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. |