The Legal Fleecing of the Poor
Daisy Thompson, a 48-year-old African American Headstart teacher with a round, friendly face and smooth dark skin, sits at the living room table of her modest two-bedroom home in South Dallas. Her daughters cook meatloaf and cornbread for dinner, while her four grandchildren wriggle in and out of her lap, stretching out their blue Kool Aid- stained tongues and hamming for a laugh.
Thompson gives a weary, appreciative smile, but as her eyes lower to the mortgage refinancing papers stretched out in front of her, her expression sinks into confusion and despair. "I used to think that I would be leaving this home for my family," she says with a sigh. "Now I will just be leaving them a mountain of debt."
It only took a blown engine and a half hour with the loan officer from Beneficial, a subsidiary of lending giant Household International, to convince Daisy to turn her home from an asset into a burden. In 1998, when Thompson's four-year old Hyundai rolled to a stop with a loud knock and a plume of smoke, she was left without any way to get to work. When Thompson realized it would take a few thousand dollars to replace the engine, she called Beneficial, whose flashy brochures had appeared regularly in her mailbox. Filled with smiling customers and bright, bold slogans like "We're here to help you," the brochures seemed to provide an answer.
But when the Beneficial loan officer arrived at her house, Thompson found out the loan would come with a steep price. He told her that she didn't qualify for a personal loan, but she would be able to borrow $10,000 by rolling all her debt together and refinancing her home at 18.5% interest. Thompson, who at the time had only seven years left on her mortgage, felt like she didn't have any other choice. "He smiled a lot, looked me in the eyes, and told me that he was here to help me with my financial situation," she recalls. "I needed to get to work, I didn't know what to do. I just signed it."
Thompson says she later tried to get out of the loan, but couldn't. So last year, when she needed a new roof, desperation drove her back to Beneficial. Once again, they told her refinancing her house was her only option. This time, even though her mortgage was extended until 2030 at 14% interest, she did not receive any cash for refinancing. Beneficial, on the other hand, made out pretty well. They issued Thompson a $4,300 personal loan at 19% interest to fix her roof, and the refinancing earned the company almost $3,000 in fees.
The fees included $1,800 for single premium credit insurance (insurance where the premium is added to the principal instead of charged monthly), which adds thousands of dollars to the interest payments. Consumer advocates such as Rob Schneider, Senior Attorney at the Consumers Union argue that single premium credit insurance is a scam. "Single Premium Credit Insurance is only sold in the predatory market," says Schneider. "Since they initially finance the cost of the insurance, the interest can easily end up doubling the cost - with no added benefit." In Thompson's case, the blow was softened a few months later when her application was rejected by the insurance carrier, and she was issued a refund.
Schneider says that an honest banker would never have refinanced Thompson's house for a $10,000 loan. If a conventional lender had agreed to issue a loan, Thompson's options would have included borrowing against the equity of her house, without refinancing. But since Beneficial got to her first, she now pays $647 of her $1,400 monthly salary in loan payments ($534 for the mortgage, and $113 for the personal loan), leaving only $753 to support a seven-member family.
If she doesn't make her payments, she risks losing her house. She will continue to pay off her mortgage until she is 76 years old, and unless she refinances for a better deal, the fees and interest will add up to more than $100,000. That's enough money to buy a whole fleet of Hyundais, or put a grandchild or two through college. Thompson's story is just one example of a widespread practice known as predatory lending, which has grown exponentially in the past decade along with growth in the so-called "subprime" lending market. Subprime lending, which features an interest rate as much as twice that of prime loans, can provide credit to individuals with low incomes, few assets, or poor credit history. However, critics say that lax laws allow unscrupulous lenders to take advantage of borrowers who are desperate and lack experience.
The debt burden is hardly necessary. A 2001 Fannie Mae study found that 35 to 50 percent of subprime borrowers could have qualified for a prime loan. Many of these borrowers end up tethered to debt for years, and those who can't keep up lose their homes. A study by the Coalition for Responsible Lending estimates that predatory lending costs borrowers $9.1 billion dollars annually through excessive interest rates (above what would be reasonable for the additional risk), hefty fees, prepayment penalties, and single premium credit insurance. Including the cost of foreclosures would likely add billions more to this estimate.
"Homeownership gives families a stake in keeping their neighborhoods clean and free of crime," says Schneider. "Predatory lending works to undermine this fundamental principal, and it is having a devastating effect on low income communities across the country."
Beneficial vehemently denies that their loans are predatory. They say that not only was Thompson's loan legal and fair, but that they provide a valuable service to low-income customers. "A bank would never have given a high-risk borrower like Thompson a loan," he says. "But we did. People who argue that our loans are unfair and deceptive are, in fact, saying that poor people are too stupid to make their own financial decisions. We believe that individuals should be allowed to think for themselves."
The loan officer who closed the deal with Thompson agrees. "Beneficial would not have loaned her money without refinancing the house," says Darrell Everett, who no longer works for Beneficial. "She may not think it was such a great deal now, but at the time she was fully aware of the consequences, and made her own choice. She had the option to go to a competitor, or simply not take out the loan."
