Finances

Preventing Foreclosures:
Spotting Loan Scams Involving Vulnerable Homeowners
Prepared by the National Consumer Law Center, March 1993. Visit their website at www.nclc.org.

Equity-rich, cash poor older Americans are an ideal target for unscrupulous operators who scheme to rob unsophisticated consumers of their homes through foreclosure. Home improvement scams and deceptive lending practices are among the most frequent problems experienced by financially distressed older Americans who seek legal assistance. This is particularly true of minority consumers who lack access to traditional banking services and rely disproportionately on finance companies and other less regulated lenders.

But there are warning signs that older Americans can look for to avoid shady home secured loans. This consumer education pamphlet explores the crisis in home equity lending abuse by providing a case study in unfair lending practices and a checklist of what consumers should be on the lookout for in evaluating a loan.

Why Scams and Foreclosures are on the Increase
With deregulation of the consumer credit industry and inflation in property values, financiers saw a lucrative new market in equity-secured lending. Today, home improvement loans are predominantly secured by one's home, and lenders, in general, have moved aggressively into home-equity secured lending to avail themselves of the inflated property values for their collateral. Consequently, many loans formerly unsecured, such as hospital bills, are now folded into higher rate loans secured by homes.

For senior citizens, who comprise a disproportionate share of those victimized by home improvement fraud or other types of home equity fraud, the use of home secured financing places them in a real bind. Often in desperate need of home repairs (e.g. roof replacement, structural reinforcements), unsophisticated homeowners fall easy prey to unscrupulous home improvement contractors. Many of these loans have inflated interest rates, outrageous carrying costs and unaffordable repayment terms.

Elderly consumers who have sought legal assistance frequently say that they were unaware of the terms of the loan agreement they were signing. Unfair terms mean that the limited resources of elderly Americans are depleted quickly and needlessly. But what is most dangerous about these home equity secured loans is that when borrowers default on the loan, either because they are unable to meet staggeringly high interest repayment rates or in reaction to shoddy or incomplete workmanship, the real danger is now foreclosure.
Foreclosure rates have increased nationally by more than 200% since 1980 and show no signs of abatement. More than 600,000 homes were foreclosed in 1989.

Each foreclosure of a residential mortgage is a personal, social and financial tragedy for the household facing foreclosure. It also has a destabilizing effect on the neighborhood in which the home is located because absentee speculators are likely to replace the family who was forced from the home.

It is estimated that at least half of the foreclosures in the last three years were caused or expedited by home equity loans. This problem has disproportionately affected the elderly, since they frequently have substantial equity built up over a long period of time.

A Case Study in Unfair Lending Practices
Mr. and Ms. "Smith" have owned a nice home in Massachusetts since 1947. They are now both past 70 and they have stable social security and pension income. Nevertheless, they are in the fight of their lives, trying to save their home from foreclosure.

Their problems began a little over five years ago when they responded to an advertisement promising "easy credit". This purveyor of credit was, unbeknownst to them, a loan broker. He arranged a small home equity loan with a suburban finance company and charged Mr. and Ms. Smith $1,200 for this service.

The Smiths borrowed less than $20,000 to consolidate some back bills. The loan was secured by more than $100,000 in equity in the Smith's home, which had been accumulated over 40 years. Nevertheless, the interest rate for the loan was 18%.

Unfortunately, the Smith's problems were only beginning. Hidden in the loan documents was a provision calling for a large penalty in the event of prepayment. If the Smiths prepaid in the first three years of the loan, they were required to pay 5% of the principal of the loan in liquidated damages. Needless to say, the lender began almost immediately to call and write to recommend that the Smiths come in for additional financing. Without understanding the penalty, the Smiths did so -- six times. Each time they were charged an additional 5% in damages.

Each of the six times the Smiths refinanced, the lender repaid itself on the prior loan and invoked the prepayment penalty to increase the proceeds due. Although it appeared that the interest rate on each of the refinanced transactions remained at 18%, the effective interest rate in the series of transactions was at least 40% because of the prepayment penalty. In addition, each refinancing involved new closing costs, including an attorney's fee averaging approximately $600 per transaction. The "attorney", it turns out, was the president and chief executive officer of the loan company. Over 5 years, the loan company actually lent the Smith just over $26,000. It now claims a right to repayment of over $60,000.

By the time of the seventh transaction, the Smiths were paying nearly 60 percent of their income toward loan payments. Mr. Smith, at 77, was forced to seek odd jobs including manual labor in order to make ends meet. Not surprisingly, the situation soon fell apart and the Smiths found themselves in foreclosure, about to lose their home.

