Predatory Lending

Professional appraisers treasure their relationships with reputable lenders who serve clients responsibly over the years. These lenders work with credit worthy consumers in financing a new home purchase, refinancing, or home equity loan from a credit-worthy position and they enjoy a solid reputation in the real estate community. Their clients have the benefit of a variety of competitive rates and sources to assist them in making a confident decision about financing.

Consumers with low incomes or bad credit are at risk for a much different experience as targets of predatory lenders. While many "subprime" lenders legitimately serve the consumers unable to secure a standard home loan, those who practice predatory lending put both owners and appraisers at risk for financial loss. Since a predatory lender is making a loan with the intent to deceive the consumer, the predator will no less put the appraiser at risk to minimize his own exposure if caught in questionable practices. In addition to lost income, a damaged reputation can impact an appraiser in both present and future business relationships.

Red Flags that Signal Predatory Lenders

Predatory lending takes several forms and each has traits that alert the astute appraiser to a potential snare. The pitfalls for the appraiser include civil lawsuits, complaints to the state licensing board, discrimination-based complaints to fair housing and civil rights boards, and criminal complaints. Many of these claims will not be covered under the appraiser's errors and omissions insurance. Defense in court is costly and the time lost during proceedings may result in further loss of income. Here are some types of misrepresentation and misconduct and the signals that will alert you to their risks:

Equity Stripping: The loan is made in excess of what the borrower is likely to be able to repay, creating a probable default. The lender intends to make money two ways; first, by charging significant fees on the loan and second, by foreclosing and reselling the property. The borrower/victim is left with nothing.

Watch for: The appraiser may be asked to "push" a value. Be especially suspicious if asked to do this repeatedly by the same lender. While the lender may promise you a steady stream of income from future transactions, the predator will only act to protect his income stream, not yours.

Loan Flipping: Repeated refinance of the consumer's loan. Believing that refinancing will save money or lower their monthly payments, the consumer pays more fees to the lender with each refinancing and incurs more debt for a longer period. Of course, each new loan requires an appraisal. The lender may offer comparable information to "assist" the appraiser or suggest that there is no need to verify the accuracy, as he is familiar with the area and has confidence in the numbers.

Watch for: Repeated requests on the same property. Be guarded about any offer to suspend verification of comparables. Avoid bracketed searches for comparables; take the time to search "zero to $_________" rather than just above and below the value named by the lender. ("We are looking at a loan in the $XXX,000 range.") In this way, you won't miss homes on the same block that sold for far less than the value your client is seeking. Avoid neighborhoods with which you are not familiar, or talk with local realtors to get their insight. Be alert to offers to "speed things along".

Packing: The practice of adding "extras" onto the loan without the knowledge or understanding of the borrower. Again, reducing the resources the customer has to apply to the principal increases the likelihood of default and produces hidden revenue for the lender. Examples include credit life insurance, disability insurance, accidental death insurance, involuntary unemployment policies, and "junk fees" such as underwriting fees, document preparation fees and other excessive processing fees.

Watch for: Know your client's reputation. Check for lawsuits, class actions and regulatory complaints filed against them. Be alert to pressure to "make the deal". Listen, if your experience tells you that the deal does not "feel right". Ask the lender what fees are "usual" for borrowers who do business with him.

The Typical Predatory Lending Scenario:

The predator's typical target is often an elderly homeowner with several years' equity in a home. Lacking cash for maintenance on his fixed income, the targeted owner has accumulated various consumer debts, which could be paid off with proceeds from an equity loan.

In our example, the homeowner, enticed by the concept of increasing his property value through improvements and reducing some personal debts, agrees to apply for a $48,000 loan on his house, which has been appraised at $60,000. The homeowner has no reason to question the appraisal amount or to check it out with others. He assumes the lender and the appraiser are "experts" in their field and are acting in his interest.

Upon reviewing the loan documents, he is dismayed that the monthly payments seem quite high, but is assured that the mortgage company would not finance a loan he was unable to repay.

He gets a second shock when he gets a check for less than $40,000 at the loan closing and learns that he has paid a more than 16% of the total loan in fees. Imagining himself to be in a positive cash position, the homeowner hires a contractor to do some work on the house, pays off his credit cards, and buys a few new things.

As anticipated, he has difficulty in meeting the scheduled payments. So, our homeowner returns to his friendly mortgage broker a year later seeking a solution. The broker is happy to refinance the loan. The monthly payments are lower, but the homeowner does not realize that the payments apply only to the interest, with a balloon payment due at the end of the loan term. The new loan (of $55,000) will generate an additional $5000 in fees for the broker. $48,000 will pay off the old loan and the borrower will get $2000 in his pocket. Even as the homeowner pockets his new windfall, the unsuspecting "target" is on the road to foreclosure.

Where the Appraiser Fits In

Simply put, no predatory loan transaction can close without a supporting appraisal. Although the appraiser may have no knowledge of any predatory practices, his report puts him smack in the middle of the problem. How? The deal can only be made if an appraiser determines the property value to be in a desirable range for the lender to corner his prey. Though the appraiser may be a naïve and unwilling accomplice, his report is one of the keys to the original deal, and to the subsequent refinancing that will likely lead to foreclosure. The loan cannot close for an amount that includes excessive "fees" without the inflated appraisal.

When the claims eventually surface, the appraiser is outraged and denies any knowledge of predatory practices. Having been duped by the lender's guidance in value and comparables selection, the appraiser is without recourse to defend himself – and may be without insurance to cover such a position.

Conclusion

Good business practice suggests that you appraise the client with the same diligence as you appraise the property. Remember: No loan closes without a valuation of the property, but an appraisal lacking diligence can turn you into a victim. Don't be the professional who gets caught in the teeth of the predator's trap. Protect the reputation you have built and enjoy the confidence of solid lender relationships and good client service.

Copyright 2002. LIA Administrators and Insurance Services. All rights reserved.