troubles. My monthly income at
that time was $458 from Social Security and my payments were
more than half of this. They took a loan on my house of about
$11,921. The very next month, Beneficial talked me into
refinancing the home loan for $16,256. I did not understand
that every time I did a new loan, I was being charged a bunch
of fees.
I began getting calls from people trying to refinance my
mortgage all hours of the day and night. I received a letter
from United Companies Lending telling me that I could save
money by paying off the Beneficial loan. On September 28, 1995,
I signed papers in their office. More fees were added and the
loan went to $24,300, at an interest rate of 13.5 percent.
Just a few months later, I received a letter from
Beneficial telling me I could save money by paying off United
and going back to Beneficial. The loan was about $26,000. On
December 14, 1995, according to the papers, Beneficial paid off
United again, charging me more fees and costs.
In February 1996, Beneficial advised me that it was time
for me to refinance again. The loan papers show that I was
charged a finance charge of $18,192 plus other fees and an
interest rate of 14 percent. By the end of February, I had five
different loans in 10 months. I did not understand that they
were adding a lot of charges each time.
After that I was called by Equity One by telephone to
refinance the loan. On May 28, 1996, I signed papers with
Equity One in Beckley, West Virginia. The new loan paid off the
Beneficial loan--which was for 60 months--and replaced it with
a loan for $28,850 for 180 months which I understand increased
my total loan from $45,000 to over $64,000. I got $21.70 cash
out of the loan. My monthly payments were $355.58. They charged
me closing costs of over $1,100. Then on June 13, Equity One
suggested that I needed another loan to pay off a side debt and
they loaned me $1,960, at over 26 percent interest. Monthly
payments were $79. This loan brought my monthly payments to
Equity One to over $434 a month. My monthly income at that time
was $470. I really could not make the payments. My
granddaughter had a monthly income from SSI, but by law, I
cannot use her money for my benefit.
Then on August 13, Equity One started me on another loan. I
was later told that Equity One was acting as a broker for an
out-of-state lender--Cityscape. This new loan was all arranged
through the Equity One office to help me by lowering my
payments. This loan included $2,770 in new fees and costs.
There were a whole lot of papers with this Cityscape loan that
I did not understand. The payments were still too much.
I missed my first payment when my brother died in December
1996. Cityscape said they would not take a late payment from me
unless I made up for the missed payment. I could not do it.
Later in 1997, I lost my home to foreclosure by Cityscape. I
now understand that these lenders pushed me into loans I could
not pay. Adding all of these fees and costs each time caused me
to lose my home, one I owned free and clear shortly after my
husband died.
Thank you.
Chairman Sarbanes. We thank all the witnesses.
We have been joined by Senator Corzine from New Jersey.
Jon, I do not know if you have an opening statement.
COMMENT OF SENATOR JON S. CORZINE
Senator Corzine. I just appreciate very much your holding
this hearing, Mr. Chairman, and to all of the witnesses, I
respect and admire your willingness to speak out on this issue.
Chairman Sarbanes. Thank you very much. I am going to be
very brief, but I just want to--Ms. Mackey, I would like to go
through your situation because you skipped over a part and then
you put it at the end and I want to try to do it in sequence so
that we get a very clear picture on what happened.
As I understand it, before you responded to this radio ad
that you heard because they were advertising that you could get
a home equity loan and you wanted to do some fixing up of your
condo and also pay off some other debts, you had a mortgage
loan of $74,000, before you went to them.
Ms. Mackey. Before I went to the home equity loan, yes.
Chairman Sarbanes. $74,000, at an interest rate of 7\1/2\
percent, and you were making a monthly payment of about $510.
Now, as I understand it, they said to you that, to get this
home equity loan, it would be in your best interest to do a
consolidation, which meant refinancing your old mortgage loan
and then having a new loan included therein. And you went ahead
and that is what you did. Is that correct?
Ms. Mackey. Yes, that is correct.
Chairman Sarbanes. All right. Now the new mortgage that
resulted out of all of this was for just over $100,000, instead
of $74,000.
Ms. Mackey. That is right, $100,750.
Chairman Sarbanes. That mortgage had an interest rate of
12.85 percent.
Ms. Mackey. That is correct.
Chairman Sarbanes. The old mortgage had 7\1/2\ percent.
Correct?
Ms. Mackey. That is correct.
Chairman Sarbanes. 12.85 percent. Your monthly payment
jumped to $1,103, and there was a prepayment penalty included
of 1 percent.
Ms. Mackey. That is correct.
Chairman Sarbanes. Okay. This meant you got this $100,750
new mortgage, $74,000 of that to pay off the old mortgage.
Ms. Mackey. Right.
Chairman Sarbanes. There were points and fees of $8,105.
Ms. Mackey. That is right.
Chairman Sarbanes. And then that left you with $18,645, in
additional funds to pay off bills and do the improvements.
Ms. Mackey. Yes.
Chairman Sarbanes. So that is how you arrive at this point
that to get the $18,645 additional, you paid $8,105 in points
and fees.
Ms. Mackey. That is right.
Chairman Sarbanes. Actually, you went to an interest rate
on the new mortgage of 12.85 percent for all of it, whereas
before, you had an interest rate of 7\1/2\ percent on the
$74,000 mortgage. You now ended up paying an extra $593 a month
in monthly payments. That jumped from $510 to $1,103. And you
will pay over a couple hundred thousand dollars in interest
over the life of the loan.
Ms. Mackey. Yes.
Chairman Sarbanes. Well, that is a pretty dramatic example
of what we are trying to address here today and I very much
appreciate your coming and telling us that story.
Now, Ms. Podelco, in the time that is left to me, because I
explained to the panel, we do 5 minute periods amongst the
Members and then we move on to the next Member. I am not going
to go all the way through this, but I want to explain it.
When your second husband died, you and your second husband
had finally purchased a small home of your own. Correct?
Ms. Podelco. Yes.
Chairman Sarbanes. Then he passed away. You became the sole
owner. You received an insurance policy payment after his
death.
Ms. Podelco. Yes, that is right.
Chairman Sarbanes. And you took $19,000 of that insurance
policy payment to pay off the mortgage on your home. Correct?
Ms. Podelco. Yes, so that I would have a home.
Chairman Sarbanes. That is right. And you had a home free
and clear of any debt. Correct?
Ms. Podelco. Yes, at that time.
Chairman Sarbanes. That is right. And then you got this
letter about doing home improvements and you thought, you
needed some new windows. You needed a new heating system and so
forth.
Ms. Podelco. Yes.
Chairman Sarbanes. So, you went and signed a loan just
under $12,000--$11,921. Right? To begin with.
Ms. Podelco. Yes.
Chairman Sarbanes. Okay. At that time, your income was $458
a month from Social Security and the payments on this loan
would be more than half of that.
Ms. Podelco. I know.
Chairman Sarbanes. Of course, that is a dramatic
illustration of the fact that these predatory loans are made
without relationship to the borrower's ability in terms of
their income to repay the loan. It is completely geared to the
equity in the home, which is one of the points that we are
trying to stress.
And then what happened over time, one or another company
kept coming to you to get you to refinance your loan. And
unfortunately, you proceeded to do that. Of course, they
charged you fees and everything each time they did it. So the
amount of mortgage on your home and the monthly payment you had
to make kept going up. Is that correct?
Ms. Podelco. Yes.
Chairman Sarbanes. In fact, it went up to the point--well,
the last figure I have here--of course, there were some add-ons
after that. It reached over $64,000, the mortgage.
The total loan went over $64,000. And of course, your
monthly payments escalated as well. And in the end, you were
not able to meet the payments. Is that correct?
Ms. Podelco. That is correct.
Chairman Sarbanes. And you lost your home.
Ms. Podelco. Yes.
Chairman Sarbanes. I believe that is a very dramatic
example. I just say to my colleagues, we have really have to
pinpoint this thing and do something about it.
Here is someone who worked all their lives, bought a home,
took the insurance policy money on their husband's death in
order to pay off the remaining mortgage on a home to own the
home free and clear, and then was manipulated over a period of
time, successively, by these operators, until finally they ran
the mortgage loan way up, ran the monthly payments way up. In
effect, they stripped the equity out of the home, when they
foreclosed and took it away.
Thank you very much for coming and being with us.
Ms. Podelco. You are welcome.
Chairman Sarbanes. Thank you all.
Senator Johnson.
Senator Johnson. Mr. Chairman, I thought the testimony here
was extraordinary and I am appreciative of your calling this
panel. I do not have any questions of my own here, other than
simply to say thank you to all four members of this panel. I
think that you have contributed in a very meaningful way to the
overall debate on this very difficult issue.
Chairman Sarbanes. Senator Reed.
Senator Reed. Well, Mr. Chairman, the testimony is
disturbing, shocking, to think that, as you so aptly
characterized it, people work all their lives and then have
their homes taken from them through manipulation, through a
pattern of deceit and dissembling, is despicable. I do not
think there is any other word for it.
I do not know what I can add in terms of questioning, but
it struck me when I was listening to Mr. Satriano and reading
his testimony, that because of an arbitration clause in your
own mortgage, you could not even go to court. Is that correct?
Mr. Satriano. That is right, sir.
Senator Reed. And I wonder, Ms. Mackey, did you ever
address some type of court filing?
Ms. Mackey. I have spoken with the Legal Aid Society of
Oakland County. They referred me to an attorney who never
returned my calls. I am going to pursue it. It is just not
fair.
Senator Reed. And Ms. Podelco, when you were in your
dilemma, did you try to get any legal assistance to try to
upset the contract?
Ms. Podelco. No, that is where I made my mistake, until I
realized that they were ready to foreclose.
Senator Reed. The other thing I should point out, Mr.
Chairman which I find disturbing is that, when we have had our
debate upon the bankruptcy bill, and we have had companies come
in and argue about how we have to reform the bankruptcy laws
because they are being taken advantage of.
And we now have stripped away many basic rights that
previously people had to protect themselves. And you find out
that--and I would not suggest the linkage between specific
companies, but you find out that within the same financial
services operations, there is a great deal of shenanigans going
on. And yet, we are hearing that we should not take any action.
We cannot do anything. That it is the market.
But certainly, when it comes to the bankruptcy bill, we
were implored that we had to take action. It just seems to me
unfair.
Thank you, Mr. Chairman.
Chairman Sarbanes. I just want to underscore, in Ms.
Podelco's case, her income was her Social Security payment. And
these companies were clearly making loans to her that could not
be repaid from her income. Obviously, they were targeting this
home that had been paid free and clear and which had equity. So
the whole process was geared to taking the equity out of that
home.
Senator Stabenow.
Senator Stabenow. Well, thank you, Mr. Chairman. And thank
you again to each of you for coming.
As we are wrestling with what to do, I would like very much
to know from each of you, from the information standpoint,
consumer information, what you would suggest to us as we look
at not only defining what predatory lending is, so that we can
clearly state that it is illegal and existing laws need to be
enforced aggressively, and we need to make sure the resources
are there to do that. But we all understand that more consumer
awareness and education is very important. And that is why your
being here today is so important and the Chairman's focus on
this issue is so important.
I would also say on the side that I am pleased and
appreciate that Freddie Mac is coming to Detroit to help us
focus in September on the whole question of community awareness
and education through an effort that they do which is called
Don't Borrow Trouble. We are appreciative in their leadership
in this, as well as the support and involvement of Fannie Mae
in efforts as well.
But I am wondering if any of you would like to comment on
what kind of information would be helpful to you to have on the
front end? Did any of you receive information in writing about
the terms, the costs, anything comparing what you were paying?
For instance, Ms. Mackey, your current--the loan before all of
this happened versus the new loan and the points and fees and
costs and so on? Did you receive any information in writing?
And if not, what would you suggest as being something that we
should focus on in terms of public information?
Ms. Mackey. I received a good-faith estimate, which I think
is something that is required from American Equity Mortgage,
before the final paperwork. I did not see any paperwork other
than that until the final paperwork that I went in to sign. And
everything had been increased significantly at that time.
Senator Stabenow. I am not sure I understood correctly. Did
you have paperwork that said something different for the exact
same----
Ms. Mackey. I am sorry. I had this bug in my ear.
Senator Stabenow. That is okay. You received information on
the front end. What exactly did they give you information
about? What were the numbers? What were the terms that they
shared with you?
Ms. Mackey. They went over the rates that I already had and
they gave me the suggested interest rate or estimated interest
rate, which was 11-something. The monthly payment would be
probably around $900 and something.
At that time, my income was about, take-home was about
$1,800 a month. So $900 sounded like a whole lot. But sounded
do-able if I was not going to have all of these other debts to
take care of.
All the information on that good-faith estimate, and I am
sorry I do not have it right before me, the figures were all
significantly lower. The costs, the points, whatever, all were
lower than the final paperwork.
I would like to see something that could be put in the
hands of the borrower by the lender in advance that was the
final paperwork, final numbers. An estimate is wonderful, but
when they up everything by several hundred dollars or more, it
does not really do much good. And you get there and you think,
oh my gosh, what have I done? And you are embarrassed and you
do not know.
I sat there thinking, I really should just walk out of
here. But I cannot do that. It is silly to even think that way.
But I think if I had something to look over at home before I
went in to sign those papers, it would have given me a better
opportunity.
I could have taken it to someone, although I do not know
that I would, because I did not want to--now I am talking about
it all. But at that point--what I am doing now is not for me.
But at that point, I did not want anybody to know what I had
done.
Senator Stabenow. Thank you. And so, you were given a piece
of paper that said the payment would be around $900.
Ms. Mackey. Yes.
Senator Stabenow. Instead, it was $1,103.
Ms. Mackey. Yes.
Senator Stabenow. And a different interest rate.
Ms. Mackey. Correct.
Senator Stabenow. And so, you walked in assuming one thing
and found out something else.
Ms. Mackey. And you know, Senator Stabenow, it was several
days after I went home with this paperwork and looked it over
thoroughly on my own, that I discovered that my main reason for
getting this, one of my credit card debts had not been paid.
And when I called the young man who did the work, he said we
could not pay everything and give you what you wanted for the
improvements on your condo. But they could charge me over
$8,000 in fees.
You are talking about equity stripping. I had the
difference between $150,000 and $74,000, what is that? $75,000?
And now I may have $50,000 equity in my home, if I am lucky.
I just think that there has to be more education. And it is
not just the responsibility of the Committee or the industry,
but it is also our responsibility to avail ourselves of that
information.
And that again was my own fault for not doing that because
I know that there is information out there. But it is that
embarrassment situation again, which is--I am not embarrassed
any more. I have learned.
Senator Stabenow. Well, thank you so much.
Chairman Sarbanes. Senator Dodd.
Senator Dodd. Thank you, Mr. Chairman. Again, I think that
this has been tremendously helpful to have all four of you
share your testimony.
I realize, something you just said, Ms. Mackey, was very
worthwhile because in all of this, obviously, there are some
other sources of responsibility here. But you properly point
out, if nothing else, we hope people watching this or listening
to this will take note of what you just said.
The important thing is to always check and ask other
people. There are people you can go to in most communities that
will help you find out whether what you are being offered is--
my mother used to say, if it sounds too good to be true--
remember that?
Ms. Mackey. It usually is.
Senator Dodd. It usually is, yes. And when you hear these
radio ads and so forth and they are offering to make your life
easy, offering you more money at less cost, that is usually a
good signal.
Ms. Mackey. I understand that. And I was at a point where I
was very, almost desperate to get this taken care of.
Senator Dodd. Yes, I understand that.
Ms. Mackey. So, I lost all good sense.
Senator Stabenow. Would my friend yield for just one
moment?
I would just want to add that in this particular situation,
Ms. Mackey got information ahead of time, saying, it would be a
$900 payment and it changed at closing. So, I would just add
that even when we ask ahead of time, if it is changed, there is
a problem.
Senator Dodd. No, I agree. But my point is, again, for
people listening out there, or who are watching this, who have
not yet done this, but who are being approached by people, your
testimony here is a good warning. It does not offer you any
immediate relief, obviously, but maybe just by being here, you
may be saving some people from the same kind of tragedy.
You have been through basically a financial mugging. That
is what this is. You were mugged. It is almost like walking
down the street and being mugged. Now it took longer and it was
more subtle and it was cute. But it is as much as if someone
had held you up, in my view.
Senator Reed made a very good point. There are some of us
who have strongly objected to this so-called bankruptcy reform
bill. One of the reasons that the bill has not become law today
is because there are a couple of States in this country where
affluent homeowners do not want their homes subject to
bankruptcy laws--the Homestead Exemption. And Ms. Podelco, if
you just moved to Palm Beach and bought yourself a nice big
condo, you might not be in this trouble today.
[Laughter.]
I do not know if that was possible for you in West
Virginia. But it is somewhat ironic in a way that we are
talking about so-called reforms here, where people want to
prohibit the discharge of credit card responsibility and make
it more difficult for people who get caught in difficult
situations to be able to get themselves out of it. But that is
an aside that I raise to you here today.
Let me just ask you, because one thing was common in all of
your stories here. They all have a poignancy to them. But it
just seemed to me in every case, with some variations on it--
Mr. Satriano, you have something next to you there. What is
that?
Mr. Satriano. It is just a picture of my house.
Senator Dodd. Why not get it the right side up?
[Laughter.]
There we go. That is your home?
Mr. Satriano. Yes.
Senator Dodd. How long had you been in that house?
Mr. Satriano. My wife grew up in there.
Senator Dodd. Your father-in-law built that house?
Mr. Satriano. Right. 1947.
Senator Dodd. Well, the one thing I saw as I was listening
to you talk about it here is that the solicitors in every case
withheld information, it seems to me, in every case. And
correct me if I am wrong, but you had very important
information withheld from you as the solicitations were being
made. And important information about the terms of the loan,
you were directly misled in every single case. Is that true?
Mr. Satriano. [Nods in the affirmative.]
Ms. Mackey. [Nods in the affirmative.]
Mr. Williams. [Nods in the affirmative.]
Ms. Podelco. [Nods in the affirmative.]
Senator Dodd. You are nodding your head yes.
Ms. Mackey. Yes.
Senator Dodd. Now the marketing of this just seems to me it
is fraud in your cases here. I do not know how else to describe
it. The marketing techniques that were used against you were
all in the case promising you a much better deal, obviously,
than you had in every single case.
Again, I thank you, Mr. Chairman. I know we have other
witnesses to hear from. I hope maybe some of our colleagues
when we look at it--there was a piece in The Wall Street
Journal, I think it is today's home economics--refinancing boom
helps explain strength of consumer spending.
An unprecedented cashflow may prevent recession. Economists
figure that all of the refinancing activity contributed nearly
half of 1.2 percent annualized growth in the first quarter
gross domestic product.
I mean, this is going on. There is a lot of refinancing
going on all over the country. Now I am not suggesting,
obviously, that the refinancing, all of it is predatory
lending. But I get nervous when I see this, a lot of these
solicitations going out. And as long as home prices stay up--I
remember in Hartford, Connecticut a few years ago, we had the
mid-1980's. And there was this tremendous inflation in values
of homes. And then we had the real estate market crash. And
people had mortgages on their homes that vastly exceeded the
value of these homes.
I have an uneasy feeling that we may be entering a period
like that. And we are going to find that not just people like
yourselves sitting here that have been through and dealt with
unscrupulous lenders out there that have taken advantage of you
by withholding information and lying to you, basically,
deceiving you, that we may find a more compounded problem here
as a result of this effort to convince people that they can
refinance their homes and ought to do so, and find that these
homes are not going to be worth as much as they thought they
were.
Again, I thank all four of you. You are courageous people.
We are grateful to you for being here.
Chairman Sarbanes. Senator Corzine.
Senator Corzine. I will be brief, Mr. Chairman.
I certainly concur that you are courageous to sit and tell
us these stories, which I think accentuate a major flaw, a
reprehensible flaw in our economic system. I hope we can get at
some of the fundamental problems here with precise but
important legislation as we come through this.
One thing that yells out at us is the need for financial
literacy exposure. This morning I was with a group of people
from the Urban League and Historic Black Colleges and Freddie
Mac on a Credit Smart program that is designed to deal with
getting financial literacy out in the community so that we can
deal with this when you are faced with people that are smooth
talking and fast talking and trying to give you something for
nothing.
But I have one question. How many of you had an
independent, outside participant with you as you went through
this, for example, a lawyer?
For the life of me, I have never gone to a closing on a
mortgage without a lawyer. And I am wondering whether any of
you in the situations you had had some independent party that
would challenge the efficacy of this process.
Ms. Podelco. [Nods in the negative.]
Ms. Mackey. [Nods in the negative.]
Mr. Williams. [Nods in the negative.]
Mr. Satriano. [Nods in the negative.]
Chairman Sarbanes. I think the record should show that all
four panelists, they did not have someone with them.
Senator Corzine. I am not sure on all of the steps that we
need to take in this process, but the idea that people who deal
in the subprime market and this secondary lending have the
ability to have a one-on-one relationship without someone who
has the financial skills to evaluate some of these programs
makes a lot of sense.
You are courageous. I appreciate very much your statements
and participation and help in this process, and I look forward
to us pushing aggressively forward. And I also have to identify
with the bankruptcy remarks that the Senators from Connecticut
and Rhode Island made. This is not a one-sided affair, as I
think we heard it mostly debated on the floor of the Senate.
Chairman Sarbanes. Thank you very much, Senator Corzine.
I want to tell the panel members how much we appreciate
their testimony. As I said at the outset, I know it is
difficult to appear in this public atmosphere to tell your
personal story, but it constitutes a valuable contribution to
this effort we have undertaken.
Some of my colleagues made note of it, and I think I ought
to, for the completeness of the record, observe that there are
a number of financial institutions that have announced
recently, subsequently to when we scheduled these hearings, a
number of steps that would address some of the concerns that
are here today.
In particular, a number of companies have announced that
they will no longer finance single premium insurance in their
loans, roll it into the mortgage and then you end up paying
interest over a sustained period of time. Other practices have
also been changed.
Those are important steps and we welcome them. But there is
more to be done, obviously, and we intend to continue to press
forward with really laying out exactly what the problem is, so
it is fully understood.
We want the regulators to exercise more effective control.
We want tougher enforcement of existing laws, which may well
need the commitment of more resources.
But there are practices going on that are not illegal under
existing laws. The repeated refinancing of a loan and the
stripping out of equity is technically not illegal.
And so, we need to address those problems. We need to
address the education dimension which Senator Corzine talked
about. And I encourage the industry itself to continue to try
to establish best practices and raise the level of activity
within the industry.
It is very helpful in all of this that people will come in
and speak out about their own experience. I know it is, in some
respects, as Ms. Mackey said, embarrassing for you, although
you have passed that threshold, I gather, now.
But you have made a very substantial contribution here
today and we thank you very much. We will excuse this panel and
move on to our next panel.
Thank you all very much.
The Committee will take just a brief pause while we move
this panel out and bring the other panel on.
[Pause.]
Chairman Sarbanes. I want to welcome the second panel. I
know you have been waiting quite a while.
On this panel we have: Tom Miller, the long-time Attorney
General of Iowa, and the Chairman of the Predatory Lending
Working Group of the National Association of State Attorneys
General; Steve Prough, the Chairman of Ameriquest Mortgage
Company, one of the larger subprime lenders in the country. And
Ameriquest has developed a program, with a number of civil
rights and community organizations, which we are looking
forward to hearing about this morning; Charles Calomiris,
professor of finance at the Columbia Business School and the
Codirector of the Project on Financial Deregulation at the
American Enterprise Institute; and Martin Eakes, who is the
President and CEO of the Self-Help Credit Union in North
Carolina. Mr. Eakes has, as I think we all know, been a leader
in the effort to fight predatory practices, both in his home
State of North Carolina and nationally. And of course, North
Carolina has taken a number of very important initiatives that
I think are worthy of attention. We welcome all of you.
Gentlemen, we are running late this morning. I think what
we will do is we will include your full statements in the
record. I very much appreciate the obvious effort and time and
thought that was devoted to preparing these statements. They
are quite comprehensive and they will be of enormous help.
If you could summarize your statements in 8 to 10 minutes,
we would appreciate that. And then we will go to a question
period. Attorney General Miller, why don't we start with you?
We are pleased to welcome you before the Committee, and I might
note that many years ago, in his younger life, Attorney General
Miller worked as a Vista volunteer in Baltimore, Maryland. We
were pleased to have him there and we are pleased to have him
here today before the Committee.
Mr. Miller.
STATEMENT OF THOMAS J. MILLER
ATTORNEY GENERAL, THE STATE OF IOWA
Mr. Miller. Thank you, Mr. Chairman.
You might add that I was also a very enthusiastic volunteer
in your campaign.
Chairman Sarbanes. I did not want to make it political.
[Laughter.]
Mr. Miller. I will try and summarize as you suggested. In a
way, a summary is made easy because of what happened before.
The testimony that we heard before was compelling. It was
strong. It was complete. And it tells the story. It tells the
story because it did not happen to just those four individuals.
It happens to many people throughout the country.
Even in a place like Iowa. I met 2 days ago with three very
similar people to the four you heard this morning, very similar
stories and very sad stories. Indeed, the conduct is bad enough
and it is being done often enough throughout the country, that
I believe it is truly a national scandal.
I think you summarized the elements that are used by
various people against low income people to do this in America
and I will just mention them briefly. And keep in mind that it
is the combination of these tricks and these gimmicks and these
charges that accomplishes the draining of their equity and the
loss of their house.
First of all, as was mentioned, it is the points and
related charges that can add up to thousands of dollars, often
5 to 10 percent and more. Then it is the credit insurance. And
there is absolutely no reason for this insurance. Let us look
at this.
A low income person that is trying, struggling to buy a
house, going to an equity loan, a second mortgage, in terms of
what they need and what they would choose, would they choose
insurance payments at a large level? It just does not make
sense. It is pure exploitation. And I am pleased, as you
mentioned, that three companies have decided not to use that.
One of the people we talked to earlier this week had paid
$10,000 for a single premium credit insurance. And then they
were going to pay $66,000 in interest. So $76,000 for a product
that they do not need, would not choose, given their other
needs.
The interest rate is higher, sometimes even getting into
the high-teens and into the 20 percent. And one thing that was
alluded to by the earlier speakers that I want to point out is
a whole group of people that are involved in this. And they are
called bird dogs. They are independent brokers or they are home
improvement people that often do very fraudulent home
improvement. And they are out looking for these people.
They are out looking for the four people that you saw this
morning, the three people that I saw on Tuesday. And they have
various ways of finding them. And they do find them. And all of
this is below the radar screen. They will lie about everything.
It reminds me a little bit about telemarketing fraud that we
fought a few years ago. When people got on the phone, those
telemarketing fraud operators, they would lie about everything
to close that deal. These bird dogs do exactly the same thing.
Another abusive practice is the balloon payment. Because of
everything that these people are being charged and the interest
rate that is high in addition, people cannot pay off the loans.
So what they do is they give them a 15 year balloon payment at
about the same price of the loan itself. So there is no chance
that they will ever pay it off.
Then there is flipping that the lady from West Virginia so
eloquently laid out, the flipping from company to company to
company, adding on those charges, those 10-, 20-, 30-percent
charges each time--that is part of it.
And then just to make sure, once they have people hooked,
that they do not get off the hook somehow by maybe a family
member helping or a friend helping, there is the prepayment
penalty, to hold them on onerous terms. And if they decide that
they might want to go to court, it is the arbitration clause.
It is all of these things that are brought together. They
are a national scandal because of what they do to people. And
you can tell they are the part of business plans of some of
these companies.
The bird doggers that I mentioned are part of just a
fraudulent operation. This is just a whole set of people and
circumstances that are exactly out to abuse people in the way
that is described. And of course they do it primarily with poor
people, primarily with minorities, primarily with elderly, the
ones that are most vulnerable in our society. As I say, I
believe it is a national scandal. The question is what do we do
about it?
Well, first of all, society has to recognize that this is
totally unacceptable. We as a society need to push back. And
that is why I think it is so important that you have called
this hearing. Putting the light of day on these practices is
extremely important. But of course much more has to be done.
Some things have to be done by the companies. Some very
reputable companies are involved by owning some of the
subsidiaries, by buying some of the loans, in some instances
dealing with the bird dogs.
They have to change their companies. And I think some of
them are about doing that. You mentioned on credit insurance. I
talked to one other company. It is amazing, when my name showed
up on the witness list, I started to get calls, Senator from
one of the large companies that indicated perhaps some real
constructive change.
The industry has to clean this up because what we have seen
happen is totally intolerable. And any self-respecting
individual or company cannot be involved with what I just
described. They need to recognize that and I think they are
starting to get the message.
We need enforcement. We attorney generals recognize this as
a problem, a big problem. We have just recently put together a
working group, as you mentioned, of attorney generals to work
on this, that I lead as well as Attorney General Roy Cooper of
North Carolina and Attorney General Betty Montgomery of Ohio.
It is something we are concerned about. The FTC is
involved. Other law enforcement people are involved, and
understanding the grievous nature of this problem and what
needs to be done.
The Federal Reserve needs to act on the regulations that
are proposed before them. Thirty-one States and 31 State
Attorney Generals have endorsed and pushed for those
regulations. I think it is very important that those reforms go
forward.
Congress needs to act. They need to look at some of the
features perhaps that are preemptive on States. There may be a
role for States to play, a somewhat larger role, realizing that
we are dealing with a national problem.
And you need to take a look at HOEPA. HOEPA has changed
some things in a constructive way. But there are more things
that you can do on credit insurance, on balloon payments, on
the size of fees and charges, and on the ability to pay. We
need to look at this from a whole range of people.
Like many problems in the public policy arena, there is no
silver bullet. There is no one thing that we can do. But we can
focus on it from a number of different aspects in combination.
Much like they put those various combinations of bad things
together to achieve the result, we can push back and make a
difference.
And I appreciate what the Senator said about this being a
problem that needs to be dealt with in a way that does not harm
legitimate subprime credit. It is very important that low
income people have the opportunity to get loans and buy houses
through sub-
prime credit that is reasonable and fair.
And companies can tell the difference. Companies can tell
the difference of these elements and the kind of lending that
Senator Gramm and others talked about.
It is very important that people like Senator Gramm's mom
be able to buy a house like she did. But I will tell you what.
If these people got a hold of her, she would not have been able
to buy that house. She would either be paying yet today, 52
years later, or be out of the house.
That is what is at stake here--to preserve what is good in
the credit industry, constructive credit, and to deal strongly
and effectively with destructive credit, which drains the
equity and the hopes and the dreams from the people of America
that are affected.
Mr. Chairman, thank you for inviting me to testify and
thank you for bringing this issue to the fore. It is a very
important issue.
Chairman Sarbanes. Thank you very much, Attorney General
Miller.
Mr. Prough.
STATEMENT OF STEPHEN W. PROUGH
CHAIRMAN, AMERIQUEST MORTGAGE COMPANY
ORANGE, CALIFORNIA
Mr. Prough. Good morning, Mr. Chairman. My name is Steve
Prough and I am Chairman of Ameriquest Mortgage Company.
Ameriquest Mortgage Company is a specialty lender. We provide
affordable loans to average American homeowners who have
imperfect credit profiles. We are headquartered in Orange,
California. We have 220 offices nationally in 33 States and we
have 3,200 professionals assisting our customers to utilize
their most important asset--their home--in order to obtain
affordable credit to help meet their own personal needs.
Virtually all of our loans are to allow homeowners to refinance
and access capital. Our loan production grew to approximately
$4.1 billion in originations in 2000, and we anticipate that
growth will continue in 2001, resulting in approximately $5.5
billion of loan originations. Our servicing portfolio
totals $8.5 billion in loans.
From the company's senior management down through our
newest hires, we at Ameriquest Mortgage Company believe that
borrowers are best protected against abusive lending practices
when lenders adopt firm lending practices and when borrowers
are given the information they need to make informed decisions
in their own best interests. That is why we instill in all our
employees a commitment to promoting the importance of fair
lending practices and consumer awareness.
As we developed our business, we found that the financial
needs of many average Americans with impaired credit were not
being met at all, or at affordable prices by the home financing
industry. Ameriquest sought to meet those needs by providing
financing on more favorable terms and at lower cost than had
historically been offered to credit impaired individuals by
other lenders.
Leveraging secondary market sources and capital from Wall
Street, we originate, package, and then sell our loans. As a
result of the efficiency of these markets, we are able to offer
lower costs to our customers. Thus, through our Wall Street
financing model, we have substantially lowered the cost of
financing for Ameriquest borrowers.
We help working families and individuals whose credit may
be impaired for a variety of reasons. Our average customer is:
47 years old, from a suburban community, a 10 year homeowner,
stable income with an average of 12 years' employment and,
finally, an average income of $70,000. This is a portrait of
the Ameriquest customer who has special credit needs that we
have helped achieve their goals.
We at Ameriquest are very proud of our history of making
loans available to borrowers who have been denied credit, but
have credit needs. It should be recognized that the specialty
lending industry has contributed to the highest homeownership
in the Nation's history and has helped open access to capital
for traditionally underserved communities. We feel very
strongly that all lenders must be subject to rules that
effectively prevent them from engaging in misleading or
deceptive practices and from imposing unfair terms or
practices. These actions are wrong. They have no place in the
real estate lending industry or, for that matter, in any credit
transaction whatsoever.
While we believe that it is important that lenders refrain
from acting in a manner that seeks to take advantage of
borrowers, we also believe that it is equally important that
responsible lenders take action to adopt and implement
practices specifically designed to promote fair lending and to
enable borrowers to make intelligent, informed decisions about
their credit needs. It is for this reason that our business
philosophy is ``Do The Right Thing.''
Ameriquest Mortgage Company has fostered long-standing
relationships with the Leadership Conference on Civil Rights,
the Nation's oldest and largest civil rights coalition, the
National Fair Housing Alliance, the National Association of
Neighborhoods, and more recently, with the Association of
Community Organizations for Reform Now--ACORN. These groups
have been our allies in the cause to promote fair lending and
consumer awareness. Ameriquest Mortgage Company has partnered
with these committed advocates to develop and implement a set
of best practices to ensure that our borrowers receive top
quality service and fair treatment and are able to obtain loans
that meet their financial needs on reasonable terms and at fair
prices.
In developing our set of best practices, we asked our key
community group allies to help us identify their principal
concerns regarding subprime lending activities. While
Ameriquest had long ago
addressed many of those concerns, we implemented practices and
policies to address others as part of our constant effort to
improve our programs to meet our customers' needs.
Ameriquest Mortgage Company provides to every customer:
reasonable rates, points, and fees; full and timely disclosure
of loan terms and conditions in plain English; recommended
credit counseling; a full week to allow customers to evaluate
whether our loan best suits their needs; a highly qualified
loan servicing officer who has been trained in fair lending
practices.
In addition, we: report all borrower repayment history to
credit bureaus; maintain arm's-length relationship with third
parties such as title companies, loan appraisers, and escrow
companies.
The following practices, although legal and conducted by
some, are not offered by Ameriquest: no single premium credit
life insurance to borrowers; no refinancing of a loan within 24
months of its origination; no loans with mandatory arbitration
clauses; no loans with balloon payments; no negative
amortization loans.
Our best practices include providing each customer a one-
page document, written in plain English, that clearly
identifies all of the important terms of the loan using very
simple phrases.
We are very concerned about the fact that you receive a
big, huge bundle of information and there is no one page that
this is all put on. So that is why we clearly state on one
page: your interest rate is--; you have a prepayment charge
of--; your total fees are--
Very simple, very straightforward. We prepare a side-by-
side comparison for prospective borrowers of our initial loan
quote and the final loan offering so that people can see
exactly what they are getting from what we originally had
offered them in order to ensure dialogue that would take place
during the process.
We recommend credit counseling to all our customers by
providing the 800-number for HUD-certified loan counseling.
Instead of the standard three-day rescission period called for
under existing law, we provide all of our customers in our
retail lending network with a full week to allow them to shop
for better loans. That added time allows them to determine
without pressure and with the help of trained credit counselors
if ours is the best loan for them. Our loan servicing
associates go through a stringent training program, with a
minimum of 80 hours of training. We want to ensure that in the
case of every borrower, we are being sensitive to that
borrower's needs.
All of our best practices empower consumers to make the
right choice for them. Why do we do this? We do it because it
is the right thing to do. But we also do it because we honestly
believe our business benefits from our best practices. We
benefit when we have fully informed borrowers who recognize
that they have been treated fairly, rather than dissatisfied
customers who feel that they have been taken advantage of.
There are many of us in the specialty lending sector that
have been fairly and responsibly assisting traditionally
underserved communities, and have helped countless, hard
working families gain access to capital. I know you want us to
continue to lend to this segment of America, since
homeownership is one of the key elements of our society that
most embodies the American Dream.
No responsible lender wishes to engage in abusive lending
practices. And I am sure everyone in this room would agree that
a single deceitful loan is one too many. Regulatory authorities
need to use the full range of their existing enforcement powers
and to devote more resources to enforcement of existing laws
designed to guarantee that customers receive loans appropriate
for their needs and fair terms. We at Ameriquest Mortgage
Company believe that our set of best practices is designed to
achieve that very result in three ways: one, our best practices
prohibit certain specific kinds of abusive practices; two, our
best practices provide clear and full disclosure of the
critical loan terms in plain English; and three, we make credit
counseling available to our borrowers and encourage them to
make use of it and provide a one-week, post-approval
period during which the borrower can shop our loan and
evaluate, with the help of a credit counselor, whether the loan
we have offered is truly a loan the borrower wants.
In short, strong enforcement of existing laws coupled with
a strong set of best practices is the best tools to ensure that
consumers are best served. Although we do not believe that
additional laws or regulations are needed, it would be best, if
there is to be action, for it to come at the Federal level,
rather than adding to the existing patchwork of State and local
ordinances.
Ameriquest Mortgage Company creates loans the old-fashioned
way--we take the time to develop a loan for each borrower based
on their individual needs. This is how I started my lending
career 30 years ago, when banks were more personal and took the
time to get to know their customers. It is important to
recognize that this form of lending is more subjective at the
individual level and requires increased personal attention from
the loan officer.
We hope as this Committee considers any proposed new
legislation, you are careful as you proceed to ensure that
there are no unintended consequences that would have the effect
of limiting access to credit for those who need it most. In
that way, we ask for your support in helping us to continue to
serve Middle America and reach traditionally underserved
communities.
Ameriquest commends you for focusing attention on these
issues. As one of the Nation's largest retail special lenders,
we share your commitment to making the dream of homeownership
affordable and fairly accessible for all Americans. We at
Ameriquest look forward to continuing to work with you.
Thank you very much.
Chairman Sarbanes. Well, thank you very much, Mr. Prough,
and we appreciate, as Chairman of Ameriquest Mortgage Company,
you coming across the country from California, in order to be
here with us at this hearing and to give us this testimony.
I am also very appreciative of the attachment that you have
to your statement setting out in considerable detail Ameriquest
Mortgage Company's retail best practices. It is very helpful to
the Committee to have that information.
Professor Calomiris.
STATEMENT OF CHARLES W. CALOMIRIS
PAUL M. MONTRONE PROFESSOR
OF FINANCE AND ECONOMICS
GRADUATE SCHOOL OF BUSINESS, COLUMBIA UNIVERSITY
NEW YORK, NEW YORK
Mr. Calomiris. Thank you, Mr. Chairman. It is a pleasure
and an honor to address you today on the important topic of
predatory lending.
Predatory lending is a real problem. It is, however, a
problem that needs to be addressed thoughtfully and
deliberately, with a hard head as well as a soft heart.
Chairman Sarbanes. That is what we are trying to do, yes.
Mr. Calomiris. There is no doubt that people have been hurt
by the predatory practices of some creditors and we have heard
about that today quite a bit. But we must make sure that the
cure is not worse than the disease. Unfortunately, many of the
proposed or enacted municipal, State and Federal statutory
responses to predatory lending would have adverse consequences
and in fact already have had adverse consequences that are
worse perhaps than the problems they seek to redress. Many of
these initiatives would reduce the supply or have reduced the
supply of credit to low income homeowners, raise their cost of
credit, and restrict the menu of beneficial choices available
to borrowers.
Fortunately, there is a growing consensus in favor of a
balanced approach to this problem. That consensus is reflected
in the viewpoints expressed by a wide variety of individuals
and organizations, including Robert Litan of the Brookings
Institution, Fed Governor Edward Gramlich, most of the
recommendations of last year's HUD Treasury report, the
voluntary standards set by the American
Financial Services Association, the recent predatory lending
statute passed by the State of Pennsylvania, and the
recommendations and practices of many subprime lenders.
An appropriate response to predatory practices should
occur, I think, in two stages. First, there should be an
immediate regulatory response to strengthen enforcement of
existing laws, enhance disclosure rules, provide counseling
services, amend existing regulation in some ways, and limit or
ban some practices. I believe that these initiatives, which I
will describe in detail in a minute, will address all of the
serious problems associated with predatory lending.
Second, in other areas, especially the regulation of
prepayment penalties and balloons, any regulatory change, I
think, should await a better understanding of the extent of
remaining predatory problems that result from these features.
And the best way to address those is through appropriate
regulation. The Fed is currently pursuing the first systematic
scientific evaluation of these areas as part of its clear
intent to expand its role as the primary regulator of subprime
lending. Given its authority under HOEPA, the Fed has the
regulatory authority and the expertise necessary to find the
right balance between preventing abuse and permitting
beneficial contractual flexibility.
I think the main role Congress should be playing at this
time is to rein in actions by States and municipalities that
seek to avoid established Federal preemption by effectively
setting mortgage usury ceilings under the guise of consumer
protection rules. Immediate Congressional action to dismantle
these new undesirable barriers to individuals' access to
mortgage credit would ensure that consumers throughout the
country retain their basic contractual rights to borrow in the
subprime market.
The problems that fall under the rubric of predatory
lending are only possible today because of the beneficial
democratization of consumer finance and mortgage markets in
particular that has
occurred over the past decade. Predatory practices are part and
parcel of the increasing complexity of mortgage contracting in
the high-risk, subprime mortgage area. That greater contractual
complexity has two parts: One, the increased reliance on risk
pricing using Fair Issac scores rather than the rationing of
credit via a yes or no lending decision. And second, the use of
points, credit insurance, and prepayment penalties to limit the
risks lenders and borrowers bear and the costs borrowers pay.
These practices make economic sense and can bring great
benefits to consumers. Most importantly, these market
innovations allow mortgage lenders to gauge, price, and control
risk better than before and thus allow them to tolerate greater
gradations of risk among borrowers.
According to last year's HUD-Treasury report, subprime
mortgage originations skyrocketed since the early 1990's,
increasing by ten-fold since 1993. The dollar volume of
subprime mortgages was less than 5 percent of mortgage
originations in 1994, and in 1998, it was 12.5 percent. As
Governor Gramlich has noted, between 1993 and 1998, mortgages
extended to Hispanic-Americans and
African-Americans increased the most, by 78 and 95 percent,
respectively, largely due to the growth in subprime mortgage
lending.
Subprime lending is risky. The reason that so many low-
income and minority borrowers tend to rely on the subprime
market is that, on average, these classes of borrowers tend to
be riskier. It is worth bearing in mind that default risk
varies tremendously in the mortgage market. The probability of
default--based on Standard & Poor's credit ratings--for the
highest risk class of subprime mortgage borrowers is roughly 23
percent, which is more than 1,000 times the default risk of the
lowest risk class of prime mortgage borrowers.
When default risk is that great, in order for lenders to
participate in the market, they must be compensated with
unusually high interest rates. But, default risk is not the
only risk that lenders bear. Indeed, prepayment risk is of a
similar order of magnitude in the mortgage market.
In the subprime market where borrowers' creditworthiness is
also highly subject to change, prepayment risk results from
improvements in borrower riskiness, as well as changes in U.S.
Treasury interest rates.
Borrowers in the subprime market are subject to significant
risk that they could lose their homes as a result of death,
disability, or job loss of the household's breadwinners.
Because single premium insurance commits the borrower to the
full length of the mortgage, the monthly cost of single premium
credit insurance is much lower than the cost of monthly
insurance.
Single premium insurance has been much maligned here today.
Mr. Miller said there is no reason to have single premium
insurance. But I checked on some facts. I called up Assurant
Group, which is a major provider ultimately of credit insurance
in the mortgage market, and asked for a cost comparison. The
monthly cost, that is, taken on a monthly basis over the life
of the mortgage, the monthly present-value cost for monthly
credit insurance that is paid each month, not all at once, on a
5 year mortgage, on average, is about 50 percent more expensive
than the monthly cost of single premium credit insurance.
A lot of these intermediaries have left the market because
the bad public relations about single premium insurance has
been bad for their business. That is unfortunate, I think, and
I will come back to how I think we can regulate single premium
insurance without doing harm to borrowers.
The Congress recognized that substantial points, prepayment
penalties, short mortgage maturities, and credit insurance,
have arisen in the primary market in large part because these
contractual features offer preferred means of reducing overall
costs and risks to consumers. Default and prepayment risks are
higher in the subprime market and therefore, mortgages are more
expensive and mortgage contracts are more complex.
The goal of policymakers should be to define and address
predatory practices without undermining real important
opportunities in the subprime market. So what are those
practices? They have already been mentioned.
According to the HUD-Treasury report, they are loan
flipping, packing or excessive fee charges, lending without
regard to the borrower's ability to repay, and outright fraud.
Many alleged predatory problems revolve around questions of
fair disclosure and fraud prevention. But the critics of
predatory lending are correct when they say inadequate
disclosure and outright fraud are not the only ways borrowers
may be fooled. Let me now turn to an analysis of specific
proposed remedies.
First, I would recommend enhanced disclosure and new
counseling opportunities for mortgage applicants. In my
statement, I go through a very long list of ways to improve
disclosure and counseling, but I will omit that here in the
interest of time.
Credit history reporting. It is alleged that some lenders
withhold favorable information about customers in order to keep
and use that information privately. I think it is appropriate
to require lenders not to selectively report information to
credit bureaus.
Now single premium insurance. Keep in mind, roughly one in
four households do not have any life insurance. And so, single
premium credit insurance or monthly credit insurance can be
very beneficial. To prevent abuse, though, of single premium,
there should be a mandatory requirement that lenders that offer
single premium insurance have to do three things. One, they
must give borrowers a choice between single premium and monthly
premium credit insurance. Second, they must clearly disclose
that credit insurance, whether single premium or monthly, is
optional and that the other terms of the mortgage are not
related to whether the borrower chooses credit insurance. And
third, they must allow borrowers to cancel their single premium
credit insurance and receive a full refund of the payment
within a reasonable time after closing.
What about limits on flipping? Well, I think there have
been several new proposals. I agree that there needs to be some
action. The Fed rule that has been proposed would prohibit
refinancing of
a HOEPA loan by the lender or its affiliate within the first 12
months, unless that refinancing is, ``in the borrower's
interest.'' This is a reasonable idea so long as there is a
clear and reasonable safe harbor in the rule for lenders that
establishes criteria under which it will be presumed that the
refinancing was in the borrower's interest. For example, if a
refinancing either, A, provides substantial new money or debt
consolidation, B, reduces monthly payments by a certain amount
or, C, reduces the duration of the loan, then any one of those
features should protect the lender from any claim that the
refinancing was not in the borrower's interest.
What about limits on refinancing of subsidized government
or not-for-profit loans? It has been alleged that some lenders
have tricked borrowers into refinancing heavily subsidized
government or not-for-profit loans. Lenders that refinance
these loans, I believe should face very strict tests for
demonstrating that the refinancing was in the interest of the
borrower.
Should we have any outright prohibitions? Well, I believe
that some mortgage structures really do add little real value
to the menu of consumer options and are especially prone to
abuse. In my judgment, the Federal Reserve Board has properly
identified payable-on-demand clauses or call provisions as
examples of such contractual features that should be
prohibited.
How should we deal with prepayment penalties? We should
require lenders to offer loans with and without prepayment
penalties. Rather than regulate prepayment penalties at this
time, I would recommend requiring that HOEPA lenders offer that
choice.
What about balloons? I think that, again, limits on
balloons and also proposed limits on new brokers' practices may
be a good idea, but I think that we should await more data
before we know exactly how to shape those rules.
My final point and I know I am running out of time is
dealing with usury laws. These are very bad ideas. I want to
focus on the recent legislation that has been enacted and the
problems that have come from it. Because of legal limits on
local authorities to impose usury ceilings because of Federal
preemption, explicitly, that is, they cannot explicitly impose
usury ceilings, they have adopted what I would call an
alternative stealth approach to usury laws. The technique is to
impose unworkable risks on subprime lenders that charge rates
or fees in excess of government-specified levels and thereby,
drive high-interest rate lenders from the market. Several
cities and States have passed or are currently debating these
stealth usury laws for subprime lending.
For example, the City of Dayton, Ohio, this month passed a
Draconian antipredatory lending law. This law places lenders at
risk if they make high-interest loans that are, ``less
favorable to the borrower than could otherwise have been
obtained in similar transactions by like consumers within the
City of Dayton.'' And lenders may not charge fees and/or costs
that, ``exceed the fees and/or costs available in similar
transactions by like consumers in the City of Dayton by more
than 20 percent.''
In my opinion, it would be imprudent for a lender to make a
loan in Dayton governed by this statute. Indeed, I believe that
the statute's intent must be to eliminate high-interest loans,
which is why I describe it as a stealth usury law. Immediately
upon the passage of the Dayton law, Banc One announced that it
was withdrawing from origination of loans that were subject to
the statute. No doubt, others will exit, too. The recent 131
page antipredatory lending law passed in the District of
Columbia is similarly unworkable.
What about North Carolina, which pioneered this area in
1999? As Donald Lampe points out, massive withdrawal from the
subprime lending market has occurred in response to the overly
zealous initiative against predatory lending by North Carolina.
Michael Staten of the Credit Research Center of Georgetown
University has compiled a new database on subprime lending that
permits one to track the damage, the chilling effect, of the
North Carolina law on subprime lending in the State.
Staten's statistical research, which I reproduced with his
permission in the appendix to my testimony, compares changes in
mortgage originations in North Carolina with those of South
Carolina and Virginia before and after the passage of the 1999
North Carolina law.
Staten finds that originations of subprime mortgage loans,
especially first lien subprime loans, in North Carolina,
plummeted after passage of the 1999 law, both absolutely and
relatively to its neighbors, and that the decline was almost
exclusively in the supply of loans available to low- and
moderate-income borrowers, those most dependent on high-cost
credit. For borrowers in the low income group, with annual
incomes less than $25,000, originations were cut in half. For
those in the next income class, with annual incomes between
$25,000 and $49,000, originations were cut by roughly a third.
The response to the North Carolina law provides clear evidence
of the chilling effect of antipredatory laws on the supply of
subprime mortgage loans to low-income borrowers. And in fact,
was anticipated in the critical remarks that Bob Litan made
about these laws.
The history of the last two decades shows that usury laws
are highly counter-productive. Limits on the ability of States
to regulate consumer lenders headquartered outside their State
were undermined happily by the 1978 Marquette National Bank
case and furthered by the 1982 passage of the Alternative
Mortgage Transaction Parity Act.
I will not go into all my details in this discussion, but I
want to emphasize that it would be very useful for Congress to
reassert Federal preemption to prevent any more damage from
taking place.
Let me conclude, for the most part, predatory lending
practices can be addressed by focusing effort on better
enforcing laws, improving disclosure rules, offering government
finance counseling, and placing a few well thought-out limits
on credit industry practices. The Fed already has the authority
and the expertise to formulate those rules and is in the
process of doing so based on a new data collection effort that
will permit an informed and balanced approach to regulating
subprime lending.
And again, I emphasize, the main role of Congress should be
to reestablish Federal preemption. And I hope also Members of
Congress, and especially Members of this Committee, will speak
out in defense of honest subprime lenders, of which there are
many. The possible passage of State and city usury laws is not
the only threat to the supply of subprime loans. There is also
the possibility that bad publicity, orchestrated perhaps by
well-meaning community groups, itself could force some lenders
to exit the market.
Thank you, Mr. Chairman.
Chairman Sarbanes. Well, thank you. This is a very useful
statement and appendix for the Committee to have because it
puts together a lot of the assertions that have been made,
which I think will require very careful analysis on our part.
We are approaching this issue with a hard head and we would
be interested to see how this analysis withstands a hard head
analysis, how this statement withstands a hard head analysis.
So, it is helpful to have it all put together the way you have
done it and I want to thank you because, obviously, a good deal
of effort has gone into it.
Mr. Calomiris. Thank you, Mr. Chairman.
Chairman Sarbanes. Mr. Eakes.
STATEMENT OF MARTIN EAKES
PRESIDENT AND CEO, SELF-HELP ORGANIZATION
DURHAM, NORTH CAROLINA
Mr. Eakes. Thank you, Mr. Chairman.
I too in the last couple of weeks since my name has been on
this list have been called by numerous lenders telling me that
they are giving up single premium credit insurance, hoping that
I would not mention their names in this hearing, including one
as late as yesterday. I come to you today in two roles.
The first is in my role as CEO of Self-Help, which is an
$800 million community development financial institution. That
makes us the largest nonprofit community-development lending
organization in the Nation, which is also about the size of one
large bank branch, to put it into perspective. Self-Help has
been making subprime mortgage loans for 17 years. We are
probably one of the oldest, still-remaining, subprime mortgage
lenders. We have provided $1.6 billion of financing to 23,000
families across the country. We charge about one-half of 1
percent higher rate than a conventional-rate mortgage. We have
had virtually no defaults whatsoever in 17 years. If you have a
23 percent default, I can almost assure you, it is the result
of lending with fraud in that process. Subprime lending can be
done right. We agree that there are good subprime lenders. We
hope that we are one.
I come to you, second, as a spokesperson for an
organization that started in North Carolina, called the
Coalition for Responsible Lending. The coalition that formed in
North Carolina was a really remarkable event for anyone who
watches politics among financial institutions. This coalition
started in early 1999 and started with 120 CEO's of financial
institutions who came together to ask for a law to be passed in
order that they could squeeze the bad apples out of the lending
industry in North Carolina.
Let me ask you on this Committee, how many times have you
had credit unions and every bank in the country come together
and ask you to pass a bill that would regulate them as well as
everyone else? Ever?
Chairman Sarbanes. We are working at that right now.
Mr. Eakes. We are working at that.
[Laughter.]
We ended up with a coalition that had 88 organizations that
represented over 3 million people in the membership of those
organizations in North Carolina. North Carolina only has 5
million adult voters in the State. This group included all the
credit unions, every thrift, every bank, the Mortgage Bankers
Association, the Mortgage Brokers Association, the realtors,
the NAACP, civil rights groups, housing groups, AARP and
seniors groups--every single organization that had something to
say about mortgage lending in the State of North Carolina came
together to pass what was not a perfect bill, it was a
compromise bill among all those parties. And we passed a bill.
The bill in North Carolina in 1999 passed both the Senate and
the House virtually unanimously. We had one vote against in the
Senate and two in the House out of 120 members.
Let me tell you what the philosophy of the North Carolina
bill was, which shows you why there was such an encompassing
consensus. We started with two key principles. The first
principle was that this bill would add no additional
disclosures whatsoever. The industry representatives and the
consumer representatives agreed that real estate closings now
have 30 plus documents to sign and go through.
I am a real estate attorney. I have closed hundreds, if not
thousands, of real estate loans. And I am not sure that I can
understand every little piece of fine print in those 30 forms.
I assure you that no ordinary real person can read those
documents and understand them. It is also unfair to say that
education or disclosure will solve the problem. I will give you
an example.
My father, who was this ornery--some people think I am
ornery and hard to get along with. I used to be nicer. My
father was at least twice as mean as I am. He ran a business,
contracting business. No one could take advantage of him until
the last 6 months of his life when he was bedridden with
cancer. And then, all of a sudden, he had people calling him,
saying, can you refinance your house? And even my father, mean,
technically competent, a business person, could fall prey to a
lender who approached him in his own house.
The second principle that we had was that we would place no
cap on the interest rate on mortgages. Now this was somewhat
controversial. We did that for an explicit reason. We said, by
putting no cap on the interest rate, there can be no rationing
of legitimate subprime credit in the State of North Carolina.
Instead, we focused on all the hidden elements of pricing
in a mortgage loan. And we said, we are going to try to
prohibit those and force the price into the interest rate, the
one factor that most borrowers understand best. It has been
said that it is hard to define predatory lending. Well, in
North Carolina, whether you like what we did or did not do,
that is precisely what we did. We identified six practices that
we thought were the essence of predatory lending.
In the North Carolina bill, we dealt with only four of
them. That is all we could do in the first bill. But what we
did in legislation was precisely define these four predatory
lending practices in legal, legislative language, and enact
them into law. The following four practices are what we focused
on in the North Carolina bill.
First, we put a threshold limit on upfront fees. It is
simply a problem, as we heard from the woman from West
Virginia, when you have upfront fees, you can never get them
back. The moment you sign the document, you may have lost your
entire life savings in less than one second of signing your
name. Instead, what the North Carolina bill said was, no
financing of fees if the amount of fees is greater than 5
percent. Now, in all honesty, 5 percent fee to originate a
mortgage is a very large number. The standard amount paid for a
conventional, middle-class mortgage that most of us would go
and obtain is 1.1 percent. That is the standard across the
country.
So 5 percent is a pretty extreme compromise. It is not
something I went home and was proud of after the bill was
passed. And we said 5 percent of fees, not counting lawyer
fees, not counting
appraisals, any of the third-party fees that you normally pay
at a mortgage closing, that is a limit beyond which there are
some protections in the North Carolina law. And I guess I would
call that a stealth usury provision if you want to say that
charging more than 5 percent fees is a good thing.
Second, we focused on the practice of flipping. The reason
that this was so poignant for us in North Carolina is that we
had done research--you may know this--but President Carter came
to Charlotte. We have one of the most active Habitat For
Humanity networks in North Carolina of any State. We found
researching loan by loan at courthouses that more than 10 to 15
percent of all Habitat for Humanity borrowers who had $40,000,
zero-percent first mortgages from Habitat, had been refinanced
into 14 percent finance company mortgages. Now what does that
tell you?
That 10 to 15 percent could not have been acting rationally
in the way that in academia we assume is a fully functioning
perfect market. Moreover, it shows that if lenders will take
advantage of 10 to 15 percent of people who have zero percent
mortgages and refinance them into 14 percent mortgages, what do
you think that says about the people who have those measly 7\1/
2\ and 8 percent mortgages. They are certainly fair game for
flipping. We passed a prohibition for all home loans in North
Carolina that says you may not flip, refinance a home loan,
unless there is a net tangible benefit to the borrower.
Third, we prohibited prepayment penalties on all mortgage
loans. Well, that is nothing new. In North Carolina, we had
that prohibition already since 1973. In fact, 31 States across
the country have limitations prohibiting or restricting
prepayment penalties on mortgages currently. This one really
drives me crazy.
We tell poor people that it is your goal and your message
is to get out of debt. That is what we charge people with. And
yet, for the average African-American family with a $150,000
loan on a home, the average prepayment penalty is about 5
percent. To pay off that debt, get out of debt, or refinance to
another borrower, is 5 percent of $150,000, $7,500. That is
more than the median net wealth of African-American families in
this country. So in one second, when you sign up for this
mortgage, you can put at risk an entire lifetime savings of
wealth for the average median African-American family in this
country.
And four, we prohibited in North Carolina the financing of
credit insurance on all home loans in North Carolina. Before
predatory lending, I was a nicer human being. But as I listened
to Professor Calomiris, I hope in the question and answer
session you will let me come back and maybe engage him in a
little academic questioning on those terms.
To say that monthly pay insurance costs 50 percent more
than single premium insurance is the worst kind of analytic
mistake or intellectual dishonesty that I can imagine. Every
analyst who has looked at single premium insurance finds it
more expensive, which it is. I will give you an example.
If I came to you and said, you pay for your electric bill
on a monthly basis every month for the next 5 years and you pay
it with no interest. Instead, I give you the option to finance
all 60 months of your electric payment into a loan at the front
end and pay the interest on it over the next 5 years. And a
typical case would come to, say, $7,000 or $8,000 of interest.
At the end of the 5 years, you still owe all of the electric
payments because you have not paid anything off. Everyone who
has analyzed single premium credit insurance will tell you that
it costs twice as much as monthly pay, no matter how you run
the assumptions, no matter what you do.
The predatory lenders use this tactic with a borrower the
same way it is used in public--to say that your monthly cost
will be lower because all you are paying is the interest. But
the cost for the single premium credit insurance, like
financing your electric payments, is still 100 percent, 99
percent due at the end of 5 years.
I used to not lose my temper, but this is really driving me
nuts. Let me tell you how I came to this work.
For 17 years, I worked and was a preacher preaching that we
needed to get access to credit, particularly for African-
American homeowners. Access to credit was my watchword.
In the last 2 years, it has turned totally on its head and
I no longer worry about whether there is access to credit. It
is now the terms of credit. And where there were sometimes
lenders who were starving communities from getting credit they
needed, the problem now is that many lenders are actually
eating those communities. They are eating the equity of these
families.
I had a borrower who came into my office and he told me
this story which I really did not believe. I said, bring me
your paperwork for your loan, which he did. We sat down. He
showed me his loan. He had gotten a refinance loan from the
Associates in 1989. It refinanced a Wachovia Veterans
Administration loan and it was a $29,000 loan. On his
paperwork, it showed that he had $15,000 of charges added into
the loan for what was a $29,000 refinance. So, he had $44,000
of total debt. He paid on that loan for 10 years until he came
to see me in early 1999. He told me that he had three different
times tried to pay the loan and that the Associates, recently
purchased by Citigroup, would not allow him to pay off the loan
and refinance it.
I said, I am a lawyer. I know that cannot be true. That is
illegal. I do not believe it. As I got ready to call the
company on his behalf, he sat down and tears welled up in his
eyes and he said, let me tell you one more thing. The reason
that this house means so much to me is not just the shelter,
that it is the house I have lived in, but I lost my wife 3
years ago and I have a 9-year-old daughter. And this house is
the only connection that my 9-year-old daughter will ever have
with her mother. And I am sitting here, oh, God.
And I call the company and the woman on the phone says, ``I
am not going to give you the pay-off quote.'' Well, there are
people who have worked with me for 18 years who have never
really seen me get mad. But at that point, I really lost it and
I told her--she said,``You are just a competing lender. Why
should I give you the pay-off quote?'' You are just going to
refinance them.
And I told her, if it takes me the rest of my life, I will
sue you to hell and back and we will get this person out from
under your thumb. And we will refinance this loan if I lose
every penny of it. I do not care any more.
And we did. We refinanced it. We litigated. We reduced the
loan in half. And that was the beginning, my first knowledge of
the
Associates, which many people knew was the rogue company in
predatory lending. There are a lot. But that one is just a
horrible company. That was the beginning for me of this
coalition that started in North Carolina.
I have since traveled around the country and I have said
that I will spend every penny that Self-Help owns, I will spend
every penny that I own until we stop this practice of basically
stealing people's homes in the guise of lending. A couple more
stories and I will end and then we can have some questions.
I got called as an expert witness by the banking
commissioner in North Carolina who was trying to remove the
license of a lender. The story was this. The lender has made
5,000 loans in North Carolina. This can only happen in the
South. He had advertised on the radio that this is a good
Christian company. Please come here and we will take care of
you. He did take care of them. The average fees--he would not
close a loan for less than 11 points on the front end for any
of those loans. The person who was the principal of this
business had met his other senior management in prison for
trafficking cocaine.
What came out in the hearing, and I am on the witness stand
and his lawyer is cross-examining me, saying, why are you
picking on this company? We are not nearly as bad as three
others he named. The problem in North Carolina we found was
unbelievable.
We found that between 10,000 and 20,000 families in North
Carolina were losing the equity in their homes or losing their
homes outright every year. For me, personally, this was really
an affront. I had spent 18 years at that point helping families
own homes. And what I found was one or two lenders--I do not
have to look at the average for the industry--but one or two
lenders who are undoing in a month's time every possible step
of good that Self-Help had done with its 23,000 loans over 18
years. It stopped being an academic issue for me at that point,
although I think I would be pleased to argue it on academic
terms.
There are things that Congress needs to do. We need to
repeal the Parity Act in its entirety. We need to strengthen
HOEPA.
But I will stop there. Thank you.
Chairman Sarbanes. Thank you very much, Mr. Eakes.
I am going to ask a few questions. I hope that no one on
the panel is under an immediate time pressure.
I want to go to this single premium credit life insurance
and the assertion that it is cheaper than paying it by the
month. I just have great difficulty with that analysis. First
of all, the mortgage is usually for 30 years. The single
premium is for 5 years. Correct, in most instances?
Mr. Calomiris. That is not what I am talking about,
Senator.
Chairman Sarbanes. Are you talking about a 30 year single
premium?
Mr. Calomiris. No.
Chairman Sarbanes. No one does a 30 year single premium
because the cost of that premium would be so huge, that it just
would not fly.
Mr. Calomiris. I am talking about a 5 year single premium.
Chairman Sarbanes. That is right. And then they get to the
end of the 5 years and then they refinance, and then they throw
in another 5 year single premium. Is that right? Is that what
happens in almost every instance?
Mr. Calomiris. I do not think anyone knows what happens in
almost every instance, Mr. Chairman. But I think we can agree
on some basic arithmetic principles. I hope we can.
First of all, we are talking about a stream of cashflows,
whether you talk about the monthly premium or the single
premium. And then the question is, if it is monthly premium,
you have to decide what discount rate do you discount those
cashflows to arrive at a present value because the right
comparison, I think you will agree, is that you want to ask
whether the present value of monthly premium insurance or the
present value of single premium insurance is larger. If you
discount, which is the correct way to do it, at the interest
rate that is charged in the loan, because that is the
borrower's discount rate, you arrive at a calculation that
single premium is half as costly.
Whether you are financing that single premium up front or
paying it up front, it is equivalent. It does not matter. The
fact that you are only paying the interest and then 5 years
from now, you still have to continue paying the interest
because you have not repaid the balance on the money you
borrowed to pay the single premium insurance, is irrelevant to
the computation. I think what we are really having a problem
with here is what I would call basic finance arithmetic. And I
think that is unfortunate.
Chairman Sarbanes. Well, Martin, do you want to address
that?
Mr. Eakes. I would love to get into basic finance
arithmetic with someone because now you are really on my turf.
I have been a lender for almost 20 years. There is no way that
you can have a cashflow that includes interest and discount it
back at any interest rate and have that come out to be lower
than something that has no interest whatsoever.
It does not matter. You still have the terminal amount that
is the full amount of the premium. It does not matter. I am
absolutely certain that this is an analytic bad mistake in
every way it can be.
