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 Sub-Prime and
Predatory Lending
            Prime Lending
 Risk
 Lending
 The consumer is “buying” a loan
 The consumer must fit into the
 lending product box
      Sub-Prime Lending
 Risk
 Lending Characteristics
 The consumer is
 “sold” a loan
 Loan is customized
 to consumer
 The Value of Sub-Prime
Opened market to many unserved

Allowed consumers with credit
issues to remain homeowners
    The Risk of Sub-Prime
 Lender assumes
 higher risk of default

 Interest rate should
 correlate to risk

 Homeowner at higher risk of losing
   Sub-Prime Credit Levels
 Credit Risk Factors
     Credit Score
     Equity
     Late Payments
     Debt Ratio
     Property Quality/Type
   Sub-Prime Credit Levels
Loan Determinants
 Loan Amounts
 Type of Income Documentation
 Purpose of Loan
     Purchase
     Refinance
       Rate Reduction
       Debt Consolidation
       Cash Out Only
  Sub-Prime Credit Levels
Types of Income Documentation
  Full
     Traditional Verifications
     Requires Least Equity

  Lite
     6 Months Bank Statements
     Self employed Borrowers
  Sub-Prime Credit Levels
Types of Income Documentation
  Stated
     Disclosed On Initial Signed Loan
    Relies on Consumer
     Statement of Income
    Verifications and Bank
     Statements Not Required
          Sub-Prime Credit Levels
         Credit Level              Max             Loan                Purchase/Rate       Debt
                                   Loan        Documentation           Reduction LTV   Consolidation

 Credit score mid – hi 600s
 None or one late               $400,000   Full                       95%             90%
rent/mortgage payments
 BK/FC – none in last 3 years   $400,000   Lite                       85%             80%
 Debt ratio 50 – 55%
                                 $300,000   Stated (If a 3-4 unit or   85%             80%
                                            condo, can’t use
                                            stated income)
          Sub-Prime Credit Levels
         Credit Level            Maximum           Loan                 Purchase/Rate       Debt
                                   Loan        Documentation            Reduction LTV   Consolidation

 Credit score very hi 500s to
mid 600s                         $400,000   Full                       90 – 95%         85 – 90%
 1 or 2 30-day late rent/
mortgage payments                $400,000   Lite                       85%              80%
 BK/FC – none in last 2 years
 Debt ratio 50 – 55%            $300,000   Stated (If a 3-4 unit or   80%              75 – 80%
                                            condo, can’t use
                                            stated income)
         Sub-Prime Credit Levels
        Credit Level          Maximum          Loan               Purchase/Rate       Debt
                                Loan       Documentation          Reduction LTV   Consolidation

 Credit score mid 500s
 One 60 day, two 60 day or   $300 -     Full                    80 – 85%         80 – 85%
one 60 and one 90 day late    $350,000
rent/ mortgage payments                                          80 – 85%         80%
 BK/FC – none in last year   $300,000   Lite
 Debt ratio 50 – 55%
                              $300,000   Stated (If a 3-4 unit   70 – 75%         65 – 70%
                                         or condo, can’t use
                                         stated income)
          Sub-Prime Credit Levels
         Credit Level            Maximum          Loan               Purchase/Rate         Debt
                                   Loan       Documentation          Reduction LTV     Consolidation

 Credit score low 500s
 90+ days late on rent/         $300,000   Full                    75 – 80%           75 – 80%
mortgage payments
 BK/FC – within last year       $300,000   Lite                    70 – 80%           70 – 80%
 Debt ratio 50 – 55% for full
45% for stated/lite              $300,000   Stated (If a 3-4 unit   70% (will not      65% (will not
                                            or condo, can’t use     use stated         use stated
                                            stated income)          income if credit   income if credit
                                                                    score is in very   score is in very
                                                                    low 500s)          low 500s)
     Typical Loan Costs
Appraisal fee                        $300-350
Underwriting/Commitment Fee          $300-600
Credit Report                        $20-30
Processing Fee                       $275-450
Title search                         $250-300
Plat Drawing                         $50-60
Origination fee                      1%
Brokers Fee                          2-4%
Closing Fee                          $175-260
Closing Process Fee (Couriers,etc)   $50-200
Doc Prep Fee                         $60-150
Tax Service Fee                      $80-100
Escrow Waiver Fee (Not sub-prime)    .25%
    Key Sub-Prime Terms

 Prepayment Penalty
 Yield Spread Premium
 Hybrid Loans
 Rescission
     Prepayment Penalty

Fee charged by a lender when a
borrower pays off a mortgage debt prior to
the due date

