Consumers Union, West Coast Regional Office
Hearing before the Federal Reserve Board of Governors Predatory Lending Practices
Docket No. R-1075
San Francisco, September 7, 2000
On behalf of Consumers Union (1) , I would like to thank you for this opportunity to address the Federal Reserve Board of Governors. We commend the Federal Reserve for its leadership in examining more closely the phenomenon of predatory lending practices in the home equity market and their deleterious effect on the American public. It is our hope that these hearings will result in the Board using its rulemaking authority to curb predatory home equity lending practices that have stripped the homes and equity from countless Americans.
Consumers Union has studied the problem of predatory lending and included our findings in two reports: Dirty Deeds: Abuses and Fraudulent Practices in California’s Home Equity Market (1995), and The Hard Sell-Combating Home Equity Lending Fraud in California (1998). We have also examined the potential for the financial abuse of senior citizens with another equity-based mortgage product, the reverse mortgage, and have published our findings in a 1999 report entitled, There’s No Place Like Home, The Implications of Reverse Mortgages on Seniors in California.
In our examination of predatory lending, we found that the practice of intentionally making equity-based loans on impossible terms is not new and is not unique to California. In 1998, Consumers Union found that in California, the estimated losses due to home equity lending fraud and overpriced, unfairly induced loans ran at least into the tens of millions of dollars and very possibly hundreds of millions. The victims are mostly elderly, minority and low-income residents who have owned their homes for many years. Although many of the victims have few cash assets, they have built tremendous equity through decades of hard-earned mortgage payments and appreciating real estate values. This has made these individuals prime targets for predatory lenders.
In our reports, we cite many cases where lenders aggressively sought out unsuspecting borrowers for equity loans with interest rates as high as 30%, and fees of 20 or more points. Many loans cited in our reports had terms that are clearly stacked against the borrower, such as, mandatory arbitration clauses, balloon payment provisions, and stiff pre-payment penalties, to name a few.
Several of the cases cited involved violations of existing lending laws and regulations. However, the sad reality is that while many of the practices complained about by the borrowers are unfair, abusive and even immoral, many of them are not illegal.
There are many subprime lenders who defend the practice of charging high interest rates and fees by saying that they are performing a community service by lending to those without other borrowing options. Indeed, there may be those for whom they are providing necessary financial services who have been denied a mortgage from a conventional source. However, there is another segment of the subprime industry, the predatory lenders, who aggressively cast a wide net to ensnare any potential borrower into an expensive mortgage. This pool of potential borrowers can include those not looking for a loan in the first place, those not savvy enough to know that they could qualify for a better priced loan on better terms, or those who succumb to hard sell tactics and find themselves in financially impossible loans that may cost them their homes.
Until regulators and legislators enact serious protections against predatory lending, particularly against those practices which are not technically illegal, predatory lending will continue to flourish. Because of California’s soaring real estate values and the high percentage of California’s home equity held by senior citizens, fully 72.5% of the state’s seniors are homeowners, our senior population will continue to be heavily targeted by predatory lenders. Seniors who live on fixed incomes, or in minority or low-income communities abandoned by conventional lending institutions, are at increased risk as their diminished borrowing options make them ripe prey for predatory lenders.
Consumers Union firmly believes that a multi-prong approach is necessary to stem the tide of home equity lending fraud and abuse. Certainly, the public needs to be active in protecting itself from the pitfalls of predatory lending. Additionally, the federal government must act to ensure that it is not the public policy of this nation to allow any business to engage in practices that result in unsuspecting borrowers losing their homes to impossible loans. Today presents an opportunity for this Board to create new protections and to strengthen existing protections for America’s mortgage borrowers.
II. THE CREATION OF HOEPA
Finding an absence of state controls against abusive loans and laws that allow interest rates of up to 60% per year, Congress took action in 1994 in a bipartisan effort to provide some relief. The result was the federal Home Ownership and Equity Protection Act of 1994, which places special provisions on “high-rate, high-fee mortgages. High rate, high fee mortgages are defined in the Home Ownership and Equity Protection Act as loans with interest rates 10 percentage points above comparable terms for U.S. Treasury securities with similar maturities, (2) or a loan for which the consumer pays total points and fees exceeding the greater of $400 or eight percent of the total loan amount (including all costs and compensation for brokers). The provisions require creditors to provide disclosures at least three days before the loan is closed to borrowers whose loans are subject to the Act, in addition to those required by TILA. Transactions covered by HOEPA are subject to certain substantive limitations that prohibit certain terms from being included in the loan contract.