Chairman Sarbanes. My perception of it is that it is like
trying to walk up the down escalator. You just keep losing
ground.
Let me give you an example from one company. They had a
$50,000, 15 year mortgage loan with a single premium life
insurance policy costing $1,900 that was in force for 5 years.
At the end of the 5 years, the homeowner still owed about
$1,600 on the original insurance premium. So then he
refinances. He takes out another policy. So there is another
$1,900 that is thrown into the loan. Now it is $3,500 that has
been pulled out of him. We do not really go after the
protections of the insurance if they pay it on a monthly basis.
But that is outside of being folded into the loan and then
paying interest on that large charge. Then the person ends up
losing their home because you have packed all these fees into
it.
Mr. Miller. Senator, if I could just make a couple of
practical points, too. Think about the income level of the
people we are talking about.
Chairman Sarbanes. I want to get to that, too, in a minute
on the balloon payment, yes.
Mr. Miller. In this context. All the demands on their
financial resources. Life insurance would not naturally be high
on their list. It would not fit in, except for what the lenders
are doing.
And think, too, to finance insurance, would that be
something they would want to put their home in jeopardy for and
put that in the mortgage? No. It just does not make sense from
the consumer's point of view. It is only in there for the
lenders. And indeed, in my view, it is a litmus test of whether
a lender is in good or bad faith.
They are out to drain the consumer, if they are selling
single premium credit life insurance. It is just very clear to
me where they are headed.
Mr. Calomiris. Mr. Chairman, if I could just interject.
Chairman Sarbanes. Certainly.
Mr. Calomiris. What I am proposing, of course, is not to
leave things as they are. I am proposing some pretty big
changes. I am proposing that the lender has to offer both
products--single premium and monthly premium--that the lender
has to fully disclose what is the cash that I am going to get
back? What is the monthly payment I am going to have to make in
totality? All the charges. And then let the borrower choose.
And make it also clear that this is entirely optional
because a lot of the complaints have been that people did not
understand it was optional, that all of the other terms in the
loan do not change.
Somebody has to explain to me why, when somebody is being
given a choice that is clearly spelled out, and we are going to
make sure that the disclosure is right, and they decide that
they would prefer what I would regard, in some cases, at least,
and from what I understand, on average, cheaper insurance over
the life of that 5 years, somebody has to explain to me why,
because a Senator or an activist or an attorney general
believes that is not the right choice, why they, with
counseling, on their own, with all information, cannot do it?
Mr. Miller. Charles, were you here this morning? Did you
hear what was going on?
Mr. Calomiris. I was here this morning.
Mr. Miller. And do you have any sense of the power and
influence of the industry making these loans and running them
through? Yours is an academic approach. What we really need to
do is deal with the real people that we saw this morning, and
in that setting, to set up these complicated disclosures just
does not make any sense in the real world.
Mr. Eakes. This is a product that never benefits the
consumer. Never. Not a single case. That is why it is so easy.
And if we have a trained economist who cannot get it right, how
do we expect a borrower to get it right? When you offer a
choice between something that in every case costs you the extra
interest, every single case, it makes it a false choice.
And so the borrower, yes, they can be deceived into
choosing it because the predatory lender focuses on the monthly
payment. And they say, this example of a $100,000 loan with
$10,000 of up front credit insurance, if you pay for that
interest only, it would be $133 a month, which is what
financing it as single premium is. If you pay for it on a
monthly basis, your monthly payment will be $167.
So, he is right. It does, on the monthly basis, cost a
little bit less. But at the end, you still owe $9,900 of the
single premium credit insurance. To offer a choice of something
that, in every single case, is worse for the borrower, is
merely a deception. How can we possibly have the consumer
understand that. Put it in the interest rate if the lender
needs that compensation. This is ridiculous.
Chairman Sarbanes. Let me ask this question.
How is a borrower in the subprime market who almost by
definition is right at the limit of their ability to handle the
matter, going to handle a balloon payment at the end of the
mortgage period?
Is that not, to a large extent, building up a huge risk of
default, or perhaps more likely which keeps happening, a
refinancing when they get to that point, again in which a lot
of fees are packed into the loan and we get the sort of process
that was laid out here this morning where the equity is being
stripped out of this loan? Does anyone want to address that?
Mr. Calomiris. When I was younger, I borrowed balloon loans
because the interest rates are lower because, by keeping
maturity lower, typically, in a loan, risk is lower--and then I
rolled it over with the same bank.
Chairman Sarbanes. And what were your earning prospects
when you did that?
Mr. Calomiris. I do not know. I was in my early 20's. I was
a graduate student at the time. I suppose that if you were
optimistic about my career ability, you would say they were
pretty good.
Chairman Sarbanes. They were pretty good. Now suppose you
were 70 years old and you were living on Social Security.
What is the rationale for the balloon payment in that case?
That is your income. You are at the end of your working life.
That is your income. And you take out a subprime loan. They
slap on this balloon payment. Now what is the rationale there?
Mr. Calomiris. Again, balloon payments tend to reduce
interest cost, so they can be beneficial. In my statement, of
course, I recognize that you may want to limit balloons in some
cases. And, in fact, I argue that was one of the things that I
hope the Fed will look at. But I do not believe we want to
rashly decide whether a 1 year balloon or a 3 year balloon or a
5 year or 7 year, is the right route.
Chairman Sarbanes. We are not going to decide anything
rashly.
Mr. Calomiris. Right.
Chairman Sarbanes. Let me make that very clear. Nothing
will be decided rashly.
Mr. Calomiris. Balloon payments reduce interest costs and
that is the main benefit anyone derives from them. If there is
rollover risk, as I think you are suggesting there can be in
some cases, or if people are tricked and do not understand that
they are facing a balloon, then I think there is a real issue.
But let us again not throw the baby out with the bathwater.
But if I can just make one other comment about flipping.
Again, I have specific ideas about how you can prevent
flipping. The problem with the North Carolina law, and the
reason that it is had such a chilling effect on subprime
lending already in North Carolina is that it does not give
anybody safe harbor.
If you are going to say people cannot flip, that is fine. I
am all for it. But let us define what flipping is in a very
clear way, because if we do not define what it is, the legal
risk that comes from being potentially sued for having flipped
puts a chilling effect on lending. Let us go after flipping.
But let us not go after it in a vague way, which is what the
North Carolina law does. And that is why I think it is had such
a negative effect.
Chairman Sarbanes. Well, Mr. Eakes, Professor Calomiris to
some extent, took out after North Carolina.
Mr. Eakes. Yes, I think he called me out to a duel, right?
Chairman Sarbanes. So, you are entitled to some response to
it, if you choose to make it.
Mr. Eakes. Let me respond and maybe I will ask a question.
The data that is cited is from a study paid for by industry
that looked at nine lenders. Nine lenders. That is the study.
What it shows is that there has been a drop in lending, which I
have not seen before today, that says that North Carolina
dropped in the third quarter of 1999 and the fourth quarter and
the first two quarters of 2000. That was the data that I saw in
that study.
I wish that data were correct. I really do, because it
would show that the goal that we had in North Carolina--Mr.
Calomiris may or may not know this--but of the four practices
that I mentioned, only one of them had gone into effect as of
the third quarter of 1999 and that is the flipping. So that had
to be what would show a reduction in originations, by 25 and 50
percent.
I wish that number were right because when we passed the
bill, the goal of the North Carolina legislation was to reduce
flipping. And the way you reduce flipping is have less loans
originate. That data would show that gap.
Here is what I would like to ask, is whether Mr. Calomiris
knows of any other events that were active in North Carolina
during the third quarter of 1999? Are you aware of any other
environmental changes?
Mr. Miller. Was there a hurricane?
Mr. Eakes. We had in North Carolina, on September 15, 1999,
the largest flood in the history of North Carolina ever
recorded. It took 15,000 units directly down the river. As many
as 100,000 families were dislocated. September 15, 1999. They
could not have borrowed money if the predatory lenders had come
to them in a boat.
[Laughter.]
So, his assessment--I wish it were right. I wish that
really had seen a, ``chilling effect because the only provision
that we had in effect was the antiflipping.''
That is what we wanted to do, was to reduce the number of
flips. But, unfortunately, I am afraid--I actually have heard
this. It is remarkable. I travel around the country and I hear
the North Carolina bill--first, I heard that every lobbyist who
supported it lost their job. Totally false.
Chairman Sarbanes. Mr. Prough, I want to put a couple of
questions to you. You have been very patient.
Mr. Prough. Yes, sir. Well, I would have liked to have
participated in the conversation on credit life and balloons,
but since we do not offer those products, there was no need.
Chairman Sarbanes. Yes. Ameriquest does not engage in those
practices. Correct?
Mr. Prough. Never. We never have.
Chairman Sarbanes. I have the impression by establishing
this high level of performance, you have been able to make it
succeed. But I am concerned about--I want to ask this question,
which may not be fully applicable to you because you have
really made it work. But if lenders try to follow that course,
would they be at a competitive disadvantage with respect to
others in the industry?
Let me put it this way. I guess they would be missing out
on the opportunity to make some fast money. Now they choose to
do that. But they are passing up such an opportunity, are they
not?
Mr. Prough. Everybody runs their own business model,
Senator.
Our approach is that by using the secondary market, using
Wall Street, and bundling our loans, we are able to create
efficiencies and create our profits through moving loans that
way. And that way, we can pass that cost savings on to the
consumer.
Some of these other products just do not fit for that model
because you are adding costs to the loan which eventually then
have to be financed through Wall Street. That causes
complications. We prefer to keep it very simple, very
straightforward, and do exactly what the customer expects us to
do, provide home financing.
Chairman Sarbanes. Well, it is a very interesting model and
we appreciate your coming here today to tell us about it. No
question.
I am going to draw this to a close.
Mr. Calomiris. May I just make one comment, Mr. Chairman?
Chairman Sarbanes. Certainly.
Mr. Calomiris. Because I did not get a chance to respond.
Chairman Sarbanes. I do not want you to go away feeling
that. We try to be eminently fair here. Yes.
Mr. Calomiris. I mean respond on one fact.
Chairman Sarbanes. Yes.
Mr. Calomiris. The evidence that I presented in the
appendix showed that the decline in subprime lending occurred
only in some income classes. So it seems a little strange to
say it was the result of a flood, because then you would have
to believe that the flood only affected people with incomes
below $50,000.
Chairman Sarbanes. But the subprime lending occurs
primarily in certain income classes, does it not?
Mr. Calomiris. The point, Mr. Chairman, is that I have it
for the different income classes, only subprime lending. I am
not looking at all lending. Just subprime. The point is that it
only affected people who are really subject to these particular
rules. And I did note that was phased in over 2000 and the data
are about 2000, not about the end of 1999. I just want to
emphasize that we do not have all the facts here before us. I
do not claim that we do.
Chairman Sarbanes. You want to get out from under the
flood, I take it. Is that it?
Mr. Calomiris. Exactly.
[Laughter.]
As I say, that dog is not going to hunt.
Mr. Eakes. If I could just--and I promise I will be quick.
Chairman Sarbanes. Yes, I have to draw this to a close.
Mr. Eakes. The poor people, where they own homes, happens
to often be in low-lying land that ends up being flood plain.
Rich people do not live in flood areas. And so it is
extremely reasonable that you would have families in the lower
income brackets who are homeowners who are subject to these
loans.
I really wish I could bring--you are at Columbia? I would
love to bring him just for a few days to actually see how the
marketplace works, both in floods and out of floods, because he
does not get it right now.
[Laughter.]
Chairman Sarbanes. Mr. Prough, you sat quietly through all
of this. Is there any comment you want to add before I draw
this to a close?
Mr. Prough. No, sir.
[Laughter.]
Chairman Sarbanes. No wonder you all have been so
successful.
[Laughter.]
Well, I want to thank this panel very much. I am sure we
will be back to you about one thing or another as we proceed to
explore this matter. Again, I want to thank you for your
helpful testimony and for the obvious careful thought that went
into the statements.
The hearing now stands adjourned.
[Whereupon, at 1:10 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional materials supplied for the record follow:]
PREPARED STATEMENT OF SENATOR PAUL S. SARBANES
Today is the first of two hearings on ``Predatory Mortgage Lending:
the Problem, Impact, and Responses.'' This morning we will hear first,
from a number of families that have been victimized by predatory
lenders. Then, later this morning and tomorrow, an array of public
interest and community advocates, industry representatives, and legal
and academic experts will have the opportunity to discuss the broader
problem and the impact predatory mortgage lending can have on both
families and communities.
Homeownership is the American Dream. It is the opportunity for all
Americans to put down roots and start creating equity for themselves
and their families. Homeownership has been the path to building wealth
for generations of Americans; it has been the key to ensuring stable
communities, good schools, and safe streets.
Predatory lender play on these hopes and dreams to cynically cheat
people of their wealth. These lenders target lower income, minority,
elderly, and, often, unsophisticated homeowners for their abusive
practices. It is a contemptible practice.
Let me briefly describe how predatory lenders and brokers operate.
They target people with a lot of equity in their homes, many of whom
may already be feeling the pinch of growing consumer and credit card
debts; they underwrite the property often without regard to the ability
of the borrower to pay the loan back. They make their money by charging
extremely high origination fees, and by ``packing'' other products into
the loan, including upfront premiums for credit life, disability, and
unemployment insurance, and others, for which they get significant
commissions but for which homeowners continue to pay for years beyond
the terms of the policies.
The premiums for these products get financed into the loan, greatly
increasing the loan's total balance amount. As a result, and because of
the high interest rates being charged, the borrower is likely to find
himself in extreme financial difficulty.
As the trouble mounts, the predatory lender will offer to refinance
the loan. Unfortunately, another characteristic of these loans is that
they have high prepayment penalties. So, by the time the refinancing
occurs, with all the fees repeated and the prepayment penalty included,
the lender or broker makes a lot of money from the transaction, and the
owner has been stripped of his or her equity and, oftentimes, his home.
Nearly every banking regulator has recognized this as an increasing
problem. Taken as a whole, predatory lending practices represent a
frontal assault on homeowners all over America.
I want to make clear that these hearings are aimed at predatory
practices. There are people who may have had some credit problems who
still need access to affordable mortgage credit. They may only be able
to get mortgage loans in the subprime market, which charges higher
interest rates. Clearly, to get the credit they will have to pay
somewhat higher rates because of the greater risk they represent.
But these families should not be charged more than the increased
risk justifies. These families should not be stripped of their home
equity through financing of extremely high fees, credit insurance, or
prepayment penalties. They should not be forced into constant
refinancings, losing more and more of the wealth they have taken a
lifetime to build to a new set of fees, with each transaction. They
should not be stripped of their legal rights by mandatory arbitration
clauses that block their ability to go to court to vindicate their
protections under the law.
Some people argue that there is no such thing as predatory lending
because it is a practice that is hard to define. I think the best
response to this was given by Federal Reserve Board Governor Edward
Gramlich, who said earlier this year:
``Predatory lending takes its place alongside other concepts,
none of which are terribly precise safety and soundness, unfair
and deceptive practices, patterns, and practices of certain
types of lending. The fact that we cannot get a precise
definition should not stop us. It does not mean this is not a
problem.''
Others, recognizing that abuses do exist, contend that they are
already illegal. According to this reasoning, the proper response is
improved enforcement.
Of course, I support increased enforcement. The FTC, to its credit,
has been active in bringing cases against predatory lenders for
deceptive and misleading practices. However, because it is so difficult
to bring such cases, the FTC further suggested last year a number of
increased enforcement tools that would help to crack down on predators.
I hope we will get an opportunity to discuss these proposals as the
hearings progress.
I also support actions by regulators to utilize authority under
existing law to expand protections against predatory lending. That is
why I sent a letter, signed by a number of my colleagues on the
Committee, strongly supporting the Federal Reserve Board's proposed
regulation to strengthen the consumer protections under current law. I
also note that the Federal Trade Commission voted 5 to 0 last year in
support of many of the provisions of the proposed regulation.
Campaigns to increase financial literacy and industry best
practices must also be a part of any effort to combat this problem.
Many industry groups have contributed time and resources to educational
campaigns of this type, or developed practices and guidelines, and I
applaud and welcome this as an integral part of a comprehensive
response to the problem of predatory lending.
But neither stronger enforcement, nor literacy campaigns are
enough. Too many of the practices we will hear outlined this morning
and in tomorrow's hearing, while extremely harmful and abusive, are
legal. And while we must aggressively pursue financial education, we
must also recognize that education takes time to be effective, and
thousands of people are being hurt every day. At his recent
confirmation hearing, Fed Governor Roger Ferguson summed it up well
when he said that ``legislation, careful regulation, and education are
all components of the response to these emerging consumer concerns.''
Again, I want to reiterate, subprime lending is an important and
legitimate part of the credit markets. But such lending must be
consistent with and supportive of the efforts to increase
homeownership, build wealth, and strengthen communities. In the face of
so much evidence and so much pain, we must work together to address
this crisis. Before taking your testimony, let me express my
appreciation to all of you for your willingness to leave your homes and
come to Washington to speak publically about your misfortunes. I know
it must be very difficult. In my view, you ought to be proud that you
are contributing to a process that I hope will lead to some action to
put an end to the kinds of practices that have caused each of you such
heartache and trouble.
----------
PREPARED STATEMENT OF SENATOR WAYNE ALLARD
I would like to thank Chairman Sarbanes for holding this hearing.
This is an
important topic, and I am glad that this Committee will have an
opportunity to examine it more closely. I know that predatory lending
is an issue that Chairman Sarbanes has followed very closely, as the
so-called ``flipping'' form of predatory lending has been a particular
problem in Baltimore.
In the various Housing and Transportation Subcommittee hearings
over the last 3 years, predatory lending came up on several occasions.
It is an abhorrent practice, and as Ranking Member of the Subcommittee
I am particularly concerned about predatory lending that involves FHA
loans. The fraud perpetrated in those cases not only victimizes the
individual family, but also robs the taxpayers, who are responsible for
backing the loan through FHA.
During my years as Chairman, and now as Ranking Member of the
Housing Subcommittee, I have seen firsthand how important homeownership
is to Americans, after all, it is the American Dream. It is
reprehensible that a small number of individuals prey upon those hopes
and dreams, turning the dream into a nightmare.
I am pleased that this Committee will have an opportunity to
examine some of the issues surrounding predatory lending. While we hear
a great deal about predatory lending, much of what we know seems to
come from anecdotes. I believe it is important that we examine the
problem in a careful, reasoned way. In this manner we can first get a
clear idea of exactly what constitutes predatory lending, and how great
the scope of the problem is. Next, we can consider whether current laws
are adequate or whether we need additional laws.
I particularly wish to focus on the matter of enforcement. While
predatory lending is obviously occurring under the current laws, it may
very well be that the current laws are adequate, but simply not well
enforced. Similarly, any additional laws that this Committee may pass
would be of little value if they are not enforced.
As important as it is to curb predatory lending, any actions
considered by Congress, the States, or regulatory bodies must be made
with caution. While predatory lending is by its nature deceptive and
fraudulent and should be stopped, there is certainly room for a
legitimate subprime lending market. Subprime lending expands
homeownership opportunities for those families that may have
experienced credit problems or who have not had an opportunity to
establish credit. The subprime market gives them access to financing
that allows them to experience the dream of homeownership.
Without access to this market, far fewer people would own a home.
It is no coincidence that subprime lending has greatly expanded as the
country is experiencing record homeownership rates. If we are not
careful with any legislation, we could end up hurting the very people
that we are trying to help.
We also cannot lose sight of the fact that laws cannot solve all
problems. Because there will always be those who disregard the laws, we
must also find ways to promote personal protection and responsibility.
I believe that we need to find a better way to educate and empower
consumers. I believe that knowledge can be a very powerful weapon, and
this is particularly true for financial matters. Survey after survey
has found that Americans lack basic financial knowledge. This lack of
information can lead to financial disaster. Better consumer and
financial knowledge will leave consumers better protected--regardless
of what the laws may be.
Again, I would like to thank the Chairman for holding this hearing.
While today's cases are genuine tragedies, I hope that we will be able
to learn from their situations to help stem predatory lending in
America. I thank the witnesses for being willing to come forward to
share their stories. I look forward to your testimony.
----------
PREPARED STATEMENT OF SENATOR JIM BUNNING
Mr. Chairman, I would like to thank you for holding this hearing,
and I would like to thank our witnesses for testifying today and
tomorrow.
Nobody is in favor of ``Predatory'' lending. We have all heard the
horror stories of unscrupulous people preying on the elderly, going
through an entire neighborhood and negotiating home improvement loans.
These same individuals then strip the
equity from these homes, usually without even doing the repairs. There
is a word for these practices, and it is fraud. These practices should
not and cannot be tolerated. The perpetrators of these practices should
be prosecuted to the fullest extent of the law.
But we must not throw the baby out with the bath water. Sixty-eight
percent of Americans own their own homes. While I do not know the exact
statistics, I am willing to bet not all of that 68 percent were
candidates for the prime rate. I am pretty sure many of them did not
qualify for prime.
So then, how are these people, who are not rich, or may have missed
a payment or two in their lifetime able to afford homes? The answer, of
course, is the subprime market.
The subprime market has been the tool for many Americans to achieve
the American Dream of owning their own home. Many of our largest and
most reputable financial institutions are a part of the subprime
industry. I believe this is a good thing, and a viable subprime market
is good for our country.
We need to punish the bad actors. When fraud is committed, the
perpetrators should be punished and punished severely. But we also
should encourage the good actors. Citibank and Chase, to name two, have
put into practice new guidelines to help eliminate abuses or even the
possibility of abuses. Companies taking these steps should be
commended.
When we try to eliminate abuse, we must make sure we do not kill
the subprime market. We must not drive out the reputable institutions
that make home ownership possible to so many who otherwise would not be
able to achieve that dream.
Thank you Mr. Chairman.
----------
PREPARED STATEMENT OF THOMAS J. MILLER
Attorney General, the State of Iowa
July 26, 2001
Introduction
I would like to thank you, Mr. Chairman, and the Committee for
giving me the chance to speak on this critically important issue. This
is one of the most important challenges among the issues within this
Committee's jurisdiction, and I welcome the opportunity to participate
in the public discussion.
Homeownership is ``the American Dream,'' and America is rightfully
proud of its record in the number of Americans who have achieved
that.\1\ The mortgage market we normally think of, and are proud of, is
``productive credit''--a wealth-building credit that millions of
Americans have used to make an investment in their lives and their
childrens' futures: the market that has helped those 66 percent of
Americans buy their homes; keep those homes in good repair; help
finance the kids' education, and for some, helped them start a small
business. But make no mistake: what we are talking about today is a
threat to that dream and a very different mortgage market. Today, we
are talking about asset-depletion. This is ``destructive debt,'' with
devastating consequences to both the individual homeowners and to their
communities. We are talking about people who are being convinced to
``spend'' the homes they already own or are buying, often for little or
nothing in return.\2\ Tens of thousands of Americans, elderly Americans
and African-Americans disproportionately among them, are seeing what
for many is their only source of accumulated wealth--the equity in
their homes--siphoned off. Too often, the home itself is lost.\3\ Then
what? How do they--particularly the elderly--start over?
---------------------------------------------------------------------------
\1\ Homeownership reached a record level of 66 percent in 1998.
Arthur B. Kennickell, et al., Recent Changes in U.S. Family Finances:
Results from the 1998 Survey of Consumer Finances, 86 Fed. Res. Bull.
1, 15-18 (2000).
\2\ Part of the problem with the subprime market generally is it is
not offering what many people need. Overwhelmingly, it offers refinance
and consolidation loans--irrespective of whether that is wanted,
warranted, or wise. See section I-C, below.
\3\ See Alan White and Cathy Lesser Mansfield, Subprime Mortgage
Foreclosures: Mounting Defaults Draining Home Ownership, (testimony at
HUD predatory lending hearings, May 12, 2000), indicating 72,000
families were in or near foreclosure.
While the foreclosures are devastating for the families, the impact
on the lenders is less clear. First, there is a distinction to be made
between delinquencies/defaults and actual credit loss. Second, as we
note below, some of this risk to the lender is self-made. See Section
II-A , below. See also Appendix B, page 1, in which insurance padding
added $76,000 to the cost of the loan, raised the monthly payment
nearly $100, and all by itself, created a $54,000 balloon payable after
the borrower would have paid over $204,000.
---------------------------------------------------------------------------
Please keep this in mind when you hear the caution that legislative
action will ``dry up credit.'' Drying up productive credit would be of
grave concern; drying up destructive debt is sound economic and public
policy.\4\
---------------------------------------------------------------------------
\4\ We should also keep in mind that this prediction has been made
of most consumer protection and fair lending legislation in my memory--
from the original Truth in Lending up through HOEPA. And it has never
happened.
---------------------------------------------------------------------------
In the previous panel, some of those affected by this conduct
shared their experiences with you. Earlier this week, some Iowans
shared their experiences with me. Their stories were typical, but the
suffering caused by these practices is keenly felt by each of these
individuals. One consumer who has paid nearly $18,000 for 4 years would
have had her original $9,000 mortgage paid off by now, had she not been
delivered into one of these loans by an unscrupulous contractor. The
lender who worked with the contractor to make the home improvement loan
refinanced that mortgage with the $27,000 home improvement cost. But
the contractor's payment was little more than a very large broker's
fee, for he did incomplete and shoddy work, and then disappeared. The
lender's promises to make it right were all words for 4 years, while
they took her money. In the other cases, the homeowners I visited with
were not looking for loans, but they have credit cards from an issuer
who also has a home equity lending business. They were barraged by
cross-marketing telemarketers, and convinced that it would be a sound
move to refinance. Indeed a sound move--for the lender who charged
$6,900 in fees on $57,000 of proceeds. (The fees, of course, were
financed.) These families are the faces behind these lenders' sales
training motto: ``These loans are sold, not bought.'' \5\ These
families are the faces behind the sordid fact that predatory lending
happens because people trusted; and because these lenders and the
middlemen who deliver the borrowers to them do not deserve their trust.
These lives have been turned upside down by a business philosophy run
amuck: a philosophy of total extraction when there is equity at hand.
---------------------------------------------------------------------------
\5\ See Gene A. Marsh, ``The Hard Sell in Consumer Credit: How the
Folks in Marketing Can Put You in Court,'' 52 Cons. Fin. Law Qtrly Rep.
295, 298 (Summer, 1998) (quoting from a sales training manual: another
instruction--``sell eligible applicants to his maximum worth or high
credit.'')
---------------------------------------------------------------------------
I know that my counterparts in North Carolina heard similar
stories, which is why Former Attorney General, now Governor Easley and
Attorney General Cooper as well, have been so instrumental in North
Carolina's pioneering reform legislation. This problem is about these
people--in Iowa, West Virginia, Pennsylvania, North Carolina--and all
over this country; this is not about abstract market theories. And it
is a problem that Congress has a pivotal role in curbing.
In some of our States, we are finding other types of predatory
practices that are preying on the vulnerable by appealing to--and
subverting--their dreams of buying a home. Some cities are seeing a
resurgence of property flipping. In some areas of my State, we are
seeing abusive practices in the sale of homes on contracts. In fact, it
appears that such contracts may be taking their place along with
brokers and home improvement contractors as another ``feeder'' system
into the high-cost mortgage market.\6\
---------------------------------------------------------------------------
\6\ As is discussed below, many homeowners do not select the
lenders they use, but are delivered to those lenders by middlemen. In
the case of some of the abusive land contracts, a contract seller will
sell a home to an unsophisticated borrower at a greatly inflated price
on a 2-5 year balloon, telling the buyer that their contract payments
will help establish a credit record. The hitch is that it is likely to
be difficult, if not impossible, to get conventional mortgage financing
when the balloon comes due because the inflated sales price would make
the loan-to-value ratio too high for a conventional market. The result?
Another way of steering the less sophisticated home buyer into the
high-cost refinancing market.
---------------------------------------------------------------------------
My office has made predatory lending a priority--both in the home
equity mortgage lending context and in the contract sales abuses. In
addition to investigations, we are considering adopting administrative
regulations to address some of the areas within the scope of our
jurisdiction, and are working with a broad-based coalition on education
and financial literacy programs. But today I am here to talk to this
Committee solely about the home equity mortgage lending problem,
because that is where Congressional action is key. HOEPA has been a
benefit, but improvements are needed. Federal preemption is hindering
States' ability to address these problems on their own. The measures
which have been introduced or passed at the State and municipal levels
dramatically demonstrate the growing awareness of the serious impact on
both individuals and communities of predatory lending, and the desire
for meaningful reform.\7\
---------------------------------------------------------------------------
\7\ See section III-B, below on how preemption has hampered the
ability of States to deal with the kind of predatory lending practices
we are talking about in these hearings.
---------------------------------------------------------------------------
What Is Predatory Lending and How Does It Happen?
The Context: The Larger Subprime Marketplace
Predatory lending is, at its core, a mindset that differs
significantly from that operating in the marketplace in which most of
us in this room participate. It is a marketplace in which the operative
principle is: ``take as much as you think you can get away with,
however you can, from whomever you think is a likely mark.'' This is
not Adam Smith's marketplace.
Today's prime market is highly competitive. Interest rates are low,
and points and fees are relatively so. Competition is facilitated by
widespread advertisement of rates and points. Newspapers weekly carry a
list of terms available in the region and nationwide, and lenders
advertise their rates. The effectiveness of this price competition is
demonstrated by the fact that the range of prime rates is very narrow,
and has been for years. But in the subprime mortgage market, there is
little price competition: there are virtually no advertisements or
other publicity about the prices of loans, and it is difficult for
anyone seeking price information to get it. Marketing in the subprime
market, when terms are mentioned at all, tends to focus on ``low-
monthly payments.'' This marketing is, at best, misleading, given the
products being sold, and is often simply an outright lie.
I do not mean to imply that all subprime lending is predatory
lending, nor does my use of statistics about the subprime generally so
imply. However, most of the abuses do occur within the subprime market.
We must understand the operations and characteristics of that
marketplace in order to recognize how and why the abuses within it
occur, and to try to address those problems.
Interest rates in the subprime market are high and rising.
During a 5 year period when the median conventional rates ranged
from 7-8 percent, the median subprime rate was 10-12 percent. But
that 5 year period saw two disturbing trends. First, the
distribution around that median has changed--with the number of
loans on the high side of that median rising. Second, rates have
increased, with the top rates creeping up from a thinly populated
17-plus percent to nearly 20 percent.\8\
---------------------------------------------------------------------------
\8\ A graph of the distribution of loans around the median rate
shifted from a bell-curve distribution in 1995 to a ``twin peaks''
distribution around the median in 1999, indicating greater segmentation
within the subprime market, and shows the ``rate creep'' on the high
side of the distribution. See Cathy Lesser Mansfield, The Road to
Subprime ``HEL'' Was Paved With Good Congressional Intentions, 51 So.
Car. L. Rev. 473, p. 578, Graph 2; p. 586, Graph 6 (2000).
Percent of loans in securitized subprime pools sold on Wall Street:
above 12 percent in 1995 was 30 percent; and 1999 was 44 percent;
above 15 percent in 1995 was 3 percent; and 1999 was 8 percent;
above 17 percent in 1995 was .02 percent; and 1999 was 1.5
percent.
See id., p. 577 Table 1.
Collecting price data on subprime lending is extraordinarily
difficult, as the author of this article, one of my constituents,
Professor Mansfield of Drake University law school, reported to the
House Committee on Banking and Financial Services a year ago. (May 24,
2000). As noted above, unlike the prime market, there is no advertising
information about rates and points in the subprime market available to
most consumers. Furthermore, that information is not reported for any
regulatory purposes. It is not information required by the Home
Mortgage Disclosure Act (HMDA). These statistics relate solely to pools
of loans packaged as securities, where interest rate information is
required by SEC rules for prospective investors.
---------------------------------------------------------------------------
Points and fees in the subprime market, while down from the
10-15 percent frequently seen prior to the enactment of HOEPA (with
its 8 percent points-and-fees trigger), are still high, in the 5-
7.9 percent range, while the typical cost in the prime market is 1-
3 percent.
Subprime loans are disproportionately likely to have
prepayment penalties, making it expensive to get out of these
loans, and sometimes trapping the borrower in an overly expensive
loan. (Seventy-seventy-six percent, compared to less than 2 percent
in the prime market.) \9\
---------------------------------------------------------------------------
\9\ Figures cited in U.S. Department of Treasury Comment on
Regulation Z (HOEPA) Proposed Rulemaking, Docket No. R-1090 (January
19, 2001), at page 7.
---------------------------------------------------------------------------
Single-premium credit insurance, virtually nonexistent in the
prime mortgage market, has been estimated to be as much as 50
percent of subprime loans, though accurate statistics are not
available. (The penetration rate varies considerably, depending
upon the provider. Some subprime lenders market it heavily,
others very little.) \10\
---------------------------------------------------------------------------
\10\ Estimate courtesy of the Coalition for Responsible Lending.
Recently, three major lenders, Citigroup, Household, and American
General, announced they will stop selling single-premium credit
insurance.
The demographics of the subprime marketplace are significant.
Thirty-five percent of borrowers taking out subprime loans are over 55
years old, while only 21 percent of prime borrowers are in that age
group.\11\ (This despite the fact that many of the elderly are likely
to have owned their homes outright before getting into this market.)
The share of African-Americans in the subprime market is double their
share in the prime market.\12\
---------------------------------------------------------------------------
\11\ Howard Lax, Michael Manti, Paul Raca, Peter Zorn, Subprime
Lending: An Investigation of Economic Efficiency, p. 9 (unpublished
paper, February 25, 2000).
\12\ Twelve percent of subprime loans are taken out by African-
Americans. Subprime loans are 51 percent of home loans in predominately
African-American neighborhoods, compared with
9 percent in white neighborhoods. Blacks in upper-income neighborhoods
were twice as likely to be in the subprime market as borrowers in low-
income white neighborhoods. HUD, Unequal Burden: Income and Racial
Disparities in Subprime Lending in America.
The Zorn, et. al study also notes that lower income borrowers are
also twice as likely to be in the subprime market ``despite the fact
that FICO scores are not strongly correlated with income.'' p. 9. The
Woodstock Institute study also found that the market segmentation ``is
considerably stronger by race than by income. Daniel Immergluck and
Marti Wiles, Two Steps Back: The Dual Mortgage Market, Predatory
Lending, and the Undoing of Community Development, p. iii (Woodstock
Institute, November 1, 1999.)
With the aid of a Community Lending Partnership Initiative grant,
the Rural Housing Institute is gathering information on lending in
Iowa. Preliminary data indicates a similar picture of racial
disparities in Iowa, though the researchers are awaiting the results of
the 2000 Census income data to see whether the correlation in Iowa is
similarly more correlated to race than income.
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My co-panelist, Martin Eakes and his colleagues have estimated that
the cost of abuses in these four areas cause homeowners to lose $9.1
billion of their equity annually, an average of $4,600 per family per
year.\13\ When I look at that figure in the context of who is most
likely to be hurt by those abuses, my concern mounts.\14\ Others will
be talking to this Committee about the fact that predatory lending is
at the intersection of civil rights and consumer protection, so I will
only say that, for what may be the first time, our civil rights and
consumer protection divisions in Attorneys General offices around the
country are beginning to work together on this common problem.
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\13\ The per family figure was found in Coalition for Responsible
Lending Issue Paper, ``Quantifying the Economic Cost of Predatory
Lending.'' (March 9, 2001). Mr. Eakes' testimony today may reflect
revised figures.
\14\ According to 1990 census, the median net worth for an African-
American family was $4,400. Comparing that to Mr. Eakes estimate of
$4,600 per family loss is, to put it mildly, sobering.
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The most common explanation offered by lenders for the high prices
in the subprime market is that these are risky borrowers, and that the
higher rates are priced for the higher risk. But that is far too
simplistic. Neutral researchers have found that risk does not fully
explain the pricing, and that there is good reason to question the
efficiency of subprime lending.\15\ That core mindset I mentioned
earlier leads to opportunistic pricing, not pricing that is calibrated
to provide a reasonable return, given the actual risk involved.
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\15\ Howard Lax, Michael Manti, Paul Raca, Peter Zorn, Subprime
Lending: An Investigation of Economic Efficiency, p. 3-4 (unpublished,
February 25, 2000). While risk does play a key role, ``borrowers'
demographic characteristics, knowledge, and financial sophistication
also play a statistically and practically significant role in
determining whether they end up with subprime mortgages.'' Id. p. 3.
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Moreover, the essence of predatory lending is to push the loan to
the very edge of the borrower's capacity to handle it, meaning these
loans create their own risk. We cannot accept statistics about
delinquencies and foreclosure rates in the subprime market without also
considering how the predatory practices--reckless underwriting, push
marketing, and a philosophy of profit maximization--create a self-
fulfilling prophecy.\16\ And even with comparatively high rates of
foreclosures, many lenders continue to be profitable.
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\16\ It is beyond the scope of my comments to discuss the
relationship between risk and pricing. But it is important that
policymakers look not just at delinquency and foreclosure rates without
also looking at actual losses and revenues.
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How and Why It Happens?
If neither risk nor legitimate market forces explain the high
prices and disadvantageous terms found so frequently in the subprime
market, then what does explain it?
``Push marketing:'' The notion of consumers shopping for a
refinance loan or a home improvement loan, comparing prices and terms,
is out of place in a sizeable portion of this market. Frequently, these
are loans in search of a borrower, not the other way around, as was the
case with the Iowa borrowers I spoke with this week. Consumers who buy
household goods with a relatively small installment sales contract are
moved up the ``food chain'' to a mortgage loan by the lender to whom
the retailer assigned the contract; door-to-door contractors come by
unsolicited with
offers to arrange manageable financing for home improvements;
telemarketers offer to ``lower monthly payments'' and direct mail
solicitations make false representations about savings on consolidation
loans. Another aspect of push marketing is ``upselling.''
(``Upselling'' a loan is to loan more money than the borrower needs,
wants, or asked for.)
``Unfair and deceptive, even downright fraudulent sales
practices:'' In addition to deceptive advertisements, the sales pitches
and explanations given to the borrowers mislead consumers about high
prices and disadvantageous terms (or obscure them) and misrepresent
benefits. Some of these tactics could confuse almost anyone, but when
the consumer is unsophisticated in financial matters, as is frequently
the case, the tactics can be quite fruitful.
While Federal and State laws require disclosures, for a variety of
reasons, these laws have not proven adequate against these tactics.
Reverse competition: Price competition is distorted when lenders
compete for referrals from the middlemen, primarily brokers and
contractors. When the middleman gets to take the spread from an
``upcharge'' \17\ on the interest rate or points, it should come as no
surprise to anyone that some will steer their customers to the lenders
offering them the best compensation. (Reverse competition is also a
factor with credit insurance because of commission incentives and other
profit-sharing programs.) It should also come as no surprise that the
people who lack relevant education, are inexperienced or have a real or
perceived lack of alternatives, are the ones to whom this is most
likely to happen.
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\17\ An ``upcharge'' is when the loan is written at a rate higher
than the underwriting rate. For example, an evaluation of the
collateral, the borrower's income and debt-to-income ratio, and credit
history indicates the borrower qualifies for a 11.5 percent interest
rate. But the broker has discretion to write the note at 14 percent,
and the broker gets extra compensation from that rate spread. He may
get it all, or there may be a sharing arrangement with the lender, for
example, the broker gets first 1 percent, and they split the other 1.5
percent. The Eleventh Circuit has recently found that a referral fee
would violate RESPA. Culpepper v. Irwin Mtg. Corp., 253 F. 3d 1324
(2001).
A recent review of yield-spread premiums in the prime market found
that they added an average cost of over $1,100 on each transaction in
which they were charged. The author found that the most likely
explanation for the added cost was not added value, nor added services.
Rather, it is a system which lends itself to price discrimination:
extra broker-compensation can be extracted from less sophisticated
consumers, while it can be waived for the few who are savvy about the
complex pricing practices in today's mortgage market. See Report of
Howell E. Jackson, Household International Professor of Law, Harvard
Law School, pp. 72 , 81 (July 9, 2001), submitted as expert witness'
report in Glover v. Standard Federal Bank, Civ. No. 97-2068 (D. Minn.)
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Even without rate upcharges, the brokers, who may have an agreement
with the borrower, often take a fee on a percentage-basis, so they have
an incentive to steer the borrower to a lender likely to inflate the
principal, by upselling, fee-padding, or both. These are self-feeding
fees. A 5 percent fee from a borrower who needs--and wants--just $5,000
for a roof repair is only $250. But if the broker turns that into a
refinance loan, of $40,000, further padded with another $10,000 of
financed points, fees, and insurance premiums, his 5 percent, now
$2,500, looks a lot better.
This divided loyalty of the people in direct contact with the
homeowner is particularly problematic given the complexity of any
financing transaction, considerably greater in the mortgage context
than in other consumer credit. As with most other transactions in our
increasingly complex society, these borrowers rely on the good faith
and honesty of the ``specialist'' to help provide full, accurate, and
complete information and explanations. Unfortunately, much predatory
lending is a function of misplaced trust.
These characteristics help explain why the market forces of
standard economic theory do not sufficiently work in this market. There
are too many distorting forces. Factor in the demographics of the
larger subprime marketplace in which these players operate, and we can
better understand how and why it happens.
Definition
Having looked at the context in which predatory lending occurs, we
come to the question of definition. I know that some have expressed
concern over the absence of a bright line definition. I do not see this
as a hurdle, and I believe that Attorneys General are in a position to
offer reassurance on this point. There is a real question as to whether
a bright line definition is necessary, or even appropriate. All 50
States and the United States have laws which employ a broad standard of
conduct: a prohibition against ``deceptive practices,'' or ``unfair and
deceptive practices.'' \18\ Attorneys General have enforcement
authority for these laws, and so are in a position to assure this
Committee that American business can and has prospered with broad,
fairness-based laws to protect the integrity of the marketplace.
Indeed, a good case can be made that they have helped American business
thrive, because these laws protect the honest, responsible, and
efficient businesses as much as they protect consumers, for unfair and
deceptive practices are anticompetitive.
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\18\ See Section III, below, for a discussion of the adequacy of
these laws to address predatory mortgage lending.
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While statutes or regulations often elaborate on that broad
language with specific lists of illustrative acts and practices, it has
never been seriously advanced that illustrations can or should be an
exhaustive enumeration, and that anything outside that bright line was
therefore acceptable irrespective of the context. There is a simple
reason for this, and it has been recognized for centuries: the human
imagination is a wondrous thing, and its capacity to invent new scams,
new permutations on old scams, and new ways to sell those scams is
infinite. For that reason, it is not possible, nor is it probably wise,
to require a bright line definition.
Several models for defining the problem have been used. One model
relates to general principles of unfairness and deception. The
Washington State Department of Financial Institution defines it simply
as ``the use of deceptive or fraudulent sales practices in the
origination of a loan secured by real estate.'' \19\ The Massachusetts
Attorney General's office has promulgated regulations pursuant to its
authority to regulate unfair and deceptive acts and practices to
address some of these practices.\20\ Improving on the HOEPA model has
been the basis for other responses within the States, most notably
North Carolina's legislation.\21\ (In enacting HOEPA, Congress
recognized that it was a floor, and States could enact more protective
legislation.\22\)
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\19\ See, Comments from John Bley, Director of Financial
Institutions, State of Washington, on Responsible Alternative Mortgage
Lending to OTS (July 3, 2000). (I note that some abuses also occur in
the servicing and collection of these loans, so limiting a statutory
definition to the origination stage only would leave gaps.) Mr. Bley's
letter notes that the HUD/Treasury definition, quoted in his letter, is
similar: ``Predatory lending--whether undertaken by creditors, brokers,
or even home improvement contractors--involves engaging in deception or
fraud, manipulat-
ing the borrower through aggressive sales tactics, or taking unfair
advantage of a borrower's lack of understanding about loan terms. These
practices are often combined with loan terms that, alone or in
combination, are abusive or make the borrower more vulnerable to
abusive practices.''
\20\ 940 C.M.R. Sec. 8.00, et seq. See also United Companies
Lending Corp. v. Sargeant, 20 F. Supp. 2d 192 (D. Mass. 1998).
\21\ N.C. Gen. Stat. Sec. 24-1-.1E. See also 209 C.M.R. 32.32
(Massachusetts Banking Commission); Ill. Admin. Code 38, 1050.110 et
seq.; N.Y. Comp Codes & Regs. Tit. 3 Sec. 91.1 et seq. Some cities have
also crafted ordinances along these lines, Philadelphia and Dayton
being two examples. While legal concerns about preemption and practical
concerns about ``balkanization'' have been raised in response to this
increasingly local response much care and thought has gone into the
substantive provisions, building on the actual experience under HOEPA,
and may be a good source of suggestions for improvements on HOEPA
itself.
\22\ ``[P]rovisions of this subtitle preempt State law only where
Federal and State law are inconsistent, and then only to the extent of
the inconsistency. The Conferees intend to allow States to enact more
protective provisions than those in this legislation.'' H.R. Conf. Rep.
No. 652, 103d Cong. Sess. 147, 162 (1994), 1994 U.S. C.C.A.N. 1992.
That has not prevented preemption challenges, however. The Illinois DFI
regulations have been challenged by the Illinois Association of
Mortgage Brokers, alleging that they are preempted by the Alternative
Mortgage Transaction Parity Act.
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There is considerable consensus about a constellation of practices
and terms most often misused, with common threads.
The terms and practices are designed to maximize the revenue to the
lenders and middlemen, which maximizes the amount of equity depleted
from the borrowers' homes. As mentioned earlier, when done by means
which do not show in the credit price tags, or may be concealed through
confusion or obfuscation, all the better. That makes deceptive sales
techniques easier, and reduces the chances for any real competition to
work.
Among those practices:
Upselling the basic loan (includes inappropriate refinancing
and debt consolidation). The homeowner may need (and want) only a
relatively small loan, for example, $3,000 for a new furnace. But
those loans tend not to be made. Instead these loans are turned
into the ``cash-out'' refinancing loan, that refinances the first
mortgage or consolidation loans (usually consolidating unsecured
debts along with a refinance of the existing first mortgage). In
the most egregious cases, 0 percent Habitat for Humanity loans, or
low-interest, deferred payment rehabilitation loans have been
refinanced into high rate loans which stretch the limits of the
homeowner's income. But even refinancing a 9-10 percent mortgage
into a 14 percent mortgage just to, get the $3,000 for that furnace
is rarely justifiable. Like other practices, this has a self-
feeding effect. A 5 percent brokers fee; or 5 points will be much
more remunerative on a $50,000 loan than on a $3,000 loan. Since
these fees are financed in this market, they, in turn, make the
principal larger, making a 14 percent rate worth more dollars. For
the homeowner, of course, that is all more equity lost.\23\
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\23\ While most of these loans are more than amply secured by the
home, well within usual loan-to-value ranges, some lenders are
upselling loans into the high LTV range, which bumps the loan into a
higher rate. Some lenders do this by ``loan-splitting,'' dividing a
loan into a large loan for the first 80-90 percent if the home's
equity, at, for example, 13-14 percent, and a smaller loan for the rest
of the equity (or exceeding the equity) at 16-21 percent. These loans
are often made by ``upselling,'' not because the borrower sought a high
LTV loan. The practice seems to involve getting inflated ``made-to-
order'' appraisals, then upselling the loan based on the phony
``appreciation.'' As with some of the other tactics, like stiff
prepayment penalties, these loans marry the homeowner to this lender.
The homeowner cannot refinance with a market-rate lender.
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Upcharging on rates and points (includes yield spread premiums
and steering). The corrosive impact of yield spread premiums
generally was described above in connection with the discussion of
reverse competition. (See note 17.) The problem is exacerbated in
the subprime market, where the much greater range of interest rates
\24\ makes greater upcharges possible, and the demographics of the
subprime market as a whole lends itself to the type of
opportunistic pricing that Professor Jackson posed as the likely
explanation.
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\24\ See text accompanying note 8.
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Excessive fees and points/padded costs. Since the fees and
charges are financed as part of the loan principal, and since some
of them are percentage-based fees, this kind of loan padding
creates a self-feeding cost loop (an example is described earlier
in the discussion of upselling), which makes this a very efficient
practice for extracting more equity out of the homes.
Financing single-premium credit insurance. Appendix B is a
good example of how effective single-premium credit insurance is as
a tool for a predatory lender to strip equity from a borrower's
home. It is also a good example of how well it lends itself to
manipulation and deceptive sales tactics. Appendix B shows that
adding a $10,000 insurance premium (of which the lender keeps
approximately 35-40 percent as commission) over the life of the
loan, will cost the borrower an extra $76,000 in lost equity over
the life of the loan. Even if the borrower prepays (or more likely
refinances) at 5 years, the credit insurance adds $9,400 to the
payoff. And the lender's estimated commission from the premium was
double the amount of revenue the lender got from the three points
charged on that loan.\25\
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\25\ See Appendix B, p. 2 line 5. Compare columns 5 and 6. This is
not a hypothetical example. It is a loan made to an Iowa couple.
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Prepayment penalties. Prepayment penalties trap borrowers in
the high cost loans. They are especially troublesome, since
borrowers are often told that they need not worry about the high
payments, because these loans are a bridge, that can be refinanced
after a couple of years of good payment history.\26\
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\26\ This is another instance which demonstrates the limits of
disclosures. A recent loan we saw has an ``Alternative Mortgage
Transactions Parity Act Prepayment Charge Disclosure,'' which explains
that State law is preempted, and provides an example of how their
formula would apply to a $100,000 loan. It is doubtful the example
would score on any literacy scale below upper college-level.
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Flipping. Flipping is the repeated refinancing of the
consumer's loan. It is especially useful for equity-stripping when
used by lenders who frontload high fees (points, truncated credit
insurance,\27\ and so forth). The old fees are pyramided into the
new principal, and new fees get added. My staff has seen loans in
which nearly 50 percent of the loan principal simply reflected
pyramided fees from serial refinancing.
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\27\ Truncated credit insurance is insurance sold for a term less
than the loan term in the example in Attachment B, page 1, the loan
premium financed in the 20 year balloon note purchased a 7 year policy.
That frontloads the premium, so if the loan was refinanced at 5 years,
over 90 percent of the premium would have been ``earned,'' and rolled
over into the new loan principal--but without any insurance coverage
from that extra $9,400 in the new loan.
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Balloons. While HOEPA did succeed in reducing the incidence of
1 and 2 year balloons, what we are seeing now is long-term balloon
loans which seem to be offered solely to enable the lender, broker,
or contractor to sell the loan based on the low monthly payment. We
are seeing 15, and even 20 year balloon loans. The Iowa couple
whose loan is discussed in Appendix B borrowed $68,000 (including a
$10,000 insurance premium). Over the next 20 years of scheduled
payments, they would pay $204,584, and then they would still owe a
$54,300 balloon.
Unfair and deceptive sales practices in sales of the credit: In
addition to misleading advertisements, the sales pitches and
explanations given to the borrowers mislead consumers about high prices
and disadvantageous terms (or obscure them) and misrepresent benefits.
Again, just a few examples:
While Federal and State laws require disclosures, for a
variety of reasons, these laws have not proven adequate against
these tactics. Techniques such as ``mixing and matching'' the
numbers from the note and the TIL disclosure low-ball both the loan
amount (disguising high fees and points), and the interest rate,
thus completely pervert the basic concept of truth in lending.\28\
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\28\ This was the technique at issue in the FAMCO cases, see
Section III, below.
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When door-to-door contractors arrange financing with these
high-cost lenders (often with lenders who use the opportunity to
upsell the credit into a refinancing or consolidation loan), it
appears to be common to manipulate the cancellation rights so that
the consumer believes he must proceed with a loan which costs too
much.\29\
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\29\ The practice is a variation of ``spiking.'' (``Spiking'' means
to start work or otherwise proceed during the cooling off period, which
leads the consumer to believe they cannot cancel, ``because work has
begun.'') By trying to separate the sale of the home improvement from
the financing for it, the borrowers' right to cancel under either the
State door-to-door sales act or the TIL are subverted. This practice,
which appears to be common, is described more fully in National
Consumer Law Center, Truth in Lending Sec. 6.8.4.2, esp. 6.8.4.2.2 (4th
Ed. 1999.)
Some of the front-line personnel selling these loans even use the
lack of transparency about credit scores to convince people that they
could not get a lower-cost loan, either from this lender or anywhere
else. As one lawyer who has worked for a decade with elderly victims
put it, when the broker gets through, the homeowners feel lucky if
anyone would give them a dime.\30\
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\30\ Oral presentation of an AARP lawyer at a conference on
predatory mortgage lending in Des Moines, Iowa, June 1999.
It is a fertile area for misrepresentations. When looking at
mortgage lending in the prime market, the Boston Federal Reserve Bank
found that approximately 80 percent of applicants had some ding on
their credit record which would have, looked at in isolation, justified
a denial.
The recent move by Fair Isaac to bring transparency to credit
scores may help, but it will more likely be a help in the prime market
than in the subprime market. Again, a knowledgeable broker or
contractor-cum-broker would assure that the consumer knew that, but the
reverse competition effect may impede that.
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Ability to pay: These lenders pay less attention to the ability of
the homeowner to sustain the loan over the long haul. The old standard
underwriting motto of ``the 3-C's: capacity, collateral, and
creditworthiness'' is shortened to ``1-C''--collateral. Capacity is, at
best, a secondary consideration. Creditworthiness, as mentioned above,
becomes an instrument for deceptive sales practices in individual
cases.
A recent example from Iowa: A 72 and 64 year old couple were
approached by a door-to-door contractor, who sold them on the need for
repairs to their home, and offered to make arrangements for the loan.
The work was to cost approximately $6,500. The contractor brought in a
broker, who arranged for a refinance plus the cash out for the
contractor. (The broker took a 5 percent fee on the upsold loan
($1,800) plus what appears to be a yield-spread premium amounting to
another $1,440. Now the payments on their mortgage, (including taxes
and insurance) are $546. That is nearly 60 percent of their income: It
leaves them $389 a month for food, car and health insurance, medical
expenses, gasoline and other car expenses, utilities, and everything
else. This terrific deal the broker arranged was a 30 year mortgage.
The loan amount was $36,000, and the settlement charges almost $3,900
(though not all in HOEPA trigger fees). The APR is 14.7 percent.\31\
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\31\ The homeowners tried to exercise their right to cancel. But
the lender claims they never got the notice, and the contractor told
them not to worry about those payments, they would lower them . . . .
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The consequence of all this? ``Risk'' becomes a self-fulfilling
prophecy. Home ownership is threatened, not encouraged.
It is not an insurmountable challenge to bring this experience to
bear in crafting legislation and regulation, as our experience with
illustrative provisions in UDAP statutes and regulations, and in HOEPA
itself, show.\32\
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\32\ A good example is the FTC Credit Practices Rule, 16 C.F.R.
444, which prohibited certain practices common in the consumer finance
industry as unfair or deceptive. At the time it was under
consideration, opponents predicted it would ``dry up credit to those
who need it the most.'' It did not. (Indeed, it was predicted that
HOEPA would ``dry up credit to those who need it the most.'' It has
not.)
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What Can Be Done Now?
State Attorneys General have used our State Unfair and Deceptive
Acts and Practices (UDAP) laws against predatory mortgage lenders,
including most notably, First Alliance Mortgage Company (FAMCO).\33\
FAMCO demonstrates that lenders can be in technical compliance with
disclosure laws like Truth in Lending and RESPA, yet nonetheless engage
in widespread deception. When regulators did routine examinations, they
would see very expensive loans, but no violations of any ``bright
line'' disclosure laws. The problem was that FAMCO employees were
rigorously trained as to how to disguise their 20 point charges through
a sales script full of tricky and misleading information designed to
mislead consumers into thinking that the charges were much lower than
they were. This sales script was dubbed ``The Monster Track.''
Attorneys General in Minnesota, Massachusetts, Illinois, Florida,
California, New York, and Arizona have taken action against the
company, along with the Department of Financial Institutions in
Washington State. (In the wake of all the litigation and enforcement
actions, the company filed bankruptcy.)
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\33\ FAMCO's practices were the subject of a New York Times
article, Diana B. Henriques, ``Mortgaged Lives,'' NYT, A1 (March 15,
2000).
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(States which either opted-out of Federal preemption of State
limitations on points or reenacted them may have effectively prevented
companies like FAMCO from doing business in their State. Iowa opted-out
of the Federal preemption on first lien points and rates, and kept a
two-point limit in place. While there is no concrete proof that this
point-cap is why FAMCO did not do business in Iowa, it seems a
reasonable assumption.)
But our UDAP laws, and our offices are by no means as much as is
needed for this growing problem.
Impediments to Enforcement of Existing Laws
Some of the predatory lending practices certainly do fall afoul of
existing laws. But there are important loopholes in those laws, and
there are also serious impediments to enforcement of those laws against
predatory lenders.
Public enforcement
Resource limitations: One of the most significant impediments to
public enforcement of existing applicable laws is insufficient
resources. While State and Federal agencies have many dedicated public
servants working to protect consumers and the integrity of the
marketplace, in the past 15 or so years we have seen an ever-growing
shortfall in the personnel when compared to the workload. The number of
credit providers, the volume of lending, and the amount of problem
lending have all exploded at the same time that the resources available
to examine, monitor, investigate them, and enforce the laws have
declined in absolute numbers. The resulting relative disparity is even
greater. The experience in my State is probably not atypical. The
number of licensed nondepository providers of household credit has
roughly tripled in, the past 15 years, and the volume of lending has
risen accordingly. (And not all out-of-State lenders operating through
mail, telephone, or the Internet are licensed.) Three entire new
categories of licensees have been created during those years. Yet, the
staff necessary to examine these licensees and undertake any
investigations and enforcement actions have decreased. This is
undoubtedly true at the Federal level, as well as the State level.
This disparity between need and supply in the Attorneys General
offices is exacerbated by the fact that credit is only one of many
areas for which we have some responsibility. For example,
telecommunications deregulation and the explosion in
e-commerce have resulted both in expanded areas of concern for us, and
an expanded volume of complaints from our citizens.
Holes in coverage: Some State UDAP statutes do not include credit
as a ``good or service'' to which the Act applies, or lenders may be
exempted from the list of covered entities.\34\ Some State statutes
prohibit ``deceptive'' practices, but not unfair practices. In my
State, we have no private right of action for our UDAP statute,
magnifying the impact of the problem of inadequate resources for public
enforcement. Other claims which might apply to a creditors' practices
may be beyond the jurisdictional authority given to public agencies.
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\34\ The theory for exempting lenders is generally that other
regulators are monitoring the conduct of the entity. Yet, the regulator
may not have the jurisdictional authority to address unfair and
deceptive acts and practices generally.
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The silent victim: There is also a threshold problem of detection.
Most of the people whose homes are being drained of their equity do not
complain. Like most Americans, they are unfamiliar with applicable laws
and so are unaware that the lender may have crossed the bounds; many
people are embarrassed, or simply feel that it is yet one more of
life's unfortunate turns. Coupled with the ``clean paper'' on many of
these loans, this silence means activity goes undetected--at least
until it is too late for many. As mentioned above, regulatory
examinations of the records in the lenders' offices (even if there was
sufficient person-power), often do not reveal the problems.
Private enforcement
Mandatory arbitration: We have always recognized that the public
resources for enforcement would never be adequate to assure full
compliance. Thus, the concept that consumers can vindicate these rights
themselves is built into many of the statutes which apply to these
transactions. Under these statutes, as well as common law, these
actions may be brought in our courts, where impartial judges and juries
representing the community at large can assess the evidence and apply
the law. Some of these statutes help assure that the right is not a
phantom one, by providing for attorney's fees and costs as part of the
remedy against the wrong-doer. Critically, the legal system offers an
open and efficient system for addressing systemic abuses--abuses that
Governmental enforcement alone could not address.
But private enforcement faces a serious threat today. Mandatory
arbitration clauses which deny consumers that right to access to
impartial judges and juries of their peers are increasingly prevalent.
This denies all of us the open system necessary to assure that systemic
problems are exposed and addressed. This is not the forum to discuss in
detail the way the concept of arbitration has been subverted from its
premise and promise into a mechanism used by one party to a contract--
the one that is holding all the cards--to avoid any meaningful
accountability for their own misconduct. These are not, as arbitration
was envisioned, simple consensual agreements to choose a different
forum in which to resolve differences cheaply and quickly; these are
intended to insulate the ones who insist upon them from the
consequences of their improper actions. While not unique to predatory
mortgage lending, this rapidly growing practice in consumer
transactions is a serious threat to effective use of existing laws to
address predatory lending, as well as to enforcement of any further
legislative or regulatory efforts to curb it. It is within Congress'
power to remove this barrier.\35\
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\35\ The European Union recognizes the problems inherent in
mandatory arbitration in consumer transactions, and includes it among
contract terms that are presumptively unfair. See European Union
Commission Recommendation No. 98/257/EC on the Principles Applicable to
the Bodies Responsible for the Out-of-Court Settlement of Consumer
Disputes, and Council Directive 93/13/EC of April 5, 1993 on Unfair
Terms in Consumer Contracts.
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Preemption
Federal laws which, by statute or by regulatory action, preempt
State laws, have played a role in the growth of predatory mortgage
lending.\36\ Unlike some examples of Federal preemption, preemption in
the credit arena did not replace multiple State standards with a single
Federal standard. In important areas, it replaced State standards with
no real standards at all.
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\36\ See, for example Mansfield, The Road to Subprime ``HEL,'' note
8, above.
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With commerce increasingly crossing borders, the industry asks that
it not be subjected to ``balkanized'' State laws, and now, even
municipal ordinances. But the industry and Congress should recognize
that these efforts are born of concern for what is happening now to
people and to their communities, and of frustration at inaction in
Congress.
Congress did, on a bipartisan basis, enact HOEPA, which has helped,
but needs to be improved. However, Congress has not done anything about
the vacuum (and the uncertainty) left by preemption. Some Federal
regulatory agencies have made the problem even worse since then,
through broad (arguably overbroad) interpretations of Federal law. For
example, the 1996 expansive reading of the Alternative Mortgage
Transactions Parity Act (AMTPA) to preempt State laws on prepayment
penalties has contributed to the problems we are talking about today.
Over a year ago, the OTS asked whether that Act and interpretations
under it had contributed to the problem, and 45 States submitted
comments saying ``yes.'' But nothing has come of that.\37\ In the
meantime, regulators in Virginia and Illinois have been sued by
industry trade associations on grounds that AMTPA preempts their
rules.\38\
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\37\ It is also possible that AMTPA has contributed to the
prevalence of the ``exploding ARM'' by predatory lenders, as the
existence of a variable rate is one of the triggers for AMTPA coverage.
12 U.S.C. Sec. 3802. Although we are focused today on mortgage lending,
we are also concerned about overbroad preemption interpretations by the
OCC affecting our ability to address problems in other areas, such as
payday lending, and, now, perhaps even car loans.
\38\ Illinois Assoc. of Mortgage Brokers v. Office of Banks and
Real Estate, (N.D. Ill, filed July 3, 2001); National Home Equity
Mortgage Association v. Face, 239 F. 3d 633 (4th Cir. 2001), cert.
Filed June 7, 2001.
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What More Needs To Be Done?
It is simply not the case that existing laws are adequate. In an
imperfect market, there must be ground rules. These are some
suggestions.
Federal Reserve Board: HOEPA Regulation
Thirty-one States submitted comments to the Federal Reserve Board
urging it to adopt the HOEPA rules as proposed, without being weakened
in any respect. Our comments emphasized the importance of including
single-premium credit insurance among the trigger fees. (A copy of the
comments is submitted as Appendix A.)
Other Legislative Recommendations
In addition to closing the enforcement and substantive loopholes
created by mandatory arbitration and preemption, HOEPA could be
improved in light of the lessons we have learned from almost 6 years of
experience with it. Some of the suggested reforms include:
Improve the ``asset-based lending'' prohibition. Since this is
the key issue in predatory lending, it is vital that it be
effectual and enforceable. As it stands, it is neither. The
``pattern and practice'' requirement should be eliminated from the
provision prohibiting making unaffordable loans.\39\ The concept of
``suitability,'' borrowed from the securities field, might be
incorporated.
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\39\ It is not a violation to make unaffordable loans, it is only a
violation to engage in a ``pattern and practice of doing so,'' a
difficult enforcement challenge. See Newton v. United Companies, 24 F.
Supp. 2d 444 (E.D. Pa 1998).
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Prohibiting the financing of single-premium credit insurance
in HOEPA loans, as HUD and the FRB have recommended.
Remove the Federal preemption hurdle to State enforcement of
laws prohibiting prepayment penalties, or, at a minimum, prohibit
prepayment penalties in HOEPA loans. The current HOEPA provision on
prepayment penalties, as a practical matter, is so convoluted as to
be virtually unenforceable.
Improve the balloon payment provisions. While we no longer see
1 and 2 year balloons, we now see 15 and 20 year balloons, whose
sole purpose is to enable the lender or broker to low-ball the cost
by selling on ``low monthly payments.'' And without prepayment
penalties, there is no real reason for balloon loans: if a consumer
is planning on selling in 5 years, they can prepay the loan in any
event.
Limit the amount of upfront fees and points which can be
financed.
My colleagues and other State and local officials are seeing more
and more of the hardship and havoc that results from these practices.
We are committed to trying to address them as best we can within the
limits of our jurisdiction and our resources. Federal preemption is
part of what is limiting our ability to respond. Congress has a signal
role here, for this is a national problem.
I would like to offer my continuing assistance to this Committee,
and I know that my colleagues will, as well.
Thank you for giving me this opportunity to share my views with
you.
ORIGINAL PREPARED STATEMENT OF CHARLES W. CALOMIRIS
Paul M. Montrone Professor of Finance and Economics
Graduate School of Business, Columbia University, New York, New York
July 26, 2001
Mr. Chairman, it is a pleasure and an honor to address you today on
the important topic of predatory lending.
Predatory lending is a real problem. It is, however, a problem that
needs to be addressed thoughtfully and deliberately, with a hard head
as well as a soft heart. There is no doubt that people have been hurt
by the predatory practices of some creditors, but we must make sure
that the cure is not worse than the disease. Unfortunately, many of the
proposed or enacted municipal, State, and Federal statutory responses
to predatory lending would have adverse consequences that are worse
than the problems they seek to redress. Many of these initiatives would
reduce the supply of credit to low-income homeowners, raise their cost
of credit, and restrict the menu of beneficial choices available to
borrowers.
Fortunately, there is a growing consensus in favor of a balanced
approach to the problem. That consensus is reflected in the viewpoints
expressed by a wide variety of individuals and organizations, including
Robert Litan of the Brookings Institution, Fed Governor Edward
Gramlich, most of the recommendations of last year's HUD-Treasury
Report, the voluntary standards set by the American Financial Services
Association (AFSA), the recent predatory lending statute passed by the
State of Pennsylvania, and the recommendations and practices of many
subprime mortgage lenders (including, most notably, Household). In my
comments, I will describe and defend that balanced approach, and offer
some specific recommendations for Congress and for financial
regulators.
