Dirty Deeds: Abuses and Fraudulent Practices in California’s Home Equity Market
by Norma Paz Garcia
Through home equity loan abuse and fraud, homes are stolen and lives are devastated. High cost home equity loans sold to homeowners with no reasonable ability to repay them, have taken the homes and devastated the lives of California homeowners, many of whom are low-income and elderly. High pressure home improvement salespeople, foreclosure "rescue" services, and unscrupulous lenders and mortgage brokers have ensnared victims into traps that rob them of their homes. The victims are manipulated and deceived into signing for loans with interest rates as high as 30% and fees of 20 or more points.1 Often times a home improvement project is used to tie the homeowner into an unconscionable home equity loan.
It appears the lenders or brokers are more interested in the borrower’s equity than the ability to repay the loan because the lender can recoup the investment at a handsome profit or take the equity from the unsuspecting homeowner once the borrower falls behind on the payments. Some brokers steer borrowers to high cost, hard money lenders who will lend solely on the basis of the amount of equity in the home, regardless of the borrowers ability to repay the loan.
The lender or loan broker makes money even if the consumer can’t repay the loan through one or more of these means:
- pocketing high loan fees and points charged to make or arrange the loan;
- getting paid in full when the homeowner refinances with another lender (usually at exorbitant rates),
- selling the loan to a private investor, who may or may not realize that the borrower is unable to repay it, or
- foreclosing on the loan, thereby acquiring the home and all the homeowner’s equity at the foreclosure sale for the price of the remaining loan amount, rarely paying the fair market value of the property.
The victims are mostly elderly, minority and low-income residents who have owned their homes for many years. Although many of the victims are "cash poor" they have built tremendous equity through decades of hard-earned mortgage payments. This makes them prime targets for this "insidious form of urban economic violence."2
According to victims’ advocates and law enforcement officials, Los Angeles (especially the South Central neighborhood), San Francisco and Oakland are the areas hardest hit in California by home equity fraud artists and unscrupulous lenders. There are several parts to the problem: legal, high cost loans made to people who can’t afford to repay (combined with poor or absent disclosures of loan terms) and outright fraud in the inducement or creation of the loan. Estimated losses due to home equity fraud and overpriced and unfairly induced loans in California run at least into the tens of millions of dollars and very possibly hundreds of millions. Law enforcement officials and lawyers for victims say the cases that are discovered and brought to court are just the tip of the iceberg.
Nationally, home equity fraud and home repair fraud have stripped the value from the homes of an estimated 100,000 people in 20 states.3
The evidence available from Los Angeles County alone suggests that a serious problem exists in California:
- The Los Angeles County District Attorney’s office in 1994 established a special real estate fraud unit to respond to an exploding caseload of home equity lending abuse cases.
- The Los Angeles District Attorney’s major fraud division is currently prosecuting 28 real estate fraud cases — involving 52 defendants and nearly 1,000 victims. Of these, approximately one-third involve home equity fraud where victims lost an estimated $183 million during 1993 and 1994.4
- The Los Angeles County Recorder, under a pilot program, sends a notice to a homeowner when a deed or trust deed is recorded on his or her property. (A trust deed is the document that gives a lender rights in the debtor’s home.) About 10% percent of homeowners — or 3,900 — who received a notice under this program (between March 1994 and March 1995) were unaware that deeds had been recorded. The Los Angeles County District Attorney’s office estimates that approximately 400 of those cases involve criminal wrongdoing.
The Forms of Home Equity Loan Abuse
Abusive and questionable home equity loans often are initiated through door-to-door solicitations and usually involve hard-sell tactics. Borrowers are frequently told they will qualify for a loan as long as there is equity in the home. The loans usually involve high interest rates and high fees, and are made through non-bank lending sources such as small mortgage companies, consumer finance lenders, mortgage brokers and private individuals. Often these loans involve seemingly low monthly payments with exorbitant, impossible balloon payments due at the end of the loan. Unprincipled lenders see these loans as a way to offer a false ray of hope to those borrowers experiencing financial difficulties. In reality, these loans can be simply an avenue toward acquiring the home at a rock-bottom price or placing the consumer on a cycle of increasingly expensive short term loans that eventually lead to foreclosure.
Generally, home equity fraud and abuse appears in one of four forms:
- Home Improvement Contracts. These are often initiated by door-to-door contractors who also arrange financing for their work through a home loan. Often there is no "improvement" at all. The work is substandard or left incomplete. The homeowner generally ends up deeply in debt and in grave danger of foreclosure after contractors (frequently unlicensed) charge very inflated prices for earthquake repairs, interior or exterior remodeling, floor coverings, siding or other similar products.
- Disaster Related Home Loan Abuses. Unsuspecting homeowners are easy prey for friendly door-to-door salesmen who offer services to repair damages to a home following a natural disaster. This is a variation on the "home improvement contract" theme, although the results are usually the same.
- Foreclosure Rescue. When homeowners fall behind in their mortgage payments — even one day late — lenders may file notices of default against them and start the foreclosure process. Mortgage brokers and hard money lenders scan these notices of default, which are public record, and use them to target people for refinance loans which the already strapped borrower cannot afford to pay back. The loan may be presented to the consumer as a "bailout" but often ends up draining the remaining equity out of a home while offering little more than postponing the inevitable.
- Bill Consolidation/Refinancing Offers. Lenders may claim that a home equity loan will reduce monthly payments on credit cards and other debts through lower interest rates and tax deductions. The primary targets for these offers are homeowners with poor credit and an immediate need for funds. These victims may accept these loans because they are attracted by deceptively low monthly payments preceding a large final balloon payment at the end of the loan. They may also be willing to accept a higher-than-average interest rate because they would have trouble qualifying for a loan from a mainstream lender. These loans often result in higher debt — driven by high interest rates and fees — with impossible balloon payments. The result may be foreclosure even though the consolidated loan was for unsecured debts (such as credit card debt) that could not otherwise have resulted in the loss of the home.
