California homeowners at risk for lending fraud & abuse

July 28, 1998

Contact: Norma Garcia
(415) 431-6747
Consumers Union West Coast Office

CALIFORNIA HOMEOWNERS AT RISK FOR LENDING FRAUD & ABUSE

SAN FRANCISCO, CA – Home equity fraud and abuse rob California homeowners of tens to hundreds of millions of dollars, with homeowners who are "cash poor but equity rich" falling prey to scams and refinancing deals they cannot afford. A report by Consumers Union shows that new laws, increased prosecution and creative education efforts recently implemented in a few California counties offer some consumers limited protection. But without further legislative and regulatory action, the report finds, aggressive tactics by the growing subprime lending industry will lead thousands of low-income consumers into deeper debt.

According to the report, Hard Sell: Combating Home Equity Lending Fraud in California, victims are often elderly, minority, low-income homeowners who are equity-rich through years of living in their homes, but cash-poor because they live on fixed incomes. The number of potential fraud cases reported to a San Francisco home equity hotline have increased each year since its inception in 1996. As home values increase throughout the state and subprime companies compete aggressively for customers, Consumers Union staff attorney Norma Garcia said, "This may lead to an increase in home equity fraud and predatory lending practices – calls from consumers to our office and other advocacy organizations are certainly on the rise."

Hard Sell identifies new programs to combat such fraud and abuse, most of which have been implemented since the release of Consumers Union’s groundbreaking 1995 report on home equity fraud. However, many of the most successful programs are limited to certain geographic areas or narrow audiences. In addition, Governor Wilson last year vetoed two important consumer protection measures.

"In California, we have successful fraud-busting programs that no other state in the country has. But many of these programs are limited to a few metropolitan areas," said Garcia, who is author of the report. "Meanwhile, low-income California homeowners are being inundated with direct mail, telemarketing and door-to-door pitches for loans they can’t afford to repay. Many people simply fall through the limited safety net of protection."

Unscrupulous lenders continue to use four common practices to sell high-cost home equity loans to California homeowners, regardless of their ability to repay the loan. Lenders do the following:

1. Make loans in conjunction with home improvement contracts, which are often not fulfilled;

2. Sell loans under the guise of "rescuing" a homeowner from foreclosure;

3. Offer disaster-related home loans;

4. Consolidate various types of debt into unaffordable home equity loans.

Some of the reports from consumers include outright fraud; others include technically legal, but high-cost loans, with poor term disclosures that borrowers on fixed incomes cannot repay.

"While the tragedy of home equity fraud and abuse continues to plague California homeowners," Garcia said, "a few new programs in the state serve as models. There are new protections, earlier notification of potential fraud and increased consumer education programs to help consumers avoid becoming victims."

NEW PROGRAMS & EDUCATION EFFORTS

REAL ESTATE FRAUD UNITS WITHIN LOCAL DISTRICT ATTORNEYS OFFICES.

The legislature passed a landmark bill that went into effect in 1996 to fund real estate fraud units within local district attorneys offices. California is the first and only state in the nation to have units dedicated to pursuing these criminal actions. Prior to this legislation, many DAs did not pursue real estate fraud cases, often citing a lack of resources. Los Angeles county, which had the only dedicated unit, served as impetus for the bill and as model for other offices. Units now exist in four other counties: Santa Clara, Santa Cruz, San Diego and Alameda. These units have led to some significant convictions, sending a signal that fraud will be dealt with seriously. The San Diego unit, for example, established in 1996, had received 127 complaints as of late 1997, had 30 cases under investigation and had already filed 14 cases resulting in 10 convictions. In Los Angeles, cases under investigation in the fall of 1997 involved 13,000 potential victims and more than $300 million in losses to homeowners and investors.

"This provides California with the greatest opportunity to enhance law enforcement resources to combat real estate fraud," according to Garcia. "Other counties should protect their citizens by launching similar real estate fraud units."

HOME EQUITY FRAUD HOTLINE OF BAR ASSOCIATION OF SAN FRANCISCO.

Bay Area homeowners can call this unique resource if they have problems with home equity borrowing. A Hotline staffer conducts an intake interview, and gathers additional documents for review. If appropriate, the agency then matches the homeowner with a pro bono attorney trained in the matter. According to Haydee Alfonso, supervising attorney for the Hotline, the number of cases the Hotline has placed with private attorneys has steadily increased since its inception. In 1996 the agency placed nine cases; in 1997, 13 cases; and in the first five months of 1998, 17 cases. Since 1994, the Bar Association has trained more than 200 layers to represent clients in equity fraud and abuse actions.

REGISTRAR-RECORDER PROGRAM OF LOS ANGELES

The state legislature passed a bill reinstating a Los Angeles county program to alert homeowners when deeds are recorded against their property. These notices often serve as an early fraud alert. Over a 10-month period, 3400 individuals indicated that the notice had alerted them to deeds recorded without their knowledge. The program has led to a marked decrease in cases involving forged deeds.

DIRECT CONSUMER EDUCATION

• Consumers Union’s Homeowners Project has published two brochures, Don’t Lose Your Home: Home Equity Fraud and Guarding the Golden Years: Reverse Mortgage Essentials, in English and Spanish. The organization created an educational curriculum and conducts free seminars for seniors in the Bay Area. Next year, the Homeowners Project will train other community-based organizations to use the seminar curriculum, to extend those outreach efforts.
• Consumer Action has several publications available related to home equity fraud and protecting home ownership. All are available in English and Spanish, and some are available in other languages.
• Los Angeles County Department of Consumer Affairs conducts a real estate fraud and information program to protect consumers. The agency actively investigates cases and works with other agencies to prosecute fraud. The agency also maintains a toll-free hotline for consumers, and currently receives approximately 1600 calls per month.
• Bet Tzedek Legal Services of Los Angeles provides many services to seniors facing home equity fraud. The group includes information on home equity fraud in monthly forums on elder abuse, and also represents victims of home equity fraud. They also created a law enforcement training video entitled, They Steal Houses, Don’t They? Investigating Home Equity Fraud.

