A mortgage transaction is a complex process that contains a lot of industry lingo and the transfer of large sums of money. Needless to say, getting a home loan can be a scary process, regardless of whether or not a person has done it before. However, first time home buyers have it particularly rough since they mostly have no idea what to expect. Plus, in many cases, they don’t have enough knowledge to know all of what the lenders, real estate agents, and lawyers are talking about.
Still, even a repeat home buyer can find themselves in over their heads with the whole process, particularly when getting into the nitty-gritty of a whole new loan program or product with terms unlike any they have had in the past. It’s almost as if the whole process was designed to be as confusing as possible to those who don't actually work in home finance. To make matters worse, there are some truly dishonest people in the industry. And, unfortunately, many of them intentionally exploit borrowers’ confusion and lack of industry knowledge in order to trick them into loan agreements that only benefit brokers and lenders.
This underhanded behavior is known as predatory lending and, sadly, it happens a lot more than anyone would like to admit. Any type of loan can be susceptible to predatory lending practices, but it can be extremely detrimental when it involves mortgages, since this is generally the largest investment that the average person makes in their lifetime. Predatory mortgage lending can lead a borrower to foreclosure or bankruptcy before they even have a chance to remedy the situation.
At home.loans, we strive to educate and empower home buyers and homeowners alike in hopes that they will know how to avoid any lenders or loans that are predatory in nature. While there are laws in place to help keep that predatory lending under wraps, the first line of defense is always knowledge and awareness. That’s why borrowers should try to learn all there is to know about predatory lending and how to avoid it.
What is Predatory Lending?
Predatory lending is any lending act that leads a borrower into a loan agreement with unfair or abusive terms. Lending is considered predatory when a borrower is convinced to accept these unfair terms by exploitative, deceptive, coercive, or even unscrupulous means. Often times, the loan that the borrower agrees to is one that they do not need or want, or simply cannot afford.
Predatory lending, in general, is lending that solely benefits the lender. It typically overlooks or even obstructs a borrower's ability to repay the debt, in favor of terms that put more money in the hands of the lender. Sadly, predatory lending is typically carried out by taking advantage of a borrower's ignorance of mortgage loans, industry terms, and financial practices.
Due to the nature of predatory lending, targets are typically those in more desperate or less fortunate positions, followed closely by the elderly and the uneducated. Another set of targets for predatory lenders are those with bad credit, large debts, or a recent loss of income. It’s easier to entice a borrower into a predatory deal when they have been denied financial help everywhere else.
A mortgage loan is any predatory lender’s dream, as there are simply so many ways to profit from the transaction. Not only can costs be stretched and monthly payments overburdened, but the loan utilizes real property as collateral, which can later be sold after an almost unavoidable foreclosure. Unfortunately, these loans can be setup to all but guarantee that a borrower defaults at some point during the loan term.
How Predatory Lending Works
The most important thing that borrowers should be aware of is that not all predatory lending practices are illegal. That may come as a shock, since predatory lending has the power to ruin lives, have borrowers shackled to unimaginable debt obligations, completely destroy a person’s credit, or even leave them homeless. The thing is, predatory lending wouldn’t be as big of a problem if many parts of the act were downright illegal. In reality, much of the danger is created by stretching and bending interpretations of what is already legal.
Predatory Lending Practices
There is no set list of what constitutes a predatory lending practice, as the practices are more or less under dispute all of the time. Still, certain actions taken by lenders are nothing other than predatory, and whether illegal or not, do not benefit the borrower in any way. Interestingly enough, a lot of these practices are utilized in conjunction with one another, in order to create an environment that promotes financial hardship, and strengthens debt and the possibility of default.
Such practices include (but are not limited to):
False or Inadequate Disclosure
This is arguably the most common predatory lending practice. Straying from the best practices described in the Truth in Lending Act and the Real Estate Settlement Procedures Act, predatory lenders may misrepresent costs and risks, or simply neglect to disclose them at all. In some cases, the lender may even alter terms, costs or risks after already disclosing the details of the loan to the borrower, effectively having them agree to an entirely different loan than what was initially offered.