In Part II of this report are several case histories involving egregious lending practices. These include:
- A 75-year-old woman who reported she was convinced by a door-to-door solicitor to contract for painting services even though she told him she did not have the money. He told her she did not need cash, just equity in her home, as long as she could afford $140 per month. What he didn’t tell her was there would be a balloon payment of more than $11,000 due in seven years. Several months later, her grandchildren found her at home with no utilities, no phone, and no electricity because she had run out of money trying to make her loan payments.
- A San Francisco widow with a $1,200 per month income whose home was damaged in the Loma Prieta earthquake reported she was approached by a contractor and loan officer regarding repairs. Because she suffers from glaucoma and had broken her eyeglasses, she could not read or sign loan documents — so the loan officer convinced her to sign a blank piece of paper. Without her knowledge, the mortgage company arranged for a $150,000 loan and charged $23,000 in origination fees, tripling her monthly mortgage payment. The work was never completed by the contractor. The widow was evicted from her house when it was sold at the foreclosure sale, and was carried out of her home in a wheelchair by paramedics.
- A 95-year-old mentally incompetent man and his 82-year-old wife were living on a small fixed income and according to their lawyer a mortgage broker arranged for a home equity loan to refinance their credit card debt and several home improvement projects (performed by a company owned by the cousin of the lending company’s president). The mortgage broker put them in a loan for $30,000, even though their total debt was only $15,000. The broker kept $15,000 of the proceeds as broker fees. By the time the loans were refinanced, liens against the home totaled about $92,000 — almost all resulting from work on a single bathroom.
California’s weak regulatory environment does little to discourage abusive home equity loans.
- Regulation of non-bank home equity lending is not centralized in any single government agency. Jurisdiction can be either with the Department of Corporations, which regulates consumer finance lenders and industrial loan companies, or with the Department of Real Estate, which regulates real estate licensees engaged in mortgage brokering and lending.
- Financial standards and annual reporting requirements vary with each agency, with the Department of Corporations imposing stricter standards. Companies holding a DOC license must meet financial standards and file annual reports showing lending activities.5
- Many lenders avoid the DOC requirements by lending under a Department of Real Estate license, which does not require brokers to meet minimum financial standards and does not make records public regarding companies’ activities.
- The Department of Real Estate is widely considered to be weak and indifferent in its enforcement efforts. In fact, attorneys say they seldom report cases to DRE for investigation because the DRE does little to help their clients. That may explain why a DRE official said the department receives very few complaints about cases of home equity loan abuse.
Some relief came last year at the federal level in the form of the Home Ownership and Equity Protection Act of 1994, which places certain restrictions and requirements on "high-rate, high-fee mortgages." The new provisions will be included in the Truth in Lending Act (TILA) as of October 1, 1995.
While the expanded federal law provides some much needed reforms, it success will depend on how aggressively states enforce it. The priority California officials will give the Home Equity Protection Act remains to be seen. Also looming is the possibility that the Act may be revised or diminished in the deregulation environment of the new Congress. Proposals to remove or restrict the three day right of rescission on home loans were recently defeated. Additional proposals would change the definition of high cost mortgages to exclude first liens providing incentives for lenders to consolidate pre-existing liens into a new first mortgage to obtain immunity from the provisions of the Home Ownership and Equity Protection Act, including these provisions governing high cost mortgages.
Potential victims of home equity loan fraud and abuse must be protected through more vigorous regulatory action, new laws, and effective community education programs. Large mortgage companies and mainstream financial institutions also can contribute to the solution by offering quality home equity loan products in neighborhoods targeted by abusive lenders and by carefully scrutinizing the fairness of the loans they purchase to ensure that they are not providing funding for hard money loans.
The financial and emotional toll home equity loan abuse takes on Californians can be reduced by: 1) strengthening existing laws and regulations, 2) fully enforcing existing laws, 3) preserving existing remedies such as the Truth in Lending Act; 4) educating homeowners about the risk of these loans; and 5) providing access to affordable home equity loans on fair terms for low-income and elderly homeowners. These actions will require concerted efforts by a combination of agencies, the legislature, and the lending industry. To effectuate these actions Consumers Union recommends these measures:
- Consolidate all mortgage lending licenses under the Department of Corporations and set reporting and financial standards for all lending entities.
- Prohibit balloon payments on home equity loans unless the borrower has the option to fully amortize the balloon payment on reasonable terms at the end of the initial loan term.
- Prevent weakening consumers’ right of rescission for refinance loans and equity loans under the Truth in Lending Act.
- Reinstate reasonable usury laws with floating rate caps.
- Restrict "high-rate, high-fee" loans and their sale on the secondary market.
- Prohibit home improvement contractors from acting as mortgage brokers or de facto agents of mortgage companies, and prohibit door-to-door soliciting of home equity loans and home improvement services that are financed through home loans.
- Require pre-loan counseling for high-risk borrowers, and for borrowers refinancing loans for which a notice of default has been filed.
- Require notaries statewide to record a thumbprint to verify the identity of a person signing a deed, quitclaim deed or deed of trust, and expand statewide the pilot program requiring county recorders to notify homeowners of filings affecting title to or rights in their homes.
- Provide law enforcement agencies with the funds and legal tools they need to fight home equity fraud and to prosecute criminals. This could be paid for by assessments on persons holding licenses to make or arrange home loans.
- Regulatory agencies should act vigorously to investigate and prosecute cases of home equity lending abuses and fraud.
