TESTIMONY OF ASSISTANT SECRETARY FOR HOUSING
FEDERAL HOUSING COMMISSIONER WILLIAM APGAR
COMMITTEE ON BANKING AND FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
May 24, 2000
Good Morning Chairman Leach, Congressman LaFalce and members of the Committee. My name is William Apgar, and I am the Assistant Secretary for Housing/Federal Housing Commissioner at the United States Department of Housing and Urban Development (HUD). On behalf of HUD Secretary Andrew Cuomo, I want to thank you for the opportunity to testify today on what HUD believes to be widespread consumer mistreatment commonly termed "predatory lending."
Predatory lending practices vary from one community to the next, operating on the fringes of the burgeoning subprime lending market. Predatory practices take many forms, including overcharging consumers with illegitimate fees, employing bait-and-switch tactics, aggressive sales solicitation and targeting of low-income, minority and elderly homeowners, racial steering to high rate lenders and home improvement scams. Predatory lenders target untold numbers of the most vulnerable homeowners focusing on the elderly, minorities, and low-income families, loading them down with debt, and stripping them of equity. In a growing number of cases, these predatory loan terms are too much to bear and, as a result, the family loses its home to foreclosure.
While we dont have enough detailed data on mortgage costs and terms to precisely estimate the growth and current extent of predatory lending, there can be little doubt that these practices are on the rise. This is the consistent report of state consumer affairs organizations, housing counseling agencies, legal services organizations, and others who work with low- and moderate-income homeowners on a daily basis. The most dramatic evidence of the growth of predatory practices is the wave of foreclosures now coming out of the subprime market. These foreclosures not only ruin the financial future of individual families, they threaten to destabilize entire communities. In short, for millions of low- and moderate-income families, minorities, seniors, and others not well served by the primary market place, predatory lending threatens to turn the American dream of homeownership into an American nightmare.
HUD/TREASURY TASK FORCE
Recognizing the growing problem of predatory lending in many communities, HUD Secretary Andrew Cuomo joined forces with Treasury Secretary Lawrence Summers in early April to form a Joint Task Force on Predatory Lending. The Task Force was made up of representatives of consumer, civil rights, community groups, industry groups and state and local officials. At HUD, I co-chair the Task Force with our General Counsel Gail Laster. Our goal in establishing the Task Force was to ask the Task Force members to share with us their knowledge of predatory lending practices, their views on the extent and forms of the problem in their communities and throughout the nation, and their proposed solutions. We also asked the Task Force to help us identify recognized experts and identify individuals who have been victimized by predatory practices, as well as the best available literature on the topic. This quick start enabled us to hold to our ambitious schedule to develop a set of proposals to present to Congress in June.
Between April 26th and tomorrow, May 25th, we will have held public forums in five cities including Atlanta, Los Angeles, New York, Baltimore and Chicago. Soon after the forums conclude, we will be presenting two reports: The first will summarize the testimony from each of the five hearings and the second will present our recommendations to the Congress. And while I cant tell you what those final recommendations will be yet, I can tell you what we have learned about the problem to date.
TESTIMONY OF VICTIMS
In each of our five public forums, we have focused on a different aspect of predatory lending. The Atlanta forum examined issues of racial targeting, while the Los Angeles forum looked at how predatory lending issues affect the elderly. In New York, we heard about the sources of funding for predatory lending; and in Baltimore we focused on other key, non-lender players such as appraisers and brokers. Finally, tomorrow in Chicago, we will be learning more about state and local initiatives to curb predatory lending practices.
At each forum, HUD and Treasury officials have heard from the victims of predatory lending. More powerful than any statistics or analysis, these victims told how they were drawn into making a bad loan, and in most instances how they had lost their homes and their life savings to the predators. Here are a few examples of what we heard:
Irene Eichel, a 62 year old woman from Calabasas, CA., told the Task Force of her experience with a reverse mortgage. Ms. Eichel paid cash for her home in 1986. In 1994, Ms. Eichel contacted a subprime lender about obtaining a $30,000 loan for home improvements caused by the earthquake. She obtained a reverse mortgage at what she understood to be 13% interest. The loan did not require Ms. Eichel to make any monthly payments of principal and interest. Unbeknownst to her, however, the loan terms also changed the method of calculating interest after four years, granting the note holder a 55 percent equity stake in her home after four years.
