April 3, 2006
Commentary: Loan sharks | Maine needs to strengthen its laws to crack down on predatory mortgage lending
By Hannah Thomas
Research associate, Coastal Enterprises Inc., Wiscasset
Coastal Enterprises Inc.'s February report on predatory mortgage lending shows that predatory lenders are active in Maine. It also says that state law is not protecting Mainers from these lenders. That's why we think it's time to improve the law ˆ and apparently so does Gov. John Baldacci. He's requested the Office of Consumer Credit Regulation to review the issue over the summer and make recommendations to the Legislature next session.
Predatory lending takes place in the subprime mortgage market, which is supposed to serve borrowers who do not qualify for prime mortgages because of credit problems or a limited credit history. Borrowers in the subprime market pay a higher interest rate for access to credit. In Maine, the subprime mortgage market is dominated by non-bank lenders and mortgage brokers, many of whom do lend responsibly. There was no evidence of predatory practices by Maine banks and credit unions.
However, the subprime market has spawned many predatory practices. The three general predatory practices are:
ˆ Equity stripping, for example by charging excessive upfront fees;
ˆ Steering borrowers to high-priced loans when they qualify for less expensive ones; and
ˆ Loan terms that research shows lead to an increased risk of foreclosure, such as prepayment penalties over two years.
Not all subprime loans are predatory. However, predatory loans are nearly always subprime. Maine's high rate of homeownership, rising property values, the highest median age in the country, and pockets of economic decline make the state ripe for abuse. The data also demonstrates Mainers are using the subprime mortgage market to take cash out of their homes more than in any other state. This segment of subprime loans is most vulnerable to predatory lenders, who extract excessive fees upfront from the equity in the house.
One study quoted in our report estimated in 2000 alone the state lost $23 million in equity stripped from homeowners through predatory practices. That figure would be much higher today. Mortgage industry data show the subprime mortgage market in Maine was worth only $193 million that year. In 2004, the subprime market was $1.036 billion ˆ a 436% increase.
Interviews with victims, brokers, attorneys, lenders, housing counselors and bankruptcy trustees corroborated mortgage data that suggested somewhere in the range of 1,000 subprime mortgages being made with predatory characteristics in 2004. That's 1,000 families in Maine subjected to unconscionably high fees, repeated refinancing with no benefit to the borrower, or terms that help push them into foreclosure and bankruptcy.
Two of the problem practices we heard about in Maine were excessive points and fees, and flipping. Stakeholders and borrowers described seeing large upfront points and fees charged for many borrowers, which translate into equity immediately lost to a family. A responsible credit union or bank might charge a flat one to two percent of the value of the loan, and some responsible brokers are charging three percent. But stakeholders saw charges as high as six percent, and we saw evidence in our research of borrowers being charged close to eight percent.
Flipping builds on these large fees by continually refinancing a borrower and charging large fees to do so each time. In one example we saw, a borrower lost more than $40,000 during four refinances in just two years.
There is further evidence of predatory lending from the Attorney General's office and the Office of Consumer Credit Regulation. In January, Maine Attorney General Steven Rowe, with officials from 48 other states, settled a predatory lending suit with the giant lender Ameriquest for $325 million. In 2004, Ameriquest was the second largest subprime mortgage originator in Maine.
We know from experience working with families that predatory terms and equity stripping can lead to foreclosure. Recent research has corroborated an increased risk of foreclosure from some lending terms ˆ notably prepayment penalties and balloon payments. Maine already has a high subprime foreclosure rate (see chart on previous page), and it's likely these kinds of lending practices are making that rate worse.
However, unlike states with strong laws ˆ such as Massachusetts, North Carolina, New Mexico and half a dozen more ˆ Maine's current law leaves several loopholes that allow predatory lenders to operate legally. There are a few major ways that Maine could strengthen its law. Based on the experience of other states, the state could lower the fees that borrowers are expected to pay for high-cost loans. For example, currently a Maine borrower could pay as much as $8,000 in closing costs for a $100,000 loan. In states with strong laws, a borrower paying more than $5,000 in closing costs for the same $100,000 loan would get extra protections like mandatory counseling.
Maine also could prevent flipping by requiring that all loans have a net tangible benefit to the borrower. This would prevent unnecessary churning of a loan to reap more fees for the broker.
Some people will claim tougher regulation of the subprime market will choke off credit to those who need it most. However, studies show that in North Carolina, which has had a tough law for five years, the market is booming. We think Maine can do better and urge policy makers to take action to protect Maine consumers as soon as possible.