It’s a simple, yet dishonest way for lenders to ensure that the loan terms are stacked in their favor. In some cases, it is as simple as lenders only reporting monthly mortgage payments based on principal and interest, without disclosing the costs of taxes and insurance, which the borrower is still responsible for paying. This lures borrowers into the belief that they will have a super low monthly mortgage payment when in reality, the actual amount due each month is likely hundreds of dollars more.
Loan Packing
Much like the acts of fraud committed by certain stockbrokers, loan packing is when unnecessary and even made-up charges are added into the cost of the loan. A popular loan packing technique is the addition of an item such as “credit insurance” into the loan agreement, which sounds important, but in reality is a nearly made up fee that is almost never delivered on. The borrower ends up paying more each month for every little extra charge that is packed into the loan, greatly exaggerating the monthly mortgage payment.
Junk Fees
Junk fees are tricky. Like loan packing, junk fees include made up or unjustly inflated fees due at closing and bundled into a loan’s closing costs. Even when clearly disclosed, sometimes it’s hard for a borrower to discern between the actual fees or costs of fees and the junk fees or inflated costs that are slipped into the disclosure. Many times, even some of the best loan agreements have junk fees added to the closing costs. These fees are even sometimes added by lenders specifically so that when borrowers try to negotiate the closing costs down, they are only subtracting some of the junk fees and still paying costs higher than they actually should be.
Risk-based Pricing
This is one of those practices that really isn’t illegal, but can be abused heavily. With risk-based pricing, lenders take into account a borrower’s current financial situation and credit history and charge accordingly. Technically, most loans utilize this practice in some form or another, as a sort of safety net to protect themselves against high-risk borrowers.
It becomes predatory when lenders abuse this practice by heavily inflating interest rates and fees to amounts well beyond what reputable lenders would charge. To take it a step further, these lenders may even try to guilt or shame borrowers into accepting the payment of these fees by stressing how poor their financial situation truly is, and how they may be the only lender willing to loan them any money in the first place.
Loan Flipping
Loan flipping occurs when a borrower is coerced into refinancing their existing loan into a larger loan, with greater fees and/or a higher interest rate. Lenders can be excessively pushy or adamant about refinancing a loan, even going as far as to say that a borrower will need to do so in order to avoid foreclosure when in reality it is only to land a larger loan at a higher cost to the borrower.
Loan Cycling
Loan cycling, as we call it here at home.loans, is not too far off from loan flipping. With loan cycling, lenders will continuously seek out a borrower and convince them to refinance in order to trap the borrower’s business, and simultaneously reap all of the costs and fees of multiple closings. The most common way that lenders pull this off is through the use of adjustable rate mortgage products, where they promise low introductory rates during the initial period, but warn against much higher rates when the interest rate adjusts. They then bank on the borrower’s desire to refinance before the adjustable period sets in, and refinance the loan with another adjustable rate mortgage, in order to keep the cycle going.
Asset Based Lending or “Equity Stripping”
Lenders who try to convince borrowers into taking out larger loans based solely off of the equity that they have available are sometimes practicing a predatory technique. Many home buyers utilize the equity they have accrued to take out loans. However, when a lender seems to only care about the equity as collateral, and not the borrower’s actual ability to repay the debt obligation, it’s more of an unsavory practice than anything else. In the worst case scenario, borrowers can’t actually afford the loan that they take out, and since their home equity is what ‘s used as collateral for the loan, they are now at risk of losing their home.
Negative Amortization / Balloon Mortgages
While it isn’t inherently predatory, lenders can definitely abuse negatively amortized loan structures, and cause some serious financial hardships. With negatively amortized loans, monthly payments are greatly reduced by removing a portion of the payment that is supposed to cover the interest due on the loan amount. Borrowers get lower monthly payments, sure, but all of the interest that is not being paid adds up over time and is added into the principal amount due, causing borrowers to owe a lot more than they bargained for at the end of the loan term.
