Consumer Protection: Federal and State Agencies Face Challenges
in Combating Predatory Lending (24-FEB-04, GAO-04-412T).
While there is no universally accepted definition, the term
"predatory lending" is used to characterize a range of practices,
including deception, fraud, or manipulation, that a mortgage
broker or lender may use to make a loan with terms that are
disadvantageous to the borrower. Concerns about predatory lending
have increasingly garnered the attention and concern of
policymakers, consumer advocates and participants in the mortgage
industry. This statement is based on GAO's report, released at
today's hearing, and discusses federal and state efforts to
combat predatory lending; factors that may make elderly consumers
more susceptible to predatory lending; the roles of consumer
education, mortgage counseling, and loan disclosures in
preventing predatory lending; and how the secondary mortgage
market can affect predatory lending.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-04-412T
ACCNO: A09331
TITLE: Consumer Protection: Federal and State Agencies Face
Challenges in Combating Predatory Lending
DATE: 02/24/2004
SUBJECT: Mortgage loans
Lending institutions
Fraud
Ethical conduct
Consumer protection
Elderly persons
******************************************************************
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GAO-04-412T
United States General Accounting Office
GAO Testimony
Before the Special Committee on Aging,
U.S. Senate
For Release on Delivery Expected at 10:00 a.m. EST
Tuesday, February 24, 2004 CONSUMER PROTECTION
Federal and State Agencies Face Challenges in Combating Predatory Lending
Statement of David G. Wood, Director Financial Markets and Community Investment
GAO-04-412T
Highlights of GAO-04-412T, a testimony before the Special Committee on
Aging, U.S. Senate
While there is no universally accepted definition, the term "predatory
lending" is used to characterize a range of practices, including
deception, fraud, or manipulation, that a mortgage broker or lender may
use to make a loan with terms that are disadvantageous to the borrower.
Concerns about predatory lending have increasingly garnered the attention
and concern of policymakers, consumer advocates and participants in the
mortgage industry. This statement is based on GAO's report, released at
today's hearing, and discusses federal and state efforts to combat
predatory lending; factors that may make elderly consumers more
susceptible to predatory lending; the roles of consumer education,
mortgage counseling, and loan disclosures in preventing predatory lending;
and how the secondary mortgage market can affect predatory lending.
In its report, GAO suggested that Congress consider (1) providing the
Federal Reserve Board with the authority to routinely monitor and, as
necessary, examine nonbank mortgage lending subsidiaries of financial and
bank holding companies to ensure compliance with federal consumer
protection laws applicable to predatory lending, and (2) giving the Board
specific authority to initiate enforcement actions under those laws
against these nonbank mortgage lending subsidiaries.
www.gao.gov/cgi-bin/getrpt?GAO-04-412T.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact David G. Wood at
202-512-8678 or [email protected].
February 24, 2004
CONSUMER PROTECTION
Federal and State Agencies Face Challenges in Combating Predatory Lending
Federal agencies have taken a number of enforcement actions, sometimes
jointly, using various federal consumer protection laws to combat
predatory lending. The Federal Trade Commission (FTC) has played the most
prominent enforcement role, filing 19 complaints and reaching multimillion
dollar settlements. The Departments of Justice and Housing and Urban
Development have also taken various predatory lending-related enforcement
actions. Federal banking regulators report little evidence of predatory
lending by the institutions they supervise. However, concerns exist about
nonbank mortgage lending companies owned by financial or bank holding
companies. While FTC is the primary federal enforcer of consumer
protection laws for these entities, it is a law enforcement agency that
conducts targeted investigations. In contrast, the Federal Reserve Board
is well equipped to routinely monitor and examine these entities and,
thus, potentially deter predatory lending activities, but its authority in
this regard is less clear.
As of January 2004, 25 states, as well as several localities, had passed
laws to address predatory lending, often by restricting the terms or
provisions of certain high-cost loans; however, federal banking regulators
have preempted some state laws for the institutions they supervise. Also,
some states have strengthened their regulation and licensing of mortgage
lenders and brokers.
