Predatory mortgage lending involves a wide array of abusive and unethical practices. Here, the “Center for Responsible Lending” (“CRL”) boils it down to eight (8) of the most common signs of a bad home loan.
Your best defense? Shopping. Before accepting a mortgage, it is always a good idea to talk to several lenders to make sure you understand the most competitive options available to you, and be on the lookout for predatory signs. If you encounter any one of the “red flags” described below, say NO and look for a better deal.
• Excessive fees
• Prepayment penalties
• Inflated interest rates from brokers (yield-spread premiums)
• Steering and targeting
• Adjustable interest rates that “explode”
• Promises to fix problems with “future refinancings”
• Not counting taxes and insurance in a monthly payment
• Repeated refinancings that drain your resources
EXCESSIVE FEES
When buying a home or refinancing, you should shop based on interest rate, of course, and you should also make sure you understand all the other costs of the mortgage. “Points” or “discount points” are the lender’s fee for making the loan. On a competitive loan, you will be charged one point, or one percent of the loan amount. You also can expect additional fees, which may include payment to a broker and charges for such necessities as an appraisal and title insurance. High points and fees are the hallmark of a predatory loan. It’s worth your time to get your credit score in advance and research typical fees in your area.
PREPAYMENT PENALTIES
A prepayment penalty—most common on subprime mortgages—means that you will have to pay a steep fee before refinancing. A prepayment penalty can become a trap that locks you into an expensive mortgage even when you could qualify for a more affordable loan. The penalty is typically effective for two or three years and costs more than six months’ interest. Before agreeing to a mortgage, make sure it does not come with a prepayment penalty. If it does, refuse the loan and find a better deal.
INFLATED INTEREST RATES FROM BROKERS (YIELD SPREAD PREMIUMS)
Mortgage brokers receive frequent updates on what kinds of loans lenders are offering and at what price. Watch out for brokers who try to sell you a loan with an inflated interest rate—i.e., higher than the rate acceptable to the lender. Be aware that brokers have plenty of incentive to increase interest rates unnecessarily, since lenders often reward them by paying a “yield spread premium.” This compensation is essentially a kickback for making the loan more costly than necessary. To make sure your transaction doesn’t include a yield spread premium, ask for a good faith estimate in advance, and make sure you understand all items that represent compensation to the broker.
STEERING AND TARGETING
Predatory lenders may try to steer you into a more expensive loan, such as a subprime mortgage, even when you could qualify for a mainstream loan. If you are a senior citizen or a minority, be on the lookout for predatory lenders who target vulnerable groups. Fannie Mae has estimated that up to half of borrowers with subprime mortgages could have qualified for loans with better terms. Remember that you don’t need to give in to aggressive sales tactics. Don’t respond to ads that say bad credit doesn’t matter, and be especially wary of lenders or brokers who contact you or those who try to rush you into decisions. An ethical lender will answer your questions and encourage you to make an informed decision based on your own best interests.
ADJUSTABLE INTEREST RATES THAT “EXPLODE”
During the height of the reckless boom in subprime lending, the most common type of subprime mortgage was an “exploding ARM”—a home loan with an adjustable interest rate that can increase sharply after a short time, usually two or three years. If you are a person of modest income, this type of loan is not appropriate for you. Beware of adjustable-rate loans that can rise significantly, especially if the interest rate can never go down. Make sure you understand the worst-case scenario before agreeing to this type of loan. And don’t count on a future refinance to get out of trouble in the future (see next item
PROMISES TO FIX PROBLEMS WITH FUTURE REFINANCING
Predatory lenders are notorious for selling bad deals by promising that they will refinance the loan within a short time, or if it becomes unmanageable for you. It is important to remember that the lender is not bound by that promise, and it is best to refuse a loan if it stretches you too much financially, now or in the foreseeable future. Also, avoid any mortgage that comes with a “balloon” payment, meaning that you will be obligated to pay the loan in full after a relatively short period of time.
NOT COUNTING TAXES AND INSURANCE IN A MONTHLY PAYMENT
Home buyers should find out up front whether their monthly mortgage payment will include the costs of property taxes and insurance (i.e., whether the lender has established an escrow account for these costs). If not, the homeowner will be responsible for paying these costs separately, usually in a lump sum each year. Unscrupulous lenders make monthly payments seem artificially low by excluding taxes and insurance, and many families have been pushed into foreclosure because they couldn’t afford to pay these costs.
REPEATED REFINANCINGS THAT DRAIN THE BORROWER’S RESOURCES (LOAN FLIPPING)
Beware of lenders who aggressively approach you to refinance your home loan. They may try to entice you with cash, but these loans typically increase the amount you owe on your home and can also increase your monthly payment. It is important to consider all that you are likely to lose valuable equity that you have already acquired on your home—equity that could help send a child to college or fund retirement. Flipping can quickly drain borrower equity and increase monthly payments—sometimes on homes that had previously been owned free of debt. In too many cases, predatory lenders have refinanced families repeatedly until there is nothing left and the family is forced into foreclosure.
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