SUBPRIME LENDING AND ITS INTENDED BENEFITS
When most mortgage loans were originated by depository institutions, the limited credit went to prime borrowers at prime rates.1 Prime rates are generally the most favorable and least costly to borrowers and they are normally only offered to those whose income, assets, and credit record meet certain minimum standards established by prime lenders.2 Conversely, subprime mortgages are offered to home buyers who fail to meet the strictest lending standards. Such borrowers may be denied prime loans because they have low income and/or they may have poor credit history. In theory, subprime loans offer an invaluable service to borrowers as they provide loans to those who can afford the mortgage, but could not obtain financing due to sub-par credit scores.3 Subprime borrowers? credit scores typically fall below 620, on a scale of 350 to 850.4 Subprime loans offer borrowers who would potentially only be eligible to be rent the opportunity to become homeowners, and in 2005, subprime loans helped boost U.S. home ownership to a record 69 percent of households,5 which would seem to please advocates of the CRA. Subprime mortgage originations now make up 20 percent of all mortgages, while historically subprime loans have been just 10 percent to 12 percent of the overall market.6
Subprime loans are not exclusively made for mortgages, but are also originated for refinances. If someone already owns a home, a subprime loan can give him an opportunity to clean up his credit. The cash out that a refinance provides could be used to pay off other debt, such as higher rate credit cards, and ultimately help the borrower refinance into a lower rate at a later time.7
However, due to the risk profile of the subprime borrower, this access to credit comes at the price of higher interest rates. As a result, whether for a purchase or refinance, subprime loans should typically be used as a short term solution, approximately two to four years.8 During that time, a borrower should aim to clear up his credit, so that he can qualify for a refinance into a lower risk, lower rate loan.9
WHY THE GREAT INCREASE?
There was an explosion of subprime lending during the last ten years and subprime lenders were highly visible in American culture. Ameriquest Capital Corporation (Ameriquest), one of the nation’s largest subprime lenders, paid an estimated $15 million to sponsor Super Bowl XL halftime show and became a season-long NFL sponsor.10 In addition, the California-based firm had acquired the naming rights to the Texas Rangers’ baseball stadium, Ameriquest Field.11 This great increase can be explained twofold. First, there was a great demand from the borrower side because of the unprecedented rise in U.S. home prices during the past six years.12 As a result, borrowers were forced to agree to risky financing as it was the only way many of them could afford a home in some of the hottest housing markets where prices more than doubled in five years.13 In addition, many subprime lenders target potential refinances, where the individuals have a great deal of home equity but little else. Because equity increases not only as the mortgage is paid, but also as the property enjoys appreciation, many borrowers saw an unprecedented growth in their equity due to the great appreciation of homes during the housing boom. As a result, they used the equity in their homes to obtain an additional loan. With home prices high and interest rates low, refinancing seemed appealing.
Second, there was a great increase in subprime loans because the lenders were more than willing to offer loans with high interest rates. Because the typical subprime borrower has a low credit score, lenders can charge higher fees and higher rates, which leads to greater profits for the lenders. According to Forbes Magazine, subprime consumer finance companies can enjoy returns up to six times greater than those of the best-run banks, which typically produce more sound loans, but yield fewer profits because of lower interest rates than those of the subprime category.14 Unfortunately, many believe the rise in subprime lending is largely attributed to aggressive and misleading advertising to low-income, elderly, and minority communities. This type of lending has become known as predatory lending.
PREDATORY LENDING
Although there is no uniform definition of predatory lending, it is generally described as the practice of making loans containing interest rates, fees, or closing costs that are higher than they should be in light of the borrower?s credit and net income, or containing other exploitive terms that the borrower does not comprehend.15 Mortgage brokers often had arrangements with lenders whereby incentives were included to steer borrowers to the lenders that pay brokers the most, rather than the lenders who provide the most favorable terms for borrowers.16 In addition, some lenders made home mortgage loans without regard to the borrower?s ability to repay.17 Furthermore, aggressive brokers sometimes steered borrowers who could qualify for prime loans into subprime loans because there were higher fees involved. It is estimated that up to 15 percent of subprime borrowers have credit scores which would qualify them for traditional prime loans.18
1 Julia Patterson Forrester, Still Mortgaging the American Dream: Predatory Lending, Preemption, and Federally Supported Lenders, 74 U. CIN. L. REV. 1303, 1326 (2006).
2 Dennis E. Gale, Subprime and Predatory Mortgage Refinancing: Information Technology, Credit Scoring, and Vulnerable Borrowers, http://repositories.cdlib.org/iber/bphup/meeting_papers/C01-001 (last visited Apr. 15, 2007).
3 Kimberly Blanton, Dark Side of Subprime Loans: Mortgages for those with bad credit leap in popularity despite high foreclosure rate, THE BOSTON GLOBE, Aug. 3, 2005, available at http://www.boston.com/business/personalfinance/articles/2005/08/03/dark_side_of_subprime_loans/.
4 Id.
5 Id.
6 Liz Moyer, Overblown Fears in Subprime Land?, Mar. 14, 2007, Forbes.com, http://www.forbes.com/business/2007/03/13/subprime-mortgage-risk-biz-cx_lm_0314subprime.html (last visited Apr. 15, 2007).
7 Jefferson Funding LLC, Subprime Loans, http://rws.mortgage101.com/templateroot/articles/LoanPrograms.asp?ArticleID=1226&PVLID=16311 (last visited Apr. 15, 2007)
8 Id.
9 Id.
10 Sue Kirchhoff & Sandra Block, Subprime Loan Market Grows Despite Troubles, USA TODAY, http://www.usatoday.com/money/perfi/housing/2004-12-07-subprime-day-2-usat_x.htm (last visited April 16, 2007).
11 Id.
12 Andy Laperriere, Mortgage Meltdown, THE WALL STREET JOURNAL, Mar. 21, 2007 (Opinion).
13 Id.
14 Anne-Marie Motto, How Predatory Mortgage Lenders are Destroying the American Dream, 18 GA. ST. U. L. REV. 859, 867 (2002).
15 Tania Davenport, An American Nightmare: Predatory Lending in the Subprime Home Mortgage Industry, 36 SUFFOLK U. L. REV. 531, 541 (2003).
16 Subprime Lenders: Southeast Tennessee Legal Services, http://www.selegal.org/subprime.htm, (last visited Apr. 12, 2007).
17 Barr, supra note 1.
18 Blanton, supra note 17.
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