Is This a Good Definition of Predatory Lending?
18 October 2004, Reviewed July 21, 2009
"The California mortgage brokers association has recently come out with a definition of ‘predatory lending’, which they claim will allow borrowers to protect themselves. Do you agree?"
I think they get an A for effort, and are on the right track in equating predatory lending with price-gouging. However, the execution is a bit muddled. Here is their definition.
"Predatory lending is defined as intentionally placing consumers in loan products with significantly worse terms and/or higher costs than loans offered to similarly qualified consumers in the region for the primary purpose of enriching the originator and with little or no regard for the costs to the consumer."
According to this definition, a loan is predatory if the terms are unfavorable relative to other loans "offered to similarly qualified borrowers". But this is incomplete. The other loans to which the subject loan is compared must be identical with regard not only to borrower qualifications, but also with regard to the type of property, the purpose of the loan, the type of loan, and the timing of the loan. How mortgage brokers could overlook these things that they understand so well is hard to fathom.
A useful definition of predatory lending can’t be dependent on what goes on in the mind of the loan originator (LO), yet that is the case in the CAMB definition. Notice the word "intentionally". It means that if the LO charged 7% to a borrower who could have borrowed at 5%, but the LO didn’t know that, his actions weren’t predatory.
Not only is the knowledge of the LO relevant, but also his intentions, which must be to enrich himself. If he charged 7% to a borrower who could have borrowed at 5% but the LO planned to donate his fee to the poor, his actions are not predatory.
Both these problems can be fixed, as per my revised definition below:
"Predatory lending is defined as placing a consumer in a loan at more onerous terms, including rate, points, other fees and other important provisions such as prepayment penalties, than that consumer could have obtained shopping other sources for the same loan at the same time."
I believe this retains the spirit of the CAMB definition, while it removes ambiguity concerning the standard. It also eliminates LO subjectivity, which should not be part of the definition. My version also has a clear and useful implication that is obscured in the CAMB version: predatory lending exists only because borrowers won’t shop or can’t shop effectively. Public policy would be more effective if it were focused more directly on that problem.
My definition is incomplete, however. There is another type of LO behavior that also deserves to be called "predatory". Predatory lending also involves persuading a borrower to refinance a loan that the borrower would have declined to do had she been fully aware of all the implications and consequences of the deal.
Refinance deals can be very complicated, as two loans are involved, and sometimes three or four. The LO often focuses the borrower’s attention on the immediate impact of the deal on mortgage payments, ignoring the impact on loan balances, and possible future increases in payments. Borrowers are left to discover these for themselves, and the discovery may come too late.
From the standpoint of public policy, this is a more difficult problem to deal with than price-gouging because no one can say with certainty that a refinance deal is not in a borrower’s interest – except the borrower. The right granted to borrowers to rescind the deal without cost within 3 days of closing is an appropriate remedy, and probably the only one that makes sense.
But the right of rescission only works for borrowers who use the 3 days to take a hard look at their deal, which very few do. Jeff Jaye, an Upfront Mortgage Broker in California, tells me that over 15 years and about 3,000 transactions, he has had 3 rescissions, each one of which he remembers vividly. In one, the married couple hit a slot machine jackpot for $250,000; in the second, the husband died suddenly; and in the third the couple decided to divorce! Not a single rescission arose from a reconsideration of the costs and benefits of the transaction.
Perhaps more borrowers would reconsider if they better understood what they should be looking for. Read Rescinding a Mortgage Refinance.
"The California mortgage brokers association has recently come out with a definition of ‘predatory lending’, which they claim will allow borrowers to protect themselves. Do you agree?"
I think they get an A for effort, and are on the right track in equating predatory lending with price-gouging. However, the execution is a bit muddled. Here is their definition.
"Predatory lending is defined as intentionally placing consumers in loan products with significantly worse terms and/or higher costs than loans offered to similarly qualified consumers in the region for the primary purpose of enriching the originator and with little or no regard for the costs to the consumer."
The Standard
According to this definition, a loan is predatory if the terms are unfavorable relative to other loans "offered to similarly qualified borrowers". But this is incomplete. The other loans to which the subject loan is compared must be identical with regard not only to borrower qualifications, but also with regard to the type of property, the purpose of the loan, the type of loan, and the timing of the loan. How mortgage brokers could overlook these things that they understand so well is hard to fathom.
Subjectivity
A useful definition of predatory lending can’t be dependent on what goes on in the mind of the loan originator (LO), yet that is the case in the CAMB definition. Notice the word "intentionally". It means that if the LO charged 7% to a borrower who could have borrowed at 5%, but the LO didn’t know that, his actions weren’t predatory.
Not only is the knowledge of the LO relevant, but also his intentions, which must be to enrich himself. If he charged 7% to a borrower who could have borrowed at 5% but the LO planned to donate his fee to the poor, his actions are not predatory.
My Revision
Both these problems can be fixed, as per my revised definition below:
"Predatory lending is defined as placing a consumer in a loan at more onerous terms, including rate, points, other fees and other important provisions such as prepayment penalties, than that consumer could have obtained shopping other sources for the same loan at the same time."
I believe this retains the spirit of the CAMB definition, while it removes ambiguity concerning the standard. It also eliminates LO subjectivity, which should not be part of the definition. My version also has a clear and useful implication that is obscured in the CAMB version: predatory lending exists only because borrowers won’t shop or can’t shop effectively. Public policy would be more effective if it were focused more directly on that problem.
Another Type of Predatory Lending
My definition is incomplete, however. There is another type of LO behavior that also deserves to be called "predatory". Predatory lending also involves persuading a borrower to refinance a loan that the borrower would have declined to do had she been fully aware of all the implications and consequences of the deal.
Refinance deals can be very complicated, as two loans are involved, and sometimes three or four. The LO often focuses the borrower’s attention on the immediate impact of the deal on mortgage payments, ignoring the impact on loan balances, and possible future increases in payments. Borrowers are left to discover these for themselves, and the discovery may come too late.
From the standpoint of public policy, this is a more difficult problem to deal with than price-gouging because no one can say with certainty that a refinance deal is not in a borrower’s interest – except the borrower. The right granted to borrowers to rescind the deal without cost within 3 days of closing is an appropriate remedy, and probably the only one that makes sense.
But the right of rescission only works for borrowers who use the 3 days to take a hard look at their deal, which very few do. Jeff Jaye, an Upfront Mortgage Broker in California, tells me that over 15 years and about 3,000 transactions, he has had 3 rescissions, each one of which he remembers vividly. In one, the married couple hit a slot machine jackpot for $250,000; in the second, the husband died suddenly; and in the third the couple decided to divorce! Not a single rescission arose from a reconsideration of the costs and benefits of the transaction.
Perhaps more borrowers would reconsider if they better understood what they should be looking for. Read Rescinding a Mortgage Refinance.