Understanding SubPrime and Predatory Lending

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Understanding Sub-Prime and Predatory Lending
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Prime Lending

• Risk
• Lending Characteristics
• The consumer is buying a loan product
• The consumer must fit into the lending product
  box

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Sub-Prime Lending

• Risk
• Lending Characteristics
• The consumer is sold a loan
• Loan is customized to
  consumer

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The Value of Sub-Prime

• Opened market to many unserved homebuyers
• Allowed consumers with credit issues to remain
  homeowners

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The Risk of Sub-Prime

• Lender assumes higher
  risk of default
• Interest rate should correlate
  to risk
• Homeowner at higher risk of losing home

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Sub-Prime Credit Levels

• Credit Risk Factors
• Credit Score
• Equity
• Late Payments
  (Mortgage/Rent)
• Debt Ratio
• Property Quality/Type

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Sub-Prime Credit Levels

• Loan Determinants
• Loan Amounts
• Type of Income Documentation
• Purpose of Loan
• Purchase
• Refinance
• Rate Reduction
• Debt Consolidation
• Cash Out Only

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Sub-Prime Credit Levels

• Types of Income Documentation
• Full
• Traditional Verifications
• Requires Least Equity
• Lite
• 6 Months Bank Statements
• Self employed Borrowers

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Sub-Prime Credit Levels

• Types of Income Documentation
• Stated
• Disclosed On Initial Signed Loan Application
• Relies on Consumer
  Statement of Income
• Verifications and Bank Statements
  Not Required

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Sub-Prime Credit Levels

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Sub-Prime Credit Levels

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Sub-Prime Credit Levels

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Sub-Prime Credit Levels

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Typical Loan Costs

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Key Sub-Prime Terms

• Prepayment Penalty
• Yield Spread Premium
• Hybrid Loans
• Rescission

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Prepayment Penalty

• Fee charged by a lender when a borrower pays
  off a mortgage debt prior to the due date
• Most prepayment penalties enforced for two
  three years but may last longer

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Prepayment Penalty

• Typical Penalty is 6 Months Interest
• Charged on any prepayment greater than 20 of
  the mortgage
• Example
• 150,000 Loan at 10
• Prepayment Penalty 6,000

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Prepayment Penalty

• Prepayment Penalty Disparity
• 80 Sub-Prime Loans
• 2 Conventional Loans
• 20 of All Lending is Sub-Prime

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Prepayment Penalty

• Main Purpose of Prepayment Penalty
• Are They the Necessary Evil?
• 53 Sub-Prime Borrowers Prepay With a Penalty
• 68 Sub-Prime Borrowers Prepay without a Penalty

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Prepayment Penalty

• Does Prepayment Penalty Reduce
  Interest Rate?
• Cost of penalty is typically 3-4 times greater
  than any interest savings

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Prepayment Penalty

• Prepayment penalty is a back end cost
  that is generally collected yet not factored in
  at origination avoiding HOEPA triggers.
• Usually not well explained at closing.

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Yield Spread Premium (YSP)

• Fee from a mortgage lender to the broker when a
  loan is closed at an interest rate higher than
  the rate the borrower qualifies
• Premium typically equals the difference between
  the qualified interest rate and the actual
  interest rate.

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Yield Spread Premium

• Borrower Seldom Knows
• Disclosed on HUD 1
• 85-90 Sub-Prime Loans Have YSPs
• Cost to homeowner 800 - 3,000
• Average cost 1,850

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Prepayment Penalty YSP

• Typical YSP for Sub-Prime Loan without a
  Prepayment Penalty 2.5
• Typical YSP for Sub-Prime Loan with a
  Prepayment Penalty 4.25
• Brokers third party originators are
  originating an increasingly higher percentage of
  loans, 72.4 in 2004

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Hybrid Loans

• Often referred to as 2/28 or 3/27 loans
• Majority of sup-prime loans are hybrid loans
• Loans are fixed for 2-3 years then adjust
  thereafter, often at 6 month intervals
• Loan documents often say
  Fixed creating confusion for
  consumer

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Hybrid Loans

• The Benefits
• Window of opportunity to repair credit or gain
  time on a job or resolve credit risk factors
• At the end of the fixed term, the homeowner
  should be able to refinance into a more favorable
  loan.

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Hybrid Loans

• The Dangers
• Consumers dont realize the
  loan is only fixed for a short
  time.
• Must be diligently working toward resolving
  credit risk issues.
• Targeted for repeated refinancings to avoid
  adjustable nature.
• Prepayment penalties may extend beyond the fixed
  period of time.

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Rescission

• Only available with
  refinancing
• Three business days
• Election not to rescind
• should not be signed
• at closing
  
  
  

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Sub-Prime Vs. Predatory Lending

• Sub-Prime Does NOT Equal Predatory

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Predatory Lending

• Just as the expansion of subprime lending has
  increased access to credit, the expansion of its
  unfortunate counterpart, predatory lending, has
  made many borrowers worse off.
• Edward M. Gramlich
• Governor
• Federal Reserve System Board of Governors

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Evolution of Predatory Lending

Predatory Lending
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Predatory Lending Components

• High Pressure Sales or Deceptive Sales
  Tactics
• Preys on Lack of Information or lack
  of Credit Confidence
• Abuses Lending and Credit Practices
• Lending Not Beneficial to Homeowner

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Human Components of Predatory Lending

• They robbed me, they robbed my kids, man, they
  robbed my community.
• Yet, I feel like I
• did something
• wrong.

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Human Components of Predatory Lending

• The Target Market
• Low moderate income persons
• Persons of color
• Elderly persons
• Persons in a financial or housing crisis
• Persons who are equity-rich but cash-poor
• Persons who lack information they need to choose
  the best product
• Persons who do not perceive themselves as having
  financial options
• Persons who are scared of the lending process and
  dont comparison shop

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Human Components of Predatory Lending

• The Costs
• It destroys credit and opportunities
• It causes foreclosures
• It creates homelessness
• It robs wealth from families, neighborhoods and
  communities
• It strips families of hopes and replaces dreams
  with shame embarrassment

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Predatory Lending Practices

• Equity Stripping
• Asset Based Lending
• Mortgage Flipping
• Packing
• Foreclosure Rescue
• Property Flipping
• Balloon Mortgage
• Home Improvement Scams

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Predatory Lending Characteristics

• Unwarranted high interest rate
• Unwarranted high discount points
• Closing costs that exceed 5 of the loan amount
• Undisclosed negative amortization
• Inflated appraisal costs or fees
• Excessive broker fees

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Predatory Lending Characteristics

• Unbundling (itemizing duplicate services and
  charging separately for them) Requiring credit
  insurance
• Falsely identifying loans as lines of credit or
  open end mortgages
• Mandatory arbitration clauses