BILL ANALYSIS
SB 2128
Page 1
Date of Hearing: July 6, 2000
ASSEMBLY COMMITTEE ON BANKING AND FINANCE
Louis J. Papan, Chair
SB 2128 (Solis) - As Amended: May 23, 2000
SENATE VOTE : 27-12
SUBJECT : Predatory Lending
SUMMARY : An urgency measure which creates a task force to study
predatory lending. Specifically, this bill :
1)Creates a 12 member task force (10 voting and 2 non-voting)
with 4 members appointed by the Governor, 3 by the Assembly,
and 3 by the Senate with the two non-voting members being an
Assembly Member and a Senator.
2)Appropriates $100,000 to fund the task force.
3)Provides that the task force is to be comprised of an equal
number of consumer and industry representatives drawn from
mortgage brokers, mortgage lenders, consumer protection
advocates, borrowers affected by predatory lending, real
estate professionals, and other knowledgeable experts.
4)Requires the task force to:
a) Establish a definition or criteria for those home
purchase or refinance lending practices which are
considered predatory lending practices.
b) Evaluate current available information related to
predatory lending inside and outside of the state.
c) Assess the range of lending practices in the state,
including those that are or may be considered predatory,
the impact of these practices, and the frequency of these
practices with regard to areas of different income and
race.
d) Assess the growth or decline in rates of foreclosure and
the distribution of foreclosures in areas of different
income and race in the state.
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e) Assess the adequacy of current law in preventing
predatory lending practices.
1)Requires the task force to conduct three public hearings in
the state and report to the Legislature on or before May 1,
2001.
EXISTING LAW : All regulated lenders which make loans secured by
real property can make loans denominated as sub-prime home loans
whether as first or second encumbrances. Personal property
lenders can also make loans which are sub-prime.
FISCAL EFFECT : Appropriates $100,000 from the General Fund for
the creation of the task force
COMMENTS : Initially it is helpful to distinguish predatory
lenders from sub-prime lenders. Although many predatory lenders
are sub-prime lenders it can not be said syllogistically that
all predatory loans are made to sub-prime borrowers.
A preliminary question is, why are we studying the issue when we
know that there is a need to begin to address the problem.
Several other states have begun to address the issue, North
Carolina and Illinois.
Initially we should consider the frame of reference within which
sub-prime and predatory lending occur.
"HOW DO people with poor credit records borrow enough money to,
say, buy a second-hand car or a mobile home? In Britain those
rejected by a bank have to save up or borrow from small firms at
high rates. In America, however, they can turn to a unique class
of big financial institutions that specialize in lending to
people others shun as bad risks.
"So-called 'sub-prime' '' lending has evolved into a huge
industry and has spawned some of America's fastest growing
financial firms. By some estimates, these euphemistically named
loans account for more than 10% of all the money borrowed in the
United States. Recently, however, a rash of scandals has put
into doubt the sub-prime industry's improbable star status."
(FALL OF THE WINGED MESSENGER, Economist, February 22, 1997)
The following is a list of abusive practices prepared by the
House of Representatives Banking Committee:
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LIST OF ABUSIVE SUBPRIME MORTGAGE
LENDING PRACTICES
I. ORIGINATION OF THE LOAN
Solicitations. Predatory mortgage lenders target lower
income and minority neighborhoods for extensive marketing.
They advertise through television commercials, direct mail,
highly visible signs in neighborhoods, telephone and door
to door solicitations, and flyers stuffed in mailboxes.
Many companies deceptively tailor their solicitations to
resemble social security or other government checks to
prompt homeowners to open the envelopes and otherwise
deceive them about the transaction.
Home Improvement Scams. Predatory mortgage lenders use
local home improvement companies essentially as mortgage
brokers to solicit loan business. These companies target
homeowners and solicit them to execute home improvement
contracts. Sometimes they falsely claim that government
subsidies are available to pay for the cost of the home
improvements. The company may originate a mortgage loan to
finance the home improvements and sell the mortgage to a
predatory mortgage lender, or steer the homeowner directly
to the predatory lender for financing of the home
improvements. The homeowners are often grossly overcharged
for the work, which the contractors often perform shoddily
and fail to complete as agreed. They sometimes damage the
homeowner's personal property in the process. In other
cases, the contractor fails to obtain required permits,
thereby making sure that the work is not inspected for
compliance with local codes, and that shoddy work need not
be corrected.