In addition to these new programs and education efforts, the regulatory agencies charged with protecting consumers have taken some positive steps forward, according to the report.

In the past, law enforcement officials, victims’ lawyers and consumer advocates consistently regarded the California Department of Real Estate (DRE) as being weak and ineffective in its enforcement efforts. Now the agency receives mixed reviews, according to the report. In Los Angeles, the agency is part of the District Attorneys Real Estate Fraud Task Force and produced an educational video in conjunction with the City Attorney’s office. The agency now makes some basic consumer information available on the Internet, such as its licensee database and desist and refrain orders. However, consumer advocates also report that it often takes a year or more for the DRE to bring a case to hearing, even when cases have been assigned to the high-priority Crisis Response Team.

In 1997, the California Department of Corporations (DOC) pursued its first case under the state’s Residential Mortgage Lending Act. The agency sought to revoke the license of a mortgage lender and ensure restitution to 10,000 borrowers who may have been affected by abusive home loan practices, including excessive interest payments and delayed transfer of funds for home equity loans. The DOC and the company reached a settlement, which included a civil fine.

"The regulatory watchdogs can and should sharpen their teeth to protect consumers," Garcia said.

SUBPRIME INDUSTRY

In addition to detailing some of the new programs to battle home equity fraud and abuse, the report also offers an in-depth look at the subprime lending industry. The subprime industry has moved from the fringes of the lending industry, into the mainstream. The industry is lucrative and is one of the fastest growing areas in the mortgage lending business, according to industry publications. Lenders profit from loan origination fees and hefty interest rates, plus high pre-payment penalties. Many major lenders now have subprime divisions.

The industry argues that it is meeting the needs of borrowers with poor credit histories. Consumer advocates warn that the products offered often exploit those borrowers, leading them into further debt.

"Predatory lenders, the underbelly of the subprime industry, take advantage of borrowers’ desperation," according to Garcia. "They charge more than what the lender needs to protect itself from increased risk. Some companies in this industry create the very problems we hope to solve."

As competition in the lucrative subprime industry has increased, lenders have created new, higher risk products to capture market share. Two such products are:

1) No Equity Loan (or 125% LTV loan). This allows homeowners to borrow more than their home is worth. Companies market it as a substitute for credit-card debt. It was originally offered to consumers with good repayment records; because of increased competition, many consumer advocates fear that these risky loans will now be extended to consumers with weak repayment histories.

2) Home-secured credit card. A credit card secured by a borrower’s home equity. First Alliance Mortgage Company heavily markets this product to high-risk borrowers. Their card has an annual interest rate of up to 24.8%, plus a large sign-up fee and high annual fee. The card costs consumer much more than most other credit cards and subjects borrower’s home to the risk of foreclosure. Credit cards lend themselves to more casual purchases than a home equity line of credit, usually used for debt consolidation or home improvements.

"It is not a community service to aggressively market an expensive, extremely risky product to those who are not experienced with credit cards," Garcia said. "A good credit card can be a useful financial tool. But one that results in home foreclosure for non-payment can be a recipe for disaster. This card is one of the most perilous products to emerge from the subprime lending industry."

Some subprime industry practices have drawn federal scrutiny. The Federal Trade Commission and the Department of Justice announced earlier this year that they were investigating alleged abuses in the industry. In March, the U.S. Senate Special Committee on Aging held hearings on predatory lending. At that hearing, a former employee of a lending company offered "a detailed account of how he lured non-English speakers, racial minorities and the elderly into signing away their homes by taking on big loans that promised low monthly payments," according to news accounts.

"Regulators and consumer advocates are just beginning to understand how this industry impacts consumers," according to Garcia. "Many of its practices are legal, but still lead to devastating results for some borrowers."

RECOMMENDATIONS

• County administrators and District Attorneys in more California counties should launch Real Estate Fraud Units to harness resources to protect residents throughout the state.
• Other Bar Associations should follow the lead of San Francisco in creating home equity fraud hotlines.
• The legislature should pass and the governor should sign two bills similar to bills vetoed by Gov. Wilson last year. One measure would have required a lender to consider a borrower’s ability to repay the mortgage, and established identifiable high-risk indicators. Those borrowers exhibiting certain high-risk indicators would need to obtain counseling from an independent party such as a community credit counselor. The other bill would have prohibited a home improvement contractor from taking a security interest in a person’s home, beyond a mechanic’s lien, to secure payment of a home improvement loan.
• Other measures that the Legislature should pass include the following: prohibit all door-to-door soliciting of loan and home improvement services that are financed through a home equity loan; require pre-loan counseling for all homeowners applying for loans that will result in debt payments exceeding 40 percent of income; and require counseling for borrowers seeking to refinance an existing loan which has gone into default. These counseling requirements would provide a disincentive to predatory lenders.
• Counties and cities with low-cost loan programs for home improvements must conduct more outreach. Many services remain wasted resources because of the public’s lack of information.
• More organizations should sponsor education efforts. Many victims say that if they had more information or knew of where they could receive free counseling, they would not have entered into contracts that led to the loss of their home. Education efforts should be conducted at churches, women’s clubs, senior’s groups, service clubs and community organizations in neighborhoods where elderly have built significant equity.

"The lending industry must make great efforts to cooperate with regulators and join in the efforts to eradicate from their industry, rather than defend, those who exploit unsuspecting homeowners under the guise of ‘free enterprise,’" Garcia said.