Predatory lending is a booming industry and has contributed to the housing bubble and the current recession in the United States. Find definitions for some common terms associated with predatory lending, as well as links to further information on many topics.
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Adjustable-rate mortgage (ARM): a mortgage loan with an interest rate that varies or "adjusts," potentially changing mortgage payments from month to month. ARMs are distinct from fixed-rate mortgages, in which interest rates remain constant and do not fluctuate as immediately throughout the lifetime of the loan.
ARMs became popular as they were marketed aggressively during the housing boom. Because they were often granted to borrowers who didn't fully understand and/or couldn't afford the loans, many borrowers defaulted on payments, just one factor for the current foreclosure crisis.
Annual Percentage Rate (APR): the interest rate on a loan expressed in terms of annual percentage of the amount of credit granted for the total loan, useful for comparing lenders and loan options.
Cash-out refinance: a process in which the buyer refinances a mortgage at a lower interest rate and receives some or all of the equity accrued in cash. During the housing bubble, the extremely low interest rates led nearly a third of all American homeowners to refinance, many with the cash-out option. The resulting disappearance of equity that these homeowners had accrued contributed in part to widespread negative equity when home values dropped.
Credit card cash advance: a short-term loan of cash associated with a credit card. The terms of a cash advance are different than those of your credit card, and often include higher interest rates (up to double or higher your credit card interest rate), daily-accruing interest and an advance fee.
Some credit cards will count your monthly payment toward purchases on credit first before your cash advance, which can cause your interest to pile up quickly.
Chapter 13 bankruptcy: a type of bankruptcy that involves working with the bankruptcy court to develop a three- to five-year repayment plan to eliminate debts.
Chapter 13 bankruptcy filers may be able to keep secured debts like homes and cars, meaning that Chapter 13 can be an option for homeowners who are facing foreclosure due to a temporary inability to pay mortgage loans.
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Countrywide Financial: one of the largest subprime lenders in the United States. Countrywide was forced to lay off up to 12,000 employees after major writedowns that came as a result of defaulted subprime mortgages, and has been investigated by the FBI and SEC for securities fraud. Bank of America has announced that it plans to take over Countrywide.
Related Articles: Countrywide Financial Corp. To Enact Major Layoffs
Equity: the difference between the market value of a property and the amount of the mortgage or home equity loan you hold against it. Equity can increase in two ways: your home can rise in value, and/or your monthly payments lower the amount of the principal you owe on the loan.
If the value of your home decreases below the amount you owe on your loan, you have negative equity.
Fixed-rate mortgage: the "traditional" home loan plan, fixed rate mortgages require borrowers to pay a constant payment over the life of the loan (usually about 30 years). Compare to "adjustable rate mortgage."
Foreclosure (mortgage foreclosure): the process whereby a bank or mortgage company reclaims ownership of a house when a homeowner violates the terms of the mortgage agreement, typically for defaulting on the loan.
The current foreclosure crisis in the United States is the result of the bursting of the housing bubble, in which historically-low interest rates and lax lending standards to unqualified buyers caused unsustainable levels of value in home prices. Now, many homeowners with negative equity and ARMs are finding it impossible to pay monthly mortgage payments.
Home equity loan: a form of credit in which you use your home as collateral for the loan. Your credit limit for a home equity loan is determined by taking a percentage of the appraised value of your home and subtracting the balance that is owed on the mortgage.
Housing bubble: a period of incredibly rapid growth in a local real estate market that leads to unsustainable valuations in property. The downside of the bubble-often metaphorically termed as a "bursting" of the bubble-is a rapid decrease that can cause negative equity leading to defaults and foreclosures.
The current U.S. housing bubble followed as a result of the dot-com bubble, and was caused by historically-low interest rates, widespread speculation in housing markets and non-traditional loans such as ARMs offered with very low standards.
Loan "flipping": A practice used by a lender to generate fee income by refinancing the loan without providing any benefit to the borrower. On homes that have had "loan flips," monthly payments can increase while draining equity.
Loan to value ratio (LTV): the ratio of the outstanding balance of a mortgage loan compared to the appraised value of the home.
Mandatory arbitration: A clause that may be found in loan contracts that prevents the borrower from filing a civil lawsuit over grievances, but rather forces them to have grievances decided in third-party arbitration. Mandatory arbitration is often criticized for skirting the legal process that homeowners are guaranteed by law for protection.