While there are no comprehensive data, federal, state, and consumer
advocacy officials report that elderly people have disproportionately been
victims of predatory lending. According to these officials and relevant
studies, predatory lenders target older consumers in part because they are
more likely to have substantial home equity or may live on limited incomes
that make them more susceptible to offers for quick access to cash. Older
consumers may also have cognitive or physical impairments such as poor
eyesight, hearing, or mobility that limit their ability to access
competitive sources of credit.
GAO's review of literature and interviews with consumer and federal
officials suggest that consumer education, mortgage counseling, and loan
disclosures are useful, but may be of limited effectiveness in reducing
predatory lending. A variety of factors limit their effectiveness,
including the complexity of mortgage transactions, difficulties in
reaching target audiences, and counselors' inability to review loan
documents.
The secondary market-where mortgage loans and mortgage-backed securities
are bought and sold-benefits borrowers by expanding credit, but may
facilitate predatory lending by allowing unscrupulous lenders to quickly
sell off loans with predatory terms. In part to avoid certain risks,
secondary market participants perform varying degrees of "due diligence"
to screen out loans with predatory terms, but may be unable to identify
all such loans.
Mr. Chairman and Members of the Committee:
I appreciate the opportunity to be here today to discuss federal and state
efforts to deter predatory home mortgage lending, especially as it affects
the elderly. While there is no universally accepted definition, the term
"predatory lending" is used to characterize a range of practices,
including charging excessive fees and interest rates, making loans without
regard to borrowers' ability to repay, or refinancing loans repeatedly
over a short period of time without any economic gain for the borrower. No
comprehensive data are available on the extent of these practices, but
they appear most likely to occur among subprime mortgages-those made to
borrowers with impaired credit or limited incomes. Predatory practices,
often targeted at the elderly, minorities, and low-income homeowners, can
strip borrowers of home equity built up over decades and cause them to
lose their homes.
My statement today is based on the report on predatory lending that you
requested and are releasing today.1 Specifically, my statement discusses
(1) federal laws related to predatory lending and federal agencies'
efforts to enforce them; (2) actions taken by states to address predatory
lending; (3) factors that make elderly consumers susceptible to predatory
lending practices; (4) the roles of consumer education, mortgage
counseling, and loan disclosure requirements in preventing predatory
lending; and (5) how the secondary market for mortgage loans can affect
predatory lending. The scope of this work was limited to home mortgage
lending and did not include other forms of consumer loans. In preparing
the report, we examined federal laws, as well as selected state and local
laws, and interviewed officials from federal, state, and local agencies.
At GAO's request, federal agencies identified enforcement or other actions
they have taken to address predatory lending. We also met with officials
from industry and consumer advocacy groups and reviewed relevant
literature. We conducted our work in accordance with generally accepted
government auditing standards from January 2003 through January 2004.
1U.S. General Accounting Office, Consumer Protection: Federal and State
Agencies Face Challenges in Combating Predatory Lending, GAO-04-280
(Washington, D.C.: Jan. 30, 2004).
In summary:
o Federal agencies have addressed predatory lending by enforcing a
variety of federal laws, including the Federal Trade Commission Act, the
Home Ownership and Equity Protection Act (HOEPA), the Real Estate
Settlement Procedures Act (RESPA), and the Truth in Lending Act (TILA).
The Federal Trade Commission (FTC) took 19 enforcement actions against
predatory home mortgage lenders and brokers between 1983 and 2003-17 of
them between 1998 and 2003-to combat alleged deceptive acts or other
illegal practices, with some resulting in multimillion dollar settlements.
