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Recommendations

NCRC offers the following recommendations.

Programmatic Partnerships

Banks, community organizations, and public agencies should work together to establish programs for refinancing ARM high-cost loans into lower-cost fixed-rate loans. Counseling organizations can identify borrowers who were steered into high-cost loans when they qualified for lower-cost loans. In addition, counseling organizations and lending institutions must identify borrowers who are having difficulties paying ARM high-cost loans with rates that are adjusting upward. Agencies and Federal Home Loan Banks can provide grants and low-interest- rate loans, when necessary, to assist borrowers with temporary cash shortfalls. In 2007, the federal banking agencies issued a statement encouraging banks to engage in these activities. The statement reiterated that banks can earn points on their Community Reinvestment Act (CRA) examinations when engaging in loan modifications and refinancing borrowers into lower-cost loans (Federal Reserve Board 2007).

Table 8.2. Loan Abuses Summarized

Abuses

Description

Asset-based lending

Lenders evaluate a loan application by looking only at the quality of the security or equity, and not at the ability of the borrower to repay the loan

Forced placed insurance

Servicer assigns hazard insurance to borrower; coverage is usually much more expensive

HOEPA loan

A loan with a very high interest rate and/or fees that is covered by federal consumer protections. Predators violate the legal protections of HOEPA loans.

Mandatory arbitration

Stipulation that a borrower cannot sue a lender in a court of law but must use an arbiter

Prepaid credit insurance

Insurance financed into the loan that would cover mortgage payments in a case of disability, unemployment, death. Much more expensive than paying monthly outside of loan

Abuse of right to cancel

Abusive practices that make it hard for a consumer to cancel a mortgage (i.e., abusing right of rescission)

Abusive collection practices

Aggressive tactics of collecting late payments

Default interest rate

Increasing interest rate in case of delinquency

Excessive prepayment penalty

Excessive fee for paying off a mortgage before its maturity

Insincere co-signers

Adding insincere co-signers to the application in order to inflate the income of the borrowers. Abusive lenders will add children and other insincere co-signers who cannot contribute to loan payments.

Loans made in excess of 100% LTV

When the loan amount exceeds the fair market value of the home

Negative amortization

Loan product that requires a monthly payment that does not fully amortize a mortgage loan, thereby increasing the loan's principal balance

Flipping

Persuading a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced

Fraud

Example: forging signatures on loan documents

Lack of Tangible net benefits

Lack of TNBs that justify the origination of a new, higher-balance and high-cost loan

Targeting/discrimination

Cases when lenders specifically market predatory loans to customers on basis of race, ethnicity, or age

Predatory appraisal

Overestimating the market value of the house

Balloon payment

A mortgage that has level monthly payments over a stated term but provides for a large lumpsum payment due at the end of a previously specified term

Equity stripping

A case when a homeowner's equity is reduced due to repeatedly refinancing, high fees, and other abuses

Home-improvement scam

Home-improvement costs financed into the mortgage usually paid by a lender to a home- improvement contractor directly

Misrepresentation

Misrepresentation of loan terms to a borrower

Falsified application

Falsifying loan applications (particularly income level or adding insincere co-signers, etc.)

Stated income

Not requiring full documentation of income from tax forms and paystubs. Reduced documentation or stated income loans increase the chances of fraud.

Yield spread premium

Fee paid by lenders to brokers for loans carrying interest rates above a par rate

Abusive servicing practices

Servicers not recording payments, forcing placed insurance, applying high late fees, etc.

Unfair terms

High interest rates and loan terms not justifiable by risk (consumer's credit score)

Fee packing

Charging undisclosed, improper, and high fees

Table 8.3. CRF Predatory Loan Study Rsults

CRF Cases

Unaffordable Loans

Debt-to-Income Ratios

Front-End Ratio

Back-End Ratio

Average

40.77%

50.28%

Median

35.43%

49.78%

National Foreclosure Prevention

NCRC urges policymakers to adopt a foreclosure prevention bill that provides funding for foreclosure prevention counseling. In the spring of 2007, Senators Charles Schumer (NY) and Jack Reed (RI) introduced foreclosure prevention bills worthy of swift congressional passage.

Senator Schumer proposed that Congress appropriate $300 million to provide funding through HUD to nonprofit counseling agencies to engage in foreclosure prevention counseling. A foreclosure can impose societal costs of $80,000 in contrast to foreclosure prevention counseling, which costs about $1,000 per assisted borrower (Joint Economic Committee 2007). The senator's approach is cost effective and promises to prevent financial and emotional stress inflicted upon families losing their homes.