Mortgage Broker's Fees and Kickbacks. Predatory mortgage
lenders also originate loans through local mortgage lenders
who act as "bird dogs", or finders for the lenders. These
brokers represent to the homeowners that they are working
for them to help them obtain the best available loan, and
the homeowners usually pay a broker's fee. In fact, the
brokers are working for predatory lenders, who pay brokers
kickbacks to refer borrowers for loans at higher interest
rates than those for which the borrower would otherwise
qualify. On loan closing documents, the industry uses
euphemisms to describe these referral fees: yield spread
premiums and service release fees. Also, unbeknownst to the
borrower, her interest rate is increased to cover the fee.
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The industry calls this bonus upselling or par-plus premium
pricing; we call it paying unlawful kickbacks.
Steering to High Rate Lenders. Some banks and mortgage
companies steer customers to high rate lenders, even though
those customers may have good credit and would be eligible
for a conventional loan from that bank or lender. Sometimes
the customer is turned or steered away even before
completing a loan application. In other cases, the loan
application is wrongfully denied and the customer is
referred to a high rate lender, who is often an affiliate
of the bank or mortgage company. Kickbacks or referral fees
are paid as an incentive to steer the customer to a higher
rate loan.
Making Unaffordable Loans. Some predatory mortgage
lenders purposely structure loans with monthly payments
that they know the borrower cannot afford so that when the
homeowner is led inexorably to the point of default, she
will return to the lender to refinance the loan, and the
lender can impose additional points and fees. Other
predatory mortgage lenders, called hard lenders,
intentionally structure the loans with payments the
homeowner cannot afford in order to lead to foreclosure so
that they may acquire the house and the valuable equity in
the house at a foreclosure sale.
Falsified or Fraudulent Applications. Some lenders
knowingly make loans to unsophisticated homeowners who do
not have sufficient income to repay the loan. Often, such
lenders wish to sell the loan to an investor, which
requires that the borrower appear to have sufficient income
to repay the loan. Such lenders have the borrowers sign a
blank application form, and then insert false information
on the form, claiming that the borrower has employment
income that she does not, so it appears that she can make
the payments.
Adding Co-signers. This is done to create the false
impression that the borrower is able to pay off the loan,
even though the lender is well aware that the co-signer has
no intention of contributing to the payments. Often, the
lender requires the homeowner to transfer half ownership of
the house to the co-signer. The homeowner thereby loses
half the ownership of the home and is saddled with a loan
she cannot afford to repay.
Incapacitated Homeowners. Some predatory lenders make
loans to homeowners who are clearly mentally incapacitated.
They take advantage of the fact that the homeowner does not
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understand the nature of the transaction or the papers that
she signs. Because of her incapacity, the homeowner does
not understand that she has a mortgage loan, does not make
the payments, and is subject to foreclosure and subsequent
eviction.
Forgeries. Some predatory lenders forge loan documents.
In an ABC Prime Time Live news segment that aired April 23,
1997, a former employee of a high cost mortgage lender
reported that each of the lender's branch offices had a
"designated forger" whose job it was to forge documents. In
such cases, the unwary homeowners are stuck with loans they
know nothing about.
High Annual Interest Rates. Because the purpose of
engaging in predatory lending is to reap the benefit of
high profits, these lenders always charge extremely high
interest rates. This drastically increases the cost of
borrowing for homeowners, even though the lenders' risk is
minimal or non-existent. Predatory lenders may charge rates
of 19% to 25%, or three times the rates of 7% to 7.5% being
charged for conventional mortgages.
High Points. Legitimate lenders charge points to
borrowers who wish to buy down the interest rate on the
loan. Predatory lenders charge high points, but offer no
corresponding reduction in the interest rate. These points
are imposed through prepaid finance charges (or points or
origination fees), which are usually 5% to 10%, but may be
as much as 20%, of the loan. The borrower does not pay
these points with cash at closing. Rather, the points are
always financed as part of the loan. This increases the
amount borrowed, which produces more actual interest to the
lender.