To summarize my recommendations at the outset, I believe that an
appropriate response to predatory practices should occur in two stages:
First, there should be an immediate regulatory response to strengthen
enforcement of existing laws, enhance disclosure rules and provide
counseling services, amend existing regulation, and limit or ban some
practices. I believe that these initiatives, described in detail below,
will address all of the serious problems associated with predatory
lending.
In other areas--especially the regulation of prepayment penalties
and balloon payments--any regulatory change should await a better
understanding of the extent of remaining predatory problems that result
from these features, and the best ways to address them through
appropriate regulations. The Fed is currently pursuing the first
systematic scientific evaluation of these areas, as part of its clear
intent to expand its role as the primary regulator of subprime lending,
given its authority under HOEPA. The Fed has the regulatory authority
and the expertise necessary to find the right balance between
preventing abuse and permitting beneficial contractual flexibility.
Congress, and other legislative bodies, should not rush to judgment
ahead of the facts and before the Fed has had a chance to address these
more complex problems, and in so doing, end up throwing away the
proverbial baby of subprime lending along with the bathwater of
predatory practices.
I think the main role Congress should play at this time is to rein
in actions by States and municipalities that seek to avoid established
Federal preemption by effectively setting mortgage usury ceilings under
the guise of consumer protection rules. Immediate Congressional action
to dismantle these new undesirable barriers to individuals' access to
mortgage credit would ensure that consumers throughout the country
retain their basic contractual rights to borrow in the subprime market.
My detailed comments divide into four parts: (1) a background
discussion of subprime lending, (2) an attempt to define predatory
practices, (3) a point-by-point evaluation of proposed or enacted
remedies for predatory practices, and (4) a concluding section.
Subprime Lending, the Democratization of Finance, and
Financial Innovation
The problems that fall under the rubric of predatory lending are
only possible today because of the beneficial ``democratization'' of
consumer credit markets, and mortgage markets in particular, that has
occurred over the past decade. Predatory practices are part and parcel
of the increasing complexity of mortgage contracts in the high-risk
(subprime) mortgage area. That greater contractual complexity has two
parts: (1) the increased reliance on risk pricing using Fair, Isaac &
Co. (FICO) scores rather than the rationing of credit via yes or no
lending decisions, and (2) the use of points, insurance, and prepayment
penalties to limit the risks lenders and borrowers bear and the costs
borrowers pay.
These practices make economic sense and can bring great benefits to
consumers. Most importantly, these market innovations allow mortgage
lenders to gauge, price, and control risk better than before, and thus
allow them to tolerate greater gradations of risk among borrowers.
According to last year's HUD-Treasury report, subprime mortgage
originations have skyrocketed since the early 1990's, increasing by
tenfold since 1993. The dollar volume of subprime mortgages was less
than 5 percent of all mortgage originations in 1994, but by 1998 had
risen to 12.5 percent. As Fed Governor Edward Gramlich (2000) has
noted, between 1993 and 1998, mortgages extended to Hispanic-Americans
and African-Americans increased the most, by 78 and 95 percent,
respectively, largely due to the growth in subprime mortgage lending.
Subprime loans are extended primarily by nondepository
institutions. The new market in consumer credit, and subprime credit in
particular, is highly competitive and involves a wide range of
intermediaries. Research by economists at the Federal Reserve Board
indicates that the reliance on nondepository intermediaries reflects a
greater tolerance for lending risk by intermediaries that do not have
to subject their loan portfolios to examination by Government
supervisors (Carey et al. 1998).
Subprime lending is risky. The reason that so many low-income and
minority borrowers rely on the subprime market is that, on average,
these are riskier groups of borrowers. It is worth bearing in mind that
default risk varies tremendously in the mortgage market. The
probability of default for the highest risk class of subprime mortgage
borrowers is roughly 23 percent, which is more than one thousand times
the default risk of the lowest risk class of prime mortgage borrowers.
When default risk is this great, in order for lenders to
participate in the market, they must be compensated with unusually high
interest rates. For example, even if a lender were risk-neutral
(indifferent to the variance of payoffs from a bundle of loans) a
lender bearing a 20 percent risk of default, and expecting to lose 50
percent on a foreclosed loan (net of foreclosure costs) should charge
at least the relevant Treasury rate (given the maturity of the loan)
plus 10 percent. On second trust mortgages, loan losses may be as high
as 100 percent. In that case, the risk-neutral default premium would be
20 percent. Added to these risk-neutral premia would be a risk premium
to compensate for the high variance of returns on risky loans (to the
extent that default risk is nondiversifiable), as well as premia to pay
for the costs of gathering information about borrowers, and the costs
of maintaining lending facilities and staff. These premia would be
charged either in the form of higher interest rates or the present
value equivalent of points paid in advance.
Default risk, however, is not the only risk that lenders bear.
Indeed, prepayment risk is of a similar order of magnitude in the
mortgage market. To understand prepayment risk, consider a 15 year
amortized subprime mortgage loan of $50,000 with a 10 percent interest
rate over the Treasury rate, zero points and no prepayment penalty. If
the Treasury rate falls, say by 1 percent, assume that the borrower
will choose to refinance the mortgage without penalty, and assume that
this decline in the Treasury rate actually happens 1 year after the
mortgage is originated.
If the interest rate on the mortgage was set with the expectation
that the loan would last for 15 years, and if the cost of originating
and servicing the loan was spread over that length of time, then the
prepayment of the loan will result in a loss to the lender. An
additional loss to the lender results from the reduction in the value
of its net worth as the result of losing the revenue from the mortgage
when it is prepaid (if the lender's cost of funds does not decline by
the same degree as its return on assets after the prepayment).
In the competitive mortgage market, lenders will have to protect
against this loss in one of several ways: First, lenders could charge a
prepayment fee to discourage prepayment, and thus limit the losses that
prepayment would entail. Second, the lender could ``frontload'' the
cost of the mortgage by charging points and reducing the interest rate
on the loan. This is a commitment device that reduces the incentive of
the borrower to refinance when interest rates fall, since the cost of a
new mortgage (points and interest) would have to compete against a
lower annual interest cost from the original loan. A third possibility
would be avoiding prepayment penalties and points and simply charging a
higher interest rate on the mortgage to compensate for prepayment risk.
In a competitive mortgage market, the present value of the cost to
the borrower of these three alternatives is equivalent. If all three
alternatives were available, each borrower would decide which of these
three alternatives was most desirable, based on the borrower's risk
preferences.
The first two alternatives amount to the decision to lock in a
lower cost of funds rather than begin with a higher cost of funds and
hope that the cost will decline as the result of prepayment. In
essence, the first two choices amount to buying an insurance policy
compared to the third, where the borrower instead prefers to retain the
option to prepay (effectively ``betting'' that interest rates will
fall).
If regulation were to limit prepayment penalties, by this logic,
those wishing to lock in low mortgage costs would choose a mortgage
that frontloads costs through points as an alternative to choosing a
mortgage with a prepayment penalty.
Loan maturity is another important choice for the borrower. The
borrower who wishes to bet on declining interest rates can avoid much
of the cost of the third alternative mentioned above (that is, paying
the prepayment risk premium) by keeping the mortgage maturity short-
term (for example, by agreeing to a balloon payment of principal in,
say, 3 years). Doing so can substantially reduce the annual cost of the
mortgage.
In the subprime market, where borrowers' creditworthiness is also
highly subject to change, prepayment risk results from improvements in
borrower riskiness as well as changes in U.S. Treasury interest rates.
The choice of either points, prepayment penalties, or neither amounts
to choosing, as before, whether to lock in a lower overall cost of
mortgage finance rather than betting on the possibility of an
improvement. Similarly, retaining a prepayment option, or choosing a
balloon mortgage, allows the individual to ``bet'' on an improvement in
his creditworthiness.
Borrowers in the subprime market are subject to significant risk
that they could lose their homes as the result of death, disability, or
job loss of the household's breadwinner(s). Some households will want
to insure against this eventuality with credit insurance. Credit
insurance comes in two main forms: monthly insurance (which is paid as
a premium each month), or ``single-premium'' insurance, which is paid
for the life of the mortgage in a single lump sum at the time of
origination, and typically is financed as part of the mortgage. Because
single-premium insurance commits the borrower to the full length of
time of the mortgage (and because there is the possibility that the
borrowers' risk of unemployment, death, or disability will decline
after origination), the monthly cost of single-premium insurance is
much lower than the cost of monthly insurance. Borrowers who want the
option to be able to cancel their insurance policy (for example, to
take advantage of a decline in their risk of unemployment) pay for that
valuable option in the form of a higher premium per month on monthly
insurance. According to Assurant Group (a major provider of credit
insurance to the mortgage market), the monthly cost for monthly credit
insurance on 5 year mortgages, on average, is about 50 percent more
expensive than the monthly cost of single-premium credit insurance.
Economists recognize that substantial points, prepayment penalties,
short mortgage maturities, and credit insurance have arisen in the
subprime market, in large part, because these contractual features
offer preferred means of reducing overall costs and risks to consumers.
Default and prepayment risks are higher in the subprime market, and
therefore, mortgages are more expensive and mortgage contracts are more
complex. Clearly, there would be substantial costs borne by many
borrowers from limiting the interest rates or overall charges on
subprime mortgages, or from prohibiting borrowers from choosing their
preferred combination of rates, points, penalties, and insurance. As
Fed Governor Edward Gramlich writes:
``. . . some [predatory lending practices] are more subtle,
involving misuse of practices that can improve credit market
efficiency most of the time. For example, the freedom for loan
rates to rise above former usury ceilings is mostly desirable,
in matching relatively risky borrowers with appropriate
lenders. . . . Most of the time balloon payments make it
possible for young homeowners to buy their first house and
match payments with their rising income stream. . . . Most of
the time the ability to refinance mortgages permits borrowers
to take advantage of lower mortgage rates. . . . Often mortgage
credit insurance is desirable. . . .'' (Gramlich 2000, p. 2)
Any attempts to regulate the subprime market should take into
account the potential costs of regulatory prohibitions. As I will argue
in more detail in section 3 below, many new laws and statutory
proposals are imbalanced in that they fail to take into account the
costs from reducing access to complex, high-cost mortgages.
Predatory Practices
So much for the ``baby''; now let me turn to the ``bathwater.'' The
use of high and multiple charges, and the many dimensions of mortgage
contracts, I have argued, hold great promise for consumers, but with
that greater complexity also comes greater opportunity for fraud and
for mistakes by consumers who may not fully understand the contractual
costs and benefits they are being offered.
That is the essential dilemma. The goal of policymakers should be
to define and address predatory practices without undermining the
opportunities offered by subprime lending.
According to the HUD-Treasury report, predatory practices in the
subprime mortgage market fall into four categories: (1) ``loan
flipping'' (enticing borrowers to refinance excessively, sometimes when
it is not in their interest to do so, and charging high refinancing
fees that strip borrower home equity), (2) excessive fees and
``packing'' (charging excessive amounts of fees to borrowers, allegedly
because borrowers fail to understand the nature of the charges, or lack
knowledge of what would constitute a fair price), (3) lending without
regard to the borrower's ability to repay (that is, lending with the
intent of forcing a borrower into foreclosure in order to seize the
borrower's home), and (4) outright fraud.
It is worth pausing for a moment to note that, with the exception
of fraud (which is already illegal) these problems are defined by
(often subjective) judgments about the outcomes for borrowers
(excessive refinancing, excessive fees, excessive risk of default), not
by clearly definable actions by lenders that can be easily prohibited
without causing collateral harm in the mortgage market.
For example, with regard to loan flipping, it may not be easy to
define in an exhaustive way the combinations of changes to a mortgage
contract that make a borrower better off. There are clear cases of
purely adverse change (for example, across-the-board increases in rates
and fees with no compensating changes in the contract), and there are
clear cases of improvement, but there are also gray areas in which a
mix of changes occurs, and where a judgment as to whether the position
of the borrower has improved or deteriorated depends on an evaluation
of the probabilities of future contingencies and a knowledge of
borrower preferences.
Similarly, whether fees are excessive can often be very difficult
to gauge, since the sizes of the fees vary with the creditworthiness of
the borrower and with the intent of the contract. For example, points
are often used as a commitment device to limit prepayment risk.
And what is the maximum ``acceptable'' level of default risk on a
mortgage, which would constitute evidence that a mortgage had been
unreasonably offered because of the borrower's inability to repay?
Many alleged predatory problems revolve around questions of fair
disclosure and fraud prevention. These can be addressed to a great
degree by ensuring accurate and complete disclosure of facts (making
sure that the borrower is aware of the true APR, and making sure that
legally mandated procedures under RESPA, TILA, and HOEPA are followed
by the lender). In section 3, I will discuss a variety of proposals for
strengthening disclosure rules and protections against fraud.
But the critics of predatory lending argue that inadequate
disclosure and outright fraud are not the only ways in which borrowers
may be fooled unfairly by lenders. For some elderly people, or people
who are mentally incapacitated, predatory lending may simply constitute
taking advantage of those who are mentally incapable of representing
themselves when signing loan contracts. And for others, lack of
familiarity with financial language or concepts may make it hard for
them to judge what they are agreeing to.
Of course, this problem arises in markets all the time. When
consumers purchase automobiles, those who cannot calculate present
values of cashflows (when comparing various financing alternatives) may
be duped into paying more for a car. And when renting a car, less savvy
consumers may pay more than they should for gasoline or collision
insurance. In a market economy, we rely on the time-honored common law
principle of caveat emptor because on balance we believe that market
solutions are better than Government planning, and markets cannot
function if those who make choices in markets are able to reverse those
choices after the fact whenever they please.
But consumer advocates rightly point out that, given the importance
of the mortgage decision, a misstep by an uninformed or mentally
incapacitated consumer in the mortgage market can be a life changing
disaster. That concern explains why well-intentioned would-be reformers
have turned their attentions to proposals to regulate mortgage
products. But those proposed remedies often are excessive. Reformers
advocate what amount to price controls, and prohibitions of contractual
features that they deem to be onerous or unnecessary.
Some of these advocates of reform, however, seem to lack a basic
understanding of the functioning of financial markets and the pricing
of financial instruments. In their zeal to save borrowers from harming
themselves they run the risk of causing more harm to borrowers than
predatory lenders.
Other reformers seem to understand that their proposals will reduce
the availability of subprime credit to the general population, but they
do not care. Indeed, one gets the impression that some paternalistic
community groups dislike subprime lending and feel entitled to place
limits on the decisionmaking authority even of mentally competent
individuals. Other critics of predatory lending may have more sinister
motives related to the kickbacks they receive for contractually
agreeing to stop criticizing particular subprime lenders.
Whatever the motives of these advocates, it is easy to show that
many of the extreme proposals for changing the regulation of the
subprime mortgage market are misguided and would harm many consumers by
limiting their access to credit on the most favorable terms available.
There are better ways to target the legitimate problems of abuse.
Evaluating Proposed Reforms
Let me now turn to an analysis of each of the proposed remedies for
predatory lending, which I divide into three groups: (1) those that are
sensible and that should be enacted by Fed regulation, (2) those that
are possibly sensible, but which might do more harm than good, and thus
require more empirical study before deciding whether and how to
implement them, and (3) those that are not sensible, and which would
obviously do more harm than good.
Sensible Reforms That Should Be Implemented Immediately by the Fed
Under HOEPA, the Fed is entitled to regulate subprime mortgages
that either have interest rates far in excess of Treasury rates (the
Fed currently uses a 10 percent spread trigger, but can vary that
spread between 8 percent and 12 percent) or that have total fees and
points greater than either 8 percent or $451. HOEPA already specifies
some contractual limits on these loans (for example, prepayment
penalties are only permissible for the first 5 years of the loan, and
only when the borrowers' income is greater than 50 percent of the loan
payment). It is my understanding that the Fed currently has broad
authority to establish additional regulatory guidelines for these
loans, and is currently considering a variety of measures. Following is
a list of measures that I regard as desirable.
Disclosure and Counseling
Disclosure requirements always add to consumers' loan costs, but in
my judgment, some additional disclosure requirements would be
appropriate for the loans regulated under HOEPA. I would recommend a
mandatory disclosure statement like the one proposed in section 3(a) of
Senate bill S. 2415 (April 12, 2000), which alerts borrowers to the
risks of subprime mortgage borrowing. It is also desirable to make
counseling available to potential borrowers on HOEPA loans, and to
require lenders to disclose that such counseling is available (as
proposed in the HUD-Treasury report). The HUD-Treasury report also
recommends amendments to RESPA and TILA that would facilitate
comparison shopping and make timely information about the costs of
credit and settlement easier for consumers to understand and more
reliable. I also favor the HUD-Treasury suggestions of imposing an
accuracy standard on permissible violations from the Good Faith
Estimate required under RESPA, requiring lenders to disclose credit
scores to borrowers (I note that these scores have since been made
available by Fair Isaac Co. to borrowers via the Internet), and
expanding penalties on lenders for inadequate or inaccurate
disclosures. The use of ``testers'' to verify disclosure practices
would likely prove very effective as an enforcement tool to ensure that
lenders do not target some classes of individuals with inadequate
disclosure. I also agree with the suggested requirement that lenders
notify borrowers of their intent to foreclose far enough in advance
that borrowers have the opportunity to arrange alternative financing (a
feature of the new Pennsylvania statute) as a means of discouraging
unnecessary foreclosure. Finally, I would recommend that, for HOEPA
loans where borrowers' monthly payments exceed 50 percent of their
monthly income, the lender should be required to make an additional
disclosure that informs the borrower of the estimated high probability
(using a recognized model, like that of Fair Isaac Co.) that the
borrower may lose his or her home because of inadequate ability to pay
debt service.
Credit History Reporting
It is alleged that some lenders withhold favorable information
about customers in order to keep information about improvements in
customer creditworthiness private, and thus limit competition. It is
appropriate to require lenders not to selectively report information to
credit bureaus.
Single-Premium Insurance
Roughly one in four households do not have any life insurance,
according to Household (2001). Clearly, credit insurance can be of
enormous value to subprime borrowers, and single-premium insurance can
be a desirable means for reducing the risk of losing one's home at low
cost. To prevent abuse of this product, there should be a mandatory
requirement that lenders that offer single-premium insurance (1) must
give borrowers a choice between single-premium and monthly premium
credit insurance, (2) must clearly disclose that credit insurance is
optional and that the other terms of the mortgage are not related to
whether the borrower chooses credit insurance, and (3) must allow
borrowers to cancel their single-premium insurance and receive a full
refund of the payment within a reasonable time after closing (say,
within 30 days, as in the Pennsylvania statute).
Limits on Flipping
Several new laws and proposals, including a proposed rule by the
Federal Reserve Board, would limit refinancing to address the problem
of loan flipping. The Fed rule would prohibit refinancing of a HOEPA
loan by the lender or its affiliate within the first 12 months unless
that refinancing is ``in the borrower's interest.'' This is a
reasonable idea so long as there is a clear and reasonable safe harbor
in the rule for lenders that establishes criteria under which it will
be presumed that the refinancing was in the borrower's interest. For
example, if a refinancing either (a) provides substantial new money or
debt consolidation, (b) reduces monthly payments by a minimum amount,
or (c) reduces the duration of the loan, then any one of those features
should protect the lender from any claim that the refinancing was not
in the borrower's interest.
Limits on Refinancing of Subsidized Government or Not-for-Profit Loans
It has been alleged that some lenders have tricked borrowers into
refinancing heavily subsidized Government or not-for-profit loans at
market (or above market) rates. Lenders that refinance such loans
should face very strict tests for demonstrating that the refinancing
was in the interest of the borrower.
Prohibition of Some Contractual Features
Some mortgage structures add little real value to the menu of
consumers' options, and are especially prone to abuse. In my judgment,
the Federal Reserve Board has properly identified payable-on-demand
clauses or call provisions as an example of such contractual features
that should be prohibited.
Require Lenders To Offer Loans With and Without Prepayment Penalties
Rather than regulate prepayment penalties further as some have
proposed, I would recommend requiring that HOEPA lenders offer
mortgages both with and without prepayment penalties, so that the price
of the prepayment option would be clear to consumers. Then consumers
could make an informed decision whether to pay for the option to
prepay.
Proposals That Require Further Study
In addition to the aforementioned reforms, many other potentially
beneficial, but also potentially costly, reforms have been proposed and
should be studied to determine whether they are necessary over and
above the reforms listed above, and whether on balance they would do
more good than harm. The list of potentially beneficial reforms that
are worthy of careful scrutiny includes:
(1) A limit on balloons (for example, requiring a minimum of
a certain period of time between origination and the balloon
payment) is worth exploring--although many of the proposed
limits on balloons do not seem reasonable; for example both the
Pennsylvania statute's 10 year limit and the HUD-Treasury
report's proposed 15 year limit, seem to me far too long; but
shorter-term limits on balloons (say, a 3 or 5 year minimum
duration) may be desirable.
(2) The establishment of new rules on mortgage brokers'
behavior (as proposed in the HUD-Treasury report) may be
worthwhile, as a means of ensuring that mortgage brokerage is
not employed to circumvent effective compliance; and
(3) It may be desirable, as the Fed has proposed, to lower
the HOEPA interest rate threshold from 10 percent to 8 percent.
The main drawback of lowering the trigger point for HOEPA,
which has been noted by researchers at the Fed, and by Robert
Litan, is the potential chilling effect that reporting
requirements may have on the supply of credit in the subprime
market. (I note in passing that I do not agree with the
proposal to include all fees into the HOEPA fee trigger; fees
that are optional, and not conditions for granting the
mortgage--like credit insurance--should be excluded from the
calculation.)
Proposals That Should Be Rejected
Usury Laws
Under the rubric of bad ideas, I will focus on one in particular:
price controls. It is a matter of elementary economics that limits on
prices restrict supply. Among the ideas that should be rejected out of
hand are proposals to impose Government price controls--on interest
rates, points, and fees--for subprime mortgages.
Because of legal limits on local authorities to impose usury
ceilings (due to Federal preemption) States and municipalities intent
on discouraging high-cost mortgage lending have pursued an alternative
``stealth'' approach to usury laws. The technique is to impose
unworkable risks on subprime lenders that charge rates or fees in
excess of Government specified levels and thereby drive high-interest
rate lenders from the market.
Additionally, some price control proposals are put forward by
community groups like ACORN in the form of ``suggested'' voluntary
agreements between community groups and lenders.
Several cities and States have passed, or are currently debating,
stealth usury laws for subprime lending. For example, the city of
Dayton, Ohio this month passed a draconian antipredatory lending law.
This law places lenders at risk if they make high-interest loans that
are ``less favorable to the borrower than could otherwise have been
obtained in similar transactions by like consumers within the City of
Dayton,'' and lenders may not charge fees and/or costs that ``exceed
the fees and/or costs available in similar transactions by like
consumers in the City of Dayton by more than 20 percent.''
In my opinion, it would be imprudent for a lender to make a loan in
Dayton governed by this statute. Indeed, I believe that the statute's
intent must be to eliminate high-interest loans, which is why I
describe it as a stealth usury law. Immediately upon the passage of the
Dayton law, Bank One announced that it was withdrawing from origination
of loans that were subject to the statute. No doubt others will exit,
as well.
The recent 131 page antipredatory lending law passed in the
District of Columbia is similarly unworkable. Lenders are subject to
substantial penalties if they are deemed to have lent at an interest
rate ``substantially greater than the home borrower otherwise would
have qualified for, at that lender or at another lender, had the lender
based the annual percentage rate upon the home borrowers' credit scores
as provided by nationally recognized credit reporting agencies,'' or if
loan costs are ``unconscionable,'' or if loan discount points are ``not
reasonably consistent with established industry customs and
practices.''
The District law is fundamentally flawed in several respects.
First, it essentially requires lenders to charge no more than the rate
indicated by the customer's credit score. That is an improper use of
credit scores. Credit scores are not perfect indicators of risk; they
are used as one of many--and sometimes not the primary--means of
judging whether and on what terms to make a loan. Second, the DC law
places the ridiculous burden on the lender of making sure, prior to
lending, that his customer could not find a better deal from his
competitors. Finally, the vague wording makes the legal risks of
subprime lending so great that no banker would want to engage in it.
As Donald Lampe points out, massive withdrawal from the subprime
lending market occurred in response to the overly zealous initiative
against predatory lending by the State of North Carolina. To quote from
Lampe's (2001) summary of the North Carolina experience:
``Virtually all residential mortgage lenders doing business
in North Carolina have elected not to make ``high-cost home
loans'' that are subject to N.C.G.S. 24-1.1E. Instead, lenders
seek to avoid the ``thresholds'' established by the law.'' (p.
4)
Michael Staten of the Credit Research Center of Georgetown
University has compiled a new database on subprime lending that permits
one to track the chilling
effect of the North Carolina law on subprime lending in the State. The
sample coverage of the database nationwide includes 39 percent of all
subprime mortgage loans made by HMDA-reporting institutions in 1998.
Staten's statistical research (reproduced with permission in an
appendix to this testimony) compares changes in mortgage originations
in North Carolina with those in South Carolina and Virginia, before and
after the passage of the North Carolina law (which was passed in July
1999 and phased in through early 2000). South Carolina and Virginia are
included in these tables as controls to allow for changes over time in
mortgage originations in the Upper South that were not specific to
North Carolina.
As shown in the appendix, Staten finds that originations of
subprime mortgage loans (especially first-lien loans) in North Carolina
plummeted after passage of the 1999 law, both absolutely and relatively
to its neighbors, and that the decline was almost exclusively in the
supply of loans available to low- and moderate-income borrowers (those
most dependent on high-cost credit). For borrowers in the low-income
group (with annual incomes less than $25,000) originations were cut in
half; for those in the next income class (with annual incomes between
$25,000 and $49,000) originations were cut by roughly a third. The
response to the North Carolina law provides clear evidence of the
chilling effect of antipredatory laws on the supply of subprime
mortgage loans to low-income borrowers.
Robert Litan (2001) had anticipated this result. He wrote that:
``. . . statutory measures at the State and local level at
this point run a significant risk of unintentionally cutting
off the flow of funds to creditworthy borrowers. This is a very
real threat and one that should be seriously considered by
policymakers at all levels of government, especially in light
of the multiple, successful efforts that Federal law in
particular
has made to increase lending in recent years to minorities and
low-income borrowers.
``The more prudent course is for policymakers at all levels
of government to wait for more data to be collected and
reported by the Federal Reserve so that enforcement officials
can better target practices that may be unlawful under existing
statutes. In the meantime, Congress should provide the Federal
agencies charged with enforcing existing statutes with
sufficient resources to carry out their mandates, as well as to
support ongoing counseling efforts to educate vulnerable
consumers about the alternatives open to them in the credit
market and the dangers of signing mortgages with unduly onerous
terms.'' (p. 2)
The history of the last two decades teaches that usury laws are
highly counterproductive. Limits on the ability of States to regulate
consumer lenders head-
quartered outside their State were undermined by the 1978 Marquette
National Bank case (see DeMuth, 1986). In 1982, the Federal Government
further expanded consumers' access to credit by preempting State
restrictions on mortgage lending by mortgage lenders headquartered
within the State (the Alternative Mortgage Transaction Parity Act of
1982).
These measures were crucial contributors to the democratization of
consumer finance, and particularly, mortgage finance in recent years.
The Marquette case opened a flood of competition in credit card
lending, which led the way to establishing a deep market in consumer
credit receivables and the new techniques for credit scoring--
innovations which have increased the supply and reduced the cost of
consumer credit.
The 1982 Parity Act expanded the range of competition in consumer
mortgage finance preempting State prohibitions on alternative mortgages
originated by both depository and nondepository institutions. In
particular, as I understand this law, it effectively preempts State
usury laws as applied to subprime mortgages. Because mortgage lending
relies on real estate as security, it can be provided more
inexpensively than credit card loans or other unsecured consumer credit
(Calomiris and Mason, 1998). Thus the 1982 Act provided an important
benefit to consumers over and above the beneficial undermining of State
usury laws after the Marquette case.
But the new stealth usury laws of North Carolina, Dayton, and
Washington DC, and similar proposals elsewhere, pose a new threat. If
Congress fails to restore the preemption principle in the subprime
mortgage market established in 1982, then lenders will be driven out of
the high-risk end of the market, and therefore, many consumers will be
driven out of the mortgage market and into higher-cost, less desirable
credit markets (credit cards, pawn shops, and worse).
That is not progress. Congress should do everything in its power to
amend the Parity Act to clearly define stealth usury laws as usury
laws, not consumer protection laws, and thus prevent any further damage
to individuals' access to credit from these pernicious State and city
initiatives.
Other Prohibitions
I have already argued against further regulatory or statutory
limits on prepayment penalties, or prohibition of single-premium credit
insurance, in favor of alternative approaches to the abuses that
sometimes accompany these features.
I am also opposed to the many proposals that would prevent
borrowers from agreeing to mandatory binding arbitration to resolve
loan disputes. Individuals should be able to choose. If an individual
wishes to commit to binding arbitration, that commitment reduces the
costs to lenders of originating mortgages, and in the competitive
mortgage market, that cost is passed on to consumers. Requiring
consumers not to commit to binding arbitration is only good for
America's trial lawyers.
Conclusion
For the most part, predatory lending practices can be addressed by
focusing efforts on better enforcing laws against fraud, improving
disclosure rules, offering Government-financed counseling, and placing
a few well thought out limits on credit industry practices. The Fed
already has the authority and the expertise to formulate those rules
and is in the process of doing so, based on a new data collection
effort that will permit an informed and balanced approach to regulating
subprime lending.
The main role of Congress, in my view, should be to monitor the
Fed's rulemaking as it evolves, make sure that the Fed has the
statutory authority that it needs to set appropriate regulations, and
amend the 1982 Parity Act to reestablish Federal preemption and thus
defend consumers against the ill-conceived usury laws that are now
spreading throughout the country.
Members of Congress, and especially Members of this Committee, also
should speak out in defense of honest subprime lenders, of which there
are many. The possible passage of State and city usury statutes is not
the only threat to the supply of subprime loans. There is also the
possibility that bad publicity, orchestrated by community groups,
itself could force some lenders to exit the market.
Some community organizations have been waging a smear campaign
against subprime lenders. To the extent that zealous community groups,
whether out of noble or selfish intent, succeed in smearing subprime
lenders as a group, the public relations consequences will have a
chilling effect on the supply of subprime credit. The first casualty
will be the truth. The second casualty will be access to credit for the
poor.
References
Calomiris, Charles W., and Joseph R. Mason (1998). High Loan-To-
Value Mortgage Lending. Washington: AEI Press.
Carey, Mark, Mitch Post, and Steven A. Sharpe (1998). ``Does
Corporate Lending by Banks and Finance Companies Differ? Evidence on
Specialization in Private Debt Contracting.'' Journal of Finance 53
(June), 845-78.
DeMuth, Christopher C. (1986). ``The Case Against Credit Car
Interest Rate Regulation.'' Yale Journal on Regulation 3 (Spring), 201-
41.
Gramlich, Edward M. (2000). ``Remarks by Governor Edward M.
Gramlich at the Federal Reserve Bank of Philadelphia Community and
Consumer Affairs Department Conference on Predatory Lending.'' December
6.
Household International Inc. (2001). ``News Release: Household
International to Discontinue Sale of Single Premium Credit Insurance on
All Real Estate Secured Loans.'' July 11.
Lampe, Donald C. (2001). ``Update on State and Local Anti-Predatory
Lending Laws and Regulations: The North Carolina Experience.'' American
Conference Institute, Predatory Lending Seminar, San Francisco, June
27-28.
Litan, Robert E. (2001). ``A Prudent Approach To Preventing
`Predatory' Lending.'' Working Paper, The Brookings Institution, 2001.
U.S. Department of Housing and Urban Development and U.S.
Department of the Treasury (2000). Curbing Predatory Home Mortgage
Lending: A Joint Report. June.
REVISED PREPARED STATEMENT OF CHARLES W. CALOMIRIS
Paul M. Montrone Professor of Finance and Economics
Graduate School of Business, Columbia University, New York, New York
July 27, 2001
Mr. Chairman, it is a pleasure and an honor to address you today on
the important topic of predatory lending.
Predatory lending is a real problem. It is, however, a problem that
needs to be addressed thoughtfully and deliberately, with a hard head
as well as a soft heart. There is no doubt that people have been hurt
by the predatory practices of some creditors, but we must make sure
that the cure is not worse than the disease. Unfortunately, many of the
proposed or enacted municipal, State, and Federal statutory responses
to predatory lending would have adverse consequences that are worse
than the problems they seek to redress. Many of these initiatives would
reduce the supply of credit to low-income homeowners, raise their cost
of credit, and restrict the menu of beneficial choices available to
borrowers.
Fortunately, there is a growing consensus in favor of a balanced
approach to the problem. That consensus is reflected in the viewpoints
expressed by a wide variety of individuals and organizations, including
Robert Litan of the Brookings Institution, Fed Governor Edward
Gramlich, most of the recommendations of last year's HUD-Treasury
Report, the voluntary standards set by the American Financial Services
Association (AFSA), the recent predatory lending statute passed by the
State of Pennsylvania, and the recommendations and practices of many
subprime mortgage lenders (including, most notably, Household). In my
comments, I will describe and defend that balanced approach, and offer
some specific recommendations for Congress and for financial
regulators.
To summarize my recommendations at the outset, I believe that an
appropriate response to predatory practices should occur in two stages:
First, there should be an immediate regulatory response to strengthen
enforcement of existing laws, enhance disclosure rules and provide
counseling services, amend existing regulation, and limit or ban some
practices. I believe that these initiatives, described in detail below,
will address all of the serious problems associated with predatory
lending.
In other areas--especially the regulation of prepayment penalties
and balloon payments--any regulatory change should await a better
understanding of the extent of remaining predatory problems that result
from these features, and the best ways to address them through
appropriate regulations. The Fed is currently pursuing the first
systematic scientific evaluation of these areas, as part of its clear
intent to expand its role as the primary regulator of subprime lending,
given its authority under HOEPA. The Fed has the regulatory authority
and the expertise necessary to find the right balance between
preventing abuse and permitting beneficial contractual flexibility.
Congress, and other legislative bodies, should not rush to judgment
ahead of the facts and before the Fed has had a chance to address these
more complex problems, and in so doing, end up throwing away the
proverbial baby of subprime lending along with the bathwater of
predatory practices.
I think the main role Congress should play at this time is to rein
in actions by States and municipalities that seek to avoid established
Federal preemption by effectively setting mortgage usury ceilings under
the guise of consumer protection rules. Immediate Congressional action
to dismantle these new undesirable barriers to individuals' access to
mortgage credit would ensure that consumers throughout the country
retain their basic contractual rights to borrow in the subprime market.
My detailed comments divide into four parts: (1) a background
discussion of subprime lending, (2) an attempt to define predatory
practices, (3) a point-by-point evaluation of proposed or enacted
remedies for predatory practices, and (4) a concluding section.
Subprime Lending, the Democratization of Finance, and
Financial Innovation
The problems that fall under the rubric of predatory lending are
only possible today because of the beneficial ``democratization'' of
consumer credit markets, and mortgage markets in particular, that has
occurred over the past decade. Predatory practices are part and parcel
of the increasing complexity of mortgage contracts in the high-risk
(subprime) mortgage area. That greater contractual complexity has two
parts: (1) the increased reliance on risk pricing using Fair Isaac Co.
(FICO) scores rather than the rationing of credit via yes or no lending
decisions, and (2) the use of points, insurance, and prepayment
penalties to limit the risks lenders and borrowers bear and the costs
borrowers pay.
These practices make economic sense and can bring great benefits to
consumers. Most importantly, these market innovations allow mortgage
lenders to gauge, price, and control risk better than before, and thus
allow them to tolerate greater gradations of risk among borrowers.
According to last year's HUD-Treasury report, subprime mortgage
originations have skyrocketed since the early 1990's, increasing by
tenfold since 1993. The dollar volume of subprime mortgages was less
than 5 percent of all mortgage originations in 1994, but by 1998 had
risen to 12.5 percent. As Fed Governor Edward Gramlich (2000) has
noted, between 1993 and 1998, mortgages extended to Hispanic-Americans
and African-Americans increased the most, by 78 and 95 percent,
respectively, largely due to the growth in subprime mortgage lending.
Subprime loans are extended primarily by nondepository
institutions. The new market in consumer credit, and subprime credit in
particular, is highly competitive and involves a wide range of
intermediaries. Research by economists at the Federal Reserve Board
indicates that the reliance on nondepository intermediaries reflects a
greater tolerance for lending risk by intermediaries that do not have
to subject their loan portfolios to examination by Government
supervisors (Carey et al. 1998).
Subprime lending is risky. The reason that so many low-income and
minority borrowers rely on the subprime market is that, on average,
these are riskier groups of borrowers. It is worth bearing in mind that
default risk varies tremendously in the mortgage market. According to
Frank Raiter of Standard & Poor's, the probability of default (over the
lifetime of the mortgage, which is typically 3 to 5 years) for the
highest risk class of subprime mortgage borrowers is roughly 23
percent, which is more than one thousand times the default risk of the
lowest risk class of prime mortgage borrowers. There is variation in
default risk within the highest risk class, as well, so that some
subprime mortgages have even higher risk of default.
When default risk is this great, in order for lenders to
participate in the market, they must be compensated with unusually high
interest rates. Consider an extreme case. For example, even if a lender
were risk-neutral (indifferent to the variance of payoffs from a bundle
of loans) a lender bearing a 20 percent risk of default (on average, in
each year of the mortgage), and expecting to lose 50 percent on a
foreclosed loan (net of foreclosure costs) should charge at least the
relevant Treasury rate (given the maturity of the loan) plus 10
percent. On second-trust mortgages, loan losses may be as high as 100
percent. In that case, the risk-neutral default premium would be 20
percent. Added to these risk-neutral premia would be a risk premium to
compensate for the high variance of returns on risky loans (to the
extent that default risk is nondiversifiable), as well as premia to pay
for the costs of gathering information about borrowers, and the costs
of maintaining lending facilities and staff. These premia would be
charged either in the form of higher interest rates or the present
value equivalent of points paid in advance.
Default risk, however, is not the only risk that lenders bear.
Indeed, prepayment risk is of a similar order of magnitude in the
mortgage market. To understand prepayment risk, consider a 15 year
amortized subprime mortgage loan of $50,000 with a 10 percent interest
rate over the Treasury rate, zero points and no prepayment penalty. If
the Treasury rate falls, say by 1 percent, assume that the borrower
will choose to refinance the mortgage without penalty, and assume that
this decline in the Treasury rate actually happens 1 year after the
mortgage is originated.
If the interest rate on the mortgage was set with the expectation
that the loan would last for 15 years, and if the cost of originating
and servicing the loan was spread over that length of time, then the
prepayment of the loan will result in a loss to the lender. An
additional loss to the lender results from the reduction in the value
of its net worth as the result of losing the revenue from the mortgage
when it is prepaid (if the lender's cost of funds does not decline by
the same degree as its return on assets after the prepayment).
In the competitive mortgage market, lenders will have to protect
against this loss in one of several ways: First, lenders could charge a
prepayment fee to discourage prepayment, and thus limit the losses that
prepayment would entail. Second, the lender could ``frontload'' the
cost of the mortgage by charging points and reducing the interest rate
on the loan. This is a commitment device that reduces the incentive of
the borrower to refinance when interest rates fall, since the cost of a
new mortgage (points and interest) would have to compete against a
lower annual interest cost from the original loan. A third possibility
would be avoiding prepayment penalties and points and simply charging a
higher interest rate on the mortgage to compensate for prepayment risk.
In a competitive mortgage market, the present value of the cost to
the borrower of these three alternatives is equivalent. If all three
alternatives were available, each borrower would decide which of these
three alternatives was most desirable, based on the borrower's risk
preferences.
The first two alternatives amount to the decision to lock in a
lower cost of funds rather than begin with a higher cost of funds and
hope that the cost will decline as the result of prepayment. In
essence, the first two choices amount to buying an insurance policy
compared to the third, where the borrower instead prefers to retain the
option to prepay (effectively ``betting'' that interest rates will
fall).
If regulation were to limit prepayment penalties, by this logic,
those wishing to lock in low mortgage costs would choose a mortgage
that frontloads costs through points as an alternative to choosing a
mortgage with a prepayment penalty.
Loan maturity is another important choice for the borrower. The
borrower who wishes to ``bet'' on declining interest rates can avoid
much of the cost of the third alternative mentioned above (that is,
paying the prepayment risk premium) by keeping the mortgage maturity
short-term (for example, by agreeing to a balloon payment of principal
in, say, 3 years). Doing so can substantially reduce the annual cost of
the mortgage.
In the subprime market, where borrowers' creditworthiness is also
highly subject to change, prepayment risk results from improvements in
borrower riskiness as well as changes in U.S. Treasury interest rates.
The choice of either points, prepayment penalties, or neither amounts
to choosing, as before, whether to lock in a lower overall cost of
mortgage finance rather than betting on the possibility of an
improvement. Similarly, retaining a prepayment option, or choosing a
balloon mortgage, allows the individual to ``bet'' on an improvement in
his creditworthiness.
Borrowers in the subprime market are subject to significant risk
that they could lose their homes as the result of death, disability, or
job loss of the household's breadwinner(s), which might make them
unable to make their mortgage payments. Some households will want to
insure against this eventuality with credit insurance. Credit insurance
comes in two main forms: monthly insurance (which is paid as a premium
each month), or ``single-premium'' insurance, which is paid for the
life of the mortgage in a single lump sum at the time of origination,
and typically is financed as part of the mortgage.
Much has been said and written recently about single-premium,
insurance. Single-premium insurance, it is often alleged, is a means
unscrupulous lenders employ to trick borrowers into overpaying for
coverage. The reason for that claim is that, in present value terms,
single-premium insurance is more expensive for borrowers than monthly
premium insurance.
For example, using data provided to me by Assurant Group (a major
provider of credit insurance to the mortgage market), a typical single-
premium policy for a 12 percent APR mortgage would have a monthly
payment today of approximately $22 per month for 30 years. That policy
provides coverage, however, for only the first 5 years. Its costs are
amortized, however, over the entire 30 year period. A comparable 5 year
average monthly cost for monthly insurance would be roughly $33, but
that higher monthly payment would end after 5 years. Clearly, monthly
insurance is much cheaper on a present value basis.
Defenders of single-premium insurance argue that it is sold because
insurers are unwilling to supply monthly insurance in many cases
because its price (which is regulated at the State level) is set too
low to be profitable for issuers. Defenders also argue that single-
premium insurance has some benefits that customers appreciate which
would make them prefer it, even at current prices, even if both single-
premium and monthly insurance were available. The former argument seems
to have some merit, although I have not been able to assemble evidence
to prove or disprove it. The latter argument I find hard to believe,
although I do not have evidence to refute it.
In any case, while I am in favor of regulating single-premium
insurance to prevent abuse (as discussed below in section 3), I am not
in favor of prohibiting it, for two reasons. First, it may be that, as
defenders argue, under current State price controls, it is the only
economically feasible alternative. In that case, prohibiting it,
without also changing State price limits, would reduce the supply of
credit insurance available to consumers.
Second, if it were possible to deregulate the pricing of credit
insurance, to allow the market to set prices for both kinds of
insurance, and if reasonable objections to current practices of selling
credit insurance could be addressed, then some consumers would prefer
single-premium coverage over monthly coverage. The reason is that the
market price (in present value) of single-premium coverage would
probably be lower than that of monthly coverage. Because single-premium
insurance commits the borrower to the full length of time of the
mortgage (and because there is the possibility that the borrowers' risk
of unemployment, death, or disability will decline after origination),
if prices were set by a competitive market, single-premium insurance
would be less expensive (in present value terms) because buyers of
monthly insurance are also purchasing an implicit option. Borrowers who
want the option to be able to cancel their insurance policy (for
example, to take advantage of a decline in their risk of unemployment,
or upon repaying their mortgage) would prefer monthly insurance and
would pay for that valuable option in the form of a higher premium per
month on monthly insurance.
So, while I recognize that under current rules, single-premium
insurance is priced above monthly insurance, that does not imply that
buyers of single-premium insurance have been cheated, or that it should
be prohibited. If we can find a way for lenders to offer both kinds of
insurance in a way that enhances consumer choice, and avoids defrauding
borrowers, theory suggests that this would be desirable.
In short, economists recognize that substantial points, prepayment
penalties, short mortgage maturities, and credit insurance have arisen
in the subprime market, in large part, because these contractual
features offer preferred means of reducing overall costs and risks to
consumers. Default and prepayment risks are higher in the subprime
market, and therefore, mortgages are more expensive and mortgage
contracts are more complex. Clearly, there would be substantial costs
borne by many borrowers from limiting the interest rates or overall
charges on subprime mortgages, or from prohibiting borrowers from
choosing their preferred combination of rates, points, penalties, and
insurance. As Fed Governor Edward Gramlich writes:
``. . . some [predatory lending practices] are more subtle,
involving misuse of practices that can improve credit market
efficiency most of the time. For example, the freedom for loan
rates to rise above former usury ceilings is mostly desirable,
in matching relatively risky borrowers with appropriate
lenders. . . . Most of the time balloon payments make it
possible for young homeowners to buy their first house and
match payments with their rising income stream. . . . Most of
the time the ability to refinance mortgages permits borrowers
to take advantage of lower mortgage rates. . . . Often mortgage
credit insurance is desirable. . . .'' (Gramlich 2000, p. 2)
Any attempts to regulate the subprime market should take into
account the potential costs of regulatory prohibitions. As I will argue
in more detail in section 3 below, many new laws and statutory
proposals are imbalanced in that they fail to take into account the
costs from reducing access to complex, high-cost mortgages.
Predatory Practices
So much for the ``baby''; now let me turn to the ``bathwater.'' The
use of high and multiple charges, and the many dimensions of mortgage
contracts, I have argued, hold great promise for consumers, but with
that greater complexity also comes greater opportunity for fraud and
for mistakes by consumers who may not fully understand the contractual
costs and benefits they are being offered.
That is the essential dilemma. The goal of policy makers should be
to define and address predatory practices without undermining the
opportunities offered by subprime lending.
According to the HUD-Treasury report, predatory practices in the
subprime mortgage market fall into four categories: (1) ``loan
flipping'' (enticing borrowers to refinance excessively, sometimes when
it is not in their interest to do so, and charging high refinancing
fees that strip borrower home equity), (2) excessive fees and
``packing'' (charging excessive amounts of fees to borrowers, allegedly
because borrowers fail to understand the nature of the charges, or lack
knowledge of what would constitute a fair price), (3) lending without
regard to the borrower's ability to repay (that is, lending with the
intent of forcing a borrower into foreclosure in order to seize the
borrower's home), and (4) outright fraud.
It is worth pausing for a moment to note that, with the exception
of fraud (which is already illegal) these problems are defined by
(often subjective) judgments about the outcomes for borrowers
(excessive refinancing, excessive fees, excessive risk of default), not
by clearly definable actions by lenders that can be easily prohibited
without causing collateral harm in the mortgage market.
For example, with regard to loan flipping, it may not be easy to
define in an exhaustive way the combinations of changes to a mortgage
contract that make a borrower better off. There are clear cases of
purely adverse change (for example, across-the-board increases in rates
and fees with no compensating changes in the contract), and there are
clear cases of improvement, but there are also gray areas in which a
mix of changes occurs, and where a judgment as to whether the position
of the borrower has improved or deteriorated depends on an evaluation
of the probabilities of future contingencies and a knowledge of
borrower preferences.
Similarly, whether fees are excessive can often be very difficult
to gauge, since the sizes of the fees vary with the creditworthiness of
the borrower and with the intent of the contract. For example, points
are often used as a commitment device to limit prepayment risk.
And what is the maximum ``acceptable'' level of default risk on a
mortgage, which would constitute evidence that a mortgage had been
unreasonably offered because of the borrower's inability to repay?
Many alleged predatory problems revolve around questions of fair
disclosure and fraud prevention. These can be addressed to a great
degree by ensuring accurate and complete disclosure of facts (making
sure that the borrower is aware of the true APR, and making sure that
legally mandated procedures under RESPA, TILA, and HOEPA are followed
by the lender). In section 3, I will discuss a variety of proposals for
strengthening disclosure rules and protections against fraud.
But the critics of predatory lending argue that inadequate
disclosure and outright fraud are not the only ways in which borrowers
may be fooled unfairly by lenders. For some elderly people, or people
who are mentally incapacitated, predatory lending may simply constitute
taking advantage of those who are mentally incapable of representing
themselves when signing loan contracts. And for others, lack of
familiarity with financial language or concepts may make it hard for
them to judge what they are agreeing to.
Of course, this problem arises in markets all the time. When
consumers purchase automobiles, those who cannot calculate present
values of cashflows (when comparing various financing alternatives) may
be duped into paying more for a car. And when renting a car, less savvy
consumers may pay more than they should for gasoline or collision
insurance. In a market economy, we rely on the time-honored common law
principle of caveat emptor because on balance we believe that market
solutions are better than Government planning, and markets cannot
function if those who make choices in markets are able to reverse those
choices after the fact whenever they please.
But consumer advocates rightly point out that, given the importance
of the mortgage decision, a misstep by an uninformed or mentally
incapacitated consumer in the mortgage market can be a life changing
disaster. That concern explains why well-intentioned would-be reformers
have turned their attentions to proposals to regulate mortgage
products. But those proposed remedies often are excessive. Reformers
advocate what amount to price controls, and prohibitions of contractual
features that they deem to be onerous or unnecessary.
Some of these advocates of reform, however, seem to lack a basic
understanding of the functioning of financial markets and the pricing
of financial instruments. In their zeal to save borrowers from harming
themselves they run the risk of causing more harm to borrowers than
predatory lenders.
Other reformers seem to understand that their proposals will reduce
the availability of subprime credit to the general population, but they
do not care. Indeed, one gets the impression that some paternalistic
community groups dislike subprime lending and feel entitled to place
limits on the decisionmaking authority even of mentally competent
individuals. Other critics of predatory lending may have more sinister
motives related to the kickbacks they receive for contractually
agreeing to stop criticizing particular subprime lenders.
Whatever the motives of these advocates, it is easy to show that
many of the extreme proposals for changing the regulation of the
subprime mortgage market are misguided and would harm many consumers by
limiting their access to credit on the most favorable terms available.
There are better ways to target the legitimate problems of abuse.
Evaluating Proposed Reforms
Let me now turn to an analysis of each of the proposed remedies for
predatory lending, which I divide into three groups: (1) those that are
sensible and that should be enacted by Fed regulation, (2) those that
are possibly sensible, but which might do more harm than good, and thus
require more empirical study before deciding whether and how to
implement them, and (3) those that are not sensible, and which would
obviously do more harm than good.
Sensible Reforms That Should Be Implemented Immediately by the Fed
Under HOEPA, the Fed is entitled to regulate subprime mortgages
that either have interest rates far in excess of Treasury rates (the
Fed currently uses a 10 percent spread trigger, but can vary that
spread between 8 percent and 12 percent) or that have total fees and
points greater than either 8 percent or $451. HOEPA already specifies
some contractual limits on these loans (for example, prepayment
penalties are only permissible for the first 5 years of the loan, and
only when the borrowers' income is greater than 50 percent of the loan
payment). It is my understanding that the Fed currently has broad
authority to establish additional regulatory guidelines for these
loans, and is currently considering a variety of measures. Following is
a list of measures that I regard as desirable.
Disclosure and Counseling
Disclosure requirements always add to consumers' loan costs, but in
my judgment, some additional disclosure requirements would be
appropriate for the loans regulated under HOEPA. I would recommend a
mandatory disclosure statement like the one proposed in section 3(a) of
Senate bill 2415 (April 12, 2000), which alerts borrowers to the risks
of subprime mortgage borrowing. It is also desirable to make counseling
available to potential borrowers on HOEPA loans, and to require lenders
to disclose that such counseling is available (as proposed in the HUD-
Treasury report). The HUD-Treasury report also recommends reasonable
amendments to RESPA and TILA that would facilitate comparison shopping
and make timely information about the costs of credit and settlement
easier for consumers to understand and more reliable. I also favor the
HUD-Treasury suggestions of imposing an accuracy standard on
permissible deviations from the Good Faith Estimate required under
RESPA, requiring lenders to disclose credit scores to borrowers (I note
that these scores have since been made available by Fair Isaac Co. to
borrowers via the Internet), and expanding penalties on lenders for
inadequate or inaccurate disclosures. The use of ``testers'' to verify
disclosure practices would likely prove very effective as an
enforcement tool to ensure that lenders do not target some classes of
individuals with inadequate disclosure. I also agree with the suggested
requirement that lenders notify borrowers of their intent to foreclose
far enough in advance that borrowers have the opportunity to arrange
alternative financing (a feature of the new Pennsylvania statute) as a
means of discouraging unnecessary foreclosure. Finally, I would
recommend that, for HOEPA loans where borrowers' monthly payments
exceed 50 percent of their monthly income, the lender should be
required to make an additional disclosure that informs the borrower of
the estimated high probability (using a recognized model, like that of
Fair Isaac Co.) that the borrower may lose his or her home because of
inadequate ability to pay debt service.
Credit History Reporting
It is alleged that some lenders withhold favorable information
about customers in order to keep information about improvements in
customer creditworthiness private, and thus limit competition. It is
appropriate to require lenders not to selectively report information to
credit bureaus.
Single-Premium Insurance
Roughly one in four households do not have any life insurance,
according to the Life and Health Insurance Foundation (1998). Clearly,
credit insurance can be of enormous value to subprime borrowers, and
single-premium insurance may be, as its defenders claim, a desirable
means for reducing the risk of losing one's home at low cost. To
prevent abuse of this product, however, there should be a mandatory
requirement that lenders that offer single-premium insurance must do
three things. (1) Lenders, when computing the equivalent monthly
payment on single-premium insurance in their disclosure statement,
should be required to fully amortize the cost of the insurance over the
period of coverage (typically 5 years) rather than over a 30 year
period. That will avoid confusion on the part of borrowers about the
effective cost of the insurance product. (2) Lenders should clearly
disclose that credit insurance is optional and that the other terms of
the mortgage are not related to whether the borrower chooses credit
insurance. (3) Lenders should allow borrowers to cancel their single-
premium insurance and receive a full refund of the payment within a
reasonable time after closing (say, within 30 days, as in the
Pennsylvania statute).
Limits on Flipping
Several new laws and proposals, including a proposed rule by the
Federal Reserve Board, would limit refinancing to address the problem
of loan flipping. The Fed rule would prohibit refinancing of a HOEPA
loan by the lender or its affiliate within the first 12 months unless
that refinancing is ``in the borrower's interest.'' This is a
reasonable idea so long as there is a clear and reasonable safe harbor
in the rule for lenders that establishes criteria under which it will
be presumed that the refinancing was in the borrower's interest. For
example, if a refinancing either (a) provides substantial new money or
debt consolidation, (b) reduces monthly payments by a minimum amount,
or (c) reduces the duration of the loan, then any one of those features
should protect the lender from any claim that the refinancing was not
in the borrower's interest.
Limits on Refinancing of Subsidized Government or Not-for-Profit Loans
It has been alleged that some lenders have tricked borrowers into
refinancing heavily subsidized Government or not-for-profit loans at
market (or above market) rates. Lenders that refinance such loans
should face very strict tests for demonstrating that the refinancing
was in the interest of the borrower.
Prohibition of Some Contractual Features
Some mortgage structures add little real value to the menu of
consumers' options, and are especially prone to abuse. In my judgment,
the Federal Reserve Board has properly identified payable-on-demand
clauses or call provisions as an example of such contractual features
that should be prohibited.
Require Lenders To Offer Loans With and Without Prepayment Penalties
Rather than regulate prepayment penalties further as some have
proposed, I would recommend requiring that HOEPA lenders offer
mortgages both with and without prepayment penalties, so that the price
of the prepayment option would be clear to consumers. Then consumers
could make an informed decision whether to pay for the option to
prepay.
Proposals That Require Further Study
In addition to the aforementioned reforms, many other potentially
beneficial, but also potentially costly, reforms have been proposed and
should be studied to determine whether they are necessary over and
above the reforms listed above, and whether on balance they would do
more good than harm. The list of potentially beneficial reforms that
are worthy of careful scrutiny includes:
(1) A limit on balloons (for example, requiring a minimum of
a certain period of time between origination and the balloon
payment) is worth exploring--although many of the proposed
limits on balloons do not seem reasonable; for example both the
Pennsylvania statute's 10 year limit and the HUD-Treasury
report's proposed 15 year limit, seem to me far too long; but
shorter-term limits on balloons (say, a 3 or 5 year minimum
duration) may be desirable.
(2) The establishment of new rules on mortgage brokers'
behavior (as proposed in the HUD-Treasury report) may be
worthwhile, as a means of ensuring that mortgage brokerage is
not employed to circumvent effective compliance; and
(3) It may be desirable, as the Fed has proposed, to lower
the HOEPA interest rate threshold from 10 percent to 8 percent.
The main drawback of lowering the trigger point for HOEPA,
which has been noted by researchers at the Fed, and by Robert
Litan, is the potential chilling effect that reporting
requirements may have on the supply of credit in the subprime
market. (I note in passing that I do not agree with the
proposal to include all fees into the HOEPA fee trigger; fees
that are optional, and not conditions for granting the
mortgage--like credit insurance--should be excluded from the
calculation.)
Proposals That Should Be Rejected
Usury Laws
Under the rubric of bad ideas, I will focus on one in particular:
price controls. It is a matter of elementary economics that limits on
prices restrict supply. Among the ideas that should be rejected out of
hand are proposals to impose Government price controls--on interest
rates, points, and fees--for subprime mortgages.
Because of legal limits on local authorities to impose usury
ceilings (due to Federal preemption) States and municipalities intent
on discouraging high-cost mortgage lending have pursued an alternative
``stealth'' approach to usury laws. The technique is to impose
unworkable risks on subprime lenders that charge rates or fees in
excess of Government specified levels and thereby drive high-interest
rate lenders from the market.
Additionally, some price control proposals are put forward by
community groups like ACORN in the form of ``suggested'' voluntary
agreements between community groups and lenders.
Several cities and States have passed, or are currently debating,
stealth usury laws for subprime lending. For example, the city of
Dayton, Ohio this month passed a draconian antipredatory lending law.
This law places lenders at risk if they make high-interest loans that
are ``less favorable to the borrower than could otherwise have been
obtained in similar transactions by like consumers within the City of
Dayton,'' and lenders may not charge fees and/or costs that ``exceed
the fees and/or costs available in similar transactions by like
consumers in the City of Dayton by more than 20 percent.''
In my opinion, it would be imprudent for a lender to make a loan in
Dayton governed by this statute. Indeed, I believe that the statute's
intent must be to eliminate high-interest loans, which is why I
describe it as a stealth usury law. Immediately upon the passage of the
Dayton law, Bank One announced that it was withdrawing from origination
of loans that were subject to the statute. No doubt others will exit,
as well.
The recent 131 page antipredatory lending law passed in the
District of Columbia is similarly unworkable. Lenders are subject to
substantial penalties if they are deemed to have lent at an interest
rate ``substantially greater than the home borrower otherwise would
have qualified for, at that lender or at another lender, had the lender
based the annual percentage rate upon the home borrowers' credit scores
as provided by nationally recognized credit reporting agencies,'' or if
loan costs are ``unconscionable,'' or if loan discount points are ``not
reasonably consistent with established industry customs and
practices.''
The District law is fundamentally flawed in several respects.
First, it essentially requires lenders to charge no more than the rate
indicated by the customer's credit score. That is an improper use of
credit scores. Credit scores are not perfect indicators of risk; they
are used as one of many--and sometimes not the primary--means of
judging whether and on what terms to make a loan. Second, the DC law
places the ridiculous burden on the lender of making sure, prior to
lending, that his customer could not find a better deal from his
competitors. Finally, the vague wording makes the legal risks of
subprime lending so great that no banker would want to engage in it.
As Donald Lampe points out, massive withdrawal from the subprime
lending market occurred in response to the overly zealous initiative
against predatory lending by the State of North Carolina. To quote from
Lampe's (2001) summary of the North Carolina experience:
``Virtually all residential mortgage lenders doing business
in North Carolina have elected not to make ``high-cost home
loans'' that are subject to N.C.G.S. 24-1.1E. Instead, lenders
seek to avoid the ``thresholds'' established by the law.'' (p.
4)
Michael Staten of the Credit Research Center of Georgetown
University has compiled a new database on subprime lending that permits
one to track the chilling
effect of the North Carolina law on subprime lending in the State. The
sample coverage of the database nationwide includes 39 percent of all
subprime mortgage loans made by HMDA-reporting institutions in 1998.
Staten's statistical research (reproduced with permission in an
appendix to this testimony) compares changes in mortgage originations
in North Carolina with those in South Carolina and Virginia, before and
after the passage of the North Carolina law (which was passed in July
1999 and phased in through early 2000). South Carolina and Virginia are
included in these tables as controls to allow for changes over time in
mortgage originations in the Upper South that were not specific to
North Carolina.
As shown in the appendix, Staten finds that originations of
subprime mortgage loans (especially first-lien loans) in North Carolina
plummeted after passage of the 1999 law, both absolutely and relatively
to its neighbors, and that the decline was almost exclusively in the
supply of loans available to low- and moderate-income borrowers (those
most dependent on high-cost credit). For borrowers in the low-income
group (with annual incomes less than $25,000) originations were cut in
half; for those in the next income class (with annual incomes between
$25,000 and $49,000) originations were cut by roughly a third. The
response to the North Carolina law provides clear evidence of the
chilling effect of antipredatory laws on the supply of subprime
mortgage loans to low-income borrowers.
Robert Litan (2001) had anticipated this result. He wrote that:
``. . . statutory measures at the State and local level at
this point run a significant risk of unintentionally cutting
off the flow of funds to creditworthy borrowers. This is a very
real threat and one that should be seriously considered by
policymakers at all levels of government, especially in light
of the multiple, successful efforts that Federal law in
particular
has made to increase lending in recent years to minorities and
low-income borrowers.
``The more prudent course is for policymakers at all levels
of government to wait for more data to be collected and
reported by the Federal Reserve so that enforcement officials
can better target practices that may be unlawful under existing
statutes. In the meantime, Congress should provide the Federal
agencies charged with enforcing existing statutes with
sufficient resources to carry out their mandates, as well as to
support ongoing counseling efforts to educate vulnerable
consumers about the alternatives open to them in the credit
market and the dangers of signing mortgages with unduly onerous
terms.'' (p. 2)
The history of the last two decades teaches that usury laws are
highly counterproductive. Limits on the ability of States to regulate
consumer lenders head-
quartered outside their State were undermined by the 1978 Marquette
National Bank case (see DeMuth, 1986). In 1982, the Federal Government
further expanded consumers' access to credit by preempting State
restrictions on mortgage lending by mortgage lenders headquartered
within the State (the Alternative Mortgage Transaction Parity Act of
1982).
These measures were crucial contributors to the democratization of
consumer finance, and particularly, mortgage finance in recent years.
The Marquette case opened a flood of competition in credit card
lending, which led the way to establishing a deep market in consumer
credit receivables and the new techniques for credit scoring--
innovations which have increased the supply and reduced the cost of
consumer credit.
The 1982 Parity Act expanded the range of competition in consumer
mortgage finance preempting State prohibitions on alternative mortgages
originated by both depository and nondepository institutions. In
particular, as I understand this law, it effectively preempts State
usury laws as applied to subprime mortgages. Because mortgage lending
relies on real estate as security, it can be provided more
inexpensively than credit card loans or other unsecured consumer credit
(Calomiris and Mason, 1998). Thus the 1982 Act provided an important
benefit to consumers over and above the beneficial undermining of State
usury laws after the Marquette case.
But the new stealth usury laws of North Carolina, Dayton, and
Washington DC, and similar proposals elsewhere, pose a new threat. If
Congress fails to restore the preemption principle in the subprime
mortgage market established in 1982, then lenders will be driven out of
the high-risk end of the market, and therefore, many consumers will be
driven out of the mortgage market and into higher-cost, less desirable
credit markets (credit cards, pawn shops, and worse).
That is not progress. Congress should do everything in its power to
amend the Parity Act to clearly define stealth usury laws as usury
laws, not consumer protection laws, and thus prevent any further damage
to individuals' access to credit from these pernicious State and city
initiatives.
Other Prohibitions
I have already argued against further regulatory or statutory
limits on prepayment penalties, or prohibition of single-premium credit
insurance, in favor of alternative approaches to the abuses that
sometimes accompany these features.
I am also opposed to the many proposals that would prevent
borrowers from agreeing to mandatory binding arbitration to resolve
loan disputes. Individuals should be able to choose. If an individual
wishes to commit to binding arbitration, that commitment reduces the
costs to lenders of originating mortgages, and in the competitive
mortgage market, that cost saving is passed on to consumers. Requir-
ing consumers not to commit to binding arbitration is only good for
America's trial lawyers.
Conclusion
For the most part, predatory lending practices can be addressed by
focusing efforts on better enforcing laws against fraud, improving
disclosure rules, offering Government-financed counseling, and placing
a few well thought out limits on credit industry practices. The Fed
already has the authority and the expertise to formulate those rules
and is in the process of doing so, based on a new data collection
effort that will permit an informed and balanced approach to regulating
subprime lending.
The main role of Congress, in my view, should be to monitor the
Fed's rulemaking as it evolves, make sure that the Fed has the
statutory authority that it needs to set appropriate regulations, and
amend the 1982 Parity Act to reestablish Federal preemption and thus
defend consumers against the ill-conceived usury laws that are now
spreading throughout the country.
Members of Congress, and especially Members of this Committee, also
should speak out in defense of honest subprime lenders, of which there
are many. The possible passage of State and city usury statutes is not
the only threat to the supply of subprime loans. There is also the
possibility that bad publicity, orchestrated by community groups,
itself could force some lenders to exit the market.
Some community organizations have been waging a smear campaign
against subprime lenders. To the extent that zealous community groups,
whether out of noble or selfish intent, succeed in smearing subprime
lenders as a group, the public relations consequences will have a
chilling effect on the supply of subprime credit. The first casualty
will be the truth. The second casualty will be access to credit for the
poor.
References
Calomiris, Charles W., and Joseph R. Mason (1998). High Loan-To-
Value Mortgage Lending. Washington: AEI Press.
