The Nature and Attributes of Predatory Lending

Predatory lending is an umbrella term that is generally used to describe  cases in which a broker or originating lender takes unfair advantage of a  borrower, often through deception, fraud, or manipulation, to make a loan  that contains terms that are disadvantageous to the borrower. In  November 2003, the Federal Trade Commission (FTC) and the Department  of Housing and Urban Development (HUD) reached a settlement with a  large national mortgage servicer, Fairbanks Capital, after the company was  accused of unfair, deceptive, and illegal practices in the servicing of  mortgage loans. Objectives, Scope, and Methodology

Our objectives were to describe (1) federal laws related to predatory  lending and federal agencies’ efforts to enforce them; (2) the actions taken  by the states in addressing predatory lending; (3) the secondary market’s  role in facilitating or inhibiting predatory lending; (4) how consumer  education, mortgage counseling, and loan disclosures may deter predatory  lending; and (5) the relationship between predatory lending activities and  elderly consumers. The written comments of the Board,  DOJ, HUD, and NCUA are printed in appendixes II through V.  We  conducted our work between January 2003 and January 2004 in accordance  with generally accepted government auditing standards in Atlanta, Boston,  New York, San Francisco, and Washington, D.C.

	Federal Agencies Have Taken Steps to Address Predatory Lending, but Face Challenges

While HOEPA is the only federal law specifically designed to combat  predatory mortgage lending, federal agencies, including federal banking  regulators, have used a number of federal consumer protection and  disclosure statutes to take actions against lenders that have allegedly  engaged in abusive or predatory lending. Among the most frequently used  laws are TILA, HOEPA, the Real Estate Settlement Procedures Act  (RESPA), and the FTC Act. HOEPA covers only a limited portion of all  subprime loans, although there is no comprehensive data on precisely what  that portion is. FTC is the  primary federal enforcer of consumer protection laws for these nonbank  subsidiaries, but it is a law enforcement rather than supervisory agency. Matters for Congressional Consideration

To enable greater oversight of and potentially deter predatory lending from  occurring at certain nonbank lenders, Congress should consider making  appropriate statutory changes to grant the Board of Governors of the  Federal Reserve System 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. Most of the state laws  restrict the terms or provisions of certain high-cost loans, while others  apply to a broader range of loans. Some states have also reorganized their agencies’ operations to better  address abuses by lenders and brokers. Federal  banking regulators have said that they have found little to no evidence of  predatory lending by the institutions they regulate, pointing out that  federally supervised institutions are highly regulated and subject to  comprehensive supervision. However, the secondary market may also serve to  facilitate predatory lending, as it can provide a source of funds for  unscrupulous originators that quickly sell off loans with predatory terms. Secondary market participants may use varying degrees of due diligence to  avoid purchasing loans with abusive terms. The act also expressly made  mortgage brokers and loan servicers liable for violations. While  consumer education efforts have been shown to have some success in  increasing consumers’ financial literacy, the ability of these efforts to deter  predatory lending practices may be limited by several factors, including the  complexity of mortgage transactions and the difficulty of reaching the  target audience. Elderly Consumers May Be Targeted for Predatory Lending

Although little data is available on the incidence of predatory lending  among the elderly, government officials and consumer advocacy  organizations have reported consistent observational evidence that elderly  consumers have been disproportionately victimized by predatory lenders. Abusive lenders are likely to target older consumers for a number of  reasons, including the fact that older homeowners are more likely to have  substantial equity in their homes and may be more likely to have  diminished cognitive function or physical impairments that an  unscrupulous lender may try to exploit.
Why GAO Did This Study

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. 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. GAO was asked to examine actions taken by federal agencies and states to combat predatory lending; the roles played by the secondary market and by consumer education, mortgage counseling, and loan disclosure requirements; and the impact of predatory lending on the elderly.

What GAO Found

While only one federal law--the Home Ownership and Equity Protection Act--is specifically designed to combat predatory lending, federal agencies have taken actions, sometimes jointly, under various federal consumer protection laws. 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 entered into predatory lending-related settlements, using laws such as the Fair Housing Act and the Real Estate Settlement Procedures Act. Federal banking regulators, including the Federal Reserve Board, report little evidence of predatory lending by the institutions they supervise. However, the nonbank subsidiaries of financial and bank holding companies--financial institutions which account for a significant portion of subprime mortgages--are subject to less federal supervision. 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 Board is well equipped to routinely monitor and examine these entities and, thus, potentially deter predatory lending activities, but has not done so because 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. 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. GAO's review of literature and interviews with consumer and federal officials suggest that consumer education, mortgage counseling, and loan disclosure requirements 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. While there are no comprehensive data, federal, state, and consumer advocacy officials report that the elderly have disproportionately been victims of predatory lending. According to these officials and relevant studies, older consumers may be targeted by predatory lenders because, among other things, they are more likely to have substantial home equity and may have physical or cognitive impairments that make them more vulnerable to an unscrupulous mortgage lender or broker.