Recently, the media have presented many stories about predatory
lending practices. In both cities and rural areas, instances of
predatory lending have devastated communities and left borrowers
deeply in debt. When it comes to predatory lending, many people
feel that they know it when they see it, but creating a comprehensive
definition of the practice that does not include benign lending
practices has proved difficult.
On March 26, 2001, Federal Reserve Governor Edward M. Gramlich
delivered remarks titled, "Tackling Predatory Lending: Regulation
and Education" to the Neighborhood Reinvestment Corporation
luncheon in Raleigh, North Carolina. In the speech, Governor Gramlich
discusses the common elements of predatory loans and draws distinctions
between predatory lending and subprime lending. That portion of
the speech is reprinted below. (For the full text of Governor Gramlich's
speech, including comments on the efforts of the Federal Reserve
System and the Federal Reserve Banks to address predatory lending
issues, visit www.federalreserve.gov/boarddocs/speeches/2001.)
I am pleased to participate in today's conference on predatory
lending. This seems to have become a major problem around the country.
One of the welcome developments in recent years is the expansion
of the home mortgage market to a broader socioeconomic range of
borrowers. Studies of urban metropolitan data submitted under the
Home Mortgage Disclosure Act (HMDA) have shown that lower-income
and minority consumers, who have traditionally had difficulty in
getting mortgage credit, have been taking out loans at record levels
in recent years. Specifically, conventional home-purchase mortgage
lending to low-income borrowers nearly doubled between 1993 and
1999, whereas that to upper-income borrowers rose 56 percent. Also,
over the same period, conventional mortgage lending increased by
about 120 percent to African American and Hispanic borrowers, compared
with an increase of 48 percent to white borrowers.
Much of this increased lending can be attributed to the development
of the subprime mortgage market. Again using HMDA data, the number
of subprime home equity loans has grown from 66,000 in 1993 to 856,000
in 1999, a thirteen-fold increase. Over this same period, the number
of subprime loans to purchase homes increased sixteen fold, from
16,000 to 263,000. This rapid growth has given credit access to
consumers who have difficulty in meeting the underwriting criteria
of prime lenders because of blemished credit histories or other
aspects of their profiles. This expansion of credit gives people
from all walks of life a shot at the twin American dreams of owning
a home and building wealth.
But along with these positive developments have come disquieting
reports of abusive lending practices, targeted particularly at female,
elderly, and minority borrowers. These practices, many of which
can result in consumers losing much of their equity in their home,
or even the home itself, are commonly referred to as "predatory
lending." Predatory lending can damage these same hardworking
but low-income people and the communities in which they live. Its
growth is a noticeable blight in this otherwise attractive mortgage-lending
The term "predatory lending," much like the terms "safety
and soundness" and "unfair and deceptive practices,"
is far-reaching and covers a potentially broad range of behavior.
As such, it does not lend itself to a concise or a comprehensive
definition. But typically, predatory lending involves at least one,
and perhaps all three, of the following elements:
- Making unaffordable loans based on the assets of the borrower
rather than on the borrower's ability to repay an obligation (asset-based
- Inducing a borrower to refinance a loan repeatedly in order
to charge high points and fees each time the loan is refinanced
(loan flipping); and
- Engaging in fraud or deception to conceal the true nature of
the loan obligation from an unsuspecting or unsophisticated borrower.
Some of these practices are clearly illegal and can be combated
with legal enforcement measures. But some are more subtle, involving
the misuse of practices that most of the time can improve credit
market efficiency. For example, the freedom for loan rates to rise
above former usury law ceilings is generally desirable in that it
matches relatively risky borrowers with appropriate lenders. But
sometimes the payments implicit in very high interest rates can
spell financial ruin for borrowers.
Most of the time, balloon payments make it possible for young homeowners
to buy their first house and match payments with their rising income
stream. But sometimes balloon payments can ruin borrowers who do
not have a rising income stream or who are unduly influenced by
an immediate need for money.
Most of the time, the ability to refinance mortgages permits borrowers
to take advantage of lower mortgage rates, but sometimes easy refinancing
invites loan flipping, resulting in high loan fees and unnecessary
Often credit life insurance is desirable, but sometimes the insurance
is unnecessary, and at times borrowers pay hefty up-front premiums
as their loans are flipped. Generally, advertising enhances information,
but sometimes it is deceptive. Most of the time, disclosure of mortgage
terms is desirable, but sometimes disclosures are misleading, with
key points hidden in the fine print.
Predatory lending entails either fraud or the misuse of these and
other complex mortgage provisions that are generally desirable and
advantageous to a borrower, but only when the borrower fully understands
them. . . .
In the long run, the very best defense against predatory lending
is . . . thorough knowledge on the part of consumers of their credit
options and resources. Educated borrowers who understand their rights
under lending contracts and who know how to exercise those rights
put up the best defense against predatory lenders.