When Ms. Eichel sold her home six years later, the lender took $126,800 - more than half of the equity in her home. Ms. Eichel did not realize that the loan provisions would give the lender a large share of the equity. Because of the small proceeds Ms. Eichel received from the sale of her home due to this provision, she was forced to cancel the purchase of a new home and now lives in a studio apartment.
Lucinda Ewing, a 70 year old African-American woman, told the Atlanta panel of how she lost the equity in her home and incurred significant debt as a result of successive high cost refinances. Ms. Ewing purchased her home in 1989 for $70,000, which included a purchase money mortgage of $30,000. Soon after, Ms. Ewing began receiving mail offers to refinance her mortgage to receive cash. Over the next few years, Ms. Ewing refinanced her home mortgage four times, with four different subprime lenders. With each refinance, Ms. Ewing paid substantial additional loan fees and twice she paid significant broker fees.
Ms. Ewing originally contacted the last lender after receiving a mail advertisement for a VA loan. When Ms. Ewing went to closing, she learned that she was not receiving a VA guaranteed loan, but instead a $97,600, high interest rate mortgage with a balloon payment. Thinking that it was too late to reconsider, Ms. Ewing signed the closing papers. At the time of her testimony, Ms. Ewing was $5,000 behind in the mortgage payments, and she had already received an notice of intent to foreclose from the lender.
Gail Floyd, a homeowner from Philadelphia, PA., told us about her experience with predatory lending. When Ms. Floyd made the decision to change from oil to gas heating, she contacted a company from the yellow pages to perform the work. This contractor informed Ms. Floyd that the work would cost $2,500. Ms. Floyd had $1,000, but needed to finance the additional $1,500.
At that time, Ms. Floyd had a first mortgage for $17,000 at 9 ½% and a second mortgage for $8,400 at 11%. Her monthly payment was only $143. When Ms. Floyd tried to obtain the $1,500 loan for the home improvement costs, she was told that she could not obtain a loan for that low an amount. Instead, a subprime lender refinanced her conventional first and second mortgages and combined this amount with other unsecured debt, resulting in a new mortgage for $33,600. The loan, financed at 12%, included excessive fees and prepaid credit life insurance.
THE GROWING SUBPRIME MARKET
Not all predatory practices are confined to the conventional subprime market. Indeed, it is well documented how scam artists have abused FHA and VA borrowers, as well as hosts of programs operated at the state and local level. Even so, the recent rapid rise of subprime lending appears to have provided predatory lenders with a fertile ground for their abusive practices.
By providing loans to borrowers who do not meet the credit standards for borrowers in the prime market, subprime lending can and does serve a critical role in the Nations economy. These borrowers may have blemishes in their credit record, insufficient credit history or non-traditional credit sources. Through the subprime loan market, they can buy a new home, improve their existing home, or refinance their mortgage to increase their cash on hand.
But there are two sides to this story. Since many players in the subprime market are not federally regulated, subprime lending is a fertile ground for predatory activities, such as excessive fees, the imposition of single premium credit life insurance and prepayment penalties that provide no countervailing benefit to the borrower.
A recent HUD report entitled Unequal Burden: Income and Racial Disparity in Subprime Lending in America revealed that subprime lending has grown at an unprecedented rate over the past several years. In fact, from 1993 to 1998, the number of subprime refinance loans increased ten-fold. In 1993, there were 80,000 loans reported under HMDA - the Home Mortgage Disclosure Act - which HUD identified as originating with subprime lenders. By 1998, there were more than 790,000 loans which HUD identified as subprime. Over the same period, there was a seven-fold increase in the dollar volume of subprime loans, from $20 billion to $150 billion. HUDs report also revealed that a disproportionate percentage of subprime loans are made in low and very-low income neighborhoods and in African-American communities. In fact, subprime loans are three times more likely in low-income neighborhoods than in high-income neighborhoods and five times more likely in African-American than in white neighborhoods. Race appears to be a critical issue, since subprime lending is twice as prevalent in high-income African-American neighborhoods as it is in low-income white communities.
