Avoiding Predatory Lending
If you are considering refinancing or taking out a home equity loan, it’s important to know what to avoid when choosing a lender. If your income is low or irregular or your credit is less than perfect, you could be targeted by predatory lenders who engage in practices that could ultimately cost you your home.
You may believe that you can’t qualify for a loan in the mainstream market and may instead turn to marginal or “sub-prime” sources to meet your refinancing or home equity loan needs. While home loans are readily available in the sub-prime market, the cost is often quite high. Some sub-prime lenders charge points and origination fees in excess of 10% of the loan amount and then finance those fees at high rates.
In addition to paying more, you could fall victim to predatory practices, such as “flipping,” “packing,” and “equity stripping.” Keep reading for some examples of specific predatory practices from the North Carolina Attorney General’s office.
Excessive mortgage broker compensation
Most mortgage brokers arrange a loan with the best terms and at the lowest possible rate and charge a reasonable fee for their services. However, in the sub-prime market, some mortgage brokers do just the opposite by attempting to sell you a loan with the most fees and highest rate possible so that they get more compensation. Some of these brokers may charge fees of 8 to 10 points. That could cost you an additional $8,000 to $10,000 on a $100,000 loan.
In addition, the broker may get additional compensation by arranging a higher-than-necessary interest rate for you. For example, you may qualify for an 8% interest rate, but if the broker can sell you a 9% rate, he can keep the difference. This method of indirect payment is called a "yield spread premium." Before contracting with a mortgage broker, find out how the broker will be paid.
Excessive points and fees
You can expect to pay a 1% origination fee and possibly another 1% of the loan amount in points, as well as basic closing costs that include appraisal and attorney's fees. Some predatory lenders load up loans with these up-front charges and charge additional "junk fees" to pad the closing costs.
As a real life example, a broker recently arranged a $48,000 home loan for a borrower in Fayetteville that included a $4,352 origination fee, $1,089 in points, a $175 "underwriting" fee, a $200 "processing" fee and a $175 "document prep" fee, in addition to standard closing costs. These fees were then rolled into the loan and financed at a high rate of interest. Even if the borrower were able to refinance the loan later at a lower interest rate, he cannot get any refund on the fees because they are earned as soon as the loan is closed.
Sell the monthly payment
Many brokers and lenders advertise "bill consolidation" home equity loans. They encourage you to pay off credit card, retail and motor vehicle debt by consolidating them all into one home loan with a monthly payment. While you can lower your monthly payments, you are ultimately trading short-term debt for long-term debt. Instead of paying off your credit bills in three to four years, it will take 15 to 30 years to pay off the new consolidation loan, and you will pay a much higher total interest payment. To avoid being victimized, look beyond the monthly payment and analyze all the terms of the loan.
Another way for a predatory lender to reduce the monthly payment on a home loan is to have you pay off only the accrued interest each month. This method of financing results in a huge balloon payment at the end of the repayment term (usually 15 years). While you may believe you are paying down the loan after making all the payments, after 15 years, you will owe almost as much as you originally borrowed. If you are unable to make the balloon payment or to refinance the loan, you could face foreclosure.
If you have a significant amount of equity in your home, you could be a target for the predatory practice known as equity stripping. An unscrupulous lender may lend an amount that is more than you can afford, knowing that you are likely to default. The lender can then foreclose and sell the house, stripping you of all the equity you have earned over the years.
Flipping is the repeated refinancing of your loan. When you have paid down the loan slightly, a predatory lender may encourage you to refinance and get a little more cash out of the available equity in your home. Each time the loan is refinanced the lender charges fees, placing you further in debt over a longer period of time.
Packing is the practice of adding unwanted extras to the loan without your full knowledge. The most common product added to loans is credit life or disability insurance. Credit insurance is almost always overpriced and a poor value for consumers, but in mortgage loans, the cost can be enormous. For example, on a $28,000 loan, the cost of credit life insurance can exceed $4,000. The $4,000 premium is added to the loan and financed over the life of the loan, earning the lender more interest income in addition to the commission from the sale of the insurance.
How am I protected?
North Carolina has taken steps to protect you through its predatory lending law. G.S. 24-1.1 mandates that persons considering high-cost home loans must receive counseling from a North Carolina Housing Finance Agency-approved counselor before they complete the loan process. The purpose of the free counseling is to ensure that you fully understand the material terms of the loan, and the amount of fees and costs you will be required to pay. The counselor must certify to the lender that counseling services have been rendered.
If you are considering a high-cost loan, find counselors in your area who have been approved by the North Carolina Housing Finance Agency.
If you receive predatory lending counseling, you can expect to learn about the following topics:
- Interest rate or APR
- Whether fixed or variable rate
- Term (duration) of loan
- Monthly payment amount (including whether this amount is subject to change)
- Loan origination fee
- Discount points
- Commitment fee
- Broker compensation
- Loan application fee
- Other lender fees
- Prepayment penalty
- Credit insurance
Financing prepaid, single premium credit life, disability or unemployment insurance is prohibited in all home loans under the Predatory Lending Act.
A high-cost home loan cannot contain the following terms:
- Balloon payment
- Financing of points or fees
- Financing of closing costs, including charges payable to third parties.
Your individual circumstances:
- Purpose of loan
- Your credit history
- History of repeated financing?
- Amount of equity in home
- Your ability to repay
- Did you shop or compare rates and terms with other lenders?
- Explanation of your rights to cancel within three days (in refinancing transactions).
Problems with lending practices were the second most common group of complaints filed with the North Carolina Attorney General’s Office of Consumer Protection in 2003. If you suspect you have been the victim of predatory lending, you can file a complaint with the Attorney General’s Office or call Consumer Protection toll-free at 1-877-5-NO-SCAM. You can also file a complaint with the North Carolina Commissioner of Banks.