Our bank is considering extending a line of credit to a builder for $14mm to construct "assembly line" houses that are completed in 30 days. We would have a valid 1st lien position in this transaction. The builder in turn makes a loan, 2nd lien, to low to moderate income people at what I consider a predatory rate 11% fixed for 30 years. I am not comfortable with this. Indirectly, in my opinion it conflicts with fair lending standards since I do think we are enabling the builder to take unfair advantage of borrowers. Also, if the builder defaults, even though the homeowner has been making their payments, we could end up with that property. We are not in the B&C lending business.
Am I off base here?

How is the builder selling the property without taking you out of 1st position? I would look at this very carefully.

The builder is most likely taking a second for the down payment or percieived equity. We do this very thing all the time in our local CDC, and it has worked well. But we don't do them at above market rates, and the second is forgiveable over a number of years. You could argue you are providing a service to low income people that could not get into the house otherwise, but I think that is a stretch with all the affordable housing programs available.

That's the problem. The homebuyer doesn't get clear title until we (the bank) are paid off by the builder. I am told by our attorney that this is like the old contract for deed transactions. Doesn't this translate into a predatory relationship? (indirectly). It just doesn't sound right to me.

So, are you also taking an assignment of the contract and deed from the subsequent buyer?

Will everyone get the same 11% rate, no matter the status of their credit quality?

When I can offer 1 or 2% rates to LMI folks using special programs, even with credit challenges (not huge challenges obviously) I'd say 11% won't pass the smell test. I wouldn't want any part of it.

The issue of "predatory lending" is always a touchy subject, and none of us want to see anyone get treated improperly. However, nobody has convinced me that there actually is predatory lending in this example. Borrowers with under-660 FICO scores, who have high debt-to-income ratios, who have high loan-to-value ratios, and who otherwise have credit impairment, are not going to be attractive to secondary market investors unless the risk is properly priced. I know many people don't like the fact that higher risk borrowers pay more -- just like higher risk drivers pay more -- but that's how the process works. Regrettably, credit impairment affects low-mod borrowers disproportionately. The only thing that can be done is to ensure that all of the prospective borrowers and homebuyers are provided with accurate, clear, and fair disclosures, and that they fully understand that they're paying a higher rate. Ideally, your borrower should also give you a "profile" of the intended FICO ranges and debt-to-income ratios that he will use for his 11% term. However, in a free-trade capital market such as the U.S., the reality is that I would rather see someone in a house servicing a mortgage, instead of sitting in an apartment paying rent. Fair lending does not mean that lenders have to give everyone the same rate, it just means that for like FICOs and DTI ratios you can't give a better rate to one party, then charge a much higher rate to another party -- when both have the same risk profile.

If you really want to help these people, then tell your boss that you'd like your bank to give these people preferred loans -- regardless of their FICO or other repayment indicators -- and you hold the loans in your portfolio.

I have to disagree with you. Part of predatory lending is putting a person in a house they can't afford so that it will come back to you. Also known as flipping. If an 11% interest rate puts the payment high enough that they have no squeak room, then you haven't done them a favor at all and they would be better off in an apartment they can afford.

I don't think the issue of predatory lending is really that much of a consideration in this transaction. It's really a safety and soundness concern. I never did get an answer concerning what specifically the bank's collateral position was going to be. The loan structure would have to be such that the bank controlled or had direct access to the servicing of the loans in second position to ensure they hadn't paid off or paid ahead without the bank being paid. There was no discussion regarding the true collateral values involved in the transactions. There are just too many unknowns - and predatory lending is the least of the bank's concern - because it was not the bank that was going to be making the 11% loans anyway.

I would bet that the builder has no clue that his loans are subject to TILA, RESPA, ECOA, financial privacy and information security rules, and all of the alphabet regs.

Randy has best captured the essence of what the underlying risk issue is here: The proper protection of the lending institution through the obtaining, if needed, of clear access to the underlying collateral. I agree with Randy's assessment that the greatest risk is a safety and soundness risk involving the specific loan to the developer. The developer is this institution's borrower/customer, not the ultimate recipients of the developer's financing. The design of this loan to the developer is no different than a line of credit from a bank to a finance company.

Regarding "flipping"; my understanding of loan flipping is that it is the repeated re-writing or refinancing of a borrower's note in order to "pack" repeated fees and costs. Obviously, flipping is bad, but I don't see evidence of that having occurred in this discussion. And as far as the allusion to the developer's underlying intent being to go after the low- and moderate-income homebuyers' homes, this is only speculation and, again, that's not cited here as being this developer's history, nor is it stated that the homebuyers will be "over their heads".

Even calling this thread "Predatory Lending" gets to the heart of the emotions surrounding subprime lending, but the unfortunate thing is that not everyone will get the same rate because not everyone has the same debt-repayment profile. All we can do is promote education about financial literacy and understanding credit and debt repayment, and hope that people will become responsible. You can't force a lender to lend to everyone at the same rate, and, as KCGeoQueen states, maybe it is better to just let them stay in rentals.

Sorry, I couldn't get back online because of deadlines. No we are not taking an assignment of the contract and deed from the subsequent buyer. The bank's position is a first lien, the builder's mortgage to the buyer a second. Basically, the way it is structured, the homebuyer could religiously make his payments, the builder could decide not to pass through funds to pay us off, and we could end up with a string of properties. Since I am in compliance, my concern is the predatory lending. Concurrence has to address the safety and soundness issues.

Either way it's structured, you are participating in a "special" program for LMI people. Unfortunately it's not a good "special" program, it's uncomfortably priced. I would not allow a lender to enter into a deal like this because it could have a significant negative effect on my CRA exam. We'd also worry about the marketing piece in general. With HMDA a hot button in 2005, do you really want the press to see how you're "helping" LMI folks with a program like this? I sure wouldn't.