Testimony of Ms. Gloria Waldron
Member, Brooklyn ACORN
House Banking & Financial Services Committee
Hearing on Predatory Lending
May 24, 2000
Chairman Leach, Representative LaFalce, Members of the Committee, on behalf of ACORNs 120,000-plus low-income members in thirty-five cities across the country, I appreciate the chance to talk with you about predatory lending practices that strip wealth from our neighborhoods. My name is Gloria Waldron, and I have been a Brooklyn ACORN member for the last twelve years.
I want to start off with some stories of victims of predatory lending -- just two for now. Its important that you all understand that there are stories like these on every block in my neighborhood in East New York in Brooklyn, and in neighborhoods like it.
· Nancy Ward of Miami had a home loan at a 7% fixed rate. A mortgage broker from First Mortgage America told her she could refinance and lower it to 4.5%. She learned later that her rate of 4.5% was for the first month only. After that, it became adjustable. Today her rate is close to 9%, and her monthly payments of $860 don't even cover the interest. Her loan principal is actually increasing, what they call negative amortization. Nancy paid over $6,000 in fees on her loan, and the lender paid the broker a yield spread premium of nearly $2,300 for getting her to accept the higher rate.
· Last spring, Cesar Ramos from Oakland, California, missed a mortgage payment when his son became ill and his wife suffered an injury at work. Almost immediately, he received a call from Golden Gate Mortgage offering to refinance his mortgage and other debts at a 7.25% interest rate. When Golden Gates representative came to the Ramos house, he pressured Mr. Ramos into signing the papers without reading them and told him not to worry because he had three days to cancel his loan. After the representative left, Mr. Ramos saw that the loan had an 11.25% interest rate, $8,000 in fees financed into it, and monthly payments of $1,800, over $400 more than his previous payments. When he didnt see how to cancel his loan in the documents, he called Golden Gate but was told his agent was on vacation and someone else would call him back. Mr. Ramos continued to call , but no one would assist him. The three days expired, and he was stuck with a loan he knew he couldnt repay. Eight months later, the Ramos family lost their house.
Concentration of subprime lenders in lower-income and minority neighborhoods
Again, these are not isolated cases. Similar abusive practices, both legal and illegal, go on every day in neighborhoods like mine in Brooklyn. These lenders target our neighborhoods, and they are fast becoming the lenders in our neighborhoods. Using Home Mortgage Disclosure Act (HMDA) data, ACORN found that subprime lenders accounted for 72% of the refinance loans made to low and moderate income African-American homeowners in Brooklyn and 60% of the loans to low and moderate income African-Americans in the Bronx. For low and moderate income Latinos, subprime lenders accounted for 60% of the refinance loans made in Brooklyn and 43% of the refinance loans in the Bronx. A series of ACORN studies of over twenty-five cities across the country shows similar patterns of highly disproportionate numbers of subprime loans being made in low- and moderate-income communities and communities of color.
HUD recently issued a report, 1998 HMDA Highlights, that provides further evidence of the subprime industrys lending patterns. In 1998, subprime loans were three times more likely in low-income neighborhoods than in high-income neighborhoods. While 11% of refinance mortgages in 1998 were subprime nationwide, the percentage more than doubles in low-income neighborhoods to 26% and quadruples in the poorest communities, where families make only 50% of the median income, to 44%.
That same study indicates even more troubling trends for African-Americans, as subprime loans are five times more likely in black neighborhoods than in white neighborhoods. The disparities increase as incomes rise. Homeowners in low-income black communities are almost three times as likely as homeowners in low-income white communities to have subprime refinancing. For moderate income neighborhoods, black neighborhoods are four times as likely and in the upper income neighborhoods, blacks neighborhoods are six times as likely as white neighborhoods to have subprime financing. Almost unbelievably, homeowners in high-income black neighborhoods are more than twice as likely as homeowners in low-income white neighborhoods to have subprime loans. In fact, the entire growth from 1995 to 1998 in home loans made to African-Americans was due to subprime loans.
