PREDATORY MORTGAGE LENDING: A PROFESSIONAL PERSPECTIVE by Luke Erickson

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PREDATORY MORTGAGE LENDINGA PROFESSIONAL
PERSPECTIVEbyLuke Erickson
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Background

• Homeownership has been encouraged over the years.
• Homeowners are thought to be more productive and
  more stable citizens.
• The political environment encourages homeownership

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There is a lot more money available for home
loans than there was 20 years ago(Engel McCoy).

• Deregulation
• Increased technology
• Secondary market
• International investing

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Prime Market
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Prime Market (Engel McCoy, 2001)

• Traditional loans
• Minimal fees
• Standard interest rates
• Requires 20 down
• Customers generally have steady employment and
  good credit.
• These loans primarily originate with banks
  (depository institutions).

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Market Separation
Subprime Market
Prime Market
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Subprime Mortgage Market

• Non-traditional loans
• Higher than average fees
• Higher than average interest rates
• Often does not require a substantial down payment
• Customers usually have bad credit and unsteady
  employment.
• These loans primarily originate with
  non-depositories (non-banks).

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Predatory Lending

• Banks used to red line
• Certain lenders today actually green line those
  populations (Lord, 2005)
• Target individuals who are naïve, or not
  particularly financially savvy, and lack
  connections to the prime market (Engel McCoy,
  2001).
• Deception, unethical procedures, and hard sell
  tactics are used to trick and trap these
  borrowers
• Disproportionately benefit the lender, and harm
  the borrower (Engel McCoy, 2001).

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Overlapping Markets.
Subprime Market
Prime Market
Predatory Loans
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Overlapping Markets.
Subprime Market
Prime Market
Predatory Loans
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How does mortgage fraud fit in?(Federal Bureau
of Investigation, 2005)

• Fraud is illegal activity.
• There are two kinds of fraud.
• Fraud against the lender
• Fraud against the borrower

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Overlapping Markets.
Predatory Loans
Subprime Market
Prime Market
Fraud against the borrower
Fraud against the lender
Mortgage Fraud
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• HUD/Treasury joint report (2000), predatory
  lending is difficult to define and therefore
  difficult to regulate and control.

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Purpose of this Study

• To define and describe predatory mortgage lending
  in Utah.
• Qualitative research study,
• Interviews with 12 full-time mortgage
  professionals from around the state of Utah.

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Objectives

• 1. Conceptualize a definition of predatory
  mortgage lending.
• 2. Determine the extent or magnitude of predatory
  loans in Utah.
• 3. Identify the common characteristics of
  borrowers who end up with these loans.
• 4. Identify the major factors behind the
  existence of high cost and abusive home loans.
• 5. Document specific predatory practices seen in
  home loans.
• 6. Determine optimal strategies for reducing
  predatory mortgage lending in Utah.

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METHODOLGY AND PRODEDURES
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Qualitative research paradigm

• Unlike quantitative data, numbers are not the
  objective of this research.
• The goal was to collect highly detailed and
  descriptive data (Rubin Rubin, 2005).

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Sampling

• 12 full time mortgage professionals
• 4 consumer advocates
• 4 industry advocates
• 4 neutral participants
• 182 years of collective experience

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Interviewing

• 7 Main Questions
• Follow-ups and probes
• Two pilot interviews

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Data Recording Procedures

• Written notes
• Key verbal responses
• Initial concepts and themes
• Other thoughts and reflective notes
• Interviews were also audio recorded
• Later transcribed into text

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Data Analysis Procedures

• Read through interviews individually.
• Assigned content to major categories
• Using NVivo7 computer program organized material
  by topic
• Identified subtopics, arranged content accordingly

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RESULTS
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Definition

• Targeted practices that intentionally exploit the
  vulnerabilities of borrowers.
• In use and description it was much more than
  that.
• Predatory lending is misunderstood.
• Meaning is often associated with the perceptions
  of those who use it
• Can sometimes carry negative connotations,
  attacking implications, or stigma.

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• On the inadequacy of the term predatory lending
  one branch manager complained
• I dont like the term predatory lending.
  Theres something about that term that really
  bothers me as a lender. But I dont know a
  better term for it. And thats the term
  everybody is using, but its such a broad
  paintbrush that I wish someone would come up with
  a better definition for it, and figure that out.
• The conclusion is that the term predatory lending
  serves as more of an obstacle to common
  understanding, than a tool

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Unfair Lending

• The term unfair lending was used throughout the
  remainder of the study to refer to all instances
  of predatory, abusive, fraudulent and harmful
  lending
• Unfair lending as defined by participants is one
  or more of the following
• a) a transaction without a fiduciary duty or
  having the borrowers best interest in mind,
• b) a transaction the borrower does not completely
  understand for any reason including age, language
  barrier or lack of financial savvy,
• c) a transaction that has no beneficial use or
  results in harm to the borrower,
• d) a loan that delivers the lender excessive
  profits, and
• e) a loan that the borrower does not have the
  ability to repay.

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New findings

• Term predatory lending itself was an obstacle to
  achieving common understanding.
• Distinction between targeted and untargeted abuse.

