Disentangling the Differences between Abusive and Predatory Lending: Professionals' Perspectives

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This study describes how mortgage professionals differentiate abusive from predatory lending. Data were analyzed qualitatively. The results indicate that some users of this term do not always adhere to a strict definition of predatory lending but rather use it as a term for any general mortgage abuse and mortgage fraud. Existing laws at the federal- and state-level curtail abusive lending and promote fairness in the market place and they are highly enforced among depository financial institutions. However, unregulated nonfinancial institutions, mortgage brokers, and originators are still a primary source of predatory lending.

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As a vocabulary term in the mortgage market, predatory lending frequently is misunderstood because it carries stigmas, and slightly different meanings and connotations, depending on the context in which it is used. It has long been noted that the term is so elusive that it may, itself, contribute to regulatory difficulties (Cart and Kolluri 2001; Goldstein 1999). Loans with hidden prepayment penalties, for example, could fit the description of predatory lending. But loans that simply offer higher interest rates cannot be said to be predatory. Researchers have defined predatory lending as consumer loans with any or all of the following characteristics: aggressive and deceptive marketing, lack of concern for the borrower's ability to pay, high interest rates and excessive fees, unnecessary provisions that do not benefit the borrower, large prepayment penalties, or faulty underwriting (Hill and Kozup 2007).

Lack of a common definition of predatory lending impedes efforts to quantify its true prevalence. The Center for Responsible Lending (CRL) estimates that predatory lending of all kinds costs U.S. borrowers $25 billion annually. The problem has worsened as the subprime lending market expanded (Bailey 2005). One approach that has been used to measure the magnitude of the problem is the examination of the number (at least 20) and amount of settlements over the past fifteen years. From 1991 to the present, approximately $1,651 million have been paid by companies involved in lawsuits over accusations of predatory lending (Erickson 2006). Despite the large total sum of the settlements, compensation to individual victims is still inadequate to cover the losses they incurred from lending abuses, and are far from inflicting any punitive or disciplinary cost to the companies (ACORN 2003).

In order to address predatory lending adequately, there needs to be a differentiation between what constitutes abusive lending, predatory lending, and mortgage fraud. Descriptions of predatory lending are plentiful, but a precise definition that would inform regulators and consumer advocates is nonexistent. To date, a mix of abusive, illegal, and unethical practices, or characteristics of the victims have been given as definitions by stakeholders dealing with the issue. Only by disentangling the differences among these terms can efforts be concentrated on remediating current practices. The lack of agreement as to what constitutes predatory lending contributes to deadlock at the legislative level, facilitates grounds for unsound lending practices, and diminishes accountability among major players in the mortgage lending industry.

To address the issue of conceptual and definitional clarity, a study of professionals and consumer specialists in the field of housing and mortgage lending was conducted. The research was guided by two assumptions: (1) there is not a universally accepted definition of predatory lending and (2) abusive lending is usually equated to predatory lending. Just as it is known that a legitimate subprime market is different from a predatory market, we argue that not all abusive lending is predatory. Predatory loans are abusive, but not all abusive loans are predatory.

This study takes concrete steps to disentangle the terms by reporting on how mortgage lending professionals differentiate abusive from predatory lending, and whether or not both terms are used interchangeably. Mortgage professionals include regulators, counselors, and lenders. Their actions shape both lending practices and consumer protection. Therefore, their accounts are the focus of this study. Abusive and predatory mortgage lending is examined in the context of mortgage lending professionals' experiences, perspectives, and expert opinions.

Predatory Lending as Defined by Stakeholders

It is generally accepted that most predatory loans occur in the subprime lending market (CRL 2005; Fishbein and Bunce 2005), although some cases of predatory lending occur in the prime market (Engel and McCoy 2002). In a very general sense any lender can be a predatory lender simply by adding excessive fees and interest rates to an otherwise mutually beneficial loan, or by excessively or deceitfully pushing an unsuitable loan or loan product on a customer (Fishbein 2006). Most stakeholders agree that legitimate subprime lenders fill a particular niche in the lending industry. Subprime loans have helped to provide mortgage financing for millions of homebuyers with few credit options, and this segment of the population is important to the economy (Rushton 2007). What most stakeholders do not agree on is precisely what constitutes predatory lending.

Regulators

In 2000, the Department of Housing and Urban Development (HUD) defined predatory lending as the following:

   [Predatory lending] involves engaging in deception or fraud,
   manipulating the borrower through aggressive sales tactics, or
   taking unfair advantage of a borrower's lack of understanding about
   loan terms. These practices are often combined with loan terms
   that, alone or in combination, are abusive or make the borrower
   more vulnerable to abusive practices (U.S. Department of Housing
   and Urban Development and U.S. Department of Treasury 2000, 1)

A different attempt to define predatory lending in lay terms was provided by HUD in a brochure published in 2003, HUD-2003-01-H Don't Be a Victim of Loan Fraud: Protect Yourself from Predatory Lenders. In this brochure, HUD basically equated predatory lending with loan fraud. The brochure posed the question, what is predatory lending? For an answer, practices that make homeowners lose their homes were listed, including use of (1) false appraisals, (2) encouraging borrowers to lie about their income, (3) knowingly lend more money than a borrower can afford to repay, (4) charge higher interest rates to borrowers based on race or national origin, (5) charge fees for unnecessary or nonexistent products or services, (6) pressuring borrowers to accept high-risk loans, (7) targeting vulnerable borrowers to cash out refinancing, (8) stripping home owners' equity from their homes, and (9) using high-pressure sales tactics to sell home improvements (HUD-2003-01-H 2003).

In 2003, the Office of the Comptroller of the Currency (OCC) brought attention to the fact that federal laws and regulations that govern mortgage and other lending transactions do not contain a comprehensive definition of "predatory" or "abusive" lending practices (OCC Advisory Letter AL-2003-2 2003). However, the OCC asserted that a fundamental characteristic of predatory lending is the provision of credit to borrowers without regard for the borrower's ability to service and repay the loan according to its terms.

The most comprehensive government document on predatory lending was published in 2004 by the U.S. General Accounting Office; yet, it did not provide a universally accepted definition of the term predatory lending, either. In this document, predatory lending was defined as "an umbrella term that is generally used to describe cases in which a broker or originating lender takes advantage of a borrower, often through deception, fraud, or manipulation, to make a loan that contains terms that are disadvantageous to the borrower" (U.S. General Accounting Office 2004, 23). Predatory lending then is associated with some abusive loan characteristics and lending practices. Throughout the report, the terms predatory lending and abusive lending are used interchangeably.

In 2007 testimony before the House Sub-Committee on Financial Services, Sheila C. Bair, chairman of the Federal Deposit Insurance Corporation, recognized that there was no universally accepted definition of predatory lending. She added that determining whether a loan product was predatory involved looking at both the loan and the borrower--and, typically, the whole course of the transaction. Instead of defining what predatory lending is, what this regulatory agency has done is to identify the characteristics most often associated with predatory lending, which include making …