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August 20, 2001
�I
read a lot about predatory lending. How do I avoid becoming a
victim?�
To
educate myself on what makes a victim, I recently studied 51 case
histories of households victimized by mortgage lenders.
The histories were provided by ACORN, which has been in the
forefront of the struggle against predators.
(If you have a case history to add, or an interest in joining their
effort, they can be reached through
www.acorn.org.)
While
every case is different, victims share certain features that make them
vulnerable to predators. This
column and two others to follow will describe the most important features
of victims. If you see
yourself in any of these descriptions�you are now forewarned.
Passivity:
Perhaps the most pervasive characteristic of victims by far is that they
are passive. They don�t
select a loan provider, the loan provider selects them.
In more than half the cases compiled by ACORN, the victims were
solicited by the lenders. In
most of the remaining cases, the victims approached a lender they knew
from prior experience, either their own or someone they knew.
Predators
in the jungle select prey carefully, and so do predators in the home loan
market. Hardly a day goes by
when someone does not try to sell me a list of potential borrowers.
[Because I write about mortgages, I have been misclassified as a
lender/broker in many databases.] Here
is a recent example:
�[Name
of company] is a leader in providing specialty home loan leads, such as
our sub-prime file of home owners where you can select by credit score,
amount of revolving credit card debt, or equity in property.�
A
homeowner with lots of credit card debt, decent credit and substantial
equity in a home is a prime lead. Lenders
who pitch debt consolidation will pay a good price for it.
Most
predators solicit their clients. If
you passively go with a loan provider who solicits you, the risk of
getting a predator is high. Since
most loan providers are not predators, the risk of getting one is much
lower if you throw a dart at the loan providers listed in the yellow
pages. Of course, getting a
referral from someone who understands the market is even better.
Borrowers
who allow themselves to be selected by loan providers, stay selected.
Passive borrowers don�t shop alternatives.
They also don�t ask as many questions as they should, which is
one of the reasons they usually end up confused about the transaction.
Passivity
can be overcome. Resolve to
select the lender rather than have the lender select you.
Selecting an Upfront Mortgage Broker from among those listed on my
site, or a loan provider recommended by a HUD-approved counselor,
virtually eliminates the risk of getting a predator.
Approved counselors are listed at http://www.hud.gov/offices/hsg/sfh/hcc/hccprof14.cfm.
Confusion:
Almost all of the case histories, which were provided by ACORN, the
national community group, involved confusion by the borrower about one or
another feature of the transaction. In
some cases, borrowers were under the impression that they were getting
unsecured loans rather than mortgages.
In many cases, they purchased credit life insurance under the
impression that it was required. Often,
they thought that they were paying a lower interest rate than was in fact
the case. The total amount of
fees packed into the loan balance usually surprised them.
A large number did not know that their contract included a
prepayment penalty until years later when they went to prepay.
Why
so much confusion? Victims
often don�t read documents, or if they do read they are afraid to ask
questions about what they don�t understand.
The �Plain English� movement has not impacted mortgage
documents, although there isn�t a segment of the economy that needs it
more.
Not
reading is not a major problem if the loan provider is honest and
competent. Predators,
however, thrive on confusion, which provides a smoke screen for their
shenanigans. To a predator, a
reading-challenged borrower is an invitation to take advantage in every
possible way. And mortgages
provide lots of ways.
Confusion
and passivity go hand in hand, and must be overcome together.
Remember two things: 1. Mortgages
are so complicated even professors get confused; 2.
It is the loan provider�s responsibility to eliminate your
confusion. If he doesn�t do
it, walk out the door.
Indebted:
Victims are often heavily in debt, and therefore vulnerable to the
siren call of debt consolidation. Debt
consolidation was the primary motivation in about 2/3 of the ACORN cases.
The
argument is compelling. Make
one lower payment, and enjoy tax benefits besides.
While these advantages can be real, they tend to disappear in
dealing with a predator. Sometimes
the payment is higher rather than lower because of the stiff interest
rate. Even if the payment is
lower, the borrower�s equity is depleted by the inclusion of large
upfront fees in the loan. Consolidate
debts with a predator and you end up worse off than you were before.
Consumers
who have accumulated too much short-term debt have an option other than
debt consolidation. They can
instead work out a debt management plan with a credit counselor.