The Department of Justice and the Department of Housing and Urban
Development have also taken individual and joint enforcement actions
related to abusive lending. While federal banking regulators-the Federal
Deposit Insurance Corporation, the Board of Governors of the Federal
Reserve System (the Board), the Office of the Comptroller of the Currency,
the Office of Thrift Supervision, and the National Credit Union
Administration- report little evidence of predatory lending by the
depository institutions that they supervise, concerns exist about nonbank
mortgage lending companies that are owned by financial or bank holding
companies. Our report recommends that Congress consider making statutory
changes to provide the Board with clear authority to monitor, examine, and
take enforcement actions against nonbank mortgage lending subsidiaries of
financial and bank holding companies.
o As of January 2004, 25 states, 11 localities, and the District of
Columbia have passed their own laws addressing predatory lending,
according to a database that tracks state and local legislation.2 In
addition, some
states have strengthened the regulation and licensing of mortgage lenders
and brokers, and state law enforcement agencies and banking regulators
have taken a number of enforcement actions under state consumer protection
and banking laws. However, a state law may not apply to all mortgage
lenders within the state. The Office of the Comptroller of the Currency,
the Office of Thrift Supervision, and the National Credit Union
Administration have asserted that federal law preempts some state
predatory lending laws for the institutions they regulate, stating that
federally chartered lending institutions should be required to comply with
a single uniform set of national regulations.
2Information relating to state and local laws and their provisions is from
a database maintained by Butera & Andrews, a Washington, D.C., law firm
that tracks predatory lending legislation. These laws only include state
and local laws that placed actual restrictions on lending. For example,
they do not include local ordinances that consist solely of a resolution
that condemns predatory lending.
o While there are no comprehensive data, government officials and
consumer advocacy organizations have reported that elderly consumers have
been disproportionately targeted and victimized by predatory lenders.
Elderly consumers appear to be favored targets for several reasons-for
example, because they may have substantial equity in their homes or live
on limited incomes that make them susceptible to offers for quick access
to cash. Further, some seniors have cognitive or physical impairments such
as poor eyesight, hearing, or mobility that may limit their ability to
access competitive sources of credit. While most government and private
class-action enforcement activities seek to provide redress to large
groups of consumers, some private efforts have focused on helping older
victims of predatory lending.
o A number of federal, state, nonprofit, and industry-sponsored
organizations offer consumer education initiatives designed to deter
predatory lending by, among other things, providing information about
predatory practices and working to improve consumers' overall financial
literacy. Most of these efforts seek to serve the general consumer
population, but a few education initiatives have specifically addressed
predatory lending and the elderly. GAO's review of literature and
interviews with consumer and federal officials suggest that while consumer
education, mortgage counseling, and disclosures are useful, they may be of
limited effectiveness in reducing predatory lending. For example, consumer
education is hampered by the complexity of mortgage transactions and the
difficulty of reaching the target audience. Similarly, unreceptive
consumers, lack of access to relevant loan documents, and the sheer volume
of mortgage originations each year limit the potential impact of universal
counseling. And while efforts are under way to improve the federally
required disclosures associated with mortgage loans, the complexity of
mortgage transactions hinders the effectiveness of disclosures, especially
given the lack of financial sophistication among many borrowers who are
targeted by predatory lenders.
o The secondary market for mortgage loans-which allows lenders and
investors to sell and buy mortgages and mortgage-backed securities-
provides lenders with an additional source of liquidity and may benefit
borrowers by increasing access to credit and lowering interest rates. But
the secondary market may also inadvertently serve to facilitate predatory
lending, both by providing a source of funds that enables unscrupulous
originators to quickly sell off loans with predatory terms and by reducing
incentives for these originators to ensure that borrowers can repay their
loans. Secondary market participants use
varying degrees of "due diligence"-a review and appraisal of legal and
financial information-to avoid purchasing loans with abusive terms, but
even the most extensive due diligence may not detect some predatory
lending practices. Some states have passed laws making secondary market
buyers liable for violations by loan originators, although such laws may
have the unintended consequence of reducing the availability of legitimate
credit to consumers.
Background While there is no uniformly accepted definition of predatory
lending, a number of practices are widely acknowledged to be predatory.
