| Prepayment penalties, balloon payments
increase risk |
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Prepayment penalties and balloon payments are abusive
and predatory, say Stegman and fellow critics of subprime loans.
They are costly, are applied unfairly, lead to foreclosures and
don't even give borrowers a break on interest rates, says Keith
Ernst, senior policy counsel for the Center for Responsible Lending
in Durham, N.C.
That last assertion is disputed by the subprime-lending
industry. Ameriquest, the biggest subprime lender, has a set of
best practices that pledges "to show borrowers how they can reduce
their rates through discount points and prepayment options."
New Century Financial Corp.,
the second-biggest subprime mortgage lender, says that it does not make or buy
loans with balloon payments. As for prepayment penalties, New Century says it
offers loans with and without them: "When a borrower opts for a loan with a prepayment
charge, the borrower benefits from a lower interest rate or pays lower upfront
fees," its set of best practices says. Nevertheless, Ernst,
in a report issued this month by the Center for Responsible Lending, concludes
that on subprime refinance loans, there was no significant difference in rates
between mortgages with prepayment penalties and those without, "as borrowers receive
the burdens of penalties without the compensating benefits."
"Once the penalty is in place," Ernst says, "the borrower's
ability to build wealth is significantly hampered since the borrower
either continues to pay excess interest or gives up accumulated
home equity to get a better loan."
The
University of North Carolina study says that, of the borrowers who got loans with
prepayment penalties, 37 percent ended up paying the fees, either because they
refinanced or they sold their homes. "These penalties, if fully enforced, generated
hundreds of millions of dollars for lenders at the expense of borrower equity,"
the report says.
The report was released at a news conference attended
by Stegman, Ernst and Nina Simon, an attorney for the AARP Foundation
who sues predatory lenders. A reporter invited the three to identify
egregious lenders, but they declined. Ernst said that 70 percent
to 80 percent of subprime mortgages have prepayment penalties, so
the whole industry is culpable.
The
industry's trade association, the National Home Equity Mortgage Association, or
NHEMA, had no immediate response to the report. Stegman, Ernst
and Simon praise states (such as North Carolina, Massachusetts and New Jersey)
that have anti-predatory lending laws that ban practices such as excessive prepayment
penalties or balloon loans. They contend that subprime mortgages are just as available
in these states as in others -- but with less onerous terms. NHEMA
counters with its own studies, including one released last year that concluded
that subprime lending in New Jersey "dropped significantly" after that state's
anti-predatory lending law went into effect. That study said it was more difficult
to borrow in New Jersey afterward -- borrowers needed higher incomes and higher
credit scores to qualify for subprime mortgages.
Stegman and his co-authors scrutinized a national
database of subprime, refinanced mortgages that were originated
in 1999. They tracked the loans to the end of 2003 and analyzed
them statistically. They chose to look at refinanced mortgages because
such loans were more likely to have prepayment penalties and balloon
payments than purchase mortgages. About 73 percent of the borrowers
had done "cash-out" refinancing -- they had refinanced for than
they originally owed and pocketed the difference.
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