They are so-called "predatory lenders." They advertise themselves as companies that can secure home loans for people with poor credit. What they don't advertise are the hidden fees and dubious sales tactics that often result in a financial obligation the borrower can't possibly meet.
"They will look at a borrower who is unable to pay, knowing that in foreclosure they will get everything they can out of the seizure of the house," says New Orleans fair-housing attorney Spencer Livingston. "Their purpose is to make money without regard to whether people lose their homes or not. Foreclosure is not a concern to them."
The Association of Community Organizations for Reform Now (ACORN), a national nonprofit coalition for moderate- to low-income communities, calls predatory lending "legalized robbery."
ACORN has campaigned against exploitative lending practices for decades, lobbying federal and state governments to close the loopholes in lending laws that allow predatory lenders to operate freely. "Legitimate lending institutions will look at a borrower's ability to pay the loan back and make decisions based on that. Predatory lenders, in many cases, don't care whether people can pay it back," says Livingston, an attorney for ACORN of New Orleans who has handled predatory-lending cases in several states.
Predatory financiers thrive among "subprime" lenders that charge high interest rates to balance the risk of customers with poor credit. Not all subprime lenders are predatory. But many of the people served by subprime lenders are inexperienced or undereducated homebuyers and owners, and are easily exploited.
Under the federal Home Ownership Protection Act (HOEPA), when loans are 8 percent or more above Treasury rates, lenders must alert borrowers their homes will be in jeopardy if they fall behind on payments. Predatory lenders often don't heed HOEPA regulations. And though HOEPA's "trigger" was lowered in December from 10 to 8 percent, critics say it wasn't enough to protect the public from predatory loans.
One man who testified about predatory lending before Congress says he was lucky to have enlisted ACORN's help before a shady lender made off with everything he had.
As an accounts payable clerk for a Minnesota hotel, Paul Satriano works with numbers a lot. So when he told the Senate Banking Committee last summer he was duped into a "predatory" home loan, senators learned that exploitative loans aren't simply incurred by people who can't do math.
In 1998, Paul and his wife, Mary Lee, took out a mortgage to buy the St. Paul house she grew up in. The following year, they refinanced and then took out a second mortgage for home improvements. Soon after, the lending institution that financed their car loan offered the Satrianos another loan, promising to consolidate both mortgages and pay off their credit card bills.
"Instead," Satriano told the committee, "we ended up with a loan that did not pay off most of our credit card bill, but that did cost us $10,000 in fees -- plus almost $5,000 in credit insurance -- and which had a higher total interest rate than we had before, and making a couple hundred dollars more in total monthly payments on our debt.
"We lost $15,000 in equity in our home," he said. "And now we are locked into our new higher interest rate and higher payments -- both because the loan has a five-year prepayment penalty for about $6,000, and because we now owe more than our house is worth [and] no one will refinance us."
Satriano is now suing the company who made his loan. "We also testified here in Minnesota before the Banking Commission," he says. "The banking commissioner at first couldn't believe there were so many people hit by predatory lenders. My wife and I just feel if we can stop somebody else from going through this, it's worth it."
In the arena of predatory lending, the Satrianos actually got off easy: they still own their home. Many others end up in foreclosure.
Predatory lending has many faces, but generally involves a lender extending home loans with fees and penalties so great the borrower can't afford the payments. Such loans are structured to make money off the equity homeowners have built up, often their only financial asset.
There are dozens of ways unsavory lenders operate. Many lure clients with mail-outs that resemble Social Security envelopes or government-certified letters. Some send checks for thousands of dollars that, when cashed, lock the recipient into a loan.
Sometimes, predatory lenders work in cahoots with others to solicit borrowers. "This can be in the form of a contractor who sets up the potential victim," says Jeffrey May, executive director of the Greater New Orleans Fair Housing Center (FHAC). "They usually knock on their doors or send out flyers saying they do home improvement repairs and they can help the person qualify for a loan. In some instances, they are the lender -- they are the mortgage broker as well as the contractor."
Often, the contractor steers the borrower toward a bad loan and starts work on the house, but disappears once the payment comes through. "The person is not only stuck with a loan they can't afford, but now they're stuck with a house they can't fix and virtually no way to get their money back," says Jeff Karlson, Fair Housing Director for ACORN of New Orleans. Unscrupulous real estate agents and appraisers also steer customers toward high-income loans.
"It's more than a mortgage lender who may have given someone a bad loan," Karlson says. "You're talking about other people in the housing industry who are working hard to rip people off."
Predatory lenders overwhelmingly tell customers they can only qualify for a subprime loan even if their credit could earn them better financing. Officials with Fannie Mae, the federal home-mortgage financier, estimate that as many as half the people who receive subprime loans in America actually qualify for prime loans.
"There is a lot of deception," Livingston says. "When these lenders are making loans to people, they're done in a high-pressure environment and they're handing them things to sign that they didn't read in advance. When you are buying a home and you're down to the last day, and you're an inexperienced or unsophisticated buyer, anything that's pushed toward you to sign, you'll sign."
The interest rates on subprime mortgages are generally about three to six percentage points higher than those of prime loans. Some lenders charge additional percentage points, but sometimes don't explain that to the customer.
"It's not unusual for a person to pay an excess of five points -- which is 5 percent of the sales price -- in just fees," May says. "The [prime] interest rates today are running about 6.75 percent on a 30-year fixed-rate mortgage. [Subprime] rates may be 12 or 13 or 16 percent, and they may not even be a fixed-rate mortgage, they may be an adjustable-rate mortgage. To be paying 13, 14, 16 percent? That's ridiculous."
