Mortgaged to the Hilt
This is a story about the American Dream gone awry. It's a story of unbridled greed, and the harm it can do. It's the story of a dirty little secret about how one American business can operate.
Let's begin the story with Kirk and Yalanda Young. The Youngs are in their mid-30s, have been married for eight years, live near Flint, a blue-collar town about an hour north of Detroit. Kirk's a blue-collar guy, works hard, brings home a paycheck. Yalanda's on disability. The message on their phone answering machine says, "Leave a message, and God bless you."
In 1991 they moved into a rental, a little two-bedroom on the edge of town. Nothing fancy.
In 1994 they had a chance to buy, so they did. Their first house. The mortgage was peanuts for lots of people -- $27,500. Kirk could handle the $302 a month, no problem. He was driving a forklift, pulling down $12 an hour.
But Kirk and Yalanda lived beyond their means. They admit that. Not extravagantly, mind you, but they had car payments and too much on credit cards.
Then, disaster. Kirk lost his job.
He looked for work for two months. Finally he found another forklift job, but this time at $6 an hour. Kirk and Yalanda started falling behind on payments. They got scared. It was the summer of 1997. Things looked bleak. They started looking for a way out.
Then they saw it. An advertisement. Their salvation.
You've seen similar ads. On TV and radio. In the newspaper. On billboards. In the yellow pages. In the mail. "Need cash? Stop living from paycheck to paycheck. We can help."
It doesn't matter whether you have bad credit. It doesn't matter whether you have too many bills.
"Be debt free," the ads gush. "Start over, fresh."
The ad the Youngs saw was for CommonPoint Mortgage, a company that then had offices all over southern Michigan and in 13 other states.
Kirk and Yalanda were on the phone to CommonPoint fast. They talked to a rep we'll call Chad. (They never met Chad until the closing. Everything was done over the phone.)
"Own a house? You'll get a loan," he promised. "No problem."
Too bad the Youngs didn't have a chance to read the warning published by the Federal Trade Commission last year: "Do you own your own home? If so, it's likely to be your greatest single asset. Unfortunately, if you agree to a loan that's based on the equity you have in your home, you may be putting your most valuable asset at risk."
The FTC report continued, "Certain abusive or exploitative lenders target these borrowers, who unwittingly may be putting their home on the line."
If Kirk and Yalanda thought that a loan from CommonPoint would solve their financial problems, they were wrong. Their real problems were about to begin.
Remember the good old days, when you had to show a bank that you could make the payments before they'd give you a loan? There was a joke: "Banks only lend money to people who can prove they don't need it."
Lenders loved, even fought over, "A" borrowers, those with good credit ratings. They called them "prime" borrowers, like prime beef. But that was in the boring days of regulation and lending rules.
About 15 years ago, all that changed.
A cosmos of cash
According to material developed by the National Consumer Law Center (NCLC) and submitted to the Senate Special Committee on Aging in 1998, several factors led to abuses in the equity loan business: deregulation of consumer lending, the rise in real estate values, new standards for lending, and a change in cultural attitudes regarding excessive profits.
First came federal deregulation laws passed in the early '80s. Then home values exploded. A huge new equity universe was created. Billions and billions of dollars. Lenders got stars in their eyes. They wanted to rocket into that cosmos of cash.
This led to something the financial folk call "asset-based lending." In plain English, it means that to get a loan, you don't have to show you can pay it back. All you need is equity. Some critics say asset-based lending is nothing more than a justification for making loans to people who can't afford them.
Meanwhile, in the shift of attitudes, greed came to be viewed as an engine for growth. "Greed is good," we were told.
Thanks to asset-based lending, there were big bucks to be made arranging "nonconforming" loans for "B"- and "C"-rated borrowers. People with problem credit ratings could get a loan as long as they owned a house. "Sub-prime" homeowners became the hot new market of the '90s. Maybe not as tender and juicy as prime, but many business people were willing to chew a little longer, swallow a little harder for the huge payoffs.
And huge they were.
Why, you could get people with poor credit ratings to pay outrageous fees, and outrageous interest rates. You could take what can be construed as kickbacks from investors.
And when "subprime" borrowers couldn't keep up with the new, higher payments, you could get them to refinance, again and again, and get more fees and more kickbacks.
Best of all, it was legal! Maybe stretching the rules a bit. Maybe not the most ethical. But you could almost feel self-righteous about helping people out of a financial jam. And if you didn't make a bundle off them, somebody else would. So go for it. Soon, new mortgage companies were popping up like mushrooms in manure. Companies like CommonPoint Mortgage.
Most of these new companies were not financial institutions in the traditional sense, like banks or savings and loans, with depositors and money to loan. They were a new breed of company. They were marketers, sales organizations, going under various names and descriptions.