- Centralize records of home equity-related complaints against lenders and contractors, and make these records readily available to the public.
- Develop and expand training programs for law enforcement officers and education programs for potential victims.
- Encourage banks to properly serve low-income areas by providing a full range of loans and services to these communities.
The victims of home equity loan abuse and fraud must not be blamed for falling under the spell of unscrupulous lenders, brokers, or contractors, any more than victims of muggings and armed robberies can be blamed for becoming targets of assaults. Home equity loan abuse and fraud will not go away by being ignored.
This report recommends steps necessary to stop an assaultive economic abuse on California’s elderly and low-income population of homeowners. The magnitude of the crimes and the need to stop them from occurring are summed up in the words of one victim. Of the people who cheated her out of her home, she said to the Massachusetts Attorney General’s office:
"They did to me what a man with a gun in a dark
alley couldn’t do: They stole my house." 6
The tremendous surge in real estate prices in the late 1970s and early 1980s opened the door for the creation of a new source of funds for many homeowners: home equity loans. Many homeowners found the appreciation in property values a welcome source of funds for remodeling projects and their children’s college education. But the growth of home equity loans also has its dark side. An increasing number of homeowners in California have been the target of unscrupulous lenders who use fraud or confusing tactics to lead homeowners with low and moderate incomes into loans they cannot possibly afford to repay. The very loans that homeowners thought would be beneficial may instead cost them their homes and life savings.
Elderly, minority, low-income and inner city residents who owned their homes through the real estate boom of the ’70s and ’80s and built tremendous equity are prime targets for home equity scam artists. According to law enforcement officials, legal advocates and news reports, Los Angeles (especially the South Central neighborhood), San Francisco and Oakland are the state’s centers for exorbitantly priced home equity loans, fraud and manipulation that place residents in imminent danger of losing their homes.
By the early 1990s, home equity loan scams in Boston, New York, Atlanta and Los Angeles became the focus of national news coverage. Shows such as "60 Minutes," "Prime Time Live," and nightly network news reports showed how loan documents were falsified, how lenders packed loans with costs that tripled or quadrupled the amount homeowners initially intended to finance, and how incomplete home improvement projects left trusting homeowners on the verge of foreclosure. The exposure of the problem led to U.S. Senate hearings on the issue, passage of landmark federal legislation and major legislative reforms in Massachusetts and New York.
In California, it is estimated that losses caused by home equity fraud and unscrupulous loans run into the tens of millions of dollars and possibly into the hundreds of millions. The human toll of displaced homeowners and lost life savings is also monumental.
The options available to victims of home equity lending abuses are few, if any. Seeking redress in the courts is a slow and costly process that greatly taxes the emotional and financial resources of the victims. In the end, even success in court can still leave a victim liable for thousands of dollars in loans needed to refinance an unfair loan. Access to litigation also is limited. Many of the victims are low-income, and depend upon already strapped legal aid societies to advocate on their behalf. The prognosis for legal aid societies to handle more of these cases is bleak. Presently there is only a limited number of lawyers to handle expanding caseloads, and legal services programs are facing the threat of serious budget cutbacks. Intervention by state regulatory agencies also has been limited. The lack of complete jurisdiction by a single regulatory agency lessens the likelihood that any future action taken at the administrative level will be effective. The new federal statute, while helpful, is not sufficient to resolve the problem, and homeowners’ rights are under attack in Congress.
Potential victims of home equity loan fraud and abuse must be protected through more vigorous regulatory and law enforcement, new laws, and effective community education programs. Large mortgage companies and mainstream financial institutions also can contribute to the solution by offering quality home equity loan products in neighborhoods targeted by abusive lenders and by carefully scrutinizing the fairness of the loans they purchase.
The objective of this report is to provide the general public and public policy makers with important background about home equity loan abuse and fraud. Personal histories illustrate the scope of the problem and show the shattering effect abusive loans have on the lives of Californians. According to Ron Kaye of the Legal Aid Foundation of Los Angeles, incidences of home equity loan abuse and fraud cases have reached "epidemic" proportions. Recommendations are provided for substantive action needed by government, lenders and the public to stem this tide of abuse.
An Overview of Home Equity Loan Fraud and Abuse
Home Equity Loan Defined
The basis for a home equity loan or line of credit is the "equity" in a homeowner’s property. Equity is measured by the difference between outstanding obligations — such as a first mortgage — and the home’s market value. For example, a $250,000 home with $150,000 due on the first mortgage and any other liens has $100,000 in equity that might be borrowed against.
Home equity loans were introduced to the marketplace in the 1970s. During that decade real estate prices soared and longtime homeowners suddenly found their homes worth far more than the amount of their mortgage balances. Lenders saw home equity loans as an opportunity for a new product for the market, and homeowners found a new way to tap into a valuable asset.
A home equity loan uses the traditional loan structure of equal monthly payments covering principal and interest over a designated period. Home equity lines of credit, which now exceed home equity loans in volume, provide a revolving line of credit that homeowners can call upon as necessary, much as they would a credit card. In both products the loans may be non-amortizing. This means the loan principal is not reduced by the monthly payments and is still owed at the end of the loan term.
Home equity loans differ from standard mortgages used to purchase or refinance a home. The principal difference is that they are based on the market value minus what is owed under the existing mortgage and any other encumbrances. A home equity loan is sometimes — although not always accurately — referred to as a "second mortgage," or a mortgage taken in addition to the primary loan used to finance the purchase of the property.
Benefits and Detriments of Home Equity Borrowing
Home equity loans and lines of credit can be a way for consumers to turn the investment they’ve made in their homes into a liquid asset. Equity built over many years often can mean substantial funds are available for home improvement, college tuition, major purchases and other purposes. But home equity loans also come with risks. Consumers must plan their finances properly and be careful they choose an affordable, competitive, fully amortizing loan from a reliable lender.
