Unethical Lending Practices - Assignment Example

Unethical Lending Practices Introduction Predatory lenders have time and time again looked for opportunities to take advantage of consumers in unethical lending practices through the use of loopholes. While some lenders under the extra scrutiny of the public’s eye are investing time and money into the loan distribution process others are constantly in the media spotlight with accusation’s and public negative exposure. Unethical behavior on the part of the lender can take many forms. Common behaviors include lending based on assets versus income, extremely high fees on short term loans, non-negotiable status loans, balloon payments, and assorted tactics and behaviors in order to make more money from the consumer. Though the government takes steps to ensure that consumers are protected it is easy for large corporations and organizations to continually change their practices in attempts to be as corporate advantageous as possible. The Fraud Enforcement and Recovery Act of 2009 was signed by President Obama after 62,000 cases of mortgage fraud were reported in 2008, with the amount of mortgage fraud cases opened tripling from the preceding three years (Bellan, Toof). The bill established several goals and funded means to meet this goals. Federal law was updated to include mortgage lending practices that the government does not oversee, regulate, or insure. It also became a federal crime for government contractors to defraud the government in any dealing through the use of the Economic Stimulus package. Resources amounting to 165 million for 2010 and 2011 were allocated to the Attorney General to prosecute these cases, while the FBI received 65 million in 2010 and 40 million annually to the Department of Justice Criminal, Civil, and Tax Divisions to provide litigation in these cases (Bellan, Toof). An outside commission was also created to investigate and determine possible rationale for the current financial crisis. Short Term Lending Payday Lending Current economic and financial conditions means this is the perfect climate for what is known as advanced payday lending. This type of lending usually involves small quantities of money for short periods of time at extremely high interest rates and conditions unfavorable to the client. Because of the client or consumers pressing financial need these payday advances often seem like good solutions to resolving immediate financial crisis. With many Americans living pay check to pay check it is easy for families living at or below poverty level to find they are short each week. Frequently these families rely on these short terms lending businesses and become accustomed to using the business each week or pay period. The credit these businesses offer, while convenient, is much more expensive than the credit used by mainstream America (Aitken, p81). While these payday loans create further financial burden and ability to meet economic obligations they provide no way for the customer to become a mainstream financial customer, thus keeping a segment of the population which relies on these services dependent upon these services. One commentary estimates that there are between 25,000 and 30,000 payday lending business’ (Aitken, p 85) though none were in existence twenty years ago. Most regulation within the lending industry are targeted to deposit holding institutions and pay day lenders do not fall directly within banking sector regulators. Those who regulate financial lending institutions have seemed hesitant in attempting regulatory policy in this area. Though they are outside the scope of other lending business’ they still rely on many services provided by mainstream financial practices. Payday lenders must often depend on the credit from larger institutions and many are publicly traded firms. Due to the short term nature of the credit and the guidelines for establishing payday credit the fees and interest rates are extremely high. Working class credit has also been high and payday lending has possibly led to uniformity of this high cost. Annual percentage rates can be between 50-100% and it is not unusual to encounter these. This is further compounded by roll over loans, which occur when a customer is not able to meet their payday payment and must receive a new loan or pay twice the cost to extend the terms of the original loan. Frequent payday loans can lead to serial borrowing and one estimate estimates that 91% of payday loans are made to consumers who borrow at least five times per year (Aitken, p86). Evidence suggests that this short term credit is most frequently used by those on the fringe of the mainstream financial world and many are unable to acquire other forms of credit. Controversy, both in Canada and the United States stems over the consistent way these lending practices violate conventional interest rate laws. Each State has its own payday lending laws, despite these laws payday lenders are often able to circumvent these laws with loopholes and difficult wording. Truth in Lending disclosures are required but many who use this