Carey, Mark, Mitch Post, and Steven A. Sharpe (1998). ``Does
Corporate Lending by Banks and Finance Companies Differ? Evidence on
Specialization in Private Debt Contracting.'' Journal of Finance 53
(June), 845-78.
DeMuth, Christopher C. (1986). ``The Case Against Credit Car
Interest Rate Regulation.'' Yale Journal on Regulation 3 (Spring), 201-
41.
Gramlich, Edward M. (2000). ``Remarks by Governor Edward M.
Gramlich at the Federal Reserve Bank of Philadelphia Community and
Consumer Affairs Department Conference on Predatory Lending.'' December
6.
Lampe, Donald C. (2001). ``Update on State and Local Anti-Predatory
Lending Laws and Regulations: The North Carolina Experience.'' American
Conference Institute, Predatory Lending Seminar, San Francisco, June
27-28.
Life and Health Insurance Foundation (1998). America's Financial
Security
Survey.
Litan, Robert E. (2001). ``A Prudent Approach To Preventing
`Predatory' Lending.'' Working Paper, The Brookings Institution, 2001.
U.S. Department of Housing and Urban Development and U.S.
Department of the Treasury (2000). Curbing Predatory Home Mortgage
Lending: A Joint Report. June.
PREPARED STATEMENT OF MARTIN EAKES
President and CEO, Self-Help Organization, Durham, North Carolina
July 26, 2001
Mr. Chairman and Members of the Committee, thank you for holding
this important hearing to examine the problem of predatory mortgage
lending and thank you for providing Self-Help and the Coalition for
Responsible Lending the opportunity to testify before you today.
Introduction
Fundamentally, I am a lender. Self-Help (www.self-help.org), the
organization for which I serve as President, consists of a credit union
and a nonprofit loan fund. Self-Help is a 20 year old community
development financial institution that creates ownership opportunities
for low-wealth families through home and small business lending. We
have provided $1.6 billion dollars of financing to help 23,000 low-
wealth borrowers buy homes, build businesses, and strengthen community
resources. Self-Help believes that homeownership represents the best
possible opportunity for families to build wealth and economic security
and take their first steps into the middle class. Accumulating equity
in their homes is the primary way most families earn the wealth to send
children to college, pay for emergencies, and pass wealth on to future
generations, as well as develop a real stake in society. Some would
call us a subprime lender. We have had significant experience making
home loans available to families who fall outside of conventional
guidelines because of credit blemishes or other problems, and our loan
loss rate is well under 0.5 percent each year. Self-Help's assets are
$800 million.
I am also spokesperson for the Coalition for Responsible Lending
(CRL). CRL (www.responsiblelending.org) is an organization representing
over three million people through 80 organizations, as well as the
CEO's of 120 financial institutions. CRL was formed in response to the
large number of abusive home loans that a number of lenders and housing
groups witnessed North Carolina. We found that the combination of the
explosive growth in subprime lending, the paucity of regulation of the
industry and the lack of financial sophistication for large numbers of
subprime borrowers have created an environment ripe for abuse.
We discovered that too many families in our State--over 50,000--
have been victimized by abusive lenders, losing their homes or a large
portion of the wealth they spent a lifetime building. Some lenders, we
found, target elderly and other vulnerable consumers (often poor or
uneducated) and use an array of practices to strip the equity from
their homes.\1\ We even found that abusive lenders ``flipped'' over 10
percent of Habitat for Humanity borrowers from their zero percent first
mortgages
to high interest and high cost subprime loans.\2\ The problem is not
anecdotal; it is closer to an epidemic.\3\
---------------------------------------------------------------------------
\1\ See an example loan document at www.responsiblelending.org/
hud1.pdf. Note that the borrower in this case needed $53,755.22 to pay
off other debts. But total loan amount was $76,230.12, a difference of
over $20,000. Five thousand dollars was dispersed to borrower. The bulk
of the rest of the fees are a $4,063 origination fee and an $11,630
upfront credit insurance premium. The loan also includes a $63,777.71
balloon payment due at the end of the 15 year term. This is not an
atypical case. Abusive lenders often obtain a list of homeowners in
lower-middle class neighborhoods and target those with high equity,
low-income and credit blemishes. The sales pitch focuses on lowering
monthly payments by consolidating debts, getting cash for a vacation,
or other needs. The unwitting borrower signs the loan, not realizing it
is packed with credit insurance premiums, high origination fees, hidden
balloons (that allow the lender to charge high fees AND show a lower
monthly payment), and/or prepayment penalties that lock the borrower
into the loan. And then, if there is more equity left, the same lender
or broker or another lender will come and offer to refinance the loan
again (or ``flip it'') and charge high fees once more.
\2\ See http://www.responsiblelending.org/PL%20Issue%20-
%20Habitat%20FAQ.htm
\3\ See Joint HUD/Treasury Report, pp. 12-49; Panels I to III at
May 24, 2000 House Banking Committee Hearings: http://www.house.gov/
banking/52400toc.htm; Unequal Burden: Income and Racial Disparities in
Subprime Lending in America, Department of Housing and Urban
Development, April 12, 2000; National Training and Information Center,
Preying on Neighborhoods: Subprime Mortgage Lenders and Chicagoland
Foreclosure (September 21, 1999); Daniel Immergluck & Marti Wiles, Two
Steps Back: The Dual Mortgage Market, Predatory Lending, and the
Undoing of Community Development (The Woodstock Institute, 1999). See
also New York Times Special Report by Diana Henriques with Lowell
Bergman: MORTGAGED LIVES: A SPECIAL REPORT: Profiting From Fine Print
With Wall Street's Help, March 15, 2000, Section 1, page 1 (companion
piece ran on ABC's 20/20 the same night).
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The North Carolina Law
The standard industry response at the national level has been to
fight against stronger rules and for tighter enforcement of existing
laws. We found that those calls rang hollow: people's hard-earned
equity was being stolen and their homes being lost through practices
that complied with the law. These practices were entirely legal. Since
Federal law was insufficient, as a second-best solution we decided to
try to amend North Carolina's mortgage lending law to prohibit
predatory lending practices.
Thus, in 1999, CRL spearheaded an effort that helped enact the
North Carolina predatory lending law. The bill was the result of a
collaborative effort supported by associations representing the State's
large banks, community banks, mortgage bankers, credit unions, mortgage
brokers, realtors, the NAACP, and consumer, community development, and
housing groups. There were two principles we all agreed upon from the
beginning. First, we would not rely on disclosures. In the blizzard of
paper that constitutes a home loan closing, even lawyers can lose track
of what they are signing. In addition, 22 percent of the adult American
population is functionally illiterate, unable to fill out an
application.\4\ In our experience, disclosures often do more harm than
good, because unscrupulous lenders use them as a shield for abuse.
Second, we would not ration credit by attempting to cap interest rates.
We believe in risk-based pricing; in fact, Self-Help has engaged in it
for 17 years. Loans with higher risk should bear an appropriately
higher interest rate in order to compensate lenders for this risk. We
believe, however, that the risk should primarily be paid for through
higher interest rates rather than fees, because a subsequent lender can
always refinance a borrower out of a loan with an excessive rate
(barring a prepayment penalty). Fees, on the other hand, must be paid
in full once agreed to; there is nothing a responsible lender can do to
help a borrower whose prior loan financed exorbitant fees.
---------------------------------------------------------------------------
\4\ ``National Adult Literacy Survey,'' National Center for
Education Statistics, 1992. These Level 1 individuals cannot read
``well enough to fill out an application, read a food label, or read a
simple story to a child.'' See http://www.nifl.gov/nifl/
faqs.html#literacy.
---------------------------------------------------------------------------
The bill we supported utilized market principles and common sense
rather than credit rationing or other extreme measures, it enjoyed
widespread support within the North Carolina banking industry and the
State's credit unions. Some would say that if the State's credit unions
and banks could come to agreement over the bill, it had to be a good
idea. Consumer groups did just that. They saw the bill as a credible
response to the predatory lending that was harming our communities. As
a result of the support of all major groups, the bill passed both
chambers almost unanimously in July 1999.
Some say that it is impossible to define predatory lending. I
disagree. The North Carolina bill did just that, in the same way that
statutes attack any problem: by setting parameters for what is
acceptable, that encourage certain actions while discouraging others.
The practices that the North Carolina law discourages are exactly the
abusive lending practices that we find most harmful to borrowers.
Please see the Coalition for Responsible Lending Issue Paper entitled
Quantifying the Economic Cost of Predatory Lending that is included in
the appendix for a discussion of the cost that predatory lending
practices imposes on hundreds of thousands of borrowers across the
country.
Abusive Lending Practices
Financing single-premium credit insurance on home loans.
Charging fees, direct and indirect, over 3-5 percent of the
loan amount.
Levying back end prepayment penalties on subprime loans, which
serve as anticompetitive tools to keep responsible lenders from
remedying abusive situations.
``Flipping'' borrowers through repeated fee-loaded
refinancings.
``Steering'' borrowers into loans with higher-rates than those
for which they
qualified.
Permitting mortgage broker abuses, including broker kickbacks.
Requiring mandatory arbitration clauses in any home loans.
I would like to briefly discuss these abusive practices and how the
North Carolina law has defined and attempted to correct them.
Financing Single-Premium Credit Insurance On Home Loans
One type of credit insurance, credit life, is paid by the borrower
to repay the
lender should the borrower die. The product can be useful when paid for
on a monthly basis. When it is paid for upfront, however, it does
nothing more than strip equity from homeowners. This is why the
mortgage industry is disavowing single-premium credit insurance (SPCI)
in the face of heavy criticism.
Fannie Mae and Freddie Mac, U.S. Departments of Treasury and
Housing and Urban Development, bills introduced in the Senate and House
Banking Committees, and the Federal Home Loan Bank of Atlanta have all
condemned the practice for all home loans.\5\ In addition, Bank of
America, Chase, First Union, Wachovia, Ameriquest, Option One,
Citigroup, Household, and just this week, American General, have all
decided not to offer SPCI on their subprime loans.\6\ The Federal
Reserve has proposed to count SPCI in determining what loans are ``high
cost,'' which will further disfavor the practice. Conseco Finance,
formerly Greentree, seems to be the last large lender continuing to
defend it. Conventional loans almost never include, much less finance,
credit insurance. The North Carolina law prohibited the practice for
all home loans.
---------------------------------------------------------------------------
\5\ See http://www.freddiemac.com/news/archives2000/predatory.htm
and http://www.fanniemae.com/
news/speeches/speech--116.html; Joint HUD/Treasury Report, page 91;
H.R. 4250 (Rep. LaFalce/S. 2415 (Senator Sarbanes), Sec. 2(b)(3);
Federal Home Loan Bank of Atlanta BankTalk, Nov. 27, 2000.
\6\ See ``Equicredit to Stop Selling Single-Premium Credit Life,''
Inside B&C Lending, April 2, 2001, p. 3 (Bank of America); Erick
Bergquist, ``Gloom Turns to Optimism in the Subprime Business,''
American Banker, May 15, 2001, p. 10 (Chase); ``First Union and
Wachovia Announce Community Commitment for the New Wachovia,'' May 24,
2001; statements by officers of Ameriquest and Option One; Jathon
Sapsford, ``Citigroup Will Halt Home-Loan Product Criticized by Some as
Predatory Lending,'' Wall Street Journal (6/29/01); Anitha Reddy,
``Household Alters Loan Policy,'' The Washington Post (7/12/2001).
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Charging Fees Greater Than 3-5 Percent of the Loan Amount
Points and fees (as defined by HOEPA) that exceed this amount (not
including third party fees like appraisals or attorney fees) take more
equity from borrowers than the cost or risk of subprime lending can
justify. By contrast, conventional borrowers generally pay at most a 1
percent origination fee. Again, subprime lenders can always increase
the interest rate. The North Carolina law sets a fee threshold for
``high cost'' loans at 5 percent. If a loan reaches this threshold, a
number of protections come into place: the lender cannot finance any
upfront fees or make a loan without considering the consumer's ability
to repay; the loan may not be structured as a balloon where the
borrower owes a large lump sum at some point during the term or permit
negative amortization; and the borrower must receive housing counseling
to make sure the loan makes sense for his or her situation.
Charging Prepayment Penalties On Subprime Loans
(defined by interest rates above conventional)
Prepayment penalties trap borrowers in high-rate loans, which
too often leads to foreclosure and bankruptcy. The subprime sector
serves an important role for borrowers who encounter temporary
credit problems that keep them from receiving lower-rate
conventional loans. This sector should provide borrowers a bridge
to conventional financing as soon as the borrower is ready to make
the transition. Prepayment penalties prevent this from happening.
Why should any borrower be penalized for doing just what they are
supposed to do--namely, pay off a debt?
Prepayment penalties are hidden, deferred fees that strip
significant equity from over half of subprime borrowers. Prepayment
penalties of 5 percent are common. For a $150,000 loan, this fee is
$7,500, more than the total net wealth built up over a lifetime for
the median African-American family.\7\ According to Lehman
Brothers' prepayment assumptions, over half of subprime borrowers
will be forced to prepay their loans--and pay the 4 percent to 5
percent in penalties--during the typical 5 year lock-out period.
And borrowers in predominantly African-American neighborhoods are
five times more likely to be subject to wealth-stripping prepayment
penalties than borrowers in white neighborhoods. Prepayment
penalties are therefore merely deferred fees that investors fully
expect to receive and borrowers never expect to pay.
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\7\ According to the 1990 census, median net worth for African-
American families was $4,400 compared to $44,000 for white families.
Home equity is the primary factor in this disparity.
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Borrower choice cannot explain the 80 percent penetration rate
of prepayment penalties in subprime loans. Only 2 percent of
conventional borrowers accept prepayment penalties in the
competitive conventional market, while, according to Standard &
Poor's, 80 percent of subprime loans had prepayment penalties. The
North Carolina law prohibited prepayment penalties on all loans of
less than $150,000.
``Flipping'' Borrowers Through Repeated Fee-Loaded Refinancings
One of the worst practices is for lenders to refinance subprime
loans over and over, taking out home equity wealth in the form of high
fees each time, without providing significant borrower benefit. Some
lenders originate balloon or adjustable rate mortgages only to inform
the borrowers of this fact soon after closing to convince them to get a
new loan that will pay off the entire balance at a fixed rate. Others
require borrowers to refinance in order to catch up if the loan goes
delinquent. The North Carolina law prohibits refinancings that do not
provide the borrower with a net tangible benefit, considering all of
the circumstances; this standard is similar to the ``suitability''
standard applicable to the securities industry.
Mortgage Broker Abuses, Including Broker Kickbacks
Brokers originate over half of all mortgage loans and a relatively
small number of brokers are responsible for a large percentage of
predatory loans. Lenders should identify--and avoid--these brokers
through comprehensive due diligence. In addition, lenders should refuse
to pay kickbacks (yield-spread premiums) to brokers. These are fees
lenders rebate to brokers in exchange for placing a borrower in a
higher interest rate than that for which the borrower qualifies. These
lender kickbacks violate fair lending principles since they provide
brokers with a direct economic incentive to steer borrowers into costly
loans. While we decided to focus on lenders and not brokers in the
bill, we are working in collaboration with the brokers' association in
North Carolina on a mortgage broker licensing bill this session to
crack down on abusive brokers.
``Steering'' Borrowers Into Higher Cost Loans
Than That for Which They Qualify
As Fannie Mae and Freddie Mac have shown, subprime lenders charge
borrowers with prime credit who meet conventional underwriting
standards higher rates than justified by the risk incurred. This is
particularly troubling for lenders with prime affiliates--the very same
``A'' borrower who would receive the lender's lowest-rate loan from its
prime affiliate pays substantially more from the subprime affiliate.
HUD has shown that steering has a racial impact since borrowers in
African-American neighborhoods are about five times more likely to get
a loan from a subprime lender--and therefore pay extra--than borrowers
in white neighborhoods. A minority borrower with the same credit
profile as a white borrower simply should not pay more for the same
loan. Therefore, lenders should either offer ``A'' borrowers loans with
``A'' rates, or refer such borrowers to an affiliated or outside lender
that offers these rates. This is not a problem we were able to address
in the North Carolina bill.
Imposing Mandatory Arbitration Clauses in Home Loans
Increasingly, lenders are placing predispute, mandatory binding
arbitration clauses in their loan contracts. While many lenders' mantra
has been the need to enforce current laws, many of these same lenders
are making this goal impossible by denying borrowers the right to have
their grievances heard. These clauses burden consumers because they
increase the costs of disputing unfair and deceptive trade practices,
limit available remedies, and prevent consumers from having their day
in court. Mandatory arbitration imposes high costs on consumers in
terms of filing fees and the costs of arbitration proceedings.\8\
Arbitration also limits the availability of counsel, cuts off
traditional procedural protections such as rules of discovery and
evidence, slows dispute resolution, and restricts judicial review.\9\
Lenders benefit unfairly from arbitration as repeat players, and in
some cases, have used the mandatory arbitration clause to designate an
arbiter within the industry, producing biased decisions. Further,
lenders are able to use arbitration to handle disputes in secret,
avoiding open and public trials which would expose unfair lending
practices to the public at large.\10\
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\8\ See Victoria Nugent, Arbitration Clauses that Require
Individuals to Pay Excessive Fees are Unconscionable, The Consumer
Advocate 8, 9-10 (September/October 1999).
\9\ Paul D. Carrington and Paul H. Haagen, Contract and
Jurisdiction, 1996 Sup. Ct. Rev. 331, 346-9 (1996).
\10\ See John Vail, Defeating Mandatory Arbitration Clauses, Trial
70 (January 2000).
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Lenders have used mandatory arbitration to close the courtroom door
for millions of consumers and have forced borrowers to waive their
constitutional right to a civil jury trial. This situation has only
been made worse as many mandatory arbitration clauses have been
expanded to also contain provisions that waive the consumers' right to
participate in class action suits against the lender, making it more
difficult for smaller claims to prevail. For these reasons, mandatory
arbitration clauses are unfair to consumers who do not know what they
are giving up or do not have a choice but to sign adhesion contracts.
If an informed consumer thinks that arbi-
tration is a helpful step in resolving a dispute with a lender, the
consumer and lender should be permitted to agree to arbitration at that
time. Because the Federal
Arbitration Act preempts State regulation of mandatory arbitration
clauses, we were unable to get any language prohibiting mandatory
arbitration in the North Carolina bill.
And what are the results of North Carolina's law? The only
significant data to date about the law's effects are comforting. The
Residential Funding Corp., the Nation's largest issuer of subprime
mortgage securities, reported that North Carolina's share of subprime
mortgages issued nationwide actually increased in 2000. And we have
publicly and repeatedly challenged lenders to show us a single
responsible loan made impossible under the law. No one has accepted our
challenge to date.
Congress Should Address the Weaknesses in Federal Law
That the North Carolina Law Identified
The fact that so many people went to so much trouble to help enact
North Carolina's law is an indictment of current Federal law. While
mortgage lending in our State conforms to reasonable rules, balancing
consumer protections and lenders' need to make a profit, families in
the rest of the country have no such protection. Ideally, therefore,
Congress should pass a Federal statute that would address the seven
predatory lending practices identified above in ways similar to what we
accomplished in North Carolina.
The major Federal law designed to protect consumers against
predatory home mortgage lending is the Home Ownership and Equity
Protection Act of 1994. HOEPA has manifestly failed to stem the
explosion of harmful lending abuses that has accompanied the recent
subprime lending boom. Strengthening the law is important to protect
homeowners from abuse. I recommend for the Committee's consideration
two excellent HOEPA bills: legislation introduced last session by
Chairman Sarbanes and Senator Schumer.
Looking at our definition of abusive lending practices, while I
would go a bit further, the bill Chairman Sarbanes introduced is very
strong. Specifically, it prohibits the financing of single-premium
credit insurance, reduces the HOEPA points and fees trigger to 5
percent from the current 8 percent, imposes significant limits on
prepayment penalties for high cost loans, disfavors broker kickbacks by
including them in the definition of points and fees, and prohibits
mandatory arbitration for HOEPA loans.
The Federal Reserve Board Should Promptly Issue
Strong Predatory Lending Regulations
It is important that regulators take advantage of the authority
that current laws have provided them to address predatory lending. The
Federal Reserve Board (the ``Board'') is the regulatory agency with by
far the most existing authority to address predatory lending practices.
In December of last year, the Board proposed substantial regulations on
HOEPA and the Home Mortgage Disclosure Act (HMDA). While modest, the
Board's proposed HOEPA and HMDA changes are a very constructive step
forward.
HOEPA Regulation Proposal
The proposed HOEPA regulations would broaden the scope of loans
subject to its protections by, most significantly, including single-
premium credit insurance and similar products in its fee-based trigger,
as well as by reducing its rate-based trigger by 2 percentage points.
In addition, the Board suggested a modest flipping prohibition that
would restrict creditors from engaging in repeated refinancing of their
own HOEPA loans over a short time period when the transactions are not
in the borrower's interest and similarly restrict refinancing
subsidized-rate nonprofit and Governmental loans.
The Board's HOEPA proposal to include SPCI would be an
extraordinarily important move against predatory lending. In 1994, the
Board stated that ``The legislative history [of HOEPA] includes credit
insurance premiums as an example of fees that could be included, if
evidence showed that the premiums were being used to circumvent the
statute.'' \11\ It has become clear in the seven succeeding years that
unscrupulous lenders have indeed used the exclusion of credit insurance
from ``points and fees'' to circumvent the application of HOEPA to
loans that really are ``high cost''. Financed credit insurance alone
exceeds the HOEPA limits in many cases--up to 20 percent of the loan
amount--yet the borrowers do not qualify for HOEPA protections.
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\11\ 59 Fed Reg. 61,832, 61,834 (December 2, 1994).
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The Board should address this evasion, as proposed, by including
these fees in the definition of ``points and fees''. Since including
SPCI in a loan in most cases will make it a HOEPA loan, and HOEPA
imposes certain duties on lenders and has a stigma attached, lenders
will have the incentive to provide credit insurance on a monthly basis,
a form that does not strip borrower equity. This is exactly what has
happened in North Carolina: lenders have uniformly switched from SPCI
to monthly outstanding basis (except for CUNA Mutual, which has always
done almost exclusively monthly outstanding balance credit insurance),
and borrowers have benefited enormously.
The Board's proposal to reduce the APR trigger is welcome also,
since at present only 2 percent of subprime loans are estimated to meet
the very high HOEPA triggers. Finally, the restriction on refinancing
subsidized loans would benefit thousands of borrowers and avoid what we
experienced in North Carolina, where Habitat for Humanity borrowers
were flipped from zero percent loans to 12 percent and 14 percent
loans.
HMDA Regulation Proposal
The Board's proposed changes to HMDA would enhance the public's
understanding of the home mortgage market generally, and the subprime
market in particular, as well as to further fair lending analysis. At
the same time, the Board has attempted to minimize the increase in data
collection and reporting burden. Most significantly, the Board would
require lenders to report the annual percentage rate of the loan. The
lender also would have to report whether the loan is subject to HOEPA
and whether the loan involves a manufactured home. In addition, it
would require reporting by additional nondepository lenders by adding a
dollar-volume threshold of $50 million to the current loan-percentage
test.
The Board's proposal to require lenders to report the APR on loans
is crucial. It is currently impossible to obtain any pricing data on
loans and therefore to determine which loans are subprime and which are
not, or to draw any conclusions about the cost of credit that borrowers
undertake. The most important fair lending issues today are no longer
the denial of credit, but the terms of credit. Providing the APR is a
good start in providing information on terms. Requiring additional
nondepository lenders to report is also important; Household Finance,
the Nation's second largest subprime lender, does not currently report
HMDA information because of a quirk in the rule that the Board rightly
proposes to fix.
Because these proposed changes would significantly help in the
battle to combat predatory lending, I would urge the Board not to
backtrack on any of these suggestions and to finalize these regulations
as soon as possible.
Notwithstanding our support for these proposals, I believe that
each should be strengthened. For HOEPA, first, the Board should count
authorized prepayment penalties in the new loan in the points and fees
threshold. When a borrower pays a
5 percent prepayment penalty on the back end, that 5 percent is
stripped directly out of the family's accumulated home equity wealth
exactly the same as if it were a fee that was financed on the front
end. This fee should therefore also be counted in determining which
loans are high cost. Some mortgage industry representatives will argue
that a prepayment penalty should not be counted because it is a
contingent fee. When 50 percent of borrowers actually pay the fee, it
is hardly a speculative contingency. If the contingent nature of an
authorized prepayment penalty is persuasive to the Board, however, then
the Board at minimum should include the authorized prepayment penalty
discounted by the frequency with which it is paid.
Second, the Board should hold the initial purchaser of a brokered
loan responsible for the broker's actions, so the marketplace will
self-police equity-stripping practices by mortgage brokers. When these
activities occur, borrowers are often left with no remedy because many
brokers are thinly capitalized and transitory, leaving no assets for
the borrower to recover against. The borrower generally cannot recover
against the lender who benefited from the broker's actions because the
broker is considered an independent contractor under the law. In
addition, many times the holder-in-due-course doctrine prevents the
borrower from raising these defenses against the note holder, even in a
foreclosure action.
The Board should address the problem of brokers by making the
original lender funding the loan responsible for the broker's acts and
omissions, for all loans. To accomplish this goal, the Board should
prohibit a lender from funding a loan where the broker violates State
or Federal law in arranging the loan unless the lender exercised
reasonable supervision over the broker transaction. In addition, the
Board should prohibit lenders from funding a loan arranged by a broker
who is not certified or licensed under State law.
For HMDA, the Board should replace the HOEPA yes-no field with
``points and fees.'' Loan pricing is the most important issue in
understanding the fairness of mortgage markets. Although in the popular
mind, abusive lending is primarily associated with high interest rates,
the primary issue is actually the high fee total charged to borrowers.
Lenders should use the HOEPA definition of ``points and fees,'' since
lenders already count these fees to determine whether the loan is
subject to HOEPA. HOEPA also provides the most comprehensive, and
therefore descriptive, catalogue of charges available. It is a very
simple calculation. Reporting APR does not lessen the need for
reporting points and fees, because the APR understates the true cost of
fees since the APR amortizes fees over the original term of the loan,
and almost all loans are paid off well before the term expires.
At A Minimum, Weak Federal Law Should Not Preempt
State Consumer Protections
Little is as frustrating or disheartening than to observe specific
predatory lending abuses happening to real people; work successfully to
get a State law or regulation passed to address the problem; and then
find that Federal law has been interpreted to preempt this State
consumer protection. Congress has not acted in a substantial manner
against predatory lending practices since it enacted HOEPA in 1994.
Since then, however, subprime lending has increased 1,000 percent, and
abusive lending is up commensurately. Rather than acting as a sword in
the fight against abusive practices, Federal law has functioned instead
as a shield, enabling the continuation of abusive lending at the
expense of entire neighborhoods.
I already discussed the problem of mandatory arbitration
restrictions being preempted by the Federal Arbitration Act. The FAA
was originally enacted in 1925 to overturn a common law rule that
prevented enforcement of agreements to arbitrate between commercial
entities. Ironically, it was intended to lower the costs of dispute
resolution within the business community, but today is used to raise
the costs of vindicating consumer rights. The States are unable to
respond to this problem, because the Supreme Court has held that State
laws that impose any restrictions specific to arbitration clauses are
incompatible with the FAA. Preemption even applies to basic disclosure
requirements such as a Montana law that required notice of an
arbitration requirement to be ``typed in underlined capital letters on
the first page of the contract'' in order to make the agreement
enforceable.
The States are unable to protect their consumers from mandatory
arbitration as long as the FAA preempts even requiring disclosure of
arbitration clauses. We propose the prohibition of mandatory
arbitration clauses in consumer loan contracts and amending the FAA to
allow State regulation of consumer arbitration agreements. Of course,
these changes would not affect the ability of consumers to voluntarily
agree to submit a dispute with a lender to arbitration after the
dispute had occurred. These changes would only protect consumers from
signing away their rights before they knew the consequences.
A second important example is the Alternative Mortgage Transaction
Parity Act (the Parity Act). Passed during the high interest rate
crisis of the early 1980's, the Parity Act enabled State depository
institutions and ``other housing creditors'' (unregulated finance
companies) to make adjustable rate mortgages without complying with
State laws prohibiting such mortgages. For 13 years, this Federal
preemption did not pose a significant problem to consumers. However, in
1996, the OTS ``reexamined'' the purposes of the Parity Act and
``reevaluated'' its regulations. This ``reinterpretation'' occurred 10
years after States lost the ability to opt-out of the law. At that
time, the OTS concluded the Parity Act required it to extend Federal
preemption to restrictions on prepayment penalties and late fees.
Since this novel interpretation, predatory lending by unregulated
finance companies has exploded, based in part on these companies'
ability to avoid compliance with State laws, especially those State
laws limiting prepayment penalties. In fact, the Illinois Association
of Mortgage Brokers has filed suit asserting that the Parity Act
preempts the State of Illinois' predatory lending regulations in their
entirety for all alternative mortgages, including even the common sense
requirement that lenders verify borrower ability to repay the loan. The
OTS's definition of ``alternative mortgage'' is so loose, that nearly
any loan could be made to fall under this category. CRL estimates that
up to 460,000 families across the country have $1.2 billion stripped
from their home equity each year directly as a result of the Parity
Act.
Forty-six State Attorneys General, both Republican and Democrat,
have urged the Office of Thrift Supervision (OTS) to reduce the scope
of Parity Act preemption,\12\ but without Congressional action, OTS
feels constrained to act. The best solution to the legacy of problems
caused by the Parity Act is simply to repeal the legislation. It serves
no good purpose anymore, and many unregulated nondepository
institutions are taking advantage of Federal preemption in ways that
are abusive to borrowers without any corresponding regulatory
obligations. If the Parity Act were
repealed, finance companies would not be able to use the Federal law to
avoid meaningful regulation by States. A less preferable, although
still extremely helpful, solution would be to simply delete reference
to finance companies in the Act. This would still allow State-chartered
depository institutions to piggyback on the preemption authority that
Federally chartered institutions have. At a minimum, given that the
Act's broad effect goes far beyond what was understood when it was
enacted, Congress should reopen the opt-out period for States that did
not initially opt-out (only six States did).
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\12\ See OTS comments of the National Association of Attorneys
General at http://www.ots.treas.gov/
docs/48197.pdf.
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Finally, although it does not involve mortgage lending, we have
been active in North Carolina attempting to reform payday lending. This
relatively new industry has grown, rapidly to 10,000 outlets and
provides desperate borrowers with a two-week loan, often at 500 percent
annualized interest rates, secured by a deferred check. However, with
such a short term, borrowers invariably lack the time to solve the
problems that led them to take such a high fee loan in the first place.
They therefore get stuck paying a $45 fee every 2 weeks just to keep
same $255 loan outstanding; in fact, 90 percent of total payday loans
come from customers caught on flipping treadmill (five or more payday
loans per year). Reforming this industry is made much more difficult by
the payday lenders engaging in a ``rent a charter'' partnership
arrangement to enable them to take advantage of the Federal preemption
of usury limits available to regulated depository institutions. For
example, Eagle National Bank (1 percent of payday fee) claims
preemption on behalf of its ``agent'' Dollar Financial (99 percent of
payday fee).
Conclusion
Fundamentally, I am a lender. Attempting to make loans to borrowers
stuck in predatory loans taught me what lender practices were abusive.
Finding out that these practices were legal under Federal law made me
angry. And so, on behalf of thousands of borrowers who face losing
their homes and all the wealth they accumulated through a lifetime of
hard work, I would ask the following: pass the bill that Chairman
Sarbanes introduced last session, urge the Federal Reserve Board
expeditiously to adopt the predatory lending rules it has proposed, and
remove the obstacles placed on States in protecting their citizens by
revising the Federal Arbitration Act, the Parity Act, and laws
potentially allowing payday lending ``rent a charters.'' If Congress
could take these steps, then we will have come a long way to making
sure that family home equity wealth is protected.
Thank you for the opportunity to testify before this Committee
today. I am happy to answer any questions and to work with the
Committee in the future.
STATEMENT OF ELIZABETH C. GOODELL, COUNSEL
Community Legal Services of Philadelphia, Inc., Philadelphia,
Pennsylvania
On Behalf of Leroy Williams
July 26, 2001
The interest (note) rates on Mr. Williams' loans were as follows:
EquiCredit, 9.65 percent. New Jersey Mortgage, 14.5 percent. Option
One, 11.25 percent. We do not know the APR's for the loans from
EquiCredit and New Jersey Mortgage, but the APR for the Option One loan
is 13.136 percent.
We do not know, if the loans from EquiCredit or New Jersey Mortgage
were HOEPA loans. Based on the TILA disclosures for the Option One
loan, the fees, and other prepaid finance charges totaled 7.469 percent
of the amount financed, just barely under the HOEPA fee trigger of 8.0
percent.
The transaction costs in the third loan (including prepaid finance
charges and fees that are not included in the finance charge) total
approximately $2,700, or 8.3 percent of the principal balance of the
loan. Although we do not have all the loan documents from the first two
loans, if the transaction costs of the first and second loans were
similar to the costs of the third loan, Mr. Williams paid approximately
$8,700 to lenders, brokers and title companies (including the
prepayment penalty and interest paid on the second loan when the third
tender refinanced it barely 3 months after origination) in connection
with the three loans, representing nearly 27 percent of the $32,435
principal balance of the most recent loan.
Mr. Williams' story is typical of low income homeowners with
subprime loans in several respects. First, once Mr. Williams had
executed one high-cost loan, he became the victim of targeted marketing
by other brokers and lenders of high-cost subprime loans. We find that
brokers and lenders research public records to identify homeowners with
mortgages originated by other subprime lenders and target such
homeowners, attempting to sell new loans within a relatively short
period of time. Like many low income homeowners with a succession of
subprime, high-cost loans, Mr. Williams was sought out by the lenders
rather than seeking them.
Second, Mr. Williams was caught up in loans with complex terms he
did not understand. Based on the loan documents, the second (New Jersey
Mortgage) loan included a prepayment penalty and a balloon. Mr.
Williams did not know about and did not understand either of these
terms. The third (Option One) loan includes a prepayment penalty, a
variable rate, and an arbitration provision. Again, Mr. Williams did
not know about and did not understand these terms, although there is
some indication that the broker tried to explain the prepayment
penalty.
It is a fiction that the market--or present statutes and
regulations--adequately protect homeowners when they are
unsophisticated about consumer lending. Additional protections are
needed to prevent what happened to Mr. Williams. A lower HOEPA fee
trigger which included the prepayment penalty might have discouraged
the third senseless and in fact harmful refinancing. Substantive
prohibitions against such blatantly inappropriate/no benefit
refinancings would accomplish the same goal directly, as would imposing
a duty on mortgage brokers and lenders to avoid making loans that are
unsuitable, a duty already required of stockbrokers.
----------
STATEMENT OF DANIEL F. HEDGES, COUNSEL
Mountain State Justice, Inc., Charelston, West Virginia
On Behalf of Mary Podelco
July 26, 2001
In thirty years of representing low income consumers, I have always
observed some level of home improvement fraud (particularly in the
decade of the 1970's, to a lesser extent in the 1980's). In the last 5
to 7 years, however, there has been an explosion of predatory home
equity lending and flipping. Predatory practices on low income
consumers, and in particular, vulnerable consumers such as the elderly,
illiterate working families and minorities, have become routine.
Current law provides no meaningful restriction on the kind of
flipping that occurred in Ms. Podelco's case and occurs in hundreds of
other cases per year in my State, which results in the skimming of
equity from borrowers in their homes. Meaningful prohibition of
flipping calls for a simplified remedy (for example, the prohibition of
charging new fees and points). West Virginia had such a time limitation
on refinancing by the same lender and charging new points and fees. The
2000 enactment was repealed in 2001, after the new Banking Commissioner
pushed for the elimination of that restriction at the industry's
behest.
The opportunity for recurring closing points and fees financed in
the loan and the lender to be rewarded immediately for refinancing
leads to disregard of whether or not a borrower can repay. Ms. Podelco
is typical of a frequent pattern of consistent loan flipping with the
last loan pushed off onto another lender who takes the loss. Ms.
Podelco provides one example of hundreds of West Virginians. On these
loans no laws are being broken but the flipping is so exploitive that
it results in loss of the individual's equity in their home, and
ultimately in many cases the loss of the home, forcing the elderly or
otherwise vulnerable citizens out of their residence.
A meaningful cap on fees and on financing points and fees would
have a substantial impact upon these exploitive loans. I would urge the
Committee to consider an easy definition that limits high points and
fees up front and provides other protections against exploitive equity
based lending, a system that rewards the lender immediately on closing,
no matter what the fees, regardless of whether the borrower pays, and
provides economic incentive for this type of conduct to continue
unchecked.
A single definition of high points and fees is easily enforceable.
Lowering the HOEPA points and fee trigger to the greater of 4 percent
of the loan amount or $1,000 is a first step but it is still not low
enough to prevent the abuses. The proposed legislation will be helpful
in (1) prohibiting balloon mortgages, (2) creating additional
protections in home improvement loans, (3) expanding the TILA
rescission as a remedy for violations of all HOEPA prohibitions, (4)
prohibiting the sale of lump sum credit insurance and other life and
health insurance in conjunction with these loans, and (5) limiting
mandatory arbitration.
Virtually all of the subprime balloon mortgages observed in my
State are very exploitive to the consumer. The fact of such balloon
payment predestines foreclosure for the consumer in many cases.
Mandatory arbitration clauses are now used by the majority of home
equity lenders and they are increasing daily as the technique to deny
consumers any meaningful opportunity to contest the loss of their home.
Arbitrators selected by the creditors now decide whether a consumer
gets to keep his home. Notwithstanding the fact that there are many
exploitive abuses, the arbitrator designated by the lender in the loan
agreement now decides the merits of all claims. Practically speaking,
this means that the consumer loses, and arbitration rules provide that
the practices of the lender are kept confidential.
In the subprime mortgage context, that is, outside of conventional
loans, there is an urgency to address the following exploitive lending
practices:
(1) Prohibition of mandatory arbitration clauses in all
subprime loans.
(2) Prohibition of subprime balloon payment loans. Low income
borrowers generally cannot meet these loans and the lender
cannot expect them to make a balloon payment. Such loans assure
(a) the loss of a home or (b) require refinancing on usually
very exploitive terms if the borrower can even get the loan.
(3) Excessive interest rates, not justified by any additional
risk, are frequent for the vulnerable consumer groups. The risk
is covered by the real property security.
(4) Broker kickbacks should be prohibited. They are a very
anticompetitive practice and in the subprime market result
primarily in increasing the cost.
(5) Home solicitation scams have been with us for many years
but as a means for skimming the equity from unsophisticated
consumers, home equity lenders are now more frequently using
them as a solicitation tool.
(6) Altered and falsified loan applications are now becoming
commonplace in the subprime market. These are altered after
signature by fudging the income of the prospective borrower or
by alteration of the proposed loan amount. The impact is a
level of payments that the consumer cannot make.
(7) Credit insurance packing (by consumer finance companies)
into regular, nonhome secured consumer loans and flipping them
into home equity secured loans is commonplace. Consumer finance
loans with five insurance policies are common to a greater
extent than home equity loans with credit life insurance.
(8) Excessive loan points and broker fees are primary
incentives to abuses. Conventional mortgages with 1-1\1/2\
percent broker fees are standard, while the lack of
sophistication of vulnerable groups leads to broker
compensation of 3 to 7 percent. These are very discriminatory
to unsophisticated consumers given the similarity in the work
performed.
(9) Excessive loan to value loans. One hundred twenty five
percent to 200 percent of actual market value loans are not
uncommon for brokered loans given the financial incentives to
flip, and the lack of any concern for ability of the borrower
to pay. The broker's only concern is closing the loan for the
fee.
STATEMENT OF AMERICA'S COMMUNITY BANKERS
July 26, 2001
America's Community Bankers (ACB) is pleased to take this
opportunity to submit a statement on predatory lending practices. ACB
represents the Nation's community banks of all charter types and sizes.
ACB members pursue progressive,
entrepreneurial and service-oriented strategies in providing financial
services to benefit their customers and communities.
General
ACB members participate in many important programs and partnerships
that help average Americans become and remain homeowners. This
commitment of ACB's members to homeownership is good for communities
and is good for business. In contrast, predatory lending practices
undermine homeownership and damage communities. ACB pledges to work
with this Committee and other policymakers to eliminate predatory
lending practices in the most effective way and to enhance all
creditworthy borrowers' access to sound loans. ACB also would
appreciate the opportunity to provide the Committee with the views of
our recently formed task force on predatory lending when they are
available.
Legislative and regulatory attempts to deal with predatory lending
face serious challenges. New laws and regulations could discourage
certain types of lending by inaccurately labeling loans as
``predatory'' or stigmatizing legitimate loan terms and at the same
time failing to stop predators from engaging in egregious practices. It
is essential to recognize the important difference between legitimate
loan product terms and predatory lending practices. Any loan term is
subject to abuse if it is not properly disclosed or if the loan officer
falsifies documents.
An overly broad law or regulation could impose restrictions that
would limit the availability of credit while allowing predators to
continue their deceptive practices. Rather than imposing more
regulations on heavily supervised institutions, ACB continues to
recommend stronger supervision of unsupervised lenders. A combination
of vigorous enforcement of existing laws and regulations and enhanced
opportunities for homeownership education and counseling would be the
best approach to the problem.
The Board of Governors of Federal Reserve System (Federal Reserve)
is considering amendments to its regulations implementing the Home
Ownership and Equity Protection Act of 1994 (HOEPA).\1\ The Office of
Thrift Supervision and the FDIC continue their review of regulations
and policies. In addition, the new Administration--particularly the
Department of the Treasury and the Department of Housing and Urban
Development (HUD)--have indicated that they will become engaged on the
topic. While this Committee's hearings are timely and appropriate,
Congress will likely wish to review the Federal Reserve's and the
agencies' final regulations and receive the Administration's views
before moving on legislation.
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\1\ Pub. L. 103-325, Title 1, Subtitle B (September 23, 1994). Our
comments on the Federal Reserve's proposed amendments are an appendix
to this testimony.
---------------------------------------------------------------------------
One troubling development is the actions by various State and local
governments regarding predatory lending. They have considered--and in
some cases passed--overly broad legislation. The effect has already
been to discourage lenders from making subprime loans in some of these
jurisdictions, cutting off credit to those who need it most.
While regulation and improved supervision have important roles to
play, the consumer is the first line of defense against abusive
practices. Homeownership education and counseling cannot be
overemphasized as a way to help borrowers avoid becoming victims of
predatory lenders. This is particularly true for borrowers with little
or no experience in homeownership and finance. ACB members currently
provide counseling on their own or in combination with other
institutions or community groups. ACB will continue to work with the
American Homeowner Education and Counseling Institute as a founding
member to provide more education and counseling. Lenders, community
groups, and public agencies should work to expand these programs.
Equal Enforcement Is Essential
Most proposed legislation and regulations would, in theory, apply
to almost all mortgage lenders. Indeed, many nondepository institution
lenders assert they must adhere to the same regulations that insured
depository institutions must follow. However, many of the firms most
commonly associated with predatory practices are not Federally insured
and are not subject to regular examination and rigorous supervision.
Such firms are examined on a complaint-only basis. The joint report by
the Federal Reserve and the HUD issued in 1998 acknowledged these
facts, stating:
Abusive mortgage loans are not generally a problem among
financial institutions that are subject to regular examination
by Federal and State banking agencies. Abuses occur mainly with
mortgage creditors and brokers that are not subject to direct
supervision.\2\
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\2\ Joint Report to the Congress Concerning Reform to the Truth in
Lending Act and the Real Estate Settlement Procedures Act, July 1998,
p. 66.
Abusive practices--for example, falsifying documents; hiding or
obscuring disclosures; orally contradicting disclosures--are the
essence of predatory lending. The proper remedy for these abuses is to
ensure that loan originators do not violate laws against fraud and
deceptive practices and properly disclose loan terms. If existing and
new regulations are effectively applied only to Federally supervised
depository institutions, they will fail to deal with the problem. ACB
is concerned that the current focus on abusive lending practices could
lead to overly broad regulations. By unduly tightening restrictions on
subprime lending, there is a risk of discouraging insured depository
institutions from making responsible subprime loans, which would
effectively open the door even wider to unregulated predators.
To avoid this, the focus of regulatory efforts should be on
enhancing systems to detect and deter deception and fraud without
restricting the availability of credit. Borrowers should enjoy the same
consumer protections, regardless of the institutions they patronize,
and the institutions that offer similar products should operate under
the same rules. Therefore, ACB strongly encourages increased
supervision of non-Federally insured lenders.
ACB recommends that Congress provide the Federal Trade Commission
(FTC) with adequate resources to enforce the laws under its
jurisdiction, particularly with respect to unsupervised lenders. The
Federal banking agencies should work with the States and the FTC to
ensure that Federal regulations apply in practice, as well as in
theory, to all lenders, including State-licensed, nondepository
lenders.\3\ The application of the standards and enforcement of these
regulations is particularly important because State-licensed lenders
can choose to follow regulations issued by the Office of Thrift
Supervision under the Alternative Mortgage Transactions Parity Act.\4\
Without adequate enforcement, there may be situations where State law
is preempted but Federal regulations are not enforced.
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\3\ Letter of July 5, 2000 in response to OTS advanced notice of
proposed rulemaking on responsible alternative mortgage lending.
\4\ 12 U.S.C. 3801-3806.
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Subprime Lending vs. Predatory Practices
It is important that policymakers distinguish between subprime
lending and predatory lending practices. These terms are often
mistakenly used interchangeably. Subprime lending provides financing to
individuals with impaired credit or other risk factors, though at
somewhat higher rates or under stricter terms than are available to
more creditworthy borrowers. The rise of subprime lending has given
many previously underserved borrowers access to credit; before the
expansion of subprime lending, a consumer either qualified for a prime
loan or was denied credit. Subprime loans now offer a middle ground and
have helped consumers achieve and maintain home ownership at record
levels.
A properly underwritten subprime mortgage benefits both the
borrower and the lender. To be considered properly underwritten, a
subprime loan--indeed any loan--must be priced appropriately. The best
credit risk enjoys the lowest rate; those with weaker credit histories
are risk priced at higher rates for access to credit. By expanding the
pool of eligible borrowers, lenders are able to add earning assets to
their books. However, subprime borrowers also add risk to the balance
sheet. By taking borrowers' circumstances into account in pricing,
lenders are properly compensated for the risks they take. Done right,
subprime lending is good for an institution's customers, community,
stakeholders, and deposit insurance fund.
In contrast, true predatory lending benefits only the lender. All
lending should balance the interests of lenders and borrowers. In the
case of loans made on an
abusive or predatory basis, the mortgage broker, home improvement
contractor, or lender receive excessive fees, while borrowers who
cannot meet the terms of their loans may diminish their equity, damage
their credit ratings, and even risk the loss of their home. To avoid
foreclosure, borrowers must often carry ultra-high debt service until
they can secure new financing. These predatory lenders charge far more
than what is required to fairly compensate for risk or lend to
borrowers that are unqualified. They do so to extract as much profit
from the transaction as possible.
Adjusting the HOEPA Triggers
The Federal Reserve has authority under HOEPA to adjust the annual
percentage rate (APR) trigger from 10 to 8 percentage points over the
comparable treasury rates. The Federal Reserve may also include
additional fees in to the points and fees trigger.
Adjusting the APR Trigger
There are many descriptions of predatory lending practices, but
they cannot easily be translated into a clear statutory or regulatory
definition of predatory lending. Rather than attempting to define the
term, HOEPA draws a line between high-cost loans--which require special
disclosures and restrictions--and all other loans. This bright line has
the advantage of clarity, but HOEPA does not encompass all loans that
might be predatory. That is probably an impossible goal, but ACB
members believe that the current APR threshold of 10 percent over
comparable Treasuries could be lowered to 8 percent without restricting
the subprime market.
According to last year's report on predatory lending practices by
HUD and the Treasury, only 0.7 percent of subprime loans originated
from July through September of 1999 met the current HOEPA APR
threshold.\5\ By lowering the threshold from 10 to 8 percent, HUD and
Treasury estimated that 5 percent of subprime loans would be
covered.\6\ ACB recommended that the Federal Reserve take this step
under its current HOEPA authority.
---------------------------------------------------------------------------
\5\ ``Curbing Predatory Home Mortgage Lending: A Joint Report''
(June 20, 2000) p. 85.
\6\ Id at p. 87.
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Lowering the threshold to 8 percent would cover a larger universe
of transactions and provide additional protection to consumers. Doing
so will not, however, solve the problem. Some lenders may try to avoid
the HOEPA trigger by shifting the coupon rate and the upfront fees by
small amounts. In any event, predatory lenders may not bring the HOEPA
disclosures to the borrowers' attention or may tell the borrower the
disclosures are irrelevant. As pointed out above, rules without
enforcement are no solution.
In addition, we caution against lowering the thresholds too far, as
proposed in some legislation. That could unfairly label legitimate
subprime loans as predatory and impose additional burdens on legitimate
subprime lenders.\7\ Imposing additional disclosures; restrictions on
terms; and reduced access to the secondary market would be harmful, but
still not effectively deal with the predatory lending problem.
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\7\ Federal Reserve Governor Edward Gramlich described the problem
this way in his May 1, 2000 letter to Senate Banking Committee Chairman
Phil Gramm. The Governor wrote: ``HOEPA's triggers may bring subprime
loans not associated with unfair or abusive lending within the acts's
coverage. Similarly, abusive practices may occur in transactions that
fall below the HOEPA triggers.'' In a similar letter sent on May 5 to
Chairman Gramm, Comptroller of the Currency John D. Hawke, Jr. summed
up the problem this way: ``I am concerned that attempting to define
this term [predatory lending] risks either over- or under-
inclusiveness.''
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Regulators have suggested that they will not consider HOEPA loans
for purposes of Community Reinvestment Act compliance, a step ACB
supports. The secondary mortgage market, at least as far as the
Government-sponsored enterprises are concerned, will not now accept
HOEPA loans. These are helpful steps under the current HOEPA limits,
but could be perversely damaging if the current trigger values are
decreased too far. Such a chain of events could force more borrowers
away from regulated lenders to the unregulated.
Points and Fees Trigger
In general, ACB opposes adding additional items to the points and
fees trigger. We recommend applying the HOEPA definition to a
substantial number of additional loans by reducing the APR trigger.
That change, when coupled by the increased reluctance of lenders to
make any HOEPA loans and investors to buy such loans, would have a
substantial effect. Policymakers risk overreaching if they also bring
more loans under HOEPA through the points and fees mechanism. If
Congress or the Federal Reserve believe it is necessary to add items to
the points and fees trigger, ACB believes it should apply only to cases
where the refinancing takes place within a relatively short period,
such as 12 months or less.
Prepayment Penalties
ACB opposes including prepayment fees in the points and fees
trigger for HOEPA loans as proposed by the Federal Reserve. Prepayment
penalties are a common option the borrower can accept in exchange for
other consideration, such as a lower interest rate. This earlier
transaction has no direct relationship to the new loan. ACB understands
the concern with the abusive practice known as ``loan flipping'' that
is used to increase opportunities for predatory loan arrangers to
impose inappropriate costs and fees at closing. However, the suggestion
that a new rule be imposed runs the risk of bringing legitimate loans
and lenders into the HOEPA ambit. ACB recommends that policymakers
attack these abuses directly, through better enforcement and consumer
education and counseling. This is a better approach than unfairly
stigmatizing legitimate transactions.
Points
As with prepayment penalties on the original loan, ACB believes
that points paid on that loan have no relationship to the points and
fees--and hence the HOEPA trigger--on a new loan. The proposed addition
to the points and fees trigger is another way to discourage loan
flipping by predatory lenders. Again, ACB urges policymakers to attack
this problem directly.
Scope of Restriction on Certain Acts or Practices
In its request for comment last year, the Federal Reserve sought
comment on several approaches to deal with predatory lending practices
and asks whether they should apply to:
All mortgage transactions;
To refinancings only; or
To HOEPA loans only.
The current anecdotal information does not implicate the vast
majority of mortgage transactions or refinancings. Therefore, ACB
recommended that any new restrictions apply only to HOEPA-covered
refinancings to avoid limiting the availability of legitimate subprime
loans.
Specific Terms and Conditions
During the debate on this issue, a number of specific proposals
have been advanced to attempt to prevent predatory lending practices.
ACB is concerned that certain rates and terms might be defined as
``predatory,'' even though in most circumstances they would be
appropriate. Whether a particular term is predatory generally depends
on the facts and circumstances of the particular transaction. Blanket
restrictions on loan terms that have a legitimate role in the
marketplace is not the right solution.\8\
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\8\ Governor Gramlich described the problem with new rules this way
before the House Banking Committee on May 24, 2000: ``Frankly, the
value of rules prohibiting such practices is uncertain, given the
nature of predatory practices. Some occur even though they are already
illegal, and others are harmful only in certain circumstances. The best
solution in many cases may simply be stricter enforcement of current
laws.''
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These are ACB's comments on some of these specific issues:
Unaffordable Loans
One practice used by predatory lenders is to make a loan to an
individual that he or she is clearly in no position to repay, based on
the stated amortization schedule. ACB opposes such a practice where the
borrower does not understand the terms of the loan and has no other
means to repay. However, there may be some situations where both the
lender and the borrower understand at the outset that the borrower
lacks the capacity to amortize the loan from ordinary sources but
structures the loan to accommodate repayment from an extraordinary
source. One common example is a ``bridge loan'' where repayment will
come from the sale of the borrower's current residence. ACB urges that
policymakers avoid imposing legislation or regulation that might
interfere with these kinds of accommodating transactions.
Federally insured banks and savings associations must already
demonstrate that their loans are made according to sound underwriting
guidelines. They have a good record of making loans that borrowers can
repay. If other lenders adhered to similar good business practice, this
aspect of the predatory lending issue would be substantially mitigated.
There are some indications that the capital markets are already
pulling away from predatory lenders because of losses due to
foreclosures and increased public and regulatory scrutiny. While many
predatory loans may remain on the books and reports suggest that
borrowers are continuing to suffer from predatory practices, capital
market discipline is likely to become increasingly effective.
Therefore, it is important that policymakers not overreact and impose
rules that discourage mainstream lenders from providing credit to
underserved areas and populations.
Limits on Refinancing
Another predatory technique involves frequent refinancings,
sometimes within a brief period. One of the most egregious examples
involves refinancing low-cost loans on community development housing
and simply replacing them with much higher-rate loans. Such practices
are completely inappropriate.
Yet additional regulation to protect consumers is not the answer.
First, refinancing a loan at a higher rate is not, by itself, a
predatory practice. For example, a borrower may wish to convert a
substantial amount of equity into cash, resulting in a higher loan-to-
value ratio and risk profile for the new transaction. Alternatively,
that borrower may find that market rates may have simply risen since
the original loan was made. While repeated refinancings at higher rates
may well be a common predatory practice, a borrower and a lender may
find it mutually agreeable to restructure their business relationship.
A well-informed consumer who chooses and can afford the obligation
should not have that option foreclosed.
Second, repeated refinancing is generally just one aspect of a
broader preda-
tory lending scheme that involves deceiving the borrower, falsifying
loan papers, and ``packing'' the loan with hidden fees. Without these
illegal practices, there would be little point in repeated refinancing.
Thus, a special rule on refinancing is not
necessary.
Some have suggested language that would permit refinancing at
higher rates if there is a tangible net benefit to the borrower. This
is an intensely fact-based standard that--if imposed by law--could
create an unprecedented burden on institutions, for example to analyze
and document the ``tangible net benefit'' for every loan. ACB opposes
this standard as both unnecessary and overly burdensome.
Balloon Payments
Balloon payment provisions can be used by predatory lenders to
force a refinancing or even foreclosure. However, it is important to
recognize that balloon payments can serve legitimate purposes. A
balloon provision would make sense for a borrower who wishes to pay the
loan on a long-term schedule, but fully expects to refinance or repay
the loan before the date the balloon payment is due. For example, a
borrower may have a fixed-rate, fully amortizing loan (no balloon)
coupled with a line of credit with interest-only payments until a date
certain when the loan must be paid in full. Properly used balloon
transactions give borrowers the benefits of short-term interest rates
and long-term amortization of the loan debt. A borrower who is fully
informed by the lender and who understands his or her obligations can
avoid foreclosure by a planned sale of the property, refinancing the
balloon transaction, seeking an extension before the final due date, or
taking some other action.
These positive features depend on an informed borrower who
understands the implications of a balloon payment. Based on the
anecdotal information provided during last year's HUD-Treasury forums,
it appears that some victims of predatory lending practices have not
understood this particular loan term. As indicated below in the
discussion of improved disclosures, ACB believes that it should be
determined why this is the case and steps taken to correct the problem,
rather than imposing unnecessary and disruptive restrictions.
Prepayment Penalties
Unreasonable prepayment penalties can make it extremely difficult
for a borrower to replace a loan made on an abusive or predatory basis.
In other instances, prepayment penalties which are typically in effect
only a few years--are appropriate and beneficial to borrower and lender
alike. They decrease the likelihood that a borrower will pay off a loan
quickly (decreasing anticipated income to investors) or compensate the
investor for lost income if the borrower does decide to prepay the
loan.
What is the benefit to the borrower? Investors are willing to
accept a loan with a lower interest rate, with the protection of a
prepayment penalty. This is an especially good option for borrowers who
expect to remain in their homes for a longer period. It is also
important to emphasize that these clauses may discourage the refinance
option for only a limited time and may not be binding at all if the
borrower seeks to sell the home. In some cases, borrowers prefer loans
without prepayment penalties and lenders do not include them. This is
an appropriate market response.
Some have proposed limiting prepayment penalties to cases where the
borrower receives a benefit, such as lower upfront costs or lower
interest rates. This is similar to the ``tangible net benefit'' test
discussed above in connection with limits on refinancing. However
expressed, ACB believes that it would be extremely difficult for an
institution to reliably measure and demonstrate compliance with such a
requirement across an entire loan portfolio, especially in periods of
high mortgage interest rates. Each case would depend on particular
facts and circumstances, requiring an economic analysis of each
situation.
Regulatory evaluation could even turn on the subjective intent of
the borrower. For example, a borrower who had no intention, at the time
of closing, of selling the home soon might later decide for any number
of reasons to sell his or her house and prepay the mortgage. He or she
would have received a lower interest rate or fewer points in exchange
for a prepayment penalty that he or she never expected to incur.
However, what might have looked like a good bargain at closing could
turn out to be relatively costly just a short time later simply because
the borrower chose a different course.
ACB believes that this is another case where informed consumer
consent, rather than a difficult to enforce standard makes the most
sense.
Negative Amortization
Some loans have payment schedules that are so low that interest is
added to the principal, rather than being paid as it accrues. This can
be harmful if too much interest is added to the loan's principal and
the loan terms do not provide a way to reverse the process. However,
like a prepayment penalty, the possibility of negative amortization can
help borrowers. For example, some lenders offer fixed-payment,
adjustable rate loans that--depending on prevailing interest rates--
could result in some negative amortization. These loans are sometimes
made to ease the debt service requirement for a defined and often
limited period. The interest rate on these loans is capped, the
possibility of negative amortization is fully disclosed, and the
negative amortization potential is itself capped. Sometimes the
negative amortization is provided to assist the borrower in a time of
financial stress or in times of unusually high short-term interest
rates.
Misrepresentations Regarding Borrower's Qualifications
Some have suggested a rule that would prohibit lenders from
misleading consumers into thinking that they do not qualify for a lower
cost loan. In a request for comment last year, the Federal Reserve
indicates that, ``Such a practice generally would be illegal under
State laws. . . .'' \9\ ACB believes that State authorities should
enforce these laws with respect to lenders they regulate. It is
unlikely that Federally insured depository institutions are engaged in
these practices and, if they are, the existing examination process
would correct them.
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\9\ 65 Fed. Reg. 42892 (July 12, 2000).
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Reporting Borrowers' Payment History
One important potential benefit of responsible subprime lending is
that it can give those borrowers with credit blemishes a chance to
qualify for prime loans. ACB strongly supports the reporting of all
loan performance data and is opposed to the reported practice by some
lenders of choosing not to report positive performance for fear their
customers will be targeted by competitors for refinancing. If a lender
does not report positive credit experience, the credit report is no
longer accurate and the benefit of an improved credit report is lost.
Lenders that report data must report all data and not subjectively
choose what to report. This is an instance where consumers benefit from
appropriate disclosure of their financial information.
Referral to Credit Counseling Services
ACB strongly supports homeownership education and counseling and
our members have no objection to telling borrowers that counseling is
available. In fact, many of our members offer counseling or participate
in joint programs. And, as indicated above, ACB is a founding member of
the American Homeowner Education
and Counseling Institute. However, we are reluctant to endorse
mandatory counseling for all high-cost loans, as some have suggested--
particularly if a substantially higher number of loans are covered by a
new definition. Mandatory counseling could create perverse incentives
and give rise to meaningless counseling programs. Consumer
representatives told the HUD-Treasury joint task force that they were
concerned that counseling certifications could become yet another
document that predatory lenders would routinely falsify. And, they
indicated that if the mandatory counseling actually took place, it
could be used as a shield against later claims that the loan was
predatory or otherwise improper.
Nevertheless, ACB believes that counseling can be a real benefit to
borrowers,
especially those with little or no experience in homeownership and
finance. Counseling gives potential victims of predatory lenders tools
to avoid an inappropriate transaction.
Mandatory Arbitration
Arbitration agreements have been criticized when included in some
HOEPA loans or loans deemed ``predatory.'' However, arbitration can be
a simple, fast, more affordable alternative to foreclosure litigation.
Attorneys who represent homeowners victimized by predatory lenders
often complain that they lack the time and resources to pursue claims
in court. Fair and properly structured arbitration arrangements could
help them. Of course, they must be fully and properly disclosed. In
legitimate agreements, consumers retain all of their substantive legal
rights. And, the record shows that there is no inherent bias against
consumers in arbitration proceedings.
HOEPA Disclosures
In addition to increasing the number of loans considered high-cost,
some have suggested increasing the disclosures that must be made for
these loans. ACB believes that requiring substantial additional
disclosures would provide little benefit. The HUD-Treasury forums
presented convincing evidence that the existing
disclosures are sometimes ineffective, and more elaborate disclosures
might even give predators more opportunities to confuse consumers.
Rather, ACB recommends that the Federal Reserve and other policymakers
thoroughly study why the existing disclosure regime is ineffective and
what alternatives might work. Those efforts should concentrate on
simpler, ``plain English'' disclosures that focus consumer
attention on relevant information. Regulators also should work to
ensure that disclosures are provided in a timely way, particularly by
institutions that are not regularly supervised.
One approach might be adapted from the Truth in Lending Act (TILA)
tables required for mortgage loans and the requirement that credit card
solicitations include a special table (sometimes known as the ``Schumer
box'') that highlights key terms.\10\ For a loan (as opposed to credit
sale) the highlighted terms are:
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\10\ Regulation Z, Appendix G-10(A) & (B) & H-2.
Annual percentage rate
Finance charge
Amount financed
Total of payments
Payment number, amount, due dates
The form also includes information on credit insurance, security
interest, filing fees late charges, and prepayment penalties.
For credit cards, these terms are:
Annual percentage rate
Variable rate (if any)
Method of computing the balance for purchases
Annual fees
Minimum finance charge
Transaction fee for purchases
Transaction fee for cash advances and fees for paying late or
exceeding the credit limit
These special disclosure boxes provide consumers with conspicuous
disclosures of the key terms, though do not substitute for the full
TILA disclosures.
In contrast, the special HOEPA disclosures--provided 3 days before
closing--are limited to APR, monthly payment, and statutorily
prescribed language that states, ``You are not required to complete
this agreement . . .'' and ``. . . you could lose your home . .
.''.\11\ These disclosures do not address the predatory practices used
to strip equity from borrowers' homes.
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\11\ 15 U.S.C. 1639(a).
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ACB suggests that policymakers carefully study why the current
HOEPA disclosure system may be inadequate and determine how it could be
improved. As things now stand, in some situations borrowers do not
understand the disclosures or lenders do not provide the disclosures or
discourage their use.
If the problem is lack of borrower understanding, the disclosures
should be improved and lenders should make greater efforts to educate
and counsel consumers. If the problem is with the lenders, ACB urges
greater enforcement.
Certainly, disclosures should be written using plain language. But
in addition, ACB recommends that Congress direct the agencies to work
with lenders to field test the entire disclosure system. Such a review
may reveal that even disclosures drafted in plain language are not
fully understood by consumers. ACB cautions against overloading
consumers with too much detail. ACB members' ``field tests''--conducted
at loan closings every day--demonstrate that many consumers do not
understand the current disclosures.
Open End Home Equity Lines
Some have raised concern that lenders could use open-end credit
lines to evade HOEPA and, if so, whether such structuring should be
prohibited. ACB does not have any evidence that HOEPA is being evaded
in this fashion. In addition, ACB members generally do not offer open-
end mortgage loans; secured lines of credit are generally offered for a
specified term, for example, 5 or 10 years, to give the lender an
opportunity to review and restructure the agreement. In any case, ACB
believes it would be very difficult to distinguish between legitimate
lines of credit and ``evasions,'' because whether a particular loan was
an evasion would depend on the lenders state of mind.
Community Outreach and Consumer Education
The Committee should be aware of a wide variety of community
outreach activities and consumer education efforts already underway. As
indicated above, ACB is a founding member of the American Homeowner
Education and Counseling Institute (AHECI), a nonprofit organization,
which supports national standards for organizations and individuals
that provide education and counseling services. This organization is
the creation of a diverse group of mortgage industry stakeholders who
realized that existing educational programs or counseling services had
neither uniform content or value. The effort also recognized the need
to determine and measure the qualifications and standards of conduct of
those who deliver these services. AHECI has established minimum
standards for educational program content and duration; these standards
have been widely circulated and well received by the industry. AHECI
certification of instructors and program approval will provide
borrowers and lenders of a degree of assurance as to the quality and
utility of locally offered programs never before available, once the
certification/approval process is in place.
ACB also participated with other associations in the creation of a
brochure designed to help consumers understand the terms of their loans
before they commit in writing. This brochure defines key loan terms and
includes a worksheet to help consumers compare their monthly spending
plans before and after taking out a new mortgage loan. It also helps
consumers compare all the terms of various mortgages. Finally, the
brochure lists key rights available to protect against predatory
lenders, such as the right to cancel a refinancing within three
business days of a closing. A copy of this brochure is included with
this statement. (Brochure held in Senate Banking Committee files.)
Whether through formal counseling programs or in the normal loan
underwriting process, ACB member institutions work to ensure that
borrowers understand their responsibilities and will be able to fulfill
them.
