Prime Lenders Offer Home Loans example essay topic

The Ethics of Predatory Lending in the Housing Industry The real estate industry is thriving with approximately sixty-eight percent of all Americans being homeowners. With low interest rates, 1st time home buyer down payment assistance programs, and government funded educational opportunities (i.e. the Home Ownership Center of Greater Cincinnati), the real estate and mortgage lending industries will continue to flourish. However, there are some unethical lending practices that are threatening the housing industry as a whole. Those involved in the mortgage lending process have some duty to the borrower. They are expected to perform their specific duties in an ethical manner and have some form of direct or indirect contact with the client.

Banks (Prime Market): Banks are lenders who generally handle all facets of the lending process through their own institution. They function differently from brokers in that they usually only service those clients with good credit ratings / scores of 700 or more. Mortgage Brokers (Sub-prime Market): According to HUD, the Department of Housing and Urban Development, mortgage brokers are involved in about sixty percent of all mortgage loan transactions. Brokers try to find the best loan for their clients by shopping their loan applications around to lenders who are willing to accept the clients credit package.

Brokers generally service clients, known as B-C-D credit clients, with ratings / scores of 650 and below. In some instances, a major problem for borrowers is that a broker may work in the best interest of the lender as well. Furthermore, in some states they can act as brokers and lenders. Brokers can be considered dual agents. Brokers (1) originate loans using "table funding" provided by a pre-arranged buyer of the loan (2) originate loans using a line of credit from a bank / financial institution (3) originate loans using their own funds (4) bring the borrower and lender together in a transaction that they do not originate. Real Estate Agents: In most cases, Realtors refer borrowers to a lender or mortgage broker.

They are paid a percentage of the sales price of a home. The seller pays a Realtors fee. Closing Agent: Closing agents perform property title searches and prepare documents for the actual closing of the sale of a home. Most closing agents are lawyers. The borrower pays for the closing agents fees. Mortgage Servicer: A servicer collects monthly mortgage payments and holds money in an escrow account to pay for property taxes and homeowners insurance.

Mortgage Insurance Companies: Mortgage insurance companies are generally used if the borrowers down payment are less than twenty percent of the purchase price of the home. This is called PMI (Private Mortgage Insurance). The cost of private mortgage insurance is included in a buyer's monthly payment. What is happening is that there are some unethical lending practices that are threatening the housing industry as a whole. The concern involves the practices of some sub-prime lenders. These practices are considered to be "predatory" on consumers.

Sub-prime lenders offer home loans (Equity Loans & 1st Time Home Purchase Loans) to moderate to lower income families. These clients are considered to be high credit risk borrowers, also know as B-C-D credit clients. Interest rates and other loan terms generally cost more than those paid by clients served by prime lenders with better credit records (A credit clients). Sub-prime borrowers end up paying more simply because the risk of loan repayment is fundamentally higher than that of a prime market borrower.

These predatory practices include, but are not limited to: o Extremely high interest rates, discount points, closing costs, and broker fees. o Borrowers with inadequate income, receiving loans that they will default on. o Flipping-occurs when someone makes a new loan to refinance an already existing loan. o Debt consolidation in the form of an unaffordable home equity loan. o Packing-the selling of additional products without borrowers informed consent (i.e. credit life insurance being implied as necessary to obtain a loan). o Failure to report good payment on a borrower's credit report. o Falsifying loan documents. o Making loans to mentally incompetent parties. o Mailing "live" loan checks to clients that do not request them. Through the use of false promises and sneaky sales tactics, borrowers are convinced to sign a loan contract before they have had a chance to review the paperwork. If the borrower is allowed the chance to go over the fine details of the contract, a significant amount of the borrowers targeted by predatory lenders haven't been updated enough to really understand what they are signing. In most cases, sub-prime borrowers do not hire attorneys to represent them.

They either don't have the cash flow to do so, or they are not made aware of the opportunity. An example of the predatory lending practice of high interest rate financing is as follows: A $100,000 mortgage at 8% and zero points over a 30-year time period yields interest worth $164,155. Not all loans are available at 8% because not all borrowers have great credit. Now, let's say that 8% is the base rate for loans today but rates as high as 12% and zero points will be allowed.

This means that a $100,000 loan over 30 years would have a projected interest cost of $270,300. Any loan with a higher projected yield-including interest, points, loan discount fees, origination fees, and other payments to a lender will be defined as "predatory". In some cases, predatory loans carry high up-front fees as well. These fees are added to a clients loan balance, decreasing the homeowner's equity. When a borrower has trouble re-paying the debt, they are often encouraged to refinance the current loan. This is attractive to the loan holder because they see this as a way out of foreclosure, when in actuality the refinancing of the current loan decreased their equity even more.

