Understanding Sub-Prime and Predatory Lending. Prime Lending Risk Risk Lending Characteristics...

Understanding Understanding Sub-Prime and Sub-Prime and

Predatory LendingPredatory Lending

Prime LendingPrime Lending

RiskRisk

Lending Lending CharacteristicsCharacteristics

The consumer is “buying” a loan The consumer is “buying” a loan productproduct

The consumer must fit into the The consumer must fit into the lending product boxlending product box

Sub-Prime LendingSub-Prime Lending

RiskRisk

Lending CharacteristicsLending Characteristics

The consumer is The consumer is “sold” a loan“sold” a loan

Loan is customizedLoan is customized to to consumerconsumer

The Value of Sub-PrimeThe Value of Sub-Prime

Opened market to many unserved Opened market to many unserved homebuyershomebuyers

Allowed consumers with credit Allowed consumers with credit issues to remain homeownersissues to remain homeowners

The Risk of Sub-PrimeThe Risk of Sub-Prime

Lender assumes Lender assumes higher risk of defaulthigher risk of default

Interest rate should Interest rate should correlate to riskcorrelate to risk

Homeowner at higher risk of losing Homeowner at higher risk of losing homehome

Sub-Prime Credit LevelsSub-Prime Credit Levels

Credit Risk FactorsCredit Risk Factors

Credit ScoreCredit Score

EquityEquity

Late Payments Late Payments (Mortgage/Rent)(Mortgage/Rent)

Debt RatioDebt Ratio

Property Quality/TypeProperty Quality/Type


Loan DeterminantsLoan Determinants Loan AmountsLoan Amounts Type of Income DocumentationType of Income Documentation Purpose of LoanPurpose of Loan

PurchasePurchaseRefinanceRefinance

Rate ReductionRate Reduction Debt ConsolidationDebt Consolidation Cash Out OnlyCash Out Only


Types of Income DocumentationTypes of Income Documentation

FullFullTraditional VerificationsTraditional VerificationsRequires Least EquityRequires Least Equity

LiteLite6 Months Bank Statements6 Months Bank StatementsSelf employed BorrowersSelf employed Borrowers


Types of Income DocumentationTypes of Income Documentation

StatedStatedDisclosed On Initial Signed Loan Disclosed On Initial Signed Loan

ApplicationApplication

Relies on Consumer Relies on Consumer Statement of IncomeStatement of Income

Verifications and Bank Verifications and Bank Statements Not RequiredStatements Not Required


Credit Level Max

Loan Amount

Loan Documentation

Purchase/Rate Reduction LTV

Debt Consolidation

Credit score mid – hi 600s None or one late rent/mortgage payments BK/FC – none in last 3 years Debt ratio 50 – 55%

$400,000 $400,000 $300,000

Full Lite Stated (If a 3-4 unit or condo, can’t use stated income)

95% 85% 85%

90% 80% 80%


Credit Level Maximum Loan

Loan Documentation


Debt Consolidation

Credit score very hi 500s to mid 600s 1 or 2 30-day late rent/ mortgage payments BK/FC – none in last 2 years Debt ratio 50 – 55%

$400,000 $400,000 $300,000


90 – 95% 85% 80%

85 – 90% 80% 75 – 80%



Loan Documentation


Debt Consolidation

Credit score mid 500s One 60 day, two 60 day or one 60 and one 90 day late rent/ mortgage payments BK/FC – none in last year Debt ratio 50 – 55%

$300 - $350,000 $300,000 $300,000


80 – 85% 80 – 85% 70 – 75%

80 – 85% 80% 65 – 70%



Loan Documentation


Debt Consolidation

Credit score low 500s 90+ days late on rent/ mortgage payments BK/FC – within last year Debt ratio 50 – 55% for full45% for stated/lite

$300,000 $300,000 $300,000


75 – 80% 70 – 80% 70% (will not use stated income if credit score is in very low 500s)

75 – 80% 70 – 80% 65% (will not use stated income if credit score is in very low 500s)

Typical Loan CostsTypical Loan Costs

Appraisal fee

Underwriting/Commitment Fee

Credit Report

Processing Fee

Title search

Plat Drawing

Origination fee

Brokers Fee

Closing Fee

Closing Process Fee (Couriers,etc)

Doc Prep Fee

Tax Service Fee

Escrow Waiver Fee (Not sub-prime)

$300-350

$300-600

$20-30

$275-450

$250-300

$50-60

1%

2-4%

$175-260

$50-200

$60-150

$80-100

.25%

Key Sub-Prime TermsKey Sub-Prime Terms

Prepayment PenaltyPrepayment Penalty

Yield Spread PremiumYield Spread Premium

Hybrid LoansHybrid Loans

RescissionRescission


Fee charged by a lender when a Fee charged by a lender when a borrower pays off a mortgage debt prior to borrower pays off a mortgage debt prior to the due datethe due date

Most prepayment penalties enforced for Most prepayment penalties enforced for two – three years but may last longertwo – three years but may last longer


Typical Penalty is 6 Months InterestTypical Penalty is 6 Months Interest

Charged on any prepayment greater than Charged on any prepayment greater than 20% of the mortgage 20% of the mortgage

Example:Example:

$150,000 Loan at 10%$150,000 Loan at 10%

Prepayment Penalty = $6,000Prepayment Penalty = $6,000


Prepayment Penalty DisparityPrepayment Penalty Disparity

80% Sub-Prime Loans 80% Sub-Prime Loans

2% Conventional Loans2% Conventional Loans

20% of All Lending is Sub-Prime20% of All Lending is Sub-Prime


Main Purpose of Prepayment Main Purpose of Prepayment PenaltyPenalty

Are They the Necessary Evil?Are They the Necessary Evil?

