Helping Consumers Skirt Scams

When predatory lenders target borrowers with outrageous interest rates, balloon payments, and other unfair credit terms, trial lawyers can help them seek justice.

Predatory mortgage lending, home-improvement fraud, and payday loans—these are just a few of the ways un scrupulous lenders take advantage of unsuspecting borrowers.  The Boston-based National Consumer Law Center (NCLC) works to educate citizens about their rights under federal and state consumer protection statutes and represents them in litigation seeking economic justice.

The NCLC provides case assistance, legal research, and advocacy workshops for legal-services and private attorneys, lay advocates, and community-based organizations representing low-income clients.  It also supports legislation that would strengthen consumer protections against fraud, debt-collection abuses, and predatory lending.

Odette Williamson is a staff attorney with the center.  In this interview with TRIAL Assistant Editor Sara Hoffman Jurand, she discusses some of the financial scams that victimize consumers, the available remedies, and ways trial lawyers can help.

Your organization monitors a wide variety of consumer scams in the financial services arena.  Can they be considered intentional torts, with statutory or common law remedies available?

Yes.  A lot of the marketplace practices that we monitor are intentional—in fact, most of them are intentional.  There are some good federal statutes out there to combat these practices.

The Truth in Lending Act (TILA), for example, is one tool consumer lawyers can use to combat some of these practices.  TILA is primarily a disclosure statute.  Lenders must provide a disclosure of the interest rate, amount financed, and finance charge, among other items, so consumers can accurately evaluate the cost of credit.  For homeowners facing foreclosure due to unethical lending practices, TILA's rescission remedy may be extremely beneficial.  A valid rescission voids the lender's security interest in the home, and the lender no longer has an interest upon which to foreclose.

Let's discuss some specifics.  "Predatory lending" is a practice your organization is fighting.  What exactly is it, and what is its negative effect on consumers?

"Predatory lending" usually refers to a variety of practices that harm consumers looking for credit, including outright misrepresentation or fraud in solicitation or marketing of a loan, outrageously high interest rates, or high closing costs and fees.  Predatory lending might take the form of balloon payments in consumer loans, excessive prepayment penalties, or multiple refinancing—also called "flipping."

Flipping is a good example of a mortgage scam.  Lenders encourage consumers, especially those with balloon payments, to refinance.  Every time the consumer refinances, the lender gets a new set of closing costs and fees.  The lender encourages the homeowner to consolidate any unsecured debt, such as credit card or medical bills, into this new loan. The lender then calculates the interest rate, fees, and costs based on the higher principal amount of the new loan.

Sometimes homeowners are flipped several times.  They might start out with a small loan and end up doubling the amount they owe in a couple of years.  This practice occurs frequently with elderly consumers.

 Some critics might argue that it is OK to charge higher interest rates and fees for higher risk loans. What is the difference between this "subprime" lending and the predatory lending that we are discussing?

Subprime lending is the practice of lending to borrowers with B, C, & D credit, folks whose credit is not perfect.  Subprime lenders claim they need to price these loans higher due to a greater risk of default.  However, these lenders actually structure these loans in ways that virtually guarantee that the lender will be paid in full in the event of a foreclosure.  So the risk of loss is minimal.  Pricing a loan in a manner that is excessive and does not reflect the real risk of making the loan crosses the line into predatory lending.

 What are the telltale signs of a predatory loan?

Besides the ones I mentioned previously—excessively high interest rates not justified by the risk and cost of providing credit to a B, C, or D borrower; high closing fees and costs; balloon payments; multiple refinancing—I would add credit insurance.  Credit life insurance, accident, and health insurance are often sold to individuals who cannot benefit from it.

Another major problem is mortgage-broker kickbacks.  Borrowers pay a fee to a mortgage broker to find the best available rate on a loan.  But instead of doing that, the broker refers the borrower to a lender with an interest rate a little bit higher than he or she would qualify for because the broker is getting a separate fee or commission from that lender for the referral.  The fee the lender pays to the broker is passed on to the homeowner in the form of a higher interest payment over the life of the loan.  That happens a lot in predominantly minority neighborhoods where people don't have access to traditional lenders and use brokers often.

In addition, some predatory lenders make loans that homeowners cannot afford to repay.  These types of loans are based solely on the substantial equity in a property.  The lender profits when it buys the property at a foreclosure sale, pays off its small lien, and resells the property for its full value.

Elderly homeowners are particularly attractive targets for this practice because they have substantial equity in their homes after paying down their mortgages for decades.  They need money for medical care, home improvement, and other expenses.  On the other hand, they are less likely to be able to repay these loans because they have fixed or limited incomes.

