Predatory lending

From Wikipedia, the free encyclopedia

The neutrality of this article is disputed.
Please see the discussion on the talk page.

Predatory lending is the practice of convincing borrowers to agree to unfair and abusive loan terms.^[1] Although predatory lenders are most likely to target racial minorities and the elderly, victims of predatory lending are represented across all demographics^[2] ^[3].

Predatory lending often occurs on loans backed by some kind of collateral, such as a car or house, so that if the borrower defaults on payment, the lender can profit by selling the repossessed or foreclosed property. Other types of lending sometimes also referred to as predatory include payday loans, credit cards, and overdraft loans, when the interest rates are considered unreasonably high.

1 Abusive or unfair lending practices
2 Disputes over predatory lending
3 Underlying issues
4 United States legislation combating predatory lending
5 See also
6 External links
7 References

[edit] Abusive or unfair lending practices

There are many lending practices which have been called abusive and labeled with the term "predatory lending." There is a great deal of dispute between lenders and consumer groups as to what exactly constitutes "unfair" or "predatory" practices, but the following are sometimes cited.

Risk-based pricing. This is the practice of charging more (in the form of higher interest rates and fees) for extending credit to borrowers identified by the lender as posing a greater credit risk. The lending industry argues that risk-based pricing is a legitimate practice; since a greater percentage of loans made to less creditworthy borrowers can be expected to go into default, higher prices are necessary to obtain the same yield on the portfolio as a whole. Some consumer groups argue that risk-based pricing is an excuse for price gouging vulnerable consumers.^{[citation needed]} They argue that higher prices paid by more vulnerable consumers cannot always be justified by increased credit risk.

Single premium credit insurance. This is the purchase of insurance which will pay off the loan in case the homebuyer dies. It is more expensive than other forms of insurance because it does not involve any medical checkups, but customers almost always are not shown their choices—because usually the lender is not licensed to sell other forms of insurance. In addition, this insurance is usually financed into the loan which causes the loan to be more expensive, but at the same time encourages people to buy the insurance because they do not have to pay up front.

Any situation where a loan price is negotiable and the buyer is not made aware of it. Many lenders will negotiate the price structure of the loan with borrowers. In some situations, borrowers can even negotiate an outright reduction in the interest rate or other charges on the loan. Consumer advocates argue that borrowers—especially but not only unsophisticated borrowers—are not aware of their ability to negotiate, and might even be under the misapprehension that the lender is placing the borrower's interests above its own. Thus, many borrowers do not take advantage of their ability to negotiate.

Short-term loans with proportionally high fees, such as Payday loans, credit card late fees, checking account overdraft fees, and Tax Refund Anticipation Loans, where the fee paid for advancing the money for a short period of time works out to an annual interest rate significantly in excess of the market rate for high-risk loans. The originators of such loans dispute that the fees are interest.

Car finance, if the price of the car if financed is higher than if paid for in cash.

[edit] Disputes over predatory lending

The organization ACORN claims that predatory loans are usually made in poor and minority neighborhoods where better loans are not readily available.^[4]

Organizations such as AARP, Inner City Press, and ACORN have worked to stop what they describe as predatory lending. ACORN has targeted specific companies such as Household Finance and H&R Block, successfully forcing them to change their practices^[5]. Inner City Press and Fair Finance Watch watch the practices of HSBC and Citigroup as they export their controversial subprime lending models beyond the United States. These groups have also successfully spearheaded legislation that would make forms of lending they deem predatory illegal.

On the other side of the issue are various subprime lending advocates such as NHEMA, the National Home Equity Mortgage Association, who say that many practices commonly called "predatory," particularly the practice of risk-based pricing, are not actually predatory, and that many laws aimed at "predatory lending" significantly restrict the availability of mortgage finance to lower-income borrowers.^[6]

[edit] Underlying issues

There are many underlying issues in the predatory lending debate:

Risk-based pricing: The basic idea is that more-risky borrowers who are more likely to default should pay more interest to avoid the tragedy of the commons, the unfair punishment of those who have never defaulted and never will. Risk-based pricing is a universal practice in bond markets and the insurance industry, and it is implied in the stock market and in many other industries. Risk-based pricing allows lenders to lend to a group they would not otherwise lend to; the higher interest rate compensates for money lost due to the higher-than-normal default rate. Some people believe risk-based pricing is unfair in principle.^{[citation needed]} There are also some who, while agreeing that the rates are generally set fairly considering the risk that the lender assumes, feel that it is not good to allow borrowers with credit problems to take out such a loan.