Other people's money
The new mortgage companies that refer to themselves as mortgage lenders were not lending their own money, but the money of mortgage investors, companies such as ContiMortgage and Greentree Financial, both of which worked with CommonPoint Mortgage.
Today, in one suburban Detroit Yellow Pages alone, the mortgage section is 23 pages long. More than half of those pages are full-page, color ads, at a cost of $3,375 a month, better than $40,000 a year. And that's just for one area directory.
Mortgage companies have become one of the biggest advertisers on television. One TV sales rep who handles mortgage company advertising confided to me that spending on local TV is "upwards of $20 million a year. And remember," he added. "I used the phrase upwards of." One TV sales exec joked that his station had so many mortgage company advertisers that they had a hard time finding enough different advertisers to put in between them.
The "point spreads"
Exactly how do these companies make the big bucks? Various studies of the industry and interviews with mortgage brokers point to the following sources of income.
First, from "points."
Points used to mean fees you'd pay to a lender to "buy-down" the interest rate. You could get a loan at 8 percent, or you could buy-down the rate, pay two or three points (2 percent or 3 percent of the loan amount) and get the loan at 7 percent. But now, "points" can also simply mean the fee the mortgage company charges. They'll bring in a loan at 12 percent with five points, but they don't use the "points" to buy down the rate. The "points" go directly into their pockets, not to the investor, not to the company providing the cash. In fact, mortgage companies routinely charge the points, and then present loans at a higher rate than they could.
That leads to the second big money stream for many lenders. Delicately called "yield premium spreads," it is the cash mortgage companies get from investors as a reward for bringing in those high interest loans. This cash (some would call it a kickback) can be as much as 10 percent of the loan amount. In the trade, it's called getting paid on the backside.
By law, mortgage brokers -- middlemen who simply arrange loans -- must disclose these yield-spread premiums to the borrower. Mortgage bankers do not.
The spiral begins
Which brings us back to Kirk and Yalanda. This is what they say happened:
Chad set up a credit check. Told them they could get a loan to totally refinance the house at 10 percent. He arranged for an appraisal. He chose the appraiser.
Chad told them the interest rate would be 11.5 percent, not the 10 percent he'd told them earlier. He'd had to take their application to a different lender. Their credit was bad. (Actually, it wasn't quite as bad as Chad apparently implied. They'd had a few late payments, giving them probably a "B" rating.) But no problem, he said. The appraisal had come in at $61,200. The loan would be for $48,800.
On October 17, 1997, the Youngs went to the CommonPoint office to close the deal. They were expecting an interest rate of 11 percent to 12 percent. And they weren't told any differently when they were handed the pen to sign the papers.
That's when Yalanda noticed a number on the paperwork. "What's that?" she asked. It was the APR, or annual percentage rate.
The final rate was 13.9 percent. The fees were almost $4,000, about 18 percent of the newly borrowed amount. Kirk and Yalanda were in shock.
Look, Chad told them, your credit is lousy. This is the best I could do. Nobody else will give you a loan. You won't be able to do better than this.
The Youngs felt cornered. They were afraid of losing their home. So they signed.
Many consumer advocates, as well as lenders, admit that what the Youngs did is financially foolish. Credit card debt and other installment loans are unsecured. If you don't pay up, your creditors will harass the hell out of you, and ruin your credit. But when desperate people like the Youngs remortgage to pay off their bills, they are converting unsecured debt into secured debt. Now if they don't pay, they can lose their house.
New-style lenders encourage this kind of borrowing. Their advertising is an incessant drumbeat to pay off credit cards, get out of debt, get a fresh start, use the equity in your house to pay off your loans.
The Youngs' new loan paid off their old mortgage, but only about half of their credit card debt. Kirk and Yalanda got a check for around two thousand dollars. The new payment was $551.51, and they still had all those credit card payments every month.
CommonPoint immediately assigned the Youngs' loan to ContiMortgage, a New York-based company with a loan portfolio of more than $1.8 billion. Now the Youngs owed the money to ContiMortgage. A corporate profile describes ContiMortgage as a "servicer of home equity loans to borrowers whose needs may not be met by traditional financial institutions."
Still in trouble, with a higher mortgage payment and a big hunk of credit card debt remaining, Kirk and Yalanda got behind on their mortgage payments again. They made a payment to ContiMortgage in August 1998, still leaving them two months behind. ContiMortgage refused to accept the payment.
And the Youngs say they were having difficulty with ContiMortgage.
"It looks like they want us to lose our house," concludes Yalanda.
Recently, ContiMortgage suggested the Youngs refinance, referring them to another lender, which came up with a new plan that would still leave them owing ContiMortgage more than $10,000. It didn't sound like such a great deal.