THE EXPLOSION OF FORECLOSURES
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 a pioneering analysis entitled Preying on Neighborhoods: Subprime Mortgage Lenders and Chicagoland Foreclosures, the National Training and Information Center (NTIC) recently examined foreclosure trends for the period 1993 to 1998. The NTIC study found that between 1993 and 1998, foreclosures nearly doubled, with subprime lenders accounting for a large share of this increase. In particular, subprime lenders and servicers foreclosed on only 30 loans in the Chicago region in 1993, or 1.3 percent of all loan foreclosures that year. In contrast, foreclosures on subprime loans increased by more than 40 times to 1,417 in 1998, accounting for some 35.7 percent of total foreclosures in Chicago in that year.
Building on the NTIC Study, Debbie Gruenstein and Christopher Herbert of Abt Associates examined foreclosures in Atlanta for the period 1996 to 1999. This study found that while the overall volume of foreclosures in Atlanta declined by 7 percent over that period, the volume of foreclosure actions initiated by subprime lenders grew by 232 percent. In Atlanta, the overall share of foreclosures attributable to subprime lending increased from 5 percent in 1996 to 16 percent in 1999. Today, the subprime share of foreclosures (16 percent) is larger than the subprime share of originations (9 percent). Abt also found that the subprime share of foreclosures is highest in lower-income and predominantly minority neighborhoods.
A HUD report released last week at the hearing in Baltimore confirmed that foreclosures of subprime loans have emerged as a major problem confronting urban neighborhoods. Working cooperatively with the St. Ambrose Housing Center and the Circuit Court of Baltimore City, HUD examined all petitions to initiate foreclosure actions in Baltimore for the three month period of January to March 2000 and compared these results with available HMDA data on mortgage originations. The study reveals that while subprime loans made up only 33 percent of the 1998 market share for loans in low-income Baltimore neighborhoods, by early 2000, subprime lenders accounted for 50 percent of mortgages being foreclosed upon in those areas. In Baltimores African-American neighborhoods, subprime lending accounted for almost 60 percent of all foreclosures but only 42 percent of all loans. Moreover, many subprime loans were in foreclosure only months after they were originated. For Baltimore, the mean lag between the loan origination and the date that the foreclosure petition was filed was only 1.8 years for subprime loans.
These local studies mirror the national findings presented at the New York Forum held on May 12, 2000 by the HUD/Treasury Task Force. Based on extensive analyses of reports filed with the Securities and Exchange Commission, Alan M. White and Cathy Lesser Mansfield examined the default and foreclosure experience of 16 large subprime lenders. White and Mansfield estimated that for these subprime lenders, total defaults for subprime loans in the 4th Quarter of 1999 were three times as high as total defaults for all mortgages. White and Mansfield observe that these default rates imply that at the end of 1999, more than 72,000 families with subprime loans are in or near foreclosure--an alarming number when you consider that these loses only reflect the activities of 16 large subprime lenders who hold fewer than half of all subprime loans.
THE MANY FACES OF PREDATORY PRACTICES
So the evidence is clear: as subprime lending grows, foreclosures grow and so too presumably do the predatory practices which lead to them. We have more work to do in identifying exactly how predatory lenders operate throughout the country, and how specific predatory practices set homeowners up for failure. Even so, based on the testimony of victims at our forums and our research, we do have an extensive list of many of the common practices occurring today.
In July, 1998, HUD and the Board of Governors of the Federal Reserve System carefully reviewed the Real Estate Settlement Procedures Act (RESPA) and the Truth in Lending Act (TILA) to determine, among other things, if these laws provided adequate protection against abusive lending practices. In their resulting report to Congress, the agencies stated that while abusive practices can take many forms, there are two major categories: (1) blatantly fraudulent or deceptive practices that involve unlawful acts, and (2) various techniques used to manipulate borrowers into exorbitantly priced or simply unaffordable loans.
The first type of abusive practices, blatant fraud or unlawful acts of deception, include: (1) forging signatures or obtaining signatures on blank documents; (2) falsifying loan applicants income or the appraised value of the property; (3) overcharging consumers with illegitimate fees; (4) selling credit life or disability insurance to consumers who do not qualify for the insurance, or writing policies for amounts that exceed the consumers indebtedness; (5) fraudulently conveying title in the property to third parties to facilitate the diversion of loan proceeds; and (6) employing bait-and-switch tactics.