In exchange for agreeing to take on no new debt and to pay off the
old debt within a prescribed period, the counselor can get the creditors
to agree to a reduction in interest rates.
The consumer makes one payment to the agency, which in turn pays
the creditors. This avoids
one of the perils of debt consolidation, which is that it may encourage a
new credit binge.
If
the indebted consumer opts for debt consolidation, it can be done by
taking a second mortgage for the amount of the debt, or by a cash-out
refinancing of the first mortgage. In
the refinancing, the new loan balance is large enough to cover the debt as
well as the old balance.
Whether
a second mortgage or a cash-out refi is less costly for the consumer is a
tricky question that depends on a number of factors.
One of the calculators on my web site was designed to answer this
question. But you won�t
find this (or any other) calculator being used by a predator.
Predators consolidate in the way that is most costly to the
consumer, because that generates the most revenue for the predator.
Consumers
with excessive short-term debt who are too passive or confused to use a
calculator or shop alternatives will do better seeing a credit counselor
rather than a loan provider. While
not all counselors are great, the loss is small if you get a bad one.
If you go to a loan provider who turns out to be a predator, the
loss can be catastrophic.
Cash-Dazzled:
Many
victims are cash-dazzled -- the prospect of pocketing a significant sum of
money causes a complete lapse of judgment.
They ignore where the money is coming from and what it is costing
them.
Predators
love cash-dazzled victims because they are prime candidates for cash-out
refinancing � refinancing into loans that are larger than the
outstanding balance of the old loans.
Frequently, the new loan has a higher interest rate than the old
one, and the refinancing fees are added to the loan balance.
Some borrowers will refinance again and again, a practice known as
�flipping�, until they have used up all their equity.
There
are many legitimate cash-out refinance transactions.
They become predatory when the cash-dazzled victim agrees to terms
that are far more costly than the borrower could have obtained by shopping
alternative sources. The
alternatives include home equity loans.
In
many cases, borrowers who need cash do much better with a home equity loan
than with a cash-out refinance. Even
when the rate on the home equity loan is high, that rate is paid only on
the additional cash required. On
a cash-out refi, the new higher rate is paid on the old loan balance as
well as the additional cash.
The
worst rip-off is cash-out refinancing of zero interest loans, a problem
that has plagued the Habitat for Humanity program.
The Coalition for Responsible Lending estimates that ten percent of
all Habitat borrowers between 1987 and 1993 subsequently refinanced their
zero interest loans into loans carrying rates of 10-16%.
Borrowers who did this were paying interest costs of 60% and up for
the cash in their pockets. Cash-dazzled
victims don�t see it.
In
the case histories of borrowers victimized by predators, a surprisingly
large number had had a satisfactory credit experience with a reputable
lender in prior years. In
some cases, they had completely paid off their mortgages.
Then the prospect of cash-in-hand lured them into the hands of a
predator.
Payment
Myopic:
Victims often base decisions solely on the affordability of monthly
payments; they are payment myopic. They
don�t consider interest costs or how the decisions will affect the
equity in their homes.
Predators
love payment myopic victims because, like cash-dazzled victims, they offer
little resistance to upfront charges that are included in the loan amount.
An upfront fee of $2,500 reduces the borrower�s equity in his
home by the same amount, but that doesn�t matter to the payment myopic
borrower. What matters is that at 10% and 30 years, the $2,500 converts
into only $22 a month.
Here is the
kind of deal that payment myopic/cash dazzled borrowers find irresistible.
The borrower has paid down his 8% loan to $100,000 and has only 12 years
to go. He is offered a
30-year loan for $110,000 at 9%. The
monthly payment would fall from $1082 to $885, and he puts $10,000 in his
pocket tax free. What a deal!
Of course, 5
years down the road, he would have owed only $69,449 had he stayed with
his original mortgage. With
the new mortgage he will owe $105,468 -- even more if there are upfront
fees included in the new loan, which is almost always the case.
Payment-myopic borrowers don�t look down the road.
Just because
you are cash-dazzled or payment myopic does not mean you must be a victim.
You can avoid victimization if you steer clear of temptation.
Alcoholics who are on the wagon have a trusted advisor who they
call when they feel their control weakening.
Impulsive borrowers can do the same.
If all else fails, you can email me, but expect a stern lecture.
Copyright
Jack Guttentag 2002
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