The result is usually a balloon mortgage payment, which is oftentimes a large sum of money, ranging in the thousands (or sometimes tens of thousands), that’s due at the end of a loan term. Borrowers are almost always expected to pay that sum in full, regardless of their financial position, or risk defaulting on the loan or going into foreclosure. Balloon payments are sometimes utilized in loan cycling as a threat to coerce borrowers into refinancing.
Prepayment Penalties
Prepayment penalties are a point of debate among many in the industry. While some believe they’re predatory, others believe they are absolutely necessary. A prepayment penalty is a fee charged for paying off a debt obligation before the agreed-upon payment date on the loan agreement. In theory, prepayment penalties are meant to protect lenders from losing out on collecting the interest that they would have received if the loan was paid over the course of the loan term. Still, many would argue that a borrower should not be punished for paying back a debt.
Either way, these penalties do exist, and in many cases, they’re not actually imposed in a predatory manner. They only become truly predatory when lenders hide these fees from borrowers or impose prepayment penalties with no expiration date or of ridiculously high costs. Most of the time they are used to scare borrowers away from refinancing the mortgage.
Subprime Lending
Subprime lending is more bittersweet than anything else on this list. You see, some borrowers turn to subprime mortgage loans when they cannot qualify for conventional financing. Subprime loans are high-interest loans originated for borrowers with poor credit. The idea is that the borrower, in order to be approved for the loan, must be responsible for paying the higher than average interest as a security to the lender.
This generally isn’t a good idea, since credit history is more or less a reflection of a borrower's ability to repay debts. These loans can be extremely predatory because the lender knows that the borrower may not be able to afford the loan or repay it, yet still originates the loan, and at a higher price than a borrower with better credit would be expected to pay. Subprime lending is considered by many to be the cause of the housing crisis back in the early 2000s.
Mandatory Arbitration
Mandatory arbitration occurs when contracts use legal wording to prevent borrowers from pursuing legal action against the lender for any misinterpretations or even fraud. It’s all too common for lesser-known mortgage companies to free themselves from any legal responsibilities with these unconscionable contracts and clauses. This allows them to push any legal disputes that may arise from a borrower catching them on any of their predatory lending tactics into a mandatory arbitration, which occurs outside of a courtroom. In arbitration, the borrower has almost no ground to stand on, and the ball is definitely in the lender’s court. In fact, many arbitrators are actually paid by lenders themselves, which makes the arbitration process incredibly unfair.
How to Protect Yourself Against Predatory Lending
With many more predatory lending practices in existence (and some being created as you read this), simply knowing what these lenders can do isn’t enough. Now more than ever, borrowers need to be aware of how they can avoid falling into financial hardship because of dishonest lending. The absolute best way to defend against predatory lending (and in some cases the only way) is to learn how to avoid it altogether.
Borrowers who take a more cautious approach, and have an idea of what to look out for, stand a much better chance of avoiding predatory lending tactics and the financial hardships that come with them. Of course, learning all there is to know about the mortgage process and home loans, in general, is already a huge step forward, and part of the reason that home.loans exists in the first place. Still, there are always signs of predatory lending that borrower can look out for, and may even be able to report to a higher authority when found.
Signs of Predatory Lending
Here are a few things a borrower might notice when dealing with a predatory mortgage lender or predatory mortgage loan:
A Deal That’s Too Good to be True
When it comes to borrowing large sums of money, a general rule to live by is that if it sounds too good to be true, it probably is. Loans are advertised very competitively, but even so, borrowers should be able to distinguish between what’s realistic and what’s unrealistic. Some brokers can make any deal sound sweet, but it’s important to remember that lenders are not simply going to just give away money for next to nothing.
There’s always a catch to a loan agreement, and there’s always a risk. Loans offered with no credit checks or to borrowers with poor credit typically come with high fees or extreme interest rates. Loans that require zero down often come with insurance fees added to the monthly mortgage payments. Super cheap monthly mortgage payments may mean a large balloon payment at the end of the loan term. Borrowers should always be looking for the catch.
