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Committee on Financial Services

United States House of Representatives

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The National Home Equity Mortgage Association ("NHEMA")


Predatory Practices In Mortgage Lending

Before The

U.S. House of Representatives’

Committee on Banking and Financial Services

May 24, 2000


The National Home Equity Mortgage Association ("NHEMA") appreciates the opportunity to participate at this hearing on predatory lending practices. I am Laura J. Borrelli, NHEMA’s immediate Past President and a member of its Executive Committee. NHEMA’s members are responsible for originating a large majority of the nation’s subprime mortgage loans.

Let me begin by noting that "subprime lending" is not "predatory lending" as some parties seem to believe. Subprime 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 lending industry 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 get a mortgage for a home, or to use their home equity to pay for important credit needs. We are very proud that our industry has played a key role in democratizing the mortgage credit markets and helping so many consumers.

We also are strongly opposed to abusive lending practices that some unscrupulous mortgage brokers and lenders engage in, and NHEMA commends you for having an oversight hearing on this important issue. As I will explain subsequently, NHEMA believes that three immediate steps should be taken to address the problem of predatory practices, including voluntary self-policing actions by the industry; greater consumer education efforts by all interested parties; and, most importantly, tougher enforcement of existing laws which already cover most of these abusive practices.

"Predatory lending," which refers to certain abusive lending practices, can and do occur to some extent in almost all types of consumer credit transactions. In the mortgage industry, predatory or abusive practices, such as charging highly excessive brokers’ fees, can arise in either the prime or subprime segments of the marketplace. We abhor such practices, and NHEMA is working to make sure that those involved stop such abuses. However, we do not subscribe to the views of some parties who contend that there is a "crisis" level of predatory practices occurring in our market segment. Quite frankly, we think that the level of predatory lending abuses has been seriously overstated by some industry critics. We also believe that many of the practices that are being termed as "predatory" are not necessarily abusive. As I will discuss, some practices being criticized, like higher interest rates than prime loans, are necessary to attract lenders to make loans that are by definition higher in risk. Other practices, like balloon payments and prepayment fees, can be structured as abuses, but are far more often important options that help borrowers manage a loan they could not otherwise afford.

Nevertheless, there clearly are instances of real abuse, and concerted actions must be taken to prevent them. Great care must be taken, however, in crafting any regulatory and legislative changes so that credit availability is not unintentionally sharply curtailed and rates increased for consumers who have serious credit needs.

Subsequently, I will highlight some of the perceived abusive practices and suggest how NHEMA believes they can best be stopped. First, however, I want to give the Committee a brief overview of subprime mortgage lending since many misimpressions exist.

Subprime Mortgage Lending Is Not Predatory

In the mortgage industry, there is no precise definition of what is a "subprime" loan. In essence, "subprime" tends to include all loans that do not meet the underwriting standards of the so-called "prime" or "A" mortgage market that is controlled by Fannie Mae and Freddie Mac. Most subprime mortgage loans are made to people who have at least some credit impairments, but this market segment also includes loans that do not conform to other underwriting standards such as documentation requirements. There are a number of other factors that prevent borrowers from qualifying for prime loans: they may be new to the job market, they may temporarily be between jobs, they may be looking for a higher loan than is standard for the value of the house, etc. Not long ago simply being a single parent would have prevented most people from being able to receive a prime loan---making affordable loans to people like these who do not fit the relatively rigid formulas for prime loans is a fundamental reason the subprime industry exists.

Let me now provide you with some background data describing the subprime industry.

  • There are around 5 million outstanding subprime loans, with roughly 1.5 million +/- being made last year.
  • The subprime industry is highly competitive, with thousands of banks, thrifts, finance companies, mortgage bankers and other institutions offering loans to customers who do not qualify for "prime" grade loans. Many of the top subprime lenders are now major banking institutions or their subsidiaries.
  • Mortgage brokers, who typically are independent small businessmen and businesswomen, originate over 50% of the subprime loans. Brokers typically are compensated for their services in helping consumers obtain their loans by receiving a fee from the borrower and/or from the lender.
  • The vast majority of subprime mortgages are not for home purchases, but are either refinances of an existing loan or are a second lien on a home.
  • When most consumers obtain subprime mortgages, they draw upon the equity in their homes to obtain cash to meet a variety of consumer credit needs. Industry data suggests that only about 25% of the loan proceeds are used for home improvement. The overwhelming majority of the equity that is taken out is used for debt consolidation (e.g., paying off higher interest credit cards), educational or medical expenses, buying a car, or other general personal credit needs.
  • Borrowers in the subprime mortgage market typically are not senior citizens, but are younger or middle-aged. About 50% are between 35-49 years old; 25% are between 50-65 years old; and only 10% are over 65 years old.
  • Subprime loans are more expensive than prime loans because they involve higher levels of risk. Servicing costs, which typically run 30%-50% or higher than servicing prime loans, also cause subprime rates to be somewhat higher. Nevertheless, most subprime lenders charge very reasonable and fair rates.
  • SMR Research, which is one of the industry’s leading independent research and data analysis firms, reports that subprime note rates now only average about 2.5% higher than prime note rates.
  • Most subprime customers pay their bills and do not default. Over 90% stay current in making their monthly mortgage payments.
  • Subprime foreclosure rates are only about 2%, considerably less than FHA/VA foreclosures, and compare favorably with those for prime mortgages, which run around 1%. (Contrary to the allegations of some critics, subprime lenders rarely make money on foreclosures. In fact, just the opposite is true. Studies have shown that the lender loses a significant amount of money in over 90% of their foreclosures.)

