Not surprisingly, borrowers getting subprime loans tend to be less educated about finances and more susceptible to what is known as predatory lending practices. To protect these borrowers, the federal Home Ownership and Equity Protection Act (HOEPA) was passed. The act does not prohibit lenders from charging high rates and points, but it does require them to disclose to the borrower what is being charged and the borrower’s right to refuse the loan.
The act’s disclosure requirements come into play under certain conditions. The triggers, as they are called, happen when the annual percentage rate exceeds 8% above the Constant Maturity Treasury Bill index for first mortgages, and 10% for junior mortgages. A second trigger is when points and fees exceed the greater of 8% of the loan amount or $465 (adjusted annually).
Other provisions include prohibiting flipping, the practice of refinancing loans for no apparent benefit to the borrower in order to generate loan fees. The act prohibits refinancing a HOEPA loan with another HOEPA loan within one year, unless it is in the best interest of the borrower. Another significant requirement is that the lender must consider the borrower’s ability to repay the loan rather than basing the loan entirely on the equity in the property. Prior to the act, many loans were made knowing that there was little chance the borrower could make the required payments. As long as the property could be sold at the foreclosure auction for enough to repay the loan, the loan was made.
There are also restrictions on balloon payments for loans of less than five years and a prohibition of arbitrary calls. This prevents the lender from demanding that you repay the loan in full, even if you have been making your payments as agreed and are not selling the property. The practice of calling the loan was used to force the borrower into an expensive refinance.
Some states have enacted laws that extend beyond HOEPA. The most significant are those that take away the holder in due course protection from secondary lenders. The buyer of a loan in the secondary market is protected from liability even if the original lender unfairly took advantage of the borrower, unless the secondary lender was aware of the practice. Some states now say that the secondary lender has the same potential liability as the originating lender. If you believe you were cheated by your original lender and your loan has been sold, consult an attorney. If there was fraud involved with the possibility of punitive damages, some lawyers will take the case on a contingency fee basis, which means they only get paid if you win your case.
The argument against restrictions of hard money mortgages is that they take away the ability to borrow from those who need the money most. In order to prevent this, laws like HOEPA are designed to cover only the most egregious practices. A Federal Reserve study estimates that only about 5% of hard money loans fall under the protection of HOEPA.