type of credit are in a situation where they are unable to meet their financial obligations in any other way and this is where payday lending institutions are able to take full advantage of their clients. The FDIC has issued other guidelines, which include cooling off periods between loans, ensuring there is only one bank loan outstanding at a time, and establishing maximum amounts of payday loans per year (FDIC). Some corporations such as Amscot require only a period of twenty four hours between loans and while guidelines are in place they are very loose and regulation is lax. Loan Flipping Loan flipping is a predatory lending practice that involves the frequent refinancing or early refinancing of a loan with new loans fees financed through the increasing of the principal amount of the outstanding loan (Loan…). Citigroup is one example though they made no comment as to guilt or innocence and were fined 70 million dollars in 2004. Effective in 2009 regulation Z which prohibited this activity was amended significantly. New requirements were imposed on lenders, brokers and servicers. Strict guidance and specific rules were applied to the timing and content of disclosures, higher priced mortgage loans, prepayment penalty restrictions, advertising, and appraisal and servicing practices (Mayk). Despite these regulations foreclosures are at the highest rate ever and predatory lending practices are frequently blamed. Regulation Z amendments included: Early disclosures must be provided for any closed ended mortgage transaction and secured the by the principle dwelling (Mayk, p8) Early disclosures must be placed in the mail seven days before closing and the customer must receive any required disclosure three days before closing Repayment ability must be calculated and determined based on established guidelines Prepayment penalty may not extend beyond two years Advertising must be clear and conspicuous Subprime Lending High risk loans are loans that originate based on an individual’s assets rather than their actual income and ability to pay. Though regulations are in place to avoid this behavior by lenders it is very common as evidenced by today’s foreclosure rates. These loans are for those with a lower credit rating or who may have poor credit due to previous credit and borrowing issues. Minority groups seem to have a much higher percent and chance of receiving this type of lending. The US Department of Housing and Development states that studies show that African Americans are one and a half times more likely to have a subprime loan and that Hispanics were 1.5 times more likely than the Nation as a whole (FHEO). Often the public-ness of home mortgages may play a part in determining the population that gets subprime lending and how frequently it is used. The premise behind public-ness is that the political and economic environment provides a direction and authority regarding decisions about lending behaviors (Moulton, p88). The public-ness of the lending environment reduces the chances that an individual will receive a subprime loan. Those borrowers with low income and credit issues are most susceptible to these market influences. Demand for housing was at an all-time high in 2004 at 69.2% (Bianco). Housing prices went up along with consumer spending. Home values rose 124% between 97 and 2006 and many homeowners took advantage of the property values and refinanced. US debt rose 130% in 2007. There was 600 billion dollars’ worth of subprime loans in 2006 equaling 20% of the housing market. Loans were packaged with securities and sold to investors seeking high returns. The difference in subprime and prime mortgage interest rates declined during 2001-2006, leading to an increase in the amount of high risk loans given by lending institutions. With the housing boom in full swing 15% of new construction had defects which were sometimes more costly to fix then the value of the home (Foster, p23). Specialized mortgage lenders that were not regulated in ways that federal depository institutions were became more abundant with these lenders accounting for around 10% of the market in 2008 (Bianco, p7). The market was perfect for subprime lending and loans that did not require income documentation, adjustable rate mortgages and interest only mortgages were being received. Incentives such as low interest rates for a short time period allowed many borrowers to receive mortgage lending only to have payments as much as double once this introductory rate was over. Mortgage brokers were receiving commission for these high risk loans and automated underwriting processes in 2007 meant that many credit decisions were approved in a very short term though in prior times full documentation and review was required. When the housing market began to adjust itself refinancing became more difficult and as rates began to increase many who were unable to pay home loans simply stopped paying them. Base Point Analytics estimated that 70% of defaulted home loans in 2008 showed fraudulent misrepresentation on home loans (Bianco, p10). Those applications which were found