Balloon Payments. Predatory lenders frequently structure
loans so that the borrower's payments are applied primarily
to interest, and at the end of the loan period, the
borrower still owes most or all of the principal amount
borrowed. The last payment balloons to an amount often
equal to 85% or so of the principal. The homeowner cannot
afford to pay the balloon payment, and either loses the
home through foreclosure or is forced to refinance with the
same or another lender for an additional term at additional
cost.
Negative Amortization. This involves structuring the
loan so that interest is not amortized over the term.
Instead, the monthly payment is insufficient to pay off
accrued interest and the principal balance therefore
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increases each month. At the end of the loan term, the
borrower may owe more than the amount originally borrowed.
With negative amortization, there will almost always be a
balloon payment at the end of the loan.
Credit Insurance - Insurance Packing. Predatory mortgage
lenders market and sell credit insurance as part of their
loans, often without the knowledge or consent of the
borrower. Typical insurance products sold in connection
with loans include credit life, credit disability, credit
property, and involuntary unemployment insurance. Lenders
frequently charge exorbitant premiums, which are not
justified based on the extremely low actual loss payouts.
Frequently, credit insurance is sold by an insurance
company which is either a subsidiary of the lender or which
pays the lender substantial commissions. Another way of
charging excessive premiums is to over-insure borrowers by
providing insurance for the total indebtedness, including
principal and interest, rather than merely the principal
amount of the loan. In short, credit insurance becomes a
profit center for the lender and provides little or no
benefit to the borrower.
Padding Closing Costs. In this scheme, certain costs are
increased above their market value as a way of charging
higher interest rates. Examples include charging document
preparation fees of $350 or credit report fees of $150,
which are many times the actual cost.
Inflated Appraisal Costs. In most mortgage loan
transactions, the lender requires an appraisal. Most
appraisals include a detailed report of the condition of
the house, both interior and exterior, and prices of
comparable homes in the area. Others are "drive-by"
appraisals, done by someone simply looking at the outside
of the house. The former naturally costs more than the
latter. However, in some cases, borrowers are charged for a
detailed appraisal, when only a drive-by appraisal was
done.
Padded Recording Fees. Mortgage transactions usually
require that documents be recorded at the local courthouse,
and state or local laws set the fees for recording the
documents. Predatory mortgage lenders often charge the
borrowers a recording fee in excess of the actual amount
established by law.
Bogus Broker Fees. In some cases, predatory lenders
charge borrowers broker fees when the borrower never met or
knew of the broker. This is another way such lenders
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increase the cost of the loan for their own benefit.
Unbundling. This is another way of padding costs by
breaking out and itemizing charges that are duplicative or
should be included under other charges. An example is
charging a loan origination fee, which should cover all
costs of initiating the loan, but then imposing separate,
additional charges for underwriting and loan preparation.
Excessive Prepayment Penalties. Predatory lenders often
impose exorbitant prepayment penalties. This is done in an
effort to lock the borrower into the predatory loan for as
long as possible by making it difficult for her to
refinance the mortgage or sell the home. This practice
provides back end interest for the lender if the borrower
does prepay the loan.
Mandatory Arbitration Clauses. By inserting pre-dispute,
mandatory, binding arbitration clauses in contractual
documents, some lenders attempt to obtain an unfair
advantage by relegating their borrowers to a forum
perceived to be more favorable to the lender. This
perception exists because discovery is not a matter of
right, but is within the discretion of the arbitrator, the
proceedings are private, arbitrators need not give reasons
for their decisions or follow the law, a decision in any
one case will have no precedential value, judicial review
is extremely limited, and injunctive relief and punitive
damages are not available.
Flipping. Flipping involves successive, repeated
refinancing of the loan by rolling the balance of the
existing loan into a new loan for the new amount. Flipping
always results in higher costs to the borrower. Because the
existing balance of one loan is rolled into a new loan, the
term of repayment is repeatedly extended through
refinancing. This results in more interest being paid than
if the borrower had been allowed to pay off each loan
separately. A powerful example of the exorbitant costs of
flipping is the case of Bennett Roberts, who had eleven
loans from a high cost mortgage lender within a period of
four years. See Wall Street Journal, April 23, 1997. Mr.