ACORN works to help lower-income families enjoy the benefits of homeownership, but subprime lenders -- with their substantially higher rates and fees and their tendency to engage in deceptive practices -- are tearing down those dreams. As the subprime industry has taken off, the number of families being foreclosed upon is on the rise, despite the growing economy. In Philadelphia, for example, ACORN found that from 1995 to 1999, foreclosures more than doubled, and this troubling trend is mirrored in cities across the country.
The role of prime lenders
At the same time we consider what predatory lenders are doing wrong, we must not forget that a large part of the problem is that prime lenders are not lending in our neighborhoods. An ACORN study of HMDA data from 41 cities across the country found that both African-Americans and Latinos have been falling behind whites. From 1995 to 1998, conventional mortgage originations increased 48% to whites, while rising less than half as much for African-Americans, 22%, and for Latinos, 20%. Banks especially lag in refinances in underserved neighborhoods. From 1997 to 1998, the shares of home refinances made by conventional lenders to African-Americans and to Latinos fell substantially, as they were heavily outpaced by loans made to whites.
That study also showed that African-Americans and Latinos are rejected more frequently for conventional loans than white applicants and that the disparities are steadily growing. In 1995, African-American applicants were 206% as likely to be rejected as whites, increasing to 217% as likely in 1998. Latinos were rejected 169% as often as whites in 1995, growing to 183% as often in 1988.
Especially as Freddie Mac estimates that up to 30% of borrowers in subprime loans should be qualifying for A loans, there can be no doubt that banks bear a substantial amount of responsibility for the extra costs subprime loans impose upon the families and neighborhoods they have abandoned. This reality is frequently acknowledged by federal banking regulators, and yet a disconnect remains between that acknowledgment and their lax enforcement of banks Community Reinvestment Act (CRA) obligations. Over 98% of the same banks and thrifts that so often neglect low- and moderate-income communities and communities of color receive satisfactory or above CRA ratings. We need regulators to do more than merely recognize the link between banks withdrawal from the neighborhoods that subprime lenders have targeted and provide for the stronger enforcement of banks CRA responsibilities. Until that happens, individual borrowers will continue to pay tens of thousands of dollars more on their home loans, simply because of where they live.
It has been common to look at predatory activities as occurring at one of three points in lenders (and brokers) activities: marketing their loans, setting the loan terms, and following up to ensure payment. In all three areas, practices in the subprime market, and especially among predatory lenders, vary greatly from standard practices among prime lenders.
Predatory practices in the marketing of subprime loans
Subprime lenders win customers primarily on the basis of their marketing efforts instead of on the pricing of their loans. In practice, shopping for the least expensive subprime loan is virtually impossible, in large part because lenders advertisements or initial offers do not provide consumers with accurate assessments of the real loan costs (this is explained in more detail in the next section). In their marketing efforts, subprime lenders and mortgage brokers deluge potential borrowers from lower-income and minority communities with an endless series of mailings and phone calls. It is not surprising that residents of a neighborhood neglected by banks but heavily targeted by subprime lenders would believe that a subprime loan was their only option, regardless of their actual credit history. And with lenders and brokers frequent phone calls, they attempt to build trust that will lead borrowers to believe they are receiving the most appropriate loan product, when that is not the case most of the time.
Predatory practices during application process and setting of loan terms
Far too many of these subprime loans are hurting, not helping, our neighborhoods. Some are made in violation of current laws like the Home Ownership Equity Protection Act (HOEPA). Others are legal under current law but clearly predatory.
Subprime lenders regularly engage in deliberate deceptions that result in applicants paying excessive rates and fees. They use consistent strategies of misleading borrowers about the costs of their loans, as well as about the borrowers own credit-worthiness. As applicants sort through the barrage of advertisements from subprime lenders and mortgage brokers, they are not provided with accurate estimates of loan costs. Borrowers are frequently promised fixed rates when they are in fact being provided with adjustable rates. This practice is made more confusing by the presence of teaser starting rates, in which borrowers are not told that their rates are sure to rise considerably after the teaser rate expires. Compounding all of these problems is the fact that it is impossible for borrowers to tell if any lenders are being honest about their loan terms. Applicants for subprime loans are also frequently victimized by a variety of tactics employed by lenders to place them under substantial financial pressure to accept the loan at closing, whatever its terms, including encouraging default on previous debt.