fraudulent had a 20% higher chance of going into a default status. With the approval process being automated and verifications procedures lacking many received home loans based on income that was made up or inflated, some blatantly printing out income statements they had themselves created. The subprime mortgage market was experiencing major crisis in 2007 and it was predicted that foreclosures of an astronomical amount were in store for the Nation. Much of the crisis was blamed on federal regulators though regulators claimed they did not have authority and many lending institutions were regulated by State banks. It was suggested that some government policy contributed such as the Community Reinvestment Act, stating this type of legislature forces banks to lend to customers who would not ordinarily receive financing. Higher than expected foreclosure’s began to surface in January of 2007 and interest rates rose to their highest level in years (Bianco, p12). These foreclosures had a ripple effect and effected much more than the mortgage market. Both the S&P and the DOW had dropped and no market was left unaffected by early 2008. Home prices were on the decline in 2008 and banks were changing their lending practices and in March of 2008 it was reported that homeowner’s debt exceeded home equity for the first time since 1945. In 2010 despite more favorable economic conditions foreclosure percentages were still at alarming rates and the Home Affordable Modification Program created in March of 2009 that was designed to help 3 to 4 million of the population remain in their home has shown few results. This program included provisions for homeowners who made three consecutive payments on time and in April over half of those who had been approved for the modifications had cancelled and were unable or unwilling to meet terms of the program. The program allows specific homeowners who make three consecutive monthly payments on time to be eligible for permanent modification, lowering monthly payments for a five year period (Horowitz). Though there have been aggressive measures implemented to improve the situation there is still a recession in the housing market. HAMP will cease operation in December of 2012 leaving much of the situation in the same condition it began in. Conclusion The Center for Responsible Lending estimated that between 2009 and 2012 nine million prime and subprime loans will be foreclosed on (Lehe, p2050). The long term effect of anti-predatory laws, home loan modification programs and insurance programs is unknown and a very low percentage of homeowners have been able to take advantage of these programs. Those in opposition to these efforts believe foreclosures necessary to correct the widespread problem of individuals with mortgages that are unable to afford the payment. It is well documented that subprime lenders wrote many lending contracts with unscrupulous and questionable terms. Fannie Mae estimated that 50% of subprime loans could have possibly been financed as prime loans which would have saved the borrower thousands (Lehe, p 2052). This estimate lends credence to the theory that many buyers would be able to afford their mortgage if their financing had been prime home loans and there would be fewer foreclosures. African and Latino populations received disproportionately higher levels of subprime financing. Fair lending laws in place to avoid minority factoring in lending practice were obviously violated at some point in the lending process. The FDIC has attempted to identify a number of predatory practices for the consumer. Balloon payments, large payment due at loan maturation while monthly payments are lowered Collection practices that are considered abusive in nature Using persuasion in an attempt to get a borrower to refinance a loan and default on a current one Refinancing repeatedly which cause the homeowner to lose equity, as new fees are financed in with the home loan High loan and interest fees Fraudulent activity such as exaggerated home appraisals and property values Loan flipping Deceitful loan applications Asset Based lending, this type of lending does not consider income as means to make payments Loan to value ratios which are too high to allow a homeowner to sell their home and pay off the existing loan Written clauses that prohibit a mortgagee from suing for predatory lending damages Refinancing unsecured debt Pre-payment penalties The refinancing of subsidized mortgages which were designed to assist the homeowner in meeting monthly payments Encouraging buyers to use subprime loans or steering customers towards these types of loans versus prime loans (Lehe, p2057-2058) Though this list is not conclusive it represents the creativity and means of lenders in lending practices. Lending laws aimed at practices considered predatory are numerous. They are enforced by federal banking regulators, the FTC, HUD and DOJ (Wood, p35). Truth in lending act requires that terms of consumer loans are presented to the consumer enabling them to compare interest rates and loan terms in a uniform and consistent manner