Interest rates on home equity loans and lines of credit should be lower than rates for consumer loans not secured by real estate. In 1995, the average annual percentage rate (APR)1 for commercial bank fixed-rate credit cards was 15.23%.2 The average annual percentage rate for a home equity loan offered by commercial banks was just 10.49%, according to HSH Associates, a California financial research group. An estimated $255 billion in home equity debt was outstanding in the U.S. in 1993.3
In the loans described in this report, consumers paid annual percentage rates of up to 30%, and 15 or more points.4 By contrast, in August 1995, California’s leading financial institutions were charging 8.5% to 11.5% for a fixed-rate home equity loan with no points.5
Banks and other lenders increasingly use home equity lending as a primary feature in their marketing efforts, especially when interest rates for refinancing start to rise. Many institutions offer adjustable home equity loans or lines of credit with low introductory interest rates, often below 7% APR for a limited period, and no points or fees. One of the biggest boosts to home equity financing was the Tax Reform Act of 1986, which abolished tax deductions for interest paid on non-mortgage debt such as credit card accounts, automobile loans and student loans. Interest paid under home equity loans, in most cases, remains deductible, as long as the homeowner itemizes all deductions.
The benefits of home equity lending, however, are accompanied by serious risks. If a borrower fails to pay off unsecured debt such as credit card debt, the creditor cannot force the sale of the home to repay that debt. However, the borrower opens the door to a possible loss of his home when he pays off previously unsecured debt by obtaining an equity loan or line of credit, pledging his home as security for repayment. At that point, the previously unsecured debt is transformed into debt secured by the home which gives the lender rights to the borrower’s home that the old creditor did not have. Even though the loan is based only on a portion of a home’s value, if the borrower defaults on the home equity loan, the home can be sold by the lender to pay off the debt. The lender can sell the home without a court hearing as the final step of the foreclosure process.
Home Loan Abuse
While the introduction of home equity loans may have increased financial opportunities for consumers, it has certainly provided new opportunity for fraud and abuse by unscrupulous operators. Legal aid societies in California say they are handling a rapidly growing number of cases involving home equity loan abuse and fraud. The principal victims they see are elderly and low-income homeowners.
Nationally, home repair and home equity fraud have stripped the value from the homes of an estimated 100,000 people in 20 states.6 California, especially Los Angeles, Alameda and San Francisco counties, has been one of the biggest problem areas in the country. Although it is impossible to know exactly how many people have been victimized or how many homes and millions of dollars have been lost, the evidence that a serious problem exists is overwhelming:
- The Los Angeles County District Attorney, responding to an exploding caseload, established a special real estate fraud unit in 1994. Three assistant district attorneys and three investigators are assigned full time to investigate and prosecute real estate fraud cases. Other members of the District Attorney’s staff are often brought in to handle the overflow.
Twenty-eight real estate fraud cases — involving 52 defendants and nearly 1,000 victims — are currently being prosecuted by the L.A. District Attorney’s major fraud division. About one-third of the cases involve home equity fraud or fake deeds. In total, victims lost an estimated $183 million during 1993 and 1994. 7
The Los Angeles County Recorder, under a pilot program, notifies homeowners whenever a deed or trust deed is recorded on their property. (A trust deed is the document that gives a lender rights in the debtor’s home.) Of the 39,000 homeowners who responded to notices from the Recorder’s office between March 1994 and March 1995, about 10% percent — or 3,900 — were unaware that deeds had been recorded until they received a notice from the recorder. The L.A. County District Attorney’s office estimates that approximately 400 of those cases involve criminal wrongdoing by real estate fraud of some type.
There are several other compelling reasons to believe that the cases of home equity loan abuse and fraud reported to authorities and lawyers are indeed, as one advocate put it, the "tip of the iceberg":8
- An individual abuse or fraud report often arises out of a business practice imposed on many borrowers. Most claims include common denominators such as victim characteristics or the tactics used to take unfair advantage of homeowners.
- Victims often are reluctant to come forward because they are embarrassed, feel vulnerable or simply do not realize they have been defrauded.
- Current laws and practices make it difficult for state agencies to track home equity fraud complaints. Several different agencies are involved: licenses to make and arrange loans are under the jurisdiction of either the Department of Corporations or Department of Real Estate, while complaints against home improvement contractors usually go to the Contractors State License Board. An attorney with the California Department of Consumer Affairs, recognizing the split jurisdiction problems, says the agency plans to increase its involvement in the issue because "the ball was rolling around, and someone needed to grab it."
- In many cases, victimized homeowners appeal to local legal aid societies and other non-regulatory agencies for assistance. It is nearly impossible, therefore, to compile statistics that accurately reflect the scope of the problem. However, The New York Times quoted Troy Smith of the Legal Aid Foundation of Los Angeles as saying, "For every case seen by lawyers, 100 go unchallenged because owners are too distraught, embarrassed or do not realize they have legal recourse."9
There also are compelling social reasons to pay attention to cases of home equity fraud and abuse. Experience with abusive lending in other parts of the United States shows the potential societal impact. The economic and social stability of a neighborhood targeted by abusive lenders is substantially threatened when enough unsuspecting homeowners lose their homes to foreclosure. In low-income neighborhoods, home equity scams can be particularly devastating because the homeowners targeted are often longtime residents who provide stability and an important economic base to the neighborhood. When a home is sold in foreclosure, previously owner occupied homes frequently become rental properties managed by absentee landlord investors.
