Letter from Edward M. Gramlich, Member of the Board, Federal Reserve


April 28, 2000



The Honorable Phil Gramm Chairman
Committee on Banking, Housing,
and Urban Affairs
United States Senate
Washington, D.C.

Dear Mr. Chairman:

Thank you for your recent letter concerning "predatory lending," in which you ask for the Federal Reserve Board's definition of the term and any data that the Board has regarding predatory lending.

No law administered by the Board has a statutory or regulatory definition of "predatory lending." In response to concerns about unfair and potentially abusive practices in connection with subprime mortgage loans, the Congress enacted the Home Ownership and Equity Protection Act of 1994 (HOEPA), which amended the Truth in Lending Act. HOEPA seeks to protect homeowners from loan agreements that are likely to result in default and the loss of their homes by requiring additional disclosures and prohibiting certain loan terms, such as balloon payments for short-term loans and non-amortizing payment schedules. While HOEPA's purpose is to regulate abusive lending practices, a transaction's coverage under the act is determined by triggers related to a loan's annual percentage rate or its points and fees, rather than any definition of "predatory lending. "

HOEPA's triggers may bring subprime loans not associated with unfair or abusive lending within the act's coverage. Similarly, abusive practices may occur in transactions that fall below the HOEPA triggers. Some consumer advocates, however, have expressed the view that many subprime loans are predatory because they believe these loans generally carry rates or fees that are excessive even in light of the additional risk involved. Others view predatory lending more narrowly, based on specific practices of particular lenders.

A detailed analysis of the problem of abusive practices relating to mortgage loans is contained in the 1998 report jointly submitted to the Congress by the Board and theDepartment of Housing and Urban Development on possible reforms to the Truth in Lending Act and the Real Estate Settlement Procedures Act. (The relevant excerpt is enclosed.)

As described in the 1998 report, abusive practices in home equity lending take many forms, but principally fall within two categories. The first category includes the use of blatantly fraudulent or deceptive techniques that may also involve other unlawful acts. These practices occur even though they are prohibited under existing law. For example, loan applicants' income and ability to make scheduled loan payments may be falsified, signatures may be forged or obtained on blank documents, or borrowers may be charged fees that are not tied to any service rendered.

A second category of abuses described in the report involves various techniques used to manipulate borrowers into accepting high rates or unaffordable terms, even though they may qualify for lower-cost alternatives. The loan documentation might appear to be proper and legally enforceable, but the broker or creditor may pressure consumers to enter transactions that they do not fully understand. Homeowners are charged high up-front fees that are added to the loan amount. In some cases, if there is sufficient equity in the property, the loan may be made without consideration of the borrowers' ability to repay. In other cases, a consumer may not understand that a loan with affordable monthly payments will not amortize the principal or that there will be a balloon payment that the consumer must refinance at additional cost.

With regard to data, the information concerning predatory lending is essentially anecdotal. We are aware of no ready method for identifying predatory loans or measuring the amounts involved. Consumer advocates have expressed concern, however, that as the total number of subprime loans increases, abusive loans will also increase in absolute numbers.

Testimony about predatory lending practices was presented in hearings held by the Board in 1997 under the HOEPA. At those hearings, consumer advocates reported continued abusive practices in connection with home equity loans. A copy of that testimony is enclosed, along with a summary of the hearings published as part of the 1998 joint report.

The Board's Consumer Advisory Council has also considered subprime lending and the problem of predatory practices at meetings held in 1999 and 2000. Inconnection with the March 2000 meeting, a council member affiliated with the Woodstock Institute presented a report on predatory lending based on a study by that group. A copy of that study and reports of the Council's meetings are also enclosed.

Sincerely,



Edward M. Gramlich
Member of the Board