In many instances, lenders bundle big fees into the loan without clearly outlining them to the customer. These include origination fees and prepayment penalties, which come due when a borrower pays off the loan early, sells the house or refinances in the time period covered by the penalty. Such penalties continue to strip a home of its equity.
For senior citizens such as Cecil Williams of Washington, D.C., the equity they've built on their home is their nest egg. Losing even part of it is devastating, says Williams, who in 1999 was duped into signing two subprime loans on the $112,000 house she and her husband had bought in 1979.
"They don't really explain to you what you're getting into," says Williams, who sought ACORN's help after being locked into one loan for more than $133,000 at 11 percent interest, and the other for $19,000 at 20.9 percent. Both included prepayment penalties, which Williams says were not explained to her.
ACORN helped Williams get a new loan at a 7 percent interest rate, which Williams says saved their home. "We were stripped of over $11,000 in equity," she says. "We will probably never be able to make that money back, but at least we're not under those high finance charges anymore. We're saving over $800 a month."
Another common tactic is for a lender to add "single premium" credit insurance to the loan. Such insurance is not mandatory, but some lenders tell customers they won't get the loan without it. Exploitative lenders also make "negatively amortized" loans, in which the payments deliberately fail to cover all of the interest due and thus cut deeper into the equity. Often, borrowers will pay on a loan for years without realizing their equity has been dropping instead of building.
Other unsavory practices include granting a loan for more than the value of the home. Some lenders also fail to maintain customer records. "In some instances the people weren't given their paperwork, and that's a violation right there," May says. "In some instances the payment is made and the lender won't report it to the lending institution, and there are no records. And when a borrower is unable to support that they made those payments on time -- like if they made it with money orders, which they often do -- the [lender] starts foreclosure proceedings."
Anxious borrowers sometimes choose the worst solution possible to bail them out -- they take out another subprime loan, giving unsavory lenders the chance to strike again. This cycle of refinancing a series of bad loans until homeowners lose much or all their equity is known as "loan flipping."
"These companies are seeing someone who was suckered into a bad deal and they say, 'Let's try to do it again,'" Livingston says. "It sounds like you're getting a good deal, but the loan is packed up front with excessive points, origination fees and loan fees like credit insurance. And every time they take out another loan, they lose equity.
"Often, loans will have prepayment penalties so severe there is no way of getting out of this loan. It makes refinancing not possible in many cases. All of this strips equity from the property and people end up losing their equity because it's stripped away every time a loan is flipped."
National studies show blacks and other minority groups are disproportionately targeted for subprime loans. "Even when you look at lower-income whites and high-income African Americans," says May, "the high-income African Americans are even more likely to be in the subprime lending category than lower-income whites."
ACORN's "Separate But Unequal 2001" report, which surveys subprime loans around the country, found that in the greater New Orleans area, black borrowers took out many more subprime refinance loans than prime loans. Black homeowners who refinanced were 3.4 times more likely to receive a subprime loan than white households. In buying homes, 25.4 percent of African Americans received subprime loans, compared to 3.4 percent of white buyers.
Subprime lending is booming in low-income and minority communities. In April 2000, the U.S. Department of Housing and Urban Development released statistics showing that between 1993 and 1998, the number of subprime home refinancing loans had multiplied by 10, and subprime mortgages had multiplied by more than seven. HUD formulated a Predatory Lending Task Force, but no congressional action has been taken thus far.
"What we really need is tough legislation from Congress along the lines of what cities and states have started to do," says David Swanson, an ACORN spokesman in Washington, D.C. "If we could get that sort of action from Congress, we would be happy."
ACORN is pushing for new city legislation in New Orleans and for state legislation in Baton Rouge. Organizers are lobbying the New Orleans City Council to pass the type of ordinance adopted last year by Oakland, Calif. The ordinance would regulate tactics characterized as predatory, and would require lenders to send borrowers of high-interest loans to loan counseling.
"Bringing lawsuits against these people ultimately won't solve the problem," Livingston says. "The laws really have to change."
Councilman Oliver Thomas has not read the proposed ordinance but says he plans to speak with ACORN representatives about it. "I'm not familiar with their proposal, but growing up in New Orleans I am familiar with predatory lenders," he says. "I hear the stories."
Some lawsuits have made a difference. In January, the national lending company Household International agreed to pay almost $12 million in penalties and refunds to settle a suit by the state of California, which accused Household of deliberately overcharging thousands of clients. The company, which has also been sued by ACORN, has denied involvement in predatory lending but has agreed to change some of its practices.
Other measures to combat predatory lending involve helping victims refinance their loans. Last November, FHAC teamed up with Hibernia National Bank, Fannie Mae, and the local group Neighborhood Housing Services. Together they launched the Anti-Predatory Lending Initiative, a $2 million fund established to help people out of the hardship created by predatory lending.
In four months, the program has received more than 300 calls. About 44 of them are under investigation, and two homeowners so far have been refinanced through the program.
"We knew this had been an issue, but we really didn't realize how prevalent it is," says Laurie Marshall, Affordable Housing Manager for Hibernia. "It's so easy to get swayed. There's so many different products and services and people cropping up every day doing mortgage loans. A first-timer may not understand the difference between a predatory lender and a bank that can help them get a good mortgage."
Fair-housing advocates say prospective home-buyers or homeowners who want to refinance should attend loan-counseling programs, such as those offered by ACORN and FHAC, before signing anything. They are also encouraging lending institutions to establish more options for people with poor credit.
"We understand companies take a higher risk by dealing with people with risky credit," says ACORN's Jeff Karlson. "But just because people have a risky credit situation doesn't mean you have to rip them off and steal their houses. That's the thing that's immoral, and that's what has to change."