Losing a home can catapult a low-income homeowner, especially one living on a fixed income, into a cycle of poverty. Legal aid and assistance organizations for the elderly are reporting an increased number of individuals on the verge of homelessness or who have become homeless because of home equity loan scams. Many of the victims are elderly citizens who purchased their homes after World War II, well before prices skyrocketed in the 1980s. After losing their homes to unscrupulous lenders or brokers, victims cannot afford the high prices of new homes in the same communities.
Prosecutors tell stories of homeowners who end up living in their cars as a result of abusive loans and home equity fraud. The effects can be even more extreme. In one case study described in this report, a victim states that she believes the unaffordable payments on a home equity mortgage drove her husband to kill himself. 10
What Does an "Abusive" Loan Look Like?
Abusive loans and home equity fraud come in several different forms. It appears that in nearly every case, the loan is designed from its inception so that the borrower will never have any realistic hope of paying it off.
As the personal histories in Part II show, perpetrators of home equity abuse set up loans with payments that far exceed the incomes of the borrowers. The lender knows the borrower will not be able to repay. The lender’s only way to be repaid is to either take the home through foreclosure or place the victim into a new, more expensive loan with additional points and fees. Many abusive loans have impossibly large "balloon payments" tacked on to the end of the loan. Some victims struggle to make their high payments on high interest rate loans for several years only to lose their homes when balloon payments nearly as high as the original loan balance come due at the end of the loan. 11
Borrowers, however, are not the only victims of lending fraud. In some cases, the loan money was provided by individual investors seeking a high return on their investment. During these transactions, the broker acting as the middleman may pocket a significant portion of the funds through "fees." The broker may also mislead the investor into thinking that the homeowner has sufficient income to make the loan payments by including several months of "advance payments" in the loan to the homeowner. These advance payments are withheld by the broker and paid to the investor during the first several months of the loan. The investor may not know that the payments are coming directly from the new loan proceeds. When the homeowner goes into default, the investor — often a retiree — also loses funds through the bad loan and becomes another victim. According to the Los Angeles County District Attorney’s office, about one-third of the real estate fraud cases it is currently prosecuting involve bilked investors.
"No Job, Bad Credit OK"
High-risk lending is not an isolated phenomenon. Newspapers, radio and television all carry advertising for lenders who promise to make home equity loans despite a homeowner’s unemployment or bad credit record. "Hard money" lenders, who provide some of the highest rate loans, are the real estate equivalent of a pawn broker. They will extend a loan at high interest rates, knowing that if borrowers cannot pay, the lender can either take the home through foreclosure or refer the homeowner to another, equally high-cost lender, for another expensive loan if there is unused equity remaining in the home. These practices, while harmful to consumers, are perfectly legal.
Abusive and unfair home equity loans often are initiated through door-to-door solicitations and usually involve hard-sell tactics. In many cases, borrowers are told they will qualify for the loan as long as there is equity in the home. The loans usually involve high interest rates and high fees. They are made through non-bank lending sources such as brokers, consumer finance lenders and private individuals. Victims of abusive lending often report outrageous terms such as interest rates in the mid- and upper-teens and extraordinarily high origination fees ("points") of 14% or more.
Translated into dollars and cents, the practice is unconscionable. For example, a 30-year, $100,000 loan made to one victim — 15.55% interest and 23 points — would mean monthly payments of approximately $1,310 per month plus $23,000 in fees.12 If the points are amortized (gradually paid off at regular intervals) over the life of the loan, the payments increase by $300. In the end, the homeowner will have paid a total of more than $456,000 in interest — two and one-half times the $186,000 that would be paid on an average 8.75%, no-point loan available through major banks.
"Criminal" and "Legal" Scammers
Victims’ advocates say they see two types of operators: what they call "criminal" and "legal" scammers.
A "criminal" scammer uses boldly fraudulent techniques including convincing homeowners to sign blank documents, forging signatures, misrepresenting income and payments, or operating without a proper license. The loan often is used to finance some type of home improvement that, once the loan is funded, involves substandard work or work that is left unfinished. For example, some homeowners have reported that contractors have ripped out interiors for remodeling work and have used poor quality construction and materials. In some cases, homeowners have been left with uninhabitable shells when the contractors failed to complete the job.
A "legal" scammer is a lender who manipulates the borrower — usually an elderly person — into an expensive or unaffordable loan but creates the proper paper trails. The loan document may appear legally enforceable on its face, but the techniques used to ensnare the borrower may involve illegal fraud or misrepresentations. The legal scammer induces the borrower to sign the agreement, but does not ensure the borrower actually understands what she is signing. One approach is to give the homeowner, frequently an elderly widow, a hard sell until she finally decides to sign a "loan application" to get the salesman out of the house. Only later does she discover that the "application" was actually a loan agreement.
If the victims of these scammers are able to find legal assistance through underfunded legal services organizations or scarce volunteer attorneys, then their lawyers are usually able to find violations of law, such as misrepresenting the terms of the loan in the loan documents, which makes the loan rescindable under the federal Truth-in-Lending Act. But some disputes are barred from review by any court of law by mandatory arbitration clauses imposed by the lender. Even if the victim can go to court, during the year or more it can take to resolve the issue the loan may be "folded" or "flipped" (refinanced by an even larger loan) several times to temporarily keep the homeowner afloat. In addition, a note may be sold to a series of investors on the secondary market who assert rights of ownership. This complicates matters because the homeowner must defend against ownership claims by the investor who was not the original lender. As a result, homeowners must often quickly go to court to get a temporary restraining order to stop foreclosure, which increases their costs and anxiety.
The Four Most Common Scams and Abuses with Case Histories
There are hundreds, if not thousands, of Californians who can tell stories of how they were bilked by home improvement scams, loans to pay for repairs from natural disasters, and foreclosure "rescue" attempts. Some cases involve outright fraud and misrepresentation. The following case histories,1 supplied by legal advocates and victims, are representative of the growing number of reported and unreported home equity loan fraud and abuse cases in California. The victims are typical of those targeted by scammers: most are elderly, many are women and many are of African-American or Latino heritage.