These include, among other things, charging excessive fees and interest
rates, lending without regard to borrowers' ability to repay, refinancing
borrowers' loans repeatedly over a short period of time without any
economic gain for the borrower (referred to as "loan flipping"), and
committing outright fraud or deception-for example, falsifying documents
or intentionally misinforming borrowers about the terms of a loan. These
types of practices offer lenders that originate predatory loans
potentially high returns even if borrowers default, because many of these
loans require excessive up-front fees. No comprehensive data are available
on the incidence of these practices, but banking regulators, consumer
advocates, and industry participants generally agree that predatory loans
are most likely to occur in the market for "subprime" loans. The subprime
market serves borrowers who have limited incomes or poor or no credit
histories, in contrast with the prime market, which encompasses
traditional lenders and borrowers with credit histories that put them at
low risk of default. Subprime lending is not inherently abusive, and,
according to officials at HUD and the Department of the Treasury, the
emergence of a subprime mortgage market has enabled a whole class of
credit-impaired borrowers to buy homes or access the equity in their
homes. Originators of subprime loans most often are mortgage and consumer
finance companies but can also be banks, thrifts, and other institutions.
Serious data limitations make the extent of predatory lending difficult to
determine. However, there have been a number of major settlements
resulting from government enforcement actions or private party lawsuits in
the last 5 years that have accused lenders of abusive practices affecting
large numbers of borrowers. For example, in October 2002, Household
International, a large home mortgage lender, agreed to pay up to $484
million to homeowners to settle states' allegations that it used unfair
and deceptive lending practices to make mortgage loans with excessive
interest and fees. In addition, the rate of foreclosures of subprime loans
has increased substantially since 1990, far exceeding the rate of increase
Federal Agencies Have Taken Enforcement and Other Actions to Address Predatory
Lending, but Face Challenges
for subprime originations. Some consumer groups and industry observers
have attributed this development, at least in part, to an increase in
abusive lending, particularly loans made without regard to borrowers'
ability to repay. Additionally, groups such as legal services agencies
have reported seeing an ever-growing number of consumers, particularly the
elderly and minorities, who are in danger of losing their homes as a
result of predatory lending practices.
As shown in figure 1, Congress has passed numerous laws that federal
agencies and regulators have used to combat predatory lending. Among the
most frequently used laws-HOEPA, the Federal Trade Commission Act, TILA,
and RESPA-only HOEPA was specifically designed to address predatory
lending. Enacted in 1994, HOEPA places restrictions on certain high-cost
loans, including limits on prepayment penalties and balloon payments and
prohibitions against negative amortization. However, HOEPA covers only
loans that exceed certain rate or fee triggers, and although comprehensive
data are lacking, it appears that HOEPA covers only a limited portion of
all subprime loans. The Federal Trade Commission Act, enacted in 1914 and
amended on numerous occasions, authorizes FTC to prohibit and take action
against unfair or deceptive acts or practices in or affecting commerce.
TILA and RESPA are designed in part to provide consumers with accurate
information about the cost of credit.
Figure 1: Federal Laws and Statutes Used to Address Lending Practices
Generally Considered to be Predatory
aHOEPA covers only a limited portion of all subprime loans.
Other federal laws that have been used to address predatory lending
practices include criminal fraud statutes that prohibit certain types of
fraud sometimes used in abusive lending schemes, such as forgery and false
statements. Also, the Fair Housing Act and Equal Credit Opportunity
Act-which prohibit discrimination in housing-related transactions and the
extension of credit, respectively-have been used in cases against abusive
lenders that have targeted certain protected groups.
Using these or other authorities, federal agencies have taken a number of
enforcement actions and other steps, such as issuing guidance and revising
regulations. Among federal agencies, FTC has a prominent role in combating
predatory lending because of its responsibilities in implementing and
enforcing certain federal laws among lending institutions that are not
depository institutions supervised by federal banking regulators. FTC
reported that it has filed 19 complaints-17 since 1998-alleging deceptive
or other illegal practices by mortgage lenders or brokers and that some
actions have resulted in multimillion dollar settlements. The Department
of Justice, which is responsible for enforcing certain federal civil
rights laws, has taken two such enforcement actions related to predatory
mortgage lending practices and has taken an additional action on behalf of
FTC. The Department of Housing and Urban Development has undertaken
enforcement activities related to abusive
lending that focus primarily on reducing losses to the Federal Housing
Administration insurance fund.3 It has also taken three enforcement
actions in abusive mortgage lending cases for violations of the Real
Estate Settlement Procedures Act's prohibitions on certain types of fees.