No Concern for Credit History
While applying for a loan, many borrowers would jump at the opportunity to be approved for a loan without the invasive credit check, but should they? The answer, sadly, is no, they really shouldn’t. Lenders check credit as a means of determining the borrower's ability to repay the debt.
A quick peek into a borrower's financial history helps a lender asses just how much a borrower can afford. They do it to protect themselves, sure. But at the end of the day, this also helps out the borrower, who avoids biting off more than they thought they could chew. Lenders who show no interest in a borrower’s credit history clearly are not interested in whether or not the borrower is able to afford the loan.
Instead, they charge insane upfront fees and crazy interest rates, in order to get a quick pay off and lead the borrower into foreclosure, where they then get to sell the property. This kind of lending banks on a borrower’s desperation to get a loan, and has done more harm to borrowers than it has ever done any good.
Mandatory Electronic Payments
While it’s generally a newer issue, technology has been utilized for predatory lending tactics more than ever in recent years. Lenders who demand payment in an online-only method should not be trusted without being thoroughly vetted. No lender should make access to a borrower’s bank account a requirement. While automatic bill pay may seem like the best thing since sliced bread, it can give a predatory lender unrestricted access to a borrower’s bank account, and allow them to draw money as they deem appropriate, leaving the borrower to pay the overdraft fees.
Unlicensed Lenders
The absolute first thing that a borrower should do when looking for a mortgage loan is to make sure that any lender they come across is licensed. It’s all too easy for loan offers to be advertised in the mail, on flyers, over the phone, or in pop-ups and have borrowers think that they legitimate. Truly reputable lenders do not advertise by any of these methods and for good reason. Unfortunately, people who need loans the most typically have an idea of where to go looking for one.
Being Rushed
Any lender who seems to be in a hurry to close a loan agreement should be heavily scrutinized. A mortgage is an incredibly large and important investment. Reputable lenders, by that same logic, know to treat it as such. No one likes to get the used car salesman treatment of being given very little time to think and practically having the contract shoved down their throat.
A lender in a hurry is almost always bad news. These predatory lenders do not want you to take your time and read the contracts and paperwork because they know you will probably find the predatory tactics they are trying so desperately to accomplish. Borrowers should always be granted the time to go over every line of paperwork before signing anything, and are urged to even get them looked at by a lawyer or another professional of the industry.
High fees and High Interest
Borrowers are not barred from shopping around or at least doing their own research on current interest rates. If you notice that a lender’s rates seem much higher than what you’ve seen elsewhere, don’t hesitate to question them, and definitely do not agree to pay any of them. A predatory lender will do whatever it takes to get borrowers to agree to pay rates and fees that they know they cannot afford. Borrowers should know what is out there and go to multiple sources to get an idea of more or less what rates and fees actually make sense.
Unreasonable Prepayment Penalties
If a lender imposes a large prepayment penalty fee that makes it difficult to pay off a loan early, that’s a huge red flag. Loans were meant to be repaid, and while some prepayment penalties are minuscule, predatory lenders are known to overcharge in this area. The idea is that a higher fee will stop a borrower from attempting to get out of the loan agreement by refinancing, effectively trapping them into a terrible financial situation.
Blank Spaces in Documents
Borrowers must be wary of any documentation that is not filled out in its entirety, particularly those areas that are meant to display costs and fees. One of the oldest tricks in the book is to have a borrower sign documentation before adding in these hidden costs and fees, locking them in a contract with terms they did not originally agree to. All documentation should be thoroughly vetted, and there should be no blank areas in any portion of the contract. Additionally, copies should be made and distributed to all parties involved to be kept as a record of the transaction and what exactly was agreed to.
Limited Disclosure
The TILA-RESPA integrated disclosure forms are meant to give a borrower an accurate look at the total cost of the loan before entering the loan agreement. It’s required by law for a lender to disclose all costs and fees between the two disclosure forms. Some predatory lenders do not display all fees on the paperwork, yet mention them in discussion, or simply omit them altogether. Pay close attention to the discussions about the cost of the loan, and make sure all areas of costs are documented on the disclosure forms, with no empty areas. Even fees you are not required to pay should still be listed, with a charge of $0.
