Predatory Lending
Predatory
lending refers to the heinous act of being involved in lending practices
that take advantage of vulnerable borrowers, such as the elderly, needy or
unsophisticated.
The term also refers to the practice of
convincing borrowers to comply with unfair and abusive loan terms. Such
loans could take place either through outright deception or through
aggressive sales tactics, thus taking advantage of the borrowers' lack of
understanding of extremely complicated transactions.
One lending tactic
that is generally considered to be predatory is making a secured loan,
such as home or car loans, with the expectation that the borrower will not
repay the loan and therefore default, following which the lender acquires
the title to the home or car in a foreclosure sale. Another typical case
of this type of lending is where the monthly payment exceeds 50% or even
75% the borrower's after-tax income, or in case the borrower's income is
irregular. While the borrower may be unaware that their default is
statistically probable, the lender should be aware of this and not make
such loans.
Profits as Indicators
of Predatory Lending
Huge up-front fees,
kickbacks and / or uncompetitive interest rates often result in
extraordinary profits to predatory lenders, especially if the consumers
are convinced to undergo frequent re-financing. The making of loans with
low fees and competitive rates that are certain to go into default is
normally not a highly profitable lending strategy since the amount of the
loan may not be recovered after the sale of the collateral, which would
give the lender a financial loss on the transaction. While the borrower
remains financially liable for the loan balance, any remainder is
unsecured and relatively difficult to collect back. However, exceptions to
this include large unsecured loans made in order to obtain other
businesses from the borrower, such as a merger and acquisition business,
and complex loans that are serviced improperly.
In a loan secured by a
home or a car, lenders are still likely to make a loss because foreclosure
is an expensive process, and foreclosure sales normally yield returns well
below the market value of the collateral. The transaction is still
profitable to the lender however, if the proceeds of the sale does exceed
the loan balance. Thus, certain lenders target elderly homeowners who have
considerable equity in their homes, and who might be more easily deceived
or coerced into taking out a mortgage loan that they cannot afford to pay
back. This is one of the most common lending tactics widely considered to
be predatory in intent.
A lender might also
originate a loan to a borrower without the means or the necessary cash
flow to make the monthly payments, and then immediately sell the loan to a
secondary market investor. This usually ensures a profit for the original
lender regardless of the possibility of the borrowers default and, these
loans are later aggregated and become mortgage-backed securities. The
investor in these securities has a less-than-expected yield from them if
and when the borrower does default. Unfortunately, in many cases where a
person with a large credit card debt which is unsecured, there are also
usually no assets beyond the equity in their home and no cash flow to
cover the minimum monthly payments. A better option for them may be to
work out a payment plan with the credit card companies covered by what
ever though little cash flow they do have, or even to declare bankruptcy
so that they do not lose their home in a foreclosure sale. Another far
more complex and very innovative but allegedly criminal predatory tactic
involves predators creating and exploiting conflicts of interest among the
various purchasers and service providers in a pool of mortgages, through
frivolous foreclosures of performing loans and legal barratry contrary to
fiduciary duty that prove to be extremely profitable for these
predators.
