A group of federal agencies says that while sub- prime loans -- financing to risky borrowers with high rates -- can be a "sound and profitable business," the same is not true with predatory loans, another form of high-cost finance that is often confused with sub-prime loans. And, say the federal agencies, they are going to try and stop sub-prime lending with new regulations.
The Office of the Comptroller of the Currency, the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision have proposed new regulations to oversee subprime lending and to distinguish such loans from predatory financing. If the guidelines are approved, lenders who engage in predatory practices could be punished under regulatory sanctions, and in some cases even put out of business.
According to the agencies, "The term subprime is often misused to refer to certain 'predatory' or 'abusive' lending practices."
However, say the agencies, "some forms of subprime lending may be abusive or predatory."
"Such lending practices appear to have been designed to transfer wealth from the borrower to the lender/loan originator without a commensurate exchange of value."
The way it's done, say the agencies, is to make loans to individuals with little or no ability to repay, typically with one of three tactics:
- Making unaffordable loans based on the assets of the borrower rather than on the borrower's ability to repay.
- Inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (a form of "loan flipping").
- Engaging in fraud or deception to conceal the true nature of the loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower.
"Loans to borrowers who do not demonstrate the capacity to repay the loan, as structured, from sources other than the collateral pledged are generally considered unsafe and unsound," say the agencies.
Current federal rules require lenders to disclose predatory terms under Home Ownership Equity Protection Act of 1994 Section 32 of Regulation Z, part of the Truth in Lending Act.
According to the Federal Trade Commission, Section 32 requires extensive disclosures if:
- The annual percentage rate (APR) exceeds by more than 10 percentage points the rates on Treasury securities of comparable maturity; or
- The total fees and points payable by the consumer at or before closing exceed the larger of $451 or 8 percent of the total loan amount. (The $451 figure is for 2000. This amount is adjusted annually by the Federal Reserve Board, based on changes in the Consumer Price Index.)
However, Section 32 only requires disclosure, it does not ban predatory loans. Moreover, as the FTC points out, "The rules do not cover loans to purchase or initially construct your home, reverse mortgages, or home equity lines of credit (similar to revolving credit accounts)."