Generally, home equity fraud and abuse appears in one of four forms:
- Home improvements service contracts
- Disaster related home loan abuses
- Foreclosure "rescue"
- Bill consolidation/refinancing loans
Home Improvement Scams
A significant percentage of the home equity fraud cases litigated by legal aid advocates concern home improvement projects. These cases often involve elderly or disabled homeowners who are longtime residents of older, inner-city neighborhoods. In the San Francisco Bay Area, several cases have involved solicitations for repairs related to damage caused by the 1989 Loma Prieta earthquake.
Home improvement scams generally start with a friendly door-to-door salesperson offering services such as earthquake repair, interior or exterior remodeling, floor coverings, or siding. Sometimes the services offered include installing unattached property such as satellite dishes. Often, the sellers of these products are not licensed contractors. They use high-pressure sales tactics, and charge very inflated prices. To cover the cost of "repairs," the salesperson conveniently offers to arrange financing. Unfortunately, homeowners frequently are unaware that their homes are collateral for these loans because the salesperson skillfully uses deception or misrepresentation to dupe the unsuspecting homeowner. The salesperson may even arrange to lend against the home’s equity for equipment such as satellite dishes, even though state law forbids loans for this product to be secured by a lien against a home.
Once the contract is signed, the contractor obtains the financing and arranges for his fee to be deducted from the loan proceeds. The Federal Truth in Lending Act requires the lender to provide the borrower with certain disclosures and a three-day right of rescission period.2 Although forbidden by the Truth in Lending Act, the contractor frequently begins work before the end of the three-day rescission period. By law, work is not supposed to be performed during this period unless the homeowner signs two waivers: one agreeing that the work is of an "emergency" nature, and another waiving his or her right to rescind the loan.
Homeowners are generally not targeted randomly for high-cost, equity-based financing. Contractors and others seeking to sell high-cost loans usually look for older homes with visible signs of wear and tear, or, as demonstrated in some San Francisco cases, for city/county notices of structural deficiencies caused by earthquake damage. Public records show who owns the property, whether the owner occupies the house, how long the owner has resided there, whether the person owns the house outright or jointly, and what mortgages and encumbrances are on the property. A trip to a county hall of records also shows whether the owner is widowed and, if so, for how long.
Armed with this information, sales representatives have targeted the homeowners they know are likely to need money or to be the easiest target for an expensive loan. These salespeople have even approached the person by name on the initial cold call.
What makes these practices particularly egregious is, regardless of the quality of the home improvement work — or even whether it is ever completed — the homeowner remains liable for paying the loan to avoid losing the house to the lender. In many cases, what homeowners received was a far cry from actual home improvement services. Instead, work was left uncompleted or homes were reduced to virtually uninhabitable shells. Some of these victims have been forced from their homes into rental housing because their dwellings were no longer habitable. The monthly rental payments added to the economic burden these victims already faced with paying equity loans for work that was never completed to their satisfaction.
Here are how home improvement scams have affected some Californians:
MS. JONES is a 73-year-old woman who has suffered from several strokes and does not have full control of her mental faculties. In 1992, Ms. Jones’ roof was leaking and needed repair. Her son had spoken to various contractors in the Los Angeles area about the roofing work, but had not yet settled on a specific contractor.
One day, a representative of a home improvement contracting company came to Ms. Jones’ home and offered to have his company do roofing work for her. Ms. Jones told the representative to speak to her son. At Ms. Jones’ house, the representative called the son, and the son inquired whether the representative was from the contracting company with whom the son had previously sought an estimate for the job. The representative said he worked for another company.
Subsequently, the son told Ms. Jones that she should allow the representative to inspect the premises. But before he began, the representative told Ms. Jones that he needed her to sign an authorization form in order to inspect the premises. But what she actually signed was a contract to do remodeling work, as well as a security agreement putting a lien on Ms. Jones’ property.
Not knowing what she was entering into, Ms. Jones erroneously signed all the documents presented to her, resulting in a contract for $15,000 and a 10-year loan at 19.5% interest. The following day a crew of workers from the home improvement contracting company began ripping down the old roof and putting up plywood.
Ms. Jones eventually reached a settlement in the case.
JOSEPHINE B. is an 75-year-old widow who owns a home in Oakland. In 1991, she was approached by a salesman for a painting contractor who, according to Mrs. B., told her that it did not matter whether she had any cash to pay for the paint job because he could arrange for a loan to pay for it.
Soon thereafter, Mrs. B. was visited at her home by a loan agent from a finance company. The agent had her sign several documents, which she did not read because of the extensive wording and her limited reading ability and comprehension. According to Mrs. B., the only thing the loan officer asked her was whether she could afford to pay $140 per month. She could, she said, and the loan agent had her write a statement to that effect.
At no time, however, did the loan agent tell Ms. B. that, in addition to the monthly payments, she would be responsible for a balloon payment of $11,200, which would be due in seven years. Several months after the loan was made, Mrs. B. became ill and fell behind in her loan payments. Around Thanksgiving, 1993, Mrs. B.’s grandchildren found her at home with no utilities, no phone and no electricity. She had run out of money to pay for her utilities because she was still trying to pay her mortgage.
Mrs. B. received an injunction against the finance company when the company failed to appear in court. However, the finance company had sold the loan to an investor who had purchased several other of the finance company’s notes. The investor continued to assert his right to foreclosure on the property as a holder in due course of the loan note until a settlement was reached. All interest and fees were waived and Mrs. B. is now responsible only for payment of the loan principal.