Mr. Chairman, some parties have created the false impression that subprime lenders generally target their lending in a discriminatory manner and lend primarily to African-Americans and other potentially vulnerable minorities. This is simply not the case, and the data proves it. NHEMA strongly disputes this mischaracterization. Because some critics have been claiming that HMDA data shows subprime lenders are targeting minorities, NHEMA recently asked SMR Research to do an independent analysis of what is shown by the 1998 HMDA data. While HMDA information does not cover every subprime loan, as far as we can determine, this is the largest and best database available that provides a large sampling of recent mortgage lending by racial and ethnic background, as well as certain other key information such as borrowers’ income levels. The following charts show the results of SMR’s analysis of this HMDA information:

Subprime Borrowers’ Racial/ Ethnic Mix


We believe that this 1998 HMDA data clearly shows that the subprime mortgage industry is not disproportionately targeting African-Americans or other minorities. For example, according to the U.S. Census Bureau, African-Americans in 1998 composed about 13% of our population. The HMDA data breakdown shows subprime loans were made as follows: 17.5% to African-Americans; 71.2% to Whites; 7.8% to Hispanics; and 3.5% to other racial/ethnic groups. Subprime lending basically reflected our nation’s racial/ethnic breakdown.

The following tables give additional details of this 1998 HMDA Data analysis:

Racial/Ethnic Mix of Mortgage Loans

Home Purchase & Refinance (per 1998 HMDA Data)

Racial/Ethnic Group

% Of U.S. Population (per Census Bureau) % Of Subprime Lenders’ # of Loans (1998) % Of Prime Lenders’ # of Loans (1998)








Native American




Asian/Pacific Islander




Hispanic (not elsewhere listed)






Racial/Ethnic Mix of Mortgage Loans

Home Purchase Loans (per 1998 HMDA Data)

% Of U.S. Population



White (72%)



African-American (13%)



Hispanic (10%)



Others (5%)




Racial/Ethnic Mix of Mortgage Loans

Home Refinance Loans (per 1998 HMDA Data)


% Of U.S. Population



White (72%)



African-American (13%)



Hispanic (10%)



Others (5%)




The HMDA data also confirms what anyone in our industry would also tell you: subprime lenders make significantly more loans to lower and moderate income Americans than do prime lenders. This is hardly surprising because many less economically fortunate people do in fact have impairments on their credit records and cannot qualify for "prime" credit rates. The 1998 HMDA data shows subprime borrowers as having annual incomes approximately as follows: about 30% made less than $30,000; 30% made between $30,000 and $50,000; another 30% were between $50,000 and $100,000; and only 10% made over $100,000. The average median income of borrowers according to the 1998 HMDA data was approximately $70,000 for prime customers as compared to $55,000 for subprime borrowers. (Also, according to the U.S. Census Bureau, racial/ethnic groups’1998 per capital incomes were – Whites = $21,394; African-Americans = $12,957; and Hispanics = $11,434.)


Subprime Borrowers’ Incomes

(Per SMR Analysis of 1998 HMDA Data)

Another interesting point that was shown in the SMR’s HMDA data analysis is that subprime lenders have relatively high denial rates. This is significant because many critics contend that subprime lenders are lending without regard to repayment abilities and only want to make the loan so they can foreclose and profit off the borrowers’ homes. If this were the case, denial rates logically would be relatively low instead of relatively high.

















