A look at potential abuses in prime lending
By SAM GARCIA
11/9/2001

During a recent conversation about predatory lending data, a spokesman for the Association of Community Organizations for Reform Now (ACORN) told MortgageDaily.com that "while all subprime loans are not necessarily predatory, all predatory loans are subprime." ACORN, which is an advocate of low-income consumers, will release a report shortly about the disproportionate volume of subprime lending to minority and low-income borrowers.

So does this mean that there are no 'A' paper predatory loans? While subprime lenders have received most of the press associated with predatory lending practices, abuses can also occur on 'A' loans to 'prime' borrowers.

Joe Falk, president of the National Association of Mortgage Brokers (NAMB), says that predatory lending does occur with 'A' paper borrowers. He indicated that predatory lending is not necessarily a function of rate and points; instead, predatory lending is a function of how the loan officer handles the borrower. For instance, if a loan officer knows that a borrower will be selling the house in three months, that loan officer is not acting in the best interest of the borrower if he or she tries to convince the borrower to move forward with a refinance.

The Mortgage Bankers Association of America (MBA) says it is concerned that in the rush to protect consumers, the effect will be to limit access and increase the cost of credit to consumers. This fear has come to fruition in Washington D.C., where a number of lenders have reportedly exited the market due to the prohibitive requirements of an anti-predatory lending law enacted earlier this year. The D.C. Council recently voted to suspend the law for four months while the banking department addresses industry concerns about the law's requirements.

Craig Pittman, who is an originator and senior vice president for Axis Mortgage & Investments in Scottsdale, Arizona, said "absolutely, predatory lending practices occur with prime customers."

He cited the case of a borrower he is currently working with. The borrower, with a credit score today of 700+, was financed at 10.5% three years ago. According to Mr. Pittman -- who also serves as president of the Arizona Mortgage Lenders Association -- the borrower should have qualified for a conventional 'A' rate, which he indicates was about 8.25% at that time. The original broker is trying to refinance the borrower at 7.5 percent now, which is more than one percent higher than the rate the borrower is getting from Axis Mortgage.

The higher rate mentioned in the previous real-life example is likely the result of yield spread premium (YSP); by convincing the borrower to accept an interest rate 1% higher than the market rate, the loan officer is able to earn YSP's equal to approximately 3% of the loan amount in addition to origination fees, discount points and closing costs. While it may be usual for loan officers to legitimately use YSP's to reduce the amount of cash required by the borrower at closing, cases like the Axis Mortgage borrower have fueled disputes over the use of YSP's.

Although HUD recently offered its opinion on YSP's, lawsuits involving YSP's have yet to be resolved.

While ACORN spokeswoman Lisa Donner indicated that the organization has no official position on 'A' predatory lending at this time, she told MortgageDaily.com that "we have a problem with yield spread premiums because higher rate loans are wrong."

With mortgage production nearing two trillion dollars this year, YSP abuses on less than 1% of that amount can affect more than $10 Billion in residential mortgages.

In its recommended "Best Practices" guidelines for predatory lending, MBA says, "loan products shall be provided to consumers in a nondiscriminatory manner." Lenders that adopt and apply a 'risk based' loan pricing policy need to ensure that it does not discriminate on a prohibited basis against any consumer. Borrowers should be offered loan options commensurate with their qualifications, and such options and their costs should be clearly explained.

A look at Fannie Mae's Lender Letter 03-00 entitled "Eligibility of Mortgages to Borrowers with Blemished Credit Records" (dated 4/11/00) indicates that Fannie will allow up to 5% in points and fees (origination fees, underwriting fees, broker fees, finder's fees, and charges that the lender imposes as a condition of making the loan -- whether they are paid to the lender or a third party) to be charged to the borrower. In some cases, Fannie will allow more than 5 percent.

YSP's are not mentioned in Fannie's letter.

With the current refinance wave reaching record levels, many of the best originators may be too busy to handle more business. Unfortunately, unscrupulous originators that are aware of this may be better positioned to take advantage of uneducated borrowers.

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