understanding sub-prime and predatory lending. prime lending risk risk lending characteristics...
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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
Sub-Prime Credit LevelsSub-Prime Credit Levels
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
Sub-Prime Credit LevelsSub-Prime Credit Levels
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
Sub-Prime Credit LevelsSub-Prime Credit Levels
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
Sub-Prime Credit LevelsSub-Prime Credit Levels
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%
Sub-Prime Credit LevelsSub-Prime Credit Levels
Credit Level Maximum Loan
Loan Documentation
Purchase/Rate Reduction LTV
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
Full Lite Stated (If a 3-4 unit or condo, can’t use stated income)
90 – 95% 85% 80%
85 – 90% 80% 75 – 80%
Sub-Prime Credit LevelsSub-Prime Credit Levels
Credit Level Maximum Loan
Loan Documentation
Purchase/Rate Reduction LTV
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
Full Lite Stated (If a 3-4 unit or condo, can’t use stated income)
80 – 85% 80 – 85% 70 – 75%
80 – 85% 80% 65 – 70%
Sub-Prime Credit LevelsSub-Prime Credit Levels
Credit Level Maximum Loan
Loan Documentation
Purchase/Rate Reduction LTV
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
Full Lite Stated (If a 3-4 unit or condo, can’t use stated income)
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
Prepayment PenaltyPrepayment Penalty
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
Prepayment PenaltyPrepayment Penalty
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 PenaltyPrepayment Penalty
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
Prepayment PenaltyPrepayment Penalty
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
Prepayment PenaltyPrepayment Penalty
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 PenaltyPrepayment Penalty
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
Hybrid LoansHybrid Loans
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
Hybrid LoansHybrid Loans
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.
Hybrid LoansHybrid Loans
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