Senator Reed introduced a similar bill, S. 1386 – the Homeownership Protection and Enforcement (HOPE) Act – that would provide $610 million for nonprofit counseling agencies and state agencies to provide forbearance and loan modification services to distressed borrowers. Servicers (entities that handle loan payments on behalf of the companies owning the loans) are required to make reasonable loan mitigation efforts before foreclosing on loans.

Comprehensive Antipredatory Lending Legislation

Since our analysis revealed a disproportionate amount of high-cost lending targeted to vulnerable borrowers and communities, Congress must respond by enacting comprehensive antipredatory lending legislation along the lines of bills introduced by Representatives Watt, Miller, and Frank and Senator Schumer. Comprehensive and strong antipredatory lending legislation would eliminate the profitability of exploitative practices by making them illegal. It could also reduce the amount of price discrimination, since fee packing and other abusive practices would be prohibited. A comprehensive antipredatory law would also strengthen CRA if regulatory agencies severely penalized lenders through failing CRA ratings when the lenders violate antipredatory law.

Senator Schumer has recently introduced S. 1299, or the Borrower's Protection Act of 2007, that would require lenders to assess a borrower's ability to pay a loan at the maximum possible rate during the first seven years of the loan. This procedure eliminates the dangerous practice of qualifying a borrower based on a low “teaser” rate in place during the first two or three years of the loan. The bill would also prohibit steering or price discrimination by making it illegal, based on the loan terms for which borrowers qualify, for lenders to refer borrowers to loans that are not reasonably advantageous for them.

Fair Lending Enforcement Must Be Increased

In 2005, FRB stated that it referred about 200 lending institutions to their primary federal regulatory agency for further investigations based on the FRB's identification of significant pricing disparities in HMDA data (Avery, Canner, and Cook 2005). An industry publication subsequently quoted an FRB official as stating that these lenders accounted for almost 50 percent of the HMDA-reportable loans issued in 2004 (Inside Regulatory Strategies 2005). In 2006, FRB referred a larger number of lenders, 270, to their primary regulatory agency for further investigations (Adler 2006).

After the initial excitement, the public has not heard about the outcomes of FRB referrals. Not a single case of discrimination or civil rights violations has arisen from the FRB referrals. Given the large share of lending represented by the financial institutions under investigation, the public should receive an update on the status of these fair lending investigations from all the regulatory agencies. In addition, agencies should annually report to Congress how many fair lending investigations they conducted, the types of fair lending investigations, and the outcomes of these investigations. Since the pricing disparities remain stubborn and persistent, fair lending investigations and enforcement must be intensified, yet the public has received little word regarding the actions of regulatory agencies.

Enhance the Quality of HMDA Data

NCRC believes that Congress and the FRB (which implements the HMDA regulations) must enhance HMDA data so that regular and comprehensive studies can scrutinize fairness in lending. Specifically, are minorities, the elderly, women, and LMI borrowers and communities able to receive loans that are fairly priced? More information on HMDA data is critical to explore the intersection of price, race, gender, and income.

The first area in which HMDA data must be enhanced is pricing information for all loans, not just high-cost loans. The interest rate movements in 2005 demonstrate the confusion associated with classifying the loans that currently have price information reported. Economists as well as the general public do not know whether to call the loans with price reporting “subprime," "high-cost,” or some other name. If price was reported for all loans, the classification problems would be lessened. All stakeholders could review the number and percentages of loans in all the price spread categories. The most significant areas of pricing disparities could be identified with more precision.

HMDA data must contain credit scores. For each HMDA reportable loan, a financial institution must indicate whether it used a credit score system and if the system was its own or one of the widely used systems such as FICO (a new data field in HMDA could contain three to five categories with the names of widely used systems). HMDA data also would contain one more field indicating the quintile of risk in which the credit score system placed the borrower.

Another option is to attach credit score information in the form of quintiles to each census tract in the nation. That way, enhanced analyses can be done on a census tract level to see if pricing disparities still remain after controlling for creditworthiness. This was the approach adopted in NCRC's “Broken Credit System" and in studies conducted by FRB economists. Finally, HMDA data must contain information on other key underwriting variables, including the loan-to-value and debt-to-income ratios. Finally, Senator Reed's bill, S. 1386, would create a database on foreclosures and delinquencies that would be linked with HMDA. This important data enhancement would help policymakers understand which loan terms and conditions (such as loan-to-value ratios and fixed or ARM) are more likely to be associated with delinquencies and foreclosures.