The problem is not that borrowers on subprime loans are less sophisticated. We simply face an entirely different market. We are frequently not approaching a mortgage transaction any differently from applicants in middle- and upper-income areas. The difference is they can generally trust their bank not to rip them off with junk fees, credit insurance, or hidden prepayment penalties. People in low-income neighborhoods primarily marketed to by subprime lenders dont fare so well. When we place that same trust in their lenders or brokers, we become victims.
The pricing on subprime loans seems to be driven most often not by the credit risks of the borrowers, but by how much the lender or broker can get away with. This should come as no surprise when so many lenders pay their employees, or the brokers from whom they buy loans, large bonuses for charging higher rates and fees.
According to Freddie Macs detailed analysis of a pool of subprime loans, there was an average of 100 extra basis points on the interest rates charged that could not be accounted for when looking at the financial characteristics of the borrower. From our conversations with borrowers in subprime loans, we believe the average overcharge in the subprime market is even higher than that, as so many borrowers are convinced to pay rates unrelated to their risk. Freddie Macs analysis takes the borrowers credit scores at face value, not considering the disproportionate number of low-income people who have serious errors on their credit reports. Of the low- and moderate-income (and disproportionately minority) applicants seen by ACORN Housing Corporation loan counselors, around 40% have significant errors that unfairly lower their scores. Finally, the analysis did not look at any of the loan terms besides the interest rates; if all of the supposed higher risks are accounted for in the interest rates, any other add-ons such as prepayment penalties, which dominate much of the subprime market, become pure profit.
Subprime lenders charge origination fees many times the amounts charged by banks for providing the same service. Using borrowers understandable lack of knowledge about appropriate fee levels against them, subprime lenders frequently tack on junk fees that are unrelated to any tasks they perform. In the subprime market, discount points, which are paid by borrowers in the prime market in exchange for reduced interest rates, are often used illegitimately to produce more fees as they have little effect on loans interest rates.
Other predatory practices include:
Financing of Fees on High-Cost Loans. The financial damage caused to borrowers by excessive fees increases substantially when those fees are financed into the loan. Rather than using their monthly payments to reduce their loan principal, such borrowers are trapped into paying down their loan fees for several months or even years. The financing of fees on high-cost loans is often used by lenders to generate easy profits by stripping borrowers of the equity they have built up in their homes.
Single-Premium Credit Insurance. Credit life, disability, unemployment, and health insurance policies range from overpriced at best to a complete rip-off at worst. While we would advise borrowers to avoid all such policies, there is absolutely no justification for charging such policies as a lump-sum premium at the outset of a loan, rather than having borrowers pay them monthly like any other insurance policy. Financing credit insurance policies into home loans is another way subprime lenders strip equity from borrowers. Any credit insurance policies that are paid off monthly should also be conducted as separate transactions from home loans.
Prepayment Penalties. These penalties are used in the subprime market to trap borrowers in rates above what is appropriate for their risk by preventing them from refinancing. Prepayment penalties are profoundly anti-competitive measures which prevent the market from working for the benefit of borrowers. While only around 1% of A loans contain these penalties (in exchange for a slight reduction on standardized interest rates), industry analysts estimate that up to 70% of subprime loans contain prepayment penalties. Fannie and Freddie could perform a valuable service for future borrowers on subprime loans by pushing lenders away from their reliance on prepayment penalties.
Refinancing Without Benefit (or Loan Flipping). Loan flipping is the refinancing of home loans when the lenders only motive is to profit from fees or other charges while the borrower does not receive any benefit. We have seen cases where lenders have convinced borrowers to refinance 0% Habitat for Humanity loans into high-interest rate loans. Lenders engaged in loan flipping aggressively target homeowners who have built up substantial equity in their homes with repeated phone calls, mailings, and personal visits. The refinancings strip the equity and result in higher monthly payments, even though the only reason the borrower agreed to refinance was because they were promised lower monthly payments.