Coastal Enterprises Inc.'s February report on predatory mortgage lending shows that predatory lenders are active in Maine. It also says that state law is not protecting Mainers from these lenders. That's why we think it's time to improve the law ˆ and apparently so does Gov. John Baldacci. He's requested the Office of Consumer Credit Regulation to review the issue over the summer and make recommendations to the Legislature next session.
Predatory lending takes place in the subprime mortgage market, which is supposed to serve borrowers who do not qualify for prime mortgages because of credit problems or a limited credit history. Borrowers in the subprime market pay a higher interest rate for access to credit. In Maine, the subprime mortgage market is dominated by non-bank lenders and mortgage brokers, many of whom do lend responsibly. There was no evidence of predatory practices by Maine banks and credit unions.
However, the subprime market has spawned many predatory practices. The three general predatory practices are:
ˆ Equity stripping, for example by charging excessive upfront fees;
ˆ Steering borrowers to high-priced loans when they qualify for less expensive ones; and
ˆ Loan terms that research shows lead to an increased risk of foreclosure, such as prepayment penalties over two years.
Not all subprime loans are predatory. However, predatory loans are nearly always subprime. Maine's high rate of homeownership, rising property values, the highest median age in the country, and pockets of economic decline make the state ripe for abuse. The data also demonstrates Mainers are using the subprime mortgage market to take cash out of their homes more than in any other state. This segment of subprime loans is most vulnerable to predatory lenders, who extract excessive fees upfront from the equity in the house.
One study quoted in our report estimated in 2000 alone the state lost $23 million in equity stripped from homeowners through predatory practices. That figure would be much higher today. Mortgage industry data show the subprime mortgage market in Maine was worth only $193 million that year. In 2004, the subprime market was $1.036 billion ˆ a 436% increase.
Interviews with victims, brokers, attorneys, lenders, housing counselors and bankruptcy trustees corroborated mortgage data that suggested somewhere in the range of 1,000 subprime mortgages being made with predatory characteristics in 2004. That's 1,000 families in Maine subjected to unconscionably high fees, repeated refinancing with no benefit to the borrower, or terms that help push them into foreclosure and bankruptcy.
Two of the problem practices we heard about in Maine were excessive points and fees, and flipping. Stakeholders and borrowers described seeing large upfront points and fees charged for many borrowers, which translate into equity immediately lost to a family. A responsible credit union or bank might charge a flat one to two percent of the value of the loan, and some responsible brokers are charging three percent. But stakeholders saw charges as high as six percent, and we saw evidence in our research of borrowers being charged close to eight percent.
Flipping builds on these large fees by continually refinancing a borrower and charging large fees to do so each time. In one example we saw, a borrower lost more than $40,000 during four refinances in just two years.
There is further evidence of predatory lending from the Attorney General's office and the Office of Consumer Credit Regulation. In January, Maine Attorney General Steven Rowe, with officials from 48 other states, settled a predatory lending suit with the giant lender Ameriquest for $325 million. In 2004, Ameriquest was the second largest subprime mortgage originator in Maine.
We know from experience working with families that predatory terms and equity stripping can lead to foreclosure. Recent research has corroborated an increased risk of foreclosure from some lending terms ˆ notably prepayment penalties and balloon payments. Maine already has a high subprime foreclosure rate (see chart on previous page), and it's likely these kinds of lending practices are making that rate worse.
However, unlike states with strong laws ˆ such as Massachusetts, North Carolina, New Mexico and half a dozen more ˆ Maine's current law leaves several loopholes that allow predatory lenders to operate legally. There are a few major ways that Maine could strengthen its law. Based on the experience of other states, the state could lower the fees that borrowers are expected to pay for high-cost loans. For example, currently a Maine borrower could pay as much as $8,000 in closing costs for a $100,000 loan. In states with strong laws, a borrower paying more than $5,000 in closing costs for the same $100,000 loan would get extra protections like mandatory counseling.
Maine also could prevent flipping by requiring that all loans have a net tangible benefit to the borrower. This would prevent unnecessary churning of a loan to reap more fees for the broker.
Some people will claim tougher regulation of the subprime market will choke off credit to those who need it most. However, studies show that in North Carolina, which has had a tough law for five years, the market is booming. We think Maine can do better and urge policy makers to take action to protect Maine consumers as soon as possible.
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