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Beware: Predatory Lenders at Work

By: Source: AARP Bulletin Today Date Posted: 2003-06-20 12:53:48

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Seven years ago Theresa Duren, a retired vocational counselor living in Washington, had a nice nest egg wrapped up in the value of her home. Like many retirees her income was not high, but her house was worth around $220,000 with a remaining mortgage of only $35,000.

Then she sought a $10,000 personal loan—feeling she could easily repay it out of income—to pay owed taxes.

But the lender persuaded her instead to refinance her existing mortgage and fold into it her daughter's car loan and other debts, thus raising the loan to $92,500. She signed, not realizing that it included lenders' fees of $9,000 and that the interest rate—on the fees as well as the loan—was more than 20 percent.

Duren quickly found she could not afford the new mortgage payments. Soon she got phone calls from other lenders, each offering to reduce her payments with new refinancing loans. Within two years she had refinanced five times, but the burden only got worse.

Her monthly payments rose from the $200 she had paid for her original mortgage to $1,665. Her mortgage debt climbed to $175,000. And because she had to pay a total of $44,000 in fees and closing costs, the equity in her home vanished.

At the time of closing on the fifth loan, Duren was in the hospital. Against her wishes, she says, the lenders came to her bedside and insisted she sign the papers immediately, less than two hours before she had surgery.

THREAT OF FORECLOSURE

With the help of AARP Foundation Litigation, Duren sued the five lenders for violations of consumer protection laws and won settlements from three of them. But, as the AARP Bulletin goes to press, she is still at risk of losing her home in foreclosure.

"You don't realize when you get into these things that you're signing away your house," she says. "You don't know what's happening until you're locked into it. And then there doesn't seem a way to get out of it."

Similar stories are being told more frequently these days—in courts, at government hearings, at community housing and other help centers.

They are the result, consumer groups say, of a marked rise over the past decade in "predatory lending," a term used to describe a range of financial practices that deceive people into taking out loans they cannot afford, most often against the equity of their homes.

"It has become almost an epidemic," says Stella Adams, executive director of the North Carolina Fair Housing Center (NCFHC).

Testifying before a congressional committee last year, William Apgar, then an assistant secretary of the U.S. Department of Housing and Urban Development (HUD), used stronger words. "Predatory lending threatens to turn the American dream of homeownership into an American nightmare," he said.

Several states and cities have passed or are considering tougher laws to combat predatory lending practices. Some legislators in Congress and many consumer groups have called for more federal regulation.

AARP, too—after years of working at the federal and state levels on this issue—has recently launched a nationwide campaign both to advocate greater legal protections for consumers and to alert people on how to avoid falling prey to abusive lenders.

The campaign follows a series of interviews with more than 100 victims across the country. Its theme, "They Didn't Tell Me I Could Lose My Home," comes directly from the words those people used most often, says Adrienne Oleck of AARP's consumer protection group.

"AARP's concern is that the assets of older homeowners are based much more in their home equity than in their income. That makes them especially vulnerable to predatory lenders," Oleck says. "So we want people to be aware of this problem and not get caught in it."

THE LENDER'S PITCH

How do people get sucked into the predatory trap? It often starts with a phone call or mailing inviting householders to borrow money against their homes. According to an AARP-sponsored survey last November, 75 percent of homeowners age 50 and over receive such offers.

They may seem appealing, but a closer look reveals that "they are designed to play on people's emotions and beliefs," says Anthony Pratkanis, professor of psychology at the University of California, Santa Cruz, and an expert on advertising.

After analyzing hundreds of home-loan mailings, Pratkanis found that "the first tactic is to dangle out the bait and get you dreaming." A typical pitch: "Slash your monthly payments! Strapped by high-interest credit cards and debts? A loan from us could save you hundreds in monthly expenses, and still leave you with extra cash."

But, you may think, how is that possible? The lender helpfully escorts you across that credibility gap, Pratkanis says, by making use of what you already know to be true: that home loans often have lower interest rates than credit card debt and other consumer loans. And they clinch it with another truism: Home equity loans are tax deductible, whereas other loans are not.

So when the pitch urges you to "consolidate your debts into one low monthly payment with a home equity credit line," the logic seems complete.

But there can be a downside to debt consolidation. "Once you consolidate other loans with your home payments, you could actually lose your home for not having enough money to pay off your credit card or your car," says Oleck. "If they're separate payments, that can't happen."

Millions of homeowners do obtain home equity loans without getting into financial trouble or ever coming into the orbit of predatory lenders. Typically, most of these borrowers qualify for the low-interest loans available in today's "prime" market—that is, the market that lends money to those with good credit ratings.

But there is another market, known as "subprime," that specifically exists to lend money to people with not-so-good credit histories at higher rates of interest.

All consumer groups, including AARP, recognize the need for subprime loans to help more people achieve credit and home ownership.

But, they say, the explosion in subprime lending in recent years—up from $35 billion in 1994 to $140 billion in 2000—has been accompanied by a steep increase in abusive practices, too. Not all subprime lenders are predatory but, a HUD study shows, predatory lending—and foreclosures—are prevalent in this market.

Because few people know their credit scores (see Understanding Your Credit Score), some get involved in subprime loans needlessly. "Many older people don't belong in [this] market at all. Their homes are free and clear," says Adams of NCFHC. "These are customers who are steered to the subprime product and made to take out loans for larger amounts than they need."

TRAPPED BY PREDATORS

Another way homeowners are often lured into abusive loans is by door-to-door solicitations from predatory home improvement contractors who offer to "arrange" a loan to pay for repairs, new windows and so on.

"They make the process seem easy," says Oleck. "But they'll get a person to sign the whole house as collateral for a roof repair."

Sometimes such a loan can be purely fraudulent. One of Adams' clients, living on $591 a month, needed $5,000 for her roof. Told it could be done for $89 a month, she signed three sets of papers, thinking they were triplicates. Later, she found she'd actually signed for three $5,000 loans costing $267 a month in all, almost half her income.

It is when home loans result in asset stripping that they become truly predatory. That can happen in a variety of ways, once an unscrupulous lender has persuaded a borrower to use home equity for a loan. Among those that consumer groups describe as the most egregious are:

• Packing: Single premium credit life insurance policies and other fees added into the loan but not disclosed in advance to borrowers can inflate a mortgage by thousands of dollars.
• Balloon payments: A loan may have low monthly payments at first, because the real repayment is structured to come due a few years later in one large lump sum.
• Loan flipping: Some lenders pressure borrowers into refinancing several times. Each time the loan is "flipped," the borrower is asked to pay more high fees, such as the credit insurance noted above.
• Prepayment penalties: These ensure that the loan cannot be paid off early (like conventional loans can be) without paying a large fee, often several thousand dollars.

Consumer advocates protest that such practices strip away wealth from borrowers in two ways: by making them pay exorbitant up-front fees and high interest rates, and, if they can't keep up the payments, foreclosing on the home.

What makes it even worse, they say, is the way the predatory lenders befriend their victims and win their trust, coming to their homes, eating apple pie, offering to drive them to the lawyer. One woman, driven in a car to the closing, said: "I felt like a queen for a day."

Theresa Duren, now 68, says of her lenders: "They were very nice, personable people. And they had an answer to everything I was suspicious about. You wouldn't think they would smile to your face and stick a knife in your back."

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