Predatory loans are a problem which bothers everyone -- at least in theory. In practice, the Home Ownership Equity Protection Act of 1994 (HOEPA) -- Section 32 of Regulation Z, part of the Truth in Lending Act -- is supposed to protect the public, but its scope is limited.
"The rules," says the Federal Trade Commission, "do not cover loans to purchase or initially construct your home, reverse mortgages, or home equity lines of credit (similar to revolving credit accounts)."
In other words, virtually all real estate loans are excluded from the very legislation on which the public relies for protection against abusive mortgage lenders.
Now Freddie Mac has announced a new effort to turn away predatory loans, a strategy that has the potential to seriously impact abusive lenders.
Freddie Mac is a "Government Sponsored Enterprise" or GSE, an entity first created by the federal government but now a private company. Freddie Mac does not actually make home loans, instead it buys mortgages from local lenders -- but only those loans which meet its underwriting standards. If local lenders want to sell loans and get Freddie Mac's cash, such financing must meet certain criteria.
Part of the lending galaxy includes "subprime" loans, financing with steep interest costs. There is a place for such mortgages because there are borrowers who have poor credit and such individuals represent so much default risk that they should not be entitled to the best possible rates and terms.
Within the scope of "subprime" loans, however, are "predatory" mortgages, loans with high rates and hideous terms -- loans HOEPA largely ignores.
Freddie Mac has announced that it will no longer purchase subprime loans that include a variety of onerous features commonly associated with predatory financing.
After October 1st, Freddie Mac will not buy subprime mortgages with prepayment penalty terms that exceed three years.
Prepayment penalties -- sometimes fees equal to interest payments for six months and thousands of dollars -- discourage refinancing and loan reductions. Combine awful terms with prepayment penalties and you effectively lock-in borrowers -- even if borrower credit improves and they can now qualify for better financing.
Single-Premium Credit Life Insurance
As a condition of making a loan abusive lenders often require borrowers to obtain single-premium credit life insurance -- even though the loan is secured by the value of the property. The costs for such insurance are high, in part because the loan amount decreases each month but the one and only payment is based on coverage for the full debt and the entire loan term.
Predatory lenders -- trying to be "helpful" in their unique way -- will finance that up-front insurance premium by adding the cost to the mortgage amount. The borrower is then in the position of creating additional high-cost debt to buy something which should not be required.
As well, if the loan is quickly paid off or refinanced, the borrower again suffers because the entire premium was paid up front.
Freddie Mac will not purchase mortgages from lenders who do not report positive payment information to credit reporting agencies.
In this situation, the borrower is repaying the abusive loan and wants to obtain financing with better rates and terms. So the borrower goes to another lender, lender #2 checks the borrower's credit file and guess what: There's no mention of the borrower's good repayment record because the first lender only sends in negative items. Without independent credit data, the second lender will have a tough time making a loan and the borrower will be stuck with high-cost financing far longer then is fair or reasonable.
In effect, Freddie Mac is reducing the ability of predatory lenders to sell their loans, get new cash, and then make more loans. It's a great concept and one which may potentially have a real marketplace impact.
Other secondary lenders should adopt Freddie Mac's new rules for predatory loans, and they should also go further: Why wait until October? Awful loans that ought to embarrass everyone are being made today -- and today is when the purchase of such mortgages should stop.
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