This argument -- that freedom of choice exists in the lending market -- ignores the fact that minority neighborhoods have always tended to have less access to credit. Banks don't tend to open local branches there, so predatory lenders market hard to fill the void.
Despite the 1977 passage of the Community Reinvestment Act (CRA), a bill intended to force banks to make mortgages equitably across class and racial lines, minority applicants are still about twice as likely to be turned down for conventional mortgages than whites at the same income level, according to a study by the Association of Community Organizations for Reform Now (ACORN). These would-be borrowers are then faced with a difficult choice -- turn to a subprime lender, or forgo the credit and the dream of home ownership.
In Thompson's mostly poor South Dallas neighborhood, eight of the top ten lenders to blacks are subprime, according to a study by Consumer's Union. Facts like these, says Schneider, prove that much more needs to be done to level the playing field. "The CRA says you can't discriminate based on race," he says. "But that hasn't forced conventional lenders to suddenly serve the needs of whole communities. To this day, very few conventional lenders do outreach in minority communities." Just as the last dinner plate at Thompson's house is scraped clean and stacked in the sink, Thompson answers a knock at the door. The visitor is Kimberly Olsen, a young, energetic brunette bearing an armful of newsletters focusing on predatory lending in Texas. Olsen is the lead organizer at the Dallas chapter of ACORN , which is part of a coalition working to pass a state law protecting subprime borrowers.
The two sit at the table to review the details of the testimony Thompson will give at a legislative hearing later that week. "This hearing will be the first time Texas senators will be able to hear directly from victims like yourself," Olsen tells Thompson. "It's amazing, but we might even pass legislation in a conservative state like Texas."
ACORN's Texas campaign is part of a national effort to make predatory lending illegal. The toughest law, passed in North Carolina in 1999, prohibits a host of practices, including "flipping," or repeatedly refinancing a single loan; single premium credit insurance; and fees of more than 5 percent of the principal of the loan. By Fall 2001, ten other states and municipalities had passed laws of their own, and several others are currently considering some form of regulation.
But a federal law will be harder to pass. Although Sen. Paul Sarbanes, D-Md., head of the Senate Banking Committee, has called predatory lending a "frontal assault on homeowners" and introduced legislation to regulate the industry, Congress has shown little interest in passing it. "It is hard to describe how outgunned we are at the federal level," says Lisa Donner, Director of ACORN's Financial Justice Center. "The banking industry as a whole is opposed to any form of control. We have had a lot of success at the state level, where politicians are literally closer to the people being affected."
Even without tougher laws, some of the worst abusers are being taken to court. On March 21, 2002, the First Alliance Mortgage Corporation, accused by the Federal Trade Commission of cheating elderly homeowners, settled for $60 million. And in February, ACORN filed a class action suit in California against Household International, Beneficial's parent company, that alleges that the company deliberately misled tens of thousands of California borrowers. "It is very difficult for Household to change," says Donner. "They spend so much money on marketing that they really are forced to make it back through deception and fraud. What they need to do is stop aggressively targeting poor communities, and that would allow conventional lenders to compete effectively in the subprime market."
Although Household representatives deny any wrongdoing, they released a list of "best practices" for their branches to follow shortly after the case was filed. The best practices include limiting fees to 3 percent of the loan value, and offering easy-to-read disclosures of all terms and conditions. Donner is skeptical of the changes; she says that Household promised to stop selling single-premium credit insurance almost a year ago, but borrowers report that they are still sold the dubious product in some states. Household says that it takes time to institute changes in their 1,400 branches. "Our best practices set a standard for the subprime industry," Streem responds. "We are on the vanguard, but ACORN refuses to give us credit because we won't sign a deal with them."
Sometimes lenders can be convinced to change their behavior without lawsuits or legislation. In 2000, ACORN struck a deal with Ameriquest, the largest subprime lender, after a series of noisy protests that included filling the company's national headquarters with angry borrowers. In response, Ameriquest not only agreed to stop many of its abusive practices, but agreed to partner with ACORN to make loans at discounted terms in certain neighborhoods. "When ACORN first targeted us, we felt unfairly harassed," says Adam Bass, Senior Executive Vice President of Ameriquest. "But ultimately we decided to hear what they had to say. We found out we could learn a lot from them, and things have improved substantially."
However, ACORN has found itself on the opposite side of Ameriquest in the fight to pass anti-predatory legislation. Ameriquest, along with most lenders, feels that federal laws already prohibit predatory lending, and all that is needed is better enforcement. "If we keep passing tougher laws to regulate loans," says Bass, "then fewer people will have access to credit. ACORN might argue that those people can't afford loans, but we believe it is a personal decision."
Thompson doesn't feel empowered by the loan she got from Beneficial. She thinks about the music and ballet lessons she can't afford for her grandchildren now that so much of her paycheck goes to inflated mortgage payments, and hopes that a law will be passed to protect low income borrowers. "Looking back, I know I should have talked to a bank and asked for financial advice," she says. "But, at the same time, lenders shouldn't be able to take advantage of people in desperate situations. Beneficial cheated me out of my life savings, and they didn't even have to break the law."
Michael May is a writer living in Austin, Texas.