Understanding Sub-Prime and Predatory Lending

Prime Lending Risk Risk Lending Characteristics Lending Characteristics The consumer is buying a loan product The consumer is buying a loan product The consumer must fit into the lending product box The consumer must fit into the lending product box

Sub-Prime Lending Risk Risk Lending Characteristics Lending Characteristics The consumer is sold a loan The consumer is sold a loan Loan is customized to consumer Loan is customized to consumer

The Value of Sub-Prime Opened market to many unserved homebuyers Allowed consumers with credit issues to remain homeowners

The Risk of Sub-Prime Lender assumes higher risk of default Lender assumes higher risk of default Interest rate should correlate to risk Interest rate should correlate to risk Homeowner at higher risk of losing home Homeowner at higher risk of losing home

Sub-Prime Credit Levels Credit Risk Factors Credit Risk Factors Credit Score Credit Score Equity Equity Late Payments (Mortgage/Rent) Late Payments (Mortgage/Rent) Debt Ratio Debt Ratio Property Quality/Type Property Quality/Type

Sub-Prime Credit Levels Loan Determinants Loan Amounts Loan Amounts Type of Income Documentation Type of Income Documentation Purpose of Loan Purpose of Loan Purchase Purchase Refinance Refinance Rate Reduction Rate Reduction Debt Consolidation Debt Consolidation Cash Out Only Cash Out Only

Sub-Prime Credit Levels Types of Income Documentation Full Full Traditional Verifications Traditional Verifications Requires Least Equity Requires Least Equity Lite Lite 6 Months Bank Statements 6 Months Bank Statements Self employed Borrowers Self employed Borrowers

Sub-Prime Credit Levels Types of Income Documentation Stated Stated Disclosed On Initial Signed Loan Application Disclosed On Initial Signed Loan Application Relies on Consumer Statement of Income Relies on Consumer Statement of Income Verifications and Bank Statements Not Required Verifications and Bank Statements Not Required

Sub-Prime Credit Levels Credit LevelMax Loan Amount Loan Documentation Purchase/Rate Reduction LTV Debt Consolidation Credit score mid – hi 600s None or one late rent/mortgage payments BK/FC – none in last 3 years Debt ratio 50 – 55% $400,000 $400,000 $300,000 Full Lite Stated (If a 3-4 unit or condo, cant use stated income) 95% 85% 85% 90% 80% 80%

Sub-Prime Credit Levels Credit LevelMaximum Loan Loan Documentation Purchase/Rate Reduction LTV Debt Consolidation Credit score very hi 500s to mid 600s 1 or 2 30-day late rent/ mortgage payments BK/FC – none in last 2 years Debt ratio 50 – 55% $400,000 $400,000 $300,000 Full Lite Stated (If a 3-4 unit or condo, cant use stated income) 90 – 95% 85% 80% 85 – 90% 80% 75 – 80%

Sub-Prime Credit Levels Credit LevelMaximum Loan Loan Documentation Purchase/Rate Reduction LTV Debt Consolidation Credit score mid 500s One 60 day, two 60 day or one 60 and one 90 day late rent/ mortgage payments BK/FC – none in last year Debt ratio 50 – 55% $300 - $350,000 $300,000 $300,000 Full Lite Stated (If a 3-4 unit or condo, cant use stated income) 80 – 85% 80 – 85% 70 – 75% 80 – 85% 80% 65 – 70%

Sub-Prime Credit Levels Credit LevelMaximum Loan Loan Documentation Purchase/Rate Reduction LTV Debt Consolidation Credit score low 500s 90+ days late on rent/ mortgage payments BK/FC – within last year Debt ratio 50 – 55% for full 45% for stated/lite $300,000 $300,000 $300,000 Full Lite Stated (If a 3-4 unit or condo, cant use stated income) 75 – 80% 70 – 80% 70% (will not use stated income if credit score is in very low 500s) 75 – 80% 70 – 80% 65% (will not use stated income if credit score is in very low 500s)

Typical Loan Costs Appraisal fee Underwriting/Commitment Fee Credit Report Processing Fee Title search Plat Drawing Origination fee Brokers Fee Closing Fee Closing Process Fee (Couriers,etc) Doc Prep Fee Tax Service Fee Escrow Waiver Fee (Not sub-prime) $ $ $20-30 $ $ $ % 2-4% $ $ $ $ %

Key Sub-Prime Terms Prepayment Penalty Prepayment Penalty Yield Spread Premium Yield Spread Premium Hybrid Loans Hybrid Loans Rescission Rescission

Prepayment Penalty Fee charged by a lender when a borrower pays off a mortgage debt prior to the due date Most prepayment penalties enforced for two – three years but may last longer

Prepayment Penalty Typical Penalty is 6 Months Interest Charged on any prepayment greater than 20% of the mortgage Example: $150,000 Loan at 10% Prepayment Penalty = $6,000

Prepayment Penalty Prepayment Penalty Disparity 80% Sub-Prime Loans 2% Conventional Loans 20% of All Lending is Sub-Prime

Prepayment Penalty Main Purpose of Prepayment Penalty Are They the Necessary Evil? 53% Sub-Prime Borrowers Prepay With a Penalty 68% Sub-Prime Borrowers Prepay without a Penalty

Prepayment Penalty Does Prepayment Penalty Reduce Interest Rate? Cost of penalty is typically 3-4 times greater than any interest savings

Prepayment Penalty Prepayment penalty is a back end cost that is generally collected yet not factored in at origination avoiding HOEPA triggers. Usually not well explained at closing.