HERMAN R. is a 68-year-old retired maintenance man who has an eleventh grade education. His wife is 58 years old and is mentally incapacitated. In 1957, Herman R. purchased his home, which over the years has appreciated significantly.
His attorneys reported the following. In late November 1993, Herman R. was approached by a salesman who convinced him to undertake a home improvement project. The home improvement contractor then sent a representative from a loan company to see Herman, who signed what he thought was simply a contract for work to be done. In fact, he had signed a loan agreement.
Soon after the Northridge earthquake, Herman discovered that there were not one, but two, separate deeds of trust placed on his property for twice the amount to which he thought he had eventually agreed. Without Herman’s consent, the contractor had upped the price of the project and arranged for a second loan. When Herman complained, the salesman said earthquake safety work — for an additional fee — would be required before the lender would consolidate the loans, and if it wasn’t done the lender would call the other loans, making them due immediately.
Herman’s lawyers eventually discovered that a deed for a third loan — again made without Herman’s permission — was about to be filed when they stepped in to block it.
In all, Herman had liens totaling $35,000 against his home for shoddy construction work. Following extended settlement negotiations with the finance company, which Herman’s lawyers say have a history of abusive loans, the finance company agreed to relieve him of any obligation for the loans.
NORA B. is an 80-year-old widow who had a first mortgage on her home of just $214.00 per month. She has a ninth-grade education and is unsophisticated about financing techniques such as balloon payments.
According to Ms. B., in 1990, she was approached by a home improvement contractor who told her that he could arrange for a loan to pay for new siding and to consolidate the consumer debt of $15,000 left by her deceased husband. She was then visited at her home by a salesperson for a finance company who had her sign the loan application and several other documents. Many of the documents contained blank spaces, she said.
According to Mrs. B., the only thing the salesperson discussed with her about the loan was whether she could afford to pay $300 per month. Mrs. B. said she thought she could.
She said never, however, did the lender explain to her that a mortgage was going to be placed on her home or that a balloon payment of $32,900 would have to be paid in addition to the monthly payments. She also said she never was told the balloon payment was due in September 1995.
The lender arranged to finance the home improvements and make the loan to Mrs. B., apparently without taking into consideration her ability to pay the monthly mortgage payments or final balloon payment. In 1993, she fell behind in the mortgage payments, and the lender began foreclosure proceedings. In desperation, Mrs. B. filed for bankruptcy.
With the help of legal counsel, Mrs. B. was able to receive an injunction against the lender and delayed the foreclosure. However, the investor to whom the lender sold the note continues to assert a right to collect. Recently, the investor obtained relief to begin foreclosure proceedings again, but Nora’s lawyers got another preliminary injunction to temporarily delay the proceedings. The case is set for trial in October 1995.
DORIS is 78 years old, has an 11th grade education, and suffers from a heart condition. Her husband in 95 years old, has no formal education and is mentally incompetent. They live on a small, fixed income.
In September 1991, a salesperson tricked Doris into signing a home improvement contract to install a new fuse box and electrical wiring she did not need. Doris was already holding a loan through a traditional lender; the salesperson convinced her to arrange for a larger loan to cover the repairs and to pay off her existing lien. Eventually, a lien for $33,895.20 was placed on Doris’ home even though the value of the improvements was only $1,500.
By the time Doris settled her legal action against the lender, approximately seven deeds of trust had been signed on the property and the company had tried to buy the house. The loan was found invalid due to statutory violations by the company, including the failure of the salesman to hold an appropriate license. She now owns the home, free and clear. Punitive damages were assessed against the contractor totaling $175,000, but Doris’ attorneys say there is little hope of recovering the award.
Disaster-Related Home Loan Abuses
Many individuals whose homes were damaged by natural disasters, such as the Loma Prieta and Northridge earthquakes, are particularly vulnerable as they seek ways to make their homes — and lives — whole again. Many of the homes that were damaged, especially in low-income areas, were not insured for earthquake risks and remained unrepaired long after the quakes hit. Unsuspecting homeowners are easy prey for friendly door-to-door salesmen who suddenly offer the prospect of money for repairs and possibly even some extra money.
The Contractors State License Board has issued several bulletins warning homeowners to work exclusively with reliable, licensed contractors and to look out for "wanna-be’s looking to take advantage of people’s desire to get their lives back to normal."3 Nevertheless, several homeowners have found equity in their homes threatened or lost due to unscrupulous or unlicensed contractors who arrange home equity financing.
Here are the stories of some victims of overpriced, disaster-related loans:
EVA D.of San Francisco is a 55-year-old widow and 36-year resident of her Potrero Hill home. Ms. D. said she was lured into a loan with a lender after being approached by a contractor and loan officer who offered to repair damage done to her house during the Loma Prieta Earthquake. Mrs. D. could not read or sign the loan documents because she suffers from glaucoma and had broken her eyeglasses before the meeting. Instead, the loan officer had her sign a blank piece of paper.
Her income at the time of the loan was less than $1,200 per month, but the lender arranged for a $150,000 loan, charging $23,000 (over 15 points) in loan origination fees. The loan consolidated her existing mortgage indebtedness of $58,000. The balance was for the repairs to the home which was estimated to cost $70,000.
The loan more than tripled Ms. D.’s monthly loan payments from $619 to just under $2,000 per month. The repairs to her home were never completed by the contractor, whom Ms. D. later discovered was unlicensed.
While Mrs. D. was unrepresented by counsel, an arbitration decision was rendered against her. Mrs. D’s home was sold at trustee’s sale on April 21, 1993 after unsuccessful attempts by her present attorneys to have the arbitration decision set aside. When Mrs. D. was evicted on February 16, 1994, she was carried out of her home in a wheelchair by paramedics and taken to Mt. Zion hospital.
