Predatory Lending Practices - Report Example

Predatory Lending Practices Yvonne L. Academia Research The economic sector has recognized the growing fame of check cashing and lending businesses. Its magnitude of growth has widely targeted most communities from several billions of dollars in equity and people are loosing their homes. Predatory practices have been recognized as the draining point of home foreclosures. Such abusive practice without tangible benefits to the borrower has affected vulnerable citizens and is a cause for concern. Policies that support consumer protection against predatory practices are enhanced through research that work its way to disseminate to the business management groups that favors mutual beneficial relations to the lender and the borrower. Predatory Lending Practices: Management Research When lenders began offering loans to deprived borrowers with low or bad credit standing, sub-prime loans were priced higher to compensate for the risk. Regardless of the a client's personal credit history, these finance companies offer the chance and allowance of refinancing or new mortgage that overwhelms he borrower with high fees and expensive often unhelpful terms. Minority borrowers composed of hard working people and low-wealth are the usual of consumers availing this type of loan to obtain financing. Availability of fair credit terms should be a major priority for responsible lenders as people no matter what the noted deficiencies are members of a civilized society with moral rights to uphold regardless of condition of credit orientation. However, seemingly cognizant of the needs of this minority sector, financing institutions have blossomed giving effect to what has been observed as a tragic loophole in Federal reserves that charges people with exorbitant interests and penalties. What symptoms can cause management concern When the growth in equity lending has created risk management practices in response to financial institutions with equity lending programs, financial institutions' credit risk management practices for home equity lending have not kept pace with the product's rapid growth and easing of underwriting standards. We have seen numerous fore-closures on home properties in the past years that would eventually reflect in an economic meltdown. Further studies revealed predatory practices of lending institutions as the culprit in this scenario that charged exorbitant and often unnecessary fees and interests into the gross amounts that may no longer be viable for a medium to low wage earning homeowner. How can management eliminate the negative symptoms How can management fully capitalize on an opportunity Risk Management standards would create a favorable scenario over the increased lending with favorable tax treatments that may allow home equity loans and lines attractive to its consumers that offers a modest repayment schemes and relaxed structures that was currently devoid in its system. Institutions should capitalize on the rise on home values coupled with lower interest rates that make a product more attractive yet attainable and helpful to its user. The identification of certain risk factors in the system of practices in a financial lending institutions helps to identify the culprits that serves to practice certain features that offer an "interest-only" amortization that requires no principal amount applied. Documentation or its absence provides no room for evaluative measures and appraisals within the healthy structure. Risk management systems call for lending measures conducted in a safe and sound manner pursued with adequate allowances for loan losses and appropriate capital levels without negating sound practices in the accepted lending policies. Management principles actively assess the changes in the consumer's ability to pay and the potential decline of a home value and entertain this scenario without generating allowances that charge exorbitant fees disabling the capacity of the borrower from paying his dues and eventually leading to the foreclosure of mortgage properties. Questions: Does the management establish certain criteria that determine the appropriate valuation methodology for a particular transaction based on the risk in the transaction and loan portfolio A: With the use of automated systems in risk management with particular emphasis on the changing risk profile of home equity portfolios, vulnerability to changes in consumers' ability to pay and the potential for declines in home values is carefully monitored. Active portfolio management is especially important for financial institutions that project or have already experienced significant growth or concentrations, particularly in higher risk products such as high-LTV, "low doc" or "no doc," interest-only, or third-party generated loans. Does the management adhere to a policy of sound investigation procedure on the capacity of the borrower to pay only the amortization Consistent with most agencies' regulatory standards on real estate lending an evaluation of repayment capacity should consider a borrower's income and debt levels and not just a credit scoring based upon the borrower's historical financial performance. Such verification of these underwriting factors will depend upon the individual loan's risk that an agency may be willing to tale into consideration. (Such guidelines are reflected in 12 CFR Part 34, Subpart D (OCC); 12 CFR Part 208.51 and Appendix C (FRB); 12 CFR Part 365 (FDIC) and 12 CFR 560.100-101 (OTS)[1992]). Does the management consider the capacity of the borrower to pay amortization and principal It is therefore suggested that underwriting standards for interest-only and variable rate HELOCs should include an assessment of the borrower's ability to amortize the fully drawn line over the loan term and to absorb potential increases in interest rates. Does the management charge high interest rates over the loaned amount