Most prepayment penalties enforced for
two – three years but may last longer
      Prepayment Penalty
Typical Penalty is 6 Months Interest
Charged on any prepayment greater than
20% of the mortgage
  $150,000 Loan at 10%
  Prepayment Penalty = $6,000
    Prepayment Penalty
Prepayment Penalty Disparity

80% Sub-Prime Loans
2% Conventional Loans

20% of All Lending is Sub-Prime
     Prepayment Penalty
Main Purpose of Prepayment

Are They the Necessary Evil?
  53% Sub-Prime Borrowers Prepay With a
  68% Sub-Prime Borrowers Prepay without a
     Prepayment Penalty
Does Prepayment Penalty
Reduce Interest Rate?

Cost of penalty is typically 3-4 times
greater than any interest savings
     Prepayment Penalty

Prepayment penalty is a back end
cost that is generally collected yet not
factored in at origination avoiding HOEPA

Usually not well explained at closing.
Yield Spread Premium (YSP)
Fee from a mortgage lender to
the broker when a loan is
closed at an interest rate
higher than the rate the
borrower qualifies

Premium typically equals the
difference between the qualified
interest rate and the actual
interest rate.
    Yield Spread Premium
Borrower Seldom Knows

Disclosed on HUD 1

85-90% Sub-Prime Loans Have YSPs

Cost to homeowner: $800 - $3,000
Average cost: $1,850
 Prepayment Penalty & YSP
Typical YSP for Sub-Prime Loan without a
Prepayment Penalty: 2.5%
Typical YSP for Sub-Prime Loan
with a Prepayment Penalty: 4.25%

Brokers & third party originators are
originating an increasingly higher
percentage of loans, 72.4% in 2004
            Hybrid Loans

Often referred to as 2/28 or 3/27 loans
Majority of sup-prime loans are hybrid loans
Loans are fixed for 2-3 years then adjust
thereafter, often at 6 month intervals
Loan documents often say
“Fixed” creating confusion for
              Hybrid Loans

The 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 Loans
The Dangers

 Consumers don’t realize the
 loan is only fixed for a short time.
 Must be diligently working toward resolving credit risk
 Targeted for repeated refinancings to avoid adjustable
 Prepayment penalties may extend beyond the fixed
 period of time.

Only available with
Three business days
Election not to rescind
should not be signed
at closing
Sub-Prime Vs. Predatory Lending
  Sub-Prime Does NOT Equal Predatory
    Lenders     Subprime                     Predatory

                Serve households with        Target lower-income,
                credit problems              minority and elderly

    Fees        Charge reasonable fees       Charge exorbitant fees
                based on risks

    Practices   Use aggressive but ethical   Use deceptive and
                tactics                      possibly illegal tactics
Predatory Lending
         “Just as the expansion
         of subprime lending
         has increased access
         to credit, the
         expansion of its
         counterpart, predatory
         lending, has made
         many borrowers worse
                                  Edward M. Gramlich
            Federal Reserve System Board of Governors
Evolution of Predatory Lending
               Subprime                           Consumer
                               Record Low
                Lending                          Credit Culture
                              Interest Rates
Lenders and                                          Home Values
 Mortgage                                            Rising Faster
  Brokers                                            Than Inflation

                                                       Advent of
 Lack of                                                Home
Regulation                                              Equity
                                  Record High         Demand for
                                    National            Home
             Lack of Access
                                 Homeownership       Improvement
              to Regulated
                                     Rate               Loans
Predatory Lending Components

  High Pressure Sales or
  Deceptive Sales Tactics
  Preys on Lack of Information
  or lack of Credit Confidence

  Abuses Lending and Credit Practices
  Lending Not Beneficial to Homeowner
    Human Components of
      Predatory Lending

“They robbed me, they robbed my kids,
man, they robbed my community.
Yet, I feel like I
did something
Human Components of Predatory Lending
 The Target 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
       Predatory Lending
 The Costs
  • It destroys credit and opportunities
  • It causes foreclosures
  • It creates homelessness
  • It robs wealth from families, neighborhoods and
  • It strips families of hopes and replaces dreams with
    shame & embarrassment
Predatory Lending Practices
 Equity Stripping
 Asset Based Lending
 Mortgage Flipping
 Packing
 Foreclosure Rescue
 Property Flipping
 Balloon Mortgage
 Home Improvement Scams
Predatory Lending Characteristics
  • Unwarranted high interest rate
  • Unwarranted high discount points
  • Closing costs that exceed 5% of the loan

  • Undisclosed negative amortization
  • Inflated appraisal costs or fees
  • Excessive broker fees
Predatory 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

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