The following excellent article on the new North Carolina predatory mortgage lending law was written by Carlene McNulty and was originally published in The Pro Bono Connection (Volume 14, No. 1), a publication of the North Carolina Bar Association.  McNulty is the Litigation Coordinator/Attorney with the N.C. Justice and Community Development Center.  The author and The Pro Bono Connection have kindly consented to the posting of this article on our web site. See also the attribution credits at the end of this article.

PREDATORY MORTGAGE LENDING

By Carlene McNulty

Scope of the Problem:

Historically, home ownership has been the primary way for families to build economic security and transfer wealth from generation to generation. Over 65 percent of Americans now own their own homes. ¹  Increasingly over the last decade, however, our most vulnerable homeowners have been put at risk of losing their homes and financial security by predatory lending practices. Predatory lenders target elderly and other unsophisticated consumers and use an array of practices to strip the equity from their homes. The abusive practices include excessive loan fees, costly insurance policies, large "balloon" payments, high interest rates, and frequent refinances.

Home loans for consumers with low or irregular income or less than perfect credit records are readily available in the "subprime" market. The subprime mortgage industry has grown dramatically over the past few years, experiencing an increase from $20 billion in loan originations in 1993 to more than $150 billion in 1998. ²  This growth, and accompanying increase in high profits, has attracted new lenders and mortgage brokers to the market. The number of mortgage brokers originating subprime mortgages in the U.S. today is over 18,000, triple the number just five years ago. ³  The unprecedented expansion in the industry has been fueled by investment banks on Wall Street, which have raised more than $316.2 billion for subprime lenders since 1989. ⁴   Together, these factors have resulted in more aggressive competition for loan volume among originators, providing greater incentive and opportunity for abusive lending practices to occur.

Predatory lending is particularly devastating to its victims because subprime borrowers typically seek home equity loans at a time of great financial need. Consumers are in the weakest bargaining position at that time and most susceptible to practices that can strip them of substantial sums of money and, ultimately, their homes.

Some specific predatory lending practices:

The following specific practices are common in the subprime mortgage market:

Deceptive and Targeted Solicitations: Predatory mortgage lenders and brokers engage in extensive marketing in targeted neighborhoods, most often with a high percentage of African American and/or elderly residents. They advertise through a variety of means, including television commercials, direct mail, signs in neighborhoods, telephone solicitations, door-to-door solicitations, and fliers stuffed in mailboxes. Many of these companies deceptively tailor their solicitations to resemble social security or other U.S. government checks. Many brokers and lenders advertise "bill consolidation" home equity loans--encouraging consumers to pay off credit card, retail and motor vehicle debt by consolidating them all into one home loan and promise to reduce the monthly debt payment. This practice of "selling the monthly payment" misrepresents the benefits and risks of home equity loans.

Mortgage Broker Fees and Kickbacks. Most consumers who contact a mortgage broker expect the broker to arrange a loan with the best terms and at the lowest possible rate. In the subprime market, however, there are mortgage brokers who do just the opposite. A system of "reverse competition" has been created wherein the broker will attempt to find a loan with the most fees and highest rate possible so that the broker will get more compensation. It is not uncommon for a broker to charge fees of up to 8 to 10 points. On a $100,000 loan, that means the borrower is paying and financing an additional $8,000 to $10,000. In addition, the broker may get additional compensation for arranging a higher than necessary interest rate for the consumer. For example, if a consumer qualifies for a 10% interest rate, but the broker can arrange the loan at 11%, the broker will get compensated for his or her efforts by the lender. This method of indirect payment, commonly referred to as a "yield spread premium," is not clearly disclosed to the borrower.

Excessive Rates and Fees. It is not uncommon for predatory lenders to charge interest rates of 16 -18%, double that of conventional rates. In addition to reaping the profits from the high interest rates, predatory lenders charge borrowers an array of fees on their loans, including loan origination fees, discount points, underwriting fees, document fees, processing fees, and other "junk fees." It is not unusual to see loans with fees exceeding 10 percent of the loan amount. These fees are not paid in cash by the borrower at the time of loan closing, but are rolled into the loan and financed at the high rate of interest along with the loan principal. Even if the borrower may later be able to refinance the loan later at a lower interest rate, s/he cannot get any rebate on the fees because they are earned at the loan's inception.

Home Improvement Scams. Some predatory mortgage lenders use local home improvement companies essentially as mortgage brokers to solicit business. These companies solicit homeowners for home improvement work. The company will then either originate a loan for home improvements and then sell the mortgage to a predatory lender, or steer the homeowner directly to a predatory lender. The home improvements are often grossly overpriced, and the work is shoddy and incomplete.

Balloon Payments. Predatory lenders frequently structure the amortization of loans so that over the term of the loan, the borrower's payments are applied primarily to interest. This method of financing will result in a huge "balloon" payment at the end of the repayment term, usually after 15 years. The last payment is often almost as much as the principal amount borrowed. In most cases, this method of financing is not explained to or understood by the borrower.

Excessive Prepayment Penalties. Predatory mortgage lenders often impose exorbitant prepayment penalties. This is done in an effort to lock the borrower into a no-win loan for as long as possible by making it difficult to refinance or to sell the home. If the borrower prepays the loan, the lender still gains.