Despite these efforts, supervised mortgage lenders have a difficult
time competing with the aggressive marketing tactics of some lenders
and brokers. The economics faced by the different types of lenders may
go a long way toward explaining the problem. Simply put, a predatory
lender that charges rates and fees substantially above prime can afford
to devote substantial resources to marketing. This may include print,
broadcast, and even ``house calls'' by loan sales people. Prime or
near-prime lenders may have a better product, but their profit on a
given loan is too small to support a similarly aggressive sales
campaign.
Because of this imbalance in the market and because of the
important public policy goal of blunting predatory lending practices,
ACB believes that the Government agencies have a role in consumer
information and education. The FDIC recently launched a financial
literacy program with the Department of Labor. The OTS and the
Comptroller of the Currency also have financial literacy programs.
Federal Reserve Banks provide training sites for education and
counseling services. Government agencies could--through public service
announcements and the like--urge consumers to seek out education and
counseling and encourage lenders to offer or recommend those services.
In addition, ACB strongly supports funding for HUD's home ownership
education and counseling programs.
Mortgage Lending Reform
Some assert that simplifying the application and settlement rules
could go a long way toward solving the predatory lending problem. ACB
supports simplification efforts, but we also recognize they are not a
panacea for predatory lending. Industry and policymakers have tried
repeatedly to streamline this process, but no matter how successful
they are, making the biggest purchase and taking on the biggest
financial obligation in your life is inherently complicated. But as
indicated above, solid education and counseling can help borrowers
learn enough about the process to understand whether or not they are
being fairly treated.
Conclusion
In conclusion, we would like to emphasize the following points:
Policy makers should avoid imposing over-inclusive legislation
or regulations that unfairly label legitimate loans as predatory or
stigmatize legitimate loan terms;
Many firms associated with predatory practices are not subject
to regular examination and rigorous supervision, and the Federal
financial supervisory agencies should work with the FTC and the
States to help ensure that new and existing rules are effectively
and equally applied to all mortgage lenders;
Unless all lenders are subject to the same rigorous
enforcement, new rules only will increase the burden on
institutions that are now heavily supervised while failing to solve
the predatory lending problem;
Existing disclosures should be made clearer--and validate
these improvements through field testing--rather than adding
lengthy new disclosures.
Education and counseling can be an effective way to prevent
predatory lending. ACB and its members pledge to increase access to
high-quality homeownership education and counseling.
STATEMENT OF GALE CINCOTTA
Executive Director, National Training & Information Center
National Chairperson, National People's Action
July 25, 2001
I want to thank Chairman Sarbanes and other Members of the Senate
Banking Committee for holding hearings on predatory lending. My name is
Gale Cincotta and I serve as Executive Director of the National
Training & Information Center (NTIC) as well as the Chairperson of
National People's Action (NPA). In these positions, I remain committed
to stomping out this scourge. We hope that these hearings will lead to
Federal legislation which would protect homeowners from the
deceptive and equity-stripping practices used by predatory lenders.
NTIC is a 30 year old training and resource center for grassroots
community organizations across the country. NPA is a coalition of 302
community groups from 38 States who organize locally and coalesce
nationally around issues of mutual concern that require national
action.
We are proud that Chicago was the first city to pass an
antipredatory lending ordinance that required financial institutions
with city deposits or contracts to swear-off predatory lending
practices. We are also proud that Illinois passed strong antipredatory
lending regulations in April (see http://www.obre.state.il.us/
predatory/predrules.htm for details and attached articles).
Documenting the Problem
Both of these victories came after NTIC spent 2 years organizing at
the local and State levels to address predatory lending. We argued for
reform by getting homeowners and advocates directly involved in the
fight.
We also documented that subprime lenders are the source of an
explosion of foreclosures in the Chicago area--subprime lenders went
from initiating 163 foreclosures in 1993 to filing 4,796 in 1999 (see
attached maps). Similarly, the share of foreclosures by subprime
lenders grew from 2.6 percent in 1993 to 36.5 percent in 1999 for the
same seven county metropolitan area.
The countless stories associated with the foreclosure dots on the
maps reveal a dozen or so predatory practices that pushed the borrower
into bankruptcy and foreclosure. While this foreclosure data does not
exist in most cities, the stories do. A dozen local organizations
across the midwest, southwest, and northeast have been organizing
homeowners ripped-off by predatory lenders. The stories are similar and
the effects are devastating: elderly and other borrowers are left
homeless, the equity wealth and credit records of entire families is
ruined, and communities are left with abandoned buildings. (See
attached articles).
The roots of these problems--predatory lending--must be pulled up.
We have begun the process in one State, Illinois, and are willing to
work in 30 more.
However, we are pleased that you are using your leadership powers to
move Federal legislation.
The organizations affiliated with NTIC and NPA who are working on
this issue have all achieved intermediate success. (See attached
``NPA's National and Local Accomplishments on Predatory Lending''). All
agree, however, that ultimately the solution is strong Federal
legislation that is strictly enforced. The money to be made through
predatory lending will last as long as Americans have equity in their
homes.
Predatory Lending Policy Recommendations
NTIC and affiliated organizations have found that effective
legislation should contain the following elements:
1. Sets the annual percentage rate (APR) triggers at T-bill
plus 4 percent points and fee triggers at 3 percent of the
total loan amount to capture the full range of loans likely to
contain predatory loan terms. Predatory lending is most often
found in refinance and equity loans that carry higher-than-
normal interest rates and fees. Currently, the Home Ownership
Equity Protection Act (HOEPA) captures only a tiny percentage
of the subprime loans. Predatory lenders have learned to
originate loans that fly under the radar of HOEPA's annual
percentage rate and fee triggers; in fact, only loans with
close to a 16 percent interest rate are subject to restrictions
on predatory terms under HOEPA. However, borrowers with
interest rates of even 10 percent are being successfully
targeted with predatory loans that steal equity out from under
the homeowner. Similarly, HOEPA applies too high of a fee
trigger to loans. While Freddie Mac has determined that banks
charge a prime rate customer 1-2 percent points of the loan
amount in fees, predatory lenders often charge borrowers 5-20
percent in financed fees. These come in the form of inflated
origination & broker fees, as well any number of ``junk fees.''
2. Prohibits Steering: Charging high, subprime interest rates
(9-25 percent) on borrower's who have good enough credit to
qualify for prime-rate loans (7-9 percent).
3. Prohibits lending without ability to repay: Making a loan
based on the equity that the borrower has in the home, without
regard to the borrower's ability to repay the loan.
4. Prohibits single-premium credit insurance packing:
Including overpriced insurance such as credit life, disability,
and unemployment insurance. The lender finances the insurance
as part of the loan, instead of charging periodic premiums
outside of the loan.
5. Prohibits Loan Flipping: Frequent, unnecessary
refinancings of a loan with no benefit to the borrower.
6. Prohibits fees in excess of 3 percent of the total loan
amount: While Freddie Mac has determined that banks charge a
prime-rate customer 1-2 percent points of the loan amount in
fees, predatory lenders often charge borrowers 5-20 percent in
financed fees. These come in the form of inflated origination
and broker fees, as well any number of ``junk fees.''
7. Prohibit Prepayment Penalties: Huge fees charged when a
borrower pays off the loan early or refinances into another
loan. Prepayment penalties are designed to lock borrowers into
high-interest loans, thereby undermining our free market
economy by taking away a borrower's right to choose the best
product available to them at a given time.
8. Prohibit Balloon Loan: A loan that includes an
unreasonably high payment due at the end of or during the
loan's term. The balloon payment is often hidden and almost the
size of the original loan. These loans are structured to force
foreclosure or refinancing.
9. Prohibit Adjustable Rate Mortgages (ARM's): ARM's by
predatory lenders are usually indexed so that they only adjust
up, increasing a borrower's interest rate a full point every 6
months. As a result, a borrower's monthly payment increases
twice a year even though they likely were told that the
adjustable rate mortgage would fluctuate with the economy.
10. Requires lenders to escrow for property insurance and tax
premiums: Many predatory lenders artificially reduce a
borrower's monthly payments by not charging them the full
amount necessary to pay for property taxes and insurance
premiums out of an escrow account. As a result, homeowners who
have never had to worry about saving for separate property tax
and insurance payments are hit with bills potentially as big as
their mortgage payments twice a year.
11. Prohibits Home Improvement Scams: A home improvement
contractor arranges the mortgage loan for repairs, often
charging the borrower for incomplete or shoddy work.
12. Prohibits Bait & Switch: A lender offers one set of loan
terms when
the borrower applies, but pressures the borrower to accept
worse terms at the closing.
Other Efforts To Combat Predatory Lending
While the Congress begins to debate the legislative remedy to this
issue, we will continue to pursue four distinct strategies to combat
predatory lending:
Compelling and Supporting Increased Enforcement Through
the Federal Trade Commission (FTC), State Banking Departments,
and Attorneys General
In March 2001, Assistant to the Director of Consumer Protection,
Ron Isaac, represented the FTC at the NPA Conference. At the
conference, Mr. Isaac committed the FTC to participating in predatory
lending hearings in seven cities over within 12 months. Mr. Isaac
committed to attending himself (or sending a representative of equal
authority from the national FTC office), asking a regional
representative to also attend, and to attending the NPA Conference in
2002. At the hearings, local organizations will expose predatory
lenders through personal testimony and statistical supporting evidence.
NTIC and NPA also recognize that the FTC has sweeping powers under
Section 5 of the FTC Act to write regulations that would guard against
``unfair practices.'' We will be asking the FTC to use these powers to
regulate against predatory lending practices.
Targeting Citigroup's CitiFinancial/Associates, Nationally, and
Other Problem Lenders, Locally, for Lending Reform
Pressure from NPA and other groups has forced Citigroup to
discontinue one of its most profitable and abusive lending practices--
the sale of single-premium credit insurance. But while celebrating the
conglomerate's decision, NPA demands that Citigroup take additional
steps toward lending reform.
NPA leaders in Chicago, Cincinnati, Cleveland, Des Moines, central
Illinois, Indianapolis, Pittsburgh, Syracuse, Wichita, and other cities
say that Citigroup must cap fees at 3 percent, eliminate terms that
lock borrowers into predatory loans, and allow borrowers their American
right to sue predatory lenders in court.
Furthermore, Citigroup must review and restructure the predatory
loans made by The Associates and CitiFinancial which tens of thousands
of homeowners are currently struggling to repay. Many of these
homeowners will ultimately end up in bankruptcy and foreclosure unless
Citigroup repairs the loans so that borrowers are able to repay their
loans and remain in their homes.
Finally, NPA calls on Citigroup to offer affordable, prime-rate
loans throughout the 48 States where they operate. Currently, most
borrowers can only get high-interest loans through CitiFinancial
branches, even if they have good credit and qualify for a prime-rate
loan. This Citigroup policy creates a discriminatory loan system where
most borrowers pay too much for mortgage credit.
Pursuing Increased Protection in States Where Local Groups Are
Positioned--Through Either State-Level Legislation or Regulation
Several States are at or nearing the point where they are poised to
push for legislative or regulatory protection from predatory lending as
was accomplished in
Illinois in 2001.
Working With Responsible Lenders To Develop Lending Products
That Provide an Alternative to the Quick-cash Predatory Loans
Under the Predatory Lending Intervention and Prevention Project,
NTIC, and affiliated NPA organizations joined Fannie Mae and several
lenders in Chicago last November to kick-off a pilot product that
refinances borrowers out of predatory loans and into loans that they
can afford to repay. Similarly, some groups such as the Northwest
Neighborhood Federation in Chicago are pursuing banks to develop their
own loan products to provide borrowers alternatives to the quick-cash
promises of predatory loans. We are currently expanding this pilot to
central Illinois, Cincinnati, Cleveland, and Des Moines.
While these are all important ways to stop predatory lending,
everyone would agree that thorough, strong Federal regulation is the
most effective way to protect borrowers.
Please let me know how I, NTIC, and NPA can help the Banking
Committee on this issue in the future.
Please See the Attachments That Follow
1. Maps of ``Foreclosures Started by Subprime Lenders in Chicago,
1993 and 1999''
2. Maps of ``Foreclosures Started by Subprime Lenders in
Chicagoland, 1993 and 1999''
3. Selected articles
4. ``NPA's National and Local Accomplishments on Predatory
Lending''
STATEMENT OF ALLEN J. FISHBEIN
General Counsel, Center for Community Change, Washington, DC
July 26, 2001
My name is Allen J. Fishbein, and I am General Counsel of the
Center for Community Change and I also Codirect the Center's
Neighborhood Revitalization Project. Mr. Chairman and Members of the
Committee, I want to commend you for holding this hearing on the
problems associated with predatory mortgage lending and thank you for
the opportunity to provide testimony on behalf of my organization on
this important topic.
Prior to rejoining the Center in December of last year, I served
for almost 2 years as the Senior Advisor to the Assistant Secretary for
Housing at the U.S. Department of Housing & Urban Development. My
duties at HUD included helping to direct the activities of National
Task Force on Predatory Lending, which the Department established in
conjunction with the Treasury Department.
The Center for Community Change (www.communitychange.org) is a
national, nonprofit organization that provides training and technical
assistance of many kinds to locally based community organizations
serving low income and predominately minority communities across the
country. For the last 25 years, the Center's Neighborhood
Revitalization Project has advised hundreds of local organizations on
strategies and ways of developing innovative public/private
partnerships aimed at increasing the flow of mortgage credit and other
financial services to the residents of these underserved areas.
The rapid rise in predatory lending has been a disturbing part of
the growth in the subprime mortgage market. It threatens to quickly
reverse much of the progress made in recent years to expand
homeownership to underserved households and communities. At a time when
a record number of Americans own their own home for too many families
the proliferation of abusive lending practices has turned the dream of
homeownership into a nightmare. Abusive practices in the subprime
segment of the mortgage lending market have been stripping borrowers of
home equity they spend a lifetime building and threatens thousands of
families with foreclosure, destabilizing urban and rural neighborhoods
and communities that are just beginning to reap success from the recent
economic expansion. Further, predatory lending disproportionately
victimizes vulnerable populations, such as the elderly, women-headed
households and minority homeowners. The predators selectively market
their high-cost loans to unsuspecting borrowers, saddling these
families with expensive debt, when in many cases, they qualify for less
costly loans.
Given the nature and prevalence of this problem, a comprehensive
approach is required, involving all levels of government, the mortgage
and real estate industries, together with community and consumer
organizations. This was the approach recommended last year by the
Treasury Department and HUD and we think this approach makes the most
sense.
To be sure, increased consumer awareness about predatory lending
practices must be part of the mix and there is much that industry and
nonprofit organizations are doing and can do to improve the financial
literacy, especially for at-risk homeowners. Expanded enforcement is
needed as well.
However, efforts to increase financial literacy among consumers and
incremental increases in enforcement, in and of themselves, will not be
sufficient to curb the growing problem of predatory lending. Existing
consumer protections must also be strengthened, since existing laws are
simply inadequate to prevent much of the abuse that is occurring.
Further, better mortgage loan data collection by the Federal Government
is necessary to provide regulators and the public with more
comprehensive and consistent information about those areas most
susceptible to predatory lending activity. And there is much more to be
done by those who purchase or securitize high-cost subprime loans to
ensure that, knowingly or unknowingly, they do not support the
activities of predatory loan originators.
Later in my testimony I discuss our recommendations for the
additional Federal action that is needed to combat the problem.
What Is Predatory Mortgage Lending?
The term ``predatory lending'' is a short hand term that is
commonly used to encompass a wide range of lending abuses. The local
community organizations, housing counseling agencies, and legal aid
attorneys we work with report a steep rise over the past few years in
the incidence of these abusive practices. Disturbingly, while home
mortgage lending is regulated by the States and at the Federal level,
local groups working on this issue find that many of the most abusive
practices by predators are technically permissible under current law.
Predatory lending generally occurs in the subprime market, where
most borrowers use the collateral in their homes for debt consolidation
or other consumer credit purposes. Most borrowers in this market have
limited access to the mainstream financial sector, yet some would
likely qualify for prime loans. While predatory lending can occur in
the prime market, it is ordinarily deterred in that market by
competition among lenders, greater homogeneity in loan terms and
greater financial in-
formation among borrowers. In addition, most prime lenders are banks,
thrifts, or credit unions, which are subject to more extensive Federal
and State oversight and supervision, unlike most subprime lenders.
The predatory lending market works quite differently than the
mainstream mortgage market. It usually starts with a telephone call, a
mailing, or a door-to-door solicitation during which time unscrupulous
lenders or brokers attempt to persuade a borrower to use home equity
for a loan. High-pressure sales techniques, deception, and outright
fraud are often used to help ``close the deal.'' According to a recent
AARP survey over three quarters of seniors who own homes receive these
types of solicitations, while many takeout loans relying solely on
these overtures, without taking the necessary time to shop around to
find the best possible loan deal for themselves.
Some would have this Committee believe that the term predatory
lending is not well defined and therefore, cannot be used as a basis
for enacting stronger regulation. A broad consensus emerged last year
among a diverse range of institutions, including Federal and State
regulators and the Government Sponsored Housing Enterprises (GSE's)
about the common elements associated with predatory lending. Testimony
from victims and others at the public forums sponsored by Treasury and
HUD, and by the Federal Reserve Board, also illustrated the all too-
frequent abuses in the subprime lending market.
The joint report issued last year by the Treasury Department and
HUD, Curbing Predatory Home Mortgage Lending (June, 2000), catalogued
the key features commonly associated with predatory loans. These
include the following:
Lending without regard to a borrower's ability to repay.
Instead of establish-
ing the borrower's ability to pay, predators underwrite the
property and charge very high origination and other fees that are
not related to the risk posed by the borrower.
Packing. Single-premium credit life insurance policies and
other fees are ``packed'' into loans but not disclosed to borrowers
in advance. The financing of these products and fees increases the
loan balance, stripping equity from the home.
Loan flipping. The predators pressure borrowers into repeated
refinancings over short time periods. With each successive
refinancing the borrower is asked to pay more high fees, thus
stripping further equity.
Prepayment penalties. Excessive prepayment penalties ensure
that the loan cannot be paid off early without paying significant
fees, trapping borrowers into to high-cost mortgages.
Balloon payments. Predatory loans may have low monthly
payments at first, but the loan is structured so that a large lump
sum payment is due within a few years.
Mandatory arbitration. Mandatory arbitration clauses to
resolve disputes are usually required as a condition for receiving
a loan. Such clauses reduce the legal rights and remedies available
to victims of predatory lending.
The report concluded that practices such as these, alone or in
combination, are abusive or make the borrower more vulnerable to
abusive practices in connection with high-cost loans.
What Are the Reasons for the Growth in Predatory Lending?
The Nation's economic success has caused home values to rise.
Consequently, Americans have found greater equity in their homes, which
has fostered an enormous expansion in consumer credit, as many
homeowners have refinanced their mortgages to consolidate their debts
or pay-off other loans. The growth in the subprime lending over the
last several years may have benefited many credit-impaired borrowers.
Subprime lenders have allowed these borrowers to access credit that
they perhaps could not otherwise obtain in the prime credit market.
Nationally, subprime mortgage refinancings rose from 100,000 in 1993 to
almost one million in 1998, a ten-fold increase in just 6 years.
However, studies by HUD, the Chicago-based Woodstock Institute, and
others have demonstrated that subprime lending is disproportionately
concentrated in low income and minority communities. Mainstream lenders
active in white and upper-income neighborhoods were much less active in
low income and minority neighborhoods effectively leaving these
neighborhoods to unregulated subprime lenders. Certainly, not all
predatory practices are confined to the subprime market. However, as
the Treasury-HUD report concluded, subprime lending has proven to be
fertile ground for predatory practices.
According to HUD statistics, subprime lenders are three times more
likely in low income neighborhoods than in upper-income neighborhoods
and five times more
likely in predominately African American neighborhoods than in white
neighborhoods. Moreover, subprime lending is twice as prevalent in
high-income African American neighborhoods as it is in the low income
white communities (See, HUD's report Unequal Burden: Income and Racial
Disparities in Subprime Lending in America, April 2000).
The Effects of Predatory Lending
The dramatic growth in foreclosure actions in some neighborhoods
that has accompanied the growth in subprime lending over the last
several years suggest the damaging effects of lending abuses. In fact,
foreclosure rates for subprime loans provide the most concrete evidence
that many subprime borrowers are entering into mortgage loans that they
simply cannot afford. And the most compelling evidence that subprime
lending has become a fertile ground for predatory practices is the
current, disproportionate percentage of subprime loan foreclosures in
low income and minority neighborhoods.
HUD and others have documented the wave of foreclosures now coming
out of the subprime market in recent research studies. Studies of
subprime foreclosures in Chicago (by the National Training and
Information Center), Atlanta and Boston (by Abt Associates) and
Baltimore (by HUD), as well as other research, reinforce raises serious
concerns about the impact of subprime loans on low income and minority
neighborhoods in urban areas. These findings provide recent evidence
that predatory lending can potentially have devastating effects for
individual families and their neighborhoods.
Additional Federal Action Is Needed To Combat Predatory Lending
Predatory lending has received considerable attention in the news
media, largely because of the efforts of national and local community
and consumer organization, some of who have provided testimony to this
Committee on this subject. In addition, growing concerns about abuses
in the subprime market have led States and increasingly, localities to
mount their own legislative and regulatory efforts to curb predatory
lending.
Some industry groups have complained about and lobbied against the
adoption of State and local antipredatory laws. They say they fear
being subjected to growing set of local, and possibly, conflicting
standards. However, in our opinion, these local legislative efforts
will continue and expand in the absence of decisive action being taken
at the Federal level.
We believe that the Federal Government can make a significant dent
in the problem of predatory lending by taking action in five key areas
(similar recommendations were endorsed by the Treasury-HUD report):
Strengthening the Home Ownership and Equity Protection Act (HOEPA)
and the Fair Lending Laws
A key recommendation in the Treasury-HUD report was that HOEPA
needs to be strengthened (HOEPA is the key Federal protection for
borrowers of certain high-cost loans by requiring lenders to provide
additional disclosures and by restricting certain terms and conditions
that may be offered for such loans). We agree that Congress needs to
take this action.
As witnesses before this Committee in connection with these
hearings have testified, the ``dirty, rotten secret'' of predatory
lending is that many of the worst abuses are not necessarily illegal
under existing consumer protections. This means that beefed-up
enforcement of the existing laws alone will not curb the problem.
Currently, HOEPA is a useful, but limited tool. For one thing, it
covers very few high-cost loans (about 1 percent). It does not cover
home purchase or home equity and home improvement loans that are
structured as open-end credit lines. Moreover, the statute currently
does not cover some critical abusive practices associated with high-
cost lending and the civil remedies that are provided need to be
enhanced.
We are pleased that the Federal Reserve Board is contemplating
using the administrative discretion it has under HOEPA to revise and
expand some limited aspects of the regulations governing the
implementation of this statute. For example, the Board is proposing to
adjust the existing interest rate trigger to bring additional loans
under HOEPA. The proposal also would expand the Act's coverage to
include most loans in which credit life or similar products are paid by
the borrower at or before closing.
But the Board has yet to act on its proposal and even if these
changes were eventually adopted, the vast majority of high-cost loan
borrowers (95 percent or more, according to most estimates) still would
not be covered by HOEPA's protections.
Consequently, we support the type of legislation that was
introduced last year in the Senate by Chairman Sarbanes and in the
House of Representatives by Representative LaFalce (and reintroduced in
the House again this year, as H.R. 1051, by Mr. LaFalce). We also
commend Senator Schumer for legislation he offered last year. Passage
of this type of legislation would help to curb what appear to be the
key elements of abusive mortgage lending. We are pleased, Mr. Chairman,
that you have indicated your intention to reintroduce your bill and
your strong desire to have a bill reported out of Committee.
The proposed legislation extends HOEPA protections to a greater
number of high-cost mortgage transactions, restricts additional abusive
practices in connection with high-cost lending, and strengthens
consumer rights and legal remedies. Moreover, the proposed legislation
balances curbs that are need to deter the abusive lending without
cutting off the legitimate access to credit that helps families of
modest means to move up the economic ladder.
Also, since predatory mortgage lending appears, in many respects,
to be a fair lending problem, legislation is needed to make the Equal
Credit Opportunity Act (ECOA) a more effective tool in this area. In
particular, ECOA should be amended to explicitly prohibit ``reverse
redlining'' (that is, the discriminatory steering of inferior loan
products to neighborhoods disinvested by prime lenders). Tougher
penalties for those lenders who persist in engaging in these practices
are also needed. Representative LaFalce has introduced legislation in
the House of Representatives that addresses both of these points (H.R.
1053). Mr. Chairman, we urge you to introduce similar legislation in
the Senate.
Providing Additional Federal Funding of Home Mortgage Counseling
Virtually everyone associated with mortgage lending, both industry
and consumer and community organizations alike, agree that
understanding the terms of a home loan and taking the time to shop
around for the best available loans are critical steps that borrowers
must take to avoid being victimized by predatory lenders. This is
especially true for borrowers in the subprime mortgage market since a
substantial number of these may qualify for less expensive, prime
mortgages.
The borrowers who have access to qualified premortgage loan
counseling are less likely to enter into loans they cannot afford.
Current law requires certain categories of these borrowers, such as
recipients of HUD's Home Equity Conversion Mortgage program (HECM) to
receive preloan counseling. However, a substantial gap in qualified
counseling exists, especially for those homeowners most vulnerable to
being victimized by predatory lenders.
Congress should require lenders to recommend certified housing
counseling to all high-cost loan applicants. Additional Federal funding
should be provided to increase the availability premortgage loan
counselors. These funds should be targeted to borrowers and communities
most susceptible to predatory lending.
Encouraging the Expansion of Prime Lending In Underserved Communities
The lack of competition from prime lenders in low income and
minority neighborhoods increases the chances that borrowers in these
communities are paying more for credit than they should. According to
HUD research, higher income African-American borrowers rely more
heavily on the subprime market than low income, white borrowers which
suggests that a portion of subprime lending occurs with borrowers whose
credit would qualify them for lower cost prime loans. There is also
evidence that the higher interest rates charges by subprime lenders
cannot be fully explained solely as the function of the additional risk
they bear (for example, Fannie Mae has estimated that one-half and
Freddie Mac has estimated that 10 to 35 percent of subprime borrowers
could qualify for lower cost loans). Thus, a greater presence by
mainstream lenders could possibly reduce the high interest and fees
currently being paid by the residents of underserved areas.
One of the problems that may contribute to the misclassification of
borrowers is that by and large financial institutions do not have
adequate processes in place to refer-up borrowers who qualify for prime
credit from their subprime affiliates to mainstream banks and thrifts.
Expanding the universe of prime borrowers would help to curb predatory
lending.
Accordingly, Congress should urge the Federal banking regulators to
use authority under the Community Reinvestment Act and other laws to
``promote'' borrowers from the subprime to the prime market, while
penalizing lenders who make predatory loans. Moreover, the Federal
Reserve Board should utilize the authority it has under the Gramm-
Leach-Bliley Financial Modernization Act to conduct examinations of
subprime lenders that are subsidiaries of bank holding companies where
it believes that such entities are violating HOEPA or otherwise
engaging in predatory lending.
Improving Loan Data on Subprime Lending
Despite the explosive growth in subprime mortgage lending over the
past several years, there is no consistent, comprehensive source of
data on where those loans are being made geographically, by which
lenders, and to what types of borrowers. In truth, the data collection
requirements of the Federal Government have failed to keep up with
these trends.
Virtually all of the research to date is based on a list of
subprime lenders compiled, on his own initiative, by an enterprising
researcher at HUD. The Federal Reserve Board, HUD, and other
Governmental agencies, as well as lenders, academics use this list, and
anyone else interested in the field. Lenders on the list are classified
as subprime if they identify themselves as such. All loans reported by
those lenders are counted as subprime, and no loans reported by lenders
that do not identify themselves as subprime are counted. Further, HUD
is under no mandate to compile this list, and should it cease to do
this, there would be virtually no future information available about
where and to whom they are going. This is the best information
available on subprime lender, and nobody thinks that it serves the need
adequately.
The Federal Reserve Board has proposed to amend the Home Mortgage
Disclosure Act regulations (with which this information about subprime
lenders is combined). The Fed's proposal would, among other things,
collect and disclose information on the annual percentage rates of
loans reported, and indicate whether a particular loan was classified
as a HOEPA loan. The proposal would also revise the rules to ensure
that some large, nondepository subprime lenders, not currently covered
under HDMA, would be required to submit annual reports on their loan
activities. Unfortunately, the Fed has yet to finalize these rules.
Accordingly, Congress should adopt legislation requiring more
systematic reporting by lenders under HMDA on their subprime lending
activities. In addition to revising ECOA, the LaFalce bill (H.R. 1053)
I referenced previously amends HMDA to require reporting on subprime
lending. It also provides HUD with the necessary authority to impose
civil money penalties to enforce compliance with HMDA by nondepository
lenders, similar to the authority banking regulators have for banks and
thrifts. The lack of reporting by many nonbank financial institutions
has hindered the ability of regulators to track lenders that may engage
in abusive lending. Providing HUD with the necessary statutory
authority in this area also would establish a more level playing field
between depository and nondepository mortgage lenders.
We believe that similar legislation should be introduced in the
Senate as well.
The Federal Government Should Take Steps to Prevent the Secondary
Market
From Supporting Predatory Lending
Ultimately predatory lending could not occur but for the funding
that is provided by the secondary market to finance these loans. The
rapid rise in subprime lending that has occurred in recent years was
possible because many of these loans were purchased in the secondary
market either whole or through mortgage-backed securities (about 35
percent of subprime loans by dollar volume in 1999 was securitized).
While the secondary market to some extent has been part of the
problem connected with predatory lending, it can become an important
part of the solution. The refusal by the secondary market to purchase
or securitize loans with abusive features, or to conduct business with
lenders that originate such loans could curtail their liquidity and
thus, reduce their profitability.
Last year, Fannie Mae and Freddie Mac, the two Government sponsored
housing enterprises, pledged not to buy loans with predatory features.
HUD acted further to discourage the GSE's from purchasing predatory
loans, when it also elected to disallow the GSE's from receiving credit
toward fulfillment of their affordable housing goals for the purchase
of loans with predatory features. The GSE's pledges and the provisions
in the Affordable Housing Goals rule must be monitored to ensure that
the two enterprises are living up to their commitments.
However, the GSE's constitute a relatively small share of the
subprime market and unfortunately, other secondary market players have
been less willing to adopt similar corporate policies against predatory
lending. HOEPA provides that purchasers or assignees of mortgages
covered by that statute are liable for violations unless ordinary due
diligence would not reveal them as such. Similarly, Section 805 of the
Fair Housing Act makes the secondary market potentially liable for
financing discriminatory loans.
Consequently, the secondary market institutions appear to have
taken at least some notice of their potential legal liability for the
purchase of high-cost loans involving HOEPA violations. However,
because HOEPA loans represents such a small share of the highcost loan
market and discrimination claims are difficult to prove, these
developments have not yet resulted in across the board vigilance and
screening by the secondary market that makes an impact by constricting
the funding pipeline for predatory lenders.
Expanding HOEPA coverage to a greater share of the market and
clarifying that parent companies are liable for the sins of their
subprime affiliates (a provision contained in the Sarbanes and LaFalce
bills) could encourage loan purchasers to develop the necessary due
diligence to filter out abusive loans from their business activities.
Expanding liability in this area is critical given the recent influx of
many of the Nation's largest financial institutions into the subprime
market. Unfortunately, some of the subprime lenders acquired by these
giant entities are being sued or otherwise have been exposed for their
connection to predatory lending practices. Establishing that parent
companies and officers of lenders, or subsequent holders of loans by
contractors, or liable for the predatory practices of originators would
encourage these mega-financial institutions to develop the necessary
internal controls to deter abusive loan practices.
We urge this Committee and the Congress to move decisively in the
areas we have identified. It will take such comprehensive action by the
Federal Government to curb the predatory lending problem.
Thank you Mr. Chairman for the opportunity to provide our views on
this subject.
STATEMENT OF JEFFREY ZELTZER
Executive Director, National Home Equity Mortgage Association
July 26, 2001
Chairman Sarbanes and Committee Members, I am Jeffrey Zeltzer, the
Executive Director of The National Home Equity Mortgage Association
(``NHEMA'').\1\ I appreciate the opportunity to provide NHEMA's views
on how to stop inappropriate mortgage lending practices that many now
call ``predatory lending.'' NHEMA abhors abusive lending and wants it
stopped. We advocate a multitrack strategy for stopping these abuses:
(1) tougher enforcement of existing laws; (2) voluntary industry self-
policing by such things as adopting ``Best Lending Practices''
Guidelines; (3) greatly enhanced consumer education programs; (4)
broad-based reform and simplification of RESPA and TILA requirements;
and (5) targeted legislative reforms where appropriate to address
specific abusive practices. Subsequently, we will comment further on
each of these areas.
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\1\ Founded in 1974, NHEMA serves as the principal trade
association for home equity lenders. Our current membership of
approximately 250 companies employs tens of thousands of people
throughout the Nation and underwrites most of the subprime consumer
mortgage loans.
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Subprime consumer mortgage lenders are performing an extremely
important service by making affordable credit available on reasonable
terms to millions of Americans who otherwise could not easily meet
their credit needs. Before the subprime market became well established
over the past decade, consumers in many underserved markets often found
it difficult, if not impossible to obtain credit. Today, virtually
every American has the opportunity to obtain mortgage credit at fair
and reasonable prices. We are very proud that our industry has played a
key role in democratizing the mortgage credit markets and in helping so
many consumers. We also are deeply troubled both by the continued
existence of abusive lending practices in the subprime marketplace and
by the unintended adverse consequences that are likely to arise if
corrective measures are not drafted with extreme care.\2\ NHEMA is
committed to helping eradicate such lending abuses that are harming too
many of our borrowers and undermining our industry's reputation. We
commend Chairman Sarbanes and the Committee for focusing attention on
this problem, and we pledge to work constructively with you to help
stop the abuses.
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\2\ Federal Reserve Board Governor Gramlich recognized many of
these points in a recent speech at the Board's Community Affairs
Research Conference: ``Studies of urban metropolitan data submitted
under the Home Mortgage Disclosure Act (HMDA) have shown that lower-
income and minority consumers, who have traditionally had difficulty in
getting mortgage credit, have been taking out loans at record levels in
recent years. Specifically, conventional home-purchase mortgage lending
to low income borrowers nearly doubled between 1993 and 1999. . . .
Much of this increased lending can be attributed to the development of
the subprime mortgage market. Again using HMDA data, we see a thirteen-
fold increase in the number of subprime home equity loans and a
sixteen-fold increase in the number of subprime loans to purchase
homes. The rapid growth in subprime lending has expanded homeownership
opportunities and provided credit to consumers who have difficulty in
meeting the underwriting criteria of prime lenders because of blemished
credit histories or other aspects of their profiles. As a result, more
Americans now own a home, are building wealth, and are realizing
cherished goals. . . . However, this attractive picture of expanded
credit access is marred by those very troubling reports of abusive and
unscrupulous credit practices, predatory lending practices, that can
strip homeowners of the equity in their homes and ultimately even
result in foreclosure. . . . Though we have held discussions on the
different categories of subprime loans, the credit profiles of
vulnerable borrowers, and the marketing and underwriting tactics that
predatory lenders employ,
we find that the absence of hard data inhibits a full understanding of
the predatory lending problem. Exactly what are the most egregious
lending practices? How prevalent are they? How can they be stopped?
Absent the available data and the analysis and relationships they re-
veal, rulemakers and policymakers are challenged to ensure that their
actions do not have unintended consequences. We are mindful that
expansive regulatory action intended to deter
predatory practices may discourage legitimate lenders from providing
loans and restrict the access to credit that we have worked so hard to
expand. . . .''
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Although there is little quantitative data to document the
prevalence of such problems, we know that some abuses are occurring,
and NHEMA believes that they must be stopped. None of our borrowers
should be preyed upon and risk losing their homes by even a few
unscrupulous mortgage brokers, lenders, and home improvement
contractors. Having devoted a great deal of time and resources to
addressing these concerns, we are convinced that there is no single,
simple ``silver bullet'' solution to prevent abusive or improper
practices that some parties are perpetrating on unsuspecting and often
unsophisticated borrowers. Before discussing our five part strategy for
preventing mortgage lending abuses, we want to first share some general
information and observations that we believe will be helpful to the
Committee's understanding of the predatory lending issue and the
subprime segment of the mortgage market.
Background
What is ``Predatory Lending?'' While there is no precise definition
of the term ``predatory lending,'' it is generally recognized as a term
that encompasses a variety of practices by home improvement contractors
and mortgage brokers and lenders that are abusive, grossly unfair,
deceptive, and often fraudulent. These practices include such things as
unreasonably high charges for interest rates, sales commissions
(points) and closing costs, imposing loan terms that are unfair in
particular situations, and outright fraudulent misrepresentations. In
recent years, the label ``predatory'' has been used in recognition of
the fact that some of the perpetrators literally prey upon the elderly,
the less affluent, and more vulnerable homeowners, including in some
cases, minorities.
``Subprime Lending'' vs. ``Predatory Lending'' While abusive
practices do in fact occur to some extent in all types of consumer
credit transactions, including the so-called ``prime'' or
``conventional'' mortgage market, it appears some abuses are
concentrated more heavily in the subprime market segment. Regrettably,
this occurrence has undoubtedly caused some people to confuse
``subprime'' and ``predatory'' lending. It is critically important that
Congress fully understand that subprime mortgage lending should not be
equated with ``predatory.'' Subprime loans are a wholly legitimate and
an absolutely vital segment of the broader mortgage market. Between 10
percent to 15 percent of all U.S. mortgages fall within the subprime
category. Roughly 50 percent of subprime loans are originated through
mortgage brokers, with the remainder coming from retail sales by
lenders.
``Subprime'' is the term that generally is used to refer to loan
products that are offered to borrowers who do not qualify for what are
called ``prime'' or conventional products. Prime mortgage borrowers
have more pristine, ``A'' grade credit, are considered less risky and
accordingly qualify for the lowest available rates. Borrowers whose
qualifications are below the ``prime'' requirements are usually
referred to as ``subprime'' and have to pay somewhat higher rates as
they are viewed as being higher credit risks. Most subprime mortgage
loans are made to people who have varying degrees of credit
impairments. We want to emphasize, however, that many borrowers with
``A'' grade credit do not automatically qualify for prime mortgage
rates because credit is not the only factor considered in underwriting
a loan. Other issues, such as the amount of equity that the borrower
has to invest in the property (the ``loan-to-value ratio''),
nonconforming property types, one's employment status or the lack of
adequate loan documentation often prevent borrowers from qualifying for
a prime mortgage product.
Unlike the relatively limited number of prime loan products, there
are a wide variety of subprime products and rates, which reflect the
more customized, risk-based pricing underwriting of the subprime market
segment. Lenders in the subprime market usually offer mortgages in
categories broadly described as ``A-minus,'' ``B,'' ``C,'' and ``D.''
(Many lenders have numerous subcategories with graduated prices within
each of these general categories.) The majority of subprime loans,
roughly 60-65 percent, fall into the ``A-minus'' range and have
interest rates only moderately higher than prime loans. Another 20-25
percent qualify as ``B,'' which have a few more credit impairments and
slightly higher rates to reflect more risk. The remaining 10-20 percent
tend to be mostly ``C'' grade loans, which have substantially more
credit defects, and a small percentage of ``D'' loans, which present
the highest credit risks.
It is important to understand that while subprime borrowers present
higher risks, and accordingly must be charged higher rates to reflect
those risks, they still generally are good customers who remain current
in their mortgage payments. They do, however, require a higher level of
loan servicing work to help keep them on track, and this also entails
higher costs to the lenders, which must be reflected in loan pricing.
Who are the subprime borrowers? Many media stories relating to
abuses in the subprime market have left people with a misimpression
that most subprime borrowers are elderly, minorities, very poor, and
likely to be unable to repay their loans, and therefore are destined to
lose their homes in foreclosure. In fact, the typical subprime customer
is totally different from this stereotype. The overwhelming majority of
subprime borrowers are white, not minorities. They are mostly in their
40's, with only a small percentage over 65 years old. And, their
incomes typically range between $50,000 and $60,000 per year. Most
repay in a timely manner, and the foreclosure rate is only somewhat
higher than that for prime loans. The subprime borrower's profile is
basically that of a ``prime'' borrower, and it is one's credit record,
not age or race, that is the main distinguishing factor. NHEMA
commissioned a study last year by SMR Research, which is one of the
Nation's leading independent mortgage market research and analysis
firms, to review subprime lending. SMR's report, which we are providing
to the Committee's staff, offers additional details regarding our
market segment and customer characteristics.
Protecting Borrowers' Access to Credit
In sharp contrast to legitimate subprime or prime lending, some
unethical loan originators do engage knowingly in abusive lending
practices and many of these abuses are now often lumped together in the
term ``predatory lending.'' These abusive practices include a variety
of improper marketing practices and inappropriate loan terms. Sometimes
it is quite easy to identify predatory lending, but it often is much
more difficult to determine whether abuses are occurring. Moreover, a
number of the loan terms being attacked are not per se improper, but
can sometimes be used improperly.\3\
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\3\ Governor Gramlich, in a speech to the Fair Housing Council of
New York, aptly pointed out how wholly legitimate terms and practices
can be misused: ``. . . The harder analytical issue involves abuses of
practices that do improve credit market efficiency most of the time. .
. . Mortgage provisions that are generally desirable, but complicated,
are abused. For these generally desirable provisions to work properly,
both lenders and borrowers must fully understand them. Presumably
lenders do, but often borrowers do not. As a consequence, provisions
that work well most of the time end up being abused and hurting
vulnerable people enormously some of the time.''
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To illustrate this point, we want to highlight several loan terms
typically help consumers and are not per se abusive, yet many consumer
advocates now often seem to be alleging these terms are inherently
predatory:
Prepayment Fees--Many subprime loans contain terms that impose
a prepayment fee or penalty if the borrower pays off the loan
before the end of the agreed upon loan period. Some critics are
strongly attacking prepayment fees as predatory and unfair, and
some legislators have proposed prohibiting such fees. Are
prepayment fees abusive? Most of the time, absolutely not.
Prepayment fee clauses actually provide a major benefit to most
consumers because they allow the borrower to get a significantly
lower rate on the loan than they would get without the clause.
Prepayment provisions are very important in keeping rates lower and
helping make more credit available in the subprime market. Loans
are priced based on the assumption that they will remain
outstanding for some projected time period. If a loan is paid off
earlier, the lenders or secondary market investors who may buy the
loan cannot recover the upfront costs unless they address this
issue in the terms of the loan. Instead of charging a higher
interest rate or higher initial fees, lenders know it is usually
fairer and better for the borrower to have an early payment fee to
protect against losing these upfront costs. On the other hand, it
is certainly possible to have an abusive prepayment clause that
imposes too much of a penalty and/or that applies for too long a
time. The point here is that most of the time the consumer benefits
and the provision is not abusive. Sometimes, however, this
otherwise wholly legitimate provision can be applied in an abusive
manner. Again, the challenge for all of us is to find ways to
prevent the abusive application of such provisions without denying
the consumer the benefit of the provision, which applies in most
cases. With regard to prepayment provisions, this benefit can be
easily accomplished (for example, requiring that the borrower be
given an option of a product with and without the fee and limiting
the fee amount and the time it is applicable).
Arbitration Clauses--Some parties contend that loan terms that
require disputes between the lender and borrower to be arbitrated
are inherently oppressive and abusive. We strongly disagree with
such a general characterization of arbitration clauses. Yes, it is
certainly possible to structure a clause so that it is unfair. For
example, if a national lender operating in California required that
the arbitration always be conducted at the lender's headquarters in
New York, we think this is obviously unfair (and a court would
probably not enforce such a loan clause). On the other hand,
appropriately structured arbitration generally is recognized by
courts as an acceptable, fair alternative dispute resolution
procedure that frequently can benefit all parties. Arbitration
allows disputes to be resolved much more quickly and with less
expense than litigation. Arbitration clauses that meet certain
safeguards, such as restricting venue to where the property is
located and compliance with the rules set forth by a nationally
recognized arbitration organization, should not be deemed
inherently abusive.
In addition to preserving such loan terms that are legitimate,
NHEMA wishes to emphasize that attacks on certain lending practices are
unjustified. In particular, some consumer advocates criticize the
financing of points and fees by subprime lenders. We strongly believe
that their criticisms are not valid. Most subprime borrowers do not
have extra cash readily available to pay closing costs, so they
voluntarily elect to finance them in connection with the loan. Prime
borrowers often do the same thing. Subprime borrowers should not be
discriminated against and should be allowed to continue to finance such
costs. Why should they be forced to borrow money from other sources,
typically at higher, unsecured rates, to pay such necessary costs? In
many cases, it could prove very difficult, if not impossible, to obtain
the funds needed to pay such costs.
Legislators and regulatory officials have a difficult task in
balancing the competing and often conflicting considerations that arise
in this area. While wanting abuses stopped, NHEMA cannot overemphasize
the importance of moving very carefully and deliberately in addressing
the abuses because there is a great danger that new restrictions would
limit terms or practices that are generally helpful and desirable for
most consumers.
NHEMA believes that this Committee can make a tremendous
contribution by demonstrating how thoughtful legislators can sort
through the complexities involved and develop truly workable provisions
to the extent that additional legislation is needed as part of the
overall solution.
How Best Can Abusive Lending Problems Be Addressed?
Although NHEMA does not believe that abusive or predatory practices
are pervasive in the subprime mortgage sector, and we know that some
alleged problems are not necessarily real abuses, we recognize that
there are legitimate areas of concern. For example, ``loan flipping,''
which involves repeated refinancing of a mortgage in a relatively brief
period of time with little or no real economic benefit to the borrower,
does occur to some degree, and it should be stopped. Likewise, far too
many borrowers are victims of home improvement lending scams. Others
are required to pay excessive loan origination fees to mortgage brokers
or loan officers. Industry, regulators and legislators must work
together to find effective ways to stop such abuses. In doing so,
however, we must be very careful not to overreact and adopt
inappropriate restrictions that raise the cost of subprime mortgage
credit, or curtail credit availability to those who need it.
As mentioned earlier in our testimony, NHEMA believes that a
multitrack strategy must be taken to deal with these questions:
(1) Greater Enforcement of Existing Laws and Regulations--A
substantial portion of predatory lending abuses involve fraud
and deception that are clearly already illegal. In many cases
it also appears that some unscrupulous mortgage brokers and
lenders are disregarding current laws such as the Real Estate
Settlement Procedures Act (RESPA), the Home Ownership Equity
Protection Act (HOEPA), the Equal Credit Opportunity Act
(ECOA), and the Federal Trade Commission Act, which prohibits
unfair and deceptive practices. First, and foremost, we feel
that these laws, and related regulations, need to be enforced
more vigorously. Many abuses could be handled quite effectively
by better enforcement. The FTC has already brought a number of
enforcement actions involving most of the recognized predatory
lending practices under the existing HOEPA and the FTC Act, and
has obtained a handful of settlements. Obviously, the FTC
already has broad authority in this area. We hope that the FTC
will do much more to enforce these current laws to curtail
abuses. In addition, the Federal Reserve Board (FRB) is now in
the process of issuing enhanced HOEPA regulations. NHEMA has
provided information and comments to these and other regulatory
bodies and will continue to work with regulators to help
control abuses. NHEMA urges this Committee and the Congress
generally to support making whatever additional appropriations
are reasonably necessary to help Federal agencies enforce the
current laws and regulations more effectively. In addition, we
encourage the agencies to request additional funds if they need
them. It also is very important to remember that States have
various laws and regulations that apply to many of the
questionable practices. State regulatory officials and State
legislators need to consider how existing State laws and
regulations can be better enforced to prevent abusive lending
practices.
(2) Consumer Education--Helping Consumers to
``BorrowSmart''--Obviously, a key element of the problem is
that some borrowers, especially lower-income, less-educated
people, do not understand their mortgage loan terms. NHEMA's
number one priority is supporting the consumer's right of free
and fair access to affordably priced credit. That priority is
served by NHEMA's support of consumer education initiatives.
Educated consumers are good borrowers. They know how to avoid
unethical and abusive lending practices. They know how to get
the loan terms that work best for them. And they know how to
manage their money wisely and avoid running up new debt after
taking out a home equity loan. To educate consumers, NHEMA
created and supports the BorrowSmart Public Education
Foundation,\4\ a separate organization, which is undertaking a
number of education initiatives:
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\4\ Additional information concerning our BorrowSmart program and
educational materials is contained in Appendix A. Held in Senate
Banking Committee files.
BorrowSmart.org. This website will show consumers how the
home equity lending process works, offer tips for avoiding
abusive practices, provide borrowers with resources they can
turn to if they think they have been a victim of fraud of
misrepresentation, educate borrowers about their rights and
responsibilities and offer other valuable information.
Consumer Education Materials and Cooperation with Consumer
Groups--NHEMA has produced consumer brochures for distribution
by our member institutions to inform and educate borrowers
about the loan process, and the importance of smart money
management. We have distributed CD-ROM's with consumer
education materials to all our members so they can easily
reproduce and distribute them to their customers. NHEMA also
has worked to build education partnerships with consumer
groups. For example, we have published a joint brochure with
the Consumer Federation of America about the importance of
keeping credit card debt in check after taking out a home
equity loan to consolidate debt. The BorrowSmart Foundation is
now taking over producing such educational materials and in
working cooperatively with consumer groups.
In addition, NHEMA conferences, seminars, and publications
encourage association members to keep borrowers educated and
informed. Our goal is to keep home equity loans available as a
financial resource for all homeowners, while ensuring that
every borrower understands how to use that resource wisely and
effectively.
(3) Voluntary Actions--NHEMA has recognized that there is
much that industry can do voluntarily to help raise industry
standards and ensure that subprime mortgage lenders follow
proper practices. We have taken a proactive posture in this
area. In 1998, NHEMA adopted a new, enhanced Code of Ethics to
which our members subscribe. We also have adopted new Home
Improvement Lending Guidelines (1998) and Credit Reporting
Guidelines (2000). Last year, we adopted a particularly
significant measure--new comprehensive Fair Lending and Best
Practices Guidelines. These guidelines were the product of
months of study and analysis, and reflect input from a broad
cross-section of our membership. We believe that these
guidelines will be very helpful in improving overall industry
lending standards and practices. The guidelines provide a
useful baseline of what generally should be considered to be
appropriate lending practices and procedures.\5\
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\5\ Appendix B to this testimony contains a copy of NHEMA's Code of
Ethics and our various industry Guidelines. Held in Senate Banking
Committee files.
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(4) Comprehensive Legislative & Regulatory Reforms--NHEMA was
an active participant in the so-called Mortgage Reform Working
Group (MRWG), which began in the spring of 1997 and continued
to 1999. This group came together at the urging of key
Congressional leaders who wanted industry and consumer groups
to try to reach consensus on how the mortgage lending process
might be reformed. Participants spent literally thousands of
hours considering how mortgage lending might be improved. MRWG
participants included basically all relevant national trade
organizations and many consumer groups. Representatives from
HUD, the FTC, and FRB participated in many of the sessions.
Most MRWG participants agreed that there were various problems
with the present statutory and regulatory structure as it
applies to both prime and subprime mortgage lending. One of the
biggest problems identified was that current laws and
regulations are overly complex and often very confusing for
both borrowers and lenders. This makes it very difficult for
many consumers to understand what is occurring and to make
proper shopping comparisons. It also poses a host of compliance
burdens and uncertainties for lenders and mortgage brokers. A
number of the participants, including NHEMA, put forth various
reform concepts for discussion by the group, but no consensus
was reached, and the process essentially ended without any
resolution of the issues. Part of the reason that legislative
reforms could not be agreed upon was, and is, that these are
complex and difficult issues. For example, as noted earlier in
my testimony, many of the loan terms that some parties object
to are not necessarily abusive, and it is difficult to craft
restrictions that do not do more harm than good. In any case,
NHEMA believes that comprehensive reforms of current RESPA and
TILA mortgage lending provisions should be seriously considered
by Congress, and especially by this Committee. We are certain
that changes can be made to encourage more informed comparison-
shopping for home equity loans. Moreover, we believe that
Federal regulators can use their existing authorities to make
significant improvements. In addition to the FRB's ongoing work
regarding
additional HOEPA regulations, we want to point out that HUD has
authority to simplify and clarify many relevant policies and
regulatory provisions. We urge this Committee to encourage HUD
officials to utilize such authority, particularly as it relates
to reducing some of RESPA's burdensome and confusing
provisions.
(5) Carefully Crafted Legislation Targeted At Specific
Abuses--NHEMA originally proposed new legislative safeguards to
protect against particular abuses, such as loan flipping, as a
part of its 1997 comprehensive legislative reform proposals.\6\
We subsequently recognized that it might be easier to address
many of these concerns in a narrower bill focused on particular
practices.\7\ NHEMA has long said that new legislative
safeguards appear to be merited in some cases. On the other
hand, we have long voiced serious concern that many of the
proposals put forward by legislators have been overly broad and
would prohibit or unduly restrict perfectly legitimate lending
practices while attempting to limit perceived abuses. The old
saying that ``the devil is in the details'' is perhaps no place
so appropriate as in the context of legislation intended to
protect against predatory mortgage lending practices. We
implore this Committee to be certain that any legislative
proposals you may ultimately put forth have been carefully
vetted to ensure that they are clear and do not have the
unintended effect of curtailing legitimate lending practices
instead of being targeted to stop only the abusive ones.
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\6\ NHEMA's 1997 comprehensive outline of proposed legislative
reforms is attached as Appendix C. Held in Senate Banking Committee
files.
\7\ NHEMA's staff developed and widely circulated a working draft
of a possible model targeted legislative proposal in 1999, a copy of
which is attached as Appendix D. Held in Senate Banking Committee
files.
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Ten Key Issues for the Committee's Consideration
Given our ongoing efforts to stop abusive lending practices and our
knowledge of the subprime marketplace, we believe it is helpful to
highlight 10 key questions and considerations that Congress may wish to
explore as you grapple with predatory lending concerns:
(1) What loans should be made subject to special protections?
The present regulatory approach contained in the so-called
HOEPA provisions of the Truth In Lending Act, essentially
targets only the most costly loans made to higher risk
borrowers. Under HOEPA, loans that have a rate that is more
than 10 percent over a comparable Treasury bill rate, or that
have certain loan fees and closing costs that exceed 8 percent
of the loan amount or a minimum dollar amount, are subject to
special protections. These enhanced safeguards include special
disclosures and some specific substantive restrictions (for
example, no balloons less than 5 years in duration). Typically,
most legislative proposals
to address predatory lending, including that put forth earlier
by Chairman Sarbanes, have proposed lowering the levels of both
the rate and the point/fee triggers. In addition, proposals
generally would change the definition of what items must be
included in calculating the point/fee trigger amount. The
effect of this computational change is to cause a dramatic
increase in the number of loans that hit this second trigger
level. NHEMA recognizes that Congress might conclude that some
modest trigger reductions may be appropriate. However, we see
no justification for sweeping in essentially all subprime loans
(and many prime ones) as is frequently suggested in legislative
proposals. Many lenders will not make HOEPA loans, which
unfortunately have developed a very negative stigma, due to the
very real reputational and legal risks involved. We fear that
any significant expansion HOEPA's coverage will result in many
lenders withdrawing from offering covered products and this
will have a very negative impact on credit costs and
availability. Moreover, we believe that abuses tend to be
concentrated primarily in the highest risk grades which is
where legislation should be targeted.
(2) How might ``loan flipping'' be prevented? Without
question, ``loan flipping,'' which involves the frequent
refinancing of a mortgage loan with the borrower receiving no
meaningful benefit and typically having to pay significant
refinancing fees, is one area where abuse does exist and where
existing laws do not appear adequate to prevent it. Various
approaches have been proposed to remedy this problem. Most
suggestions have tended to apply special safeguards when a loan
is refinanced within 12 months or some other relatively brief
time period. The suggested restrictions include, for example:
prohibiting or limiting the amount of sales commissions
(points) that can be charged; requiring that the borrower
receive a benefit from the refinancing; or allowing points to
be charged only to the extent they reflect new money actually
advanced to the borrower. NHEMA feels that when considering
this issue, legislators need to recognize that many borrowers'
views of what constitutes a benefit to them differs from what
some of the industry's critics believe. Thus, most borrowers
who obtain a loan for debt consolidation purposes consider it
to be a very real and often critically important benefit to be
able to lower their monthly payment even if they will have to
pay more money over a longer period of time. Another important
point to note is that some of the tests that have been proposed
(that is, requiring a ``net tangible benefit'') are hopelessly
vague and certain to foster costly litigation. Legislators
therefore need to develop simple, clear tests in any new
provisions.
(3) How should a provision be crafted to ensure a borrower's
repayment ability is properly considered before a loan is made?
Lenders normally carefully review a borrower's credit record
and economic situation to ensure that the borrower can repay
the loan. In some instances, however, lenders may make the loan
more on the basis of the value of the collateral property than
on the borrower's ability to repay without reference to the
underlying asset. Such asset based lending can lead to loan
flipping and may eventually end in the borrower's losing his or
her home in foreclosure. HOEPA currently contains a provision
that prohibits lenders from engaging in a pattern and practice
of lending without proper regard for repayment ability. If the
Committee revises present law by removing the pattern and
practice requirement, we urge that it do so in a simple and
straightforward manner. Traditionally, many lenders have
employed a 55 percent debt to income test, but if any such test
is embodied in statute, it is important to make it clear that
no presumption of a violation arises merely because such a test
is not met. We also do not believe that it is necessary to try
to employ some complex formula regarding residual income as
some have suggested.
(4) How should single-premium credit insurance be treated?
Some lenders have offered customers various credit insurance
products that are sold on a single-premium basis where the cost
is typically assessed at the time of loan closing and this cost
is financed along with other closing costs. While those who
sell such credit insurance generally have defended it as a
valuable, fairly priced product, many consumer advocates
strongly attack such single-premium products. Recently several
major lenders have announced that they are ceasing to offer
such single pay products. Some have suggested that the
continued sale of single-premium insurance should be allowed,
provided certain safeguards are met such as: requiring that the
borrower be offered a choice of a monthly pay policy instead of
a single pay product; requiring additional special disclosure
notices relating to the product; and giving the borrower a
right to cancel with a full refund for some period of time and
thereafter the right to cancel with a refund based on an
actuarial accounting method. Many companies believe that if
additional restrictions are adopted they should, at a minimum,
allow for the sale on credit insurance on a monthly pay basis.
(5) How might safeguards be crafted to ensure certain
legitimate loan terms are not misused? Many predatory lending
proposals would prohibit or severely restrict certain loan
terms. Some of these terms, such as prepayment penalties, are
not necessarily unfair or inappropriate. Quite to the contrary,
some such terms are most often beneficial to the borrower.
Therefore, it is critically im-
portant that any new limitations on loan terms be drafted so
that legitimate uses of the terms are not prohibited. For
example, prepayment penalties can
be structured so that the borrower must be given a choice of a
loan product with and without a penalty, and the amount of the
penalty and the length of
time it can apply also can be limited. By applying such
balanced and carefully drafted provisions, the consumer can
generally gain the significant benefit of lower rates by
accepting a penalty provision, while the lender can be
protected against loss of expected revenue on which the loan
pricing is based. Certain other terms, like balloon payments,
could be addressed with similar carefully crafted safeguards.
Balloon mortgage payments usually are very helpful for
consumers who need lower initial monthly payments for a period
of time and who reasonably expect to have higher income to meet
higher obligations later. A balloon provision allows many
first-time homebuyers to acquire their home. There is nothing
inherently wrong with using a balloon payment. On the other
hand, an abusive mortgage originator can structure a mortgage
with a balloon payment that some consumers can never expect to
be able to meet. This could force the borrower to refinance one
or more times, having the equity stripped out of his or her
home, and ultimately being forced to sell the home, or face
foreclosure. By contrast, still others, such as call provisions
or accelerating interest upon default, might be appropriately
prohibited outright.
(6) Should restrictions be imposed on subprime borrowers'
rights to finance loan closing costs? Mortgage loan closing
costs are usually substantial, amounting to several thousand
dollars, and many borrowers, especially those in the subprime
segment, do not have extra cash readily available to pay such
costs. Borrowers therefore generally finance the closing costs
and the amount of such costs are rolled into the loan and paid
off over an extended period of time. Some parties who have
sought to curtail subprime lending have proposed denying
consumers' the right to finance their closing costs. NHEMA
strongly objects to this unwarranted restriction. Subprime
borrowers would be seriously harmed by such discriminatory
treatment. Borrowers would have to obtain money to pay closing
costs by borrowing from more expensive unsecured sources, or in
some cases could not obtain the funds needed to close the loan.
(7) Are more special disclosures needed? Some have suggested
adding to the disclosures that currently apply to HOEPA loans.
NHEMA basically has no ob-
jection to enhancing some present disclosures. However, we do
have concerns about continuing to flood the consumer with
confusing, lengthy notices that most parties do not read, and
would not understand if they did. Again, care must be taken in
crafting any further notices (for example, special fore-
closure warnings) to ensure that they are clear, simple, and
actually helpful to borrowers.
(8) Can home improvement lending scams be prevented? It is
well recognized that a great amount of the abuse in the
subprime marketplace comes from home improvement lending scams.
Vulnerable borrowers are suckered into loan transactions
relating to home repairs and other improvements that are never
made, or if made are not completed properly. HOEPA requires
that home improvement loan disbursements must be made by checks
that are payable to both the borrower and the contractor, or at
the borrower's option to a third party escrow agent. NHEMA has
also issued voluntary guidelines in this area. We urge the
Committee to investigate whether there may be other viable
restrictions that should be applied to prevent abuses in the
home improvement area.
(9) Should customers be forced to submit to mandatory credit
counseling? Some parties argue that all subprime customers
should be required to submit to counseling sessions with a
professional credit counselor. Although NHEMA strongly supports
making counselors available to all customers and encouraging
borrowers voluntarily to consider meeting both with a
counselor, we do not support mandatory counseling in the case
of all subprime loans. Mandatory counseling clearly is not
necessary for most customers, and many would find it offensive
to have to submit to counseling. Moreover, in many areas there
is a serious shortage of qualified counselors, so such a
requirement would unduly delay the loan process.
(10) What must be done to achieve more uniform nationwide
rules against abusive practices? \8\ Last, but certainly not
least, is the issue of Federal preemption. For most of NHEMA's
members, the single biggest concern over predatory lending
legislation arises because of the dozens of differing proposals
that are constantly being put forth at the State and local
levels. This year, we already have differing bills in thirty-
odd jurisdictions. We believe that it is critical that Congress
recognize that in today's nationwide credit markets, a uniform
Federal standard is needed for addressing predatory lending
concerns. Compliance with scores of differing State and local
rules in this area is impractical and unduly burdensome.
Federal preemption of differing State and local predatory
lending measures is badly needed.
---------------------------------------------------------------------------
\8\ Although this list is limited as a matter of priority and
convenience to 10 items, certain other issues merit the Committee's
consideration. For example, industry today typically already reports
mortgage payment history data to credit bureaus. NHEMA thus supports
requiring lenders to provide such data periodically to the major
national consumer reporting agencies. We also have no problem with
providing for a modest increase in penalties for violations of an
amended HOEPA, but believe provisions should be added to allow lenders
to correct unintentional errors. Another concern that the Committee
might consider is the question of liability of secondary market
participants. It is extremely difficult, and usually practically
impossible, for secondary market participants to know if an abuse has
occurred unless it happens to be evident on the face of the loan
documents, which is rarely the case. An additional issue relates to the
degree to which brokers' roles and compensation should be disclosed,
and whether better licensing requirements are needed.
Mr. Chairman, these are difficult and complex issues. NHEMA trusts
that this Committee and your House counterpart will give them very
careful consideration, and we want to continue working in good faith
with you to explore further how to stop abusive lending and related
concerns. During this process, we encourage everyone to remember that
the democratization of the credit markets that subprime mortgage
lenders have helped achieve would be seriously undercut by most of the
pending legislative proposals which are well-intended, but which have
serious, unintended adverse consequences for needy borrowers.
Ultimately, we hope that agreement can be reached on a package of
reforms that will include workable provisions targeted to prevent
particular abuses, together with some simplification and streamlining
of current disclosure requirements and preemption of conflicting State
and local laws.
Thank you for this opportunity to present NHEMA's views.
PREDATORY MORTGAGE LENDING:
THE PROBLEM, IMPACT, AND RESPONSES
----------
FRIDAY, JULY 27, 2001
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:08 a.m., in room SD-538 of the
Dirksen Senate Office Building, Senator Paul S. Sarbanes
(Chairman of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES
Chairman Sarbanes. The Committee will come to order.
Today is the Senate Banking, Housing, and Urban Affairs
Committee's second day of hearings on predatory lending--the
problem, impact and responses.
Yesterday, we heard some very eloquent statements of the
problem from four Americans who worked all their lives to
attain the dream of homeownership, to build up a little wealth,
only to have it slowly, piece by piece, loan by loan, taken
away from them. These people were targeted by unscrupulous
lenders, often elderly homeowners who have a lot of equity in
their homes.
In the case of one lady from West Virginia, Ms. Podelco,
she actually took the proceeds of the insurance policy on her
husband's life, $19,000, and paid off the mortgage on her home.
She had the home free and clear, in a way a prudent thing to
do, although I guess a lot of smart financial people would have
said, no, you should have kept the mortgage and invested the
money.
But that is, I believe, a standard way of thinking for
lower income people. They get their home, it is free and clear,
it is theirs. There is nothing owed on it, and then they
started approaching her and soliciting her. She had some debts
and she wanted to do some improvements on the home. She took
out a loan. Then they came along, they refinanced that loan,
and then they refinanced that loan. And every time they did it,
they packed in the fees and the charges and everything. Her
loan obligation rose and, in the end, in just a few years, she
lost her home. That is what we are trying to get at. She was
refinanced six times in about a 2 years period.
What struck me about these four stories were that many of
the practices that harmed the witnesses are legal under
existing law. There have also been abuses that are not legal
and, of course, I strongly support action by regulators to use
their authority under existing law to expand protections
against predatory lending. I support stronger enforcement of
current protections by the Federal Trade Commission and others.
I applaud campaigns to increase financial literacy.
I want to particularly acknowledge Senator Corzine's
leadership in this effort. Chairman Greenspan actually gave a
speech just on this issue, and I am hopeful that we will be
able to help to put together with the industry, and with the
regulators, and with people sitting at this table and others, a
good program of financial literacy. I do not think that this
alone is the solution to this problem.