Foreclosure has become a real possibility. A sheriff's sale scheduled for Jan. 6 was forestalled only by the Youngs filing for Chapter 13 bankruptcy on Jan. 5. Now they are working with a traditional bank, trying to get things straightened out, but they could still lose their home.
If the Youngs lose their home, they won't be alone. According to the Federal Trade Commission, home foreclosures have increased by 300 percent since 1980. This does not include the thousands of homes turned over to lenders voluntarily, called deeds in lieu, or homes that are sold for less than their value to avoid foreclosure.
CommonPoint became the subject of a major class-action lawsuit in the U. S. District Court for the Western District of Michigan. The Youngs, because they live in southeast Michigan, could not join that lawsuit.
According to the pleading filed by Drew, Cooper and Anding, a Grand Rapids law firm, CommonPoint violated the Racketeer Influenced and Corrupt Organizations Act (RICO), the Truth in Lending Act, breach of fiduciary duty, and commited other misdeeds.
According to the pleading, the defendant's "scheme is to skim equity from the borrower's home, and use that equity to fund excessive fees paid to CommonPoint that are undisclosed, unearned or not bona fide."
Specifically, CommonPoint was accused of assuming a fiduciary relationship and then not working in the best interests of their customers by charging discount points while, in fact, bringing in loans at higher interest rates than necessary; of accepting yield spread premiums without informing the borrower; and of attaching other questionable fees.
"They pursued credit-troubled home owners," attorney John Anding says. "They targeted people who were most vulnerable."
Through a series of legal maneuvers and decisions, the suit was returned to state jurisdiction, and then back to the federal court. ContiMortgage and Greentree Financial, another company that buys nonconforming loans, were joined to the suit. A decision by the court to dismiss the alleged RICO violation for a failure to satisfy a technical requirement for such a pleading is being appealed.
Recently, CommonPoint closed its doors, and the suit was continued against ContiMortgage and Greentree. The pleading states that the these two companies are "liable for the actions of CommonPoint under the Home Equity Protection Act (HOEPA)."
According to Anding, ContiMortgage and Greentree legally "stand in the shoes of CommonPoint with regard to high cost mortgages under HOEPA."
Stephen Muhich of Dykema Gossett, attorney for Greentree Financial, has filed a motion to dismiss the case, contending his client is not liable for CommonPoint's actions. The proceedings have been stayed pending a March hearing on that motion. "We believe in our case," said Muhich, "and are defending it vigorously."
Attorneys for ContiMortgage declined the opportunity to comment.
Anding says there could be close to 2,000 CommonPoint customers now seeking relief from ContiMortgage and Greentree.
In hot water
How do people get themselves into such financial hot water in the first place?
Most debt counselors agree that it has a lot to do with the ease of obtaining credit cards, and easy credit for big-ticket purchases like cars and snowmobiles and projection TVs. Americans are convinced that they can have everything they want, and have it now.
But it isn't only the financially reckless who get into trouble.
Fifty-eight percent of older Americans who are below the federal poverty line own their own homes. They are "house rich and cash poor."
Then there are the unfortunate and the unlucky affected by unexpected life events, like the loss of a job, illness, death or divorce.
Census figures published by the NCLC show that more than one-third of households in the lowest 40 percent of income range will experience a loss of income of at least 33 percent for one month in a given year. That's using a lot of numbers to tell us something pretty obvious: Income disruptions are more common in the lower income ranges, and the disruptions can have severe consequences when housing costs are a proportionately higher percentage of the monthly budget.
But even financially sound homeowners can be the victims. One of the parties in the CommonPoint suit simply wanted to get a better interest rate and lower monthly payment than they had with their current mortgage. According to the pleading, CommonPoint assured them that they were approved for a new loan, and that the closing would take place as soon as the paperwork was completed. CommonPoint told them to stop making payments to their current lender. By the time the new loan was presented, the borrowers had skipped two mortgage payments, and were being threatened with foreclosure. They felt they had no choice but to accept the new loan, even though the new payment was more than $100 more than the old payment. The borrowers happen to be Hispanic and speak limited English.
So these are the homeowners who become the targets of the aggressive mortgage brokers -- the elderly, the desperate, the financially unsophisticated. Many are minorities or foreign-born.
Of course, not all mortgage lenders engage in illegal practices.
"It's routine for some mortgage companies to bring in loans at interest rates higher than necessary," says Gayle Kaye, owner of Kaye Financial Corporation of Bloomfield Hills, Michigan, whose own TV ads specifically criticize mortgage companies that charge too much.
"Lenders will often exaggerate the seriousness of someone's credit problems, and convince them that the only loan they can get is one with a very high interest rate, and very high fees."
Most of Kaye Financial's customers have good credit, and are looking for traditional mortgages at the lowest possible rates. Kaye Financial closes about 90 percent of their loans.