Asset-based Lending. The extension of loans based on the value of a dwelling and not on the borrowers ability to repay, also known as asset-based lending, produces huge windfalls for lenders under certain circumstances. On such loans, lenders profit from the origination fees and other charges draining whatever savings the borrower may have and then more than cover any losses due to the foreclosure process on the re-sale of the house. While the lender realizes substantial profits, the family is forced out of their home by a loan the lender knew they could never afford.
Balloon Payments. Balloon payments have a limited place in the prime market for certain borrowers with rising incomes who have already demonstrated the ability to manage credit extremely well. In the subprime market, loans with teaser rates and balloon payments are harmful for borrowers. On high-cost loans with balloon payments, borrowers often are misled into believing that their monthly payments are paying down the principal, but that is not the case as the lender hides from the borrower the true costs of the fees, interest rate, and other loan provisions through a balloon payment that the borrower does not know about or understand how it works.
Yield-Spread Premiums. These kickbacks explicitly reward mortgage brokers for jacking up interest rates, a practice which is copied by some lenders in directly rewarding employees for increasing the costs of subprime loans. The higher the interest rate, the higher the kickback. Brokers often go to great lengths to build trust in their clients but then abuse that trust by convincing them to take out loans at higher interest rates.
Mandatory Arbitration Clauses. Current federal and state laws are already heavily stacked against borrowers seeking just redress for falling victim to illegal lending practices. Apparently not satisfied with those circumstances, many lenders who also lie about loan terms push borrowers into signing mandatory arbitration clauses that prevent them from asserting any of their legal rights. Lenders should not be curtailing borrowers access to appropriate legal remedies when the lender breaks the law.
Racial Steering. Minority applicants at banks are often steered down to subprime affiliates while white applicants with similar financial situations are placed in prime loans. Few subprime affiliates, which predominantly serve minority communities, take steps to ensure that applicants with A-level credit are referred up to banks for A loans.
Other predatory practices we have seen include:
-Failing to pay off all of the debts which the borrower of a debt consolidation loan has been led to believe will be paid off
-Failing to provide borrowers with the money needed for home repairs or other purposes, which was their main reason for refinancing
-Using inflated appraisals
-Falsification of information on loan applications
Post-transaction predatory practices
Up to this point, our comments have focused on the marketing and the terms of the loans, but the follow-up should also be given careful consideration, especially as the number of foreclosures continues to steadily climb (nationally, the number of foreclosures has grown from 150,000 in 1980 to 578,000 in 1997). The following are just a few examples of abusive policies common to predatory lenders:
· Many subprime lenders do not report positive payment information to the credit bureaus as a way to keep their borrowers paying higher rates than is appropriate. These policies prevent borrowers who are paying off their loans from building up a positive credit history that could help them refinance at a lower rate that is more reflective of their credit risk.
· Other lenders or servicers take advantage of borrowers who have fallen behind in their payments to trap them into refinancing at high cost. These refinancings strip what little of the equity might remain and typically result in the borrower being forced into delinquency again within a short time period. Occasionally, lenders work with collection agencies to take advantage of families who have fallen behind on their debts and are being subjected to intense pressure about their debts by forcing them to refinance at high cost.
· The right to rescind a loan after three days is one of the more effective consumer protections currently in federal law. In the subprime industry, however, applicants are often unfairly denied that right. Sometimes, they are intentionally prevented from talking with their loan officer and told that no one else can answer their questions. At other times, they are told that they do not qualify for a right of rescission when they actually do qualify.
Stronger consumer protections are needed
A home loan is the most complex financial transaction most families will ever make, and a home is the largest purchase -- for many families it represents their entire life savings. We dont ask people to make decisions about buying medications based on reading fifty pages of disclosures; we make rules about what standards drugs need to meet in order to be sold. Home loans are something like that. Borrowers are never going to know as much as lenders, and experience shows that too many subprime lenders are taking outrageous advantage of this fact.
