ACORN community rally against predatory home mortgage loans.

In April 2003, the homeownership rate reached a record high, with 67 percent of American families owning their own homes, according to the U.S. Department of Housing and Urban Development (HUD). That means more than more than 70 million families had a piece of the American dream. Low interest rates are prompting families across the country to buy homes or refinance for better rates on existing mortgages.

But for many low- and moderate-income Americans families, the process of securing a mortgage to buy a home can present pitfalls that threaten their financial security.

"Locked In"
Charleen Robinson, 33, and her husband live in Capitol Heights, Maryland with five children ages 2 through 17. For years, they've saved in anticipation of five upcoming college tuitions. This year, they've had to wipe out their savings and may now be forced to dip into their retirement funds.

In January, the Robinsons took out a loan from Wells Fargo Home Mortgage, to buy a $145,000 house, putting ten percent down and paying all the closing costs separately. The loan carried a variable interest rate starting at 8.8 percent, capped at 14.9 percent. At the time, interest rates on fixed 30-year prime mortgages were at about 6 percent.

The Association of Community Organizations for Reform Now (ACORN), a national nonprofit advocacy group for low- and middle-income families, says the Robinsons were victims of predatory lending: that the interest rate was set higher than warranted by the risk of the loan.

Their broker received $3,500 from Wells Fargo for writing this high-interest mortgage. Called a "yield-spread premium," such payments are not uncommon or illegal, but raise some questions of fairness. Truth-in-lending laws do require that they be disclosed to the borrowers. The Robinsons say there were not aware of the payment until ACORN discovered it and alerted them.

The worst part, Charleen says, is that they're locked in. She says it wasn't until closing that she was told there was a prepayment penalty. If during the first three years they "prepay"—pay off their mortgage and refinance at a better interest rate—they'll be charged six months' interest on 80 percent of the amount prepaid.

Right now, that's a $6,000 penalty.

A Growing Market
The Robinson's loan represents the fastest-growing segment of the mortgage market—the subprime market. Subprime mortgages carry higher interest rates and fees, because the borrowers represent a greater risk.

Deregulation in the mortgage market has led to a boom in subprime lending. A joint HUD-Treasury Department report found that in 1994, fewer than 3.3 percent of US mortgage loans were subprime. Now, subprime lending accounts for between 10 and 12.5 percent of all mortgages.

Prime v. Subprime A prime mortgage loan: Conforms to guidelines set by Fannie Mae and Freddie Mac, the two major purchasers of mortgage debt. Carries an interest rate pegged to the federal reserve prime rate. A subprime loan: Does not meet the guidelines and cannot be sold to Freddie or Fannie. Carries an interest rate determined by the borrower's Fair Isaac & Co. (FICO) credit score. The higher the FICO score, the lower the rate. What's the difference? Monthly payments for a $100,000 30-year fixed rate prime mortgage at 7 percent are $665. Monthly payments for a $100,000 30-year fixed rate subprime mortgage at 13 percent are $1,106.

The interest rates on subprime mortgages are significantly higher than on prime mortgages. Research indicates that lenders really are taking a greater risk when they write such loans: in June of 2002, the percentage of prime mortgage loans in serious delinquency was about one-half of one percent. Delinquency rates in subprime loan categories ranged from 1.36 percent for the "best" subprime loans to more than 21 percent for the riskiest. (See box, Prime v. Subprime.)

"There's a place for legitimate subprime [mortgage] lending that is priced according to risk," says Chris Saffert, deputy director of the Financial Justice Center at ACORN. Without a subprime market, many low- and moderate-income families wouldn't qualify for mortgage loans at all.

However, warn advocates, it's in the subprime market that abusive or "predatory" practices occur—the most common are hidden costs and fees, or lenders that inappropriately steer families into unsustainable payments. Prepayment penalties, such as those in the Robinson's loan, are only considered predatory under certain circumstances. (See box, "What's Predatory?")

What's Predatory? There is general agreement that these practices are "predatory": Steering: convincing the borrower to take out a more expensive loan than they could qualify for. Equity stripping: when homeowners are encouraged to refinance again and again, losing equity each time. Excessive fees and points: points and fees charged to close a mortgage loan should not exceed five percent of the loan, and are usually less. Prepaid single premium credit life policy: this is a life insurance policy that guarantees to pay your mortgage if you die. These policies charge large upfront premiums that get folded into the mortgage loan. Some prepayment penalties: They are considered predatory if the borrower doesn't receive a benefit for accepting the penalty, such as a lower rate; if the borrower is not also offered another mortgage product without a penalty; or if the terms are not adequately disclosed in the closing documents.