HOW TO IDENTIFY SHADY LOANS 
There are several "warning signs" for a shady home equity loan. Although loans containing the following attributes may not be scam loans, the features listed below are often associated with loans for which strong foreclosure defenses are available.

Balloon Payment
A large sum of money beyond the borrower's ability to pay becomes due all of a sudden at the conclusion of the loan. Balloon payments are often included in loans with an unenforceable (fraudulent) oral promise to refinance.

Multiple Refinancing
Hidden prepayment penalties become embedded in the loan proceeds upon each refinancing with additional closing costs each time.

High Interest Rate
As prevailing interest rates change, the definition of a high rate changes too. As a rule of thumb, rates over 13% since 1990 are high; rates over 15% in the late 1980's were similarly far above the market.

High Closing Costs
Closing costs such as attorney's fees, document preparation fees and appraisal fees are deducted from the proceeds of the loan. In some instances, up to one third of the loan proceeds were paid to the lender at closing, and the borrower must pay interest on these.

Borrower Never Received All the Money
The lender may have folded and disappeared after it obtained a mortgage, but before all the loan proceeds were distributed. The mortgage then may have turned up in the hands of a third party who supposedly innocently purchased it without knowledge of the wrongdoing.

Loan Broker Fees
Loan brokers often advertise as mortgage companies. Unsuspecting homeowners contact them seeking a loan. Rather than making the loan directly, the loan broker, unbeknownst to the borrower, sets up the loan with another mortgage company and arranges a fat commission with the lender which comes out of the loan proceeds.

Contractor Fraud
A contractor arranges the loan to pay for home improvements, obtains payment from the lender, and then fails to follow through with the work or does the work poorly. In many cases the contractor obtains an additional commission for "arranging" the loan.

Credit Insurance
The lender sells credit life insurance or credit accident and health insurance in connection with the loan. 
This primarily protects the lender in the event of the homeowners death or disability. Because a lender's profits on such policies are very high, insurance is often pressed on the borrower as a condition of the loan. This insurance often has limitations, such as age, yet is sold to people who don't meet the qualification. In one case in Western Massachusetts, for example, a nationally known lender sold disability insurance to someone who could never benefit under the policy because she was already disabled.

Borrower Couldn't Afford Payments When Loan Was Made
In some cases when there is a large amount of equity in a home, shady lenders will make a loan which they know can't be repaid. What they get is a right to foreclose on the home which more than likely will allow them to obtain the full amount of the equity even if they lent a much smaller amount. 

Excessive Points, Late Charges and Prepayment Penalties 
These are hidden traps for borrowers and profit centers for shady lenders. 

Some Options for Addressing the Problem
Most or all of these problems create opportunities for a homeowner to fight back. Some very creative remedies for unfair lending practices are in litigation around the country.

As consumer and housing advocates, it is becoming increasingly important to evaluate issues involving unfair lending practices for vulnerable. Unless legal redress is sought, unfair lending practices can strip older Americans of their financial independence and wellbeing in practically no time at all.

For more information on home mortgage scams and foreclosure defenses, contact Yvonne Rosmarin at NCLC's Boston office.

About NCLC
In 1992, NCLC received funding from AoA to launch and Eldercare Initiative in Consumer Law, intended to improve access to and quality of consumer representation for older Americans. Since 1969, NCLC has been providing legal advocates with technical and expert assistance, training and publications that cover all major topics in consumer law. Since its founding, NCLC has established itself as the nation's consumer law specialist, making its legal expertise available to low income clients and their attorneys. These services are now available to advocates representing older Americans.
The attorneys and policy analysts on NCLC's staff are all specialists in aspects of consumer law. The Center's comprehensive library of consumer law is updated continuously as attorneys conduct research on behalf of clients and revise NCLC legal practice publications.

Making Use of Consumer Law
Consumer law is powerful but complex. In any given transaction, several defenses may exist against creditor or seller claims, but detailed research and calculations are required in order to spot defenses. With financially burdened clients, it is important to recognize that the emotional stress caused by indebtedness can impair decision making or lead to other difficulties beyond the debt crisis. This recognition can help head off other legal problems that could quickly develop.
NCLC is available to consult with legal advocates for the elderly on a wide range of consumer issues, providing leading and local case law, analyzing contract documents for federal and state law compliance, defining factual and legal issues, identifying experts and legal resources to strengthen cases and training attorneys in consumer law. 

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