Predatory lending practices in the subprime market, particularly those affecting home equity borrowers, were the subject of testimony delivered today by David Medine, Associate Director for Financial Practices of the Federal Trade Commission's Bureau of Consumer Protection. Speaking on behalf of the Commission before the House Committee on Banking and Financial Services, Medine outlined a number of ways the Commission continues to address predatory lending practices, including law enforcement and consumer education.
Subprime lending refers to the extension of high rate, high fee loans to persons who are considered to be higher risk borrowers. This segment of the lending industry has grown substantially in recent years. In 1999 alone, subprime lenders originated over $160 billion in home equity loans. In addition to an expansion in the number of loans, the Commission's testimony notes that the composition of the industry is changing. One of the most dramatic changes has been the growth in subprime mortgage lending by large corporations, including bank holding companies, that operate nationwide.
The testimony addressed the variety of predatory lending practices that are occurring with some lenders in the industry and that concern the Commission, including equity stripping, packing, and flipping. Equity stripping occurs when a loan is made based on the equity in a property rather than on a borrower's ability to repay the loan. As a general rule, loans made to individuals who do not have the income to repay such loans usually are designed to fail. They frequently result in the lender acquiring the borrower's home and any equity the borrower had in the home. Packing is the practice of adding credit insurance or other "extras" to increase the lender's profit on a loan. Lenders often stand to make significant profits from credit insurance and, therefore, have strong incentives to induce consumers to buy it as part of a loan. Flipping occurs when a lender induces a borrower to repeatedly refinance a loan, often within a short time frame, charging high points and fees each time.
"Depending on the particular facts," according to the testimony, "some of the practices may constitute deceptive or unfair practices in violation of Section 5 of the Federal Trade Commission Act ("FTC Act") or a comparable state statute." In addition, some of these practices may constitute violations of the Truth in Lending Act ("TILA"), as well as violations of the protections for high-rate, high-fee loans under the Home Ownership and Equity Protection Act ("HOEPA"), an amendment to TILA, the testimony stated.
"It is crucial that as many consumers as possible have access to credit," the testimony noted, "but, at the same time, this access must not be hindered by unlawful lending practices."
Medine noted that the Commission has increased its enforcement activities to halt lenders who are engaged in predatory lending practices. At the same time, the Commission has been working with federal agencies and states to increase and coordinate enforcement efforts. The Commission is part of an interagency task force convened by the Federal Reserve Board to examine the issue of predatory lending. The Commission also is educating consumers in order to help them avoid potential home equity lending abuses.
"Due to sharp growth in the subprime mortgage industry, it appears that predatory lending practices are also on the rise," the testimony stated. "The Commission urges the Committee to consider expansion of HOEPA to: (A) prohibit the financing of single-premium, or "lump-sum," credit insurance premiums (as well as other loan "extras") in loans covered by HOEPA; (B) count lump-sum financed credit insurance premiums (and other extras) toward HOEPA's fees-based trigger; (C) provide the Commission and other law enforcers with the power to impose civil penalties for HOEPA violations; and (D) prohibit mandatory arbitration clauses in loans covered by HOEPA." According to Medine, "The Commission recognizes that predatory lending practices are a serious national problem. While some of these practices can be addressed through current laws and regulations, additional statutory changes would enhance consumer protection in this area."
The testimony summarized a March 2000 settlement announced by the Department of Justice ("DOJ"), the Department of Housing and Urban Development ("HUD"), and the FTC, with Delta Funding Corporation, a national subprime mortgage lender. The Commission alleged that Delta engaged in a pattern or practice of asset-based lending, in violation of HOEPA. Specifically, Delta allegedly extended loans to borrowers based on the borrower's collateral rather than considering the borrower's current and expected income, current obligations, and employment status to determine whether the borrower is able to make the scheduled payments to repay the obligation. In these instances, prudent underwriting criteria, such as debt-to-income ratios, residual income, and repayment history, would have indicated that the borrower likely
would have difficulty repaying the loan. The settlement, which provided for nationwide injunctive relief, also resolved claims by DOJ for violations of the Equal Credit Opportunity Act and by HUD for violations of the Real Estate Settlement Procedures Act.
In July 1999, as part of "Operation Home Inequity," the Commission settled cases against seven subprime mortgage lenders for violations of HOEPA, TILA, and Section 5 of the FTC Act. The alleged HOEPA violations included failure to provide required disclosures, asset-based lending, and use of prohibited terms (such as balloon payments on loans with less than five-year terms, increased interest rates after default, and prohibited prepayment penalties). The settlement agreements provide for substantial remedies and protections for past and future borrowers, including consumer redress totaling $572,500, and, in the case of one lender, a ban against any future involvement with high-cost loans secured by consumers' homes.
The testimony noted also that in January 1998, the Commission filed a complaint in the United States District Court for the District of Columbia against Capital City Mortgage Corporation, a Washington, DC-area mortgage lender, and its owner, alleging numerous violations of a number of federal laws resulting in serious injury to borrowers, including the loss of their homes. The company allegedly made home equity loans to minority, elderly, and low-income borrowers at interest rates as high as 20-24 percent. Many borrowers allegedly faced foreclosure on their properties, after which the company would buy the properties at auction for prices much lower than the appraised value of the properties. The Commission's complaint in this matter, which remains in litigation, alleges violations of the FTC Act, the TILA, the ECOA, and the Fair Debt Collection Practices Act.
The testimony also addressed the Commission's aggressive consumer education program, and noted that the agency has published a series of free publications specifically for homeowners and potential home buyers. For example, in 1996, the Commission produced "High-Rate, High-Fee Loans (Section 32 Mortgages)" to alert homeowners about their rights under HOEPA. In 1998, in conjunction with the filing of the Capital City complaint, the Commission issued two publications to help consumers recognize and avoid home equity scams and abuses: "Avoiding Home Equity Scams" and "Home Equity Loans: Borrowers Beware." In January 1999, the Commission, along with ten other federal agencies, produced "Looking for the BEST Mortgage - Shop, Compare, Negotiate" to help consumers shop for home loans. During the first annual National Consumer Protection Week in February 1999, which highlighted credit fraud and abusive lending practices, the Commission distributed more than 500,000 credit-related publications. And most recently, as part of "Operation Home Inequity" in July 1999, the Commission partnered with AARP to produce "Need a Loan? Think Twice About Using Your Home as Collateral."
Medine told the Committee, "As a result of unfair and deceptive practices, and other federal law violations by certain lenders, vulnerable borrowers are facing the possibility of paying significant and unnecessary fees and, in some cases, losing their homes. Using its enforcement authority, the Commission continues to work to protect consumers from these abuses. In addition, the Commission supports the expansion of HOEPA protections to enhance consumer protection in this area."
The Commission vote to approve the testimony was 5-0.
Copies of the Commission's testimony, information regarding the cases mentioned, and consumer education material about home equity fraud are available from the FTC's web site at http://www.ftc.gov and also from the FTC's Consumer Response Center, Room 130, 600 Pennsylvania Avenue, N.W., Washington, D.C. 20580; 877-FTC-HELP (877-382-4357); TDD for the hearing impaired 1-866-653-4261. To find out the latest news as it is announced, call the FTC NewsPhone recording at 202-326-2710.
(FTC File No. P004810)