The second type of abusive practices is often more difficult to identify. It includes various manipulative techniques that cause consumers to enter into abusive loans, including: (1) aggressive sales solicitation and targeting of low-income, minority and elderly homeowners; (2) racial steering to high rate lenders; (3) undue pressure to refinance unsecured debt or second mortgages into a new, high-cost first mortgage; and (4) home improvement scams.
Often the predatory nature of these practices is only clear from looking both at the practices themselves and the resulting loans. For example, while sales of subprime loans to minorities within a particular neighborhood may not in itself be an abusive or illegal practice, it may become so when minority areas are specially targeted by lenders. Lenders, mortgage brokers and home improvement contractors may utilize high-pressure sales tactics that result in loans with excessive closing costs or unexpected balloon payments.
Abuses in the first category can be devastating to consumers and, based on consumer complaints, are far too prevalent. For the most part, these abuses involve acts that are already illegal under existing state laws, which should be vigorously enforced. The second category of abuses can be equally devastating, but are not necessarily illegal except where unlawful discrimination is involved. Accordingly, this second category of abuses demands special attention from the public and from state and national legislators and policymakers.
There are many techniques used to manipulate borrowers into exorbitantly priced or
simply unaffordable loans. These aggressive or deceptive techniques may result in a loan
with one or more onerous features -- such as an excessive interest rate, disadvantageous
balloon payment, or unjustified lump sum credit insurance. These manipulative practices
Aggressive Solicitation and Targeting.
Aggressive Solicitation and Targeting.
Racial Steering to High Rate Lenders. It has been alleged by some organizations that some subprime lenders are steering a substantial number of consumers to high rate/high cost creditors based simply on their race or economic status and lack of information, rather than based on their credit histories. Several groups believe that a significant proportion of these consumers are eligible for prime loans, or higher quality subprime loans, but are not aware of their ability to obtain prime or better subprime credit. The fact that many mainstream lenders have historically underserved these borrowers and communities, frequently referring prospective borrowers from minority neighborhoods to subprime affiliates, exacerbates this problem.
Undue Pressure to Refinance First Mortgages. Although consumers may qualify for an affordable second mortgage, predatory lenders will pressure them to borrow a larger amount to pay off the existing first mortgage, even though the interest rate on the new loan exceeds the interest rate on the existing mortgage. This allows the creditor to assess points and fees based on a larger loan amount, as well as to charge a high interest rate on a larger principal balance.
Home Improvement Scams. Creditors may work with disreputable home improvement contractors that sell improvements financed by a high rate/high cost loan. These arrangements often include misrepresentations by the contractor regarding the condition of the home, and overpriced, substandard, and/or frequently unfinished work by the contractor. Borrowers nevertheless find themselves separately liable on the mortgage to the creditor.
Loan Flipping. Loan "flipping" or "churning" refers to efforts by creditors to repeatedly refinance home-secured loans. Some creditors may extend credit knowing that the consumer cannot afford the scheduled payments, or the large balloon payment due at the end of the loan term. This practice guarantees that the loan will have to be refinanced within a short time, providing the creditor with additional income from origination fees on each new loan. Loan flipping may provide little economic benefit to the consumer in comparison with its cost, but it provides significant income to the creditor, principally in points and fees charged on the new loan, often coupled with penalties assessed for prepaying the existing loan. Because the costs of the refinancing are usually added to the loan amount, loan flipping typically reduces the homeowners equity in the property.
Structuring Loans Borrowers Cannot Afford. Among the clearest cases of abuse are loans made to persons living on fixed incomes where the monthly loan payments approach or even exceed that income; in some cases these borrowers might have qualified for a reverse mortgage that assured them continued possession of their homes for their lifetimes.
In addition to these manipulative practices, the HUD/FED Report identified a series of
common onerous terms and other features often associated with predatory loans. These
High Annual Interest Rates:
High Annual Interest Rates:
Excessive Closing Costs: Consumer advocates have testified that homeowners are stripped of their equity when high-priced loans are repeatedly refinanced in conjunction with the charging of high up-front fees that consumers cannot afford to pay at closing and that are, therefore, added to the loan amount.