Competition: Some believe that risk-based pricing is fair but feel that many loans charge prices far above the risk, using the risk as an excuse to overcharge. These criticisms are not levied on all products, but only on those specifically deemed predatory. Proponents counter that competition among lenders should prevent or reduce overcharging.

Financial Education: Many observers feel that competition in the markets served by what critics describe as "predatory lenders" is not affected by price because the targeted consumers are completely uneducated about the time value of money and the concept of APR, a different measure of price than what many are used to.

Caveat Emptor: There is an underlying debate about whether a lender should be allowed to charge whatever it wants for a service, even if it seems to make no attempts at deceiving the consumer about the price. At issue here is the belief that lending is a commodity and that the lending community has an almost fiduciary duty to advise the borrower that funds can be obtained more cheaply. Also at issue are certain financial products which appear to be profitable only due to adverse selection or a lack of knowledge on the part of the customers relative to the lenders. For example, some people allege that credit insurance would not be profitable to lending companies if only those customers who had the right "fit" for the product actually bought it (i.e., only those customers who were not able to get the generally cheaper term life insurance).

Discrimination: Some organizations feel that many financial institutions continue to engage in racial discrimination. Most do not allege that the loan underwriters themselves discriminate, but rather that there is systemic discrimination. Situations in which a loan broker or other salesman may negotiate the interest rate are likely more ripe for discrimination (certain lenders like Honda Auto Finance have had to pay settlements for alleged discrimination by their auto dealers^{[citation needed]}). Discrimination may occur if, when dealing with racial minorities, loan brokers tend to claim that a person's credit score is lower than it is, justifying a higher interest rate charged, on the hope that the customer assumes the lender to be correct. This may be based on an internalized bias that a minority group has a lower economic profile. It is also possible that a broker or loan salesman with some control over the interest rate might attempt to charge a higher rate to persons of race which he personally dislikes. This is a less likely scenario, although the potential for it does exist. For this reason some call for laws requiring interest rates to be set entirely by objective measures.

[edit] United States legislation combating predatory lending

Many laws at both the Federal and state government level are aimed at preventing predatory lending. Although not specifically anti-predatory in nature, the Federal Truth in Lending Act requires certain disclosures of APR and loan terms. Also, in 1994 section 32 of the Truth in Lending Act, entitled the Home Ownership and Equity Protection Act of 1994, was created. This law is devoted to identifying certain high-cost, potentially predatory mortgage loans and reining in their terms.

Twenty-four states have passed anti-predatory lending laws. Arkansas, Georgia, Illinois, Massachusetts, North Carolina, New York, New Jersey, New Mexico and South Carolina are among those states considered to have the strongest laws. Other states with predatory lending laws include: California, Colorado, Connecticut, Florida, Kentucky, Maine, Maryland, Nevada, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Utah, Wisconsin, and West Virginia. These laws usually describe one or more classes of "high-cost" or "covered" loans, which are defined by the fees charged to the borrower at origination or the APR. While lenders are not prohibited from making "high-cost" or "covered" loans, a number of additional restrictions are placed on these loans, and the penalties for noncompliance can be substantial.

[edit] See also

[edit] External links

Don't Be A Victim Of Loan Fraud from HUD
Protect Yourself in the Loan Process from the California Department of Real Estate
ACORN, neighborhood associations opposing predatory lending
Weekly report on predatory lending by Inner City Press, an organization combatting predatory lending
Center for Responsible Lending, an organization opposing predatory lending
National Home Equity Mortgage Association, an organization promoting subprime lending
Report Predatory Lending, a complete list of resources to report suspected fraud.
Federal Citizen Information Center, site has links to state and federal regulatory agencies and other consumer information provided by the United States General Services Administration
Predatory Lending article in Dollars & Sense magazine