Wednesday, November 14, 2007

Defining Predatory Lending

Justice Brennan once famously said this about pornography.

I shall not today attempt further to define the kinds of material I understand to be embraced . . . [b]ut I know it when I see it .

The Supreme Court has continued to this day to try and define what is free speech and what is obscene and pornography. While in the matter of pornography vague definitions may suffice, I have pointed out over and over that vague and undefined regulations always lead to disaster in mortgages. What it always leads to is more useless paperwork to sign. If you go to the previous link, you will see that it is all the paperwork already part of the process that leads to much of the fraud.

Enter the term predatory lending which is at the center of the new bill H.R. 3915. Here is what one Winston Salem paper said about predatory lending.

There is no specific definition about what exactly predatory lending entails, though most observers believe that the description applies when lenders take advantage of borrowers by charging high interest rates and consider only the value of a borrower’s assets, as opposed to what the borrower can afford to pay.

Keep in mind the full name of H.R. 3915 is the Mortgage Reform and Anti-Predatory Lending Act of 2007. In other words, the Congress is trying to legislate that which it can't even define. Look at what this paper describes it as. First, it says that it involves "high interest rates". That is of course in the eye of the beholder. How do we determine high? Is high the same for a borrower of a credit score of 800 as it is 500? Is it the same for an investment property as it is for a primary residence? No one knows because "high interest rates" is another dangerously vague term.

Look at the other part of the description. It is a loan that considers value and assets over their ability to pay. I once closed a loan for two borrowers in which their debt to income ratio was almost 100%. You read that right. Keep in mind that income is before taxes and I still was able to get them approved even though just the debts on their credit report amounted to their monthly mortgage. How did this happen? The wife was the breadwinner and she recently got laid off. That income wasn't allowed to be counted. Since they were actually well off, their credit score approached 800. They had about as much in liquid assets (checking, saving, investment, retirement plans, etc) as though owed. Also, they only owed about 200k on a property that was worth 450K. Was I doing predatory lending? By this description I was. This is despite the fact that in this case I was merely lowering their rate while paying for all their costs. In other words, all I did was lower their monthly payment from their previous one.

Yet, without a clear definition of predatory lending, this could be construed as "predatory lending". Even in the current bill there are all sorts of vague characteristics of predatory lending. For instance, there is net tangible benefit. I personally have no problem with net tangible benefit. I use that concept to sell. After all, I have to have a reason for the borrower to take the loan. To me that is their net tangible benefit.

Then, there is the anti steering portion of the bill. According to the bill, if I steer someone into a sub prime loan even though they are qualified for prime, that could be construed as predatory. The problem is that there are times in which sub prime loans are better for the borrower. For instance, Fannie Mae has several different levels. It has Expanded approval and that reaches three levels. By the time a borrower is only approved for Expanded Approval III, they are most likely better off going to sub prime. Yet, unless anti steering isn't better defined, this may also be construed as predatory.

There is more. Look at this portion of the bill.

engaging in abusive or unfair lending practices that promote disparities among consumers of equal credit worthiness but different race, ethnicity, gender, or age.

Abusive and unfair can mean just about anything and frankly any borrower can feel as though they were treated as such. By leaving the definition as this vague, it opens just about any behavior to "predatory".

This should scare everyone. Congress can't even define what they are trying to prevent. Then, they use vague and unclear language to describe it. If this bill gets passed in its current form, predatory lending will mean just about whatever anyone wants it to mean. If that is the case, it opens up the industry for all sorts of law suits. More than that, it opens the process up to all sorts of new paperwork to sign. In fact, the legislators think that more paperwork is the answer. Let's look at another part of the article from the Winston Salem paper.

We should have more disclosure about the loan terms that people are signing on to … a one-page summary that every borrower sees explaining everything,” he said.

That was said by Republican Patrick McHenry. Notice he never says what everything is. In his world, after getting everything out in over one hundred documents, we still need one more to summarize everything. This is the sort of nonsensical perspective that our legislators from both sides bring to this debate. All it will lead to is more vague language, more paperwork, and ultimately more confusion.

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