Predatory lending remains a cancer in the American economy. There are still too many lenders in this country who prey on people and take advantage of them -- and their money. Despite efforts by local, state, and federal agencies to curb such practices, they unfortunately continue.

The Office of the Comptroller of the Currenty (OCC) recently issued residential real estate lending standards in an effort to protect national banks from being involved in abusive, unfair, or deceptive residential mortgage lending practices.

The guidelines (which were published in the Federal Register on February 7, 2005) are extensive. Let's look at some of the practices which the OCC intends to prohibit:

Equity Stripping: This is the situation where an innocent borrower is required to do repeated refinancing within a short period of time. With each refinance, there are unconscionable costs to the borrower, such as high points, excessive closing fees, and high interest rates. By the time the borrower goes through several such refinance procedures, the equity in their house is eaten away. Ultimately, the predatory lender ends up foreclosing on the property and starts the cycle all over again.

Loan Flipping: This is a variation of equity stripping. Here, the lender requires the borrower to go through multiple refinancings under circumstances where the terms of the new loan (and the cost of that loan) do not provide any tangible economic benefit to the borrower. Only the lender makes money on each refinance process.

Encouragement of Default: Believe it or not, there are lenders who encourage a borrower to default on their current loan so that the borrower can get a new loan from the predator. That new loan will refinance all of the old loan, but again at a much higher mortgage interest rate.

Additionally, the OCC address certain practices which it believes are susceptible to abusive, predatory, unfair, or deceptive practices. Examples include:

• Financing single premium credit, life, disability, or unemployment insurance. First, in many cases, these insurance policies are generally extremely expensive, and often unnecessary. And borrowers do not have a chance to do any comparative shopping; they first learn that they must obtain such insurance when they are at the settlement table.

  Second, by requiring a borrower to finance these insurance premiums, this just adds more money to the already excessive monthly mortgage payment.

• Balloon payments: here, the borrower is allowed to make small monthly payments, but at the end of a fixed period of time (often as short as one or two years) the entire mortgage payment comes due (i.e. balloons). Obviously, the borrower has no alternative but to refinance, and the process starts all over again.

• Interest rate increases excessively upon default: most lenders try to work with borrowers who are unable to make their mortgage payments. Ultimately, however, if an acceptable payment plan cannot be worked out, the lender will have to foreclose on the property. However, a predatory lender will often require that when a borrower is in default -- even for as much as one day -- the interest rate will increase dramatically. This makes it even more difficult for a borrower to get back on track on the mortgage payments.

• Original loan is in excess of the appraised value: let's say that the house is appraised at $150,000. The lender -- working in collusion with an appraiser friend (who may get a kickback from the lender) appraises the house at $200,000. The lender then makes a 90 percent loan-to-value ratio loan in the amount of $180,000. However, by the time all of the exorbitant fees are taken out at the settlement, the borrower still may only receive $150,000. But the loan remains higher than the house is worth, making it next to impossible to sell, or even refinance with a legitimate lender.

• Direct payments to home improvement contractors from the proceeds of a residential mortgage loan. Let us assume that the borrower plans to do $150,000 worth of construction. The lender is prepared to lend this entire amount, and payments are to be made to the contractor based on an agreed-upon draw schedule (eg when the drywall is up, the contractor will get $20,000, when the plumbing is installed the contractor will get another draw, etc).

  This is a legitimate form of mortgage lending. However, if the lender is in cahoots with the contractor, it is possible that the draws will be paid directly to that contractor, whether or not the work has been done, and regardless of the quality of the work.

  The OCC wants lenders to make the draw checks payable either jointly to the consumer and the contractor, or to an independent third party escrow agent.

• Mandatory arbitration clauses or agreements, especially if the eligibility of the loan for purchase in the secondary market is thereby impaired. Freddie Mac, for example, is on record that all homeowners should be able to voluntarily choose the mortgage dispute resolution option they believe to be in their best interests. This would include arbitration, mediation, or -- if necessary -- litigation.

The issue of mandatory arbitration is being litigated throughout the country. Lenders want borrowers to submit all claims and all complaints to binding arbitration. Often, the loan documents require that any disputes must be arbitrated in the area where the lender has its principal office. Clearly, for a consumer living in Maryland, it is inconvenient -- if not impossible -- to have to go to Oklahoma, or California in order to resolve (arbitrate) any complaints against the lender.

The Guidelines do point out, however, that under some circumstances, these same practices may be acceptable. According to the OCC:

A bank should prudently consider the circumstances, including the characteristics of a targeted market and applicable consumer and safety and soundness safeguards, under which the bank will engage directly or indirectly in making residential mortgage loans (involving some or all of the practices listed above).

Effective April 5, 2005, national banks, federal branches and agencies of foreign banks, and operating subsidiaries of such entities, are required to honor and comply with these guidelines. According to the OCC:

If the OCC believes a bank's practices fail to meet the standards in the guidelines, the OCC may require submission of a corrective plan by the bank. If the national bank fails to submit a plan, or to comply with it, the OCC may issue a cease and desist order against the bank. Orders are formal, public documents, and they may be enforced in district court or through the assessment of civil money penalties.

Let's hope that these guidelines will help put a major dent in these unsavory practices.

Published: March 21, 2005

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