Federal banking regulators have stated that their monitoring and
examination activities have uncovered little evidence of predatory lending
in federally regulated depository institutions. Four of the five federal
banking regulators reported taking no formal enforcement actions involving
predatory mortgage lending, while the fifth-the Office of the Comptroller
of the Currency-reported that it has taken one formal enforcement action
against a bank engaged in abusive mortgage lending. Regulators noted that
they have taken informal enforcement actions to address questionable
practices raised during the examination process and required their
institutions to take corrective actions. The banking regulators have also
issued guidance to the institutions they supervise on avoiding direct or
indirect involvement in predatory lending. In addition, in 2001 the Board
made changes to its regulations implementing HOEPA that, among other
things, increase the number of loans HOEPA covers. The Board also made
changes to its regulations implementing the Home Mortgage Disclosure Act
in 2002 that make it easier to analyze potential patterns of predatory
lending.
Federal agencies and banking regulators have coordinated their efforts to
address predatory lending on certain occasions through participation in
interagency working groups and through joint enforcement actions. For
example, FTC, the Department of Justice, and the Department of Housing and
Urban Development coordinated to take an enforcement action against Delta
Funding Corporation, with each agency investigating and bringing actions
for violations of the laws within its jurisdiction.
Issues related to federal oversight and regulation of certain nonbank
mortgage lenders may challenge efforts to combat predatory lending.
Nonbank mortgage lending companies owned by financial or bank holding
companies (i.e., nonbank mortgage lending subsidiaries) account for an
estimated 24 percent of subprime loan orginations, according to the
Department of Housing and Urban Development, and some have been the
3The Department of Housing and Urban Development's Federal Housing
Administration mortgage insurance program makes loans more readily
available for low- and moderateincome families by providing mortgage
insurance to purchase or refinance a home. Lending institutions such as
mortgage companies and banks fund the loans.
target of notable federal and state enforcement actions involving
allegations of abusive lending.4 The Board may be better equipped than FTC
to monitor and examine these holding company subsidiaries because of its
role in overseeing financial and bank holding companies, but the Board
does not have clear authority to do so. Our report recommends that
Congress consider (1) making appropriate statutory changes that would
grant the Board the authority to routinely monitor and, as necessary,
examine the nonbank mortgage lending subsidiaries of financial and bank
holding companies for compliance with federal consumer protection laws
applicable to predatory lending practices and (2) giving the Board
specific authority to initiate enforcement actions under those laws
against these nonbank mortgage lending subsidiaries. In commenting on our
report, the Board stated that while the existing structure has not been a
barrier to Federal Reserve oversight, the approach we recommended for
consideration by the Congress would likely be useful for catching some
abusive practices that might not be caught otherwise. The Board also noted
that the approach would present tradeoffs, such as different supervisory
schemes being applied to nonbank mortgage lenders based on whether or not
they are part of a holding company, and additional costs. However, these
nonbank mortgage lenders are already subject to a different supervisory
scheme than other lenders. We agree that costs could increase and believe
that Congress should consider both the potential costs and benefits of
clarifying the Board's authorities.
Many States Have Passed Laws Addressing Predatory Lending, but Federal
Agencies Have Preempted Some Statutes
In response to concerns about the growth of predatory lending and the
limitations of existing laws, 25 states, the District of Columbia, and 11
localities have passed their own laws addressing predatory lending
practices, according to a database that tracks such laws. Most of these
laws regulate and restrict the terms and characteristics of high-cost
loans-that is, loans that exceed certain rate or fee thresholds. While
some state statutes follow the thresholds for covered loans established in
HOEPA, many set lower thresholds in order to cover more loans than the
federal statute. The statutes vary, but they generally cover a variety of
predatory practices, such as balloon payments and prepayment penalties,
and some include restrictions on such things as mandatory arbitration
clauses that can restrict borrowers' ability to obtain legal redress
through the courts.
4These nonbank mortgage lending subsidiaries are owned by the bank or
financial holding companies and are not the direct operating subsidiaries
of the bank itself.