Adjustable Rate Mortgage Baiting
While potentially a great mortgage option for certain borrowers, ARMs can be used for predatory purposes. Lenders can utilize the uncertainty behind adjustable rate mortgages to their advantages by leaving out interest rate caps that stop the interest rate from “exploding” on the first adjustment, or making it so that the rate can never get lower, only keep rising. They can also be used as a means of creating a loan cycling situation where they entice borrowers to refinance to a new adjustable rate loan before the interest rate is to be adjusted.
How to get out of a Predatory Mortgage Agreement
Some borrowers do not realize that they are trapped in a predatory agreement until it’s far too late. While it may seem like hope is lost, there may still be time to act and avoid the financial hardships that typically accompany predatory lending. It all starts with a careful review of all of the loan documentation.
The first thing a borrower should do when they suspect that they have entered into a predatory loan agreement is to scrutinize all of the loan documentation and disclosures for any discrepancies. Predatory practices are typically disguised as legal practices but still, a borrower may be able to find something to help them prove any dishonesty in the agreement, so it never hurts to take a look. Rates that change from what was agreed on, more than 3 discount points charged, and only increasing interest on an ARM are a few that might stand out as possible predatory tactics.
Enact Your Right of Rescission
The Truth in Lending Act (TILA) gives borrowers up to three days after signing a mortgage refinance, home equity loan, or home equity line of credit contract to enact what is known as their “right of rescission” (depending on the loan). This allows borrowers to cancel the loan agreement after signing the paperwork. In some cases of predatory lending, lenders intentionally neglect to inform borrowers of their right of rescission, as they are typically required to do as stated in the disclosure requirements outlined in the TILA.
The good news is that if a lender does not inform borrowers of their right of rescission, then the contract is not legally binding. This is also true if they do inform the borrower with a notice that contains errors. Mortgage loans that close where borrowers are not notified of their right of rescission typically have a three year period in which borrowers are allowed to rescind the loan agreement. Without proper notification of rescission rights, a borrower can legally walk away from a predatory mortgage loan, and may even be entitled to collect damages in court.
Refinance the Loan
When possible, refinancing the predatory loan with a new, reputable lender may be the best way to save some money and avoid foreclosure. Some lenders use the predatory tactic of imposing extreme prepayment penalties to try to block such a move, but in the long run, it may be the only way of getting out of the deal. When you refinance the loan, under more reasonable loan terms, it can make an almost instant impact on your finances. Refinancing may be the quickest way to get clear of a predatory mortgage and into a better situation.
Take Legal Action
Suing a predatory lender may not only free you from a horrible financial burden but may also help to free others. Victims of predatory lending are generally allowed to file a civil lawsuit against their lenders. If it can be clearly shown that a lender violated the Truth in Lending Act, then that’s more than enough ground to stand on to pursue legal action.
Borrowers who win such cases are typically freed from the debt obligation and can be entitled to collect monetary damages of up to twice the sum of the charges that the lender forced them to pay. This course of action requires great deliberation, however, since state laws must be taken into consideration along with the Federal TILA. It’s highly recommended that the borrower consult a lawyer before beginning any legal discourse.
Predatory Lending: In Review
It’s always good practice to be extremely cautious when shopping around for a mortgage. Home loans are large investments, and there are people in this world who will take advantage of the fact that the average borrower is not an expert on most industry processes or terminology. Predatory lenders treat borrowers like prey and can trap them in situations that may ruin their credit, lead them to bankruptcy, or leave them homeless.
At home.loans, our goal is to make sure that home buyers are well educated about the mortgage process and what to expect from lenders and the loans that they offer. Transparency in the mortgage industry is an important factor in stopping predatory lending. Still, the practices mentioned above will likely persist as long as there are people who need to borrow money.
If you have any suspicions about predatory lending or a predatory mortgage loan that you may have entered into and would like some expert advice, feel free to give us a call. Our mortgage specialists are standing by to help you with any of your mortgage needs. Just reach out to our team to get a risk-free consultation.