Where interest rates reflect the cost of mortgage in an annual basis, interest rates are likely higher than a stated note rate or advertised rate on the mortgage, because it takes into account point and other credit cost. The Annual Percentage Rate usually allows home buyers to compare different types of mortgages based on the annual cost for each loan and most lending institutions do hereby encourage clients to study these rates before plunging in. In many cases, credit risk management practices from (HELOC's or Open-end home equity lines of credit and closed-end home equity loans (HEL's)have not kept pace with the easing of underwriting standards and it would be interesting to note that interest rates subjected several borrowers to significant payment increases particularly low interest rate environment. Note: This study reflected that most institutions refused to acknowledge their own verbal assessment of the APR's usually afforded to their clients. If this was an official study, I would say that there is a 70% chance that official records from the clients and the institution would reveal a clearer picture. Does the management charge "hidden" fees for loan documentation and processing Most lending/credit institutions upon investigation do have hidden fees not reflected on their summaries. Most of these are charged on assessment fees, lawyer's fees for notarial and processing of documents which upon study would take up to at least 2% of the loan value. These records are not officially acknowledged with proper breakdown. Other ran-of-the-mill agencies place on top of this amount a certain commission or fee treated as agents or referral fee and more often never reflected on official records. What are the credit risk management standards practiced by the financial institution Most institutions due to competition and marketability of products offer Interest-only package which features no amortization of principal for a protracted period; Limited or no documentation of a borrower's assets, employment, and income (known as "low doc" or "no doc" lending); Others offer Higher loan-to-value (LTV) and debt-to-income (DTI) ratios; Lower credit risk scores for underwriting home equity loans; Does the management employ appropriate monitoring tools and management information systems (MIS) to measure the performance of various marketing initiatives There is a wider use of automated valuation models (AVMs) and other collateral evaluation tools for the development of appraisals and evaluations. Does the management employ evaluative measures on the client's payment performance Since HELOCs often have long-term, interest-only payment features, ideally financial institutions employ techniques that identify higher risk accounts and adverse changes in account risk profiles, thereby enabling management to implement timely preventive action with the reduction or freezing of account lines. This would include periodic refreshing of credit risk scores on all customers; Use of behavioral scoring and analysis of individual borrower characteristics to identify potential problem accounts; Periodic assessment and utilization rates and payment patterns, including borrowers who make only minimum payments over a period of time or those who rely on the line to keep payments current; These actions should be commensurate with the risk in the portfolio. And most financial institutions refuse to extend additional credit or reduce the credit limit of a HELOC, bearing in mind that under Regulation Z such steps can be taken only in limited circumstances. However it is interesting to note that many institutions do not comply with these standards which often result to catastrophic scenarios. Does the management offer easy re-structuring terms favorable to the client without sacrificing its ROI In accordance with the policies of the FFIEC's "Uniform Retail Credit Classification and Account Management Policy," (June 2000), circumstances and qualifying requirements for various workout programs including extensions, re-ages, modifications, and re-writes. Qualifying criteria should include an analysis of a borrower's financial capacity to service the debt under the new terms. Is the management approachable and dependable with a trustworthy manner and expertise to handle financial transactions An increase in the number of transactions generated through a loan broker or other third party has made credit offers more accessible to all. Some see this method as another cost to the borrower in itself which agents are not fully capacitated to function better compared to the direct dealings with the Credit Company and facility itself. What is the recommended course of action given the research findings Effective procedures and controls support functions that oversee credit risk management and support certain functions to ensure properly control. Lien Recording among lending institutions take appropriate measures to safeguard their lien position. Problem Loan Workouts should establish certain policies and procedures for workout and loss mitigation practice in accordance with the requirements of the FFIEC's (June 2000), and should, at a minimum. References United States. Applicable laws include Federal Trade Commission Act; Equal Credit Opportunity Act (ECOA); Truth in Lending Act (TILA), including the Home Ownership and Equity Protection Act (HOEPA); and the Home Mortgage Disclosure Act (HMDA);Fair Housing Act; Real Estate Settlement Procedures Act (RESPA). United States. FFIEC's "Uniform Retail Credit Classification and Account Management Policy,". June 2000. United States. Comptroller's Handbook for Commercial Real Estate and Construction Lending; SR letter 94-55 (FRB). United States. Interagency Guidelines for Real Estate Lending Policies." 12 CFR Part 34, Subpart D (OCC); 12 CFR Part 208.51 and Appendix C (FRB); 12 CFR Part 365 (FDIC) 12 CFR 560.100-101 (OTS) 1992. 12 CFR 226.30(b) Read More