"Predatory mortgage lending has colossal implications for families," says Sharon Reuss, communications director of the North Carolina Center for Responsible Lending. "Their equity is stripped, leaving them more vulnerable to other emergencies. Particularly for families where there may not be a significant chunk of existing equity, much of it is in a house. When hidden fees are put in a loan, families lose wealth, they lose what they want to pass along to their children."

Along with homeownership, foreclosures, too, are on the rise. In many areas—Philadelphia and Chicago, for example—foreclosure rates more than tripled in the past decade.

Wells Fargo Responds
Citing confidentiality, Wells Fargo cannot comment on the specifics of the Robinson's loan. But Alejandro Hernandez, who works in the communications department of the Wells Fargo Home and Consumer Finance Group, says, "The allegations are contrary to the way we do business. There are laws and regulations that we follow, and we have our own standards to ensure our rates are competitive. We don't tolerate any attempts by affiliates to sell customers a product without their knowledge and consent—it's not in anyone's best financial interest."

In fact, for the last two years, he says, Wells Fargo Home Mortgage has been the number one lender to low- and moderate-income homebuyers nationwide. Lending to these groups has increased faster than the company's overall lending.

Since 2002, the company has partnered with the American Library Association and the National Council of La Raza to hold financial literacy training and home-buying seminars in their stores or local libraries and community centers.

Reuss cautions that Wells Fargo subsidiaries may be charging inappropriate fees, even if the parent company doesn't.

"Wells Fargo Financial is the subprime subsidiary to Wells Fargo Home Mortgage," she says. "We're researching subprime subsidiaries and finding that there's a whole huge chunk of fees that subsidiaries are tacking on to loans. For example, National City Bank has a subprime subsidiary, First Franklin Financial Corporation. First Franklin allows for broker's fees and a yield-spread premium of up to 7.5 percent of the loan amount. They also put folks into adjustable rate mortgages, where the interest rate can double or triple but is never allowed to drop below the initial interest rate. There are also prepayment fees."

Understanding the fine print is no easy task. It's all proving a big headache for the Robinson family. "The kids know that something's wrong," Charleen Robinson says. "But I try not to let them see the stress. The very thing I see as being essential for our family, a roof over our heads, is also the very thing causing a lot of stress and strain."

A New Red Line?
In the 1960s and 1970s, "redlining"—denying mortgage loans in areas of high minority population (marked with a red line on a map)—was a common practice. The federal 1977 Community Reinvestment Act (CRA) was passed to prohibit banks from discriminating on basis of neighborhood or geography. The Act required banks to document their activities and collect data on how loans are made and allocated, which enables regulators and advocates to track compliance.

Advocates say that inappropriately high interest rates and attached costs or hidden fees amount to a new form of redlining. Despite some improvement in recent years, a 2003 Urban Institute study found that African Americans and Hispanics who search for housing or inquire about mortgage financing options are still denied the information and the opportunities that whites take for granted.

Most prime rate mortgages don't carry prepayment penalties, but about 80 percent of subprime mortgages included a prepayment penalty in 2001, up from 50 percent in 1997 according to Standard & Poor's.

Cracking Down
Across the country, state and local organizations are working to crack down on predatory lending. In December 2003, an Alaskan mortgage lender was forced to pay millions as the result of a civil suit alleging it overcharged and over-insured homeowners and inaccurately assessed late fees.

ACORN has launched a campaign to draw attention to practices such as loan-spread premiums and unexpected fees and penalties. Since the summer, ACORN volunteers have picketed Wells Fargo offices, staged protests and spearheaded a letter-writing campaign.

In 1999, North Carolina passed the first state anti-predatory mortgage law. According to a University of North Carolina study, the law has curbed abuses while maintaining access to subprime loans for families who need them. Other states, including Connecticut, New Jersey and South Carolina have followed suit.

A federal bill offered in 2003 by Rep. Rober Ney (R-OH) offers a national approach, but advocates worry it would override stronger state laws.

Getting a Handle on Loans
For families, becoming financially savvy remains the best way to avoiding predatory lending. Most local colleges and universities offer financial literacy classes. There's also a national network of educators and counselors to help first-time home buyers. Many are nonprofit community organizations that provide classes or one-on-one counseling to families in high schools or community centers,

Homebuyers can attend a HUD-approved homeownership education course offered by a nonprofit counseling agency http://www.hud.gov/offices/hsg/sfh/hcc/hcc_home.cfm [1].

Other Resources

• Nickels, Dimes and Big Bucks [2]
• The Mortgage Bankers Association of America (MBA) has a Predatory Lending Resource Center Web site [3] with breaking news; updates on state, local, and federal regulations and activities; and useful Web links.
• ACORN [4] has comprehensive information on its anti-predatory lending campaign.
• NC Center for Responsible Lending [5]
• Wells Fargo [6]
• Federal Reserve Fair Lending page [7]
  

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Caitlin Johnson is a freelance journalist specializing in social policy.