By Mike Hudson and E. Scott Reckard, Special to The Times
Low interest rates and aggressive marketing campaigns have driven home lending to record levels. But increasingly Americans with good credit are being saddled with loans designed for high-risk borrowers.
These higher-cost loans have been the fastest-growing segment of the mortgage market — accounting for 20% of the home loans issued last year, up from 10% a decade ago.
Freddie Mac, the government-sponsored mortgage finance giant, estimates that more than 20% of people who get these so-called sub-prime loans could have qualified for more-conventional prime loans.
Consumer advocates say it’s a “borrower beware” market. Companies and independent brokers generally are not legally required to tell customers that they might get a better deal elsewhere, and regulations have not kept pace with the booming mortgage refinancing market and skyrocketing home prices.
“The reality is, if you happen to walk into the wrong door, you can be trapped,” said Kathleen Keest, senior policy counsel at the Center for Responsible Lending, a nonprofit advocacy group in Durham, N.C.
The National Home Equity Mortgage Assn., which represents sub-prime lenders, disputes the notion that large numbers of their customers could find better loans elsewhere. There are legitimate reasons, the association says, why lenders make sub-prime loans to borrowers with good credit. Self-employed people, for example, don’t have regular paychecks to document their income.
“People have a lot of choices these days, and everything doesn’t come in one package,” said Jeffrey Zeltzer, the association’s president.
Used properly, sub-prime loans can help people with spotty credit and a large amount of debt, or others who simply want to tap their equity to pay off expensive credit cards. But they also can allow loan agents and brokers to earn high commissions at the expense of people with solid credit.
Loren and Rebecca Oldham say they thought they were getting a good deal when they refinanced their mortgage at 5.25% interest, cutting their monthly payment by $150 a month. But when they sold their house outside Louisville, Ky., less than a year later, they discovered a clause that forced them to surrender nearly $16,000 as a penalty for paying off the loan early.
Prepayment penalties are usually for borrowers with bad credit, not folks like the Oldhams, who say their high credit score should have landed them a loan without the provision. They plan to seek a refund, and are kicking themselves for not taking enough time to spot the penalty.
“You know how closings are: You sign so many documents, you kind of trust what they’re saying,” Loren Oldham said.
Freddie Mac estimates that during the last two years more than 1 in 5 borrowers who got these higher-cost loans could have qualified for less-expensive prime loans.
That estimate is based on computer analyses of hundreds of thousands of sub-prime loans, taking into account factors including credit history, home value and the ability to pay, said Peter Zorn, the company’s vice president for housing analysis and research.
The number of borrowers improperly stuck in sub-prime loans is on the rise, Zorn said; until about two years ago, it was only 10% to 15%. One reason, he said, is that lenders have relaxed their standards for approving prime loans, making them easier to get than people may realize.
At least one mortgage company executive says he has also seen evidence supporting Freddie Mac’s analysis.
IndyMac Bancorp Inc. of Pasadena was considering acquiring several sub-prime mortgage specialists about two years ago, and reviewed the loans that they had made, said Chief Executive Michael Perry.
The data, including credit scores and borrower incomes, showed that about 40% of the customers of the other companies qualified for lower-cost prime loans, Perry said.
That led IndyMac to rule out the acquisitions, he said, because prime loans aren’t as profitable. His company makes both types of loans, and Perry says IndyMac’s computers automatically steer qualified customers to prime loans.
Based on estimates from Freddie Mac and the Center for Responsible Lending, as many as 1 million borrowers are paying too much for their loans. Such customers paid an estimated $3 billion in excess interest in 2001 alone, the consumer group said in a study that year.
Prime, fixed-rate loans currently charge interest of about 6% a year, along with upfront charges known as points that typically run 1% or less of the loan amount. To cover their higher risk, sub-prime loans carry interest rates averaging about 7.5% a year and upfront points of about 3% of the loan value.
For a $300,000 loan, an extra 1.5% in interest costs the borrower nearly $11,000 in additional monthly payments in the first three years, or more than $25,000 extra over seven years. The two additional points upfront translate to $6,000 more at closing.