To qualify the borrower for these loans, a broker may misstate an elderly homeowner's income on a loan by adding nonexistent rental income, for example.  This happens quite often in the home-improvement context where contractors act as brokers for predatory lenders. A contractor may come to an elderly homeowner's door and say, "Hello, Mrs. Smith. I noticed that your porch is falling down."  Then he might say, "Well, that violates housing codes" and offer to fix the porch.  If Mrs. Smith says, "I'm on a fixed income, I can't really afford it," then the contractor will offer to arrange financing for Mrs. Smith without disclosing the true cost of the loan up-front.

The list could go on and on.

 What loan scams outside the realm of home ownership are consumers exposed to?

There's an endless variety.  One area that affects primarily low-income consumers is payday loans, also called cash advances or deferred deposits.  When people need money to live on until the next payday, they go to payday lenders, which are sometimes affiliated with check-cashing agencies.

The consumer writes a check for the amount he or she wants to borrow, plus a fee. For example, to receive $300 in cash, he or she writes out a check for, say, $360, for the $300 in cash plus a $60 fee.  The lender holds the check until the consumer's next payday, which is usually about one to two weeks.  The consumer can redeem the check by paying the entire amount—in this case $360—or allow the check to be cashed, paying off the loan.

What typically happens is, because these are usually consumers who are in a cash crunch, they get to the next payday and they need the money to do other things.  They can't redeem that check, so they roll over the debt and pay another fee to extend the loan.  This can become a treadmill, and consumers keep renewing the loan and paying the fees.  The fees and interest charged on these loans often produce annual interest rates in the range of 300 percent to 600 percent.  We have seen payday loans with interest rates over 1,000 percent.

Another fringe-lending activity is auto-title pawns, also called title loans.  As with regular pawnbrokers, these lenders buy the borrower's property, but the borrower has a right to redeem it.

It works like this: The lender takes possession of the car title, and sometimes a duplicate key, in exchange for a loan.  The cash to the borrower rarely exceeds 30 percent of the Blue Book value of the car.  A month later the person comes in to redeem the title.  As with payday loans, the person often is not able to make the payment when due, so he or she pays another fee to extend the loan.  If the person defaults, the lender can sell the car at a great profit.

One relatively new practice that my organization is challenging is tax-refund-anticipation loans, which provide a cash advance against a consumer's expected tax refund.  Many of the big tax preparers offer these.  Essentially, a consumer goes in to have his or her tax return done and the tax preparer will file the taxes electronically.  Consumers get cash immediately.  The electronic refund becomes available to repay the loan in about two weeks.  The consumer pays a fee for the tax preparation, for the electronic filing, and for the loan.  The loan fee alone ranges from $30 to $85.  The fees translate into an interest rate of 67 percent to 768 percent for a two-week loan.

The problem with this is that many low-income taxpayers will take advantage of these services because they need cash right away.  But a high percentage of these folks qualify for the earned-income tax credit, which is our government's way of supplementing the income of these consumers.  Essentially, tax-refund-anticipation loans are taking away the subsidy that the government provides to low-income consumers.

Another fringe-lending area we are concerned about is rent-to-own programs offered by stores that lease appliances or furniture.  Often these leases hide what is really an installment sales agreement.  Payments are due weekly or monthly.  At the end of the transaction, the consumer buys the item for a nominal fee.

But when you look at it closely, at the end of an 18- to 24-month lease term, the consumer may be paying $1,200 for a television that he or she could have bought for $500.  The interest rate on these transactions is extremely high.  And the companies structure their programs to get around state interest-rate caps that apply to installment sales contracts.

 How can consumers identify these scams and avoid them?

The primary thing consumers can do is to educate themselves, especially on scams surrounding the mortgage lending process.  If a consumer is shopping for a mortgage and gets an offer, and he or she doesn't understand its terms or the process, help is available from nonprofit housing-counseling agencies.  Some have staff who will sit down with the consumer and evaluate different loan products.

Consumers should also know that if they apply for one type of mortgage loan and are given something totally different when they get to closing, they can walk away.  Predatory lenders often apply a lot of pressure to consumers at the closing. For example, if a consumer objects to a certain item in the papers, the lender might say, "We can't redo the papers, you have to sign here, you have to sign now."

Consumers need to be aware that they can always walk away from the loan before anything is signed.  And, under the Truth in Lending Act, if it's a home-equity loan or a non-purchase-money mortgage secured by their primary residence, they have three business days after they've signed the loan documents to cancel the loan.

Consumers need to be aware that if they have a loan covered by the Home Ownership and Equity Protection Act (HOEPA), they should receive a notice three days before closing.  They should read this notice carefully and be advised that if they go forward with the loan, they may lose their home.  As the notice states, they do not have to complete the deal—they can always walk away from a disadvantageous loan.

 How can consumers taken in by these scams seek relief?

Besides TILA and HOEPA, in the area of mortgage lending, they can turn to statutes such as the Real Estate Settlement Procedures Act (RESPA), which prohibits the type of kickbacks I discussed earlier.  They can also use state consumer-protection statutes that prohibit unfair and deceptive acts and practices.  In many states, these apply to financial transactions.  And there are other laws—such as warranty, usury, fraud, and contract laws—that can be used to challenge the practices.