Balloon Payments: A loan may be structured with low monthly payments that the homeowner can afford, but the payments are too small to fully amortize the principal resulting in a balloon payment at the end of the loan term. When faced with an unexpected balloon payment, the consumer must refinance the loan (paying additional fees and closing costs) or face possible default.
Negative Amortization: In some cases, consumers enter into a loan unaware that the monthly payments do not even cover the accrued interest, causing the principal loan balance to increase; this is known as "negative amortization". Although loans covered by the Home Ownership and Equity Protection Act (HOEPA) are prohibited from having payment schedules that result in negative amortization, some abusive loans may fall just below the HOEPA coverage triggers.
Lump Sum Credit Insurance: Consumer advocates say that because credit insurance is highly profitable, consumers are frequently subjected to high-pressure sales tactics for this product at or before the loan closing or the product is simply added, with little opportunity for the consumer to comparison shop or reflect on the decision. Consumer groups also express concern about the practice of collecting the insurance premiums for the entire loan term in advance. These premiums are commonly added to the loan amount, increasing the total finance charges paid by the consumer. If the loan is later refinanced or is paid off before maturity, the entire premium will not have been earned, but consumers may not know to seek a rebate, or may not know how to do so.
INITIAL HUD RESPONSES
Creating the nation-wide Task Force is not the only action HUD has taken this year to address predatory lending. In response to a hearing held by Senator Barbara Mikulski in March, 2000, HUD Secretary Andrew Cuomo joined Senator Mikulski in launching a Baltimore Task Force to learn more about the explosion of predatory lending abuses in Baltimore City. Senators Mikulskis hearing revealed that predatory practices were being visited upon both subprime and FHA borrowers in low and moderate-income Baltimore communities. The Task Forces goals were to use Baltimore as a laboratory to gather information on the cause and extent of mortgage scams and resulting foreclosures, and develop recommendations that would benefit Baltimore and serve as a model for FHA programmatic reform throughout the nation.
Evidence suggested that predators were purchasing homes in Baltimore and reselling them with cosmetic improvements at significantly inflated prices to first time homebuyers. The homes were over-appraised, substantial settlement fees were charged and the result was that these homebuyers were saddled with inflated mortgage loans and loan payments.
As a first step, at the suggestion of the Baltimore Task Force, FHA declared a 90-day moratorium on foreclosures of FHA-insured loans in Baltimore City. This gave HUD time to send a "SWAT Team" in to identify fraud or predatory practices involved in FHA loans before they foreclosed and to help as many homeowners as possible to avoid foreclosure. HUD staff intensively reviewed case files for the 350 FHA borrowers in Baltimore that had been sent a notice of intent to foreclose since January 1, 2000, and found evidence of fraud or predatory lending in 50 - 60 cases. These cases will be sent to the appropriate authorities, HUDs Inspector General or U.S. or State Attorney Generals for review and possible further action.
The second focus of the "SWAT Team" was to pursue an aggressive strategy to help defaulting Baltimore homeowners avoid foreclosure. To do this, FHA attempted to contact all borrowers with impending foreclosures to try to put them into one of FHAs foreclosure avoidance actions. In addition, FHA contacted the corresponding lender for each case to ensure that they were properly evaluating borrowers and offering appropriate foreclosure avoidance options.
We learned a great deal from our work in Baltimore and, last week, we announced several new FHA initiatives that will apply the lessons-learned to the rest of the country. FHAs reforms to protect homeowners from predatory lending focus on two main areas: (1) providing relief to those FHA borrowers already in distress, especially those who have been victimized by abusive lending practices; and, (2) strengthening FHA endorsement and fraud detection procedures to prevent predatory practices from occurring in the first place. The new reforms build on existing FHA efforts to streamline operations and eliminate abusive practices including Credit Watch, the Homebuyer Protection Plan, and a variety of reforms of the FHA property disposition program including the new Marketing and Management Contractors, the Good Neighbor Sales Program, and the Teacher and Officer Next Door Programs.
To assist victims of predatory lending, FHA proposes to fund foreclosure avoidance counseling for FHA homeowners in default. By expanding the availability and improving the quality of counseling, FHA will help homeowners make better use of currently available foreclosure prevention tools such as mortgage modification, and partial loan forgiveness. These efforts, commonly referred to by lenders as loss mitigation tools, have one simple goal: to help FHA borrowers stay in their homes.
