It all started when Therese Brown received a letter with a check for $2,500. A company called Household Finance invited her to use the money to fix up her house. It just so happened that Brown’s house needed some work, so she cashed the check.
The move set in motion events that plunged the 41-year-old computer-network engineer deep into debt. In the seven years since the fateful check landed in her Chatsworth mailbox, the money she owes on her home has risen from $162,000 to almost $300,000. Her monthly mortgage payment jumped from $1,200 to $2,700, a prohibitively high figure for Brown, who has had trouble finding steady work recently.
Owning her dream house — a half-acre property with horses, chickens and dogs — has turned into a financial disaster. Brown thinks she is a victim of home-equity fraud, but the law is less clear on the matter because many unethical lending practices are legal. Household Finance denies any wrongdoing.
But aggressive lenders could find themselves on the wrong side of the law under a proposed ordinance to be considered this month by the L.A. City Council. The effort is being spearheaded by City Councilman Mark Ridley-Thomas and the grassroots community group ACORN, and follows the lead of Oakland and several other cities nationwide.
L.A.‘s proposed ordinance is likely to label some currently legal practices as illegal predatory lending, while also imposing fines for violations. Provisions could include prohibiting pre-payment penalties after the first 24 months of a loan, banning loans that contain no benefit to the borrower, and requiring that borrowers applying for high-interest loans attend mandatory financial counseling provided by a disinterested third party.
Such efforts have been resisted by the lending industry, which has challenged similar attempts in court and the Legislature. The stakes are high: What happens in L.A. could influence cities across the nation. Moreover, if the largest city in the state takes on hard-money lenders, legislators in Sacramento may take notice. “What happens in L.A. is going to be pivotal,” says Norma Garcia, a San Francisco–based attorney with pro-consumer advocacy group Consumers Union. “If Los Angeles passes a strong ordinance, we may be looking at a stronger [state] law.”
After Brown cashed the initial, $2,500 check she received from Household Finance, the company persuaded her to take out a second mortgage and pocket a cool $10,000. Then, in 1999, the lender suggested that the single mom consolidate her two mortgages into one. Brown agreed, lured, she says, by the promise of a lower interest rate.
Only after the fact did she discover $18,000 in fees and that her annual interest rate was more than 10 percent — three points higher than what she was promised, Brown testified at a City Council hearing. When Brown rushed to call the deal off, she was told she’d missed the three-day cancellation window. She later was hit with $14,000 in additional fees she claims are completely bogus. Such a loan as this could become illegal under the proposed L.A. ordinance, because it contains no benefit for the borrower.
In fact, such arrangements seem designed to bury customers further into debt, while siphoning off their accrued equity. Borrowers with blemished credit are prime candidates for high-cost loans, called “sub-prime” loans in the industry. These loans come at higher cost because they are supposed to serve customers who represent a higher risk to the lender. But lenders often pack in prohibitive closing costs, unnaturally high interest rates, and penalty fees for refinancing or prepayment. The victims are frequently the elderly, recent immigrants, non–English speakers and homeowners with equity but little income.
“It makes me cry,” Brown says today. “I feel like such a moron for falling for it. I can make a computer do anything, but sometimes when it comes to financial stuff, I‘m not very good.”
Lately she’s been thinking a lot about selling her home to break free from debt, because she fears the specter of foreclosure every day. “It‘s sad — my dream was always to have a little horse property. And I’m so close to losing it, unless I can do something.”
Brown is currently considering joining a class-action lawsuit against Household Finance filed in California this year by ACORN. But she hesitated to challenge Household Finance in court, she says, because her contract contains an arbitration clause that effectively surrenders her right to sue. The proposed L.A. ordinance is likely to forbid such restrictions, although a Household Finance spokesperson said such arbitration clauses are standard in the industry.
Not so long ago, high-cost loans were the province of fly-by-night, storefront entrepreneurs. More recently, large banking consortiums entered the sub-prime market in search of a new profit center. The last decade saw revenues generated by the sub-prime lending industry multiply tenfold.
Household Finance, a subsidiary of Illinois-based Household International, is the country‘s largest institution specializing in sub-prime loans. The company insists that it follows the law and fully discloses loan terms upfront. “We go one step beyond legal requirements, to make sure we are being as clear as we can with our customers,” says spokesperson Megan Hayden. She claims that borrowers who complain about their loans make up only 0.1 percent of the company’s 3 million customers per year.
Sub-prime lenders contend that they provide cash and loans for customers who would otherwise not qualify for this financial help. But up to a third of these borrowers, say experts, would actually be eligible for lower-cost loans. For many homeowners, hard-money loans worsen the financial picture, sometimes catastrophically. In the second quarter of 2002, the percentage of homeowners who fell behind on mortgage payments inched up to the highest level in at least 30 years, according to data released last month by the Mortgage Bankers Association. The organization has monitored defaults on home loans since 1972 and says that current foreclosure rates, up 35 percent from last year, are also the highest on record.
At a September City Council hearing, Councilman Ridley-Thomas said that he and fellow council members felt “obliged to look at the kind of remedies that would permit us to do right by those victimized.”
If the council moves ahead with the ordinance, an industry group is likely to challenge it in court, “if necessary,” says Mark T. Harris, an attorney for the American Financial Services Association (AFSA), a lobbying group that represents about 360 lending institutions, including Bank of America and Wells Fargo as well as sub-prime lending specialists like the Orange, California–based Ameriquest Mortgage Co. and Household Finance. “There is a real significant question whether [mandatory counseling] is both constitutional and legally permissible,” says Harris. AFSA also contends that federal and state laws already on the books preclude further regulation.
At the state level this year, lending-industry lobbyists pushed for a five-year moratorium on new city ordinances affecting high-cost loans. The effort was unsuccessful, but will likely be renewed next year.
In the meantime, says Harris, “We‘re going to be working with Councilman Ridley-Thomas to try to encourage him to integrate some of the successful compromises we reached in San Francisco.” He wants any L.A. ordinance to stress consumer education rather than tough regulations for lenders. Harris suggests cities should be cautious, lest they hurt low-income communities by wiping out access to sub-prime loans.
That argument has no merit, says Lisa Donner, the director of ACORN’s Financial Justice Center. “Nobody is going out of business because of [this] legislation,” says Donner. “The statutes are only meant to clear up the abuses.” In North Carolina, where such consumer protections have been on the books since 1999, “The sub-prime lending business is thriving,” she adds.
Soft is not the way to go, says Garcia of Consumers Union, because “no matter what the ordinance put out by the city of L.A. looks like, it will be sued by AFSA. L.A. should be courageous and craft the strongest ordinance it possibly can.”