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1.2.4 The Rise of Predatory Lending

The years leading up to the recent foreclosure crisis111 saw an avalanche of predatory mortgage lending. The predatory market can be seen as a subset of the subprime market.112 In the predatory market, price may have more to do with gouging than with risk.113 There is no single definition for predatory lending, and due to the lack of publicly reported data on this market, it is difficult to quantify the number of predatory loans or the percentage of the subprime market that they represent. One researcher estimated that 22.3% of properties in Philadelphia had at least one of three indicators of predatory lending.114 Similarly, in Montgomery County, Ohio, an independent study of a random sample of mortgage loans revealed that 64% of subprime mortgages in foreclosure had predatory features.115

Unsurprisingly, because of the higher costs and other unfair terms of predatory and other subprime mortgages, the rate at which loans went into foreclosure was significantly higher in the subprime market than in the prime market. During the second quarter of 2009, the height of the foreclosure crisis, 26.5% of subprime mortgage loans were seriously delinquent, meaning they were more than ninety days delinquent or in foreclosure. This stands in stark contrast to the rate for prime loans: 5.44% during the same period.116 Nationally, from 1998 to 2007, the percentage of seriously delinquent prime loans remained constant at less than 2% while the percentage of seriously delinquent subprime loans ranged from about 4% to 13%.117

A significant factor contributing to default and foreclosure risk was the increased marketing of unregulated loan products (often called “nontraditional,” “alternative,” or “exotic” loans), especially between 2004 and 2007. Such products included interest-only loans, payment-option adjustable rate mortgages, and hybrid adjustable rate mortgages, such as “2-28s” and “3-27s.”118 On the one hand, abuses in this area were just another form of lending without regard to ability to repay. On the other hand, these products represented a specific and hazardous path to foreclosure.

From 2004 to 2007, these nontraditional mortgage products—especially interest-only loans—moved from a marginal role in the mortgage market to a place of dominance.119 In the secondary market, 23.5% of all securitized subprime loan originations in 2005 were interest-only loans.120 Almost three-quarters of securitized subprime mortgages originated in 2004 and 2005 were 2/28 and 3/27 hybrid adjustable rate loans.121 These were sometimes called “exploding ARMs” because of what would happen to the payments required after the low initial teaser rate readjusted upward after the first two or three years.122

The fact that this occurred in an environment of low interest rates raises serious questions about how and why consumers received these products. Interest-only and hybrid adjustable rate loans may be suitable for households expecting significant increases in income, for those with fluctuations in income that enable the borrower to pay down principal during certain periods, or for investors seeking to maximize cash flow. But subprime borrowers generally did not fit any of these criteria. Many were on fixed incomes, and those with fluctuating incomes did not see substantial upswings in incoming funds. Accordingly, these loans could only have been made to such borrowers if the lender dispensed with underwriting that analyzed whether the borrower could afford the loan beyond the initial payments, if then.

Because many nontraditional mortgage products, and adjustable rate mortgages in general, were made without adequate underwriting, they presented major risks to consumers and to the economy. The widespread and inappropriate origination of nontraditional mortgages ultimately led to huge increases in defaults and foreclosures, devastating individual consumers, their families, and their communities.123

Footnotes

  • 111 {111} See § 1.2.5, infra.

  • 112 {112} Prime loans could be predatory, though the likelihood is much smaller in that market.

  • 113 {113} Alan M. White, Risk-Based Mortgage Pricing—Present and Future Research, 15 Hous. Pol’y Debate 503 (2004).

  • 114 {114} Ira Goldstein, Reinvestment Fund, Predatory Lending and Mortgage Foreclosures in Philadelphia, Presentation to Am. Bar Ass’n/Nat’l Legal Aid & Defender Ass’n Equal Justice Conf. at 15 (2006) (data from 2000 to 2003).

  • 115 {115} Richard Stock, Ctr. for Business & Economic Growth, Predation in the Sub-Prime Lending Market: Montgomery County at 8 (2001), available at http://mvfhc.org (data for 2000).

    Note that the definitions of predatory lending varied between the Dayton and Philadelphia studies.

  • 116 {116} Mortg. Bankers Ass’n, National Delinquency Survey 5 (2d Qtr. 2009).

  • 117 {117} Mortg. Bankers Ass’n, National Delinquency Survey 3 (4th Qtr. 2006). See also Debbie Gruenstein & Christopher E. Herbert, Abt Associates, Inc., Analyzing Trends in Subprime Organizations and Foreclosures: A Case Study of the Boston Metro Area, at i (2000) (the volume of foreclosures started by subprime lenders in the Boston area grew by 154% during 1995–1999, while the overall volume of foreclosures dropped by 30%); Daniel Immergluck & Geoff Smith, Woodstock Inst., Risky Business—An Econometric Analysis of the Relationship Between Subprime Lending and Neighborhood Foreclosures 17, 23 (2004).

  • 118 {118} See § 6.2.6.1, infra (discussing these products). See also Hearing Before the S. Comm. on Banking, Hous. & Urb. Affairs, Subcomm. on Hous. & Transp. & Subcomm. on Econ. Pol’y, Calculated Risk: Assessing Non-Traditional Mortgage Products (Sept. 20, 2006) (testimony of Michael Calhoun, Pres., Ctr. for Responsible Lending), available at www.responsiblelending.org.

  • 119 {119} See Kirstin Downey, Interest-Only: Borrower Beware: Popular But Risky Mortgage Draws Government Scrutiny, Wash. Post, Dec. 21, 2005, at D1 (23% of borrowers in 2005 received interest-only mortgages, compared to 1% in 2000); Kenneth Harney, Banks Warned They Must Scale Back on Payment-Option Mortgage, S.F. Chron., Dec. 11, 2005, at K12 (payment option mortgages accounted for roughly a third of new home loans issued by some major lenders in 2005).

    Thirty percent of purchase loans were interest-only as of March 2006. Loan Performance, Interest-Only, Neg AM and Investor Activity for Purchase Loans, The Mkt. Pulse 3 (Mar. 2006 data).

  • 120 {120} What Else Is New? ARMS Dominate Subprime MBS Mix, Inside B & C Lending (Jan. 20, 2006).

  • 121 {121} Possible Responses to Rising Mortgage Foreclosures, Hearing Before the H. Comm. on Fin. Services, 110th Cong. (Apr. 17, 2007) (statement of Sheila C. Bair, Chairman, Fed. Deposit Ins. Corp.).

  • 122 {122} Gretchen Morgenson, Beware of Exploding Mortgages, N.Y. Times, June 10, 2007, available at www.nytimes.com.

  • 123 {123} See, e.g., Debbie Gruenstein Bocian, Wei Li & Carolina Reid, Ctr. for Responsible Lending, Lost Ground, 2011: Disparities in Mortgage Lending and Foreclosures 17 (Nov. 2011), available at www.responsiblelending.org (as of February 2011, of the hybrid or option ARM mortgage loans originated between 2004 and 2008, 12.8% had been foreclosed upon and 11.7% were seriously delinquent; noting that these loans represented 25.4% of all mortgage loans originated and 56.7% of all mortgage loan foreclosed).