"But the fallout rate is tremendous, almost 50 percent, at the mortgage companies that specialize in nonconforming loans," says Kaye. "So they have to make more on each customer."
That's what leads to gouging on points, phony charges such as loan application fees, and getting paid on the backside by the investor.
Some subprime lenders try to explain away their exorbitant rates, fees and costs by claiming that they're necessary because they're assuming a higher risk. But with foreclosure always a possibility, mortgage lending can be essentially risk-free, counters the NCLC.
"Help" from Congress
Are there any protections against these deceptive practices?
Well, the last Democratic-controlled Congress passed the Home Ownership and Equity Protection Act of 1994, amending the Truth in Lending Act. The law requires the lender to make certain disclosures to the borrower if the annual percentage rate exceeds the rate on comparable Treasury securities by more than 10 percent, or if the total fees and points on the loan are more than 8 percent of the total loan amount. In other words, if the terms stink to high heaven. These loans are called Section 32 mortgages.
One FTC attorney, who declined to speak on the record, said that when the legislation was being discussed, lobbyists for the mortgage companies begged lawmakers to let them keep making the loans.
"We'll get the borrower to sign a statement that says, in 2-inch high bright red type, I'm an idiot if I sign these papers," the lobbyists told lawmakers. "Just don't make the loans illegal."
Sharp mortgage reps know they can get desperate people to sign just about anything. A rep who used to work for one of the high-profile mortgage companies in this area agreed to talk on condition of anonymity. He said that they were encouraged -- "no," he corrected himself -- "expected" to bring in Section 32 loans.
But that's not all they were expected to do.
"Management sets the tone," he said. "The guys who deal with the customers, who write the loans, they take their cue from management."
What do they do?
"Management tells you to treat every deal as if it was your last deal. You've got to make as much money as possible on this one deal, because you'll never have another one. This deal is it."
The result? Go for the highest interest rate the borrower will believe. The highest interest rate you think you can pressure them into. Go for as big a fee as you can. Pile on the junk fees, the credit insurance, the bogus application fees.
"And the key is to make the borrower think their credit is the worst you've ever seen, and that they'll never get a loan anywhere else."
Another mortgage rep asked me rhetorically, "Why would someone make only $2,000 on a deal when they could make $4,000?"
Rob Silverstein, executive vice president and a partner of World Wide Financial, a Michigan mortgage firm, concedes that there are abuses. "But the lending business is no different from the car dealers or furnace companies," he says. "There are abuses, and abusers, in every business."
Silverstein defends the higher interest rates and fees charged by some aggressive lenders. "I'm not bothered by a difference between a 13 percent rate and a 14 percent rate, or that someone might charge a $2,000 fee rather than $1,500, as long as the differences are within the range of fair negotiation."
What does bother Silverstein are rates and fees that are so far out of line they are unconscionable.
But the biggest abuse, in Silverstein's view, is in making loans to borrowers who don't have the ability to repay.
"These lenders gouge the borrower on fees and costs, and then take the house back," says Silverstein. "They know when they make the loan that it can't be repaid, and that they'll end up with the house in foreclosure."
The Michigan attorney general's office is aware of mortgage abuses, but doesn't actively pursue them. They referred questions to the state's Financial Institutions Bureau, which regulates financial institutions, including mortgage brokers and bankers. A legal activist who asked not to be identified characterized the bureau under Governor John Engler as toothless. "They consider the companies they regulate as their clients," he said.
The one agency that might have taken an interest, the Michigan Consumer Protection Council, was eliminated by a stroke of Engler's pen back in 1991. (But that's a whole other story.)
So if there is any reform, it will probably have to come from the federal level. Some of the recommendations made recently to the Senate Special Committee on Aging include reinstating usury laws, strengthening HOEPA, protection from foreclosure, and passing a law that flatly and unequivocally states that unfair, deceptive, or unconscionable practices in the making of a home loan are illegal.
But how will these reforms, even if they become law some day, help the thousands who have already been harmed, and the thousands more who are likely to be harmed in the future? How will they help the financially unsophisticated, or the desperate homeowners, who see ads that promise to make them "debt-free by Friday"? How will they help the elderly who will sign away their most precious asset, their home?
As long as "greed is good," people will be hurt.
SIDEBAR: Borrower beware: The FTC warns borrowers to watch for these predatory lending practices:
Equity Stripping: Loan based on equity, rather than ability to repay. If you can't make the payments, you could lose your house.
Loan Flipping: Lender encourages repeated refinancing and additional borrowing; you incur additional fees, interest points and debt.
Credit Insurance Packing: Lender adds unneeded credit insurance to a loan.
Bait and Switch: The lender offers one set of loan terms at the time of the application, then pressures for higher charges at the closing.
Deceptive Loan Servicing: The lender doesn't provide accurate or complete accounting statements and payoff figures.