I also encourage and welcome industry's effort to establish
best practices. There have been a number of important
developments in that regard, and we certainly encourage others
to follow along.
I think those who take the position that stronger
regulatory and/or more aggressive enforcement of existing laws
will be adequate, have a special burden to carry, particularly
in light of yesterday's testimony, to make sure that regulatory
and enforcement tools are adequate to the job.
At a minimum, at the very beginning, I think they should be
supporting the Federal Reserve Board's proposed regulation on
HOEPA, as Ameriquest, who was here yesterday, has done, and now
as some other financial institutions have undertaken to do. We
need to support the Fed's effort to gather additional
information through an expanded HMDA, and the regulatory
enforcement and enforcement agencies, such as the FTC, the
Treasury, and HUD, in their recommendations for more effective
enforcement.
But, as I said, I do not think stronger enforcement,
literacy campaigns, best practices alone are enough. Too many
of the practices that we heard about in yesterday's testimony,
while extremely harmful and abusive, are legal. And while we
must pursue aggressively financial education, we need to
recognize that takes time to be effective, and thousands of
people are being hurt every day.
I would like to quote what Fed Governor Roger Ferguson said
in his confirmation hearing, ``Legislation, careful regulation,
and education are all components of the response to these
emerging consumer concerns.'' I subscribe to that view.
Before turning to my colleagues who have joined us for
their opening statements, and to the witnesses, I just want to
take a moment to explain the arrangements here this morning.
First of all, we had far more requests to testify than we
really could accommodate. A number of groups and organizations
and companies asked to come in--the Center for Community
Change, the Neighborhood Assistance Corporation of America, the
National People's Action, Neighborhood Housing Services, the
National Neighborhood Housing Network, the Greenlining
Institute, America's Community Bankers, Assurant Credit
Insurance Company, Consumer Bankers Association, Consumer
Credit Insurance Association, the Realtors, and so forth.
We obviously could not accommodate everyone. I believe that
is apparent by the current crowded witness table. We have
offered to include statements from all of these groups who wish
to submit them in the record, as well as other organizations.
As we continue to explore and examine this issue, we may have
other opportunities for people to come in and actually appear
and to testify. I want to explain to our witnesses, we had
considered doing two panels. But it is a Friday. Members have a
lot of pressure on them at the end of the week, including the
necessity to get back to their States. We decided that we would
just put everyone at the table at the same time. We have tried
to mix you up a bit so you get to know people maybe you have
not met before.
[Laughter.]
We will encourage some dialogue at the table as a
consequence.
You have submitted very thoughtful statements. We
appreciate that. The full statements will be included in the
record. If each person could take about 5 minutes to summarize
and make their major points, we will go through the panel and
then we will have a question period. Often what happens, there
are a fair number of people around for the first panel. And by
the time you get to the second panel, a lot of people have
left.
If we do it this way, I hope it will work out. I know it is
somewhat crowded at the witness table and I apologize to you
for that, but I believe this will work out.
With that, I am going to yield to Senator Miller for any
opening statement he may have.
COMMENT OF SENATOR ZELL MILLER
Senator Miller. I do not have an opening statement, Mr.
Chairman but, again, I thank you for holding these hearings and
again, welcome to these witnesses.
We look forward to your testimony.
Chairman Sarbanes. Thank you. Senator Stabenow.
COMMENTS OF SENATOR DEBBIE STABENOW
Senator Stabenow. Well, thank you, Mr. Chairman. And again,
thank you for holding this important hearing. I think yesterday
was a very important and moving opportunity to hear from
witnesses directly about their experiences.
I will submit a full statement for the record. I just want
to welcome all of the panelists. I see a lot of familiar faces.
I want to particularly recognize Tess Canja, who hails from my
hometown in Lansing, Michigan. Before she was the esteemed head
of the AARP, we actually started together--I will not say the
date--in working on issues related to seniors and an effort to
save a nursing home in Lansing, Michigan, which got me into
politics.
We now both find ourselves here in Washington focusing
again on seniors and important issues. So welcome, Tess. And to
all of the esteemed panelists, I look forward to hearing from
all of you about what I think is an incredibly important topic,
and I hope that we will have the opportunity to move in a way
that makes sense to really address these issues.
Chairman Sarbanes. Well, we will consider giving Ms. Canja
a couple of extra minutes so that she can tell us about Senator
Stabenow in her earlier years, yes.
[Laughter.]
Senator Stabenow. That is all right, Mr. Chairman.
[Laughter.]
Senator Corzine. You ought to put her under oath on that.
[Laughter.]
Chairman Sarbanes. Senator Corzine.
STATEMENT OF SENATOR JON S. CORZINE
Senator Corzine. Senator Sarbanes, Mr. Chairman, you know
how strongly I feel about this issue. The literacy initiatives
are one step, and enforcement certainly is. And as you talked
about, some element of legislative action I think is necessary.
The stories we heard yesterday, which we must acknowledge
are anecdotal, I think are indicative of a serious market
problem that we have. And it is something that I hope we can
try to cut down to the key elements so that we can be as
precise as possible.
It is a difficult issue to define, but it is clearly a
problem. And I thank all of the witnesses here. We should have
sold admission and we would have had all of our budget taken
care of for years.
[Laughter.]
Thank you all very much for being here.
Chairman Sarbanes. I will introduce the panelists one by
one
as we turn to you to speak, instead of taking the time to
introduce everyone right at the outset.
Our first panelist will be Wade Henderson, who is the
Executive Director of the Leadership Conference on Civil
Rights, the Nation's oldest, largest, and most diverse
coalition of organizations committed to the protection of civil
rights in the United States.
The Leadership Conference on Civil Rights has played an
active role in increasing awareness of predatory lending
practices and its impact on the civil rights community.
We have interacted with Mr. Henderson on many issues that
are on the agenda of this Committee and we always appreciate
his very positive and constructive contributions.
Wade, we would be happy to hear from you.
STATEMENT OF WADE HENDERSON
EXECUTIVE DIRECTOR, LEADERSHIP CONFERENCE
ON CIVIL RIGHTS
Mr. Henderson. Well, thank you, Mr. Chairman, and good
morning to the Members of the Committee. I am pleased to appear
before you today on behalf of the Leadership Conference to
discuss this very pressing issue of predatory mortgage lending
in America.
Some may wonder why the issue of predatory lending raises
civil rights issues. But I think the answer is quite clear.
Shelter, of course, is a basic human need--and homeownership is
a basic key to financial viability. While more Americans own
their homes today than at any time in our history, minorities
and others who historically have been underserved by the
lending industry still suffer from a significant homeownership
gap.
Unequal homeownership rates cause disparities in wealth,
since renters have significantly less wealth than homeowners at
the same income level. To address wealth disparities in the
United States and to make opportunities more widespread, it is
clear that homeownership rates of minority and low income
families must rise. Increasing homeownership opportunities for
these populations is, therefore, central to the civil rights
agenda of this country.
Increasingly, however, hard-earned wealth accumulated
through owning a home is at significant risk for many
Americans. The past several years have witnessed a dramatic
rise in harmful home
equity lending practices that stripped equity from families
homes and wealth from their communities. These predatory
lending practices include a broad range of strategies that can
target and disproportionately affect vulnerable populations,
particularly minority and low income borrowers, female single-
headed households, and the elderly. These practices too often
lead minority families to foreclosure and leave minority
neighborhoods in ruin.
Today, predatory lending is one of the greatest threats to
families working to achieve financial security. These tactics
call for an immediate response to weed out those who engage in
or facilitate predatory practices, while allowing legitimate,
responsible lenders to continue to provide necessary credit.
As the Committee is aware, however, subprime lending is not
synonymous with predatory lending. And I would ask each of you
to remain mindful of the need for legitimate subprime lending
in the market.
Some have suggested, for example, that subprime lending is
unnecessary. They contend that if an individual does not have
good credit, then the individual should not borrow more money.
But as we all know, life is never that simple. Even hard
working, good people can have impaired credit, and even
individuals with impaired credit have financial needs. They
should not be doomed to a financial caste system, one that both
stigmatizes and permanently defines their financial status as
less than ideal.
Until a decade ago, consumers with blemishes on their
credit record faced little hope of finding a new mortgage or
refinancing an existing one at a reasonable rate. And
therefore, without legitimate subprime loans, those
experiencing temporary financial difficulties could lose their
homes and even sink further into red ink or even bankruptcy.
Moreover, too many communities continue to be left behind
despite the record economic boom. Many communities were
redlined when the Nation's leading financial institutions
either ignored or abandoned inner city and rural neighborhoods.
And regrettably, as I mentioned earlier, predators began
filling that void--the payday loan sharks, the check-cashing
outlets, and the infamous finance companies.
Clearly, there is a need for better access to credit at
reasonable rates and legitimate subprime lending serves this
market. I feel strongly that legitimate subprime lending must
continue, and therefore, we hope that we will not go back to
the days when inner city residents had to flee from finance
companies and others who preyed on them.
At the outset, I want to recognize that many persons and
organizations have really helped to advance this debate.
Yesterday, you heard from Martin Eakes of Self-Help, who is one
of the leaders in this effort. Maude Hurd, the President of
ACORN and her colleagues, have done a tremendous job. The
Nation Community Reinvestment Coalition and others have helped
to promote the idea of best practices and encourage the
industry to sit at the table. But in truth, they need help. It
is simply not enough.
Recent investigations by Federal and State regulatory
enforcement agencies, as you stated, Mr. Chairman, document
that lending abuses are both widespread and increasing in
number. You mentioned the Federal Trade Commission and the good
work they have done. We should also acknowledge the States
attorneys general who have taken out after these practices and
tried to address them in a significant way, and we encourage
the regulators to do more than they have done.
You have talked about the important work of the Fed. You
talked about the need for additional data under HMDA. All of
those things are necessary. But even if we got all of that,
they would still be insufficient.
Over 30 State and local efforts are currently pending and
as many as a dozen or more have recently been enacted to
address these problems. In my testimony, I list nine States and
local jurisdictions that have addressed these issues and I lay
out the kinds of steps that they have taken which I think are
significant, but, again, inadequate.
Notwithstanding that States have tried to fill the void, we
believe that more is needed and that the truth is State
legislation under the current scheme is primarily inadequate.
First, State legislation may not be sufficiently
comprehensive to reach the full range of objectionable
practices. And you mentioned that some of them are still legal
on the books today.
For example, while some State and local initiatives impose
restrictions on single-premium credit life insurance, others do
not. This, of course, leaves gaps in protection even for
citizens in some States that have enacted legislation.
Second, while measures have been enacted in some States,
the majority of States have not enacted predatory lending
legislation. And for this reason, the Leadership Conference
supports the enactment of comprehensive Federal legislation, of
the sort, Mr. Chairman, that you have introduced here in the
Senate.
The Predatory Lending Consumer Protection Act is the
standard that we think is necessary. We strongly support it and
we urge its swift enactment. Now one last point.
We have made efforts to address these issues on a voluntary
basis. We know that the industry is deeply concerned about the
problems of predatory lending and they want to disassociate
themselves from practices that would mark them as predatory.
So for those good lenders, we have made efforts to work
with them voluntarily and believing that there may have been an
opportunity for voluntary responses to these issues, several
national leaders within the prime and subprime lending
industry, also with the secondary market, join civil rights and
housing and community advocates and attempted under the
auspices of the Leadership Conference to synthesize a common
set of best practices and self-policies guidelines.
We achieved a lot of consensus on many issues. However, the
truth is, in the end, we failed to get consensus on some of the
most difficult issues which are now being discussed and being
addressed today, like credit life insurance.
And one of the reasons that we failed to get that consensus
is because many in the industry believe they could be insulated
politically from any mandatory compliance with Federal
legislation.
They were not fearful that the Congress would enact a bill
of a comprehensive nature and therefore, they were unwilling to
grapple with their own practices, even though they knew they
were questionable and created hardship on many communities. As
a result, our view is that only Federal legislation will be
sufficient.
I am going to end my testimony where I began--why subprime
lending? Why is its evil twin, predatory lending, a civil
rights issue? The answer can be found in America's ongoing
search for equal opportunity. After many years of difficult and
sometimes bloody struggle, our Nation and the first generation
of America's civil rights movement ended segregation. But our
work is far from over. Today's struggle involves equal
opportunity for all and making that a reality. Predatory
lending is a cancer on the financial health of our communities
and it must be stopped.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you very much. You made reference
to the State attorneys general and I should just note that we
had Tom Miller, the Attorney General for the State of Iowa,
here with us yesterday. He heads up the attorney general's
special task force on predatory lending and gave some very
strong testimony.
Two-thirds of the States' attorneys general have interceded
with the Federal Reserve in support of the regulation which the
Federal Reserve now has under consideration with respect to
this issue.
Next, we will hear from Ms. Judy Kennedy, the President of
the National Association of Affordable Housing Lenders.
I ought to note that over the past 11 years, the NAAHL has
worked quite successfully to infuse private capital investment
into low- and moderate-income communities by pioneering a
number of innovative community investment practices.
Ms. Kennedy, we are pleased to have you here.
STATEMENT OF JUDITH A. KENNEDY
PRESIDENT, NATIONAL ASSOCIATION OF
AFFORDABLE HOUSING LENDERS
Ms. Kennedy. Thank you, Senator. I am delighted to be here.
As you pointed out, NAAHL's members are a cross-section of
the pioneers of community investment--banks, loan consortia,
financial intermediaries, pension funds, foundations, local and
national nonprofit providers, public agencies, and allied
professionals.
In 1999, we held a conference in Chicago where Gail Cincada
and others informed us about predators' activities in that
city. We came to the conclusion then that if NAAHL is not part
of the solution to predatory lending, we will be part of the
problem. It is clear that while we are committed to increasing
the flow of capital into underserved communities, we must be
equally concerned about access to capital on appropriate terms.
So in March of this year, we sponsored a symposium that
brought together experts on this issue--regulators,
researchers, advocates, for-profit and nonprofit lenders, and
secondary market participants. We are issuing today that report
and I hope you have it before you--Juntos Podemos, Together We
Can.
Our goal was to accelerate progress in stopping the
victimization. As the Mayor of Chicago succinctly puts it, ``It
is all down the drain if we cannot stabilize the communities
that were stable until these foreclosures started to happen.''
Our findings are as follows, first, you can profile
predatory lending. It is clear.
Second, more needs to be done at the Federal level. More,
of course, is being done this year, in part, thanks to your
attention, Senator Sarbanes. But as Elizabeth McCaul, the New
York State Banking Commissioner, and you have emphasized, it is
critical to balance the need for credit with the need to end
abuses. NAAHL members have a history of tailoring credit to the
unique needs of low income households in underserved
communities. But as the Federal Reserve has pointed out, a
significant amount of mortgage lending is not covered by a
Federal framework. For example, Governor Gramlich reported that
only about 30 percent of all subprime loans are made by
depository institutions that have periodic exams. Some estimate
that as low as 15 percent of originators of subprime loans have
any reporting and examination. Even if the Fed were to do
periodic compliance exams of the subsidiaries of financial
holding companies, that would only increase the number to, at
best, 40 percent.
It is not surprising, then, that of the 21 completed
Federal Trade Commission investigations into fair lending and
consumer compliance violations, none were Federally examined.
If the Fed's recent proposal to expand reporting under the Home
Mortgage Disclosure Act to more lenders is adopted, it will
still encompass only those whose mortgage lending exceeds $50
million per year. Many of the other proposed changes to HMDA
that the Fed proposes which we supported will simply make the
playing field even less level by putting additional burdens and
costs on the responsible lenders while the worst lenders go
unexamined.
To stop the predators, the symposium confirmed, we need to
close the bar doors on examination and reporting of mortgages
in America. A level playing field in enforcement and reporting
is key. Right now, the institutions that you talk about that
have best practices in the subprime lending market do extensive
due diligence of their brokers to ensure fair lending
practices. They maintain data on those loans. They are
rigorously examined by the bank regulatory agencies. But the
majority of lenders in this market are not subject to
regulatory oversight, do not have the same level of compliance
management, and often do not even file HMDA reports. In a town
with no sheriff, the bandits are in charge. Unscrupulous
brokers who are rejected by legitimate lenders simply go to
others who have no knowledge of the loan terms or reputation or
compliance concerns about funding predatory loans.
Third, our symposium also confirmed that subprime lending
is an important source of home finance, and I think we agree on
that.
Fourth, we heard that vigorous enforcement at all levels of
Government works. We heard from people actively involved in
combatting predatory lending on the State and local level and
we think all of this will help to eradicate predatory lending.
Fifth, consumer education is key. We know that many
initiatives in the last year, some as a result of your
attention and some that preceded that, are making a difference.
But increased Federal resources for targeted counseling in
neighborhoods vulnerable to predators could greatly extend the
efforts of the private sector. As Martin Eakes points out, ``.
. . the Department of Education says that 24 percent of adult
Americans are illiterate.'' But targeted counseling could go a
long way.
Overall, our symposium confirmed once again that it is a
complex issue requiring a multifaceted solution. But as our
closing speaker, HUD Secretary Martinez, pointed out--juntos
podemos--together, we can.
As president of an organization whose members have spent
their careers trying to increase the flow of private capital
into under-served communities, I say, together we must.
Chairman Sarbanes. Thank you very much. I simply want to
note, I thought the symposium that you held out of which this
report emanated was a very important contribution toward a
deepening understanding of this issue.
Ms. Kennedy. Thank you, Mr. Chairman.
Chairman Sarbanes. I will now turn to Tess Canja, who is
President of the Board of Directors of the American Association
of Retired Persons, the AARP, which has for quite sometime now
taken a very strong campaign against predatory mortgage
lending, which disproportionately impacts seniors. Seniors are
clearly, from some of the statements that have been received
from people who work in the industry, a very heavily targeted
group.
I might note that only yesterday, in Roll Call, the AARP,
as part of its campaign against predatory lending, had this
ad--``They Didn't Tell Me I Could Lose My Home.'' And then it
details here being subjected to these pressure tactics and
high-cost loans that strip equity and then lead to foreclosure.
Ms. Canja, we would be happy to hear from you.
STATEMENT OF ESTHER `` TESS'' CANJA
PRESIDENT, AMERICAN ASSOCIATION OF RETIRED PERSONS
Ms. Canja. Thank you, Senator, and good morning. Good
morning to all of the Members of the Committee.
Thank you for showing that ad from Roll Call because we are
involved in a very big educational campaign and that is exactly
what we are calling it--They Didn't Tell Me I Would Lose My
Home--which is exactly what happens with predatory lending.
AARP appreciates this opportunity to bring into greater
focus one of the most troubling forms of financial
exploitation--namely, making unjustifiable, high-cost home
equity loans to older Americans. For most Americans, it takes
time to accumulate home equity. For many, it is a working
lifetime, so that equity become highly correlated with age. The
most abusive loans for older Americans are often refinancing
loans and home modification loans because they target the
equity value of the home. Equity in a home is frequently the
owner's largest financial asset. Abusive lending is
particularly devastating when the older homeowner is living on
a modest or fixed income.
In AARP's view, loans become predatory when they take
advantage of a borrower's inexperience, vulnerabilities, and/or
lack of information; when they are priced at an interest rate
and contain fees that cannot be justified by credit risk; when
they manipulate a borrower to obtain a loan that the borrower
cannot afford to repay; and when they defraud the borrower.
Older homeowners are often targeted for mortgage
refinancing and home equity loans because they are more likely
to live in older homes in need of repair, are less likely to do
the repairs themselves, are likely to have substantial equity
in their homes to draw on, and they are likely to be living on
a reduced or fixed income.
AARP's efforts to address these problems are directed at
improving credit market performance, not at limiting consumer
access to credit for those with a less-than-perfect credit
history. We believe that our, and other, consumer financial
literacy campaigns are very important. These public- and
private-sector efforts aim to make consumers their own first
line of defense. However, while consumer education and
counseling programs are necessary, they certainly are not
enough.
AARP believes there is a need to strengthen and expand
HOEPA's loan coverage. This upgrade will help to ensure that
the need for credit by subprime borrowers will be fulfilled
more often by loans that are subject to HOEPA's protections
against predatory practices. In this context, AARP has urged
the Federal Reserve Board to issue the final HOEPA amendment as
soon as possible.
Chairman Sarbanes, and Members of the Committee, the
problems associated with abusive home-equity-related lending
practices are complex and to date, agreement on a comprehensive
reform of the more mortgage finance system to address these
problems has proven elusive. We are, therefore, encouraged by
the Committee's continued efforts to call attention to
predatory mortgage lending and to establish effective
deterrence. AARP is committed to working with this Committee,
Congress, and the Bush Administration to address the problems
posed to the elderly by these devastating lending practices.
We thank you, and I will try to answer any questions you
may have later.
Chairman Sarbanes. Thank you very much. We appreciate your
testimony and we always appreciate working with AARP.
Our next witness will be John Courson, who is the President
and CEO of Central Pacific Mortgage Company in Folsom,
California, and the Vice President of the Mortgage Bankers
Association of America.
The Mortgage Bankers Association represents companies
involved in real estate finance, including mortgage companies,
mortgage brokers, and commercial banks. And this Committee
deals with a whole range of issues that encompass the concerns
of the Mortgage Bankers Association.
Mr. Courson, we are pleased to have you with us here today.
We look forward to hearing from you.
STATEMENT OF JOHN A. COURSON, VICE PRESIDENT
MORTGAGE BANKERS ASSOCIATION OF AMERICA
PRESIDENT AND CEO
CENTRAL PACIFIC MORTGAGE COMPANY
FOLSOM, CALIFORNIA
Mr. Courson. Thank you. Good morning, Mr. Chairman, and
Members of the Committee. Let me begin by saying that the
Mortgage Bankers Association and, indeed, all legitimate
lenders, unequivocally oppose abusive and predatory lending
practices. There is no hiding from the fact, however, that
certain rogue lenders continue to prey on our most vulnerable
populations.
We all agree that a significant problem exists and we all
share in the responsibility to address the problem. In
searching for answers, we should not focus on band-aids that
merely cover up the harms. Rather, we must work together to
find lasting solutions that will truly protect even the most
vulnerable consumers.
I know from the outset that predatory lending is not a new
problem. In fact, it has traditionally been referred to as
mortgage fraud. And I stress that those consumer laws that are
currently on the books--TILA, RESPA, HOEPA--are all aimed at
curing problems of fraud and abuses in lending. We must
recognize that these laws have existed for years and yet,
predatory lending has managed to survive. The fact that we are
holding this hearing today should wake us up to that reality.
MBA believes predatory lending is a problem that has a
number of sources. We believe there are three keys to effective
and lasting solutions. These are: enforcement, education and
simplification.
First, MBA believes that a general lack of enforcement has
done much to create an environment for unscrupulous lenders to
operate. Mortgage lending is among the most regulated of all
activities. It is subject to pervasive Federal and State
regulation.
For these laws to be effective, they need to be enforced.
We have long held and reaffirm our belief here that predatory
lenders gouge the public through techniques that constitute
outright fraud--concealment, forgery, deceptive practices, and
nondisclosure. We would note that these activities are against
the law in every single State. It is essential that we enforce
these laws to the maximum extent possible. Due to a current
lack of enforcement, there are often no consequences for those
who engage in predatory lending and we urge the allocation of
additional resources for enforcement.
Second, we believe that consumer awareness and education
are among the most effective tools for combatting predatory
lending practices. Simply put, consumers who have an
understanding of the lending process and who are aware of
counseling and other options are far less likely to fall prey
to unscrupulous lenders.
MBA is currently working on new programs designed to
educate consumers about the mortgage loan process. In
particular, we are developing interactive tools that will
empower borrowers confronted with predatory lending practices.
These tools will include important information advice, provide
typical warning signs of predatory lending, and have direct
links to State and Federal regulators that are able to assist
possible victims of abusive lending.
And third, the complexity of the current mortgage process
needs to be addressed. We need to streamline and simplify the
laws that govern consumer disclosures and protections, RESPA
and TILA.
Any consumer that has been through the mortgage process
knows how bewildering it is. No less than HUD Secretary
Martinez, who is not only an attorney, but a housing attorney,
has commented publicly that he was overwhelmed by the
complexity of the process that he went through when and his
family bought a house in Washington earlier this year.
Disclosures provided in the mortgage process are so cryptic
and so voluminous, that consumers do not understand what they
read or what they sign. This complexity is the very camouflage
that allows unscrupulous operators to hide terms and conceal
crucial information from unsuspecting consumers.
Partly because of his personal experience, Secretary
Martinez has made simplification and regulatory reform in this
area a priority. I hope that Congress will also address this
very important piece of the predatory lending issue.
In summary, MBA believes that we must address predatory
lending on three fronts--a commitment to full enforcement,
robust education, and simplification of existing laws. Nothing
short of that will suffice.
Thank you for the opportunity to appear this morning and I
look forward to answering your questions.
Chairman Sarbanes. Thank you very much, Mr. Courson. We
appreciate your coming.
We will now hear from Mr. Irv Ackelsberg, who is the
managing attorney at the Community Legal Services of
Philadelphia. Mr. Ackelsberg is recognized as one of the
leading public interest lawyers in the country, and he has been
involved, of course, in this predatory lending issue.
He is testifying today not only on behalf of his own
organization, but also the National Consumer Law Center,
Consumers Union, Consumer Federation of America, National
Association of Consumer Advocates, and U.S. Public Interest
Research Group.
Mr. Ackelsberg, we would be happy to hear from you.
STATEMENT OF IRV ACKELSBERG
MANAGING ATTORNEY, COMMUNITY LEGAL SERVICES, INC.
TESTIFYING ON BEHALF OF
THE NATIONAL CONSUMER LAW CENTER
THE CONSUMER FEDERATION OF AMERICA
THE CONSUMER UNION
THE NATIONAL ASSOCIATION OF CONSUMER ADVOCTAES
U.S. PUBLIC INTEREST RESEARCH GROUP
Mr. Ackelsberg. Chairman Sarbanes and Members of the
Committee, thank you so much for this invitation. This is
actually my first time doing this, so I am really thrilled to
be here.
Chairman Sarbanes. We put you right in the middle, as it
turned out.
[Laughter.]
Mr. Ackelsberg. Yes.
[Laughter.]
By way of personal introduction, I am a career legal
services lawyer. I have spent my entire 25 years as a lawyer
with Community Legal Services of Philadelphia, primarily as a
consumer law specialist. Because of the extremely high rate of
homeownership among low income communities in Philadelphia,
most of the work that I have done during the past 25 years has
been associated with protecting existing homeowners from loss
of their homes.
The predatory lending crisis is so devastating and so
widespread, that we are currently using six lawyers who are
working almost exclusively on defending predatory lending
victims in Philadelphia alone, and we cannot keep up with that
demand. There is no question that we are expending more
resources than any other legal service program in the country
on this problem, and we cannot keep up with it. We have just
set up, with the cooperation of the Philadelphia Bar
Association, a special predatory lending panel by which we will
be training private lawyers and working with them to teach them
how to do this work.
I believe that our office has probably reviewed more of
these transactions than any other law firm in the country and
it is from the hundreds of stories of victims that I draw most
of my experience. But I should also add that I have deposed
countless loan officers, brokers, title clerks, and I was the
principal trial counsel in the first reported case under HOEPA,
called Newton v. United Companies Financial.
I also, by the way, served on the official creditors
committee in the United Companies Lending Chapter 11
proceeding. I believe that I am uniquely qualified to speak to
you about the nature of the problem and the legislation needed
to remedy the problem.
First, just to supplement the written testimony on the
foreclosure explosion that was referred to in the written
testimony, just a few bits of data from Philadelphia.
Pennsylvania has a State emergency mortgage assistance
program that offers financial help to qualified homeowners
facing foreclosures. These are all foreclosures other than
FHA's.
In data obtained from the State agency that administers
this program, we found that in the year 2000, it received 740
applications for help from borrowers facing foreclosure in
Philadelphia. Of those 740 requests for help, 164, or 22
percent, involved threats of foreclosure from a single lender,
EquiCredit, the subprime subsidiary of Bank of America, which
at the moment, according to what we are seeing pouring into the
office, is the biggest problem.
Just this week, we looked at the sheriff 's sale listings
for the month of August. Every month, there is a list of the
sales. There is a monthly sale in Philadelphia. Forty houses
are being sold just by EquiCredit in the City of Philadelphia
in August. The undisputed explosion in foreclosure is indeed a
reflection of the predatory lending crisis. All across our
country, we have senior citizens, our mothers, our
grandmothers, who are anxious about their credit card debt and
bashful about talking about their finances. They are lonely,
and they are good, trusting people, all of which combine to
make them sitting ducks for a veritable parade of low-life
lenders, brokers, and contractors who are seeking to extract
what often is the only wealth that they have--their home.
There is a veritable gold rush going on in our
neighborhoods and the gold that is being mined is home equity.
This bleeding of wealth is not simply the result of market
forces. As we describe in our written testimony, there have
been critical Federal policies that have fueled the gold rush,
particularly the first lien usury deregulation of the 1980's
and the changes in the tax code that limited interest payment
deductions to only home equity interest.
There are also Federal policies that have undermined the
ability of lawyers to defend victims, most notably the Federal
Arbitration Act, which has been interpreted by the courts to
basically allow wholesale waiver of borrower's access to the
courts, and I might add, the restrictions in legal services,
which have basically made the work that I do virtually
impossible for Legal Services Corporation-funded programs. And
for that reason, we had to give up our funding from the Legal
Services Corporation to do this work.
The existing HOEPA triggers are too high, particularly the
points and fees trigger currently at 8 points. This allows the
predators to make costly loans just under those triggers.
Indeed, we are seeing 7 point loans, 7.9 points. We even saw
one last week that had exactly 8.0 of points.
But there is an upside to that fact. These loans used to
have 10 to 15 points. That means that the basic structure of
HOEPA is sound. It is doing good work. It is already functioned
to nudge down the cost of credit. Remember that the same
lenders who are warning you today that if you bring down the
triggers, credit will dry up, said the same thing 7 years ago,
that if you enacted HOEPA, there will be no credit.
Subprime credit did not disappear. It just got less costly,
and it needs to get less costly still. I hope within the
questioning period I will have the opportunity to discuss some
of the very specific aspects of S. 2415 which we believe will
be very helpful to those of us who are trying to save houses.
And in summation, I would just say, and I apologize if the
words seem inappropriately too strong, but these words come
from 25 years of experience.
I believe that predatory lending is the housing finance
equivalent of the crack cocaine crisis. It is poison sucking
the life out of our communities. And it is hard to fight
because people are making so much money. But we need Government
to join the fight with zeal and with smarts. S. 2415 has our
unconditional support.
Thank you.
Chairman Sarbanes. Thank you very much, sir.
We are being joined this morning by Senator Crapo. Mike, do
you have an opening statement?
COMMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you, Mr. Chairman. I do not have an
opening statement and in fact, I have to leave in just a few
minutes for a live interview. I hope to get back. I have read
about half of the testimony already and will read that which I
am not able to hear. But I appreciate your holding this
hearing. I look forward to working with you on the legitimate
problems that are identified and finding solutions that can
work for everybody.
Chairman Sarbanes. Thank you very much.
We will now hear from Neill Fendly, who is the immediate
Past President of the National Association of Mortgage Brokers,
NAMB. The NAMB provides education, certification, industry
representation, and publications for the mortgage broker
industry.
Mr. Fendly, we appreciate your being here with us this
morning.
STATEMENT OF NEILL A. FENDLY, CMC
IMMEDIATE PAST PRESIDENT
NATIONAL ASSOCIATION OF MORTGAGE BROKERS
Mr. Fendly. Thank you. Mr. Chairman and Members of the
Committee, I am the Immediate Past President of the National
Association of Mortgage Brokers, referred to as NAMB. This is
the first time that NAMB has testified in the Senate. We are
truly appreciative of the opportunity to address you today on
the subject of abusive mortgage lending practices.
NAMB currently has over 12,000 members and 41 affiliated
State associations Nationwide. NAMB members subscribe to a
strict code of ethics and a set of best business practices that
promote integrity, confidentiality and, above all, highest
levels of professional service to the consumer.
I would like to focus this testimony on helping the
Committee understand the important and unique role of mortgage
brokers in the mortgage marketplace and offer the unique
perspective of mortgage brokers in examining the problem of
predatory lending.
Today, mortgage brokers originate more than 60 percent of
all residential mortgages in America. Mortgage brokers are
critical to ensuring that people in every part of our country
have access to mortgage credit. Almost anyone can usually find
a mortgage broker right in their community that gives them
access to hundreds of loan programs. Mortgage brokers are
generally small business people who know their neighbors, build
their businesses through referrals from satisfied customers,
and succeed by becoming active members of their communities.
The recent expansion in subprime lending has also relied
heavily on mortgage brokers. Mortgage brokers originate about
half of all subprime loans. Many mortgage brokers are
specialists in finding loans for people who have been turned
down by other lenders.
Mortgage brokers often do an amazing amount of work on
these loans. I recently completed one such loan that took over
1 year from start to finish. They work with borrowers to help
them understand their credit problems, work out problems with
other creditors, clean up their credit reports when possible,
and review many possible options for either purchasing a home
or utilizing existing home equity as a tool to improve their
financial situation.
We know that mortgage credit is the least expensive source
of credit for those who may have made some mistakes or had some
misfortune in the past and now need money to improve their
home, finance their children's education, or even start a
business. They need to have the widest possible range of
choices when they are buying a home or need a second mortgage,
and today they do. It is important that Congress be very
careful to avoid measures that will deny people choices they
deserve and the tools they need to manage and improve their
financial situation.
One of the most important choices available to consumers is
the no- or low-cost loan which enables people to buy a home,
refinance, or obtain a home-equity loan with little or no cash
required up front for closing costs. These costs are financed
through an adjustment to the interest rate. Both mortgage
brokers and retail lenders offer these popular loans. When a
mortgage broker arranges a loan like this, the broker is
compensated from the lender from the proceeds of the loan. This
kind of payment goes by many names, but is often called a yield
spread premium. These payments are perfectly legitimate and
legal under Federal law, RESPA, so long as they are reasonable
fees and the broker is providing goods and services and
facilities to the lender. They must be fully disclosed to
borrowers on the good faith estimate and the HUD-1 settlement
statement, and are included in the interest rate. Retail
lenders, however, are not required to disclose their comparable
profit on a loan that is subsequently sold in the secondary
market as most mortgages are today.
Despite the great popularity of this loan with consumers,
today it is under assault in the courts. Trial lawyers across
America are pursuing class action lawsuits claiming such
payments to mortgage brokers are illegal and abusive. This is
despite Statement of Policy 1991-1, issued at the direction of
Congress by the Department of Housing and Urban Development in
1999, which clearly sets forth the Department's view that
yield-spread premiums are not, per se, illegal and must be
judged on a case-by-case basis.
Recently, the 11th Circuit Court allowed a class action to
be certified in one of these suits. This has resulted in a
flood of new litigation against mortgage brokers and wholesale
lenders and has caused a great deal of uncertainty and anxiety
in the mortgage industry. The cost of defending these class
actions is staggering. The potential liability could run over
$1 billion. The prospect of a court deciding that the prevalent
method of compensation for over half the mortgage loans in
America is illegal is chilling, to say the least.
If these lawsuits succeed, the real losers will be
tomorrow's first-time homebuyers, tomorrow's working families,
tomorrow's entrepreneurs who will not be able to get a mortgage
without paying hundreds of dollars up front. Further down the
road, many small business men and women will not be able to
stay in business as mortgage brokers without being able to
offer these no-cost loans. As competition decreases, all
potential mortgage borrowers will suffer higher costs and fewer
choices.
Mr. Chairman, this illustrates the unintended consequences
that can come from litigation, regulation, or legislation that
singles out one part of the mortgage industry, places blanket
restrictions on prohibitions of certain types of loans and
products, or unreasonably restricts interest rates and fees.
Virtually no loan terms are always abusive, and almost any
loan term that is offered in the market today can be beneficial
to some consumers. Whether a loan is abusive is a question that
turns on context and circumstances from case to case. This is
why NAMB and the mortgage industry have opposed legislation or
regulation that would impose new blanket restrictions or
prohibition on loan terms. We believe such measures will
increase the cost of homeownership, restrict consumer choice,
and reduce the availability of credit, primarily to low- and
moderate-income borrowers.
NAMB believes that the problem of predatory lending is a
three-fold problem: abusive practices by a small number of bad
actors; lack of consumer awareness about loan terms; and the
complexity of the mortgage process itself. We believe all three
of these areas must be addressed together and with equal forces
if the problem is to be solved without unintended consequences
that I mentioned earlier. The mortgage industry is working
vigorously in all three areas and NAMB wants to continue
working with Congress to address all these areas, in
particular, reform and simplification of the mortgage loan
process.
This part of the solution is one toward which NAMB has put
a tremendous amount of effort. This is a comprehensive overhaul
of the statutory framework governing mortgage lending. We
cannot emphasize enough to this Committee how badly this
framework needs to be changed and how important this is to
curtailing abusive lending.
The two major statutes governing mortgage lending have not
been substantially changed since they were enacted in 1968 and
1974. The disclosures required under these laws are confusing
and overlapping. The laws actually prevent consumers from being
as well informed as they could be and put consumers at a
decided disadvantage in the mortgage process. As one of the
borrowers at yesterday's hearing so eloquently put it, ``the
problem is the lenders know everything and the borrowers know
nothing.'' It is impossible for consumers to effectively
compare different types of mortgage loan products.
NAMB has been engaged from the beginning in efforts to
reform the laws regulating mortgage originations and we remain
committed to the goal of comprehensive mortgage reform and
simplification. We urge this Committee in the strongest terms
possible to work with our industry on mortgage reform.
In conclusion, I want to reiterate that NAMB supports
measures by the industries and regulators to curb abusive
practices, punish those who do abuse consumers, and promote
good lending practices. We support legislation that would
reform and simplify the mortgage process and believe this is
the legislation that is most needed to empower consumers. The
problem of predatory lending can only be solved through a
three-pronged approach of enforcing existing laws, targeting
bad actors, educating consumers, and reforming and simplifying
the mortgage process. In considering any new legislation, we
urge Congress to apply this fundamental principle: Expand
consumer awareness and consumer power rather than restrict
consumer choice and product diversity. That should be the goal
of any new legislation affecting the mortgage process.
Thank you for this opportunity to express our views and we
look forward to working with the Committee in the future.
Chairman Sarbanes. Thank you very much, sir.
We will now hear from David Berenbaum, the Senior Vice
President, Program and Director of Civil Rights for the
National Community Reinvestment Coalition.
For more than 10 years, the National Community Reinvestment
Coalition has been a leading force in promoting economic
justice and increasing fair access to credit, capital, and
banking services for traditionally underserved communities.
Mr. Berenbaum, we are pleased to have you with us.
STATEMENT OF DAVID BERENBAUM
SENIOR VICE PRESIDENT
PROGRAM AND DIRECTOR OF CIVIL RIGHTS
NATIONAL COMMUNITY REINVESTMENT COALITION
Mr. Berenbaum. Thank you, Chairman Sarbanes, Members of the
Committee. We are extremely concerned about the prevalence of
predatory lending in our Nation. During the next 5 minutes, I
will try to synthesize the remarks included in our over 20
pages of testimony and exhibits. We are clearly in a dual-
lending marketplace. Let it be said and let it be heard that
the continuation of redlining is in our Nation.
Despite popular belief, or the argument that in fact
subprime lending has ended redlining that is argued by some
industry associations, in fact, it has put an entirely new face
on the issue of redlining, a whole new cast on it.
Before, where overt discrimination occurred, overt consumer
denial with regard to access to credit was commonplace, today,
we are dealing with a race tax. In fact, if you look at recent
HUD-Treasury studies, they report that African-Americans are
five times more likely to receive subprime loans than their
white neighbors. Other studies document the fact, studies by
the GSE's, that 30 to 50 percent of African-Americans who are
currently receiving subprime loans should have qualified and
been afforded the opportunity to receive prime paper.
This is a major failure. Picture yourself living in an
urban community. You approach a retail lender operation. On the
front window of that lender is an equal housing opportunity/
equal lender logo. You go in and in fact, they give you papers
in compliance with the Truth in Lending Act, in compliance with
all other consumer protections. And then they try to sell you a
product that has four points, fees, single-premium credit life,
and that has a balloon note.
Now picture that individual going into a suburban location.
In fact, another division of the very same company. And you are
told, that you can get a prime note with one point, no single-
premium credit. And you have options, you have choices.
In fact, this is not, as was referenced, a rogue lender. It
is an example of many corporate lenders in our country right
now, having subprime divisions that market themselves
exclusively to urban communities while their prime traditional
lending banks covered by CRA, in fact, are operating in
predominantly white areas.
Included in our testimony, we have maps based on the Home
Mortgage Disclosure Act that look at, ``minority census
lending.''
On the board here, we have a map from the Baltimore area.
The first map documents subprime lending. You can see the
concentration of the dots. These are refinanced loans that were
originated in the subprime marketplace in 1999. You see the
concentration in the areas that have the darker shading which
represent predominantly African-American and Latino areas. The
next map looks at prime lending. Look at the strong difference.
Prime lending is happening throughout the Baltimore/
Metropolitan Washington area.
I submit to you that the prime lending that is occurring in
African-American communities is coming from responsible lenders
that are living up to their commitments under the Community
Reinvestment Act and in partnership with community-based
organizations.
Financial modernization, the changing nature of the
mortgage marketplace has prompted an atmosphere where many
lenders are not falling within compliance reviews, are not
falling with existing statutory reviews.
Best practices include the lender marketing their goods in
both the urban and suburban areas and where they have
agreements. I respectfully say, and I believe in best
practices. I believe in financial literacy. NCRC has been a
leader in doing ``train the trainer'' work with regard to
financial literacy. We believe in all that.
But with all due respect, it is not simply rogue lenders
like Cap Cities Mortgage, right here in Washington, DC, who
foreclosed on 85 percent of their loans. It is a systemic
problem with race at the background of the issue that we need
to address.
The consumer protection bills that have been introduced, in
particular, the legislation that you, Chairman Sarbanes, are
considering, are critical to address HOEPA. I hope during the
questions and answers, I can go into why these changes are
necessary.
Best practices are not enough. These are ethical issues.
The mortgage practitioner who are stealing homes from seniors,
from African-Americans, from people who are not sophisticated
borrowers, should lose their licenses.
The companies that are buying these products on the
secondary market need additional regulatory oversight. The
market is changing. The law needs to be more than a band-aid.
We need penicillin.
Chairman Sarbanes. Thank you very much, Mr. Berenbaum.
Before I turn to our final three witnesses, we have been
joined by Senators Dodd and Carper.
I yield to either of them if they wish to make a statement.
COMMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Mr. Chairman, let us continue with the
witnesses. And when the chance comes around for questioning, I
will use the time then. But you have been sitting here for a
long time.
Chairman Sarbanes. Thank you, Senator Dodd.
Senator Carper.
COMMENT OF SENATOR THOMAS R. CARPER
Senator Carper. I would simply echo the sentiments. And
again, to the witnesses, thank you for being with us today.
Chairman Sarbanes. Our next witness is Mr. George Wallace.
Mr. Wallace is counsel for the American Financial Services
Association. AFSA is a trade organization that represents a
wide variety of financial services firms, including market-
funded lenders and credit insurance providers.
Mr. Wallace, we appreciate your coming today. We would be
happy to hear from you.
STATEMENT OF GEORGE J. WALLACE
COUNSEL, AMERICAN FINANCIAL SERVICES ASSOCIATION
Mr. Wallace. Thank you, Mr. Chairman, and Members of the
Committee.
Chairman Sarbanes. I think it might help a bit if you pull
that microphone closer to you.
Mr. Wallace. Am I close enough now?
Chairman Sarbanes. That is good, although you are leaning.
Mr. Wallace. I would like to be heard.
Chairman Sarbanes. We want you to be heard.
[Laughter.]
Mr. Wallace. Some people might not want to hear me, but any
way----
Chairman Sarbanes. No, no. We want to hear everybody and
try to address everyone.
Mr. Wallace. I am a dissenter today. Today, I want to talk
about predatory lending, as everybody else is. Allegations of
predatory lending, particularly in the subprime mortgage
market, have received significant attention in recent months.
Advocates of increased regulation have claimed that stepped up
fraudulent or predatory marketing practices have persuaded
vulnerable consumers to mortgage their homes in unwise loan
transactions. Some consumer advocates have strongly urged that
various loan products and features common to the mortgage
market are predatory and should be outlawed.
Extensive new regulation of mortgage credit in the way
advocates now urge would dramatically reduce loan revenue,
increase the risk and/or increase costs the lender must bear.
And I speak for people who have to produce the loans that those
who wish to make credit available to lower and moderate income
people, we are the ones who have to produce those loans and we
are looking at your suggestions and we are seeing that it is
going to raise costs.
Initially, the resulting burdens will fall on lenders, in
the long term, the effects will most always be felt directly by
working American families, either because of decreased loan
availability, higher credit prices, or less flexible loan
administration.
The resulting reduced credit availability strikes at the
very heart of the efforts over the last quarter century by
Congress, many States, and the lending industry to make
efficiently priced consumer credit available to working
American families, including
minorities, single-parent families, and others who for so long
were unable to obtain credit.
Consumer advocacy have shared this goal. In testimony
before this Committee in 1993, Deepak Bhargava, then
Legislative Director for ACORN, spoke of a credit famine in
low- and moderate-
income and minority communities in urban and rural areas, and
also about massive problems of credit access in many
communities around the country, particularly in minority and
low-income areas.
Subprime lenders, spurred on by Congress, have been
enormously successful in delivering efficiently priced consumer
credit to working American families, regardless of race,
ethnicity, or background. Moreover, during the past 5 years, 96
percent of those who have borrowed from AFSA members have used
their subprime mortgage loan credit, successfully, 85 percent
without any significant delinquency.
Why would Government deny to these deserving Americans
access to the benefits of credit that middle-class Americans
enjoy? The 96 percent of Americans who use credit extended by
AFSA members successfully are not asking for that interference.
There are some people who have been victims of fraudulent,
deceptive, illegal, and unfair practices in the marketing of
mortgage loans. In fact, predatory lending is fundamentally the
result of misleading and fraudulent sales practices, as others
have said today.
Some advocates have mistakenly focused on loan products and
features as the reason for these victims' misfortune, and have
reached the faulty conclusion that if regulation just barred
certain loan features, the harm would be avoided.
Pursuing this mistaken reasoning, they have tried to label
as predatory highly regulated loan products and features, such
as credit insurance, prepayment penalties, balloon payments,
arbitration, higher rates and fees. However, any legitimate
consumer good or service can be marketed fraudulently.
Indeed, the scam artist prefers to use legitimate products
like loans as a cover because consumers want and need that
product. The illegality comes in the fraudulent marketing of
the good or service, not in the good or service itself. We urge
the Congress not to confuse the loan features that consumers
want and need with the fraudulent marketing practices that some
isolated operators have used to prey upon the unfortunate. If
fraudulent and deceptive practices are the root of the problem,
how should predatory lending be addressed?
First, Congress should do no harm to the present system,
which has been extremely successful in delivering consumer
credit to America's working families. Such proposals as
forbidding such features as balloon payments, financed single-
premium insurance, and prepayment fees take away legitimate
loan features useful to America's working families without
addressing in the slightest way the fraud underlying the
predatory practices, and that is an important point to
remember.
Second, consumer education should play a major role. AFSA
has been a leader in developing educational programs to help
meet the enormous need for greater financial literacy. As a
founding member of the Jump Start Coalition, a coalition of
industry, Government and private groups dedicated to increasing
financial literacy, it has for several years pushed strongly
for increased efforts to educate Americans about credit.
We urge Congress to support these and other efforts because
they hold the greatest promise to help over the long run. We
particularly want to thank Senator Corzine for his efforts in
obtaining additional support for financial literacy efforts
this year.
Third, industry self-regulation plays an important role.
AFSA has developed best practices which its member companies
have voluntarily adopted. They strike a reasonable balance
between limits on controversial loan terms and providing
legitimate consumer benefits in appropriate circumstances. A
copy of AFSA's best practices are attached to my written
statement.
And finally, Government's role is appropriately the
vigorous enforcement of deceptive practices in civil rights
laws. Any objective analysis of these laws much reach the
conclusion that they provide some powerful tools to address
both fraudulent sales practices and discrimination.
Strong enforcement is appropriate because it addresses the
real problem--the fraudulent and discriminatory practices--
without affecting the overall ability of lenders to make loans
available to working American families with less than perfect
credit.
That is the appropriate policy balance between dealing with
the real misfortunes which some borrowers have experienced and
the continued availability of credit to working American
families.
We urge Congress to encourage that an appropriate balance
be maintained. Thank you, Mr. Chairman, and Members of the
Committee, for the opportunity to address you today and I look
forward to any questions you may have later on.
Chairman Sarbanes. Well, thank you very much, sir. I also
want to thank you for your statement and for the attachment of
the best practices AFSA.
Our next witness is Lee Williams, who is the President of
the Aviation Associates Credit Union in Wichita, Kansas, and is
the Chairperson of the Credit Union National Association's
State issues subcommittee.
Ms. Williams, we would be happy to hear from you.
STATEMENT OF LEE WILLIAMS
CHAIRPERSON, STATE ISSUES SUBCOMMITTEE
CREDIT UNION NATIONAL ASSOCIATION, AND
PRESIDENT, AVIATION ASSOCIATES CREDIT UNION
WICHITA, KANSAS
Ms. Williams. Good morning, Mr. Chairman, Members of the
Committee. It is indeed a pleasure for me to be here and speak
to you on behalf of the Credit Union National Association,
CUNA.
CUNA represents over 90 percent of the 10,500 State and
Federal Credit Unions Nationwide. And as Chair of CUNA's State
issues subcommittee, I have had the privilege of carefully
considering issues surrounding abusive practices of predatory
lending and appreciate this opportunity to present to you some
of our findings.
America's credit unions strive to help their 80 million
members create a better economic future for themselves and
their families. And with that in mind, the credit union system
abhors the predatory lending practices being used by some
mortgage brokers and mortgage lenders across the country.
Predatory lending is a complex and difficult issue to
resolve. My committee, as well as this Committee, has come to
that conclusion by hearing testimony of individuals and looking
at the current situation with predatory lending. Predatory
lending's primary targets are subprime borrowers. These are
consumers who do not qualify for prime rate loans because of
poor credit history or, in some cases, simply a lack of credit
history. This segment of the population is of particular
interest to credit unions because, historically, it is this
population that has turned to us for our flexibility and our
wide range of credit options.
CUNA is concerned that the term predatory has become
synonymous with subprime in the minds of some of our
policymakers. Consequently, legitimate subprime lending
programs could suffer if broad prohibitions on certain lending
practices become law.
Credit unions urge policymakers to use a scalpel, not an
elephant gun, when drafting legislation to eliminate predatory
lending practices. Subprime borrowers need to be served and
credit unions do not want to lose their ability to create
flexible, subprime loan programs. A growing number of credit
unions offer subprime loans to members who do not qualify for a
prime rate loan. Subprime loans are offered to members with
poor credit histories at rates above prime to offset the higher
risk of lending.
Credit union subprime loans are not predatory. They are a
vital tool that give borrowers with poor credit history the
ability to build and/or rebuild their credit history.
To illustrate some of the alternative subprime lending
programs offered by credit unions, CUNA created a task force
last February. The task force has recently completed a handbook
called, ``Sub-
prime Doesn't Have To Be Predatory--Credit Union
Alternatives,'' which is included in my attachment, as you have
seen. The booklet provides a sample of credit union subprime
loan programs that are designed to help borrowers actually
improve their credit.
There are many positive programs being developed in the
subprime lending market by credit unions to assist consumers of
all economic circumstances. Credit unions urge policymakers to
address the abuse of lending practices rather than complete
prohibition of practices that, when used legitimately, would
provide flexibility and credit options to meet individual
borrower's needs.
America's credit unions support elimination of lending
practices that are intentionally deceptive and disadvantageous
to borrowers. CUNA and credit unions across the country have
been establishing programs to help our members fight back
against the effects of high cost and predatory loans.
At Aviation Associations Credit Union, we recently
initiated a Take Control program. It provides resources for our
members, allowing them to take control of their financial well-
being and effectively deter the success of payday lenders and
predatory mortgage lenders in our community.
Let me give you an example of that. We have members with
high interest mortgage loans acquired from a mortgage broker
that have come into our credit union and asked us to refinance
these loans because they cannot make the payments. My initial
response, being member-owned, is to offer to refinance these
loans and to reduce the interest rates. But often, that is no
solution. Typically, these type of loans have been initially
packed with so many fees, paid up front and financed, that the
loan-to-value ratio is often up to 125 percent. Neither my
credit union, nor many other lenders, can refinance such a
loan. Even in such a dire situation, our Take Control program
can improve the member's financial circumstances. Our program
does this through member education.
With the help of an on-site consumer credit counselor
available twice a week at our credit union, members can learn
how to pay down loans faster, obtain lower fees and rates, and
even in the grip of predatory mortgage loans, learn how to
build equity faster so the credit union can at a later point
refinance these mortgages.
This is only a band-aid on a serious injury. When the
credit union refinances for the member, the predatory lender
wins. At Aviation Associates, we believe our members must never
fall victim to predatory lending in the first place. That is
why Take Control also offers a significant component that
includes education to teach our members how to avoid predatory
mortgages in the first place. We are convinced education is a
critical tool, although not the only tool, needed for our
members to obtain financial independence.
On a national level, CUNA developed mortgage lending
standards and ethical guidelines to be adopted by credit unions
across the country. These guidelines were designed to help
emphasize credit unions' concerns for consumers and further
distinguish credit unions as institutions that care more about
people than money.
One of the most important programs CUNA is currently
promoting to combat predatory lending practices is financial
education of our Nation's youth. Credit unions believe that by
educating our young people in the area of personal finance,
they will learn to make sound financial decisions and choose
not to use high cost or predatory lenders.
Through our partnership with the National Endowment for
Financial Education and other efforts, we have reached over
130,000 students in over 5,000 schools.
Again, let me say that I am very pleased that you are
holding these hearings because I see the effects of predatory
lending daily, and it is not a pretty picture. Credit unions
are eager to see the abusive practice of predatory lending
eliminated. Credit unions have taken positive steps in that
direction through our voluntary efforts to educate our members
and provide them with fair and sound alternative products. It
is our hope that we will have allies in our efforts to assure
all consumers have access to credit products that do not
unfairly take advantage of their circumstances.
I thank you for allowing me to be here today and I would
answer any questions.
Chairman Sarbanes. Well, Ms. Williams, thank you very much
for the statement on behalf of CUNA.
If you had been here yesterday, I think you would have
appreciated and the Members of the Committee were very careful
to recognize--and as the witnesses this morning have said right
from the beginning with Wade Henderson--that there is a role to
be played in the legitimate subprime market. We are trying to
get at those people who are abusing that market with these
predatory practices.
I was looking at this pamphlet that you told us about and I
note that you very clearly try to draw that distinction. And
that is one of the things that we are about here today, is to
ascertain that line and then knock out what is on the wrong
side of that line.
Our last witness this morning is Mike Shea, who is the
Executive Director of ACORN Housing.
For over 25 years, ACORN has worked to increase
homeownership and community development in low-income and
minority communities. The organization has worked successfully
with many lenders to develop loan products that provide fair
and affordable access to credit for individuals traditionally
shut out of the economic mainstream.
Mr. Shea, we are pleased to have you with us today. We look
forward to hearing from you.
STATEMENT OF MIKE SHEA
EXECUTIVE DIRECTOR, ACORN HOUSING
Mr. Shea. Thank you, Mr. Chairman, Members of the
Committee. I appreciate the opportunity to appear. I work in
many of your States and it is a pleasure to be able to share my
insights on predatory lending. I have been Executive Director
of the ACORN Housing Corporation since 1986, when the
organization was formed to create low-income homeownership
opportunities.
We learned early on that to create homeownership in
distressed neighborhoods, you have to do two things. First of
all, you have to bring private capital back into those
communities. FHA lending and Government subsidies on their own
will not do the trick. And second, you have to provide consumer
education and prepurchase mortgage counseling to potential
homeowners so that people living in those communities will
actually apply and qualify for loans.
To educate community residents about the home-buying
process and how to qualify for a loan, we operate mortgage
counseling centers in 27 cities around the country. I am proud
to say that our lender partnerships along with our mortgage
counseling and financial literacy efforts have produced home
loans for 36,000 first-time home-buyers.
Last month, our largest banking partner, Bank of America,
announcedthe amount of home mortgages that have been originated
through our partnership with them has reached the $10 billion
mark. It is our experience that subprime lenders have not
played a major role in the creation of homeownership in this
country. The recent increases in homeownership that we have
seen in the 1990's was not because of subprime lending.
Of the 36,000 ACORN clients who have become homeowners,
only about 1,100 purchased their homes with loans from subprime
lenders. And our experience is not atypical according to the
1999 Home Mortgage Disclosure Act data which reported that just
6.6 percent of all home mortgage loans in the United States
were originated by subprime lenders, while 82 percent of all
first-lien subprime loans are refinances.
In many of the communities that we work, the benefits that
families have gained from homeownership are under attack.
Increasingly, we find that as soon as one of our clients moves
into their new home, they are bombarded with offers from
subprime lenders to refinance their mortgage or take out
additional debt, receiving three or four letters a week and
regular phone calls.
Now, we know that you have heard these numbers before, but
it is worth repeating, that half of all refinanced loans in
communities of color are made by subprime lenders. When you
consider that number in combination with the observations from
Fannie Mae and Freddie Mac, that between 30 to 50 percent of
borrowers in subprime loans could have qualified for ``A''
loans, you are clearly talking about a massive drain of equity
from these communities, the communities that can least afford
it.
At a bare minimum, these numbers indicate that huge numbers
of borrowers are paying interest rates 2 to 3 percent higher
than they would if they had an ``A'' loan. Consider, for
example, that for a $100,000 mortgage with a 30 year term, a
person with a 10\1/2\ percent interest rate will pay $65,000
more over the life of the loan than a person with an 8 percent
rate. Fannie Mae Chairman and CEO, Frank Raines, recently put
it best, and I would like to quote him, ``The central question
is whether all consumers are enjoying their basic right to the
lowest-cost mortgage for which they can qualify.'' Answering
this is critical if we are to close the homeownership gaps
facing many groups in America.
Predatory lending is everywhere. Over the July 4th weekend,
I visited my mother in Benzig County, Michigan. And as Senator
Stabenow can say, Benzig County is a very conservative, rural
county in Northern Michigan. When I told her what I was doing,
she immediately told me of two of her elderly friends, staunch
Republicans from the day they were born, how they had been
victimized by predatory lending.
Paul Satriano yesterday testified, and his testimony
received extensive coverage in Minnesota. As a result, our
office in the Twin Cities has received phone calls from
throughout the States of Minnesota, Wisconsin, South Dakota,
and even the upper peninsula of Michigan, two people called who
were victimized by predatory loans and looking for ways to get
out.
We have to get rid of all the tricks and hidden practices
that make it impossible for consumers to know what kind of loan
they are getting into. What you have now is a situation where
it is difficult for even my best loan counselors to understand
all of the damaging bells and whistles embedded in many
subprime loans.
That should not be how getting a home loan works. It is not
what happens in the ``A'' market, but that is what is happening
every day in the subprime market. We need a strong, clear set
of rules that will allow homeowners to navigate the subprime
market with some basic assurances of safety.
We often hear the argument that predatory lending can be
eliminated with more education and financial literacy. We
certainly support financial literacy efforts. In fact, I would
venture that ACORN Housing, working together with many of our
bank lending partners, has delivered more information to
homebuyers about these issues than anyone. Last year alone,
nearly 100,000 people attended our bank fairs, workshops, and
other events. We held a bank fair recently in Detroit where
3,000 people came.
And Fannie Mae's latest national housing survey found that
consumer literacy efforts have already lowered the information
barriers to buying a home, with nearly 60 percent of Americans
now feeling comfortable with the terminology and process of
buying a home. In spite of this increased financial literacy,
we see that predatory lending continues to rise.
Part of what we have learned from this experience of
providing financial literacy and education is the limits of the
approach. First, there is the question of resources. Until we
are ready to spend the $1,500 to $2,000 per originated loan
that many predators can spend, we will always be playing catch-
up.
And second, no advertisement, bus billboard or even
workbook is going to compete with a one-on-one sales pitch of a
very good salesman who knows more about the process and about
the products than the borrower.
We have also heard the argument that all that is needed is
better enforcement of existing laws. We see a lot of borrowers
in heart-breaking situations and we have tried to use current
law to help protect them. This year, we have helped 40 clients
in 10 States file grievances with State regulators, and that
has not worked.
HOEPA covers only a tiny fraction of loans and it mostly
requires disclosures. As long as the right piece of paper was
slipped somewhere into the pile, there is often little the
borrower can do.
Fraud and deceit are against the law, but they are
extremely difficult to prove. It usually turns into a matter of
he-said/she-said, and when the lender knows more about the
transaction and has the paperwork, and has the lawyers, the
borrower loses. And when we hear certain industry groups
suggest that the solution is better enforcement of current law,
we wonder how they expect that to happen if they routinely
include in their loan documents mandatory arbitration clauses
which severely limit a consumer's right to seek relief in
court.
What we need are some basis rules covering a broader group
of high-cost loans that create a level playing field where a
borrower in the subprime market, like a consumer in the ``A''
market, has a set of understandable options to choose between.
Buying or refinancing a home is a lot more like buying
medicine than like buying a tube of toothpaste. We do not
expect every patient to read the New England Journal of
Medicine and evaluate for themselves which drugs are safe and
which are not. Instead, Congress and the FDA establishes rules
about what is too dangerous to be sold, within those rules,
patients and their doctors still can choose what is best for
them. In our view, Congress and the Federal Reserve need to
make rules about subprime loans in the same way.
Chairman Sarbanes. Mr. Shea, we are going to have to draw
to a close.
Mr. Shea. Thank you. I would like to just make one more
point. There is a lot of comments by the industry about
unavailable data. I would just like to say that Jesus did not
need an economic study to convince him of the need to drive the
money changers from the temple. He had a moral compass. He knew
what was right and wrong, and he had the courage to act on
those beliefs.
Thank you.
Chairman Sarbanes. Thank you very much, Mr. Shea.
We will go to questions. A number of my colleagues have
been here for a while and I want to at least get them started.
Senator Dodd wanted to make a very quick comment.
Senator Dodd. Just while my other colleagues are here. Mr.
Chairman, thank you for these hearings and thank our witnesses,
too. It has been tremendously helpful. We are going to be
constrained in time. Our desire here is to make subprime
lending more available for people. We do not look to cut that.
There are many lenders out there who are doing a very good job,
particularly some who have reacted already. As you have just
point out, CitiCorp and others have been very helpful.
I thank them for what they are doing, and we are talking
about those who engage in predatory practices. Not all subprime
lending is a predatory practice, and I think it is important
that we state that here.
But to be as emphatic as you, Mr. Chairman that we are
determined as a Committee here, I am convinced the Republicans
as well as the Democrats, should do everything we can to stop
that.
I thank all our witnesses for their your help.
Thank you, Mr. Chairman.
Chairman Sarbanes. We have been joined by Senator Santorum.
COMMENT OF SENATOR RICK SANTORUM
Senator Santorum. Thank you, Mr. Chairman. I know people
have been here longer than me. I just want to associate myself
with the remarks of Senator Dodd that I beileve we do have some
bad actors out there in the area. But I want to also reiterate
the importance of subprime lending and having money available
for those who do not have the kind of credit rating that
otherwise can succeed. I think we are interested in engaging in
something that is constructive to deal with this issue and I
look forward to working with you.
Chairman Sarbanes. We do not intend to throw the baby out
with the bathwater. But we do intend to throw the bathwater
out.
[Laughter.]
The dirty bathwater out, I should say.
[Laughter.]
Debbie, why don't I recognize you for as long as we can go
before we have to leave for a vote. I will say to the panel, we
will have to recess briefly and go for this vote, and then we
will return and continue the question period.
Senator Stabenow. Thank you, Mr. Chairman. I appreciate
that and would note that I will not be able to come back
because I have to preside at noon. I actually have numerous
questions. We will not be able to address all of them. And
possibly, we can follow up in writing with the panelists. I
appreciate all of your comments.
We have heard and have to address complex issues. We have
issues that we heard yesterday of loan flipping and issues on
mandatory arbitration, disclosures, prepayment penalties, the
definition of what is a high-cost loan, the whole question of
regulation, and the effective ways of promoting financial
education. There is a lot of different issues that we need to
address. I would simply ask Mr. Courson, Mr. Fendly, and Mr.
Wallace, whom I will ask first.
You mentioned consumer education being the primary focus.
Yesterday, a constituent of mine was here, Carol Mackey, who
spoke about the fact that she was given a good-faith estimate
in writing several days before the loan closure, and that in
fact, when she got there, the interest rate was higher, the
payments were higher.
The information she was given on the good-faith estimate
was not accurate. So, she was attempting to be educated as a
consumer. She is a bright woman. And found herself, when she
dug through all the papers, that in fact it was different.
So, I would ask how you feel----
Chairman Sarbanes. When she dug through them afterwards,
when she went back.
Senator Stabenow. After she settled.
Chairman Sarbanes. She really was not in the position to do
so at the closing.
Senator Stabenow. That is correct, Mr. Chairman.
She came into the closing with information that she assumed
was accurate based on the good-faith estimate, found after she
got home and sorted through--and as someone who closed on a
home not that long ago and considers myself reasonably
intelligent and as a Member of the Banking Committee, I found
myself going through pages and pages and pages and trying to
make sure that there was not something there that I had not
seen before and so on, and know how complicated it was.
I appreciate the issues of simplicity. I think we do have
to address that and want to work with you on how we might
simplify this process. I certainly agree that it is extremely
complicated and difficult to sort through, even when you are
very conscientious.
But when we are talking about consumer education and
someone has been given information, and later, it was found to
be different in the final analysis, how would you correct that
through consumer education? Or do you believe, in fact, that it
is appropriate to require that the good-faith estimate be a
formal estimate so that it has to be the same 3 days before as
it is on the day that you close?
Mr. Wallace.
Mr. Wallace. Well, I was not here yesterday and I did not
hear Mrs. Mackey's statement. But as you describe it, the good-
faith estimate is, in fact, an estimate. It has to be given
within 3 days of application. Then there is a HUD-1 Statement
which does have to be accurate. So, you are describing what
appears to be a violation.
Likewise, the Truth in Lending Statement has to be
accurate. If it was inaccurate, that would be a violation of
Truth in Lending. We do have a legal system already in place
which would appear to address the concerns that you are
raising.