Roberts was charged in excess of $29,000 in fees and
charges, including 10 points on every financing, plus
interest, to borrow less than $26,000. To paraphrase from
the famous Eagles' song, "Welcome to the Hotel California,
you can check in but you can never check out."
Spurious Open End Mortgages. In order to avoid making
required disclosures to borrowers under the Truth in
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Lending Act, many lenders are making "open-end" mortgage
loans. Although the loans are called "open-end" loans, in
fact they are not. Instead of creating a line of credit
from which the borrower may withdraw cash when needed, the
lender advances the full amount of the loan to the borrower
at the outset. The loans are non-amortizing, meaning that
the payments are interest only, so that the balance is
never reduced.
Paying Off Low Interest Mortgages. A predatory lender
usually insists that its mortgage loan pay off the
borrower's existing low cost, purchase money mortgage.
Instead of lending the borrower the amount he actually
needs, the lender increases the amount of the new mortgage
loan by also paying off the current mortgage. The homeowner
is stuck with a high interest rate mortgage and a principal
amount that is much higher than necessary. This is called
overlending.
Paying Off Forgivable Loans and Non-interest Loans. Many
lower income homebuyers obtain down payment assistance
grants from state and local agencies. These grants are
included in the purchase money mortgage loan but are
forgiven as long as the homebuyer remains in the home for
five or ten years. Other government programs allow lower
income and elderly homeowners to obtain grants for
necessary home improvement work to bring homes up to code
standards. These grants are also made in the form of
mortgage loans which are forgiven as long as the homeowner
remains in possession of the home for five or ten years.
Habitat for Humanity provides home purchase mortgage loans
which no interest is charged to low income homebuyers. When
many subprime mortgage lenders make loans to these
homeowners, they insist that these forgivable loans be paid
off (to increase the amount borrowed) even though these
loans would be forgiven in a matter of a few short years.
Housing activists in North Carolina have investigated cases
where subprime mortgage lenders have refinanced Habitat for
Humanity homebuyers by paying off their no interest Habitat
mortgage loans. They offer "cash out" loans to entice these
homeowners to refinance their no interest loans.
Shifting Unsecured Debt Into Mortgage. Mortgage lenders
badger homeowners with advertisements and solicitations
that tout the "benefits" of consolidating bills into a
mortgage loan. The lender fails to inform the borrower that
consolidating unsecured debt into a mortgage loan secured
by the home is a bad idea. Paying off the unsecured debt,
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which necessarily increases closing costs, since they are
calculated on a percentage basis, increases the loan
balance. Moreover, this practice increases the monthly
payments, and exacerbates the risk that the homeowner will
lose the home.
Making Loans In Excess of 100% Loan to Value (LTV). Some
lenders are making loans to homeowners in amounts that
exceed the fair market value of the home. This makes it
very difficult for the homeowner to refinance the mortgage
or to sell the house to pay off the loan, thereby locking
the homeowner into a high cost loan. Normally, if a
homeowner goes into default and the lender forecloses on a
loan, the foreclosure sale generates enough money to pay
off the mortgage loan and the borrower is not subject to a
deficiency claim. However, where the loan is 125% LTV, a
foreclosure sale may not generate enough to pay off the
loan, and the lender may pursue the borrower for the
deficiency.
II. SERVICING OF THE LOAN
Force Placed Insurance. Lenders require homeowners to
carry homeowner's insurance, with the lender named as a
loss payee. Mortgage loan documents allow the lender to
force place insurance when the homeowner fails to maintain
the insurance, and to add the premium to the loan balance.
Some predatory lenders force place insurance even when the
homeowner has insurance and has provided proof of insurance
to the lender. The premiums for the force placed insurance
are frequently exorbitant. Often the insurance carrier is a
company affiliated with the lender, and the force placed
insurance is padded because it covers the lender for risks
or losses in excess of what the lender may require under
the terms of the loan.
Daily Interest When Payments Are Made After Due Date.
Most mortgage loans have grace periods, during which a
borrower may make the monthly payment after the due date
without incurring a late charge. The late charge often is
assessed as a small percentage of the late payment.