Advocacy groups have fought for years to persuade companies with both prime and sub-prime arms to make sure qualified borrowers get prime loans even if they are doing business with the high-cost operation. These large companies, which include Citigroup Inc., Washington Mutual Inc. and Countrywide Financial Corp., have pledged to do so, though the groups still don’t think this “referring up” happens consistently, said Kevin Stein of the California Reinvestment Committee, a San Francisco-based group.
Christine Vannoy of Long Beach said she incorrectly assumed that a loan officer with Wells Fargo Financial would provide the best price when she and her husband refinanced their home in 2002. Vannoy, an office manager for a company that stages corporate events, said she was distracted and never looked at the papers when the loan closed, as the agent chatted with her husband and assured them they’d feel good because they were paying off credit cards and taking out $1,500 in cash.
When Vannoy later separated from her husband, she found that the 20-year loan had a 10.6% interest rate, along with seven upfront “discount points” totaling $13,527.
Wells Fargo Financial is the sub-prime unit of Wells Fargo & Co. Vannoy complained to Wells Fargo and was ultimately given a new loan from Wells Fargo Home Mortgage, a part of the main bank, at 5.95%. Wells Fargo declined to comment, except to say it “only makes loans which provide a tangible benefit to the customer.”
Wells Fargo has since reined in certain practices. In August, it said it would limit points and prepayment penalties, and it pledged that by the end of this year qualified borrowers would get prime loans, even if they applied through sub-prime channels like Wells Fargo Financial.
Complaints like Vannoy’s have swirled around the sub-prime industry for years, and mortgage lenders have at times acknowledged that their employees have taken advantage of consumers.
In one well-publicized incident last year, a mid-level executive at Countrywide sent a memo urging his loan officers to misstate customers’ income and assets so they would qualify only for more-expensive sub-prime loans. Calabasas-based Countrywide said it fired the executive as soon as it learned of the memo.
Some companies, however, are sub-prime specialists — and are under no obligation to send prime-worthy customers to a rival offering traditional loans.
Orange-based Ameriquest Capital Corp. is the nation’s largest sub-prime lender. Except for a small pilot program, it does not offer prime loans. In interviews with The Times over the last year, 13 former Ameriquest employees said the company frequently sold sub-prime loans to prime-worthy borrowers.
Several of the ex-employees said loan agents were taught to exploit customers’ inexperience by pointing out minor blemishes in their credit reports. By getting a loan from Ameriquest, customers were told, they could take a first step toward repairing their credit, said Robyn Preis, who worked as a loan processor in 2003 and 2004 at an Ameriquest branch in St. Louis.
“It was pretty common,” Preis said. “They’d tell the borrower they had poor credit and they need to work on this and work on that. They would just lie to them.”
Ameriquest said in a statement that it tried to get customers the best loan available from its usual products. Ameriquest also said it sent potential borrowers a one-page “understanding your loan” letter, advising them that “better terms may be available” and suggesting they consult other lenders, including banks. The company requires borrowers to sign the letter.
Ameriquest’s lending practices are being reviewed by a 30-state task force. The company recently set aside $325 million to cover a possible settlement. Speaking generally to allegations of improper practices, Ameriquest Chairman Roland E. Arnall told a Senate panel last week that “some of our employees did not do the right thing,” but said the company had fired them and taken steps to correct problems. Arnall is awaiting confirmation as U.S. ambassador to the Netherlands.
Much of the refinancing boom has been led by independent mortgage brokers, who in theory shop around for loans from a variety of companies. In about a third of the states, including California, brokers have a fiduciary duty to represent borrowers’ best interests, Keest said.
But there are significant exceptions: California’s predatory lending law, for example, says a broker must provide a mortgage “based on the loan products offered by the persons with whom the broker regularly does business.”
“So if a prime customer walks into a broker who only ‘regularly does business’ with sub-prime lenders, he doesn’t have to — under this statute — say you can do better in the prime market,” Keest said.
The California law, passed in 2001, requires lenders to identify a benefit to customers when refinancing a mortgage. It also lists disclosures that lenders must make, including telling borrowers that their loan might have high fees.
But the law only covered loans up to $250,000 until this month, when Gov. Arnold Schwarzenegger signed a measure raising the upper limit to $359,650.
Critics say that is still too low; the average home price in Southern California last month was $475,000, and 20% of mortgages in the region are for more than $359,650, according to DataQuick Information Systems.