III. FEDERAL RESERVE REGULATORY AUTHORITY UNDER HOEPA
HOEPA requires that the Federal Reserve Board (hereinafter “the Board”) conduct public hearings to determine the adequacy of federal law in protecting consumers, particularly low-income consumers. HOEPA authorizes the Board to adjust HOEPA’s high-cost triggers, and to prohibit certain acts and practices in connection with mortgage loans if the Board makes the findings required by the statute.
IV. SUGGESTIONS ON HOW THE FEDERAL RESERVE BOARD COULD EXERCISE ITS REGULATORY AUTHORITY UNDER HOEPA TO ADDRESS CONCERNS ABOUT PREDATORY LENDING
While some individuals use the absence of a single precise definition as an excuse to stall any meaningful legislative reform, there is ample evidence that predatory lending practices continue to flourish. When HOEPA was instituted, the door was left open to determine if any weaknesses in its provisions continued to allow the very practices it was meant to prevent. Some argue that enforcing existing laws is all that is needed. Consumers Union believes that the answer is not that simple. Certainly, existing laws need to be enforced. Additionally, however, the Federal Reserve Board and others must act to close the loopholes in existing laws that circumvent the intent of HOEPA.
A. Adjusting the HOEPA Triggers
Lowering the trigger and including certain costs within the points and fees calculation is the best way to further the protections of HOEPA. This allows HOEPA’s protections to be extended to a broader class of transactions and guards against the possibility that a creditor will attempt to evade HOEPA by recouping higher costs associated with a loan by charging more fees/services that are not included in the HOEPA trigger calculations.
1. APR Trigger
HOEPA authorizes the Board to adjust the HOEPA trigger by 2 percentage points from the current standard of 10 percentage points above the U.S. Treasury securities with comparable maturities. Consumers Union believes that lowering the APR trigger to 8 percentage points would be effective in furthering the purposes of HOEPA. By lowering the APR trigger, more loans will be subject to HOEPA’s disclosures and restrictions thereby extending HOEPA protections to a broader class of loans. HOEPA was enacted to protect.
Lowering the APR trigger may have some impact on the availability and/or cost of subprime mortgage loans. However, judging by the increase of entrants into the subprime market after the enactment of HOEPA, one could conclude that the size of the subprime market will continue to attract interested lenders, even if greater protections for consumers are enacted.
2. Points and Fees Trigger
HOEPA protections are triggered if the points and fees paid by the consumer exceed the greater of 8 percent of the loan amount or $400. “Points and fees” include all items included in the finance charge and APR except interest, and all compensation paid to mortgage brokers. HOEPA specifically excludes from the “points and fees” provision reasonable closing costs that are paid to an unaffiliated third party.
Consumers Union recommends that the Federal Reserve Board should use its authority under HOEPA to add additional fees to the calculation that triggers HOEPA protections. Lenders will often add additional products or restrictions that drive-up the cost of the loan but are not included in the current definition of “points and fees” and therefore do not trigger HOEPA protections. These fees can include optional but aggressively marketed credit life insurance, and prepayment penalties which, when triggered, may significantly increase the cost of a loan.
a. Credit Insurance
With respect to credit insurance, mandatory credit insurance premiums are considered to be finance charges that are applicable to both the APR and points and fees triggers. However, optional credit life insurance premiums are not included in the points and fees test but should be. The current HOEPA distinction turns on whether these products are mandatory or optional. An alternative way of looking at credit insurance, and perhaps a more appropriate approach given the objectives of HOEPA, is to look at what all forms of credit insurance fail to offer the consumer, and the incentive for lenders to push credit insurance because, 1) the high profit margins these products generate, and 2) the exclusion of optional credit life insurance premiums from cost assessments for HOEPA protections.