Some states have also increased the regulation of and licensing
requirements for mortgage lenders and brokers, in part to address concerns
that some unscrupulous lenders and brokers have been responsible for
lending abuses and that these entities have not been adequately regulated.
For example, some states have added educational requirements that lenders
and brokers must meet in order to obtain a license. In recent years, state
law enforcement agencies and banking regulators have also taken a number
of actions against mortgage lenders involving predatory lending. For
example, an official from Washington State's Department of Financial
Institutions reported that the department had taken several enforcement
actions to address predatory lending, including one that resulted in a
lender being ordered to return more than $700,000 to 120 Washington
borrowers for allegedly deceiving them and charging prohibited fees.
Three federal banking regulators-the National Credit Union Administration,
the Office of the Comptroller of the Currency, and the Office of Thrift
Supervision-have issued opinions stating that federal laws preempt some
state predatory lending laws for the institutions that they regulate. The
regulators note that such preemption creates a more uniform regulatory
framework, relieves lending institutions of the burden of complying with a
hodgepodge of state and federal laws, and avoids state laws that may
restrict legitimate lending activities. State officials and consumer
advocates that oppose preemption argue that federal laws do not
effectively protect consumers against predatory lending practices and that
federal regulators do not devote sufficient resources toward enforcement
of consumer protection laws for the institutions they oversee. In
response, federal banking regulators have noted that federally supervised
institutions are highly regulated and subject to comprehensive
supervision. The regulators also said they found little to no evidence of
predatory lending by the institutions they regulate.
Consistent observational and anecdotal evidence, along with some limited
data, indicates that, for a variety of reasons, elderly homeowners are
disproportionately the targets of predatory lending. Because older
homeowners, on average, have more equity in their homes than younger
homeowners, abusive lenders could be expected to target these borrowers in
order to "strip" the equity from their homes. According to federal
officials and consumer groups we contacted, abusive lenders often try to
convince elderly borrowers to repeatedly refinance their loans, adding
more costs each time-an abuse known as loan flipping. In addition, some
brokers and lenders aggressively market home equity loans as a source of
Predatory Lenders May Target Elderly Consumers
cash, particularly for older homeowners who may have limited incomes but
require funds for major home repairs or medical expenses. The financial
losses older people can suffer as a result of abusive loans can result in
the loss of independence and security and a significant decline in their
quality of life.
A number of factors may make the elderly particularly susceptible to
predatory lending practices. For example:
o Diseases and physical impairments associated with aging-such as
declining vision, hearing, or mobility-can restrict elderly consumers'
ability to access financial information and compare credit terms. In such
situations, potential borrowers may be susceptible to the first lender to
offer what seems to be a good deal, especially if the lender is willing to
visit them at home or provide transportation to the closing.
o Some older people may also have diminished cognitive capacity, which
can impair their ability to comprehend and make informed judgments on
financial issues. According to a report sponsored by the National Academy
of Sciences, elderly people may be more likely to have conditions or
disabilities that make them easy targets for financial abuse and they may
have diminished capacity to evaluate proposed courses of action.5
Representatives of legal aid organizations have said
that they frequently represent elderly clients in predatory lending cases
involving lenders that have taken advantage of a borrower's confusion
and, in some cases, dementia.
o Several advocacy groups have noted that some elderly people lack
social and family support systems, potentially increasing their
susceptibility to unscrupulous lenders who may market loans by making home
visits or offering other personal contact.
o Elderly homeowners often live in older homes and are more likely to
need someone to do repairs for them. Federal officials, legal aid
services, and consumer groups have reported that home repair scams
targeting elderly homeowners are particularly common. For example, a joint
report on predatory lending by the Department of Housing and Urban
Development and the Department of the Treasury noted that
5Richard J. Bonnie and Robert B. Wallace, eds., "Elder Mistreatment:
Abuse, Neglect, and Exploitation in an Aging America," Panel to Review
Risk and Prevalence of Elder Abuse and Neglect, National Research Council
(Washington, D.C.: National Academies Press, 2003), 393.
predatory brokers and home improvement contractors have collaborated to
swindle older consumers.6 A contractor may come to a homeowner's door,
pressure the homeowner into accepting a home improvement contract, and
arrange for financing of the work with a high-cost loan. The contractor
then does shoddy work or does not finish the agreed-on repairs, leaving
the borrower to pay off the expensive loan.