ACORN members believe consumers need additional protections against the abusive practices outlined above, and those protections should apply to a much broader range of loans than are currently covered under HOEPA. High cost thresholds need to be lowered, and some protections need to apply to all loans. Loopholes that reduce the effectiveness of current protections should also be removed, such as the exemptions for certain prepayment penalties and the requirement that a pattern or practice of making loans that a lender knows borrowers cannot repay must be shown for such loans to be prohibited above the thresholds. Another important component of any anti-predatory lending bill should be requiring or, at a minimum, strongly encouraging applicants on high-cost loans to seek housing counseling. Free of any financial interest, experienced loan counselors can sit down with applicants and walk them through the terms of their loans, providing much-needed advice on whether a loan is appropriate for a borrowers financial situation.
We also believe that current law, and any new law, needs to be much more vigorously enforced, especially as the growth of the subprime industry has so tremendously outpaced the resources dedicated to enforcement through HUD, the Justice Department, and the Federal Trade Commission. In addition, victims of illegal practices should have access to improved legal remedies, both to help them recover their losses and to discourage lenders and brokers from breaking the law.
When we look at the pricing on predatory loans and then we look at the extremely high foreclosure rates, it looks like two aspects of irresponsible lending are being used to balance each other out. Loans are being made without regard to peoples real ability to repay, and with pricing that reflects the highest rates and fees the lender can get away with, rather than any real evaluation of credit. So interest rates and fees are very high, even for borrowers with good credit. And foreclosure rates are also very high, because borrowers do not understand the real loan terms, and loans are being made which people cannot afford to repay. When people meet the real world of their increasing monthly payments, rather than the world of well make it all cost less that they were promised, they cannot pay. And its a vicious circle -- the higher rates charged to balance out the foreclosures lead more people to foreclosure.
Too many investors and lenders seem to think that this balance of high rates and high foreclosures is OK. In our neighborhoods, however, it is devastating. The high rates rob people, including that majority who continue to pay unfairly expensive loans, and will never be foreclosed on, of money desperately needed for other things. It is no small thing for working people to pay tens of thousands of extra dollars on a loan. And the foreclosures , obviously, do even more damage. Legislation that prevented abusive practices could help create a different balance, where responsible lending meant fewer foreclosures and lower rates.
Actions by federal banking agencies that have preempted state protections
We believe that the Office of Thrift Supervision (and other agencies) should follow through on its advanced notice of proposed rulemaking and prevent predatory practices on alternative mortgage transactions it regulates under the Alternative Mortgage Transaction Parity Act. This would present state housing creditors with the choice of abiding by the consumer protections established by OTS or by state laws. In either case, borrowers are given at least the chance for some protection against abusive lending practices.
Other Federal Initiatives
As we push for legislative reforms to reduce the number of predatory loans, the federal government should not miss the opportunity to move forward with programs that could help families avoid losing their homes or spending tens of thousands of dollars more than is appropriate on home loans. Given the billions of dollars that the federal government has invested in fostering homeownership, it only makes sense to adequately fund programs that protect the wealth that's been created.
We need an effective response to the aggressive marketing engaged in by predatory lenders. For residents of targeted communities, it is not uncommon to receive three or four pieces of mail a week with offers to refinance their homes. A national campaign to raise consumer awareness would help many families understand predatory loan terms, gain a better sense of their own credit situations, and protect their homes. It must be more than a billboard campaign and should use trusted institutions in low-income communities to get out the message about abusive lending practices and the availability of resources such as loan counseling. Such a campaign could help change the market environment.
While a broader education campaign would raise general awareness, more intensive one-on-one counseling through community based nonprofits is essential to help applicants avoid loans with predatory terms, given the complexity of mortgage contracts. Housing counseling provides a valuable alternative to, and check on, subprime lending. A loan counselor is able to explain to an applicant the details of a loan and provide quality advice, free of any financial motive, about whether the loan is appropriate for the applicants financial situation. Despite the growing need for quality counseling services, funding for HUDs housing counseling was cut last year, not increased. At the same time counseling agencies are being hailed as an important part of the solution to predatory lending, they are swamped by the current crisis and not provided with the resources necessary to mount an effective response.