Senator Stabenow. If I might just say, though, the
documents that you are referring to are given on the day of the
closing.
Would you support having those documents given to consumers
several days in advance in straightforward, simple terms, so
that people know exactly what the costs are, the interest rate,
the points, the fees, et cetera?
Mr. Wallace. The difficulty with that is it produces a
certain degree of inflexibility with regard to borrowers.
Borrowers often wish to move straight to the closing. I have
been involved in this for 35 years. People have suggested this
for many years, and it might be nice to do that. And then you
start to work out the practicalities of it and it starts to tie
the borrower's hands.
I think in the end what we are trying to do is to develop a
regulatory system which deals both with the problems of
communicating to people, educating them so that they understand
when they are communicated to, and working out a system which
can be consistently applied and appropriately managed by
creditors without interfering too much with the borrower's
flexibility. I believe the objection to your mechanism is, and
other people have raised it, is that it starts to interfere
with the borrower's flexibility.
That is a policy trade-off that, in the end, one has to
deal with.
Senator Stabenow. I appreciate that. Well, let me just say
knowing 3 days in advance what you are walking into is not an
unreasonable request, and if we are focusing on consumer
education, I think we need to make sure that that education and
information is accurate.
Mr. Courson, would you like to respond? I know you have
spoken in your testimony about early price guarantees.
Chairman Sarbanes. Well, I think----
Mr. Courson. I am sorry, Senator?
Chairman Sarbanes. I think if I do not move my colleagues
out of here, we are going to miss this vote.
Could you give a brief----
Mr. Courson. Thirty second answer.
Senator Stabenow. Could you give us a 30 second answer?
Mr. Courson. Yes. Part of the reform that we are
advocating, simplification, is taking the front-end system, the
good-faith estimate, which really has no limits in terms of how
it can change the closing.
Chairman Sarbanes. There is no liability for a misstatement
on the estimate.
Mr. Courson. That is correct.
Chairman Sarbanes. Contrary to what I think Mr. Wallace
said, that it was illegal. As I understand it, there is no
legal penalty for that. Is that correct?
Mr. Courson. Correct.
Mr. Wallace. Are you speaking about the HUD-1 or the Truth
in Lending?
Chairman Sarbanes. No. I am talking about good-faith
estimate.
Mr. Wallace. I was speaking about the Truth in Lending.
Truth in Lending, there is clearly liability.
Chairman Sarbanes. All right. But when do you provide that?
Mr. Wallace. The Truth in Lending is what tells her----
Chairman Sarbanes. When do you provide that?
Mr. Wallace. You have to provide that 3 days after
application on an estimated basis, and then at closing.
Chairman Sarbanes. And is the estimate--are you liable for
a misstatement on the estimate?
Mr. Wallace. On the HUD----
Chairman Sarbanes. On the estimate.
Mr. Wallace. On the estimate, the answer is, at this point,
no.
Chairman Sarbanes. All right.
Mr. Courson. Our reform plan envisions, at the time of the
application, as opposed to the good-faith and the TILA that
someone gets today, they would get one simple disclosure. That
disclosure would include really what the customer wants to
know. How much cash do I have to bring to closing and what are
my payments? Of course, it would have other disclosures on
there.
One of the things that we are advocating is that the
closing costs that would be included on that disclosure would
be guaranteed.
And so, the consumer at three different times through the
transaction would see the same disclosure with more specificity
as they go through from application to credit approval to
closing, with more information completed. But the closing cost
guarantee itself would not be a violatation. It would stay. If
it did change, it would be a violation.
I heard Mrs. Mackey's testimony yesterday. And it is the
fallacy of the system of not giving the certainty to the
consumer up front, and then, in fact, when you get to the
closing, those guaranteed closing costs must remain the same.
That is part of what we have in our reform proposal and in
working with Secretary Martinez.
Chairman Sarbanes. I believe we need to recess, otherwise
we are going to miss the vote.
Senator Stabenow. Thank you very much.
Chairman Sarbanes. I certainly will return. We will recess
and return after the vote.
[Recess.]
Chairman Sarbanes. Let me bring the Committee back into
session. The hearing will come to order and we will resume.
Mr. Wallace.
Mr. Wallace. I wanted to correct my earlier remarks. I
thought that Senator Stabenow was asking a question about
conventional mortgage loans. I believe she was asking a
question about HOEPA loans. Several people have pointed out to
me, in a HOEPA loan, there is a requirement, 3 days before
closing, to give an accurate statement. If it is inaccurate,
there are civil penalties. There are enforcement provisions
that work quite strongly, and you cannot change the good-faith
estimate between the closing and the giving of it 3 days in
advance.
Indeed, this has been an issue that borrowers have raised
because they not only have 3 days advanced disclosure that I
just described, but also the 3 day recision period. So, it
takes them 6 days to get their money. So, I just wanted to
correct my remarks, sir.
Chairman Sarbanes. The correction will be noted. Ms. Mackey
did not have a HOEPA loan. One of the problems here is that a
lot of these loans are not HOEPA loans. That is one of the
reasons that the Fed is now addressing what the HOEPA limits
are in an effort to include within them more of these loans
that are now falling outside of it.
Senator Corzine.
Senator Corzine. Yes. It was a terrific presentation by all
of you and I appreciate the discussion.
I just wanted to make sure that I heard this properly from
Mr. Courson. The Mortgage Bankers Association believes this is
a problem and a pervasive problem. And that is something that
we can count on, your objective view, as we go about debating
this as we go forward?
Mr. Courson. You certainly can, Senator. We have been
involved in this debate as one piece of an effort to really
reform and simplify the entire mortgage process for over 5
years, and you have our commitment.
Senator Corzine. I think sometimes there is a debate about
whether this is just an anecdotal situation here or there and
we fine four people here, or 10 people there.
But my observation, our studies would lead me to believe
that this is actually a very pervasive issue and needs
addressing. And I believe it is informative that one of the
foremost associations underscores that.
I have this curiosity, and I will let anyone respond. But
don't most ``A''-lenders have lawyers with them at times of
closing on mortgages, pretty simple conventional mortgages?
Does anyone want to address that?
Mr. Shea. Senator, of the 36,000 families that have gotten
home loans first to buy a home from our program, we estimate
about 25 percent use lawyers at closings.
Senator Corzine. That is in the subprime market, though.
Mr. Shea. That is in the prime market.
Senator Corzine. That is in the prime.
Mr. Shea. In the prime market, there is enough protections
and it is easy to understand what you are getting into ahead of
time where you oftentimes do not need a lawyer. We advise
people to seek legal counsel and we work with them ahead of
time to review the documents. The subprime market, very few
people use lawyers.
Mr. Berenbaum. Could I respond to that on a different
level?
The issue of RESPA was addressed. I have to say that the
National Community Reinvestment Coalition strongly supports the
consumer actions that have been filed in court. Who is
empowered in a mortgage settlement or a mortgage closing
situation? Who has the power?
The consumer, as has been stated generally, does not
understand the action, where fees are going. Disclosure is very
important, and part of the problem of predatory lending are the
relationships between the players.
In fact, often a realtor may be working in concert with a
subprime lender who is a predator. And even the settlement
agent may be part of that process. We have even seen where
whole separate corporations are bidding on the foreclosure
ultimately that are related to this little group of
conspirators. And that is why in the Capital Cities case, in
fact, there is a claim trying to stretch and use existing law,
arguing racketeering.
Senator Corzine. Sounds like racketeering to me if there is
a conspiracy of people working together.
In the ``A'' market, there is a lot of uniformity,
conformity. I think Freddie Mac and Fannie Mae have asked for
conformity so that the secondary mortgage market can actually
work. Is there room for some improvement in standardization in
subprime lending that would allow for that simplicity that is
talked about? I understand the need for flexibility, but
sometimes flexibility is camouflaged for some of the practices
we have talked about.
Does anybody want to comment why and whether we ought to
get to more standardization? It certainly would provide more
liquidity to the ultimate lender.
Mr. Ackelsberg. Well, Senator, if I could speak to that.
I believe the first thing you need to do if you want
standardization is actually have the rates and the fees
available to the public to know ahead of time. You have to
understand that everything we talk about in this market is
different than your conceptions of what mortgage lending is
about.
Number one is, if you start with the assumption that when
you are in the market, you go to the newspaper on Sunday and in
the real estate or financial section, they list all the
mortgages, the prices, the points, and the rates, that does not
exist in subprime. Just yesterday, I deposed an area manager of
one of the lenders that has been mentioned as a responsible
lender within the subprime field. And I said, by the way, can I
open the paper and see what your rates are this week? And he
says, oh, no, you cannot do that. I said, why is that? Well,
subprime lenders do not do that.
Nothing is really the way that we assume it. Brokers that
we assume are representing lenders are not representing
lenders. They are representing themselves. In fact, they are
being rewarded for upselling their own customers.
Applications that we assume are being signed at sometime
early on in the process are routinely signed at the closing.
You are signing an application at the same time you are signing
the mortgage.
And that is done every day. I do not think I have seen a
transaction where the application was signed prior to the
closing. Everything about this market is different than the
notions that we come to the table with, having bought houses
ourselves, for example.
Senator Corzine. But are there lessons to be learned from
the ``A'' market that we ought to be applying to the subprime
market, since it works efficiently and relatively securely for
the consumer?
Mr. Wallace. Senator, one of the things to remember is that
Fannie Mae and Freddie Mac have withdrawn from the HOEPA market
entirely. Thus, whatever encouragement they could give to
standardization does not occur. And if the HOEPA thresholds are
lower, presumably they will continue to withdraw from the HOEPA
market. They are concerned about risks. They are concerned
about the additional liability, I guess, with regard to that
kind of paper. But there is something which you could address
perhaps with regard to the secondary market, particularly the
Government-financed entities not being interested in dealing
with subprime paper.
Chairman Sarbanes. I understand, though, that 70 percent of
the subprime market is what are called ``A''-minus loans. And
therefore there is a real opportunity, which I gather some
institutions are now undertaking to upgrade people into ``A''
loans. That seems to me a very worthwhile endeavor. And it also
seems to me that we need to consider carefully what measures or
how you can encourage just graduating people up.
And I am told that there are a fair number of people who
are getting subprime loans who really could get prime loans.
But it is not happening. Is that correct?
I am sorry, John. I did not mean to interrupt your
questioning.
Senator Corzine. No, no, no. I believe it is going in the
same direction here.
Mr. Berenbaum. There is no question. And what we are
dealing with is a blend of civil rights issues, Fair Housing
Act issues, as well as consumer issues, whether they be fraud
or issues relevant to the subprime market.
There is a new player in town, though. And I would agree
with any thought that, in fact, the entry of Fannie Mae and
Freddie Mac into the ``A''-minus market has been corrected. It
absolutely has been. We wish it would have been sooner. Who is
the new player in town? It is Wall Street. Who is funding the
growth? It is private investors? Who is specializing?
We heard about specialty lenders. Well, these specialty
lenders better start developing prime paper because right now,
I believe under existing law, they are facing civil rights
liability if they do not give an American the loan they are
qualified for. And that is what is happening here. The greed
factor, as has been mentioned, is playing a role in our
financial transactions today.
And yesterday, there were references made to in the old
times or in the days when we did things by hand. We are still
doing things by hand. There are decisions being made by
executives today with underwriting practices and points and how
to use credit in a way that is greedy, manipulative, and not
covered by law.
And these working-the-law situations are creating the
scams. There are responsible subprime lenders and then there
are ones who are making mistakes because they are not thinking
through their decisions, and then there are predators.
Senator Corzine. Mr. Fendly, where do you think the
regulatory world should actually meet the mortgage broker?
We know the Federal Reserve, the FDIC, and others review
the balance sheets and practices of the banking industry. Our
thrift industry has a regulator where the public meets
creditor. Where would you think, and how would that best be
applied in the mortgage brokering business?
Mr. Fendly. Well, obviously, we should have the same
standards applied to us as any other lender would or any other
originator would. The only problem is that an awful lot of
mortgage brokers are extraordinarily small business people. The
majority of them employ less than five people. And I do not
think a financial yardstick is what you want to use to analyze
their credibility in the marketplace.
When I was talking about mortgage reform and people were
talking about the good-faith estimate, that is part of the
whole process and should apply across the board to all lenders,
all originators, so that people have concise information. The
system now encourages fraud and it actually is an uneven
playing field for honest businessmen who cannot compete against
false good-faith estimates that are changed at closing. That is
what we are looking for, is clarity, bright lines, and
accountability.
Chairman Sarbanes. That is an interesting point because it
seems to me that if we find ways of eliminating these bad
practices, it is to the benefit of the responsible people in
the industry.
And it seems to me that the responsible people, instead of
resisting this effort, ought to be supporting it. I know they
are concerned about how the line is drawn because they are
concerned whether it will impinge upon the legitimate
activities.
But assuming the line can be drawn properly, they ought to
be supporting it because it will knock out what I guess is
potentially an unfair competitive advantage which the bad actor
is able to exploit. I just throw that out there as an
observation. Go ahead, Jon. I am sorry.
Senator Corzine. Again, who challenges it? State banking
regulators? Is that who is looking at most of the mortgage
brokers?
Or is there anyone who looks at their practices? Or is it
just voluntary?
Mr. Fendly. It depends on what kind of business that they
do. Most of them have State regulators.
In my particular State, you are audited every 2 to 3 years
on all fronts. If you have an entity that is an FHA
correspondent, they have to provide a HUD-approved audited
financial statement each year. Those individuals that are very
small, they are just dealing with their own State regulatory
agencies.
Senator Corzine. And do many of them have audits on their
practices, their business and market practices?
Mr. Fendly. Yes, they do.
Mr. Ackelsberg. Senator Corzine, I actually would have to
disagree with that. Just to use my experience from
Pennsylvania, it has been said by many people there that in
Pennsylvania, it is easier to get a broker's license than a
fishing license. The only difference is that there actually is
enforcement from the Fish and Game Commission to make sure that
the laws are being enforced.
In our experience, in that one State, as a practical
matter, no enforcement. And we sent lots of complaints. They
did finally manage, as I understand, to pull the license of
someone who had plead guilty to stealing from 16 of his
customers. But to the others, for example, the ones where we
had a fraud judgment unpaid, that did not seem to rise to the
level of regulatory interest.
Senator Corzine. Mr. Courson.
Mr. Courson. Senator, I believe that is one of the points
that we made.
I would agree. Where is the enforcement? Because it is
besmirching our industry, my company, and other lenders like
me, if we do not get the enforcement.
And so, I think what the gentleman just said is exactly
correct. We have to have the enforcement. If we have the
licensing out there and do not enforce it, then there is no
reason to have it.
It is very disheartening in our business to find the bad
actors who even have actions taken against them, showing up in
other companies under other names and other venues, propounding
the same practices for which they were eliminated from a
different venue. It makes no sense. We have to have that
enforcement level.
Senator Corzine. I do not mean to--please. Go ahead.
Ms. Williams. I just wanted to add a comment.
Earlier you had made mention of ``A''-minus borrowers and
opportunities there.
Some credit unions have programs in place now where if the
borrower, an ``A''-minus or ``B''-minus, pays the mortgage as
agreed for 1 year, then the rate could be adjusted. That may be
something that could be beneficial. It not only encourages the
consumer to get on a good plan of making payments on time, but
it also offers them long-term relief for paying more for that
mortgage.
Now I have had instances where my members have actually
said they were told they could get a 12 percent first mortgage
now. If they paid as agreed for a year, that mortgage rate
could be decreased. Only to find out after a year that their
mortgage had been sold to another company and all bets were
off.
So that may be a good option to consider, a way to have an
option for a consumer to actually pay at a subprime rate
temporarily, for a limited amount of time, and then have that
rate decreased without a lot of penalties attached to having
that done.
Chairman Sarbanes. Jon, we were so engrossed here, I do not
think we noticed it, but there is another vote on. I am going
to have to again recess the hearing in order to vote. I am sure
the panel appreciates, we have no control over this process.
Actually, those lights and bells go off, Pavlov should have
done his experiments here in the Congress.
[Laughter.]
We will return very promptly and then we will try to draw
it to a close because I know that people have conflicting
engagements.
We will stand in recess.
[Recess.]
Chairman Sarbanes. The hearing will resume. And I am
hopeful that we will have enough time here to complete. I do
not want to hold up the panel unduly.
Mr. Ackelsberg, I want to put a question to you off of
something that Mr. Shea said, where he said, the recent
increases in homeownership are not from subprime lenders.
Now you have some very interesting material in the opening
part of your statement, which, of course, because of the
truncated time, you did not present orally. But we should to
just touch on that a little bit because lots of assertions are
made about this subprime market and what it permits or what it
allows that we would regard as desirable. And of course, we
regard homeownership as desirable in every instance in which it
really can be warranted. Could you just touch on some of that?
Mr. Ackelsberg. Yes. As we mentioned in the written
testimony, you have homeownership increasing by 2 percent
during a period of time that, for example, foreclosures are----
Chairman Sarbanes. What is that period of time?
Mr. Ackelsberg.I believe the table is 1980 to 1999,
Chairman Sarbanes. What?
Mr. Ackelsberg. The period of 1980 to 1999.
Chairman Sarbanes. Okay. And it is during that period, of
course, more in the 1990's, when the amount of subprime lending
increased at a very rapid rate. Is that correct?
Mr. Ackelsberg. Absolutely, Senator. We attribute that to a
number of factors, one being, as I mentioned in my testimony,
the Federal policy favoring first-lien mortgage lending, the
deregulation of usury for first-lien mortgage lending,
basically encouraging lenders to turn--the typical example that
we see is someone, for example, wants $5,000 to fix their
kitchen. And what instead they get is a $30,000 loan that pays
off all their debt, which they did not need being paid off at
all. And it is precisely the Federal preemption of usury--the
Federal deregulation of State usury laws for first-lien lending
that has made that possible.
The other thing I would say, as I mentioned, is the change
in the tax laws to favor home equity lending. And finally, the
market forces of Wall Street securitizations which have really
made this a very profitable enterprise.
Chairman Sarbanes. This Figure 1 you have in your
statement.
Mr. Ackelsberg. Yes. It is data from the Mortgage Bankers
Association.
Chairman Sarbanes. Where you say the sources are the
Mortgage Bankers Association.
You should show Mr. Courson this, too.
[Laughter.]
Chairman Sarbanes. Is the figure from the Mortgage Bankers
or--yes. Is the chart or just the numbers that enabled you to
make up the chart?
Mr. Ackelsberg. No, it is the numbers. Actually, I am not
entirely sure. Senator, my understanding is that it is just the
numbers that were then put into this chart.
Chairman Sarbanes. The graphic form. All right. Now, let me
run through these. You say over this period, there was a 2
percent growth in the homeownership rate. Is that correct?
Mr. Ackelsberg. Yes.
Chairman Sarbanes. Then there was a 29 percent growth in
mortgages per home. What do you mean by that?
Mr. Ackelsberg. Well, as it has become more and more
attractive in the market for people to use their homes when
they are borrowing money, what you have is more and more people
doing that.
For example, many people--and I would say primarily in the
``A''-borrower kind of universe--we will have a mortgage and
then we will also have a home equity credit line. So, it has
become very common for people basically to use their homes to
access credit.
Chairman Sarbanes. And then you have foreclosures per
mortgage. That growth was 120 percent.
Mr. Ackelsberg. Yes.
Chairman Sarbanes. What is the significance of that?
Mr. Ackelsberg. Well, I would also, particularly in the
1990's, add an additional overlay, which is these have
basically been good times. You would expect in good times to
see foreclosures going down. In Philadelphia, we have seen
foreclosures tripling during a period where jobs were actually
on the upswing. And we attribute that to the radical change in
the nature of mortgage lending, that loans are being made in a
fashion that they were never made
before.
Chairman Sarbanes. And then foreclosures per home went up
184 percent over this period.
Mr. Ackelsberg. That is correct.
Chairman Sarbanes. Meaning, what?
Mr. Ackelsberg. That is just the ratio. Basically, it is
just another way of saying that the foreclosure rate has really
exploded during this period of time.
Chairman Sarbanes. As I understand it, from this footnote,
this understates the problem because this says the data of
mortgages and foreclosure at the end of each period studied
comes from 130 different lenders and is representatives of
approximately one-half of the mortgages in existence.
These numbers are actually grossly undercounted because the
foreclosures of mortgages made by finance companies are not
included in the statistics compiled by the Mortgage Bankers
Association of America, which provides the raw data for the
census statistics. Also, foreclosure statistics do not include
homeowners who simply turn their home over to the lender to
avoid foreclosure. Actually, as bad as this sounds as we run
through these figures, the problem is actually worse than that.
Mr. Ackelsberg. I would spin that another way. You could do
the same thing with default and delinquency numbers, Senator.
For example, I have looked at default and delinquency numbers,
which are very high for some of these lenders. I did a lot of
litigation against United Companies Lending that had 15 percent
default and delinquency rates. But that radically really
underestimates the problem if you are comparing it to an
ordinary lender because you are looking at a portfolio that, on
average, in that particular example was had loans 18 months
old.
When you look at a subprime portfolio that is relatively
unseasoned--that is the term, I believe--an unseasoned
portfolio, and you see rates that are--even if they are similar
and they are far higher than you see in the prime market, you
are understating it because you are not talking about a
portfolio that has loans as much as 20 years old or 30 years
old in that portfolio. You are talking about loans that are 1
year, 2 years, 3 years, often at the most.
Chairman Sarbanes. Yes. But aren't some of these lenders,
the bad actors, they are making these loans with the purpose of
foreclosing and getting the house and taking the equity?
Mr. Ackelsberg. I think in some cases, that is true. I
believe it is more accurate to say that they do not really care
one way or the other. It is probably closer to the truth to
say, they are making these loans with the intent of selling
them very quickly. And the more points that they can load into
those loans, the more revenue they can generate very quickly.
I think that what it is is basically, the loans are being
originated by lenders who have no accountability regarding the
performance of the loans. They do not really care one way or
the other how the loan performs, as long as there is a market
out there to buy it from them. And unfortunately, the market is
booming, largely fueled, I believe, by Wall Street
securitization.
I am convinced that the ultimate consumer in this whole
mess is not Ms. Mackey, with her mortgage. The ultimate
consumer is my retirement fund, your retirement fund. It is the
mutual funds insurance companies that decided, for whatever
reason, and that these were good investments.
And they have been layered with layer upon layer of credit
enhancements, so the investors really feel like they are not at
risk at all, whether it is the insurance on the securitization,
whether it is the subordinization structure built into the
instrument.
It is very complicated. But in the end, you could look at
it as a very sophisticated laundering of money, where the
ultimate consumer really has no responsibility for what is
going on. In fact, there are law review articles built on--one
that I found very enlightening was called ``The End of
Liability.'' This is all about structuring things so that no
one is responsible for what they are doing.
Chairman Sarbanes. Let me ask--and I really throw this open
to the panel. This is the joint report of the U.S. Department
of the Treasury and the U.S. Department of Housing and Urban
Development, which was issued just about a year ago, entitled:
``Curbing Predatory Home Mortgage Lending.''
I obviously found it a very interesting report and we
intend to make heavy use of it. In this report, they have a
section discussing mandatory arbitration. And this is what they
say, and I would like to get the reaction of the panel to this.
In policy recommendations, after they have a discussion of what
is the problem, challenges for reform, and so forth.
Prohibit mandatory arbitration for high-cost loans. The
most vulnerable borrowers in the subprime market may be the
least likely to understand adequately the implications of
agreeing to mandatory arbitration. Since they may also be the
most likely borrowers to default or be foreclosed upon, it is
especially important that they retain the rights afforded them
under Federal fair lending and consumer protection laws.
In the high-cost loan market, the difference in bargaining
power between lenders and borrowers is particularly acute,
making predispute mandatory arbitration an unwise option for
these consumers. And I would like to get people's reaction to
that.
Ms. Canja. I will respond to that. In fact, AARP goes even
farther. We do not believe that there should be mandatory
arbitration in any consumer protection laws because you cannot
have a level playing field. You have the very vulnerable people
who do not have the experience, they do not have the
information. They certainly do not have the resources.
All of those things are all centered on the other side. It
certainly is even more apparent and they are even more
vulnerable in this very complex issue of mortgage lending. So,
we definitely would support that there should not be mandatory
arbitration.
Chairman Sarbanes. Yes.
Mr. Henderson. Mr. Chairman, the Leadership Conference on
Civil Rights, and I think I speak here for the vast majority of
organizations in the civil rights community, would strongly
support the recommendation of the Treasury report in that
regard.
Mandatory arbitration of the kind that we are discussing
this morning is a fundamental violation of the right of
individuals to protect their own interests by going to court
when necessary to litigate issues like those that we are
discussing today, particularly where the unequal relationship
and power between the consumer and the lending institution is
as stark as we see it here, and where the regulatory scheme of
protection that exists both at the Federal level and at the
State level, is inadequate to protect their interests.
What we are seeing with these loans is that you are forced
into an arbitration system. You are in an unequal bargaining
position. As a general matter, you do not fully understand the
terms and conditions of the loan, particularly in contrast with
the lender. You do not have adequate protections at the Federal
level. You do not have adequate protections at the State level.
And now we are taking the courts away from you to protect
fundamental rights. It is an injustice. It needs to be
corrected.
Mr. Ackelsberg. I would also add that the one obvious way
that Congress, when it passes law, can see how the laws are
functioning is to read the cases that come out of the Federal
courts.
You understand, I assume, that these are basically secret
proceedings. There is no opinion. Nothing is public. And
therefore, there is really no accountability whatsoever for how
the laws that this body passes actually are getting enforced.
Mr. Berenbaum. I would concur with the other consumer
advocacy groups, and just add a slightly different wrinkle to
it. We have compliance arrangements and I have also served as a
consultant to many realtor and real estate companies. What I
see is a growing trend of realtors to bring matters forward
where they are so concerned about predatory lending impacting
on their ability to complete new sales transactions to
consummate the deals, and they are frustrated for everyone
involved in the transaction--the buyer, the seller, because
they see prepayment terms or penalties. It impacts on everyone.
And they are frustrated because they see these clauses in the
mortgage papers.
Mr. Shea. Mr. Chairman, if I could add to that. We have
found that with our clients who have mandatory arbitration
clauses, those serve as a tremendous chilling effect for those
clients seeking redress to right wrongs that they feel are in
their loans. We found many arbitration clauses, for example,
that state that if you lose the arbitration, you have to pay
the cost.
Well, if you are a low income person, you are not willing
to do that. You are not willing to take that risk often because
it could mean the difference between paying the electric bill
or not.
Chairman Sarbanes. Mr. Wallace.
Mr. Wallace. If I could speak, I am going to dissent. We
found that mandatory arbitration clauses are a substantial
benefit to the consumer. It provides a cheap, freely available
remedy. What Mr. Ackelsberg did not point out is that you do
get a remedy in the arbitration process. What we are talking
about here is whether we are going to have class actions or we
are going to have a quick and efficient remedy. The experience
with class actions has been, unfortunately, one in which the
trial bar is able to earn a fairly good compensation. But in
general, the remedies provided to individuals are small.
Chairman Sarbanes. But do you think----
Mr. Wallace. Likewise, most of these cases are fraudulent
cases, cases involving fraud. In individual fraud cases,
lawyers, individual lawyers, if they are not Legal Aid, find it
uneconomic to take the case. In arbitration, a remedy is
available. In a class action, you cannot maintain a class
action if it is based upon fraud.
So that arbitration provides an important remedy for the
consumer. It should be available to consumers and restricting
the availability of it certainly raises operating costs and
does not necessarily provide a good remedy.
Chairman Sarbanes. Well, now, when you say it should be
available to the consumer, put forward, as it were, on behalf
of the consumer, what would be your reaction to having
voluntary arbitration clauses instead of mandatory, so that the
consumer, if they made the judgment that agreed with the
rationale you have just laid out, could choose to go to
arbitration. But if the consumer did not, they would not be
precluded or denied their opportunity to go to court. What I
referenced were mandatory arbitration clauses.
Mr. Wallace. Yes, and I was addressing mandatory
arbitration as well.
Chairman Sarbanes. Oh, you were. Now why? On the rationale
you just gave me, why wouldn't you be accepting of having
voluntary arbitration clauses?
Mr. Wallace. Well, the voluntary arbitration clause is no
different from no arbitration clause at all. I can always in
litigation agree with the other litigant that I want to go into
arbitration. That is the effect of a voluntary arbitration
clause. A mandatory arbitration clause is binding on both
parties. They should be fair. AFSA's standards require that
they be fair. There was a question raised about who pays. That
needs to be fairly handled. But, nonetheless, they are an
important way of providing the consumer a remedy and they are
also an important way of managing the very high costs of class-
action strike suits.
Chairman Sarbanes. If you go to arbitration, as a consumer,
and lose, you should pay the cost of the arbitration?
Mr. Wallace. That would be a possible way in which these
should be structured, yes, sir.
Chairman Sarbanes. Well, that is the way it is structured
now.
Mr. Wallace. I am sorry. Maybe I did not hear you
correctly.
Chairman Sarbanes. Do you believe that if a consumer is
required with mandatory arbitration, goes to arbitration and
loses, that the cost of the arbitration should then be placed
upon the consumer?
Mr. Wallace. AFSA has standards on it. I do not quite
remember what the standards are. But in any event, it seems to
me that that ought to be fairly administered. I am not prepared
to answer that one way or the other. I think it ought to be
done fairly.
Mr. Ackelsberg. Senator, Mr. Wallace suggested that these
are reciprocal obligations taken on both parties.
In fact, most of the arbitration clauses out there say that
the lenders can use the courts to foreclose, whereas the
borrowers have no access to the courts to enforce their rights.
Chairman Sarbanes. That is a very important point.
Mr. Henderson. Well, that was my point, Mr. Chairman. I
think Mr. Wallace, with all due respect, is being very
disingenuous to focus on the interests of consumers when, in
fact, the relationship, the unequal bargaining position between
consumers and the lender is of such a fundamental nature, that
to structure a system that effectively precludes the option of
going to court, is to guarantee that the consumer has virtually
no protection.
We have established here this morning that the level of
regulatory inspection and protection out here is deminimus. And
the truth is that State laws and local laws have proven to be
woefully inadequate.
And we now have the courts being cut off from consumers who
are the most vulnerable and most in need of them. And the idea
that trial lawyers are being bashed because they choose to
represent individuals and to advance their interests, I think
is patently unfair.
I really just want to take issue with the concept that
forced, mandatory arbitration is in the consumer's interest.
This is a situation where let the buyer beware governs the way
in which the market operates. And it is not in the consumer's
interest to have that kind of forced arbitration clause.
Chairman Sarbanes. Is there anyone at the table who would
object to the Fed, in changing the standards to determine a
HOEPA loan, so that it would actually reach more loans than are
now being reached?
That is under consideration now, as you know. Mr. Wallace
made reference to the protections that the people get from a
HOEPA loan. But the fact of the matter is that most of these
loans that we are talking about are not encompassed within the
existing HOEPA standards.
One way to start dealing with this problem, presumably, is
to change the standards so that more loans are caught by HOEPA
and therefore, gain the protections of HOEPA. And I would like
to get the reaction to that. First, is there anyone at the
table who objects to that, moving in that direction?
Mr. Courson. Senator, may I respond to that?
Chairman Sarbanes. Sure.
Mr. Courson. The Fed proposal has, as you are well aware,
many different facets to it, several different parts, most of
which actually the mortgage bankers, in our comments back and
discussions with the Fed, certainly support.
In fact, I know there is an antiflipping provision in
there. There is a low-cost loan provision. We have had
discussions with them on the pattern and practice provision.
The one place where our comment back to the Fed did take
issue was, as I will refer to it, the dropping of the triggers
or the change of the points and fees test. And our concern was
one that we voiced in our testimony before, is one that many
lenders, when HOEPA first was originated, made a decision that
as part of their products and loans that they would make
available to consumers, not to make HOEPA loans. That was a
decision they made.
The concern is, as we drop the triggers, both rates and
fees, that there will be more lenders, or those same lenders
will actually now not serve another tranche of borrowers that
they perhaps probably today are serving. In addition to that,
in the secondary market, and we heard about the GSE's being
unavailable for HOEPA loans, as we continue to drop those
triggers, to that tranche of loans or additional borrowers, if
you will, who will be eliminated from the GSE programs.
We have some concerns about that. And we are concerned in
that we think that the triggers, per se, will not necessarily
solve the abusive practices, that is, the enforcement and the
education we have talked about that solves that issue. And we
are concerned that just moving the terms and conditions of a
loan down, which may, in fact, have the effects I have already
discussed, will also not eradicate the predatory practices we
are trying to solve.
Mr. Berenbaum. Senator Sarbanes, if I may, I would like to
respectfully disagree with the earlier remarks. We think that
the points issue and other fees issues being addressed by the
Fed do not go far enough. And we think HUD's recommendation in
this area should be supported.
Taking it a step further, we believe that the Home Mortgage
Disclosure Act should be amended to capture these issues in the
reporting, so that we will have indicators, a report card, so
to speak, on these subprime issues, which will actually aid the
Fed in its current research on the issue.
The reality is, if you look at larger subprime lenders,
responsible lenders today, once you are in their pool of
customers, you are part of the territory that they, ``farm'',
to use the industry language itself. They will approach you for
a home equity line of credit. They will possibly suggest
packing of various products. We need to capture these types of
real estate guaranteed and unsecured properties in this HOEPA
threshold.
Chairman Sarbanes. Mr. Wallace.
Mr. Wallace. Yes, sir. In general, our view is that if you
are trying to get at predatory lending, HOEPA is not the tool
to do it. That was what my testimony said and I want to
reiterate that.
You have fraudulent practices out there. HOEPA does not
address fraudulent practices. We said that in 1994. Experience
has proved that to be the case. You have fraud. That is the
cause of the predatory practices. That statute is not going to
deal with it.
Now whether the Fed should drop the thresholds I think is a
question of credit availability. I think that some of the
advocates who are here today, perhaps, and at least some of the
advocates out in the background would just as soon not have
credit so widely available. There is a hostility toward it that
is perhaps out there.
If that is the goal, well, then, drop the thresholds
because that is the effect that is going to have. We think that
is a policy question. We think that is one that the Fed can
probably make fairly well because they can see the overall
effects.
But we do caution that the basic effect of dropping HOEPA
thresholds is that the availability of capital for that type of
loan in the past has become more difficult and we expect that
to continue in the future.
Chairman Sarbanes. Well, of course, at the extreme, and you
have to ascertain what the extreme is, even though you want to
make credit available and you want people to have the
opportunity, you may say, these terms for making credit
available in the real world are so abusive, that it is a mirage
that is being made available. The person thinks he is getting
credit made available, but the next thing you know, it is all
gone, and he is in the pit, so to speak. You have to be careful
about that because we all want people to have access to credit.
I was very struck by Mr. Henderson's statement at the outset,
which I thought was very careful to draw that distinction.
But on the other hand, at some point, you can look at this
thing and say, you are packing in so many things and engaged in
a whole series of practices here, that this is not making
credit available. This is all a flim-flam to take this person
to the cleaner's, particularly when you are coming in and
refinancing the home where someone has built up to these senior
citizens that Ms. Canja talked about, built up their equities
in their home, and so forth and so on.
I understand that a number of lenders, including some large
subprime lenders, actually are supporting reductions of the
HOEPA triggers as the Fed now wrestles with this problem. Does
anyone else want to add anything on that point?
Ms. Canja. I will just add that we also support lowering
those triggers because there are so many people that just do
not--you saw yesterday, I think, that those are the cases that
came within the triggers, but there are so many that do not.
And so, we support lowering the trigger.
Mr. Ackelsberg. Senator, as between the two triggers, the
rate trigger and the points and fees trigger, I would say the
points and fees trigger is by far the most important.
Now under the current legislation, while the Fed has the
ability to lower the rate trigger from 10 to 8, it does not
have the ability to lower the points and fees trigger. What it
does have is the ability to include more items within the
definition of points and fees as they are doing with credit
life insurance.
But, again, I would reiterate what I said in my oral
testimony, that the proof is really in the pudding, in the
empirical record since Congress passed HOEPA, which is in fact,
we are not seeing less loans. We are seeing less costly loans,
precisely as was said, because many lenders are just choosing
not to make HOEPA loans because they do not want to have the
liability attached to it.
So while, theoretically, you might get to the point where
you could take the triggers so low, that you would in fact have
an impact on credit, we are certainly far away from that.
When you have lenders making loans at seven points, I do
not think there is any economic argument to say that is
connected to any aspect of credit access or risk or anything
else, other than gouging.
Mr. Berenbaum. Mr. Eakes' testimony yesterday was extremely
probative of the North Carolina experience.
Chairman Sarbanes. Yes, I was just going to refer to the
North Carolina case. Mr. Courson, let me ask you this question.
You spoke earlier about you are considering an initiative where
you would guarantee the fees ahead of time.
You provide people with information about the fees and
charges and they would be told, guaranteed that is what they
would be at closing. Is that correct?
Mr. Courson. Yes, sir.
Chairman Sarbanes. Now, do you do the same thing for the
interest rate?
Mr. Courson. No sir. On the interest rate issue, it is a
two-part process.
Chairman Sarbanes. Yes.
Mr. Courson. At the time of the application, the closing
costs would, of course, be guaranteed, the lender's cost of
making that loan.
The consumer has a couple of choices, as they do today, to
deal with an interest rate. Obviously, interest rates are a
very dynamic market. We spent a year arguing and discussing
this back and forth as to how you would deal with the interest
rate.
Today, as we would under our proposal, a consumer can
choose, in fact, to select and, if you will, lock-in or
guarantee an interest rate that exists, or they can continue to
float.
Our proposal would say, then, once credit is off the
table--we have an application. We have a guarantee of the
closing costs. Once the credit decision has been made, the
lender now has approved the loan, that is the point at which
the customer, and now the lender, knowing what they have in
terms of risk, product, and so on, can give to the customer the
right to accept a guaranteed interest rate, in addition to the
guaranteed closing costs, which would be the same because, of
course, those costs are fixed to the type of loan, as opposed
to the dynamic moving of the money markets.
There would be the second point in the process where the
consumer would get the same disclosure they received initially,
and this time it would be completed in that it would guarantee
an interest rate and points, if they choose to take it. Some
may not choose to take it at that point and continue to move
with the market, and some of us think that we are smarter than
the markets out there, so we float.
But there would be that opportunity at the time of the
credit approval for them to accept that guaranteed rate. And
then that would be the rate that would be guaranteed when the
loan moved on to the closing process.
Chairman Sarbanes. Does anyone have any reaction to that,
anyone else at the table, about that process?
Mr. Berenbaum. Again, if the consumer was afforded the
choice, the way the consumer should be, the way we all expect
to be, that would be fine. The reality is the consumer is not
being afforded that choice in our system right now, and there
is a need for a correction.
Chairman Sarbanes. Well, all of you have been very generous
with your time and we appreciate the statements. I think we
should draw this to a close. We have been here now for quite
sometime. Let me ask this, though. Is there anyone at the table
who wanted to give an answer to a question that was not asked?
[Laughter.]
Or get in that last response to something that someone else
said. I am going to give you this opportunity so you do not
walk away feeling frustrated from this hearing. Does anyone
want to--yes, Mr. Shea.
Mr. Shea. Mr. Chairman, I would just like to make one final
point, and that has to do with the reliability of so-called
risk-based pricing. I think most people at this table would say
that if you could come up with a scheme that would adequately
price a person's real risk, that that would be legitimate.
The problem is we too often times see that there is various
schemes that are being used to judge a person's risk and they
vary tremendously. I have a credit report here from one of our
clients. It is a triple-merge credit report. It contains three
credit scores. Remember, currently, 620 to 660 is considered a
prime ``A'' lender cut-off, from there and above.
This person has three credit scores on here, one from Fair
Issacs is a 505. D, very high risk. It is going to be a high
interest rate loan for this person for most lenders. The second
one has a credit score of 565 for the same person. The third
one has a credit score of 658 for the same person.
This is an inexact science we are dealing with. This is a
client, by the way, that made their home payments on time every
month for 2 years, and they still have this wide variety of
credit scores.
So the subprime industry is an inexact world right now and
people get caught up with it and they get trapped in it, which
is why many of the features that have been discussed here
today, like arbitration clauses, prepayment payments that are
lengthy, need to be eliminated.
Chairman Sarbanes. Thank you. Anyone else? Mr. Wallace.
Mr. Wallace. Yes, sir. I just wanted to make one point.
There was a discussion between yourself and Mr. Berenbaum about
North Carolina. We have studied, and I believe it was mentioned
yesterday, we have studied North Carolina. Our data ended 6
months after the North Carolina legislation went in.
We found a very major decrease in subprime loan volume
occurring amongst our members, very spectacular. Most lower-
income people, people below $50,000. I want to point that out
to you. Mr. Eakes, I understand, does not agree with that. I
was not here yesterday. But I understand that he does not agree
with that.
Chairman Sarbanes. No. Mr. Eakes made the point that was
one of the objectives of the legislation. Namely, that, as I
understand it, some 80 percent of these loans are for
refinancing. Is that correct?
Mr. Wallace. I will take your word for it, sir.
Chairman Sarbanes. All right. He said that one of the
things that they were trying to get at in passing the
legislation was to decrease or reduce the amount of refinancing
that was taking place by low income people because it was
perceived that was being used to simply strip them of their
equity in their home, which, of course, was two of the very
poignant examples that were presented to the Committee
yesterday.
It is a complicated relationship, and we need to analyze
the figures very carefully. But they are subject to a different
interpretation and a different conclusion. And he was very
forceful in making that point.
Mr. Wallace. I understand the point and we can all make
value judgments about the basic point.
But if the goal of legislation is to reduce credit
availability, that would be an enormous change in the policy of
this country, which has been to increase credit availability.
Chairman Sarbanes. No, the goal is to prevent abusive
practices. That is the goal.
Mr. Wallace. Yes.
Chairman Sarbanes. And I do not accept that in order to get
the maximum credit availability, you are going to accept
grossly abusive practices. The system ought to be able to do
better than that. I mean, America ought to have a better
performance standard than that, it seems to me.
Mr. Wallace. Well, of course. And we all agree with that.
Mr. Berenbaum. Senator Sarbanes, yesterday, the Home
Mortgage Disclosure Act data for 2000 was issued. It is brand
new raw data that I am sure everyone at the table is analyzing.
But you should be aware that, unfortunately, last year,
there was a 16 percent drop across the board in both prime and
subprime lending, loan origination. I am afraid there are
issues of our economy, as much as many other issues, impacting
on this discussion.
Mr. Wallace. This was actually compared to two adjacent
States and the effect did not occur in the other States.
There is one other point. I would like to commend ACORN in
their statement. They indicated that they are somewhat
reluctant to see local ordinances dealing with subprime issues
and predatory issues. We agree with that point of view.
Mr. Shea. Whoa. That is taken way out of context.
[Laughter.]
You just got me on that.
Mr. Wallace. I thought we all agreed together on that.
[Laughter.]
Chairman Sarbanes. Why don't you put it in context, Mr.
Shea?
[Laughter.]
I think we understand the context.
Mr. Shea. I think you do.
Chairman Sarbanes. Let me say on that point because it is
one that runs through a number of issues, I understand the
industry argument that they operate nationwide and in 50 States
and, therefore, 50 different standards are difficult for them
to meet and present administrative problems. Therefore, they
constantly are referencing Federal preemption.
But it seems clear to me that if you start to entertain
Federal preemption, intimately interrelated with that question
is the question of the substantive protections that would be
provided under the Federal standard.
The notion of preemption at an inadequate Federal standard
I find totally unacceptable. I think that needs to be
understood up-front. You really have to address at the same
time the question of the standard and how adequately that deals
with the problem and protects the consumer.
Otherwise, it seems to me, there is no basis to deal the
States out of the picture. Now many of the States feel strongly
that they should not be dealt out of the picture in any event.
And given that we have a Federal system and the role of the
States in our system, that is not a minor question. That is a
very important question that would have to be looked at. But
the notion that they should be dealt out with a standard that
is inadequate to deal with the problem, is seems to me is a
complete nonstarter. And I just thought that I would lay that
out as we draw the hearing to a close.
Thank you all very much for coming. We really appreciate
it.
The hearing is adjourned.
[Whereupon, at 1:15 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR PAUL S. SARBANES
Today is the Committee's second hearing on Predatory Lending: The
Problem, Impact, and Responses. Yesterday, we heard some very eloquent
statements of the problem from four Americans who worked all their
lives to attain the dream of homeownership, to build a little wealth,
only to have it slowly, bit-by-bit, loan-by-loan, taken away from them.
These people were targeted by unscrupulous lenders because they
were elderly homeowners that had a lot of equity in their homes. In the
case of one woman from West Virginia, she owned her home free and
clear, paid off her mortgage with the proceeds of her husband's life
insurance policy, only to end up losing her home altogether because of
a series of six or seven flips in the space of less than 2 years.
What struck me about these four stories was that many of the
practices that harmed these witnesses--the repeated flipping of the
loans, the high points and fees rolled into the loan, and the mandatory
arbitration clauses that kept some of them from effectively pursuing a
legal remedy--are all legal.
Let me reiterate what I said yesterday. I support actions by
regulators to utilize their authority under existing law to expand
protections against predatory lending. I support stronger enforcement
of current protections by the Federal Trade Commission and other
regulators. I applaud campaigns to increase financial literacy and
industry efforts to establish best practices. I know a number of
witnesses at this morning's hearing will tell us about such efforts.
But those who take the position that stronger regulatory and/or
more aggressive enforcement of existing laws will be adequate have a
special burden, particularly in light of yesterday's testimony, to make
sure that regulatory and enforcement tools are adequate to the job.
To that end, in my view, they should support the Federal Reserve
Board's proposed regulation on HOEPA, as Ameriquest has done. They
should support the Fed's effort to gather additional information
through an expanded HMDA.
And they should support the regulatory and enforcement agencies
such as the FTC, the Treasury, and HUD in their recommendations for
more effective enforcement. I sincerely hope that today's witnesses
will take these positions.
But I want to be clear: neither stronger enforcement, nor literacy
campaigns, nor best practices are enough. Too many of the practices we
heard about in yesterday's testimony, while extremely harmful and
abusive, are legal. And while we must aggressively pursue financial
education, we must also recognize that education takes time to be
effective, and thousands of people are being hurt every day.
As I did yesterday, I want to recount what Fed Governor Roger
Ferguson said in his confirmation hearing: ``legislation, careful
regulation, and education are all components of the response to these
emerging consumer concerns.'' I ascribe to that view.
Before turning to my colleagues and the witnesses, I want to take a
moment to explain that we have had far more requests to testify than we
have openings, as I think the tightly packed witness table makes
abundantly clear.
We have offered to include statements from these and other
organizations in the record of today's hearing.
----------
PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
Mr. Chairman, I am glad to be back for a second day of hearings on
the problem of unscrupulous lending practices in the subprime market.
Yesterday was a moving and important opportunity to hear from victims
of predatory lending. The story of Carol Mackey from Michigan as well
as the other hard working people on our panel of predatory lending
victims illustrates clearly why we need to act on this problem.
It is my sincere hope that something can be done to rectify the
untenable situation these citizens find themselves in. I think that
would be an important step by key participants in this debate over
predatory lending. Obviously, however, fixing these four terrible
lending situations will not address the problems that thousands of
other consumers have encountered while trying to get a loan, but it is
a start.
Mr. Chairman, speaking of a positive step forward, I should take a
moment to note the decisions, over the last few weeks, by some of the
major lenders. As many of my colleagues on the Committee pointed out
yesterday, the recent decision by some companies to stop selling
single-premium credit insurance was significant and a positive step in
the right direction.
I have had serious reservations about this product and fear that it
is usually not in the best interests of consumers. I am glad to see
companies are responding to these concerns; their actions are
responsible and appreciated.
Today, we are going to hear from an array of spokespeople
representing the civil rights community, consumer interests, seniors,
low-income families, as well as some representatives from the subprime
industry. I welcome all of them to the discussion we are having here
and I know many of them have worked very hard on this issue in
different capacities for quite some time.
I am sure that their expertise and differing perspectives will be
extremely helpful to our Committee--especially because the issues
before us are complex and different parties have different ideas about
how to stop predatory lending.
In the months ahead, we are going to have to grapple with such
issues as loan flipping, mandatory arbitration disclosures, prepayment
penalties, the definition of a ``high-cost'' loan, the role of
regulation, and effective ways of promoting financial education--to
name just a few.
In the midst of this forthcoming discussion, working through the
details and debating the policy merits of different proposals, I hope
we keep in mind what this entire discussion is about. I said it
yesterday, and I will say it again today: this discussion is about
homeownership and the right for people to build a secure future for
themselves and their families. And, as we heard so vividly yesterday,
it is about people like Carol Mackey, Mary Ann Podelco, Paul Satriano,
and Leroy Williams.
Thank you, Mr. Chairman.
----------
PREPARED STATEMENT OF WADE HENDERSON
Executive Director, Leadership Conference on Civil Rights
July 27, 2001
Mr. Chairman and Members of the Committee, I am Wade Henderson,
Executive Director of the Leadership Conference on Civil Rights. I am
pleased to appear before you today on behalf of the Leadership
Conference to discuss the very pressing issue of predatory lending in
America.
The Leadership Conference on Civil Rights (LCCR) is the Nation's
oldest and most diverse coalition of civil rights organizations.
Founded in 1950 by Arnold Aronson, A. Philip Randolph, and Roy Wilkins,
LCCR works in support of policies that further the goal of equality
under law. To that end, we promote the passage of, and monitor the
implementation of, the Nation's landmark civil rights laws. Today the
LCCR consists of over 180 organizations representing persons of color,
women, children, organized labor, persons with disabilities, the
elderly, gays and lesbians, and major religious groups. It is a
privilege to represent the civil rights community in addressing the
Committee today.
Predatory Lending Is A Civil Rights Issue
Some may wonder why the issue of predatory lending raises civil
rights issues, but I think the answer is quite clear.
Shelter, of course, is a basic human need--and homeownership is a
basic key to financial viability. While more Americans own their homes
today than any time in our history, minorities and others who
historically have been underserved by the lending industry still suffer
from a significant homeownership gap.
The minority homeownership rate climbed to a record-high 48.8
percent in the second quarter of 2001, Housing and Urban Development
Secretary Mel Martinez said yesterday. About 13.2 million minority
families owned homes in this period, up from 47.6 percent in the same
quarter last year, HUD said. However, the rate for minorities still
lagged behind the overall homeownership rate in the second quarter this
year, which, at 67.7 percent, tied a high first set in the third
quarter of 2000. Nationally, 72.3 million American families owned their
homes.
Unequal homeownership rates cause disparities in wealth since
renters have significantly less wealth than homeowners at the same
income level. To address wealth disparities in the United States and
make opportunities more widespread, it is clear that homeownership
rates of minority and low-income families must rise. Increasing
homeownership opportunities for these populations is, therefore,
central to the civil rights agenda of this country.
Increasingly, however, hard-earned wealth accumulated through
owning a home is at significant risk for many Americans. The past
several years have witnessed a dramatic rise in harmful home equity
lending practices that strip equity from families' homes and wealth
from their communities. These predatory lending practices include a
broad range of strategies that can target and disproportionately affect
vulnerable populations, particularly minority and low-income borrowers,
female single-headed households and the elderly. These practices too
often lead minority families to foreclosure and minority neighborhoods
to ruin.
Today, predatory lending is one of the greatest threats to families
working to achieve financial security. These tactics call for an
immediate response to weed out those who engage in or facilitate
predatory practices, while allowing legitimate and responsible lenders
to continue to provide necessary credit.
As the Committee is aware, however, subprime lending is not
synonymous with predatory lending. Moreover, I would ask you to remain
mindful of the need for legitimate ``subprime'' lending. We should be
careful that it is not adversely impacted by efforts directed at
predators.
The subprime lending market has rapidly grown from a $20 billion
business in 1993 to a $150 billion business in 1998, and all
indications are that it will continue to expand. The enormous growth of
subprime lending has created a valuable new source of loans for credit
strapped borrowers. Although these loans have helped many in an
underserved market, the outcome for an increasing number of consumers
has been negative.
On a scale where ``A'' represents prime, or the best credit rating,
the subprime category ranges downward from ``A''-minus to ``B,'' ``C,''
and ``D.'' Borrowers pay more for subprime mortgages in the form of
higher interest rates and fees. Lenders claim this higher consumer
price tag is justified because the risk of default is greater than for
prime mortgages. Yet even with an increased risk, the industry
continues to ring up hefty profits and the number of lenders offering
subprime products is growing.
Some have suggested that subprime lending is unnecessary. They
contend that if an individual does not have good credit then the
individual should not borrow more money. But as we all know, life is
never that simple. Even hard working, good people can have impaired
credit, and even individuals with impaired credit have financial needs.
They should not be doomed to a financial caste system, one that both
stigmatizes and permanently defines their financial status as less than
``A.''
Until a decade ago, consumers with blemishes on their credit record
faced little hope of finding a new mortgage or refinancing an existing
one at reasonable rates. Without legitimate subprime loans, those
experiencing temporary financial difficulties could lose their homes
and even sink further into red ink or even bankruptcy.
Moreover, too many communities continue to be left behind despite
the record economic boom. Many communities were ``redlined,'' when the
Nation's leading financial institutions either ignored or abandoned
inner city and rural neighborhoods. And, regrettably, as I discussed
earlier, predators are filling that void--the payday loan sharks; the
check-cashing outlets; and the infamous finance companies.
Clearly there is a need for better access to credit at reasonable
rates, and legitimate subprime lending serves this market. I feel
strongly that legitimate subprime lending must continue. I am concerned
that if subprime lending is eliminated, we will go back to the days
when the only source of money available to many inner-city residents
was from finance companies, whose rates are often higher than even
predatory mortgage lenders. It was not long ago that these loan sharks
walked through neighborhoods on Fridays and Saturdays collecting their
payments on a weekly basis and raising havoc for many families. We do
not want to see this again. However, predatory lending is never
acceptable, and it must be eradicated at all costs.
Believing that there may have been an opportunity for a voluntary
response to the predatory lending crisis, several national leaders
within the prime and subprime lending industry, as well as the
secondary market, came together last year with civil rights, housing,
and community advocates in an attempt to synthesize a common set of
``best practices'' and self policing guidelines. Although the group
achieved consensus on a number of the guidelines, several tough issues
remained unresolved. These points of controversy surrounded such issues
as prepayment penalties, credit life insurance, and loan terms and
fees, which go to the very essence of the practice by contributing to
the equity stripping that can cause homeowners to lose the wealth they
spend a lifetime building. In the end, we failed to achieve a consensus
within our working group largely because industry representatives
believed they could be insulated politically from mandatory compliance
of Federal legislation.
Given the industry's general reluctance to grapple with these tough
issues on a voluntary basis, it seems clear that only a mandatory
approach will result in a significant reduction in predatory lending
practices.
Direct Action Has Led to Changes, But More Is Needed
At the outset, I think it is important to recognize that many
persons and organizations have been actively combating predatory
lending practices, and with some success. I give credit to Maude Hurd
and her colleagues at ACORN who have been able to persuade certain
lenders to eliminate products like single-premium credit life
insurance. I think Martin Eakes of Self-Help, who testified before the
Committee yesterday, should also be recognized for his efforts in
crafting a comprehensive legislative package in North Carolina, the
first such measure among the States. These groups, including the
National Community Reinvestment Coalition and others you have heard
from in these hearings have forced real change. But they need help.
Recent investigations by Federal and State regulatory enforcement
agencies, as well as a series of lawsuits, indicate that lending abuses
are both widespread and increasing in number. LCCR is therefore pleased
to see that regulators are increasingly targeting their efforts against
predatory practices. For example, we note that the Federal Trade
Commission (FTC) has taken several actions aimed at predatory actions.
These include a lawsuit filed against First Alliance Mortgage that
alleges a series of deceptive marketing practices by the company,
including a marketing script designed to hide the trust cost of loans
to the borrower.
More recently, the FTC filed a comprehensive complaint against the
Associates First Capital alleging violations of a variety of laws
including the FTC Act, the Truth in Lending Act, and the Equal Credit
Opportunity Act. Among other things, the suit claims that Associates
made false payment savings claims, packed loans with credit insurance,
and engaged in unfair collection activities.
In addition to the activity at the Federal level, various States
Attorneys General have also been active in this area and I know the
issue is of great concern to them.
Many have observed that certain practices cited as predatory are
already prohibited by existing law. I agree, and therefore urge
regulatory agencies to step up their efforts to identify and take
action against predatory practices. At a minimum, this should include
increased efforts to ensure lenders are fully in compliance with HOEPA
requirements, particularly the prohibition on lending without regard to
repayment ability. In addition, we strongly support continued efforts
to combat unfair and deceptive acts and practices by predatory lenders.
State Legislation Has Addressed Some Practices
I think much can be learned from the actions of State legislators
and regulatory agencies. At last count, roughly 30 measures to address
predatory lending have been proposed and more than a dozen have been
enacted. The first of these was the North Carolina statute enacted in
July 1999, that Martin Eakes has described to the Committee. Following
this statute, a number of other statutes, regulations and ordinances
have been adopted, several of which are summarized below.
Connecticut
Connecticut H.B. 6131 was signed into law in May 2001 and is
effective on October 1, 2000. The new statute addresses a variety of
predatory lending concerns by prohibiting the following provisions in
high-cost loan agreements: (i) balloon payments in mortgages with a
term of less than 7 years, (ii) negative amortization, (iii) a payment
schedule that consolidates more than two periodic payments and pays
them in advance from the proceeds; (iv) an increase in the interest
rate after default or default charges that are more than 5 percent of
the amount in default; (v) unfavorable interest rebate methods; (vi)
certain prepayment penalties; (vii) mandatory arbitration clauses or
waivers of participation in a class action, and (viii) a call provision
allowing the lender, in its sole discretion, to accelerate the
indebtedness.
In addition to these prohibitions, the statute addresses certain
lending practices by prohibiting: (i) payment to a home improvement
contractor from the proceeds of the loan except under certain
conditions; (ii) sale or assignment of the loan without notice to the
purchaser or assignee that the loan is subject to the Act; (iii)
prepaid finance charges (which may include charges on earlier loans by
the same lender) that exceed the greater of 5 percent of the principal
amount of the loan or $2,000; (iv) certain modification or renewal
fees; (v) lending without regard to repayment ability; (vi) advertising
payment reductions without also disclosing that a loan may increase the
number of monthly debt payments and the aggregate amount paid by the
borrower over the term of the loan; (vii) recommending or encouraging
default on an existing loan prior; (viii) refinancings that do not
provide a benefit to the borrower; (ix) making a loan with an interest
rate that is unconscionable, and (x) charging the borrower fees for
services that are not actually performed or which are not bona fide and
reasonable.
City of Chicago
Chicago's predatory lending ordinance was effective November 13,
2000. It requires an institution wishing to hold city funds to submit a
pledge affirming that neither it nor any of its affiliates is or will
become a predatory lender, and provides that institutions determined by
Chicago Chief Financial Officer or City Comptroller to be predatory
lenders are prohibited from being designated as a depository for city
funds and from being awarded city contracts. Cook County also has
enacted an ordinance closely modeled to the one in Chicago.
Under the Chicago ordinance, a loan is predatory if its meets an
APR or points and fees threshold and contains any of the following: (i)
fraudulent or deceptive marketing and sales efforts to sell threshold
loans (loan that meets the APR or points and fees threshold to be
predatory but does not contain one of the enumerated triggering
criteria); (ii) certain prepayment penalties; (iii) certain balloon
payments; (iv) loan flipping, that is the refinancing and charging of
additional points, charges or other costs within a 24 month period
after the refinanced loan was made, unless such refinancing results in
a tangible net benefit to the borrower; (v) negative amortization; (vi)
financing points and fees in excess of 6 percent of the loan amount;
(vii) financing single-premium credit life, credit disability, credit
unemployment, or any other life or health insurance, without providing
certain disclosures; (viii) lending without due regard for repayment
ability; (ix) payment by a lender to a home improvement contractor from
the loan proceeds, unless the payment instrument is payable to the
borrower or jointly to the borrower and the contractor, or a third-
party escrow; (x) payments to home improvement contractors that have
been adjudged to have engaged in deceptive practices.
District of Columbia
The District of Columbia has amended its foreclosure law, effective
August 31, 2001 or 60 days after the effective date of rules
promulgated by the Mayor, to address predatory practices. In summary,
the amendment prohibits: (i) making ``home loans'' unless lenders
``reasonably believe'' the obligors have the ability to repay the loan;
(ii) financing single-premium credit insurance; (iii) refinancings that
do not have a reasonable, tangible net benefit to the borrower; (iv)
recommending or encouraging default on any existing debt that is being
refinanced; (v) making, brokering, or arranging a ``home loan'' that is
based on the inaccurate or improper use of a borrower's credit score
and thereby results in a loan with higher fees or interest rates than
are usual and customary; (vi) charging unconscionable points, fees, and
finance charges on a ``home loan''; (vii) post-default interest; (viii)
charging fees for services not actually performed or, which are
otherwise ``unconscionable''; (ix) failing to provide certain
disclosures; (ix) requiring waivers of the protections of the Predatory
Lending Law; (x) financing certain points and fees on certain
refinancings; and (xi) certain balloon payments.
Illinois
The State of Illinois has enacted a predatory lending law that was
effective on May 17, 2001. The Illinois law prohibits: (i) certain
balloon payments; (ii) negative amortization; (iii) disbursements
directly to home improvement contractors; (iv) financing ``points and
fees,'' in excess of 6 percent of the total loan amount; (v) charging
points and fees on certain refinancings unless the refinancing results
in a financial benefit to the borrower; (vi) loan amounts that exceed
the value of the property securing the loan plus reasonable closing
costs; (vii) certain prepayment penalties; (viii) accepting a fee or
charge for a residential mortgage loan application unless there is a
reasonable likelihood that a loan commitment will be issued for such
loan for the amount, term, rate charges, or other conditions set forth
in the loan application and applicable disclosures and documentation,
and that the loan has a reasonable likelihood of being repaid by the
applicant based on his/her ability to repay; (ix) lending based on
unverified income; (x) financing of single-premium credit life, credit
disability, credit unemployment, or any other credit life or health
insurance; and (xi) fraudulent or deceptive acts or practices in the
making of a loan, including deceptive marketing and sales efforts.
In addition, the statute requires lenders to: (i) provide notices
regarding homeownership counseling and to forbear from foreclosure when
certain counseling steps have been taken; and (ii) report default and
foreclosure data to regulators.
Massachusetts
Massachusetts adopted regulations that were effective on March 22,
2001. Those regulations prohibit the following in high-cost loans: (i)
certain balloon payments; (ii) negative amortization; (iii) certain
advance payments; (iv) post-default interest rates; (v) unfavorable
interest rebate calculations; (vi) certain prepayment penalties; (vii)
financing points and fees in an amount that exceeds 5 percent of the
principal amount of a loan, or of additional proceeds received by the
borrower in connection with the refinancing; (viii) charging points and
fees on some refinancings; (ix) ``packing'' of certain insurance
products or unrelated goods or services; (x) recommending or
encouraging default or further default on loans that are being
refinanced; (xi) advertising payment savings without also noting that
the ``high-cost home loan'' will increase both a borrower's aggregate
number of monthly debt payments and the aggregate amount paid by a
borrower over the term of the ``high-cost home loan''; (xii)
unconscionable rates and terms; (xiii) charging for services that are
not actually performed, or which bear no reasonable relationship to the
value of the services actually performed; (xiv) requiring a mandatory
arbitration clause or waiver of participation in class actions that is
oppressive, unfair, unconscionable, or substantially in derogation of
the rights of consumers; (xv) failing to report both favorable and
unfavorable payment history of the borrower to a nationally recognized
consumer credit bureau at least annually if the creditor regularly
reports information to a credit bureau; (xvi) single-premium credit
insurance, including credit life, debt cancellation; (xvii) call
provisions; and (xviii) modification or deferral fees.
Massachusetts also requires credit counseling for any borrower 60
years of age or more. The counseling must include instruction on high-
cost home loans. Other borrowers must receive a notice that credit
counseling is available.
New York
In June 2000, the New York State Banking Department adopted Part 41
of the General Regulations of the Banking Board. This regulation, which
was effective in the fall of 2000, was designed to protect consumers
and the equity they have invested in their homes by prohibiting abusive
practices and requiring additional disclosures to consumers. Part 41
sets lower thresholds than the Federal HOEPA statute, covering loans
where the APR is greater than 8 or 9 percentage points over U.S.
Treasury securities, depending on lien priority, or where the total
points and fees exceed either 5 percent of the loan amount.
The regulations prohibit lending without regard to repayment
ability and establish a safe harbor for loans where the borrower's
total debt to income ratio does not exceed 50 percent. The regulations
address ``flipping'' by only allowing a lender to charge points and
fees if 2 years have passed since the last refinancing or on new money
that is advanced. The regulations also limit financing of points and
fees to a total of 5 percent and require reporting of borrower's credit
history. The regulations prohibit (i) ``packing'' of credit insurance
or other products without the informed consent of the borrower; (ii)
call provisions that allow lenders to unilaterally terminate loans
absent default, sale, or bankruptcy; (iii) negative amortization;
(iv) balloon payments within the first 7 years; and (v) oppressive
mandatory arbitration clauses.
Finally, Part 41 requires additional disclosures to borrowers,
including the statement ``The loan which will be offered to you is not
necessarily the least expensive loan available to you and you are
advised to shop around to determine comparative interest rates, points,
and other fees and charges.''
Pennsylvania
Pennsylvania has recently enacted predatory lending legislation
that prohibits a variety of practices. These include: (i) fraudulent or
deceptive acts or practices, including fraudulent or deceptive
marketing and sales efforts; (ii) refinancings that do not provide
designated benefits to borrowers; (iii) certain balloon payments; (iv)
call provisions; (v) post-default interest rates; (vi) negative
amortization; (vii) excessive points and fees; (viii) certain advance
payments; (ix) modification or deferral fees; (x) certain prepayment
penalties; (xi) certain arbitration clauses; (xii) modification or
deferral fees; (xiii) certain prepayment penalties; (xiv) lending
without home loan counseling; and (xv) lending without due regard to
repayment ability.
Texas
Texas has enacted predatory lending prohibitions that are effective
on September 1, 2001. Among other things, the Texas law prohibits: (i)
certain refinancings that do not result in a lower interest rate and a
lower amount of points and fees than the original loan or is a
restructure to avoid foreclosure; (ii) certain credit insurance
products unless informed consent is obtained from the borrower; (iii)
certain balloon payments; (iv) negative amortization; (v) lending
without regard to repayment ability; and (vi) certain prepayment
penalties.