Federal agencies, states, nonprofits, and trade organizations have
conducted and funded financial education for consumers as a means of
improving consumers' financial literacy and, in some cases, raising
consumers' awareness of predatory lending practices. Because the elderly
may be more susceptible to predatory lending, government agencies and
consumer advocacy organizations have focused some of their education
efforts on this population. For example, the Department of Justice offers
on its Web site the guide "Financial Crimes Against the Elderly," which
includes references to predatory lending. The Department of Health and
Human Services' Administration on Aging provides grants to state and
nonprofit agencies for programs aimed at preventing elder abuse, including
predatory lending practices targeting older consumers. AARP, which
represents Americans age 50 and over, sponsors a number of financial
education efforts, including a borrower's kit that contains tips for
avoiding predatory lending.
However, federal consumer protection and fair lending laws that have been
used to address predatory lending do not generally have provisions
specific to elderly persons. For example, age is not a protected class
under the Fair Housing Act, which prohibits discrimination in
housing-related transactions. In addition, the Home Mortgage Disclosure
Act (HMDA)- which requires certain financial institutions to collect,
report, and disclose data on loan applications and originations-does not
require lenders to report information about the age of the applicant or
borrower. An exception is the Equal Credit Opportunity Act, which
prohibits unlawful discrimination on the basis of age in connection with
any aspect of a credit transaction.
Little comprehensive data exist on the ages of consumers involved in
federal and state enforcement actions and private class-action lawsuits
6HUD-Treasury Task Force on Predatory Lending, Curbing Predatory Home
Mortgage Lending: A Joint Report (June 2000).
The Usefulness of Consumer Education, Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
involving predatory lending. Such actions generally seek to provide
redress to large groups of consumers, but a few cases have involved
allegations of predatory lending targeting elderly borrowers. For example,
FTC, six states, AARP, and private plaintiffs settled a case with First
Alliance Mortgage Company in March 2002 for more than $60 million. The
company was accused of using misrepresentation and unfair and deceptive
practices to lure senior citizens and those with poor credit histories
into entering into abusive loans; an estimated 28 percent of the 8,712
borrowers represented in the class-action suit were elderly.
Some nonprofit groups-such as the AARP Foundation Litigation, the National
Consumer Law Center, and the South Brooklyn Legal Services' Foreclosure
Prevention Project-provide legal services that focus, in part, on helping
elderly victims of predatory lending. The AARP Foundation Litigation,
which conducts litigation to benefit Americans 50 years and older, has
been party to 7 lawsuits since 1998 involving allegations of predatory
lending against more than 50,000 elderly borrowers. Six of these suits
have been settled, and the other is pending.
While representatives of the mortgage lending industry and consumer groups
have noted that financial education may make some consumers less
susceptible to abusive lending practices, GAO's review of literature and
interviews with consumer and federal officials suggest that consumer
education by itself has limits as a tool for deterring predatory lending.
First, mortgage loans are complex financial transactions, and many
different factors-including the interest rate, fees, provisions of the
loan, and situation of the borrower-determine whether a loan is in a
borrower's best interest. Even an excellent campaign of consumer education
is unlikely to provide less sophisticated consumers with enough
information for them to determine whether a loan contains abusive terms.
Second, predatory lenders and brokers tend to use aggressive marketing
tactics that are designed to confuse consumers. Broad-based campaigns to
make consumers aware of predatory lending may not be sufficient to prevent
many consumers-particularly those who may be uneducated or unsophisticated
in financial matters-from succumbing to such tactics. Finally, the
consumers who are often the targets of predatory lenders are also some of
the hardest to reach with educational information.