Currently, HUD, FTC and the Justice Department are severely understaffed to take on the problem of regulating an industry that has grown exponentially. Because the role of enforcement is reactive, enforcement agencies are called in after a problem is identified and the damage is done. Enforcement should be proactive with regular oversight and evaluation of lenders. Increased resources are essential to accomplishing this. We recommend that a model based on the banking system where regulatory costs are paid by those being regulated. This will allow for a regulatory system that adjusts as the industry expands and shrinks, place costs directly on the source of the transaction, and increase consumer protection and stability in the market.
Secondary market -- Fannie Mae and Freddie Mac
There are two sets of issues regarding the secondary market -- one regarding the recent entrance of Fannie Mae and Freddie Mac into the market and how that relates to their affordable housing goals and the other being the role of the large Wall Street firms that are currently providing the bulk of the industrys capital. The entry of the government-sponsored entities (GSEs) into the subprime market will not translate into lower costs for borrowers unless there are strong standards on which loans they will buy and with which lenders they will do business.
While Fannies recently-announced standards move in the right direction and are much more responsive to the abusive practices in the subprime industry than Freddies standards, neither of their statements of principles have gone far enough. We fear that, without adequate controls, the only result of the GSEs entry into the subprime market will be to lower the cost of access to capital for subprime lenders. In a sector of the market where lenders compete more on marketing than on pricing and borrowers are so frequently unaware of the real costs of their loans, there is no evidence that these cost reductions will be passed on to borrowers.
The intention of the Affordable Housing Goals for the GSEs is properly to lower the costs of homeownership for low- and moderate-income families. Entry of the GSEs into the subprime market could help accomplish that goal if standards are in place to ensure that Fannie and Freddie do not provide liquidity to lenders engaged in deceptive and abusive practices. However, at this time HUD should not grant the GSEs credit toward the goals for the purchase of subprime loans. Instead, HUD should wait until the impact of Fannie and Freddies entry into the subprime market is better understood. An appropriate compromise in the interim might be to exclude subprime loans from both the numerators and the denominators in the calculations of goals performance. The one exception we would make to that compromise is that the purchase of loans with certain predatory terms should be counted negatively toward the calculation of the goals. ACORNs full comments on the GSEs affordable housing goals can be viewed in the public comment file at HUD headquarters and will soon be available on our web site at www.acorn.org.
Secondary Market -- Wall Street
On Wall Street, too many of the same institutions which ignore our neighborhoods when its comes to good loans and standard products are targeting these same neighborhoods with high cost, high fee products, either through their direct ownership of predatory mortgage companies or from bankrolling these predators by securitizing their mortgages and selling them to investors.
Wall Street investment banks are not just passive financiers of abusive lending practices. In their eagerness to enjoy the large profit margins offered by subprime loans, they fueled the enormous growth of the industry. Securitization is the primary funding source for subprime loans. In addition, brokerage firms often dictate some of the troubling terms and conditions of subprime loans. Extended prepayment penalties lock borrowers in expensive loans, preventing them from escape when variable rates rise, when they discover the real terms of a loan they were lied to about, or simply as their financial situation improves. But investors love them, because they ensure that people keep paying on the loans they have bought, and keep paying even as their interest rates rise.
The needs of investors are also reflected in the rush to foreclose which many subprime lenders display. Fitch Investors Service recommends that when a borrower is behind on their loan, the servicer should determine whether a workout option is appropriate or whether a quick foreclosure is in the investors best interest. And Fitch also suggests that even if a workout is selected, the servicer should continue with the foreclosure process in case the workout plan fails. In discussing loan servicing, Moodys Investor Services notes that good default managers which specialize in subprime loans can complete foreclosures about one month faster than a mainstream servicer. In our experience, most subprime borrowers get very little opportunity for a decent work out; instead they see swift foreclosure, or "rescue" offers from the same or other lenders which provide the lenders another round of fees but often leave borrowers back in exactly the same place just a short time later.
The role that Wall Street has played in the rapid growth of subprime lending underlines the need for Community Reinvestment Act responsibilities and enforcement to keep pace with the changing nature of the financial services industry, and for meaningful community reinvestment standards to apply to all sectors of the industry.
Thank you for your consideration, and we look forward to working more closely with you on this critical issue to our neighborhoods.