Letter from Robert Pitofsky, Chairman, Federal Trade Commission

May 16, 2000

The Honorable Phil Gramm United States Senate
Committee on Banking, Housing
and Urban Affairs
Washington, DC 20510-6075

Dear Chairman Gramm:

This responds to your letter of April 12, 2000, regarding "predatory lending." The Commission has played an integral role in combating abusive practices by subprime lenders and I appreciate the opportunity to share our experience in this area with you.

As you know, the Commission has wide-ranging responsibilities concerning nearly all segments of the economy. As part of its mandate to protect consumers, the Commission enforces the Federal Trade Commission Act ("FTC Act"), which broadly prohibits unfair or deceptive acts or practices. The Commission also enforces a number of laws specifically governing lending practices, including the Truth in Lending Act ("TILA"), which requires disclosures and establishes certain substantive requirements in connection with consumer credit transactions, the Home Ownership and Equity Protection Act ("HOEPA!'), which, as part of the TILA, provides special protections for consumers in certain non-purchase, high-cost loans secured by their homes, and the Equal Credit Opportunity Act ("ECOA"), which prohibits discrimination against applicants for credit on the basis of age, race, sex, or other prohibited factors. The Commission has jurisdiction over most non-bank lenders. In addition to our enforcement duties, the Commission also responds to many requests for information about credit issues and consumer credit laws from consumers, industry, state law enforcement agencies, and the media.

The first issue raised in your letter is the definition of "predatory lending." The Commission has not defined the term "predatory lending," but has testified before the Senate Special Committee on Aging about a number of abusive lending practices. These practices generally aim either to extract excessive fees and costs from the borrower or to obtain outright the equity in the borrower's home.

Among the most harmful of these reported practices is "equity-stripping. " This often begins with a loan that is based on equity in a property rather than on a borrower's ability to repay the loan -- a practice known as "asset-based lending." As a general rule, loans made to individuals who do not have the income to repay such loans usually are designed to fail; they frequently result in the lender acquiring the borrower's home equity.

Another practice of serious concern is "packing," which is the practice of adding credit insurance or other "extras" to increase the lender's profit on a loan. Typically, the insurance orother extra is included automatically as part of the loan package presented to the borrower at closing, and the premium is financed as part of the loan. The lender often fails to provide the borrower with prior notice about the insurance product and then rushes the borrower through the closing. Sometimes, the lender represents that the insurance "comes with the loan," perhaps implying that it is free. Other times, the lender simply may include the insurance in the loan closing papers with no explanation. In such a case, the borrower may not understand that the insurance is included or exactly what extra costs this product adds to the loan.

"Flipping" also has received attention. Lenders engage in this practice by inducing a consumer to refinance a loan, repeatedly, often within a short time frame, charging high points and fees each time. This causes the borrower's debt to increase steadily. While a consumer's option to refinance is an integral part of a functioning mortgage market, subprime lenders engaged in "flipping" may misrepresent to the borrower the terms and ultimate benefits of the transaction, or induce the borrower to take on more debt than she can handle.

Additional abuses can occur after loan origination in connection with loan servicing. Lenders may extract monies not owed under the loan terms. They also may fail to provide full or accurate pay-off information, thus tying the borrower to the lender without a means of escape.

One avenue that abusive lenders use to target consumers involves home improvement contractors. These contractors may obtain the borrower's consent for a loan with high rates and fees through the use of deception or coercion. In some cases, the contractor then performs lowquality work or no work at all.

Your letter also asks for the Commission's data on predatory lending. While the Commission does not have or collect data on predatory lending, the Commission has collected certain information in this area through its enforcement actions.

In March, the Commission announced a settlement, along with two other federal agencies, with Delta Funding Corporation, a large consumer finance company based in New York. The Commission alleged that Delta engaged in a pattern or practice of asset-based lending, in violation of HOEPA. Specifically, Delta extended loans to borrowers based on the borrower's collateral rather than considering the borrower's current and expected income, current obligations and employment status to determine whether the borrower was able to make the scheduled payments to repay the obligation. In these instances, prudent underwriting criteria, such as debt-to-income ratios, residual income, and repayment history, would have indicated that the borrower likely would have had difficulty repaying the loan. The settlement, which provided for nationwide injunctive relief, also included claims by the United States Department of Justice for race discrimination and by the Department of Housing and Urban Development for violations of the Real Estate Settlement Procedures Act. This is the first suit jointly brought by a group of federal agencies that combines allegations of consumer protection and fair lending violations by the same lender.

As part of "Operation Home Inequity," the Commission settled cases against seven lenders for violations of HOEPA in July 1999. All seven agreements provide substantial remedies and

protections for past and future borrowers. Six of the companies agreed to pay consumer redress totaling $572,500, two companies must obtain performance bonds before they offer or extend specified credit in the future, and one company is banned from any future involvement with high-cost loans secured by consumers' homes.

In January 1998, the Commission filed a complaint in the United States District Court for the District of Columbia against Capital City Mortgage Corporation, a Washington, DC-area mortgage lender, and its owner, alleging numerous violations of a number of federal laws resulting in serious injury to borrowers, including the loss of their homes. The company allegedly made home equity loans to minority, elderly, and low-income borrowers at interest rates as high as 2024 percent. Borrowers often faced foreclosure on their properties, after which the company would buy the properties at auction for prices much lower than the appraised value of the properties. The Commission's complaint in this matter alleges violations of the FTC Act, the TILA, the ECOA, and the Fair Debt Collection Practices Act. This matter is in litigation.

The Commission has a long enforcement history in the area of loans sold with credit insurance. Mostly recently, the Commission settled a case in 1997 against The Money Tree, a Georgia-based consumer finance lender, and its president. The case involved, in part, allegations that the company required consumers to purchase credit-related insurance and other "extras" along with their loans, without disclosing to consumers the true cost of their credit. In 1992, the Commission approved a consent agreement with Tower Loan of Mississippi settling similar charges regarding its consumer loans.

In addition to its own enforcement activities, the Commission also is taking several other steps to address reported abuses in the subprime home equity market. The Commission has been working with states to increase and coordinate enforcement efforts nationwide. On the federal level, the Commission has been participating in a task force convened by the Federal Reserve Board that examines the issue of predatory lending. The Commission also is educating consumers in order to help them avoid potential home equity lending abuses. For example, during National Consumer Protection Week in 1999, the Commission distributed 500,000 publications focused on credit, with an emphasis on abusive lending issues.

Enclosed for your further review are materials on the cases discussed above, as well as consumer brochures. I have also included a copy of the testimony provided to the Senate Special Committee on Aging in March 1998.

Thank you for your interest in these issues.


Robert Pitofsky