Yield Spread Premium (YSP) Fee from a mortgage lender to the broker when a loan is closed at an interest rate higher than the rate the borrower qualifies Premium typically equals the difference between the qualified interest rate and the actual interest rate.

Yield Spread Premium Borrower Seldom Knows Disclosed on HUD % Sub-Prime Loans Have YSPs Cost to homeowner: $800 - $3,000 Average cost: $1,850

Prepayment Penalty & YSP Typical YSP for Sub-Prime Loan without a Prepayment Penalty: 2.5% Typical YSP for Sub-Prime Loan with a Prepayment Penalty: 4.25% Brokers & third party originators are originating an increasingly higher percentage of loans, 72.4% in 2004

Hybrid Loans Often referred to as 2/28 or 3/27 loans Majority of sup-prime loans are hybrid loans Loans are fixed for 2-3 years then adjust thereafter, often at 6 month intervals Loan documents often say Fixed creating confusion for consumer

Hybrid Loans The Benefits Window of opportunity to repair credit or gain time on a job or resolve credit risk factors At the end of the fixed term, the homeowner should be able to refinance into a more favorable loan.

Hybrid Loans The Dangers Consumers dont realize the loan is only fixed for a short time. Must be diligently working toward resolving credit risk issues. Targeted for repeated refinancings to avoid adjustable nature. Prepayment penalties may extend beyond the fixed period of time.

Rescission Only available with refinancing Three business days Election not to rescind should not be signed at closing

Sub-Prime Vs. Predatory Lending Sub-Prime Does NOT Equal Predatory LendersSubprimePredatory Customers Serve households with credit problems Target lower-income, minority and elderly homeowners FeesCharge reasonable fees based on risks Charge exorbitant fees PracticesUse aggressive but ethical tactics Use deceptive and possibly illegal tactics

Predatory Lending Just as the expansion of subprime lending has increased access to credit, the expansion of its unfortunate counterpart, predatory lending, has made many borrowers worse off. Edward M. Gramlich Governor Federal Reserve System Board of Governors

Evolution of Predatory Lending Record Low Interest Rates Record High National Homeownership Rate Lack of Regulation Consumer Demand for Home Improvement Loans Advent of Home Equity Loans Unscrupulous Lenders and Mortgage Brokers Subprime Lending Boom Home Values Rising Faster Than Inflation Unsure Consumers Consumer Credit Culture Lack of Access to Regulated Capital

Predatory Lending Components High Pressure Sales or Deceptive Sales Tactics High Pressure Sales or Deceptive Sales Tactics Preys on Lack of Information or lack of Credit Confidence Preys on Lack of Information or lack of Credit Confidence Abuses Lending and Credit Practices Abuses Lending and Credit Practices Lending Not Beneficial to Homeowner Lending Not Beneficial to Homeowner

Human Components of Predatory Lending They robbed me, they robbed my kids, man, they robbed my community. Yet, I feel like I did something wrong.

Human Components of Predatory Lending The Target Market The Target Market Low – moderate income persons Persons of color Elderly persons Persons in a financial or housing crisis Persons who are equity-rich but cash-poor Persons who lack information they need to choose the best product Persons who do not perceive themselves as having financial options Persons who are scared of the lending process and dont comparison shop

Human Components of Predatory Lending The Costs The Costs It destroys credit and opportunities It causes foreclosures It creates homelessness It robs wealth from families, neighborhoods and communities It strips families of hopes and replaces dreams with shame & embarrassment

Predatory Lending Practices Equity Stripping Equity Stripping Asset Based Lending Asset Based Lending Mortgage Flipping Mortgage Flipping Packing Packing Foreclosure Rescue Foreclosure Rescue Property Flipping Property Flipping Balloon Mortgage Balloon Mortgage Home Improvement Scams Home Improvement Scams

Predatory Lending Characteristics Unwarranted high interest rate Unwarranted high discount points Closing costs that exceed 5% of the loan amount Undisclosed negative amortization Inflated appraisal costs or fees Excessive broker fees

Predatory Lending Characteristics Unbundling (itemizing duplicate services and charging separately for them) Requiring credit insurance Falsely identifying loans as lines of credit or open end mortgages Mandatory arbitration clauses