MAKING SENSE OUT OF MORTGAGE MAYHEM
Primer on subprime and predatory lending problems
BY RICHARD I. ISACOFF, ESQ
"Sub-Prime Mortgage Crisis" -"Predatory Loans" -These are headlines or lead story captions that have been in the news for more than there months. Unfortunately, the people writing or broadcasting these terms have done nothing to educate the public, the borrowers and potential borrowers, people whose homes may be lost in a foreclosure action, as to what the terms mean. More importantly there are few explanations being given as to what are really the problems.
First: while there is no legal definition of a "predatory loan" the concept can be explained. Put most simply, a loan should be considered predatory if the lender, or broker convinces a borrower to buy a mortgage loan that lender/broker suspects or actually knows the borrower cannot afford.
Second: What is a "sub-prime" loan anyway? The term "sub-prime" refers to a credit score, not the borrowers ability to pay, nor a reflection of the borrowers actual financial situation. Originally, the term was used by the mortgage industry and especially by the government agencies like Federal National Mortgage Association referred to as "Fannie Mae" and Federal Home Mortgage Corporation referred to as "Freddie Mac". Any borrower with a credit score below a certain point was considered "sub-prime", not the best risk.
The scores determining "sub-prime" have ranged between 680 and 640. What is missed here is that the scores are determined by one of three credit agencies by the Fair Isaac Credit Organization, thus the term "FICO Score". None of the credit reporting agencies actually knows about someone's income, living arrangements and expenses, job opportunities/changes, etc. Basically, they rate someone's credit worthiness, determining whether the person is "sub-prime" or not, by the past payment history, the amount of credit outstanding, credit available and unused by the consumer, and many other factors.
The reality of the so-called crisis is that too many people received loans where an honest evaluation would have led the borrower to realize that he/she could not afford the payments once they increased. Maybe the biggest problem then was the mortgage industry creating so many mortgage types which have rates that go up and even double!
Sometimes people did not understand because of simple deception, like not explaining to the borrower that the monthly mortgage payment will increase substantially in the third year of the loan and then continue to increase every six months thereafter. Sometimes the "predatory" part of the name can be attributed to outright fraud, such as "suggesting" that the borrower needs to state he/she has $X per month income in order for the loan to be approved, or where the broker/lender actually alters the borrowers application to reflect an income higher than that which the borrower has stated. Other times it could be because an appraiser placed a value on the property much higher than the actual market, in order to have the loan approved.
Numbing Numbers
The following example may provide a better understanding of the situation. There is a mortgage loan product referred to as a "2/28 Loan". The name means that the loan has a fixed rate for 2 years, and an adjustable rate for 28 years. Generally this type of loan adjusts every 6 months after the first two years, and the adjustment is up to 1%. Assume a borrower starts at a low rate of 6%. If he/she borrows $100,000 the payment for principal and interest would be $599.55 every month. At the end of the second year the payment increases by $134.21 bringing the monthly payment to 733.76. After another 6 months, the interest rate increases by another 1% for a total monthly payment of $804.62. 4 ½ years after the loan starts, the interest has risen to 12% and the monthly payment to 1028.61. An increase of 72%.! Still affordable? - probably not!!.
In the example, IF the borrower had all of the figures, knew the risks, had all of the disclosures completed correctly and not to deceive or hide the truth, and the borrower still wanted to conclude the loan- AND the lender/broker believed that the borrower could afford the payments- then the loan is not predatory; foolish maybe, but...
Good Questions
Here are some questions to ask if you have a loan that has become too expensive or are thinking of obtaining a loan. The answers will not, by themselves, prove a loan is" predatory", but will give a borrower an indication that there may be a problem or at least an issue to be examined.
- Who is the lender? Is it a local bank, a well-known mortgage company, or a out-of-state direct mail solicitor?
- Is the entity making the loan the real lender or is it merely having you sign papers and selling the loan to another "lender"? You can ask the question and the paperwork you get can actually tell you.
- Was the closing done by a lawyer? If not, it may have been illegal (in Massachusetts). If it was, did the attorney explain all of the terms to you. If not call and ask him/her for an appointment to get the explanation
- If you were refinancing, did you get a full 3 days to reconsider the loan, or did you sign documents and have the money disbursed immediately?
- Was the loan in the borrower's interest. Did the borrower get cash back, or get a better rate, or get a longer term? Did the borrower get reduced payments?
- Could you end up owing more than you borrowed, despite making all of the payments on-time?
The "predatory loan" issue is quite complex to sort out. The questions and information above is not even the tip of the iceberg! If you have questions, contact our office