Credit insurance is a bad deal for consumers. In March 1999, Consumers Union and the Center for Economic Justice issued a report entitled, Credit Insurance: The $2 Billion a Year Rip-Off-Ineffective Regulation Fails to Protect Consumers. We reported that from 1995 to 1997, more than $17 billion of credit insurance was sold in the United States. We estimated that credit insurance consumers were overcharged by over 35 percent of the amounts they pay and determined this fact by looking at credit insurance loss ratios. We reported that the credit insurance industry had a loss ratio equal to 40 percent for credit life and credit disability insurance in the 1995 to 1997 period, compared to the 60 percent recommended by the National Association of Insurance Commissioners (NAIC). Most states have failed to protect consumers from the implications of these low loss ratios and we concluded that as a result of ineffective regulation, consumers overpay for credit insurance by $2 billion dollars a year.
The target market for credit insurance is typically lower-income consumers. Because low-income consumers are most in need of the underlying loan, these consumers are most vulnerable to coercive sales tactics for credit insurance. In our opinion, the tremendous profit to producers from the sale of credit insurance has led to numerous instances of unfair and deceptive sales practices by credit insurers and producers over the years. Our report cites just three major examples from the past few years. Some of these tactics include tricking consumers into the purchase of credit insurance, high pressure sales tactics, shuffling the papers to produce two versions of the same document, the copy to the consumer omitting important documentation of the transaction, failure to disclose that the consumers signature resulted in signing up for credit insurance, and misleading consumers into believing that credit insurance is required for loan approval.
The effect of including lump-sum premiums collected at closing for optional credit insurance, from the consumers perspective, is the same as collecting the lump-sum premium at closing for mandatory credit insurance–it costs the consumer money. The consumer must pay additional fees to finance overpriced, often unnecessary credit insurance in addition to the fees to finance the loan. By treating optional credit insurance the same as mandatory credit insurance, for the reasons stated above, consumers who succumb to overpriced credit insurance sales practices, albeit “voluntarily,” will be afforded the same protections under HOEPA as those who are told that such insurance is necessary to obtain a loan. This change in HOEPA would help further the purposes of the Act to protect consumers from abuses of packing “optional” credit insurance into loans for the purposes of increasing profits and evading HOEPA’s provisions.
b. Prepayment Penalties
There have been many reports of “churning” by lenders, the practice of multiple refinances of a loan within a short period of time. The result for consumers has been that with each refinance, the consumer must pay additional points and fees associated with the loan, and in many cases prepayment penalties. With equity based borrowing, the result has been a stripping of consumers’ equity with each refinance. In some cases, multiple refinancing has resulted in consumers losing all of their equity to the lender.
To discourage this problem, the Federal Reserve Board can use its authority to broaden the class of points and fees that would trigger HOEPA protections.
The Board can include prepayment penalties (assessed on the original loan) in HOEPA’s points and fees test for the new loan when the loan is refinanced with the same creditor (or an affiliate).
Prepayment penalty provisions have been used by creditors to lock unsuspecting borrowers into costly, unfavorable loans. Prepayment penalties, by their very nature, reduce the value of the loan to the borrower by the cost that the borrower must pay to satisfy the penalty upon refinance with the existing or any other creditor. Clearly, the existence of a prepayment penalty should be assessed into the points and fees test under any circumstance as a “cost” associated with the loan. That some prime lenders allow borrowers to “buy out” of a prepayment penalty by paying a higher interest rate or additional points underscores the cost factor of prepayment penalties.
It follows, then, that when the same creditor or an affiliate of the creditor that first imposed the prepayment penalty refinances an existing loan, the cost of the prepayment penalty borne by the consumer should rightfully be subject to HOEPA’s points and fees test to further the intent of the Act. This would curb abuses by lenders who include prepayment penalty provisions to lock consumers into unfavorable terms only to use the borrower’s desperation as the basis for generating income, and in some cases, stripping equity through multiple refinancing.
The Board could add any points paid by the consumer for the existing loan to the points and fees test when the same creditor (or an affiliate) refinances the loan within a specified time period for the same reasons as outlined in the prepayment penalties section above.
B. Restricting Certain Acts or Practices under HOEPA
Consumers Union is aware that the Board has previously recommended to Congress that it consider prohibiting the advance collection of premiums for credit insurance policies in connection with HOEPA loans. We support this recommendation.