The effect of this can eventually cause foreclosure. Predatory loans are considered to be the new horror of the mortgage lending industry. Predatory lenders are in it for the money. There are a number of ways lenders make money in the predatory market. They can basically take advantage of a borrower by charging extremely high fees since they are not required to disclose this information to the borrower up front. Borrowers normally find out the fee when the transaction is completed.

When a loan is refinanced, the end result is more profit since a new round of points and fees is added to the principal of the new loan. When a buyer defaults on a loan, as long as there is enough equity, the lender benefits in this situation also. There are more ways lenders prosper from the predatory market. Financial incentives also encourage predatory lending. Lenders often pay brokers to bring them loans. This is a big pay off for everyone involved.

The problem is that these payments to brokers can drive up the cost of mortgage loans and create reverse competition where brokers have incentives to steer borrowers to the lenders that pay them the most. Predatory markets primarily consist of clients in certain communities, particularly the elderly and minorities. These markets are also made up of the poor, sick, and uneducated consumer. According to recent studies, these victims are especially likely to fall prey to predatory lending. These people end up paying far more than they should for financing secured by real estate. We must also remember that almost anyone can get caught up in these abusive lending practices, no matter their background.

There are several ethical problems that surround predatory practices. First of all, many of them are not considered to be illegal, even though the future of the open equity loan market is at stake. Secondly, lenders are not required to state their fees to borrowers up front. This allows high fees to be charged without up front disclosure. Lenders are required to provide the borrower with a Truth-In-Lending statement (enforced by the Truth-In-Lending Act), which gives borrowers an "estimate" of what their costs will be.

Now, if you take a close look at the Home Ownership Equity Protection Act of 1994 (Section 32 of Regulation Z, part of the Truth-In-Lending Act) you can see where the problem lies. According to the Federal Trade Commission, Section 32 requires extensive disclosures if: o The annual percentage rate (APR) exceeds by more than 10 percentage points the rates on Treasury securities of comparable maturity; oro The total fees and points payable by the consumer at or before closing exceed the largest of $451.00 or 8% of the total loan amount. (The $451.00 figure is for the year 2000; the Federal Reserve Board, based on changes in the Consumer Price Index, adjusts this amount annually.) There are three specific problems with Section 32. First, Section 32 requires disclosure for onerous loan terms, but it does not ban such financing. Second, Section 32 allows loans with poor terms and no disclosure. Third, a huge percentage of all real estate loans are excluded from Section 32 regulations.

As the Federal Trade Commission states, "The rules do not cover loans to purchaser initially construct your home, reverse mortgages, or home equity lines of credit". Another dilemma is that it is not easy to determine what is and is not a predatory loan. Lastly, predatory lenders are in the business of selling debt. In order to grow and profit, these lenders must continuously put more people in debt, get them deeper in debt, keep them there as long as humanly possible while striving to attain more customers. The end result is the loss of wealth from middle to lower income households, high foreclosure rates that affect the values of homes in a specific neighborhood, and unwarranted regulations on legitimate lenders. Ethical principal issues of the predatory lending industry can be evaluated by asking some of the following questions: 1.

Is it the duty of the consumer to educate themselves about the mortgage lending process in order to avoid predatory lenders? 2. What is the responsibility of an organization to its clients? 3. Do organizations have a responsibility to improve the public? 4.

What are the consequences of lenders who do not abide by a code of ethics that specifically state that you must disclose all lending terms, while only lending to those clients who can truly afford to buy? 5. Who is responsible for monitoring the actions of lenders during the mortgage loan process? 6. Is it ethical to target specific groups of people, who are economically at a disadvantage, for high interest rate loans? 7.

If there were no profit involved, would lenders continue predatory practices? If so, what would be there motivation? Taking all of these issues into consideration, I believe we must stick to the notion that ethics is about standards of conduct and moral judgment. These standards apply organizations as well as the people who make up an organization. Organizations, like individuals, must have values that guide the way they operate and do business.

According to Milton Friedman, the social responsibility of an organization is to increase its profits. He believes it's alright to deceive your fellow man when engaged in business dealings. I don't agree that we should focus on this concept knowing fully that certain practices, by organizations are hurting the public. When predatory lenders succeed, homeowners, legitimate lenders, Realtors, neighborhoods and communities lose. The housing industry is set up to help, not hurt those who want to increase their economic status. I believe in Freeman's Stakeholder Theory that suggests that profit should not be the primary aim; avoiding harm should be the focus.