 You mentioned HOEPA. In its current form, what practices does it prohibit?

If the loan is covered under HOEPA, certain terms are prohibited, including most prepayment penalties and interest rate increases in the event of default.  Some loans require, for example, that if you have a rate of 8 percent, upon default it increases to an exorbitant rate like 20 percent.  A lender can't include that requirement in a HOEPA-covered loan.

It also prohibits balloon payments in loans of less than five years, negative amortization, and extending loans to individuals without regard to their ability to repay. So some of the scams that target elders are prohibited by HOEPA.

HOEPA also prohibits disbursement of funds solely to a home-improvement contractor.  Funds must be distributed jointly or solely to the consumer.  This is a big problem because, as I mentioned, many home-improvement contractors act as brokers for predatory lenders.  So instead of allowing the loan to be disbursed directly to a contractor—risking that the contractor may take off with the money and leave the work undone or poorly done—in a HOEPA-covered loan the payment must be disbursed either jointly to the homeowner and the contractor or solely to the homeowner.

Another great thing about HOEPA is that it extends liability to the assignees of these loans.  Often, once a loan is made it's automatically sold on the secondary market.  The new holders of the loan will say, "Well, I didn't know anything about a mortgage-broker fraud.  I didn't know anything about a home-improvement fraud."

But if a loan is covered by HOEPA, the assignees are liable for all claims that the consumer could have asserted against the originator of the loan, although they are entitled to some protection if they could not have known that the transaction was a HOEPA loan.

 What remedies are available for HOEPA violations?

A loan covered by HOEPA can be rescinded for many violations.  Consumers can recover actual and statutory damages and attorney fees and costs.  In addition, there are enhanced damages including all the finance charges and fees paid by the consumer.  The enhanced damages are available unless the lender demonstrates that its failure to comply with HOEPA is not a material violation of the statute.

 And what about non-mortgage-loan scams?

A number of the same laws can be used to challenge non-mortgage predatory-lending practices as well.  But there it's more complicated.  A few states have enacted laws that permit payday lending, for example.  But in the other states, these loan practices have to comply with small-loan statutes or other usury law.  So if lenders ignore the small-loan statutes in that state, they can be sued for violating those laws.

 Would you characterize loan scams and credit discrimination as civil rights issues?

Yes, I would.  An increasing amount of cutting-edge litigation is challenging predatory lending practices as violations of federal and state civil rights and credit discrimination statutes, including the Fair Housing Act and the Equal Credit Opportunity Act. These cases are challenging these practices as "reverse redlining" and claiming that they are denying communities of color access to credit on fair terms.

With traditional redlining, lenders deny credit to borrowers who want to finance the purchase of homes in a specific geographic area, due to factors such as the borrower's race, ethnicity, and income.  With reverse redlining, instead of denying credit, lenders are targeting certain neighborhoods and extending credit to homeowners on really onerous and unfair terms.

Where the predatory lending practices that we've discussed target certain borrowers, they have been challenged as violating credit discrimination laws.  The argument essentially is that when lenders make loans with high interest rates or other predatory terms that consumers cannot afford to repay, they are putting members of the targeted group at risk of losing their homes.

 It sounds like many of these claims involve relatively small amounts of damages, which may mean the cases are not cost-effective for plaintiff lawyers to bring on behalf of consumers.  Is class action litigation an effective tool in these cases?

Class actions are a very effective tool, a way of challenging these lenders, hitting them where it hurts, and getting systemic changes.  Organizations such as ours and members of the National Association of Consumer Advocates (NACA) are challenging these predatory lending behaviors in class actions.

A few individual cases, however, have generated large awards, especially against fraudulent home-improvement contractors and the companies that finance them. We have seen such awards where there is a home-improvement scam, for example, that targets low-income, uneducated, or illiterate consumers.

 How can trial lawyers help consumers who are victims of these abuses?

There is an unmet need for more attorneys to challenge these practices.  When media reports bring attention to these issues, often there's an increase in calls to legal aid groups, but not enough attorneys are available to take the cases.

These cases can be challenging, but there are resources available to help attorneys handle them. We publish several in-depth manuals that may be useful, including Truth in Lending, Unfair and Deceptive Acts and Practices and The Cost of Credit: Regulation and Legal Challenges.  In January we debuted our Stop Predatory Lending handbook, a primer on bringing legal and nonlegal challenges to predatory lending.  We offer case consultation and may also partner with private and legal-services attorneys to do direct case representation for low-income and elderly consumers.  Attorneys who are members of NACA may also obtain assistance from the association, which is on the forefront of many of these issues.

Odette Williamson, staff attorney with the National Consumer Law Center, says there is 'an unmet need for more attorneys to challenge' predatory lending.

Reprinted with permission of TRIAL (April 2002).  Copyright the Association of Trial Lawyers of America.