More important, the law applies only to loans that charge interest rates exceeding 12% a year or upfront fees topping 6%.
Many consumer advocates and lenders support the idea of a national law to prevent lending abuses and to avoid the patchwork of regulations that vary from state to state. But they disagree over what to include. Lenders want a national standard to override state laws, while advocacy groups want to preserve state or local measures that are stronger, and say the leading proposal in Congress, the so-called Ney-Kanjorski bill, is too weak.
Industry officials contend that many of the problems that exist can be solved if borrowers check to make sure their loans match their creditworthiness.
“It’s an education problem,” said Adam Findeisen, a spokesman for the National Home Equity Mortgage Assn. “People just go to one institution and they don’t shop around and they don’t know all the loan options that are available to them.”
Borrowers can avoid many pitfalls if they steer clear of solicitations and find lenders on their own, said Jack Guttentag, an emeritus professor of finance at the Wharton School who runs a consumer-oriented website called the Mortgage Professor (www.mtgprofessor.com).
People who believe they were overcharged for a loan can also ask for a refund, or a new loan.
Going to court is another option. Jennifer and Steve Arnold filed a federal lawsuit claiming their loan broker, St. Louis-based American Equity Mortgage Inc., used bait-and-switch tactics to maneuver them into a sub-prime loan. They also said their lender, San Jose-based First Franklin Financial Corp., should have known the broker was taking advantage.
Lenders consider many issues when evaluating a mortgage, but one crucial factor is a borrower’s FICO score, a measure of creditworthiness developed by Fair Isaac Corp.
FICO scores range from 300 to 850. Scores of 620 or higher should qualify borrowers for prime loans as long as other factors, such as income and property value, are in line, said Karlene Bowen of Fair Isaac.
The Arnolds’ FICO scores ranged between 664 and 724, said Philip Graham, an attorney for the couple. He said those scores, coupled with their income and the equity in their home, should have qualified them for a fixed-rate mortgage in the 5.5% to 6.3% range, rather than the adjustable-rate loan they received, which started at 8.6% and could have gone as high as 14.6%.
The broker undermined the couple’s creditworthiness, Graham said, by putting the application only in Jennifer Arnold’s name. The couple didn’t find this out until closing, Jennifer Arnold said, but they decided to sign because they were afraid if they backed out, their home purchase would fall through.
American Equity Mortgage and First Franklin, without admitting wrongdoing, this summer settled a lawsuit filed by the Arnolds. The companies declined to comment but in court papers said that any injury suffered by the Arnolds was due to their own negligence.
The Oldhams, who were surprised by the nearly $16,000 prepayment penalty, plan to seek a refund. Their loan was arranged by a broker, Platinum Mortgage Services, and funded by a sub-prime lender, Charlotte, N.C.-based EquiFirst Corp.
The couple’s income and excellent credit history, reflected in FICO scores that went as high as 759, should have qualified them for a prime loan without a prepayment penalty, said their lawyer, David Mour.
EquiFirst said it couldn’t comment on the Oldhams’ loan. Tom Black, president of Platinum Mortgage, said the Oldhams were informed in writing about the prepayment penalty. And he said that although the couple had excellent credit, their heavy debt load might have scared away some of the lenders who work with his loan brokerage; that may have been one reason the loan included a penalty provision, Black said.
Loren Oldham said he recalled checking over the rates and fees on the loan, but not reading anything about the prepayment penalty — even though his signature is on the page authorizing it.
“It’s really aggravating,” he said. “You kind of get mad at yourself because you let this happen.”
Some tips when shopping for a mortgage:
• Start with lenders that offer traditional “prime” loans. Never accept an “easy money” pitch at face value; get a written offer and ask banks and other lenders to beat it.
• Get a copy of your credit report. Your credit history will help determine what your rate will be.
If you have credit problems or questions, free counseling is available through the U.S. Department of Housing and Urban Development and community groups.
• Don’t be pressured into signing a loan. Before closing, don’t stop paying bills that you plan to pay
off with cash from refinancing. That way, if at closing you discover that the mortgage terms are unsatisfactory, you can walk away from the deal.
• Don’t sign documents with incorrect dates or blank fields. Be wary of promises that a lender will “fix it later.”
Sources: Freddie Mac, Center for Responsible Lending, Ameriquest Capital