For those FHA borrowers saddled with inflated mortgages that stem from appraisal abuse, FHA will direct mortgage lenders to write down the mortgage to a level consistent with a fair market appraisal. In situations where the lender refuses to honor this demand, FHA will intervene, cancel the existing mortgage and refinance the mortgage at the fair market value. In addition, FHA will instruct lenders to issue a "credit repair" letter to ensure that the victims credit record is set straight.
Victim relief is just one important step in addressing the problem of FHA foreclosures such as those found in Baltimore: the next challenge is to stop predatory practices from undermining the ability of FHA to promote housing opportunity. Once again building on the initial results of the Baltimore laboratory, FHA will institute an automated system to review the sales price history of properties prior to approval of FHA insurance. This new system will identify and stop abusive appraisal practices before the loan is endorsed. In addition, FHA will form "SWAT Teams", modeled on the Baltimore team, to target abusive appraisal practices in areas with a high concentration of FHA foreclosures. Finally, FHA is launching a new Appraisal Watch System, similar to the Credit Watch system now targeted to lenders, to identify appraisers with a record of faulty appraisals and abusive practices, terminate them from FHA programs, and, if appropriate, pursue legal action.
In some instances, the new initiatives will be immediately available on a national basis. In other instances, FHA will operate pilot efforts in Baltimore and other selected "Hot Zone" cities (defined as those with excessively high default and claim rates) to further test and refine the concept before moving to national implementation. In all cases, this new Fraud Protection Plan will better protect FHA, FHA borrowers and the communities FHA serves from the harmful effects of the rampant growth of predatory practices in the home finance market.
FURTHER ACTION IS NEEDED
Our work in Baltimore and the public forums throughout the country have underscored for us the urgency with which we must act. While the new initiatives outlined above will increase protection and aid for FHA borrowers, we have learned that predatory lending abuses extend far beyond HUDs doors. Working together with the Department of Treasury, we are preparing a set of recommendations on how the Federal government can increase its overall activities in eight key areas. A consistent theme is how important it is to continue to encourage responsible lenders to serve underserved markets, including borrowers whose credit history is not perfect. While our specific recommendations will not be finalized until mid-June, we have identified eight key areas for further review:
1) We need better information on high cost lending. It is simply unacceptable that this Committee and others charged with oversight of the nations housing finance system and the public do not have readily available data on the extent of high cost lending, predatory practices and foreclosures.
2) As the President stated last year, we need to expand the Home Ownership Equity Protection Act (HOEPA) to cover a larger share of high cost loans. HOEPA was passed before the rapid growth of subprime lending. As a result, HOEPA triggers cover only a very small share of high cost lending. The HOEPA triggers must be reviewed in light of current lending trends.
3) Congress should consider restricting certain loan features strongly associated with abusive lending practices. For example, many lenders have already concluded that certain loan products, including single premium credit life insurance, have no place in todays market. Congress should consider placing similar restrictions on all loans.
4) We must improve consumer protection by increasing enforcement against fraudulent loan practices. In each of the four cities we have been to to date, the HUD/Treasury Task Force learned that local enforcement entities often struggle to keep up with the growing mortgage fraud in their area.
5) We are reviewing whether creditors making high cost loans should be required to take into account the consumers ability to repay setting a consumer up for a quick foreclosure has no place in todays market place.
6) Borrowers need more accurate and meaningful disclosures on the pricing and terms of high cost loans. Consumers are now faced with a bewildering array of documents at closing. In the face of high pressure sales techniques and new predatory lending scams, existing disclosures need a thorough review.
7) We are taking a careful look at the role of the secondary housing market in purchasing or securitizing predatory mortgages. We are examining what role better due diligence may have in this regard.
8) We need to expand consumer education and counseling. The importance of expanded education and counseling has been one consistent theme of each of the HUD/Treasury forums. Last year, the Administration requested $20 million for homeowner counseling, but Congress only appropriated $15 million. This year the administration requests $24 million for counseling. Congress should fully fund this request.
These are just some of the areas the HUD/Treasury Task force are examining. I look forward to sharing with you the final recommendations from our Task Force next month. Thank you for this opportunity.