Predatory Lending Raises Compliance Issues
Recently, FDIC chairman Donna Tanoue spoke to the National Association of Affordable Housing Lenders on predatory lending. In her speech, she discussed FDIC's concerns about predatory lending. Predatory lending leads to foreclosures and vacant properties - the very neighborhood problem that CRA is designed to solve.
Predatory lending defined
Not all loans are predatory - in fact, most loans are not. What makes a loan predatory are certain features that take advantage of naive or gullible consumers. These include misleading and even fraudulent marketing representations, excessive fees, exorbitant interest rates, prepayment penalties that deter prepayment, balloon payments to conceal true cost and trigger foreclosure, frequent refinancing with new fees, and abusive collection practices.
Tanoue acknowledges that predatory lending, both presently and historically, has not involved banks. Most predatory lenders have been and continue to be non-banks. However, this has been true of many of the financial practices that caused compliance legislation.
Banks will probably be called upon to take the lead in actions to correct or counter the results of predatory lending. In fact, predatory lending is taking advantage of the CRA programs in place, and feeding new needy borrowers into the numbers that need help from financial institutions. In addition to CRA, predatory lending may increase the sensitivity of other compliance issues. Anecdotal stories from a few consumers have led to compliance legislation before.
Fair Lending and CRA
Predatory lending practices will have ramifications throughout the compliance universe, including the already hot areas of fair lending and RESPA. Predatory lending preys on those who can least afford it. Heavy-handed high-pressure sales techniques are difficult for these consumers to resist.
"Regrettably," Tanoue states, "under-served low- and moderate- income, minority, or elderly borrowers often fall into" the target group for predatory lenders.
Thus, predatory lending often involves disproportionate numbers of "minority" groups or traditional fair lending target populations. In the hands of those who gather and publish the stories, the concepts of predatory lending and fair lending are likely to be mixed together. This will inevitably raise fair lending sensitivities. Moreover, fair lending laws may be the most effective tool - if not the only tool - for taking action to control the problem.
Fair and unfair fees
These loans are not offered at bargain prices. Lenders tend to "pack on" fees, such as excessive origination fees.
Once a customer falls behind, a predatory lender may require the borrower to refinance the loan. Refinancing is not a work-out to lower payments or adjust the payment status of the borrower. Instead, it involves the payment of additional fees. These fees may meet or exceed the amount the customer first paid to obtain the loan.
At this point the customer is in peril and at the mercy of a lender whose sole goal is to charge as much as it can. Fairness and consideration of the customer's interests are out the window. The fees themselves are now the borrower's biggest problem.
Fees may be imposed without regard for the actual need for the service. For example, a customer who has held a loan for less than 14 months probably does not need a new appraisal.
One of the potential problems in predatory lending is determining when a customer is or is not in default. Different lenders follow different practices, some allowing borrowers to get behind and then catch up while others declare a borrower in default with the first or second late payment.
Tanoue asserts that it is often a practice of predatory lenders to act quickly, giving customers little or no opportunity to catch up with their payments. This practice enables the predatory lender to force the customer to refinance - at a high cost to the customer.
Few of these borrowers realize that a bank would offer them options, such as rewriting the loan or developing a work-out agreement at little or no additional cost. The lack of information or knowledge makes the customer vulnerable to a practice that makes their loan increasingly expensive and unaffordable.
If this practice becomes abusive, it is not unlikely that advocates of the victims would turn to Congress asking for legislation that sets constraints on when and how a creditor may find a loan in default and collect a debt.
Collection practices of predatory lenders can be as damaging as the loan themselves. Techniques designed to influence the borrower are applied swiftly and intensely. Frequent, sometimes abusive calls to home and office intimidate consumers into refinancing to resolve the delinquency. The refinancing simply leads to more fees and a continuing expense spiral.
The ultimate unfortunate result of collection practices is to foreclose. When that happens, the property becomes vacant, and the downward economic cycle in the neighborhood may begin all over again.
Tanoue also noted trends in banking that may create an environment more favorable to predatory lending. She stated that the increased attention given by banks cross-selling products to high income customers takes attention and marketing away from lower income consumers, limiting their apparent choices leaving them more vulnerable to predatory lenders. Wherever a void is perceived, the opportunistic and predatory lenders will enter.
Another concern is the consequence of valid and effective CRA lending efforts. Banks have energetically implemented CRA lending programs and increased the number of low-income home-owners. These new homeowners are now targets for the predatory lender who offers "easy cash and easy monthly payments." Hard as a community group and bank may have worked to get that customer ready to own a home and qualify for a mortgage, the customer remains vulnerable to predatory lenders. In fact, the borrower becomes an ideal target.
There are also data mining techniques that predatory lenders use to identify target customers. Computers and the Internet have made data mining a profitable pastime for predatory lenders. New access to information enables them to identify homeowners that may be experiencing financial difficulties. People, facing medical bills, unemployment problems, or other financial setbacks, are particularly vulnerable to the invitation to resolve their troubles with a home equity loan.
FDIC action promised
Chairman Tanoue doesn't intend to sit back and let this happen. She promised action designed to break or alter this cycle. First, FDIC staff has begun working to open dialogues between the institutions it regulates, state regulators, and community groups. The goal is to develop guidance that will become a code of best practices - lending practices and products that are designed to meet the needs of elderly, minority, and lower-income borrowers. These best practices would also help banks guard against predatory lending practices.
Second, FDIC will hold public forums across the country in which all involved parties can discuss the problem and develop solutions, including steps the government can take to protect consumers.
Finally, Tanoue promised to reach out to fellow regulators, and state and city officials. Chairman Tanoue also promised to work more closely with the Federal Trade Commission which is the primary federal regulator of the companies engaging in predatory lending.
- Use compliance disclosures to explain the costs of credit to your customers. In particular, show customers how to use the TIL and HUD-1 to identify credit costs and avoid predatory loans.
- Create a culture of "come see us" by encouraging customers to bring in their problems before they become a credit problem.
- Review marketing and cross-selling techniques used in your bank and evaluate them for fairness or predatory elements.
- This is an ideal opportunity - and need - for education. Create an alliance with your community groups to educate low-income home-owners about predatory lending.
- Offer a free loan evaluation service at your bank. Encourage customers to bring their loan solicitations to the bank for evaluation and comparison to their existing loan.
Copyright © 2000 Compliance Action. Originally appeared in Compliance Action, Vol. 5, No. 2, 3/00
First published on 03/01/2000