Predatory lending -- the effort by some mortgage lenders and brokers to whittle away at the equity of unsuspecting homeowners -- has been around for many years. But there are several reasons why it has become a touchstone issue in 2000, and why Bankrate.com projects that some type of law targeted at certain so-called predatory practices will be in place by 2001.

A Brief History
The predatory-lending issue has been fueled by the growth in the home equity market over the past 10 years. As the North Carolina-based Coalition for Responsible Lending points out, this market has doubled in size since 1990 due to increased consumer debt, decreasing availability of tax breaks on other forms of consumer loans and the increasing popularity of high-yield home equity securities among investors.

Increased competition among lenders also has driven down rates and fees for many subprime borrowers, according to Bankrate.com, putting loans into the hands of those with a questionable ability to repay and/or who may be more vulnerable to shady lending deals. As a result, those most likely to fall prey to predatory lending practices include low-income workers and the elderly. These are the consumers most likely to be inexperienced with financial matters and terms -- and therefore less able to identify a bad lending deal.
 
What Is Likely to Pass
The latest legal moves on behalf of mortgage consumers spring from grassroots efforts in North Carolina to strengthen the federal Home Ownership and Equity Protection Act of 1994, which, in turn, was designed to bolster the Truth in Lending Act. As the debate moved beyond North Carolina and onto the national stage, a number of federal legislators took up the cause.

In sum, Bankrate.com projects that the following practices are the ones most likely to be banned under current legislation:

• Balloon payments. Predatory lenders may contact borrowers a few months after their loans have closed, offering to refinance the mortgages to eliminate the balloon -- but at an excessive fee.
• Prepayment penalties on subprime mortgages. Unscrupulous lenders may use prepayment penalties of 5 percent to 15 percent of the loan amount to discourage borrowers from refinancing high-rate mortgages.
• Excessive fees factored into the principal. In this practice, fees charged by predatory lenders may total as much as 15 percent to 20 percent of the loan amount.

Legal Issues for All
While predatory lending is a legitimate issue, current legislation may not fully address the concerns facing both consumers and lenders.

Advocates for the mortgage lending industry argue that current legislative proposals, taken together, do not uniformly agree on what constitutes predatory lending. They also note that some practices that are acceptable when used alone in a given situation become predatory when they are used together -- for example, when a balloon payment is accompanied by a high prepayment penalty.

Others maintain that the financial profiles of some customers can turn certain potentially predatory practices -- such as charging higher rates to those with poor credit histories -- into legitimate business moves. For example, B- and C-rated loans generally cost about 33 percent more to service than A-rated loans, state estimates by the National Home Equity Mortgage Association.

Shielding Themselves from the Spotlight
For most lenders, the likelihood of the passage of new (and perhaps imperfect) consumer protection laws means that the months ahead are a time to take extra precautions against appearing predatory.

The following suggestions -- especially where subprime borrowers are concerned -- may simply be a matter of making prudent recommendations to clients. At the very least, these guidelines -- supplied by Bankrate.com -- can be an excellent way to reinforce a good reputation among customers and the community as predatory lending is debated.

• For clients with good credit, quote rates no higher than 10 percent to 11 percent.
• If it is recommended that a client pay more than five points, the interest rate should be reduced proportionately.
• Fees should total no more than 5 percent of the loan.
• Do not recommend a balloon to clients who cannot afford the final payment without clearly explaining what that final payment involves.
• Avoid recommending a loan that would raise a client's overall debt-to-income ratio to more than 45 percent.
• Do not offer loans with long-dated (more than five years) or expensive (more than six months' interest) prepayment penalties.

Predatory lending is likely to remain a prominent issue in the months ahead, so it is important that mortgage lenders do whatever is possible to assure both subprime and other clients that their institution offers fair access to home equity in the community. As the storm of this debate later rolls over, fair actions by lenders and their institutions will only serve to reaffirm their reputations among current and potential clients.

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