Low interest rates and aggressive marketing campaigns have driven home lending to record levels. But increasingly Americans with good credit are being saddled with loans designed for high-risk borrowers.
These higher-cost loans have been the fastest-growing segment of the mortgage market–accounting for 20 percent of the home loans issued last year, up from 10 percent a decade ago.
Freddie Mac, the government-sponsored mortgage finance giant, estimates that more than 20 percent of people who obtain these so-called subprime loans could have qualified for more conventional prime loans.
Consumer advocates say it’s a “borrower beware” market. Companies and independent brokers generally are not legally required to tell customers that they might receive a better deal elsewhere, and regulations have not kept pace with the booming mortgage refinancing market and skyrocketing home prices.
`You can be trapped’
“The reality is, if you happen to walk into the wrong door, you can be trapped,” said Kathleen Keest, senior policy counsel at the Center for Responsible Lending, a non-profit advocacy group in Durham, N.C.
The National Home Equity Mortgage Association, which represents subprime lenders, disputes the notion that large numbers of their customers could find better loans elsewhere. There are legitimate reasons, the association says, why lenders make subprime loans to borrowers with good credit. Self-employed people, for example, don’t have regular paychecks to document their income.
“People have a lot of choices these days, and everything doesn’t come in one package,” said Jeffrey Zeltzer, the association’s president.
Used properly, subprime loans can help people with spotty credit and a large amount of debt, or others who simply want to tap their equity to pay off expensive credit cards. But they also can allow loan agents and brokers to earn high commissions at the expense of people with solid credit.
Loren and Rebecca Oldham say they thought they were getting a good deal when they refinanced their mortgage at 5.25 percent interest, cutting their monthly payment by $150 a month. But when they sold their house outside Louisville, Ky., less than a year later, they discovered a clause that forced them to surrender nearly $16,000 as a penalty for paying off the loan early.
Prepayment penalties are usually for borrowers with bad credit, not folks like the Oldhams, who say their high credit score should have landed them a loan without the provision. They plan to seek a refund, and are kicking themselves for not taking enough time to spot the penalty.
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“You know how closings are: You sign so many documents, you kind of trust what they’re saying,” Loren Oldham said.
Freddie Mac estimates that during the last two years more than one in five borrowers who received these higher-cost loans could have qualified for less-expensive prime loans.
That estimate is based on computer analyses of hundreds of thousands of subprime loans, taking into account factors that include credit history, home value and the ability to pay, said Peter Zorn, the company’s vice president for housing analysis and research.
The number of borrowers improperly stuck in subprime loans is on the rise, Zorn said; until about two years ago, it was only 10 percent to 15 percent. One reason, he said, is that lenders have relaxed their standards for approving prime loans, making them easier to get than people may realize.
At least one mortgage company executive says he has also seen evidence supporting Freddie Mac’s analysis.
IndyMac Bancorp Inc. of Pasadena, Calif., was considering acquiring several subprime mortgage specialists about two years ago, and reviewed the loans that they had made, said Chief Executive Michael Perry.
The data, including credit scores and borrower incomes, showed that about 40 percent of the customers of the other companies qualified for lower-cost prime loans, Perry said.
That led IndyMac to rule out the acquisitions, he said, because prime loans aren’t as profitable. His company makes both types of loans, and Perry says IndyMac’s computers automatically steer qualified customers to prime loans.
Based on estimates from Freddie Mac and the Center for Responsible Lending, as many as 1 million borrowers are paying too much for their loans. Such customers paid an estimated $3 billion in excess interest in 2001 alone, the consumer group said.
Upfront points
Prime, fixed-rate loans currently charge interest of about 6 percent a year, along with upfront charges known as points that typically run 1 percent or less of the loan amount. To cover their higher risk, subprime loans carry interest rates averaging about 7.5 percent a year and upfront points of about 3 percent of the loan value.
For a $300,000 loan, an extra 1.5 percent in interest costs the borrower nearly $11,000 in additional monthly payments in the first three years, or more than $25,000 extra over seven years. The two additional points upfront translate to $6,000 more at closing.
Advocacy groups have fought for years to persuade companies with both prime and subprime arms to make sure qualified borrowers receive prime loans even if they are doing business with the high-cost operation. These large companies, which include Citigroup Inc., Washington Mutual Inc. and Countrywide Financial Corp., have pledged to do so, though the groups still don’t think this “referring up” happens consistently, said Kevin Stein of the California Reinvestment Committee, a San Francisco-based group.
Never looked at paperwork
Christine Vannoy of Long Beach, Calif., said she incorrectly assumed that a loan officer with Wells Fargo Financial would provide the best price when she and her husband refinanced their home in 2002. Vannoy, an office manager for a company that stages corporate events, said she was distracted and never looked at the papers when the loan closed, as the agent chatted with her husband and assured them they’d feel good because they were paying off credit cards and taking out $1,500 in cash.
When Vannoy later separated from her husband, she found that the 20-year loan had a 10.6 percent interest rate, along with seven upfront “discount points” totaling $13,527.
Wells Fargo Financial is the subprime unit of Wells Fargo & Co. Vannoy complained to Wells Fargo and was given a new loan from Wells Fargo Home Mortgage, a part of the main bank, at 5.95 percent. Wells Fargo declined to comment, except to say it “only makes loans which provide a tangible benefit to the customer.”
Wells Fargo has since reined in certain practices. In August, it said it would limit points and prepayment penalties, and it pledged that by the end of this year qualified borrowers would get prime loans, even if they applied through subprime channels such as Wells Fargo Financial.
Complaints like Vannoy’s have swirled around the subprime industry for years, and mortgage lenders have at times acknowledged that their employees have taken advantage of consumers.
In one well-publicized incident last year, a mid-level executive at Countrywide sent a memo urging his loan officers to misstate customers’ income and assets so they would qualify only for more-expensive subprime loans. Countrywide said it fired the executive as soon as it learned of the memo.
Some companies, however, are subprime specialists–and are under no obligation to send prime-worthy customers to a rival offering traditional loans.
Many consumer advocates and lenders support the idea of a national law to prevent lending abuses and to avoid the patchwork of regulations that vary from state to state. But they disagree over what to include. Lenders want a national standard to override state laws, while advocacy groups want to preserve state or local measures that are stronger, and say the leading proposal in Congress, the so-called Ney-Kanjorski bill, is too weak.
Avoiding loan pitfalls
Industry officials contend that many of the problems that exist can be solved if borrowers check to make sure their loans match their creditworthiness.
“It’s an education problem,” said Adam Findeisen, a spokesman for the National Home Equity Mortgage Association. “People just go to one institution and they don’t shop around and they don’t know all the loan options that are available to them.”
Borrowers can avoid many pitfalls if they steer clear of solicitations and find lenders on their own, said Jack Guttentag, an emeritus professor of finance at the Wharton School who runs a consumer-oriented Web site called the Mortgage Professor (www.mtgprofessor.com).
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People who believe they were overcharged for a loan can also ask for a refund, or a new loan.
Loren Oldham said he recalled checking over the rates and fees on the loan, but not reading anything about the prepayment penalty–even though his signature is on the page authorizing it.
“It’s really aggravating,” he said. “You kind of get mad at yourself because you let this happen.”