Since that time, Mrs. D. has been staying with different relatives and has been hospitalized for high blood pressure and diabetes. She has lost her home and continues to search for affordable housing. Her case against the lender is still pending in the courts.
WILNA A. is an 80-year-old woman with a tenth-grade education who has owned her Los Angeles home since 1971. She and her 86-year-old husband live on a small, fixed income. After the Northridge Earthquake, Mrs. A. received a telephone call from a woman who claimed she worked with the Federal Emergency Management Agency (FEMA). She asked Mrs. A. if she needed food stamps to recover the food she lost because of the power outage. She also told Ms. A. that FEMA would send an inspector to Mrs. A.’s home.
The next day, a man claiming to work with FEMA came to Mrs. A’s home and convinced her to sign several documents. He told Mrs. A. that the documents were FEMA applications and promised her he would immediately take these applications to FEMA for processing. Instead, the documents turned out to be a home improvement contract with a building contractor and a financing contract through a lender two companies which often do business with each other and are run by cousins. Work was begun before the end of the three-day right of rescission period required by federal law. Liens were placed on her home for $32,635.68 for exterior paint, roof shingles, and a garage door.
Mrs. A. did eventually receive an injunction and settlement from the two companies, and the home’s title was reconveyed to her, the loan was discharged, and she received punitive damages as a result of the settlement.
ADDIE C. of San Francisco is a 43-year-old licensed home healthcare specialist who runs a board and care facility in her home. She cares for six adults with disabilities ranging from emotional difficulties to cerebral palsy.
In November of 1989, a loan officer from a finance company appeared at Addie C.’s home and asked whether she needed any financing to help complete refurbishing of two flats in her home, which had been damaged by the Loma Prieta earthquake. She agreed, and the loan agent arranged a $33,000 loan (plus loan fees of $4,950, or 15 points).
After the initial reconstruction project was completed, she was able to obtain added income by increasing the number of adults she cared for. The loan officer suggested a debt consolidation loan that would pay off her first mortgage and the smaller previous loan the finance company had already given her. She agreed again, and they met at a K-Mart store in Redwood City to sign the papers. Upon receiving the documents, however, she noted that some of the pages were blank and that the note she signed did not include the loan amount. Her income was not verified before the loan was approved and she never saw completed loan documents until after the loan was consummated.
When she did finally see the completed documents, she learned she was carrying a loan of $286,500 (including loan fees totaling $42,975). Ms. C. immediately fell behind because the payments of over $3,300 per month exceeded her income level.
As a result of these loans, Ms. C.’s home was sold in foreclosure on February 24, 1993. (Ironically, shortly after she defaulted on this loan she received a letter from a "consultant" at the lender’s subsidiary, stating that the company had "over $800,000 allocated to assist the residents of San Francisco out of foreclosure and on to a strong financial path.") After eviction proceedings were completed, Ms. C. was forced to relocate herself and her board and care patients to a new location. She reports she had great difficulty locating another affordable residence large enough to continue providing board and care to her clients, and many of them suffered trauma and disorientation as a result of the move. Her case against the lender is still pending.
Another form of home equity abuse inflicted on homeowners is so-called foreclosure "rescue." Homeowners who fall behind in their mortgage payments may have notices of default entered against them by the lender. These notices mark the beginning of the foreclosure process and are a matter of public record in the County Recorder’s offices. Lenders combing the files at the recorder’s office use default notices to target people for "foreclosure rescue" services, often in the form of a "refinance" loan. Although the loans are presented to consumers as a "bailout," the truth is they generally postpone the inevitable loss of the home while draining most or all of the homeowner’s remaining equity. Frequently, homeowners who must resort to this type of emergency, last-ditch financing would be better off selling the home earlier than accepting a short-term "rescue" at such a high cost.
Typically, homeowners in default are bombarded with unsolicited visits, phone calls and mailings (such as the one Addie C. received from a company affiliated with the lender) from so-called "foreclosure rescuers." For example, one Bay Area borrower in foreclosure saved more than 50 letters she received over a three-year period from consumer finance lenders, attorneys, real estate licensees, private investors, real estate appraisers, developers and others.
The overwhelming message of these sales pitches is "help is on the way even if the situation seems hopeless." These lenders claim to offer credit without a verifiable source of income as long as there is equity in the borrower’s home. Often, a "rescuer" will persuade an unsuspecting homeowner to deed the property to him by making lofty promises. In exchange for the deed to the property, the "rescuer" promises to make all mortgage payments, help the homeowner restore his credit, and allow the homeowner a lifelong right to stay in the home as a renter.
Recognizing that homeowners whose residences are in foreclosure are particularly vulnerable to illegal and unfair practices, the California Legislature in 1979 enacted Civil Code section 2945 et seq. to protect the public in foreclosure consulting transactions. In addition to requiring written foreclosure consulting service agreements, the statute also permits the homeowner to rescind the contract, prohibits misleading representations, and encourages fair dealing. Unfortunately, this statute has not eliminated foreclosure consultant abuses because it exempts eight classes of potential consultants from the statutory definition of "foreclosure consultant" subject to statute’s prohibitions. The exempted groups include two of the most common types of foreclosure rescuers, consumer finance lenders, and real estate licensees (making a direct loan to a homeowner from the licensee’s own funds).
The promises foreclosure rescuers use to lure homeowners are rarely honored. For example, a so-called rescuer may take title to the house and agree to make the payments, then collect rent from the homeowner but fail to make the mortgage payments. In Los Angeles, for example, the FBI and U.S. Attorney’s Office are investigating a man named Bernard Gross (he changed his name to David Love Paris in 1993, but uses his old name). The Los Angeles Times reported that