For certain home loans, the lender must also provide disclosures
concerning the availability of credit counseling.
Virginia
Virginia has enacted provisions that are effective July 1, 2001.
These provisions prohibit: (i) certain refinancings that do not result
in any benefit to the borrower; and (ii) recommending or encouraging a
person to default on an existing loan or other debt that is being
refinanced.
Federal Legislation Is Necessary
While LCCR commends State and local initiatives in this area, we
believe they are clearly not enough. First, State legislation may not
be sufficiently comprehensive to reach the full range of objectionable
practices. For example, while some State and local initiatives impose
restrictions on single-premium credit life insurance, others do not.
This, of course, leaves gaps in protection even for citizens in some
States that have enacted legislation. Second, while measures have been
enacted in some States, the majority of States have not enacted
predatory lending legislation. For this reason, LCCR supports the
enactment of Federal legislation, of the sort that has been proposed by
the Chairman, to fill these gaps.
The Predatory Lending Consumer Protection Act of 2001 contains key
protections against the types of abusive practices that have been so
devastating to minority and low-income homeowners. They include the
following: (i) Restrictions on financing of points and fees for HOEPA
loans. The bill restricts a creditor from directly or indirectly
financing any portion of the points, fees, or other charges greater
than 3 percent of the total sum of the loan, or $600; (ii) Limitation
on the payment of prepayment penalties for HOEPA loans. The bill
prohibits the lender from imposing prepayment penalties after the
initial 24 month period of the loan. During the first 24 months of a
loan, prepayment penalties are limited to the difference in the amount
of closing costs and fees financed and 3 percent of the total loan
amount; and (iii) Limitation on single-premium credit insurance for
HOEPA loans. The bill would prohibit the up-front payment or financing
of credit life, credit disability, or credit unemployment insurance on
a single-premium basis. However, borrowers are free to purchase such
insurance with the regular mortgage payment on a periodic basis,
provided that it is a separate transaction that can be canceled at any
time.
The Leadership Conference strongly supports the Predatory Lending
Consumer Protection Act of 2001 and urges its swift enactment.
Conclusion
Let me finish where I began. ``Why is subprime lending--why is
predatory lending--a civil rights issue?'' The answer can be found in
America's ongoing search for equal opportunity. After many years of
difficult and sometimes bloody struggle, our Nation and the first
generation of America's civil rights movement ended legal segregation.
However, our work is far from finished. Today's struggle involves
making equal opportunity a reality for all. Predatory lending is a
cancer on the financial health of our communities. It must be stopped.
Thank you.
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PREPARED STATEMENT OF JUDITH A. KENNEDY
President, National Association of Affordable Housing Lenders
July 27, 2001
Good morning. Thank you for the chance to appear before you today.
My name is Judith Kennedy. I am President of the National Association
of Affordable Housing Lenders, or NAAHL, the national association
devoted to supporting private capital investment in low- and moderate-
income communities. NAAHL represents 200 organizations, including 85
insured depository institutions and more than 800 individuals. Formed
more than 11 years ago, NAAHL's members are the pioneering
practitioners of community investment. They include banks,
corporations, loan consortia, financial intermediaries, pension funds,
foundations, local and national nonprofits, public agencies, and allied
professionals.
Ever since NAAHL's 1999 Chicago conference, where we heard about
predators' activities in that city, we have been convinced that if we
are not part of the solution to predatory lending, we are a part of the
problem. It is clear that while we remain committed to increasing the
flow of capital into underserved communities, we must be equally
concerned about access to capital on appropriate terms.
In March, we sponsored a symposium that brought together experts on
this issue: regulators, researchers, advocates, for-profit and
nonprofit lenders, and secondary market participants. We were pleased
to include as speakers, Martin Eakes of Self-Help, who testified before
you yesterday, and Margot Saunders of the National Consumer Law Center.
NAAHL's goal was to accelerate progress in stopping the victimization
that strips equity from peoples' homes and, all too often, triggers
foreclosures. This victimization is not only wrong in itself, but as
the Mayor of Chicago succinctly put it: ``It is all down the drain if
we cannot stabilize the communities that were stable until these
foreclosures started to happen.''
The symposium was very productive, and today we are releasing the
summary of these proceedings which is attached to my statement.\1\ Our
findings are as follows.
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\1\ Held in Senate Banking Committee files.
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First, a profile of predatory lending emerged. Loan flipping, home
improvement scams, asset-based and unaffordable mortgage loans,
repetitive financings with no borrower benefit, packing single-premium
credit life insurance, and other products into the loan amount, all of
these can strip equity and trigger foreclosures.
Second, more needs to be done at the Federal level. More is, of
course, being done, and as New York State Banking Commissioner
Elizabeth McCaul and Chairman Sarbanes have both emphasized, it is
critical to balance the need for credit with the need to end abuses.
NAAHL, like many others, has commented on the Federal Reserve's
proposals in this area. But as the Federal Reserve has pointed out, a
significant amount of mortgage lending is not covered by a Federal
framework. For example, Governor Gramlich reported that only about 30
percent of all subprime loans are made by depository institutions that
have periodic exams. Even if the Fed were to do periodic compliance
exams of the subsidiaries of financial holding companies, that would
only increase the percentage to about 40 percent.
It is not surprising, then, that of the 21 completed Federal Trade
Commission investigations into fair lending and consumer compliance
violations, 19 involved in-
dependent mortgage companies and two involved subsidiaries of financial
holding companies. None were Federally examined. If the Fed's recent
proposal to expand reporting under the Home Mortgage Disclosure Act to
more lenders is adopted, it will encompass only those whose mortgage
lending exceeds $50 million per year. Many of the proposed changes to
HMDA will only create a more uneven playing field by putting additional
burden and costs on responsible lenders while the worst lenders go
unexamined.
To stop the predators, we need to close the barn doors on
examination and reporting. A level playing field in oversight and
enforcement is key. Insured Depository Institutions (IDI) engaging in
the best practices in the subprime lending market
do extensive due diligence of their brokers to ensure fair lending
practices. They maintain data on their loans and are rigorously
examined by the bank regulatory agencies.
But the majority of lenders are not subject to the same regulatory
oversight, do not have the same level of compliance management, and
often do not even file HMDA reports. If they do file, there is very
little oversight of their disclosure. In a town with no sheriff, the
bandits are in charge. Unscrupulous brokers who are rejected by
legitimate lenders, simply go to others who have no knowledge of the
loan terms, or reputational or compliance concerns about funding
predatory loans.
Some States like New York are conducting vigorous exams of their
licensed mortgage companies, but unfortunately many States lack
sufficient resources. Some States and municipalities believe that
stricter laws and ordinances will solve the problem of predatory
practices. Many NAAHL members believe that the plethora of local laws
and ordinances may only drive out the responsible lenders who will
choose not to offer what may become ``high-cost loans'' under a crazy
quilt of new rate and fee restrictions.
Third, our symposium also confirmed that subprime lending is an
important source of home finance. For many consumers, subprime loans
may be the only way available to finance the American Dream--a home of
their own. And many, many programs exist, in both the private and
public sectors, to help subprime borrowers achieve prime borrower
status--a worthy financial goal. Cutting off access to credit on
appropriate terms would not be constructive. As OTS Director Ellen
Seidman has warned, legislation must be very clear so as not to chill
``the operation of the legitimate subprime market. The flow of
responsibly delivered credit to underserved markets is critical to
their survival and any legislative or enforcement solutions . . . must
proceed with this caution in mind.''
Fourth, we also heard that vigorous enforcement, at all levels of
Government, works. We heard from people actively involved in combating
predatory lending at the city and State levels. Increased Government
investigations, criminal prosecutions to the fullest extent of the law,
and revocations of mortgage brokers' licenses all help to eradicate
predatory lending. State bank supervisors coordinating across State
lines on a single company and its practices will also accelerate
progress.
Fifth, consumer education is key. Our experts recommend that
financial literacy education must begin early, down to and including
the high school level. The NAAHL symposium also confirmed that both the
public and private sectors, on all levels, are undertaking consumer
education and outreach campaigns, to stop predatory lending before it
even happens, with good results. For example, New York residents can
easily use State government information to shop for competitive
mortgage rates. Chicago borrowers can call 1-866-SAVE-HOME to receive
counseling and legal assistance, funded by banks and city government.
Lenders across the country fund financial literacy programs to help
borrowers with debt management, the implications of signing contracts,
and tips on how to avoid stalkers who offer financing on predatory
terms.
Increased Federal resources for targeted counseling in
neighborhoods that are vulnerable to predators could greatly extend
these efforts. Education may not solve the entire problem. As Martin
Eakes points out, ``the Department of Education says that 24 percent of
adult Americans are illiterate.'' But counseling can go a long way. As
Governor Gramlich proposed, ``the best defense is if people really know
what they are doing.''
Overall, our symposium confirmed once again that predatory lending
is a complex issue requiring a multifaceted solution. It takes a
combination of responses from both the public and private sectors,
including a broader Federal framework establishing a level playing
field for legitimate lenders, more vigorous enforcement of existing
laws, and more resources devoted to consumer education to deal with it.
But, as our closing speaker, the Honorable Mel Martinez, Secretary
of the Department of Housing and Urban Development put it, ``juntos
podemos'': together we can.
As the President of an organization whose members have spent years
trying to increase the flow of private capital into underserved
communities, I say, ``together we must.'' Equity stripping, foreclosure
triggering loans lead to family tragedies, foreclosures, and
destabilized neighborhoods. They must be stopped. We at NAAHL commit to
help you in any way we can.
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PREPARED STATEMENT OF ESTHER ``TESS'' CANJA
President, American Association of Retired Persons
July 27, 2001
Good morning, Chairman Sarbanes, Ranking Member Gramm, and Members
of the Senate Banking, Housing, and Urban Affairs Committee. My name is
Esther ``Tess'' Canja. I live in Port Charlotte, Florida, and I serve
as President of AARP.
AARP is actively engaged in efforts to protect consumer rights and
interests. The Association has been directly involved since the early
1990's in researching issues, litigating cases, and working with
Federal and State regulatory agencies and legislative bodies to expose,
hold accountable, and seek redress from those who are responsible for a
wide range of exploitive financial practices.
AARP appreciates this opportunity to bring into greater focus one
of the most troubling forms of these exploitive financial practices--
which is making unjustifiable high-cost home equity loans to older
Americans. For most Americans, home equity accumulation is a factor of
time (for many a ``working lifetime''), and therefore is highly
correlated with age. For older Americans, the most abusive loans are
often the refinancing and equity-based home modification loans because
they target the value of the home--frequently the owner's largest
financial asset. These forms of abusive lending are particularly
devastating when the older homeowner is living on a modest or fixed
income.
It has been AARP's long-standing view that loans become predatory
when they:
take advantage of a borrower's inexperience, vulnerabilities
and/or lack of information;
are priced at an interest rate and contain fees that cannot be
justified by credit risk;
manipulate a borrower to obtain a loan that the borrower
cannot afford to repay; and/or defraud the borrower.\1\
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\1\ On January 31, 2001, the OCC, FRB, FDIC, and the OTS expanded
the examination guidance for supervising subprime lending activities,
limited to institutions under their respective jurisdictions, which
recognizes ``. . . that some forms of subprime lending may be abusive
or predatory . . . designed to transfer wealth from the borrower to the
lender/loan originator without commensurate exchange of value.''
The investment in homeownership among older Americans is
substantial. For example, based on American Housing Survey data for
1999, the median mortgage Loan to Value ratios (LTV's) steadily
decrease from 74.8 for those under 35 years of age, to 31.7 for those
age 65 and older.\2\ That is to say, the median homeowner's equity
increases by more than two-and-one-half times by age 65 and older. The
U.S. Census reports that American homeownership averaged an all-time
high of 67.4 percent for the year 2000.
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\2\ See attachment 1, ``Homeownership Rates and Loan to Value
(LTV), 1999.
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What is it about older American homeowners that makes them
particularly attractive to predatory lenders? \3\ Older homeowners are
often targeted for mortgage refinancing and home equity loans because
they are more likely to live in older homes in need of repair, less
likely to perform repairs themselves, and are likely to have
substantial equity in their homes to draw on. Many of them are nearing
or are in retirement, and therefore are more likely to be living--or
are preparing to live--on a reduced or fixed income. In this context,
some of AARP's most recent research, litigation, and advocacy
activities focus on abuses found in home repair and modification loans.
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\3\ Projections by the U.S. Census Bureau estimate that by the year
2020, the number of persons age 65 and older will grow to over 53
million--representing a 55 percent increase from the 34 million
estimated for 1998. Changes in the age distribution of the Nation's
older population are also occurring. Presently, the aging of the older
population is driven by large increases in the number of persons age 75
and older.
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With some obvious qualifications, this means that the longer a
homeowner lives in his/her home, building up equity as they pay down
their mortgages, the greater the risk that they will be subject to
lenders seeking excessive financial advantage through one of these
loans. AARP has worked to educate its members as well as the public-at-
large about how consumers can better protect themselves against such
financial risks.\4\ We believe consumer education to be a necessary
part of a multilevel approach.
---------------------------------------------------------------------------
\4\ Attachment 2 provides an overview of AARP's decade-long
campaign against predatory lending practices through December 2000.
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AARP also recognizes that the damage done by predatory practices is
not limited to those who have lost, or are at risk of losing their
home--as devastating as these losses clearly are. It also includes
those older Americans who need and desire access to competitive,
realistic risk-based home loans, but are reluctant or unwilling to
pursue financial services and products due to their fear of potential
exploitation. Ultimately, all forms of commerce--including financial
services--are based on trust that each party to a transaction has been
treated fairly, and disagreements resolved equitably. Whenever it
occurs, predatory home lending undercuts the very essence of this basic
tenet of commerce.
Consider these findings from an AARP-sponsored study, released in
May 2000, entitled ``Fixing to Stay''.\5\ For Americans age 45 and
over:
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\5\ Attachment 3, which is an Executive Summary of the AARP-
sponsored national survey of housing and home modification issues,
entitled: ``Fixing to Stay,'' May 2000.
more than 4-in-5 say they would like to stay in their current
residence for as long as possible; more than 9-in-10 age 65 or over
feel this way; and
almost 1-in-4 anticipates that they or someone else in their
household will have difficulty getting around their home in the
next 5 years.
When asked why they have not modified their home, or have not
modified as much as they would have liked, respondents cited a number
or reasons, including:
not being able to do it themselves (37 percent);
not being able to afford it (36 percent);
not trusting home contractors (29 percent);
not knowing how to find a good home contractor or company that
modifies homes (22 percent).
In most areas, the results of this national survey, when compared
to its sample of minority individuals (that is, African-Americans and
Hispanics) were similar. However, there were a few important
differences:
among those who have refinanced their home or taken out a
mortgage against their home, minorities are more likely to say they
did so to obtain funds for home maintenance or repairs (50 percent
minorities versus 35 percent national sample);
however, minorities are also more likely than the national
sample to be very or somewhat concerned about:
being able to afford home modifications that would enable
them to remain at home (44 percent versus 30 percent);
finding reliable contractors or handymen (41 percent versus
28 percent);
finding information about home modifications (34 percent
versus 21 percent).\6\
\6\ HUD's detailed study of almost 1 million--mostly refinancing--
mortgages reported under HMDA in 1998, entitled: ``Unequal Burden:
Income and Racial Disparities in Subprime Lending in America,'' found a
disproportionate concentration of subprime loans in minority and low-
income communities.
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AARP's efforts to address these problems--whether through the
sentinel effects of its litigation, its legislative, and regulatory
advocacy, or its counseling and education programs--are directed at
improving credit market performance, not limiting consumer access to
credit for those with a less-than-perfect credit history. AARP believes
that our--and other--consumer financial literacy campaigns are an
important and necessary component of public and private sector efforts
to make consumers their own first line of defense.\7\ However, while
consumer education and counseling programs are necessary, they are not
sufficient.
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\7\ In April 2001, AARP launched a State-based campaign effort
that, over the course of this year, will focus on consumer education
and advocacy efforts.
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AARP submitted comments on March 9, 2001, supporting the Federal
Reserve Board's (the Board) proposal to strengthen the Home Ownership
and Equity Protection Act (HOEPA) regulations in an effort to reduce
abusive lending practices targeted at the most vulnerable borrowers. In
its comments on the proposed regulatory amendments, AARP suggests that
the Board use its current statutory authority to: lower the annual
percentage rate (APR) trigger, expand the definition of points and
fees, and prohibit certain unfair practices such as the use of
``riders'' to change the terms of a consumer agreement.
In addition, the Board solicited proposals for making legislative
changes that address predatory lending practices. AARP recommended
three statutory amendments to HOEPA that we believe are worthy of
consideration by the Board for submission to the Congress. We
recommended:
inclusion of all fees and points in the loan's finance
charges;
inclusion of open-ended credit and purchase money loans within
HOEPA's coverage; and
the elimination of the ``pattern or practice'' requirement for
HOEPA protection; that is, the borrower would only have to
establish that a lender has made an unaffordable loan under HOEPA--
not that the lender has engaged in a pattern or practice of such
lending.
AARP agrees with the Board's assessment of the beneficial impact of
its proposed amendment, that by expanding the coverage to an additional
group of high-cost loans it will ``ensure that the need for credit by
subprime borrowers will be fulfilled more often by loans that are
subject to HOEPA's protections against predatory practices.'' AARP
believes that the Board should issue the final HOEPA amendment as soon
as prudently possible.
Chairman Sarbanes, and Members of the Committee, the problems
associated with abusive home equity-related lending practices are
complex. To date, agreement on a comprehensive reform of the mortgage
finance system to address these problems has proven elusive. Therefore,
we are encouraged by the Committee's continued efforts to call
attention to predatory mortgage lending and to establish effective
deterrents. AARP is committed to working with this Committee, the
Congress, and the Bush Administration to address the problems posed to
the elderly by these devastating lending practices.
Thank you. I will try to answer any questions you may have.
PREPARED STATEMENT OF JOHN A. COURSON
Vice President, Mortgage Bankers Association of America
President & CEO, Central Pacific Mortgage Company, Folsom, California
July 27, 2001
Good morning Mr. Chairman and Members of the Committee. My name is
John Courson, and I am President and CEO of Central Pacific Mortgage
Company, headquartered in Folsom, California. I am also Vice President
of the Mortgage Bankers Association of America (MBA),\1\ and it is in
that capacity that I appear before you today. This morning I have been
asked to testify before your Committee to present MBA's views on the
very serious issue of predatory mortgage lending.
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\1\ MBA is the premier trade association representing the real
estate finance industry. Headquartered in Washington, DC, the
association works to ensure the continued strength of the Nation's
residential and commercial real estate markets, to expand homeownership
prospects through increased affordability, and to extend access to
affordable housing to all Americans. MBA promotes fair and ethical
lending practices and fosters excellence and technical know-how among
real estate professionals through a wide range of educational programs
and technical publications. Its membership of approximately 3,100
companies includes all elements of real estate finance: mortgage
companies, mortgage brokers, commercial banks, thrifts, life insurance
companies, and others in the mortgage lending field.
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First, I want to thank you for inviting the MBA into this very
important discussion on a very urgent matter. I commend the Committee's
leadership in calling for these hearings, as we believe that a full
understanding of the issues is the only responsible way to finding
solutions to the scourge of abusive mortgage lending.
As Vice President of the trade association that represents the real
estate finance industry, and as President of a mortgage company, I am
deeply troubled by the continuing reports of predatory and abusive
lending practices that persist in our industry. It is imperative that
you know, from the outset, where MBA stands on this issue. We condemn
these practices in the strongest possible terms. The MBA recognizes
that this is a problem that is real, and one that carries real
repercussions for those communities that are affected. Although so-
called predatory lending practices are difficult to measure and
quantify, there is no hiding from the fact that certain rogue lenders
and certain unscrupulous brokers continue to prey on our most
vulnerable populations. Nor can we hide from our responsibility--as
members of the finance industry--to act in the face of this continuing
problem.
For over 80 years, the MBA has stood for integrity and fairness in
mortgage lending. Our members have helped millions of Americans achieve
the dream of homeownership. In so doing, we have established a
tradition of encouraging the highest standards of responsible lending.
We, therefore, want to make clear that ending unfair lending
practices is a major priority for our association. We have devoted
substantial amounts of attention and time to this issue. We want to
state in no uncertain terms that it is time to address the problems of
predatory lending head-on, and in a way that does not constrict the
flow of capital to credit-starved communities. Today, I will address
the MBA's views on what needs to be accomplished to bring lasting and
effective solutions to these abuses.
``Subprime'' Lending
Before I do so, however, I think it is important to set forth some
background on the nature and recent growth of the so-called
``subprime'' lending, since most of the reports of mortgage abuse
appear to stem from this segment of the market. In general terms, that
sector of the mortgage market that has become known as the ``subprime
market'' serves customers that do not qualify for conventional, prime
rate loans. The reasons why such consumers do not qualify are varied,
but generally, these borrowers may have blemished credit records, or
perhaps unproven credit or income histories.
A further element of this market, and of subprime loans generally,
is that they tend to be more expensive in terms of fees and rates. This
is so because they generally carry extensive due diligence costs and
require hands-on servicing, and because they are inherently riskier
than loans made in the prime market.
It is imperative to note that subprime lending has been extremely
beneficial to thousands of families in the last couple of years.
Subprime lending has opened up new markets and helped many consumers
that would not have received needed funds but for the special products
available in this sector of the market. The subprime market provides a
legitimate and much needed source of credit for many families. As the
Department of the Treasury and the Department of Housing and Urban
Development acknowledged in a more recent report, ``[b]y providing
loans to borrowers who do not meet the credit standards for borrowers
in the prime market, subprime lending provides an important service,
enabling such borrowers to buy new homes, improve their homes, or
access the equity in their homes for other
purposes.'' \2\
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\2\ U.S. Department of the Treasury and Department of Housing and
Urban Development, Curbing Predatory Home Mortgage lending: A Joint
Report, June 2000 (HUD/Treasury Report).
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Defining the Problem
It is unfortunate, however, that as the subprime market has
expanded, the reports of predatory and abusive lending have apparently
increased as well. We note that the problem of abusive lending is not
really new nor limited to the subprime market alone. State regulators
report that they have been dealing with these types of issues for a
long time, and that what was once called ``mortgage fraud'' is now
being dubbed ``predatory lending.'' \3\ Regardless of the name, a major
part of the challenge that we face in finding solutions to this problem
is that it has proven quite difficult to answer the threshold question
of how to define ``predatory lending'' or what constitutes ``abuse'' in
the general context of mortgage lending. Surely we can identify
examples of practices that everyone would agree are ``abusive,'' but
the problem we face is that these examples could be both underinclusive
and overinclusive, depending upon the full circumstances of the loan
transaction. Thus, often identified ``predatory'' practices could
include the following: excessive fees and points that are often
financed as part of the loan; loan ``flipping'' or ``churning,'' in
which a loan is repeatedly refinanced in a way that degrades the
owner's equity in the property; intentionally making a loan that
exceeds the borrower's ability to repay; and overly aggressive sales
techniques that deliberately mislead the borrower.
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\3\ See Statement of John L. Bley, Director of Financial
Institutions, State of Washington before the Federal Reserve Hearing on
Home Equity Lending (September 7, 2000).
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It is important to note that in every example noted, the full
context of the transaction must be analyzed to properly assess whether
an abuse has occurred. It is impossible, for example, to identify
``excessive'' fees without knowing the nature and difficulty of the
service provided in exchange for that fee. Nor can we recognize repeat
refinances that are meant to strip equity without looking at the fee
structure of the transaction and the equity of the consumer. In order
to determine that a consumer has been ``deliberately misled,'' we have
to study the disclosures and the oral representations made in the
context of the specific transaction at hand. Since every loan is unique
and every transaction is tailored to specific needs and conditions, the
answer of whether mortgage abuse has occurred in any given situation is
dependent upon the totality of the circumstances of the borrower and
the transaction. It is daunting, therefore, to isolate the specific
``bad acts'' that are employed by unscrupulous lenders in a way that
allows for appropriate regulation.
We also note that even those regulatory agencies with jurisdiction
over mortgage credit practices have not provided any clear guidance on
the topic. Those agencies that have attempted to provide a definition
have uniformly avoided the real issue, opting instead to provide either
``categories'' under which the abuses ``tend to fall,'' \4\ or simply
advancing descriptive examples and anecdotes of the more common abuses
that they may have observed in the market.\5\ Under either approach,
the fundamental definitional issues are left unanswered. Sometimes the
terms ``predatory lending'' and ``subprime lending'' are used
interchangeably. This confusion and lack of adequate definitions at
Federal and State levels, and the problem of lack of organized and
coordinated data on predatory lending, is confirmed and described at
length in a recent report issued by the Senate Banking Committee staff
to Chairman Gramm, released in August 2000.
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\4\ See, for example, HUD/Treasury Report, at p. 2.
\5\ See Board Notice of Public Hearings and Request for Comments,
at p. 3.
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Source of Problem
MBA believes that predatory lending is a problem that has various
sources. As we attempt to tackle this problem, it is necessary to
isolate these sources, as they must be addressed individually before we
can be successful in crafting lasting solutions. In short, the MBA
believes that the three fundamental sources that need
to be attacked jointly are the complexity of the laws, lack of
education, and lack of enforcement.
Complexity of Mortgage Laws/Process
First and foremost, we believe that a fundamental root problem
leading to abusive lending is the confusion created by the complexity
of the mortgage process. Any consumer that has ever been through a
settlement closing knows how confusing and cumbersome the process can
be. Mortgage disclosures are voluminous and often cryptic, and
consumers simply do not understand what they read nor what they sign.
In addition, the mandated forms lack reliable cost disclosures, making
it difficult for prospective borrowers to ascertain true total closing
costs and renders comparison shopping virtually impossible.
There are various confirmations of this core problem. In a recent
report prepared by the Federal Reserve Board and the Department of
Housing and Urban Development, these Federal agencies ascertained that
most consumers do not understand the relation between the contract
interest rate and the Annual Percentage Rate (APR) listed in the Truth
in Lending disclosures. The agencies explain that ``the [consumers']
belief was based on misconceptions about what the disclosures
represent. For example, consumers believed the APR represents the
interest rate . . . and the amount financed represents the note amount.
. . .'' \6\ These are fundamental misunderstandings that can lead to
very serious repercussions for unwary or unsophisticated shoppers. In
fact, there are reports that these cryptic forms, and the public's
misunderstanding of them, make the Federally required Truth in Lending
disclosures a very useful tool for predators to confuse and defraud
consumers.\7\
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\6\ See Board of Governors of the Federal Reserve System and
Department of Housing and Urban Development, Joint Report on the Real
Estate Settlement Procedures Act and Truth in Lending Act, July 17,
1998 (Appendix A).
\7\ There are various examples noted by regulators. One of them
consists of a dishonest lender that may reveal to consumers that they
are borrowing $50,000 when, in effect, the total amount borrowed is
$60,000. This occurs because, under unique TILA rules, the ``Amount
Financed'' number is derived by taking the amount of the note and
subtracting ``Prepaid Finance Charges.'' These subtracted charges
include the lender's own loan origination fees and other fees. Under
this scenario, the unscrupulous lender can rely on the ``Amount
Financed'' disclosure to mislead the consumer into believing that they
have a much smaller loan than they actually commit to at the closing
table.
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We can name a myriad of other examples, but simply put, the
complexity of the current system is the camouflage that allows
unscrupulous operators to hide altered terms and conceal crucial
information without fear of the consumer discovering or even
understanding the import of the masked or undisclosed items. In light
of
this complexity, confounded borrowers often have no choice but to turn
to the loan officer for advice and explanation of the contents of the
disclosures. In instances of abusive lenders, the consumer's reliance
closes the loop of deception--the victims of these scams are completely
blinded to the realities and repercussions of the transaction. These
problems are exacerbated ten-fold in instances of uneducated or
illiterate consumers.
Lack of Consumer Awareness/Education
The complexity of the mortgage process leads directly to, and is
intertwined with, the second source of predatory lending--lack of
consumer awareness and education. It is a reality today that even well-
educated consumers tend to lack basic understanding of the mortgage
shopping and home buying processes. For example, the borrower surveys
conducted by the Federal Reserve Board revealed that over 20 percent of
those surveyed contacted only one single source of credit. I already
mentioned that consumers do not understand the meaning and importance
of the APR figure. Nor do mortgage shoppers entirely comprehend that
the early Good Faith Estimate disclosures are not final. Often,
homebuyers believe that ``listing'' real estate agents carry fiduciary
responsibilities vis-a-vis the purchaser. They generally do not. Again,
all these misperceptions have real repercussions in the market, and
they all stem from basic misunderstandings of the real estate and
mortgage finance market.
Lack of Enforcement
The third problem creating a favorable environment for abusive
lenders is the general absence of real enforcement in this area. It is
important to understand that the mortgage lending industry is one of
the most heavily regulated industries today. Mortgage lending is
subject to pervasive State regulation and must comply with a wide array
of Federal consumer protection laws including the Truth in Lending Act,
Real Estate Settlement Procedures Act, Fair Housing Act, Fair Credit
Reporting Act, Equal Credit Opportunity Act, Fair Credit Billing Act,
Home Mortgage Disclosure Act, Federal Trade Commission Act, and Fair
Debt Collection Practices Act. Many of the ``predatory'' abuses
reported today either violate current law or result from lack of
disclosures that violate current laws. We note that in practically all
instances, these predatory loans also involve outright fraud and
deception. We have to set a new priority to aggressively enforce the
multitude of existing laws.
MBA believes that these root causes must be addressed in order to
fully erase the pernicious lending practices that are occurring today.
Any approach that does not address these three basic prongs--
simplification, education, and enforcement--will merely deal with the
effects and not with the underlying causes of the problem. Anything
short of this full approach will fail to resolve the crisis.
Looking Ahead
I reiterate that there is general agreement that there is a problem
with abusive lending in many markets today. While there is some
disagreement as to how to eliminate these practices, I believe that the
mortgage industry, policy makers, and consumer representatives all
share a sincere desire to end the abuses. I believe that we are all
gathered here today to engage in a serious dialogue as to what needs to
be done to advance real solutions to this problem.
Let me then address some steps we can all take to bring an end to
this problem. As I mentioned before, we all share in the responsibility
to ensure that predatory lending is eliminated.
Consumers
First, as outlined above, education of consumers is a most basic
step in the struggle to push predators out of our neighborhoods. MBA
believes that an educated consumer is the best prophylactic to
predatory abuse.
Presently, MBA is assembling a workgroup to develop a series of
resources aimed specifically at consumers that believe that they are
being victimized by predatory lenders. The objectives of this
initiative is to develop advice and materials that can be accessed
directly and immediately by consumers seeking protection from unfair
activities. To this end, the workgroup is developing a full list of
legal rights and ethical norms that all consumers should expect from
honest and reputable lenders. This list will be made available to the
general public and disseminated to Government officials, consumer
protection agencies, and consumer advocates to ensure that all
prospective borrowers fully understand their rights in the transaction.
In connection with this document, the workgroup will also develop a
system whereby affected consumers can obtain direct access to an
enforcement agency or other source of immediate assistance on items
pertaining to their loan situation. MBA believes that this direct
access is crucial to protecting vulnerable borrowers. Again, the goal
under this system is to provide immediate help to those consumers that
feel they are being victimized by loan predators. This system would
include a method for identifying ``warning signs'' of possible abuses
that would alert consumers that they may be dealing with less than
honest operators. Once a consumer identifies certain suspicious signs--
that is, aggressive solicitations, unexplained changes at the closing
table, requests to leave line items blank on material forms--then that
consumer would be empowered to seek further immediate advice from a
trusted third party before completing the transaction. We note that
there is
no system today that effectively delivers help and useful information
that a victim requires at the very point where the abuse is occurring.
We are trying hard to
create a structure of support that works effectively and that can be
implemented immediately. We hope to report back to you very soon with
good news on our
advancements.
Industry
The MBA has always been proactive in the fight against
``predatory'' lending abuses. As lenders and brokers, we share a strong
responsibility to fight predatory abuses on various fronts. I will
outline some of the examples of positive industry activities that are
making a difference in this endeavor.
First, our association was the first, and remains the only national
trade association to sign a ``fair lending/best practices'' agreement
with HUD. This agreement was signed in 1994 and renewed in 1998. In
this agreement, MBA committed to a number of steps that will promote
fair lending and assist the industry in reaching underserved groups in
our society.
Recently, MBA developed a set of ``Best Practices'' for our
members. These Best Practices encourage members to conduct their
business according to the standards contained therein and participate
in periodic audits to test for compliance. These guidelines are
designed to ensure that all customers are given fair and equitable
treatment.
Further, MBA entered into a contractual relationship with the
Mortgage Asset Research Institute (MARI) to create a national database
of companies and individuals that have been identified by law
enforcement or regulatory bodies as having engaged in illegal or
improper behavior.
In 1998, MBA founded the Research Institute for Housing America
(RIHA) and currently funds its projects, which support research and
other activities to help determine how discrimination occurs in home
buying process, and to eliminate discrimination. RIHA projects also
endeavor to develop useful research on meeting consumer demand for
mortgage financing in underserved markets and to measure the societal
benefits and costs of homeownership.
As mentioned above, we believe that consumer awareness and
education are among the most effective tools available for combating
predatory lending practices. In this area, we think that industry
participants can do much to develop educational tools and programs that
will enable consumers to make more informed choices. For example, MBA
is a founding and active member of the Board of the American Homeowner
Education and Counseling Institute (AHECI). The purpose of AHECI is to
provide training and certification to the homeownership counseling
industry. As a founding member of this organization, MBA provided
$100,000 in startup funds.
MBA has worked with the National Council on Economic Education
(NCEE) over the past several years to educate school children around
the country in understanding the importance of good credit and the need
for sound financial planning and management skills, as well as how to
go about purchasing and financing a home. Recently, MBA partnered with
NCEE with a donation of $130,000 to promote a program that will educate
high school youth and adult consumers on the perils of abusive lending.
Last, MBA is currently engaged in discussions with lending
organizations and other groups to determine how to best provide useful
and complete information and education for homebuyers, with a special
emphasis on subprime borrowers.
Government
MBA believes that there is much that Government can do to put an
end to predatory lending abuses. First and foremost, MBA strongly
believes that much more must be done to enforce the laws that are
currently on the books. In the past quarter century, both Federal and
State Governments have put in place a far-reaching body of laws
designed to prevent abuse of consumers in credit transactions.
Generally, there is a myriad of laws that exist in the different States
that could effectively address the abuses that are occurring in the
market today. These laws include prohibitions against unfair and
deceptive trade practices; prohibitions against discrimination and
redlining in finance transactions; limitations on specific terms of
consumer and mortgage credit; limitations on insurance products;
penalty provisions for noncompliance; prohibitions of deception
misrepresentation, nondisclosure and concealment; and common law rules
against fraud.
Before any additional laws are adopted, policymakers must realize
that it does no good to legislate against practices that are already
illegal in all jurisdictions. More laws will inevitably increase the
complexity and costs of lending without a corresponding increase in
consumer protection. Simply piling on more prohibitions will not
resolve a crisis that today is caused by actors that operate at the
outer fringes of the law. To be serious about solutions, we must pledge
a full commitment to engage in serious enforcement of the laws.
MBA fully understands that enforcement actions are not an easy
undertaking. They require much time, careful examinations,
documentation of disclosures and documents, documentation of sales
techniques, interviews with parties involved, among other things. In
the end, however, this is the most effective way to stamp out these
pernicious practices. To this end, MBA calls for increased funding of
consumer protection agencies to accord them with all necessary
resources so that we may begin to, once and for all, clamp down on
unscrupulous actors in earnest.
Second, MBA believes that, in order to fight predatory lending, it
is absolutely essential to enact comprehensive reform of the current
mortgage lending laws. As mentioned above, predatory lending is in many
ways a symptom of larger problems that have evolved from complicated
and outdated mortgage laws. Without broad changes to existing laws and
comprehensive reform of current cost disclosures, any efforts to
address predatory lending will merely deal with the effects and not
with the underlying causes of the problem. If the process remains
confusing and perplexing, consumers will continue to be tricked and
deceived. MBA has worked tirelessly to come up with a system that
improves the consumer's opportunities to shop and allows for timely and
effective disclosure of settlement costs and vital information to
consumers.
Under MBA's comprehensive reform package, lenders would be allowed
to provide mortgage applicants with an early price guarantee that
permits consumers to effectively shop for mortgage products in the
market. Under this plan, the closing cost guarantee to be provided to
consumers would include all the costs required by the lender to close
the loan, This guaranteed disclosure system would let consumers know,
early in the mortgage application process, the maximum settlement costs
a lender could charge. Under MBA's plan, the cost guarantee would be
binding and enforceable.
MBA's reform proposal also seeks to streamline all current Federal
loan disclosures so that they provide home shoppers with clearer and
more concise information without the confusion inherent in the current
forms. We envision a system where disclosures and educational
materials, including advising consumers of the availability of
counseling, would be provided to the consumer very early in the
mortgage application process, in effect. We believe that these
educational materials must be rewritten and restructured to make them
more understandable and much friendlier to consumers. For example, MBA
believes that interactive resources or the use of media other than
booklets would go a long way in augmenting the accessibility and the
use of these materials. And, unlike the current RESPA materials, these
materials would contain full and comprehensive advice regarding
mortgage abuse, including possible sources of counseling.
We note also that by streamlining the current legal and regulatory
landscape, we also make it easier to identify abuses and prosecute
unscrupulous players. If we
remove all the gray areas from the current process, and provide for
clear penalties and remedies that punish violators, we will make it
easier to regulate, examine, and enforce.
Last, and in connection with previous statements, MBA believes that
Governmental agencies everywhere must do more to promote consumer
awareness and education. To this end, we support expanded funding for
the development of counseling programs and counseling certification
systems that assure that consumers receive all information they need to
protect themselves in this very complex transaction.
Conclusion
In summary, the MBA believes that the continuing search for
solutions to this problem must expand to comprehensively include all
the underlying factors that allow predatory lending to flourish. We can
no longer afford to focus on Band-Aids that merely cover up the harms.
We must address predatory lending through direct attacks on three
fronts--a commitment to full enforcement, robust education, and a
simplification of existing laws. Nothing short of that will suffice.
Thank you for the opportunity to appear before the Committee. I
look forward to answering your questions.
PREPARED STATEMENT OF NEILL A. FENDLY, CMC
Immediate Past President, National Association of Mortgage Brokers
July 27, 2001
Mr. Chairman and Members of the Committee, I am the Immediate Past
President of the National Association of Mortgage Brokers (NAMB), the
Nation's largest organization exclusively representing the interests of
the mortgage brokerage industry. We appreciate the opportunity to
address you today on the subject of abusive mortgage lending practices.
NAMB currently has over 12,000 members and 41 affiliated State
associations nationwide. NAMB provides education, certification,
industry representation, and publications for the mortgage broker
industry. NAMB members subscribe to a strict code of ethics and a set
of best business practices that promote integrity, confidentiality, and
above all, the highest levels of professional service to the consumer.
In these hearings, the Committee will hear a number of individual
stories as well as comments from advocates about some egregious, and in
our view inexcusable, mortgage lending practices. You will also hear
from others in the mortgage industry about possible solutions, which
NAMB supports and is actively involved in developing. My testimony
today will briefly outline some of these. But I would like to focus
this testimony on helping the Committee understand the important and
unique role of mortgage brokers in the mortgage marketplace, and offer
the unique perspective of mortgage brokers in examining the problem of
predatory lending.
Today, our Nation enjoys an all-time record rate of homeownership.
While many factors have contributed to this record of success, one of
the principal factors has been the rise of wholesale lending through
mortgage brokers. Mortgage brokers have brought consumers more choices
and diversity in loan programs and products than they can obtain from a
branch office of even the largest national retail lender. Brokers also
offer consumers superior expertise and assistance in getting through
the tedious and complicated loan process, often finding loans for
borrowers that may have been turned down by other lenders. Meanwhile,
mortgage brokers offer lenders a far less expensive alternative for
nationwide product distribution without huge investments in ``brick and
mortar.'' In light of these realities, it is no surprise that consumers
have increasingly turned to mortgage brokers. Today, mortgage brokers
originate more than 60 percent of all residential mortgages in America.
The rise of the mortgage broker has been accompanied by a decline in
mortgage interest rates and closing costs, an increase in the
homeownership rate, and an explosion in the number of mortgage products
available to consumers. These positive developments are not mere
coincidences. They would not have been possible without the advent of
wholesale lending through mortgage brokers.
Mortgage brokers now have an extremely important role in our
economy. With the collapse of the savings and loan industry in the
1980's, followed by the rapid consolidation of mortgage banking firms
in the 1990's, today we find that in many communities, particularly in
central cities and small towns, people might have a hard time finding a
retail bank branch or retail mortgage lending branch. But they can
usually find a mortgage broker right in their community that gives them
access to hundreds of loan programs. Mortgage brokers are generally
small business people who know their neighbors, build their businesses
through referrals from satisfied customers, and succeed by becoming
active members of their communities.
The recent expansion in subprime lending, which has been noted by
the Committee in these hearings and others, has also relied heavily on
mortgage brokers. Mortgage brokers originate about half of all subprime
loans. Many mortgage brokers are specialists in finding loans for
people who have been turned down by other lenders. These are hard-
working people who, for one reason or many reasons, do not fit the
profile that major lenders prefer for their customers. Each of them is
unique. Some lenders just do not want to be bothered with such
customers that take a little more time and effort to qualify. Some do
not want to accept the risk of lending to someone who may have had a
bankruptcy, an uneven employment history, or a problem with a previous
creditor.
Mortgage brokers can usually find a loan for someone who has been
turned down by others. Most mortgage brokers who originate subprime
loans do so primarily because they enjoy helping people. Certainly
these loans can be profitable, and borrowers do pay higher rates and
fees because of the increased risk, but subprime loans are also time-
consuming and often very difficult to arrange.
Mortgage brokers often do an amazing amount of work on these loans.
They work with borrowers, sometimes for weeks, to help them understand
their credit problems, work out problems with other creditors, clean up
their credit reports when possible, and review many possible options
for either purchasing a home or utilizing their existing home equity as
a tool to improve their financial situation. The brokers are rewarded
with the knowledge that they have enabled a hard-working family to buy
its first home, avoid foreclosure, get out from under a crushing load
of high-rate credit card debt, finance their children's education, pay
delinquent taxes, repair their homes, and help their parents pay off
their mortgages and health care bills.
People of all income levels may end up in situations that leave
them unable to qualify for the lowest mortgage rates and fees. But they
still need, and deserve to have, access to mortgage credit. It is a
lifeline for those who are drowning in debt, facing a huge medical
bill, trying to survive a layoff. It is the least expensive source of
credit for those who may have made some mistakes or had some misfortune
in the past and now need money to improve their home, finance their
children's education, or even start a business. They need to have the
widest possible range of choices when they are buying a home or need a
second mortgage. And today they do. It is important for them, and for
others like them in the future, that Congress be very careful to avoid
measures that will rob them of choices they deserve and the tools they
need to manage and improve their financial situation.
One of the most important choices available to consumers with low-
incomes, little or no cash, and/or impaired credit is the ``no- or low-
cost'' loan. Mortgage brokers have originated thousands of loans for
people who were able to buy a home, refinance, or obtain a home equity
loan with little or no upfront closing costs or broker fees. These
costs are financed through an adjustment to the interest rate. Retail
lenders offer ``no- or low-cost'' loans at adjusted rates as well. When
a mortgage broker arranges a loan like this, the broker is compensated
by the lender from the proceeds of the loan. This kind of payment goes
by many names, but is often called a ``yield spread premium.'' These
payments are perfectly legitimate and legal under Federal law, the Real
Estate Settlement Procedures Act, so long as they are reasonable fees
and the broker is providing goods, services, and facilities to the
lender. These payments to mortgage brokers are also fully disclosed to
borrowers on the Good Faith Estimate and the HUD-1 Settlement
Statement, and are included in the interest rate. Retail lenders,
however, are not required to disclose their profit on a loan that is
subsequently sold in the secondary market, as most mortgages are today.
This method of enabling consumers to obtain loans through mortgage
brokers with little or no upfront costs is now under assault in the
courts. Despite Statement of Policy 1999-1, issued at the direction of
Congress by the Department of Housing and Urban Development in 1999,
which clearly set forth the Department's view that the legality of
mortgage broker compensation must be judged on a case-by-case basis,
trial lawyers across America have continued to file and pursue class
action lawsuits claiming that all such payments are illegal and
abusive.
Recently, the 11th Circuit agreed with the plaintiff in one of
these suits and allowed a class action to be certified. Although at
first glance this appears to be only a procedural decision, it has
resulted in a flood of new litigation against mortgage brokers and
wholesale lenders, and caused a great deal of uncertainty and anxiety
in the mortgage industry. The cost of defending these class actions is
staggering. The potential liability could run to over a billion
dollars. The prospect of a court deciding that the prevalent method of
compensation for over half the mortgage loans in America is illegal is
chilling, to say the least.
If these lawsuits succeed, some lawyers will benefit at the expense
of the mortgage industry. Their clients might get small refunds, or a
few dollars off the cost of their next loan. But the real losers will
be tomorrow's first time home buyers, tomorrow's working families,
tomorrow's entrepreneurs who will not be able to get a mortgage without
paying hundreds of dollars upfront. And, further down this road, many
small businessmen and women may not be able to stay in business as
mortgage brokers without being able to offer these ``no-cost'' loans.
As competition decreases, all potential mortgage borrowers will suffer
higher costs and fewer choices. This illustrates the unintended
consequences that can come from litigation, regulation, or legislation
that singles out one part of the mortgage industry, places blanket
restrictions or prohibitions of certain types of loan terms or
products, or places unreasonable restrictions on interest rates and
fees. We have ample reason to believe that such measures will increase
the cost of homeownership, restrict consumer choice, and reduce the
availability of credit, primarily to low- and moderate-income
consumers.
To further illustrate the problem with blanket restrictions on loan
terms, consider the balloon loan. A balloon term in a given loan could
be abusive if the borrower has not been advised that the loan contains
such a feature and is not prepared for the practical ramifications.
Further, it may be that the borrower's situation does not make such a
feature appropriate. Yet, very often, a balloon is a valuable tool to
help a borrower obtain a lower interest rate and lower monthly payments
that are affordable. If the borrower's circumstances are such that a
refinance loan should be reasonably feasible at some time in the
future, and possibly even at a lower interest rate because the borrower
has improved his or her credit standing in the meanwhile, then a
balloon term can be a desirable feature. Many reputable, mainstream
lenders offer balloon loans to customers in all credit grades, and many
borrowers freely choose such loans, because they are good options in
many cases.
The same is true for other loan terms or conditions frequently
cited as abusive, including negative amortization, prepayment
penalties, financing of closing costs, and even arbitration clauses. In
certain circumstances, each of these may be abusive, but in the
majority of cases they provide the consumer with a feature that fits
his or her unique circumstances, such as a reduced interest rate or
lower monthly payment. Virtually no loan terms are always abusive, and
almost any loan term that is offered in the market today can be
beneficial to some consumers. Whether a loan is abusive is a question
that turns on context and circumstances, from case to case. This is the
primary reason why NAMB and the mortgage industry have opposed
legislation or regulation that would impose new, blanket restrictions
or prohibitions on loan terms. We believe such measures will increase
the cost of homeownership, restrict consumer choice, and reduce the
availability of credit, primarily to low- and moderate-income
consumers.
NAMB believes that the problem of predatory lending is a threefold
problem of abusive practices by a small number of bad actors; lack of
consumer awareness about loan terms; and the complexity of the mortgage
process itself. We believe all three of these areas must be addressed,
together and with equal force, if the problem is to be solved without
the unintended consequences mentioned earlier. The mortgage industry is
working vigorously in all three areas, and NAMB wants to continue
working with Congress to address all these areas--in particular, reform
and simplification of the mortgage process.
Addressing Abusive Practices
Those of us who are hard-working, reputable mortgage originators
want nothing more than to get the bad actors out of our industry. We do
not like competing against people who fraudulently promise deceptively
low rates or costs and do not disclose their fees, thereby making those
of us who obey the law appear more expensive. We do not like the bad
publicity our industry receives from media stories about lenders or
brokers who take advantage of senior citizens and poor people. We know
the long-term survival of our industry depends on having satisfied
customers and maintaining the trust people have in us as professionals,
so we cannot afford to have anyone making loans that hurt consumers and
violate that trust.
All types of institutions have bad actors among their ranks. This
is not an issue that is confined to lenders, mortgage brokers,
depository institutions, or independent companies. Bad actors are found
among all of these types of entities. We wish to emphasize in
particular that mortgage brokers are not the only ones involved; we
have observed that many have blurred the distinction between mortgage
brokers and various other types of companies.
A popular misconception is the belief that abusive lenders operate
within existing regulatory guidelines. Rather, most of them choose to
ignore laws and regulations that properly apply to them. There is a
small minority of institutions that do not obtain State licensure as
required. Some ignore State consumer protection laws. They do not
observe the existing restrictions in the Federal HOEPA. They may even
violate basic disclosure rules under RESPA and TILA. In many cases they
are committing outright fraud, which violates yet other State and
Federal statutes. And, in general, they do not join industry groups
such as NAMB or the comparable organizations for their respective
industries.
There are many tools at our disposal now to deal with these people
and companies. Laws already exist at the Federal and State level that
give regulators and prosecutors the authority to revoke licenses,
impose fines, and even pursue criminal prosecution of lenders or
brokers that commit fraud, charge unreasonable fees, and otherwise
violate HOEPA, RESPA, TILA, and other Federal statutes. The Federal
Trade Commission has brought enforcement actions under HOEPA. These
enforcement actions do have a deterrent effect on others. The
Department of Housing and Urban Development is improving its own lender
approval and enforcement policies for FHA lending. Many States have
toughened their licensing laws, usually with the full support of our
affiliated State mortgage broker associations.
The industry is also taking steps to address practices and
behaviors in the market that can be eliminated and thereby maintain
trust in our industry. We note that one of these, the sale of single-
premium credit life insurance, has been dramatically curtailed in
recent weeks by the major companies involved with that product. In
another example, a major subprime lender recently stopped using several
hundred mortgage originators that did not meet its standards of
professional practice. NAMB supported this effort and continues to
encourage wholesale lenders to use their broker agreements to ensure
sound origination practices. NAMB and other major mortgage lending
organizations have adopted Codes of Ethics and Best Business Practices
guidelines, and we all encourage consumers to make sure that their
lender or broker is a member of one of these national organizations.
Another unacceptable practice is loan flipping. NAMB supports
reasonable measures that would stop this kind of abusive practice, but
still allow people to refinance their loans when they need to. For
example, we support the proposal by the Federal Reserve to limit the
amount of fees that can be charged in a refinance of a HOEPA loan by
the existing lender to the new money financed. Some subprime lenders
are addressing this practice by discouraging frequent refinancing of
their existing customers. One major subprime lender just this week
announced new measures to ensure that refinances truly benefit the
borrower. We think this is a great step that other lenders should and
will soon follow. Many of the consumer groups here today are working
with major lenders on these industry initiatives.
Consumer Education
The second part of addressing predatory lending is improving
consumer awareness. An informed consumer is almost never a victim of a
predatory loan. Every organization coming before the Committee today is
involved in some way with consumer education. NAMB encourages its
members to never originate a loan to an uninformed consumer. NAMB's
website includes extensive consumer information and links to sites that
provide consumers a wealth of information they can use to make informed
mortgage choices. The NAMB Mortgage 101 Center provides consumers with
information from one of the mortgage industry's most popular and
reliable online resources. The website provides consumers with
information, in an unbiased manner, about completing applications, the
purpose of an appraisal, bankruptcy and its alternatives, mortgage
calculators, down payments, FHA loans, loan programs, refinancing,
relocation, second mortgages, VA loans and many other topics. This
website provides consumers with unbiased answers to many basic
questions and many more specific issues.
Fannie Mae, with its ``Consumer Bill of Rights'' campaign and
Freddie Mac with its ``Don't Borrow Trouble'' campaign are putting
millions of dollars into educating people about how to choose a good
mortgage loan and avoid being victims of predatory lending. AARP has
launched a great education campaign aimed at seniors, who are often the
target of predatory lenders. NAMB supports these efforts.
It is also important for consumers to understand how to use credit,
and the impact of their credit on their ability to obtain a mortgage at
the lowest cost. There are also industry efforts underway in this area,
and we understand Senator Corzine and others on this Committee are
looking at ways to use Federal education programs and dollars to
promote financial education in the public schools. NAMB supports the
education of consumers in broader financial issues, such as managing
money, managing credit card debt, and other important issues. Ideally,
these areas should be taught routinely as part of the standard junior
high school or high school curricula in schools. NAMB has also
dramatically increased educational programs offered to its members, and
revamped its certification program, to encourage all mortgage brokers
to be well informed about current laws, regulations, and ethical
business practices.
Comprehensive Mortgage Reform
The third part of the solution is one into which NAMB has put a
tremendous amount of effort. That is a comprehensive overhaul of the
statutory framework governing mortgage lending. We cannot emphasize
enough to this Committee how badly this framework needs to be changed,
and how important this is to curtailing abusive lending.
The two major statutes governing mortgage lending were enacted in
1968 and 1974. The disclosures required under these laws are confusing
and overlapping. The laws actually prevent consumers from being as well
informed as they could be, and put consumers at a decided disadvantage
in the mortgage process. For example, in most cases the borrower does
not know the exact amount of the closing costs until he/she arrives at
the closing, because the law requires only that costs be estimated
early in the process. The way the interest rate, terms, and monthly
payments on a mortgage are calculated and disclosed is confusing and
makes it impossible for consumers to effectively compare different
types of mortgage products. Mortgage brokers are required to itemize
their profit on each loan, but retail lenders are not.
This is all terribly confusing to consumers. The entire process is
much too complicated in a modern world of instant communications and
one-click transactions. Mortgage brokers are confronted every day with
the frustrations of our customers about the many confusing, and largely
useless, disclosures and paperwork. And we know better than anyone that
unscrupulous lenders take advantage of this complexity and confusion to
deceive and mislead borrowers, hide onerous loan terms in pages of fine
print, and load up unnecessary fees at closing when the borrower feels
pressured and unable to walk away. Confused consumers, oftentimes
desperate for cash or credit, are more likely to simply rely on the
word of an unscrupulous loan officer and not question their loan terms,
rates, or fees.
If the mortgage process were simplified, as we have proposed,
consumers could more effectively shop for loans. They could easily
compare fixed-rate, adjustable-rate, balloon loans, etc. They would
have simple disclosures without a lot of fine print that can hide
deceptive fees or onerous loan terms. They would easily be able to
question and change terms and fees with which they do not agree, well
before closing. In addition, a simplified process would reduce costs
for originators, and the savings would be passed on to consumers. These
changes would put the consumer in a stronger position with more
information, thereby drastically decreasing the opportunities for
abusive lending.
NAMB has been engaged from the beginning in efforts to reform the
laws regulating mortgage originations. We participated in the
Negotiated Rulemaking convened by HUD in 1995, which sought to resolve
the issues surrounding mortgage broker compensation under RESPA.
Following that effort, it became apparent to NAMB that the entire
statutory framework governing mortgage lending needed an overhaul. In
1996, NAMB was the first major industry group to form an internal task
force on mortgage reform and begin developing a proposal for
comprehensive reform of RESPA and TILA. We participated in the Mortgage
Reform Working Group in 1997 and 1998, which sought to reach a
consensus among industry and consumer advocates on how to reform RESPA
and TELA. And we participated in the HUD-Treasury Department joint task
force on predatory lending convened by the previous Secretaries of HUD
and Treasury, in which we continued to press the case for comprehensive
reform.
NAMB remains committed to the goal of comprehensive mortgage reform
and simplification. We urge this Committee in the strongest terms to
work with our industry on reform legislation. We ask the consumer
advocates here to reengage with us in developing a reform proposal.
Without comprehensive statutory reform and simplification of the entire
process, consumers will still be too confused and too vulnerable to
deceptive disclosures and unnecessary fees at closing. Legislation that
seeks only to restrict or prohibit certain loan terms or pricing will
only add to the complexity of the process and reduce the availability
of credit.
Conclusion
In conclusion, I want to reiterate that NAMB supports measures by
the industry and regulators to curb abusive practices, punish those who
do abuse consumers, and promote good lending practices. We support
legislation that would reform and simplify the mortgage process, and
believe this is the legislation that is most needed to empower
consumers. We believe the problem of predatory lending can only be
solved through a three-pronged approach of enforcing existing laws and
targeting bad actors; educating consumers; and reforming and
simplifying the mortgage process. In considering any new legislation,
we urge Congress to apply this fundamental principle: Expanding
consumer awareness and consumer power, rather than restricting consumer
choice and product diversity, should be the goal of any new legislation
affecting the mortgage process.
Thank you for this opportunity to express our views. We look
forward to working with the Committee in the future.
----------
PREPARED STATEMENT OF DAVID BERENBAUM
Senior Vice President, Program and Director of Civil Rights
National Community Reinvestment Coalition
July 27, 2001
Good morning Chairman Sarbanes, Senator Gramm, and Members of the
Committee. My name is David Berenbaum, and I am Senior Vice President--
Program and Director of Civil Rights of the National Community
Reinvestment Coalition (NCRC). NCRC is a national trade association
representing more than 800 community based organizations and local
public agencies who work daily to promote economic justice in America
and to increase fair and equal access to credit, capital, and banking
services to traditionally underserved populations in both urban and
rural areas.
NCRC thanks you for the opportunity to testify today on the subject
of predatory lending. In particular, I will focus our testimony on:
Defining predatory lending;
Identifying why existing statutory and regulatory consumer
protections are inadequate; and
Strongly endorsing new public policy legislation and private
sector initiatives to eliminate the practices that perpetuate the
dual lending market in our Nation.
With all due respect to the representatives from the subprime
lending industry who are testifying in these series of hearings, it is
important to ``cut to the chase'' and to challenge the myths associated
with subprime lending. First, subprime lending is not responsible for
the all time high levels of homeownership in the United States. Second,
subprime lending is not responsible for ending redlining in our
communities. Third, responsible subprime lenders will not stop
underwriting mortgage loans in our neighborhoods simply because new
legislation prompts industry ``best practices'' to replace ``predatory
practices'' in our cities and counties. And fourth, unfortunately
existing law--and certainly industry suggestions of consumer education
alone--are not adequate to foster greater compliance on a voluntary,
statutory or regulatory level.
The Community Reinvestment Act and fair lending laws have been
responsible for leveraging tremendous increases in loans and
investments for underserved communities. For example, vigorous
enforcement of existing CRA and fair lending laws encourage depository
institutions to compete for business in minority and lower-income
communities--precise areas predatory lenders target. Unfortunately,
financial modernization legislation has opened the doors for too many
nondepository lending institutions and affiliates of depository
institutions to escape the scrutiny of regular CRA and fair lending
reviews. One of the unintended consequences of financial
modernization has been to allow some lenders to operate in an
unregulated en-
vironment, fearless of oversight and in a predatory manner. By itself,
regulatory enforcement cannot ensure that the millions of annual
lending transactions are free of abusive and predatory terms and
conditions.
Mr. Chairman, Senator Gramm, there are lenders and brokers in the
marketplace engaged today, not only in deception and fraud, but also
discrimination. They need to be held accountable. While they masquerade
as good neighbors, bankers, brokers, and legitimate business people,
these ``predators'' systematically defraud innocent individuals out of
their money and property. They accomplish their illicit purposes by
means of fraudulent loans and high-pressure, unscrupulous methods.
Using these loans, predatory lenders extract unconscionable and unjust
fees from their victims until there is no money left to extract; then
they expropriate their victims' homes through foreclosures which, in
many cases, the loans were specifically designed to facilitate.
Predatory subprime lenders intentionally misuse and exploit the
weaknesses in existing laws and regulations to their benefit and injure
our communities every day. This was powerfully addressed by the victims
of predatory lending who testified at yesterday's hearing.
The collective efforts of the advocates at this table and others
around the Nation are responsible for 2001 heralding the death of
single-premium credit life--Citigroup, Household, American General and
several other companies and their respective trade associations have
abandoned the product.
It is our hope that 2001 will also be the year that Congress and
the President, in cooperation with the GSE's, the industry and
community organizations, will enact protections to ensure equal
professional service, fair lending and equal access to credit based
upon risk, not race and community demographics, in the subprime lending
market. New law is needed to cover both loan origination and purchases
made in the secondary market. In partnership with the GSE's and
responsible lenders we can create funds to refinance predatory loans
and realize sensible and profitable market corrections. Freddie Mac's
and Fannie Mae's recent entry into the subprime market is prompting
subprime loan originators to review problematic products and policies,
that is, credit life, through monitoring of portfolios and clear
subprime underwriting guidelines. Through new legislation,
reinvigorated use of existing laws, enlightened regulatory oversight,
and consumer empowerment and sunshine concerning the issues of credit
scoring in loan origination and automated underwriting, we can make
2001 truly a remarkable year.
Definitions
A subprime loan is defined as a loan to a borrower with less than
perfect credit. In order to compensate for the added risk associated
with subprime loans, lending institutions charge higher interest rates.
In contrast, a prime loan is a loan made to a creditworthy borrower at
prevailing interest rates. Loans are classified as ``A,'' ``A-minus,''
``B,'' ``C,'' and ``D'' loans. ``A'' loans are prime loans that are
made at the going rate while ``A-minus'' loans are loans made at
slightly higher interest rates to borrowers with only a few blemishes
on their credit report. The so-called ``B,'' ``C,'' and ``D'' loans are
made to borrowers with significant imperfections in their credit
history. ``D'' loans carry the highest interest rate because they are
made to borrowers with the worst credit histories that include
bankruptcies.
In contrast, a predatory loan is defined as an unsuitable loan
designed to exploit vulnerable and unsophisticated borrowers. Predatory
loans are a subset of subprime loans. They charge more in interest and
fees than is required to cover the added risk of lending to borrowers
with credit imperfections. They contain abusive terms and conditions
that trap borrowers and lead to increased indebtedness. They pack fees
and products onto loan transactions that consumers cannot afford. They
do not take into account the borrower's ability to repay the loan. They
prey upon unsophisticated borrowers who rely in good faith on the
expertise of the loan originator or their agent. Ultimately, predatory
loans strip equity and wealth from communities.
Recent Trends In Subprime Lending
Since predatory lending is a subset of subprime lending, it is
important to take a closer look at the subprime market and its growth
to better understand the growth of the predatory lending problem facing
underserved communities today. Increasingly, subprime lending is
becoming the only option of all too many low-income and minority
borrowers. This reality sadly documents the continued existence of the
race line in America and the continued existence of the dual lending
market in the United States. Whereas before, African-Americans were
openly denied access to credit, today the ``race tax'' is more
sophisticated, more costly--and equally exploitative. Where once
redlining undermined communities, today ``reverse redlining'' has
become the norm and threatens to undermine our communities' economies,
social services, and tax base. On an individual level, the emotional
and financial cost of predatory lending cannot even be calculated, and
endangers every family's investment in their home and future. If, for
example, an African-American female head of household who lives in
Baltimore, Maryland, with good credit refinances a $150,000 loan at
6.75 percent for 30 years, the cost to the consumer in interest is
$200,240. If, however, this same African-American female is pressured
or coerced into refinancing with a subprime loan at 14.75 percent for
30 years, the total interest paid over the life of the loan will be
$522,015--a difference of $321,775. These are funds that the mortgage
holder could have used for home improvements, a college education, to
start a small business or for financial security. This is how the dual
lending market imposes a ``race tax'' upon our communities. In fact,
predators have made the ``race tax'' situation worse for our victim by
charging her closing costs in excess of four points, tying in a high
interest credit card, and including an exorbitant prepayment penalty
fee--all standard predatory practices.
Sadly, an analogy to racial profiling is appropriate here. We have
all become familiar with the term ``Driving While Black.'' Subprime
predatory lending has become the equivalent of ``Borrowing While
Black.''
The attached exhibits, which map subprime and conventional lending
patterns using census data, vividly reveal lending disparities in
predominantly white and predominantly minority census tracts. For
example, the map of Trenton, New Jersey shows that minority
neighborhoods in 1999 were 4 times more likely to receive subprime
refinance loans. Subprime lenders made more than 43 percent of loans in
Trenton minority census tracts but only 11 percent in predominantly
white tracts. The disparity in subprime market share by minority level
of neighborhood in Austin, Texas and Baltimore, Maryland was also very
large. In Austin, subprime lenders' market share in minority
neighborhoods was about 3.5 times greater than their market share in
predominantly white neighborhoods. And in Baltimore, subprime lenders
issued approximately 50 percent of all the conventional refinance loans
issued in minority neighborhoods in 1999. When subprime lenders
dominate the refinance market in minority and low-income neighborhoods,
they are apt to take advantage of their dominance and make abusive
loans. Stronger antipredatory laws combined with stepped up CRA
enforcement of prime lenders is necessary to eliminate abuses and
increase competition and choices of loan products in these
neighborhoods. The appendix to the NCRC testimony provides data tables
and maps showing lending disparities across States including New
Jersey, New York, Texas, and Maryland. These maps easily could
represent disparities in any urban community in the United States
today. The practices which gave rise to these lending patterns
undermine our Nation's commitment to fair lending, CRA and corporate
responsibility and best practices.
A national poll conducted for NCRC in 2000 by the bi-partisan team
of Jennifer Laszlo and Frank Luntz; found that Americans overwhelmingly
support fairness in lending. Of those surveyed, 92 percent said they
believed that every creditworthy person should, by law, be given
information about the best loan rate for which they qualify. With
abusive subprime and predatory lending, this is not the practice.
NCRC, and our members, have documented over 30 widespread lending
practices that despite existing legal protections have contributed to
the problem of predatory lending. These predatory practices, which I
will now identify, include issues relevant to the marketing, sale,
underwriting, and maintenance of subprime loans.
Marketing:
Aggressive solicitations to targeted neighborhoods
Home improvement scams
Kickbacks to mortgage brokers (Yield Spread Premiums)
Racial steering to high rate lenders
Sales:
Purposely structuring loans with payments the borrower can not
afford
Falsifying loan applications (particularly income level)
Adding insincere cosigners
Making loans to mentally incapacitated homeowners
Forging signatures on loan documents (that is, required
disclosure)
Paying off lower cost mortgages
Shifting unsecured debt into mortgages
Loans in excess of 100 percent LTV
Changing the loan terms at closing
The loan itself:
High annual interest rates
Product packing
High points or padded closing costs
Balloon payments
Negative amortization
Inflated appraisal costs
Padded recording fees
Bogus broker fees