Prepurchase mortgage counseling-which can offer a "third party" review of
a prospective mortgage loan-may help borrowers avoid predatory loans, in
part by alerting consumers to predatory loan terms and practices. The
Department of Housing and Urban Development supports a network
of approximately 1,700 approved counseling agencies across the country and
in some cases provides funding for their activities. While beneficial, the
role of mortgage counseling in preventing predatory lending is likely to
be limited. Borrowers do not always attend such counseling, and when they
do, counselors may not have access to all of the loan documents needed to
review the full final terms and provisions before closing. In addition,
counseling may be ineffective against lenders and brokers engaging in
fraudulent practices, such as falsifying applications or loan documents,
that cannot be detected during a prepurchase review of mortgage loan
documents.
Finally, disclosures made during the mortgage loan process, while
important, may be of limited usefulness in reducing the incidence of
predatory lending practices. Certain federal laws, including TILA and
RESPA, have requirements covering the content, form, and timing of the
information that must be disclosed to borrowers. However, industry and
consumer advocacy groups have publicly expressed dissatisfaction with the
current disclosure system. In July 2002, the Department of Housing and
Urban Development issued proposed rules intended to streamline the
disclosure process and make disclosures more understandable and timely,
and debate over the proposed rules has been contentious.7 Although
improving loan disclosures would undoubtedly have benefits, once again the
inherent complexity of loan transactions may limit any impact on the
incidence of predatory lending practices. Moreover, even a relatively
clear and transparent system of disclosures may be of limited use to
borrowers who lack sophistication about financial matters, are not highly
educated, or suffer physical or mental infirmities. Finally, as with
mortgage counseling, revised disclosures would not necessarily help
protect consumers against lenders and brokers who engage in outright fraud
or who mislead borrowers about the terms of loans in the disclosure
documents themselves.
767 Fed. Reg. 49134 (July 29, 2002).
The Secondary Market May Benefit Consumers but Can Also Facilitate Predatory
Lending
The existence of a secondary market for subprime loans has benefited
consumers by increasing the sources of funds available to subprime
lenders, potentially lowering interest rates and origination costs for
subprime loans. However, the secondary market may also inadvertently
facilitate predatory lending by providing a source of funds for
unscrupulous originators, allowing them to quickly sell off loans with
predatory terms. Further, the existence of a secondary market may reduce
the incentive for originating lenders-who generally make their profits
from high origination fees-to ensure that borrowers can repay.
Purchasers of mortgage loans undertake a process of due diligence designed
to avoid legal, financial, and reputational risk. However, the degree of
due diligence purchasers undertake varies. Officials of Fannie Mae and
Freddie Mac-which are estimated to account for a relatively small portion
of the secondary market for subprime loans-told us that their
organizations undertake a series of measures aimed at avoiding the
purchase of loans with abusive characteristics that may have harmed
borrowers. In contrast, according to some market participants, the due
diligence of other secondary market purchasers of residential mortgages
may be more narrowly focused on the creditworthiness of the loans and on
their compliance with federal, state, and local laws. However, even the
most stringent efforts cannot uncover some predatory loans. For example,
due diligence may be unable to uncover fraud that occurred during the loan
underwriting or approval process, some excessive or unwarranted fees, or
loan flipping.
Under some state and local legislation, purchasers of mortgages or
mortgage-backed securities on the secondary market may be held liable for
violations committed by the originating lenders-referred to as "assignee
liability" provisions. Assignee liability is intended to discourage
secondary market participants from purchasing loans that may have
predatory features and to provide an additional source of redress for
victims of abusive lenders, but some argue that it can also discourage
legitimate lending activity. Secondary market purchasers that are
unwilling to assume the potential risks associated with assignee liability
provisions have stopped purchasing, or announced their intention to stop
purchasing, mortgages originated in areas covered by such provisions.
Assignee liability provisions of the Georgia Fair Lending Act were blamed
for causing several participants in the mortgage lending industry to
withdraw from the market, and the provisions were subsequently repealed.
Mr. Chairman, this concludes my prepared statement. I would be happy to
answer any questions at this time.
Contacts and For further information on this testimony, please contact
David G. Wood at (202) 512-8678, or Harry Medina at (415) 904-2000.
Individuals makingAcknowledgements key contributions to this testimony
included Jason Bromberg, Randall C. Fasnacht, Jr., Elizabeth Olivarez, and
Paul Thompson.
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