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Predatory Mortgage Lending

A dramatic increase in the incidence of predatory mortgage lending practices has created a crisis for communities of color, elderly homeowners, and low-income Americans.
The overwhelming majority of abusive loan practices occur in the subprime mortgage industry. Subprime loans—intended for people unable to obtain a conventional prime loan at standard mortgage rates—have higher interest rates to compensate for the greater risk that the borrowers represent. Lending practices are categorized as predatory when loan terms or conditions are abusive, or when lenders promote high-cost loans to borrowers who may qualify for credit on better terms. Predatory mortgage terms cost borrowers an estimated $9.1 billion per year.1
The practice of subprime lending increased ten-fold in less than ten years.
In 1993, 100,000 home purchase or refinance loans were subprime; in 1999, that number had jumped to nearly one million.2 During the same period, all other home purchase and refinance loans declined by ten percent.3 In 2005, one in every four home loans was subprime.4
The increase in subprime lending has predominantly affected minorities, the elderly, and rural homeowners.
A U.S. Housing and Urban Development Department study found that minorities were significantly more likely to receive a subprime mortgage than non-minorities with similar incomes. Subprime loans accounted for 51 percent of all refinance loans made in predominantly African American neighborhoods, compared to just nine percent of the refinance loans made in predominantly white neighborhoods.5 Almost one in three refinance loans made to Latino families were subprime. A study in North Carolina found that rural borrowers were 20 percent more likely than their urban counterparts to be subjected to excessive prepayment penalties.6 Another study found that borrowers 65 years of age or older were three times more likely to hold a subprime mortgage than borrowers under 35 years of age.7
About half of subprime borrowers could qualify for a traditional mortgage.
The victims of predatory lending practices are compelled to accept unreasonable terms and abusively high fees.
The Fannie Mae Corporation estimated that as many as half of the borrowers who receive high-cost subprime loans could have qualified for traditional mortgages at lower interest rates.8
Borrowers who are not in a position to qualify for an “A” loan are too often required to pay unreasonable rates and fees in the subprime market. Incentive systems that reward brokers and loan officers for charging more contribute to the problem. Other abusive loan practices found in the subprime industry include saddling credit-challenged borrowers with unwanted balloon payments and prepayment penalties, and “flipping”—encouraging repeated refinancing by existing customers, tacking on extra fees each time.
There is a long history of states using usury laws to limit abusive lending practices, but financial industry deregulation and statutory loopholes have made those laws ineffective.
Usury laws have been weakened so much over the past 20 years that predatory lending practices—modern day loan-sharking—are legal. Although federal law prohibits specific predatory practices, those provisions cover only certain types of loans, and the threshold for what is considered a high-cost loan is set so high that many homeowners are left unprotected.
Eleven states curtail predatory lending practices.
North Carolina became the first state to prohibit predatory lending in 1999, saving citizens an estimated $100 million in the law’s first year.9 Nine other states (AR, GA, IL, IN, NJ, NM, NY, SC, WV) have enacted moderate to strong laws against predatory lending. Massachusetts also has a series of strong regulations against predatory lending. Fifteen other states have enacted laws that purport to address the problem, but actually provide no substantive consumer protections.10
Effective legislation to prohibit predatory lending practices includes the following elements:
  • Incentives for lenders to decrease exorbitant and abusive fees.
  • Elimination of kickbacks that reward brokers for setting unjustifiably high interest rates.
  • Prohibition of prepayment penalties that trap homeowners in subprime loans.
  • Requirement of independent counseling for borrowers before they enter into high-cost mortgage loans.
  • Prevention of “loan flipping”—refinancing that worsens the borrower’s financial position.
  • Prohibition of questionable products, such as credit insurance or debt cancellation fees.

This policy summary relies in large part on information from the Center for Responsible Lending.

Endnotes
  1. Center for Responsible Lending, “Predatory Mortgage Lending Robs Homeowners & Devastates Communities,” 2005.
  2. Edward Gramlich, “Subprime Mortgage Lending: Benefits, Costs, and Challenges,” Federal Reserve Board, 2004.
  3. U.S. Department of Housing and Urban Development, “Unequal Burden: Income and Racial Disparities in Subprime Lending in America,” April 2000.
  4. “Subprime Services struggle with Portfolio Growth at Midway Mark,” Inside B&C Lending, September 1, 2006.
  5. U.S. Department of the Treasury and U.S. Department of Housing and Urban Development, “Curbing Predatory Home Mortgage Lending: A Joint Report,” June 2000; see Debbie Gruenstein Bocian et al., “Unfair Lending: The Effect of Race and Ethnicity on the Price of Subprime Mortgages,” Center for Responsible Lending, May 31, 2006.
  6. Center for Responsible Lending, “Rural Borrowers More Likely To Be Penalized for Refinancing Subprime Home Loans,” September 2004.
  7. AARP, “Subprime Mortgage Lending and Older Borrowers,” March 2001.
  8. James Carr and Lopa Kolluri, “Predatory Lending: An Overview,” Fannie Mae Foundation, 2001.
  9. Center for Responsible Lending, “North Carolina’s Predatory Mortgage Lending Law: Celebrating Over 5 Years of Success,” 2005.
  10. Center for Responsible Lending, “CRL State Legislative Scorecard: Predatory Mortgage Lending,” 2006.
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