However, if no statutory prohibition is adopted, we believe the Board should regulate the conditions under which such policies are sold or financed.
The single, most effective measure the Board could take is to enact regulations that prohibit lenders from requiring a borrower to purchase credit insurance as a precursor to obtaining a mortgage. The Board should prohibit sales of prepaid single-premium credit life policies in connection with the origination of the mortgage, regardless of whether the premium is financed in the mortgage amount or paid from the borrower’s funds. This provision can be strengthened by imposing an additional restriction to not sell credit insurance for 30 days until after a loan has closed.
Disclosures can be useful for informing consumers about important information. They are, however, not as effective for implementing the intention of HOEPA, as the measures outlined in the paragraph above, which prevent the business practices that lead to abuses. As outlined above, should the consumer decide that he or she wants credit insurance, it will still be available at a time when the consumer can decide independently of the original loan transaction whether such insurance will be beneficial. Requiring a notification to the consumer after the loan closing of their right to cancel a policy and obtain a refund is not as beneficial to the consumer as separating the two transactions and allowing the consumer to decide after the fact if credit insurance is necessary. After the fact “notices” still leave the door wide open for abuses on the front end, and require the consumer to act proactively to remedy the abuse. It is our opinion that the abuses must be prohibited in the first place.
Consumers Union is aware that under HOEPA, a creditor may not engage in a pattern or practice of extending credit based on the collateral if (given the consumer’s current and expected income, current obligations, and employment status) the consumer will be unable to make scheduled loan payments.
It might be helpful to provide additional interpretive guidelines on the “pattern or practice” requirement, such as, “loans subject to HOEPA may not be consummated if payments on all existing debt exceed 40% of the borrower’s total income and should be void if miscalculations or misstatements are made by the loan officer so the contract can appear to meet this condition.” Exceeding a certain debt-to-income guideline helps establish a minimum standard for affordability and should be considered in light of other circumstances on a case-by-case basis to determine if a lender is extending credit based on a borrower’s collateral and not on the borrower’s ability to repay, as required by HOEPA.
Refinancing Lower-Rate Loans
It is appropriate for the Board to institute regulatory action to protect consumers from refinancing abuses where lower cost debt (many times unsecured) is refinanced and converted into higher cost, home-secured debt. We have seen many instances where lenders require borrowers to consolidate in order to refinance and in many cases, this consolidation includes previously unsecured debt and lower interest rate home-secured debt, such as special loans made by cities to finance home improvements for low-income seniors.
The Board can require that for loans that include refinancing of debt, the lender must demonstrate that the refinancing will result in lower overall costs for a borrower and add real economic benefit for the borrower. For example, a borrower should realize an appreciable effect on the mortgage interest rate, terms or payments in exchange for incurring new fees for the refinancing. Absent such a showing, refinancing of lower-rate loans should be prohibited.
Consumers Union is aware that HOEPA currently prohibits balloon payments for high-cost loans that have terms of less than 5 years. We are also aware of the practice of some lenders that price their loans just under HOEPA’s triggers in order to sell balloon payment loans not subject to HOEPA restrictions. Loans based on balloon payments-a large, final payment at the termination of the loan came into common use in the late 1970s and early 1980s when high interest rates made home buying unaffordable for many Americans. The purpose was to give homeowners an opportunity for lower payments through what became known as “creative financing.”
Although balloon payment loans may have provided an entry into the home ownership market, today, unscrupulous lenders use balloon payments to convince naïve borrowers they will receive funds for a lower monthly payment, knowing the borrower will eventually not be able to make the balloon payment. When the balloon come due, these lenders foreclose on the house or arrange for a new loan at even higher rates and fees. With each subsequent refinance, the lender consumes more of the borrowers equity in the form of fees and higher interest rates.
For all balloon payment loans, whether or not covered by HOEPA, the Board should prohibit balloon payments on home equity based loans unless the borrower has the option to fully amortize the payment at the end of the initial loan term.
The Board should prohibit “payable on demand” clauses in HOEPA loans unless such a clause is exercised in connection with a consumer default. Absent a consumer default, the clause acts as a balloon payment provision. When such a clause is contained in a HOEPA loan, all of the restrictions that apply to balloon payments in HOEPA loans should apply.
