The Predator

19 03 2007

There are some stories that you stumble upon, and you just read and mentally file, then there are some you must simply share.  You need to know the difference between legitimate lenders, and predatory “loan sharks”.  Ya, the deal may sound great, but you know the saying, if it sounds to good to be true, than it probably is.  Northern Virginia Association of Realtors (NAVR) has some pointers to help you weed out the junk mail. 

Know the Basics
Before we look at abusive lending practices, a quick review of lending fundamentals is in order. All kinds of loans, including home mortgages, work pretty much the same way: the lender offers the borrower financing terms based on the amount of risk the lender believes that borrower poses. Using employment history and debt repayment records, lenders assign each borrower a rating or score designed to reflect the likelihood that the lender will receive repayment in full.

Not so long ago, home mortgage lenders would extend credit only to the most qualified borrowers, those who posed little to no risk of loss. Mortgage bankers called loans made to these highly qualified customers “prime” or “conforming” loans. People with a blemished credit history, or no credit history, usually could not obtain financing, and thus were locked out of the housing market. In response to this underserved market segment, some lenders decided to offer home purchase financing to non-prime borrowers.

The terms of these “sub-prime” loans reflect the greater risk undertaken by the lenders and have some distinctly different characteristics. As compared to prime loans, sub-prime loans usually have higher points, higher interest rates and larger pre-payment penalties. They may also have shorter repayment terms or interest rates that adjust more frequently. Thanks to these sub-prime (or non-conforming) loans, however, millions more Americans have become homeowners. The importance of sub-prime loans to our economy cannot be overstressed: without them, hundreds of thousands of Americans would never be able to own their own homes.

Know the Risks
Unfortunately, some of the same characteristics that make non-confirming loans flexible and accessible also make them a great fee-generating vehicle for the unscrupulous. While there is no dictionary definition for the term “predatory lending,” the Federal Trade Commission describes a predatory loan as “an unsuitable loan with abusive terms.” On the surface, these loans may look as though they provide a benefit to consumers by giving them the money to purchase or refinance a home. A closer examination, though, may reveal that only the lender benefits.

When asked to evaluate any loan, one of the questions you need to ask is whether the loan seems to fit the borrower: Is the lender offering to lend more than the property is worth? Does the interest rate seem to be based on that particular borrower’s credit worthiness? Is the lender offering to lend more money than the borrower can afford to repay? Will the borrower have to pay a penalty for paying the loan back early? Does the Good Faith Estimate show a large discrepancy between the stated interest rate and the APR (indicating hidden fees)? Do the costs and terms at closing match those the borrower has agreed to?

Good lenders will work to make sure that the loan product that the borrower selects works for both lender and borrower. Abusive lenders work to ensure their own short-term profit at the borrower’s expense.

Below is a useful resource from NAR. Use these guidelines to help educate yourself and your clients so that they (and you!) don’t fall prey to abusive lenders.

Yellow Light?
Possible warning signs that may indicate an abusive loan:

  • Interest rates or fees that are much higher than the local market average
  • Balloon payments or payments that will greatly increase over the life of the loan
  • Prepayment penalties or other barriers to refinancing
  • “No down payment” loans
  • Short “Introductory Rate” periods
  • Inflated property appraisal
  • Offers to lend more money than the borrower has the ability to repay
  • Fees for nonexistent products or services (junk fees)
  • Unethical loan document management
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