Flipping. "Flipping" is the repeated refinancing of the consumer's loan. Flipping is done by rolling the balance of the existing loan into a new loan instead of simply making a separate, new loan for the new amount. As soon as the consumer has paid down the loan slightly, a predatory lender may encourage the consumer to refinance and get more cash out of the available equity in his home. Each time the loan is refinanced the lender charges more fees, placing the borrower further in debt over a longer period of time. Flipping always results in higher costs to the borrower.

Insurance Packing. "Packing" is the practice of adding unwanted extras to the loan without the borrower' s full knowledge. One of the most prolific products added to consume loans is credit insurance. Some predatory mortgage lenders market and sell credit insurance through deceptive schemes that impose these items without the knowledge or consent of the borrower. Credit life and disability insurance is almost always overpriced and a poor value for consumers. In mortgage loans , the cost can be enormous. The credit insurance premium, which can exceed $10,000, is added to the loan amount and financed over the life of the loan, earning more interest income for the lender in addition to the commission and/or profit from the sale of the insurance. Coverage does not even extend for the life of the loan.

A Legislative Solution to Combat the Problem:

The enormous loss in home equity caused by these and other predatory lending practices has been receiving increasingly more attention at the national level. Federal Reserve Chairman Alan Greenspan raised the profile of the issue by announcing on March 22, 2000 that the Federal Reserve is concerned about "abusive lending practices that target specific neighborhoods or vulnerable segments of the population and can result in unaffordable (mortgage) payments, loss of homeowners' equity and foreclosure." ⁵  Housing Secretary Andrew Cuomo announced a week later that HUD will propose new laws to fight the problem. ⁶  Comptroller of the Currency John D. Hawke Jr., who oversees nationally chartered banks, also criticized the practice of predatory lending in a speech to a community investment group recently. ⁷

North Carolina, however, has become the first state in the country to comprehensively address the problem of predatory mortgage lending. It did so with the passage of Senate Bill 1149, "The Act to Prohibit Predatory Lending," on July 22, 1999. This legislative action is drawing national attention. Legislation based on North Carolina's model is now pending in at least six other states and is being carefully considered in many others.

The Act amends and clarifies Chapter 24 of the North Carolina General Statutes. The Act adds important consumer protections to all consumer home loans, while establishing increased protections for a newly established category of "high cost" loans. The protections that apply to all home loans include a prohibition on the financing of prepaid single premium credit insurance and a general prohibition on loan flipping. Also, the Act clarifies what fees and closing costs are permissible. The amended N.C.G.S. §24-8 contains a laundry list of permissible third party fees, with a general prohibition on "unreasonable compensation" for loan related services.

The Act also creates a new category of high cost home loan, codified at N.C.Gen.Stat. §24-1.1E. If a mortgage loan meets one of the "high cost" thresholds contained in the statute, a number of additional consumer protections apply. The "high cost" threshold can be met in any one of the following three ways:

1) The APR exceeds by more than ten points the yield on current treasury securities--(currently the APR would have to exceed 16% to meet the threshold);

2) The total points and fees exceed five percent of the total loan amount for loans of $20,000 or more; or the lesser of eight percent of the total loan or $1,000 if the loan amount is less than $20,000); or

3) Existence of prepayment penalty that applies more than thirty months after the loan closes or exceeds in the aggregate, more than two percent of the amount prepaid.

If a loan meets the definition of a "high cost loan" under the statute, then significant protections and prohibitions apply. None of the fees and closing costs for these loans, for example, can be financed. A high cost loan closing cannot take place until after the borrower has undergone home -ownership credit counseling. Balloon payments are prohibited. Other limitations and prohibited lender practices are delineated in the statute at §24-1.1E. Violations of the Act are subject to penalties for usury, i.e., forfeiture of all interest, and return of twice the interest paid, or Chapter 75 penalties, i.e., treble damages. The high cost loan provisions apply to both first and second mortgage loans.

Another bill to combat predatory lending practices, Senate Bill 866, was also introduced in the 1999 legislative session. This bill, which would license mortgage brokers and lenders and prohibit certain practices, was deferred for final action to the upcoming 2000 Legislative Session. This bill is designed to combat mortgage broker abuse.

Footnotes:

1.   Associated Press article by Paul Shepard, March 31, 2000
2.   Associated Press article by Paul Shepard, March 31, 2000.
3.   David Olson Research Co. The Home Equity Industry Annual Report (1999).
4.   New York Times Article, March 15, 2000.
5.   AP Business Article by Marcy Gordon, March 22,2000.
6.   AP Article by Paul Shepard, March 31, 2000.
7.   AP Business Article by Marcy Gordon, March 22,2000.

(Carlene McNulty is Litigation Coordinator/Attorney with the North Carolina Justice and Community Development Center and can be reached at 919-856-2161)

(This article first appeared in the Honor Roll, 2000 issue of the North Carolina Bar Association's publication, The Pro Bono Connection, and is posted here with the permission of the North Carolina Bar Association and the author, Carlene McNulty)