Those involved in directly providing a service to these individuals should adhere to the 2nd Categorical Imperative that states, "Act so that you treat humanity, whether in your own person or that of another, always as an end and never as a means". The industry wide argument lies in how to fix the problem. There are a number of organizations, companies, and associations who believe they have the cure-all for predatory lending practices. The National Association of Mortgage Brokers has a put together an "industry-wide" registry to eliminate abusive lending practices. This registry contains a universal listing of individual loan originators, as well as companies, who have been involved in predatory lending practices. It will allow those in the public to avoid working with those individuals with poor track records.

The argument I have with this registry is the same when you commit an offense. You may have a record of committing the offense, but be reformed through training etc. The same could be true for individuals in the mortgage industry, but they still must wear the "scarlet letter" of this registry. What isn't known is how long a person or an organization would remain on the registry from the date of their offense.

I believe in second chances and would agree that after a specific amount of time (i.e. two to three years) your name or organizations name should be taken off of the registry. The government's plan is to extend the protections of the Home Ownership and Equity Protection Act by making changes to Section 32 of Regulation Z (part of the Truth-In-Lending Act.) The following changes would be made: 1. Ban financing that contains unrealistic loan terms. 2. Lenders are to disclose these loan terms up front. 3.

Real estate loans to purchase or construct property, reverse mortgages, and home equity lines of credit would be included. The only issue that I foresee with the government's plan is defining "unrealistic" loan terms. What may be unrealistic to some may be realistic to others. Who is going to be responsible for finding the happy medium? According to the National Association of Mortgage Brokers, the government's proposal to extend the protections of the Home Ownership and Equity Protection Act to more consumers would make it more difficult and more expensive for many needy home owners to borrow against the equity they have built in their homes". Maintaining that illegal practices are the "work of a tiny minority" of loan originators who "routinely ignore" licensing and consumer protection laws, new laws aren't necessary", said Neil Fendly of NAME.

He believes they will only mean a greater compliance burden for those brokers who believe in complying and more meaningless words for those who do not. Fendly feels that the legitimate industry already feels thoroughly regulated and increased enforcement should be directed at those who ignore the law. On a federal level, the Federal Deposit Insurance Corporation (FDIC) is working to keep predatory lenders out of the mainstream banking system. Freddie Mac is advising consumer organizations and industry groups it will no longer purchase loans that are subject to the Home Ownership and Equity Protection Act. This will only be effective in conjunction with the government's extension plan of this same Act because now as it stands, real estate loans to purchase or construct property are not included.

The FDIC's plan will not make a difference without the government's extension strategy. I am very impressed with the City of Cincinnati and the implementation of the Home Ownership Center of Greater Cincinnati (HOC). They are a government-funded agency that focuses on the 1st time homebuyer. The HOC was started mainly because of the low home ownership rates in the city. The National average is approximately 68% and the city's average was about 38%. There was definitely a need for this type of program.

The Home Ownership Center offers free classes and down payment assistance funds for taking some of these classes. They teach budgeting, how to be a homeowner, home repair, and lending practices (how to avoid predatory lenders) to name a few. The HOC is a valuable resource for consumers because we may be the victims of predatory lenders, but we must remain aware by keeping ourselves informed. There are Bills that are being considered that would help curb predatory lending on state levels as well.

1. No pre-payment penalties would be allowed on any type of home loan. 2. An attorney representing the buyer must be present at the closing of a high-cost loan. The dilemma I find with the second Bill being considered is the cost of the attorney.

A huge number of these families are already financially stressed and adding to their costs by the mandatory rules of the presence of an attorney would be more financially distressing. I believe these buyers should be a given a choice; if they can or cannot afford it, they were at least able to make the choice themselves. What I would like to see done on state levels is the requirement that mortgage brokers operate the same way other businesses do in a market economy. I strongly believe they should be required to quote the price of their services up front. This would allow the consumer to make an informed pricing choice about what company they would like to contract with. On a corporate level, I think that these sub-prime loans are prone to predatory practices because the corporation, in some cases, does not have direct control over the agents who deal directly with the consumer.

The practices of these independent agents cannot be easily controlled. As a result, corporations should require mortgage brokers to screen all of their loan applications to avoid any allegations of predatory lending. In closing, it is my opinion that predatory lending is money driven trend that destroys everyone and everything in its path. The difficulty in defining where predatory lending originates, for each individual case, is that a great deal of work in the housing industry is done in partnerships and alliances with organizations, which present their own challenges for ethical conduct. In ending predatory lending, the challenge is not in generating ethical guidelines for all the organizations and licensed professionals involved. But it is in the application of how they conduct themselves and their business.

Bibliography

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