Federal Reserve Board Must Step Up Antidiscrimination and Fair Lending Oversight

The Government Accountability Office (GAO) concluded that the FRB has the authority to conduct fair lending reviews of affiliates of bank holding companies. The FRB at first insisted that it lacked this authority but now examines affiliates (GAO 1999). The FRB should clarify how and to what extent it is examining affiliates because comprehensive antidiscrimination examinations of all parts of bank holding companies are critical. Most of the major banks have acquired large subprime lenders that are then considered affiliates. A pressing question is the extent to which the subprime affiliates refer creditworthy customers to the prime parts of the bank so that the customers receive loans at prevailing rates instead of higher subprime rates. Or does the subprime affiliate steer creditworthy borrowers to high-cost loans? These questions remain largely unanswered. Consequently, we do not know the extent of steering by subprime affiliates and/or their parent banks.

Apply CRA to Minority Neighborhoods and All Geographical Areas Lenders Serve

In order to increase prime lending for minority borrowers and reduce lending disparities, CRA examinations must evaluate the banks' records of lending to minority borrowers and neighborhoods as well as scrutinize banks' performance in reaching LMI borrowers and neighborhoods. If CRA examinations covered minority neighborhoods, pricing disparities in these neighborhoods would be reduced. The FRB, in its review of 2004 HMDA data, found that bank lending exhibited fewer disparities in geographical areas covered by their CRA examinations than in areas not covered by them (Avery, Canner, and Cook 2005). CRAs mandate of affirmatively meeting credit needs is currently incomplete because it is now applied only to LMI neighborhoods, not to minority communities.

CRA must also be strengthened so that depository institutions undergo CRA examinations in all geographical areas in which they make a significant number of loans. Currently, CRA examinations assess lending primarily in geographical areas in which banks have their branches. But the overlap between branching and lending is eroding with each passing year as lending via brokers and correspondents continues to increase. NCRC endorses HR 1289, or the CRA Modernization Act of 2007. HR 1289 mandates that banks undergo CRA examinations in geographical areas in which their market share of loans exceeds one-half of one percent in addition to areas in which their branches are located.

CRA Must Be Expanded to Nonbank Lending Institutions

Large credit unions and independent mortgage companies do not abide by CRA requirements. NCRC and GAO research concludes that large credit unions lag CRA-covered banks in their lending and service to minorities and LMI borrowers and communities (NCRC 2005; GAO 2006). Unlike their counterparts, credit unions in Massachusetts are covered by a state CRA law. NCRC has also found that CRA-covered credit unions in Massachusetts issue a higher percentage of their loans to LMI and minority borrowers and communities than do credit unions not covered by CRA. Therefore, NCRC believes that applying CRA to both large credit unions and independent mortgage companies will increase their market-rate lending to LMI and minority borrowers.

CRA Examinations Must Scrutinize Subprime Lending More Rigorously

Currently, CRA examinations do not adequately assess the CRA performance of subprime lenders. For example, the CRA examination of the subprime lender Superior Bank, FSB, called its lending innovative and flexible before that thrift's spectacular collapse (Office of Thrift Supervision 1999). Previous NCRC comment letters to the regulators have documented cursory fair lending reviews for the great majority of banks and thrifts involved in subprime lending (NCRC 2004). If CRA examinations continue to mechanistically consider subprime lending, subprime lenders will earn good ratings, since they usually offer a larger portion of their loans to LMI borrowers and communities than do prime lenders.

Regulatory agencies have amended CRA to penalize banks if their lending violates antipredatory law. NCRC has not seen rigorous action to implement this amended regulation. Fair lending reviews that accompany CRA examinations do not usually scrutinize subprime lending for compliance with antipredatory law, for possible pricing discrimination, or for whether abusive loans are exceeding borrower ability to repay. All CRA examinations of subprime lenders must be accompanied by a comprehensive fair lending and antipredatory lending audit. In addition, CRA examinations must ensure that prime lenders are not financing predatory lending through their secondary market activity or servicing abusive loans.

GSEs Must Abide by Antipredatory Safeguards

The government-sponsored enterprises (GSEs), including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, purchase more than half of the home loans made annually in this country. It is vitally important, therefore, that the GSEs have adopted adequate protections against purchasing predatory loans. Fannie Mae and Freddie Mac have voluntarily adopted significant protections such as purchasing no loans with fees exceeding 5 percent of the loan amount, no loans involving price discrimination or steering, no loans with prepayment penalties beyond three years, and no loans with mandatory arbitration. HUD has ruled that Fannie Mae and Freddie Mac will not receive credit toward their Affordable Housing Goals for any loans that contain certain abusive features.

HUD's ruling is an important first step, but it needs to be enhanced. HUD's ruling, for example, does not include disqualification from goals consideration of loans with mandatory arbitration. The Federal Housing Finance Board, as the regulator for the Federal Home Loan Banks, has not formally applied protections against abusive loans to the Home Loan Banks. Congress has an opportunity to further bolster the antipredatory protections applied to GSE loan-purchasing activity as Congress considers GSE regulatory reform.

 
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