Misrepresentations Regarding Borrower’s Qualifications
Consumers would benefit greatly if the Board issued a rule that prohibits creditors or brokers from providing false or materially misleading information about a borrower’s creditworthiness. This would protect consumers against creditors or brokers who use inaccurate information to mislead borrowers into thinking that they might not qualify for better or cheaper credit elsewhere. Indeed, many borrowers have obtained high-cost loans believing that they could not have qualified for a better loan, or believing that this was the only way to meet their financial needs.
We believe that the Board should require that lenders or brokers offer loans of the highest grade possible for a given consumer. This includes not steering creditworthy borrowers to higher priced products when an applicant qualifies for a lower-cost standard mortgage product. Adding a provision requiring a subprime-only lender to offer a prime rate for a borrower who would qualify could strengthen this guideline. If a subprime-only lender cannot offer such a product, it should be required to refer the borrower to a prime lender who could.
Reporting Borrowers Payment History
The Board should require creditors to report a borrower’s positive payment history promptly and regularly to all of the national credit reporting bureaus. Positive payment history helps borrowers restore blemished credit records which allows them more borrowing options on better terms. Lenders should be prohibited from trapping performing borrowers into the high-cost credit world, especially when the motivation to do so is to keep good borrowers out of the competition’s reach.
Referral to Credit Counseling
The Board should institute a requirement for pre-loan counseling for all homeowners applying for loans that will result in debt payments exceeding 40% of income.
Conversations with dozens of victims of home loan scams reveal that many of them did not understand the impact of interest rates and points on the cost of a loan. Many of them did not realize that they could have qualified for a cheaper source of credit elsewhere or that there was a better alternative to achieve their financial goals. Many also did not understand the relationship between their monthly income and new monthly payments since they were told they could qualify for loans simply because they had equity in their homes.
Clearly, many abusive loans could have been averted if the borrowers had received pre-loan counseling from an independent consumer agency. Victims could have been made aware of lower-cost financing programs. Counseling can help the borrower determine how much money he needs to borrow-rather than simply taking what the lender offers-and to ensure that the loan documents are completed fully and accurately.
Mandatory counseling for borrowers whose total monthly debt payments (including non-mortgage payments) exceeds 40% of monthly income would create a disincentive for scammers to prey on the elderly and naïve, and would allow counselors to alert law enforcement officials about lenders exhibiting illegal or abusive practices. Counselors could include HUD approved counseling agencies, nonprofit community counseling services and community housing or consumer affairs organizations, those qualified to deliver financial counseling with no stake in the outcome.
While counseling would be mandatory, the borrower would still be free to choose to enter into a loan transaction against the counselor’s advice. Some borrowers may make this choice, but conversations with home equity loan scam victims indicate that they would have looked for alternatives if they had been given adequate information about the risks and nature of unfavorable loan terms.
The Board should require counseling for borrowers seeking to refinance an existing loan which has gone into default.
Homeowners on the verge of losing their homes are desperate for relief. They are among the most vulnerable of potential victims. Unfortunately, in many cases, it is often better to sell the home at the outset of the foreclosure process than to try rescue measures that may lead to a total loss of equity.
Homeowners who have had notices of default filed against them often are bombarded with rescue offers from lenders, mortgage brokers, attorneys and others. These often lead to desperate, expensive and ultimately worthless activities-such as high-rate loans that the homeowner has no chance of repaying. These pitfalls could be avoided through post-default financial and homeowner counseling by independent, nonprofit agencies.
Loan documents should include a statement, in bold face type, which clearly states that the borrower is entering into a contract with terms that exceed general market rates. The statement should be more direct and clear than what is required by federal law and written in the language in which the loan negotiations were conducted.
Consumers Union supports amendments to the required disclosures that more clearly alert consumers about the risks associated with high-cost borrowing. We have added our proposed changes to those recommended the Board and HUD in its 1998 report to the Congress. In addition to requiring written disclosure, lenders should be required to provide borrowers with oral disclosure of the contents of the following enhanced HOEPA disclosure:
Consumers Union supports inserting the total loan amount borrowed in the HOEPA disclosure to help inform the borrower of exactly how much he or she is borrowing. This would give borrowers a better idea of how high fees and interest rates increase the amount of actual indebtedness. In conversations with victims of predatory lending, we have found that many did not have sufficient, timely information about the effect of high interest rates and fees on the amount borrowed and would have looked for other alternatives if they had known.