Mortgage: a loan that is backed by real estate. Most people use mortgages to pay for houses because few people can afford to pay the full price of a home in cash.
A home mortgage can mean losing the property if you cannot comply with the terms of the loan.
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Negative amortization: a term that refers to a situation in which the monthly mortgage payments do not cover the interest due, causing the principal amount of the mortgage loan to increase.
Many individuals with option ARMs and other sophisticated adjustable-rate mortgages find themselves with negative amortization when the interest rate changes and they cannot afford to pay off the interest due on their monthly payment.
Negative equity: a term that refers to a situation in which the outstanding balance on a loan is greater than the value of the asset used to secure the loan. After the housing bubble burst, many individuals whose homes dropped rapidly in value in certain areas of the country were left with negative equity.
Option ARM: a version of an adjustable-rate mortgage that allows borrowers to choose their monthly payment options. Many option ARMs are offered with very low teaser interest rates that mean low monthly payments for the first year, but can often generate negative equity and mean difficulty selling the home, due to accruing interest amounts that are added to the loan principal each month for certain payment options.
Generally speaking, unsophisticated borrowers can easily become overwhelmed with the complexity of an option ARM, and many option ARM loans taken out in recent years have defaulted.
Overdraft fees: charges to your checking or savings account for purchases or withdrawals that exceed the amount of money in the account. On average, an overdraft fee for a single purchase is $34. While designed to help you avoid the hassle of returned checks, statistics show that a majority of insufficient funds withdrawals happen for purchases that are less than half of the fee amount, meaning that your protection costs more than twice as much as the amount you owed. Many unfair practices such as holding deposits longer than necessary and clearing daily transactions from highest to lowest are under criticism by consumers.
Payday loan: a short-term, small-dollar amount, high-interest loan typically marketed as a source of emergency funds between paychecks. In reality, the ultra-high interest rates on payday loans, which can be as high as 390%, can lead to a devastating cycle of debt that is difficult to escape.
Many states have enacted laws to combat payday lending, but the best way to protect yourself is to learn more about payday lending stores and the practices used by payday lenders.
Predatory lending: a phrase used by the media as shorthand for the "predatory" tactics used by lenders to convince borrowers to agree to unfavorable loan terms or to deceive the borrower in some way for profit. Typically these include targeting at-risk borrowers or concealing unfavorable mortgage terms.
Though predatory lending in the housing industry has played a major part in the current foreclosure crisis, payday loans, credit cards, and abusive overdraft loans have all been referred to as predatory loans.
Related Articles: Predatory Mortgage Lending Puts Seniors at Risk
Prepayment penalty: A prepayment penalty is a provision in a mortgage loan that requires you to pay a penalty if you pay off your mortgage loan entirely before a specified date. Typically, prepayment penalties decline or disappear over time, and many set a limit, 20% for example, on the amount of the entire loan that you may repay per year without a penalty.
Risk-based pricing: a lender's measure of risk based not on the length of the loan but on estimation of the probability that the borrower will default on the loan. In this model, different borrowers will pay different interest rates for the same type of loan.
Critics of risk-based pricing point to its prevalent use among predatory lenders, who subject vulnerable borrowers to riskier and even unsustainable loans, attracting them through bait and switch methods that offer rates for which they would never qualify.
Subprime loan: a loan given to a suprime borrower, or a borrower with a bad credit history or no credit history, such as a recent bankruptcy filer. Subprime loans have less favorable terms than prime loans because they pose a bigger risk for lenders. Many subprime loans are ARMs, taken out because they offer low introductory rates and often no money down.
Subprime lending was one of the major factors that contributed to the housing bubble, with many predatory lenders granting loans to subprime borrowers who were not able to repay them. As a result of these loan defaults and the rapid increase in home foreclosures, many subprime lenders lost billions.
Yield spread premium: commission earned by a mortgage broker from a lender for signing up a borrower for one of its loans. The YSP for a mortgage transaction is determined by selling a borrower an interest rate above the rate the borrower qualifies for, with the broker receiving the amount earned by the difference in the rates.
The YSP incentive encourages a mortgage broker to establish an interest rate higher than what the borrower qualifies for, and may encourage deception in rate offerings, according to some.
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