Alum Battles Predatory Lending
What is subprime lending? Subprime mortgages are high-cost home loans intended for people with weak or blemished credit histories. Once a tiny, niche market, subprime lending has grown enormously over the past decade and now represents roughly 20 percent of all home mortgage lending. What caused the subprime market to grow so quickly? Two of the biggest drivers of the growth in subprime lending were increases in the reliance on mortgage brokers and securitization of mortgage products. Not so long ago, mortgage lenders originated their loans and held these loans in their portfolios. However, in their efforts to expand the scope and scale of subprime lending, many lenders began relying on third-party originators, particularly mortgage brokers, to originate their loans. Relying on brokers allowed lenders to expand their market reach without incurring the cost of opening bricks-and-mortar storefronts. In addition, over the last decade, Wall Street became much more sophisticated in its ability to design and price investment products backed by mortgages. Consequently, in recent years the vast majority of subprime mortgages have been sold off to investors, thereby increasing the availability of capital available for subprime lending. What caused the current subprime market meltdown? While there is a host of contributing factors, the same two things that drove subprime growth were also at the heart of its demise: third-party originations and securitization. Back when lenders both originated and held their mortgages, they had a vested interest in making sure that borrowers could afford to repay their loans. Mortgage brokers, on the other hand, are compensated not on the performance of the loans they originate, but on the volume and terms of those loans. Consequently, many subprime loans were aggressively (and often deceptively) marketed and originated without regard for the borrowers’ ability to repay them. As a result, the market became flooded with nontraditional loan products- such as products with low introductory “teaser” rates that reset after a few years to a much higher rate or loans that did not require income verification of the borrowers. These practices was exacerbated by the growth in the securitization of subprime loans, which increased the availability of capital for subprime lending while creating yet another layer between those who originated loans and those who ultimately bore the risk of them. With housing prices sky-rocketing for the first part of this decade and a huge amount of capital available for lending, mortgage originators were driven to close as many loans as possible without regard for the long-term sustainability of those loans. When housing prices started falling, making refinancing for many borrowers impossible, defaults and foreclosures skyrocketed. What are the likely consequences? It’s estimated that 1-2 million homes will be foreclosed on in the next few years as a result of subprime lending practices. This will be devastating, not only to the families who lose their homes, but to entire communities. Foreclosures not only strip wealth away from the families that lose their homes but also decrease the value of nearby properties. Importantly, this crisis will disproportionately impact African-American and Latino families and communities, as these groups receive a disproportionate share of subprime loans. What should be done? There are a couple of things that are needed. First, we need to help current borrowers who are facing foreclosure. Second, we need to increase consumer protections to stop these abuses from happening in the future. From a policy perspective, the best way to help current borrowers who are in trouble is through reforming the bankruptcy code to allow bankruptcy judges to modify loans on primary properties. Incredibly, while bankruptcy judges already have the authority to modify loans on cars, farms, vacation homes, investment homes and credit card debt, they cannot modify abusive loans on owner-occupied homes. Congress is currently considering legislation to reform the bankruptcy code to allow this and it’s the best way to keep people in their homes. Furthermore, this change would be of no cost to taxpayers. In terms of preventing the current situation from happening again, we need strong federal laws that protect borrowers, while allowing states to legislate further protections. Consumer protections should include mandating that loan originators consider borrowers’ ability to repay loans, outlawing kickbacks from lenders to brokers for putting borrowers into unnecessarily expensive loans, and making investors liable for abusive mortgages they purchase. What are the biggest myths or misperceptions about the current situation? The two biggest myths are that investor speculation and borrower fraud caused the subprime meltdown. First of all, the vast majority of subprime lending was for owner-occupied homes, not investment properties. Second, most borrowers did not understand the loan terms they received and were victims of aggressive and deceptive marketing practices. What is the Center for Responsible Lending? The Center for Responsible Lending (CRL) is a nonprofit, nonpartisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. CRL is an affiliate of Self-Help, one of the nation's largest community development financial institutions. CRL's staff is made up of attorneys, researchers, and policy analysts in North Carolina, Washington DC, and California who study and report on predatory lending matters and advocate on behalf of increased legislative and regulatory protections. How do the experiences you had while a student at Haverford impact your work? In a couple of ways. First, I was an economics major so my coursework is directly relevant to my work at CRL, both substantively (i.e. understanding how markets work) and analytically (in terms of using statistics and econometrics) Second, although until now, I don’t know if I ever consciously made the connection between my Haverford experiences and the work that I’m doing, I do think they’re related in that the Quaker underpinnings of Haverford probably contributed to my desire to want to work in a way that promotes social justice. What are the most frustrating parts of your work on predatory lending issues? The most rewarding? On a big-picture level, the biggest frustration is knowing that predatory practices in the subprime market have been going on for a long time but had to reach result in a true crisis before it got the attention it deserved by the media and policy makers. As a researcher, another frustration is that bad research often goes unchallenged. At CRL we really try to do the best, most rigorous and objective research we can. In the course of doing so, we have uncovered a lot of ugly truths about the subprime lending industry. However, there is also a lot of terrible research out there, often conducted and/or funded by industry trade groups. This research is often based on bad data and even worse methodology but their “findings” often have influence in the media and in policy debates. However, there are many rewarding things about the work. First of all, I work with an incredible group of people- extraordinarily smart, hardworking professionals who could be making a lot more money in other endeavors but who are completely committed to CRL’s mission of fighting abusive lending practices. Second, as a policy researcher, it’s very gratifying to feel like my research is actually being used. I’ve had several jobs where I felt like my work, however interesting it may have been, was probably to a large extent inconsequential. However, with our research frequently being used and cited by policy makers, the media, and others, it really feels like we’re making a difference. Finally, while there are frustrations with all jobs, it makes it much easier to get up and go to work knowing unequivocally that we’re fighting the good fight, so to speak. What are the best ways for people to protect themselves against predatory lending practices? There are several things that people can do:
- Maintain a good credit history. The most important way to protect yourself is to maintain a good credit history- paying credit card bills in full and on time each month, paying back student loans and auto loans on time, etc. If you have good credit, you are much more likely to get a fair loan.
- Know your credit score. People often don’t know their credit score and underestimate their credit worthiness. Consequently, they might not get the best rate for which they qualify.
- Understand the role of mortgage brokers. People often think that brokers will shop around for the best loan for them but mortgage brokers actually have no fiduciary responsibility to the borrowers they serve. In fact, brokers often make extra commission in the form of a yield-spread premium (YSP), which is essentially a kickback from the lender to the broker for putting a borrower into a loan that is more expensive than that for which the borrower qualifies. You are likely to be better off shopping around yourself.
- Be wary of aggressive marketing and high-pressure sales tactics. Many abusive loans are aggressively marketed and sold to borrowers who might not be looking for a loan.
- Shop around and make sure you understand the terms of your loans.Many borrowers accept a loan based on the monthly payment. However, with the prevalence of adjustable-rate mortgages and interest-only loans, the initial monthly payments are often temporary and borrowers will experience payment shocks a few years into the loan. In particular, be wary of interest-only loans, payment option loans, adjustable rate loans, and prepayment penalties.
- Ask for the final loan papers prior to loan closing. Don’t wait until closing to review your loan documents. Ask for the papers in advance and, if possible, have a real estate attorney review them for you.