53% Sub-Prime Borrowers Prepay With a 53% Sub-Prime Borrowers Prepay With a PenaltyPenalty

68% Sub-Prime Borrowers Prepay without a 68% Sub-Prime Borrowers Prepay without a PenaltyPenalty


Does Prepayment Penalty Does Prepayment Penalty Reduce Interest Rate?Reduce Interest Rate?

Cost of penalty is typically 3-4 times Cost of penalty is typically 3-4 times greater than any interest savings greater than any interest savings


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

Usually not well explained at closing.Usually not well explained at closing.

Yield Spread Premium (YSP)Yield Spread Premium (YSP)

Fee from a mortgage lender to Fee from a mortgage lender to the broker when a loan is the broker when a loan is closed at an interest rate closed at an interest rate higher than the rate the higher than the rate the borrower qualifiesborrower qualifies

Premium typically equals the Premium typically equals the difference between the qualified difference between the qualified interest rate and the actual interest rate and the actual interest rate. interest rate.

Yield Spread PremiumYield Spread Premium

Borrower Seldom KnowsBorrower Seldom Knows

Disclosed on HUD 1Disclosed on HUD 1

85-90% Sub-Prime Loans Have YSPs85-90% Sub-Prime Loans Have YSPs

Cost to homeowner: $800 - $3,000Cost to homeowner: $800 - $3,000Average cost: $1,850Average cost: $1,850

Prepayment Penalty & YSPPrepayment Penalty & YSP

Typical YSP for Sub-Prime Loan without a Typical YSP for Sub-Prime Loan without a Prepayment Penalty: 2.5%Prepayment Penalty: 2.5%

Typical YSP for Sub-Prime Loan Typical YSP for Sub-Prime Loan with a Prepayment Penalty: 4.25%with a Prepayment Penalty: 4.25%

Brokers & third party originators are Brokers & third party originators are originating an increasingly higher originating an increasingly higher percentage of loans, 72.4% in 2004percentage of loans, 72.4% in 2004


Often referred to as 2/28 or 3/27 loansOften referred to as 2/28 or 3/27 loans

Majority of sup-prime loans are hybrid loansMajority of sup-prime loans are hybrid loans

Loans are fixed for 2-3 years then adjust Loans are fixed for 2-3 years then adjust thereafter, often at 6 month intervalsthereafter, often at 6 month intervals

Loan documents often say Loan documents often say “Fixed” creating confusion for “Fixed” creating confusion for consumerconsumer


The BenefitsThe 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.


The DangersThe Dangers

Consumers don’t 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.

RescissionRescission

Only available with Only available with refinancingrefinancing

Three business daysThree business days

Election not to rescind Election not to rescind should not be signed should not be signed at closing at closing

Sub-Prime Vs. Predatory LendingSub-Prime Vs. Predatory Lending

Sub-Prime Does NOT Equal PredatorySub-Prime Does NOT Equal PredatoryLenders Subprime Predatory

CustomersServe households with credit problems

Target lower-income, minority and elderly homeowners

Fees Charge reasonable fees based on risks

Charge exorbitant fees

Practices Use aggressive but ethical tactics

Use deceptive and possibly illegal tactics

Predatory LendingPredatory 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. GramlichGovernor

Federal Reserve System Board of Governors

Evolution of Predatory LendingEvolution of Predatory Lending

Record Low Interest Rates

Record High National

Homeownership Rate

Lack of Regulation

Consumer Demand for

Home Improvement

Loans

Advent of Home Equity Loans

Unscrupulous Lenders and

Mortgage Brokers

Subprime Lending Boom

Home Values Rising Faster Than Inflation

Unsure Consumers

Consumer Credit Culture

Lack of Access to Regulated

Capital

Predatory Lending Components Predatory Lending Components

High Pressure Sales or High Pressure Sales or Deceptive Sales TacticsDeceptive Sales Tactics

Preys on Lack of Information Preys on Lack of Information or lack of Credit Confidenceor lack of Credit Confidence

Abuses Lending and Credit PracticesAbuses Lending and Credit Practices

Lending Not Beneficial to HomeownerLending Not Beneficial to Homeowner

Human Components of Human Components of Predatory LendingPredatory Lending

“They robbed me, they robbed my kids, man, they robbed my community.

Yet, I feel like I did something

wrong.”

Human Components of Predatory LendingHuman Components of Predatory Lending

The The TargetTarget Market 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

don’t comparison shop

Human Components of Human Components of Predatory LendingPredatory Lending

The CostsThe 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

Predatory Lending PracticesPredatory Lending Practices

Equity StrippingEquity Stripping Asset Based LendingAsset Based Lending Mortgage FlippingMortgage Flipping PackingPacking Foreclosure RescueForeclosure Rescue Property Flipping Property Flipping Balloon MortgageBalloon Mortgage Home Improvement ScamsHome Improvement Scams

Predatory Lending CharacteristicsPredatory 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

Predatory Lending CharacteristicsPredatory 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

Understanding Sub-Prime and Predatory Lending. Prime Lending Risk Risk Lending Characteristics...

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