The preceding overview of the subprime mortgage industry illustrates that subprime lending generally is not abusive or predatory. Loans are made primarily to customers with impaired credit histories at rates that are reasonable, but somewhat higher than prime rates to reflect the higher risks and costs involved. Subprime lenders normally do not make loans to people who cannot repay. Subprime customers usually pay on time, and foreclosures average only about 2% as compared to 1% in the prime market. Subprime loan terms are not abusive, and loans are not made in a discriminatory manner.

Predatory Lending Practices

In sharp contrast to traditional subprime or prime lending, some loan originators do engage 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 unfair 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 alleged problems are not necessarily abuses, and the extent of the problems really has not been established. Let me explain these key points further.

As Federal Reserve Board Governor Gramlich commented in a recent speech before the Fair Housing Council of New York:

"Because the practices are shady, information is incomplete and anecdotal. No one knows how significant a problem, national or local, that predatory lending really is. But we hear distressing reports of abusive practices that include outright fraud, excessive fees and interest rates, hidden costs, unnecessary insurance, and deceptive uses of balloon payments. Self-explanatory labels from the predatory markets are ‘loan flipping’ and ‘equity stripping.’. . . . A significant component of predatory lending involves outright fraud and deception, practices that are clearly illegal. The policy response should simply be better enforcement. The harder analytical issue involves abuses of practices that do improve credit market efficiency most of the time. . . .Apart from outright fraud, these are the fundamental characteristics of predatory lending. 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." (Emphasis added.)

Congress and regulatory officials have a difficult task and should be very careful in addressing the abuses because there is a great danger that new restrictions would limit practices that are generally helpful and desirable for most consumers. Let me illustrate this point by mentioning several loan terms that are normally beneficial to consumers and are not abusive, yet many consumer advocates now often seem to be alleging these terms are per se predatory.

  • Balloon Payments - 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.
  • Arbitration Clauses – Some parties are basically contending 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, arbitration is now a generally recognized and 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 comply with the rules set forth by a nationally recognized arbitration organization should not be deemed inherently abusive. (This is the approach taken in the New York Banking Department’s proposed regulation on higher cost home loans.)
  • 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 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. The reason that prepayment fees exist is that lenders incur significant costs (frequently several thousand dollars) when they make a loan, and they generally do not recover those costs until the loan has been on their books for several years. If a loan is prepaid quickly, the lenders cannot recover these up-front costs unless they address this issue in the terms of the loan. Instead of charging a higher interest rate or higher initial fees, many lenders feel it is fairer and better for the borrower to provide an early-payment fee to protect against losing these up-front costs. On the other hand, it is certainly possible to have an abusive prepayment clause that imposes too much of a penalty and/or applies for too long a time. The point here is 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 applications of such provisions without denying the consumer the benefit of the provision which applies in most cases.

How Can Problems Be Addressed?

Although NHEMA does not believe that abusive or predatory practices are pervasive in the subprime mortgage sector, and we know that many alleged problems are not necessarily real abuses, we do feel that there are certainly some 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, some borrowers are victims of home improvement lending scams. Others are required to pay excessive loan origination fees to mortgage brokers. 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 over-react and adopt inappropriate restrictions that raise the cost of subprime mortgage credit, or curtail credit availability to those who need it.

The key issue is how to responsibly and effectively deal with these concerns. Quite frankly, we are confident that there is no simple "silver bullet" remedy here. Our association has been working actively to help address these problems for several years, and NHEMA believes that a multi-pronged approach must be taken to deal with these questions.

Greater Enforcement of Existing Laws and Regulations – As noted earlier, a substantial portion of predatory lending abuses involve fraud and deception that are clearly illegal. In many cases it also appears that some unscrupulous mortgage brokers and lenders are also disregarding current provisions of 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. Most abuses could be handled quite effectively by better enforcement.

The FTC has already brought a few enforcement actions involving alleged predatory lending 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 presume that the FTC can do much more, if it elects to do so, to enforce current laws to stop the perceived abuses.

We are pleased that the Federal Reserve has convened a nine-agency working group to come up with better enforcement approaches at the federal level. NHEMA looks forward to learning these federal agencies’ proposals, and we are happy to provide information and suggestions to them. In fact, we have already met with a number of them and had initial discussions about the perceived problems.

NHEMA urges this Committee and the Congress generally to support making whatever additional appropriations are reasonably necessary to help these agencies enforce the current laws and regulations more effectively. In addition, we encourage the agencies to request additional funds if they need them.

In particular, we also recommend that the Federal Reserve Board review whether it should utilize its existing authority under HOEPA to issue regulations to help define and control improper practices.

It is very important to remember that states also 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.