from lender to lender (Truth…) The Home Ownership and Equity Protection Act provides law and statue in the disclosure of actual loan costs, loan flipping, pre-payment penalty’s, asset based lending, and balloon payments The Real estate Settlement Procedures Act ensures consumers are provided with disclosures regarding settlement costs and protects buyers from high settlement costs The FTC Act and Title 18 of the US Code provides protection against fraud and deception by lenders Though action has been taken against predatory lenders the primary focus is on regulatory guidance. The Fraud Enforcement and Recovery Act of 2009 expanded laws and updated language to include independent mortgage companies who were not considered banking institutions previously This means that that these mortgage companies became responsible for the same regulations and guidance as federal depository organizations. These mortgage companies were responsible for up to 50% of subprime lending in 2005-2006. This bill is worded specifically to cover and govern any institution or organization that finances or refinances mortgages. It also allows for the criminal prosecution and civil penalty to mortgage lenders. False appraisals are now considered criminal acts which are thought to have directly influenced the current foreclosure and housing crisis. Lending trends today include the use of the internet to obtain financing and the use of large mortgage brokers who will search out and find financing that is appropriate for the consumer’s individual characteristics. With new guidelines and regulation in place these brokers are subject to more authority and oversight and are held to a higher degree of accountability in brokering mortgages. High fees charged and financed by these brokers were thought to be a contributor in today’s situation as well. Minority groups are still in the public eye as groups targeted for subprime lending though regulations and guidelines make this more difficult for lending institutions. The public-ness of the current mortgage market increase buyer’s awareness and allow them to be advocates in shopping for the best mortgage solution. Unethical policies have contributed to the closing of some large lending institutions with loans being transferred and bought by others. Consumers are given the opportunity to evaluate the terms of loans before making decisions and are now given more time between disclosures and closing of loans. With the many changes, policy updates and regulation there is no certain way to determine what the future will hold in the lending environment. The results of anti-predatory lending practices created to avoid market collapse such as seen in the preceding ten years will not be known for many years. Foreclosure rates have not settled as of yet and still loom as a large factor in today’s economic and political climate. References (n.d). Loan flipping. Washington Post, The. AITKEN, R. (2010). Regul(ariz)ation of Fringe Credit: Payday Lending and the Borders of Global Financial Practice. Competition & Change, 14(2), 80-99. doi:10.1179/102452910X12587274068150 Bellan, M., & Toof, J. (2009, June 1). The Fraud Enforcement and Recovery Act of 2009. Arent Fox. Retrieved 2012, from http://www.arentfox.com/publications/index.cfm?fa=legalUpdateDisp&content_id=2053 Bianco, K. (2008). The Subprime Lending Crisis. Retrieved 2012, from http://business.cch.com/bankingfinance/focus/news/Subprime_WP_rev.pdf Edmiston, K. D. (2011). Could Restrictions on Payday Lending Hurt Consumers?. Economic Review (01612387), 96(1), 63-93. FDIC: FIL-14-2005: Guidelines for Payday Lending. (n.d.). FDIC: Federal Deposit Insurance Corporation. Retrieved 2012, from http://www.fdic.gov/news/news/financial/2005/fil1405a.html FHEO - Subprime Lending - HUD. (n.d.). HUD/U.S. Retrieved 2012, from http://portal.hud.gov/hudportal/HUD?src=/program_offices/fair_housing_equal_opp/lending/subprime Foster, B. P., & Shastri, T. (2010). The Subprime Lending Crisis and Reliable Reporting. CPA Journal, 80(4), 20-25. Horowitz, C. (2010, October 04). Obama Mortgage Modification Bailout Distorts Housing Market. National Legal and Policy Center. Retrieved 2012, from http://nlpc.org/stories/2010/10/04/obama-mortgage-modification-bailout-distorts-housing-market Lehe, K. M. (2010). Cracks in the Foundation of Federal Law: Ameliorating the Ongoing Mortgage Foreclosure Crisis Through Broader Predatory Lending Relief and Deterrence. California Law Review, 98(6), 2049-2091. Mayk, J. E. (2009). Regulation Z Amendments Impose New Requirements (and Potential Liabilities) on Lenders, Brokers and Servicers. Real Estate Finance (Aspen Publishers Inc.), 25(6), 7-15. Moulton, S., & Bozeman, B. (2011). The Publicness of Policy Environments: An Evaluation of Subprime Mortgage Lending. Journal Of Public Administration Research & Theory, 21(1), 87-115. doi:10.1093/jopart/muq005 Truth in lending. (n.d.). Washoe Legal Services, (775) 329-2727, Free Legal Services in Washoe County, Nevada, Non-profit Legal Service Agency. Retrieved 2012, from http://www.washoelegalservices.org/truth.htm Read More