The Board could require that HOEPA loan borrowers receive a complete Truth in Lending disclosure statement three days before closing. However, receipt of this disclosure should not be a substitute for an improved HOEPA disclosures as suggested above.
Open-End Home Equity Lines
Consumers Union is aware that HOEPA does not cover home-equity lines of credit and that some creditors have structured loans as open-end to avoid HOEPA’s provisions. We believe that the Board should prohibit the practice of structuring a home-secured loan as open-end credit in order to evade the provisions of HOEPA. One way of identifying such spurious open-end credit transactions is by looking at whether the borrower immediately draws on the entire credit limit or close to that amount in an initial transaction.
Community Outreach and Consumer Education
As mentioned earlier, community education and outreach is a very important component to the multi-prong approach that is required to prevent predatory lending. Well-informed consumers are less likely to fall victim to the multitude of practices that can ensnare them into expensive and impossible loans that can cost them their homes. We must emphasize, however, that community outreach and consumer education efforts alone are not enough to stop predatory lending. Education efforts cannot be substitutes for meaningful regulations and laws designed to prevent the practices that lead to predatory lending. Enforcement of effective regulations and laws is also a very necessary component.
Consumers Union recently completed a two-year grant funded community education project in five San Francisco Bay Area counties. Our focus was on educating the most likely and most vulnerable victims of home equity lending fraud-the working poor, or retired seniors, who bought homes more than 20 years ago and now have significant equity, but barely any income. In the two-year period, we conducted over 75 community education seminars and reached more than 3,000 Bay Area low-income and senior homeowners through community education seminars and provided brochures in English and Spanish. Don’t Lose Your Home: Home Equity Fraud explains how to avoid loans with unfair terms; Guarding the Golden Years: Reverse Mortgages discusses the pros and cons of seniors tapping into the value of their homes in regular payments for a specified time. We also gave them important resource information on city and county sponsored alternative loan programs for home improvements available to qualified borrowers. We have included copies of our educational materials with this testimony.
Another important component of our project was to train direct service providers such as social workers from county Adult Protective Services agencies to recognize signs of predatory lending within their client base. Additionally we trained more than 125 members of the California District Attorney’s Association on how to spot equity fraud and abuse.
This is but one example of a community education project that can be employed to deliver the message about the dangers of predatory lending. A project such as this could be easily expanded out into a larger geographic area or could be duplicated in other locales. With adequate funding, consumer education on this topic could be much broader in its scope. One level of a public education campaign can be to reach large populations through billboards, and other forms of mass advertising. However, it is still important to get out into the communities that are most affected by predatory lending and use community leaders to speak to people about how to protect themselves, and what to do if they have already fallen prey to a predatory lender.
Pre-loan counseling is a very important form of consumer education which we support and discussed earlier. To make assistance accessible, realtors and title insurers should help fund free or low-cost counseling and education programs administered by nonprofit groups or governmental agencies.
Consumers Union thanks you for this opportunity to share our recommendations with the Board of Governors of the Federal Reserve System. In March 2000, the New York Times, in an extraordinary report on subprime lending, reported that the subprime industry has boomed, growing from a $20 billion dollar industry in 1993 to a $150 billion dollar industry in 1998. Most of the reports of abusive and fraudulent home equity lending practices we have received from consumers involve subprime lenders, the segment of the lending industry that generates the bulk of HOEPA loans. The time is long overdue to expand consumer protections within HOEPA so that as the subprime industry grows, current pitfalls and hazards for consumers do not expand as well.
(1) Consumers Union, publisher of Consumer Reports, is an independent, nonprofit testing and information gathering organization, serving only the consumer. We are a comprehensive source of unbiased advice about products and services, personal finance, health, nutrition, and other consumer concerns. Since 1936, our mission has been to test products, inform the public, and protect consumers.
(2) For example, if the 10-year Treasury security rate was at 8 percent, a 10-year home equity loan would be covered by the Act if its interest rate was 18 percent or higher.