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Overlapping Markets.
Predatory Loans
Subprime Market
Prime Market
Fraud against the borrower
Fraud against the lender
Mortgage Fraud
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Overlapping Markets.
Abusive Loans
Predatory Loans
Subprime Market
Prime Market
Fraud against the borrower
Fraud against the lender
Mortgage Fraud
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Overlapping Markets.
Unfair Loans
Abusive Loans
Predatory Loans
Subprime Market
Prime Market
Fraud against the borrower
Fraud against the lender
Mortgage Fraud
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Magnitude

• Unfair lending in Utah is directly indicated by
  the default, foreclosure, and bankruptcy rates in
  the state.
• Because Utah has ranked in the top ten in each of
  these categories over the last several years,
  this indicates that unfair lending in Utah is
  widespread and rampant (ABI, 2004 Mitchell,
  2003 Federal Bureau of Investigation, 2005).

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Victim Characteristics

• In the literature, borrowers are nearly always
  seen as the sole victims in unfair lending
  (Calem, Hershaff, Wachtor, 2004 Engel McCoy,
  2001 Lord, 2005 Zimmerman, Wyly Botein,
  2002).
• Investors, the industry itself, and sometimes
  even co-conspirators in fraud attempts can become
  victimized to a degree.

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• Similar to reports in literature, borrowers are
  more vulnerable due to certain personal and
  financial attributes, such as being elderly,
  minority, low-income or bad credit (Newman
  Wyly, 2002 Zimmerman, Wyly Botein, 2002).
• Unlike the literature, participants also
  explained that borrowers are generally unprepared
  mentally and emotionally to enter home loan
  transactions.

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Victim Characteristics
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Personal Attributes

• Young borrowers are exploited because of their
  naivety.
• Older adults because of the build-up of home
  equity accumulated over a lifetime.
• Minorities language barriers.
• Lending cannibalism, involving a lender or
  broker of the same ethnic background taking
  advantage because of assumed trust
• Anyone could potentially be a victim.

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Emotional Characteristics

• Hasty refinancing and buying decisions.
• Peer pressure can be very intense. One housing
  counselor related an example They werent even
  thinking about buying a home until they heard
  their friends had one . . . their friends told
  them, Hey, go ahead and get one too.
• The desire for instant credit or instant
  gratification also was an emotional factor.
• 100 financing, the first 80 at double the prime
  rate and the last 20 at quadruple the prime
  rate.

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Inadequate Financial Skills

• Inches of paper work at closing of the loan.
• A regional lending manager explained, I would
  dare say a very, very small percentage of the
  population understand what they are signing, and
  understand the terms of their loan.

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Factors

• Literature - unethical and irresponsible market
  actors (Engel McCoy, 2001).
• Participants agreed, but indicated that
  irresponsibility and lack of accountability
  persists on both sides of a transaction.
• Most unfair, predatory, or abusive acts
  that occur to victims are actually fully
  disclosed in the paper work

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• The mortgage lending market is complex and vast
• Conflicting incentives
• Market structure
• Legal jurisdictions
• Victim redress
• Literature does address each of these issues to
  some extent, though they are not emphasized as
  they were by participants (Engel McCoy, 2001
  Lord, 2005 Sturdevant Brennan, 1999)

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Practices

• According to literature, unfair loans are the
  result of harmful loan features (Sturdevant
  Brennan, 1999).
• Participants explained that loan features are not
  in and of themselves unfair, but rather become
  unfair only when misused.
• Misunderstanding has led several aggressive state
  legislatures to ban certain lending features
  (Lord, 2005 Quercia, Stegman, Davis, 2003).
• adverse consequences in some states (Downey
  Barr, 2006).

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Prevention
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Change the Laws

• Prohibitive legislation in the literature (Engel
  McCoy, 2001 Quercia, Stegman, Davis, 2004).
  
• Participants generally disagreed.
• Free market approach, with increased
  accountability for unethical actions
• Increased penalties
• Licensing
• Jurisdictional boundaries
• Mandatory borrower education
• More efficient victim redress

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Consumer Activism

• Legislative efforts
• Work with other community partners to create a
  fair housing committee.

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Education

• Literature often downplays education (Engel
  McCoy, Lord, 2005).
• Participants emphasized education as the primary
  method of reducing
• Consumer education is paramount.
• Homebuyer education courses are encouraged by
  participants as a short term remedy, as similarly
  echoed in the literature (Lord, 2005).
• But this is only a short term solution to a much
  larger problem.

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• Long term solution
• extensive exposure to financial education courses
  in the secondary schools, colleges, and
  communities
• Barely discussed in literature (Engel McCoy,
  2001).

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When asked to rate the importance of financial
education one expert replied

• I rate it a ten, in my opinion, on a scale of
  one to ten. Everybody has to go get a job,
  everybody is going to have credit of some kind
  somewhere or another down the road. . . I dont
  know how you manage in life without having some
  financial literacy. Now Algebra I would say one
  in ten might use it once they get out of school,
  but real life finances, everybody will use.

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Conclusions Implications

• Predatory Lending can be a confusing term and
  should be replaced.
• Predatory Lending in use refers to much more than
  targeted abuses.
• Less prohibitive legislation
• More accountability
• Financial Education

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Limitations

• Opinions of these twelve participants do not
  necessarily represent the opinions of the entire
  lending community of Utah
• this is an exploratory study to be built upon and
  is not a conclusive study
• Chain/snowball sampling
• Assignment of participants to the categories of
  consumer advocate, industry advocate, and neutral
  participant
• Primary Researcher bias

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Future Research

• Supplemental quantitative study
• Qualitative study to interview victims
• Financial education
• Issues of timing
• Methods
• Optimal quantity and frequency

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Questions?