However, many lenders also charge daily interest based on
the outstanding principal balance. While it may be proper
for a lender to charge daily interest when the loan so
provides, it is deceptive for a lender to charge a late fee
as well as daily interest when a borrower pays before the
grace period expires.
III. COLLECTION OF THE LOAN
Abusive Collection Practices. In order to maximize
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profits, predatory lenders either set the monthly payments
at a level the borrower can barely sustain or structure the
loan to trigger a default and a subsequent refinancing.
Adding insult to injury, the lenders use aggressive
collection tactics to ensure that the stream of income
flows uninterrupted. The collection departments call
homeowners at all hours of the day and night, send late
payment notices (in some cases, even when the lender has
received timely payment or even before the grace period
expires), send telegrams, and even send agents to hound
homeowners, who are often elderly widows, into making
payments. These abusive collection tactics often involve
threats to evict the homeowners immediately, even though
lenders know they must first foreclose and follow eviction
procedures. The resulting impact on homeowners, especially
elderly homeowners, can be devastating.
High Prepayment Penalties. See description above. When a
borrower is in default and must pay the full balance due,
predatory lenders will often include the prepayment penalty
in the calculation of the balance due.
Flipping. See description above. When a borrower is in
default, predatory mortgage lenders often use this as an
opportunity to flip the homeowner into a new loan, thereby
incurring additional high costs and fees.
Foreclosure Abuses. These include persuading borrowers
to sign deeds in lieu of foreclosure, giving up all rights
to protections afforded under the foreclosure statute,
sales of the home at below market value, sales without the
opportunity to cure the default, and inadequate notice
which is either not sent or backdated. We have even seen
cases of "whispered foreclosures", in which persons
conducting foreclosure sales on courthouse steps have
ducked around the corner to avoid bidders so that the
lender was assured he would not be out-bid. Finally,
foreclosure deeds have been filed in courthouse deed
records without a public foreclosure sale.
REGISTERED SUPPORT / OPPOSITION :
Support
AARP
Alexandria House
Attorney Arthur Krantz, Leonard Carder, Nathan Zuckerman, Ross,
Chin et al
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Attorney Jean Crawford
Attorney Patience Milrod
Attorney Robert A. Goldstein, A Professional Law Corporation
Attorney Sheila Canavan, Law Firm of Steinbock & Hofmann
Barton Hill Neighbor Organization
Bet Tzedek Legal Services
California Association of Community Organizations for Reform Now
(ACORN)
California Labor Federation, AFL-CIO
California Professional Firefighters
California Reinvestment Committee
California Rural Legal Assistance Foundation
Californians for Justice Education Fund
CALPIRG
Center for Community Change
City Line Mortgage Corporation
City of San Jose
Coalition for Economic Survival
Coalition for Humane Immigrant Rights of Los Angeles
Community Coalition
Congress of California Seniors
Consumer Action
Consumer Federation of California
Consumers Union
ECHO Housing
End Hunger & Homelessness
Fair Housing Congress of Southern California
Fair Housing Council of Orange County
Fair Housing Council of Riverside County, Inc.
Fair Housing Council of San Gabriel Valley
Fair Housing Council of the San Fernando Valley
First Allied Financial Services, Inc.
First Security Loans
Fresno County Green Party
Friends Committee on Legislation of California
Greenlining Institute
Hotel Employees and Restaurant Employees, Union Local 2850
Housing Rights, Inc.
L. A. Family Housing Corp.
Los Angeles County Federation of Labor, AFL-CIO
Lutheran Office of Public Policy - California
Midpeninsula Citizens for Fair Housing
Mobilization for the Human Family
Peter Dreier, Director, Urban & Environmental Policy Program,
Occidental College
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Sacramento Valley Progressive Agenda
SEIU Local 250
Shelter Inc. of Contra Costa County
South Bay AFL-CIO Labor Council
Southern California Association of Non-Profit Housing
Southern California Consumer Law Center
Strategic Actions for a Just Economy
Town & County Credit
Union de Vecinos
Urban Resources Inc.
Western Center of Law and Poverty
Westside Fair Housing Council
Yvonne Brathwaite Burke, Board of Supervisors, County of Los
Angeles
Opposition
California Financial Services Association
Analysis Prepared by : William C. George / B. & F. / (916)
319-3081