Consumer Education - Obviously, a key element of the problem is that some borrowers, especially lower-income, less-educated people, do not understand their mortgage loan terms. Governor Gramlich has correctly noted: "Predatory lending would not exist, or would be relatively rare, if prospective borrowers understood the true nature of their loan contracts."

NHEMA believes that industry, regulators and consumer advocacy and community groups all must do more and work together to help ensure borrowers really understand the mortgage lending process and the terms of their loans. In that regard, I want to note that NHEMA is stepping up its consumer education efforts. Appendix "A" to this testimony contains examples of several of the consumer education pamphlets that we have developed for our members to distribute to loan applicants and borrowers. The latest such pamphlet was developed jointly with the Consumer Federation of America.

NHEMA also supports the concept of urging mortgage borrowers, especially those who are only likely to qualify for the highest cost loans, to consider going to an independent, professional credit counselor to help ensure they understand their proposed loan contract before they enter into the loan.

Voluntary Actions – NHEMA has recognized that there is much the industry can do voluntarily to help raise industry standards and ensure that subprime mortgage lenders follow proper practices. We have taken a pro-active 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).

At NHEMA’s annual meeting earlier this year, we adopted new Fair Lending and Best Practices Guidelines. These guidelines are 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. Appendix "B" to this testimony contains a copy of NHEMA’s Code of Ethics and our various industry Guidelines.

Legislative 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 provisions that do not do more harm than good.

Legislation has been proposed in a number of state legislatures this year to address alleged abusive lending practices. Some apply only to subprime loans, while other apply to prime loans as well because the alleged abuses often are not limited to subprime. Virtually all of these bills have already be rejected, or in a few cases amended to the point that the provisions are very different than what was introduced. Several Congressional "predatory lending" bills also have been introduced and are pending before this Committee.

State and federal legislators who have introduced legislative proposals are undoubtedly all acting sincerely and in good faith to address what they think are problems. Yet, we believe that these various legislative proposals generally miss the mark. Most are drafted in such a way that they would cause credit availability to be greatly reduced and/or the rates to be increased for many borrowers. For example, one of the main Congressional bills would severely limit the financing of loan fees and closing costs. The practical effect, however unintended, of this would be discriminatory and would prevent hundreds of thousands of needy Americans, who lack the up-front funds to pay these costs, from obtaining the loan they need. Most also fail to address the fundamental fact that consumer confusion is at the heart of much of the problem, and it is largely the current RESPA/TILA requirements that produce much of this confusion.

In addition, there is an important issue that has not been given adequate legislative scrutiny. This is the issue of ensuring that there are tough state licensing laws for mortgage brokers and other loan originators. Licensing is a key matter of regulatory concern, and better licensing laws would be a significant help in controlling unscrupulous operators.

Mr. Chairman, these are difficult and complex issues that clearly need further study and analysis. The MRWG participants, who included some of the most knowledgeable people in the industry and consumer groups, could not agree upon workable solutions. Likewise, HUD and the FRB did an extensive study in 1998 and often reached differing conclusions or could only suggest various options be considered. Currently, federal agencies are still in the process of analyzing these issues, and a new HUD/Treasury Task Force is in the midst of reviewing how to identify and address abusive lending practices.

NHEMA believes that this Committee and your Senate counterpart need to give careful consideration to these issues and to review the immense amount of work and thinking that has already been done. As you do so, it is important that you examine how state and local lending requirements may apply. In that regard, we want to emphasize that lenders are finding that we are already facing a bewildering array of state and federal requirements that are often differing or conflicting. One of the central goals of any reform package that may be eventually considered should be to provide for much greater consistency and uniformity in mortgage lending laws, including those addressing abusive practices.

We want to continue working in good faith with the Committee and individual Members to explore further how to address abusive lending and related concerns. Ultimately, we hope that agreement can be reached on a broad package of reforms that will include simplification and streamlining of current disclosure requirements, preemption of conflicting state laws and, in any areas where it can be shown to be truly necessary, that provide carefully targeted legislative reforms to help stop abuses without restricting credit availability. "Loan flipping" and home improvement lending scams are two areas where such targeted proposals might be appropriate.

Given the very limited remaining time in this Congress, and the great complexity of these issues, we do not believe that it would be prudent for Congress to try to legislate this year. We again caution 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.

We believe that this Committee and other interested parties should pursue greater enforcement of current laws, enhanced consumer education and industry self-policing now and should continue studying the mortgage reform issues and seek to address this matter in a comprehensive way in the next Congress. NHEMA looks forward to working with you and others in these ongoing efforts.

Thank you for this opportunity to present our association’s views. I would be happy to respond to any questions that you may have.


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