James R. Balmforth: Foreclosure Lawyer Herriman Utah

If you are facing foreclosure speak to an experienced Herriman Utah foreclosure lawyer. Chances are you may be a victim of subprime lending.
Two of the most important imperfections in subprime credit markets are information asymmetries and disparate bargaining power. Information asymmetries arise because lenders generally have more information about potential borrowers than vice versa. The informational advantage of lenders creates bargaining power that can be exploited when dealing with borrowers.

For example, even today, in an age where consumers can buy their credit report on the Internet, many consumers do not have a good understanding of the implications of their credit history before they start shopping for mortgages. In the best-case scenario—where prime borrowers shop for credit in the prime market—the customer may settle upon one lender she believes is reasonable and start the application process, during which the lender obtains the customer’s credit report. This provides the lender with an informational advantage because it has had the opportunity to scrutinize the customer’s credit history to determine the mortgage terms for which the customer qualifies. The lender can then attempt to capitalize on its informational advantage by offering less favorable terms or, alternatively, by giving the customer the terms she requests, rather than giving her the “best deal.”

The end result of a lender’s information advantage, while potentially bad in the prime market, is much more devastating in the subprime market. Indeed, many customers in the subprime market do not even initiate the loan process themselves (particularly in the case of refinance and home-equity loans). In these cases, the lenders themselves initiate the process through the use of push-marketing tactics. Furthermore, under the Fair Credit Reporting Act, a borrower’s credit history needs to be disclosed only if she is rejected (15 U.S.C. 1681(m)). This post application disclosure is designed to address concerns with credit discrimination, and is an insufficient deterrent for predatory lenders who are more likely to provide an abusive loan than deny an application outright. Predatory lenders routinely steer “families to higher-cost loans whenever they thought there was a chance they could get away with it.”

The most extreme cases of informational asymmetry occur when borrowers who could actually qualify for loans in the prime market instead apply for loans with subprime lenders. The chances of a prime customer incorrectly self-sorting into the subprime market appear greater than ever, as underwriting criteria have become increasingly complicated, including not only traditional factors such as loan-to-value and debt-to-income ratios, but additional factors such as income potential and stability, and timely payment of utility bills and rent. Since lenders have no legal obligation to inform borrowers of their prime status or refer them to prime lenders, these borrowers wind up paying substantially more for credit.

Moreover, even if borrowers accurately evaluate their creditworthiness beforehand, they still face an informational disadvantage in the subprime credit market with regard to their knowledge of relevant interest rates and fees. While the Internet has diminished this disadvantage to some extent for prime borrowers, those who respond to mail, phone, or television solicitations for subprime loans are once again at an informational disadvantage because the advertised interest rate will in all likelihood no longer be the “true” rate by the time the customer responds to the advertisement. In fact, customers most likely expect the actual interest rate to be different. Unfortunately, even if the customer knows the actual interest rate will differ from the advertised one, the customer is ill-equipped to figure out what her proper rate should be because such advertisements usually do not provide enough information to do meaningful comparison-shopping.

So the customer is likely either to (a) believe her rate will not necessarily be the same, but will be “close” to what is advertised, or (b) believe the advertised rate is a “special” low rate that she should insist on receiving—even though, unbeknownst to her, her “proper” rate may be much lower than the advertised one. This price uncertainty leads to suboptimal outcomes for borrowers because it creates yet another opportunity for lenders to exploit their customers.

One distinction between predatory lenders and legitimate ones is that predatory lenders choose to exploit their informational advantage on “subprime” borrowers who, due to a host of factors including a lack of previous experience with conventional lending markets, may be perceived as being less financially sophisticated than “prime” borrowers. Three types of lenders—prime, subprime, and predatory—can be defined as follows. Prime lenders are lenders who deal exclusively with “prime” customers—customers who have very good credit histories and are presumed to be financially savvy, and thus not easily exploited. Subprime lenders include lenders who cater to customers who may or may not be financially sophisticated but in most cases have blemished credit histories that preclude them from obtaining credit in the prime credit market. Predatory lenders seek to do business with customers who have blemished credit and who are not financially sophisticated, two characteristics that together make such customers prone to exploitation. These three categories of lenders are not mutually exclusive, because predatory lenders are mainly a subset of subprime lenders. (Of course, specific lenders may at various times assume all three identities.) What sets predatory lenders apart is that legitimate subprime lenders seek to do business with this group of borrowers on a more or less fair basis, while predatory lenders knowingly seek to do business with subprime borrowers on an exploitative basis.

Prime lenders may engage in all of the above types of competition. Casual observations suggest that subprime lenders, on the other hand, are less likely to compete in terms of price than prime lenders but more likely to compete in terms of quantity (offering guaranteed loan approval to boost loan volume, for example) or product differentiation—touting their ability to make a loan to fit the specialized, nonstandard situation of the borrower with blemished credit.

The mortgage process usually proceeds as follows. The lender, either directly or through a mortgage broker, originates the loan to the borrower. The lender packages the loan with other mortgage loans and sells the loans to a securitizer in the secondary market, and receives payment. The lender may also choose to sell the rights to servicing the loans to the securitizer as well (or to another entity), or the lender may keep the servicing rights and service the loan itself. At this point, if the lender has sold off both the loan and the servicing rights, the lender is seemingly out of the picture, because it has already received its profit. All future cash flows from loan repayment are collected by the servicer, who passes them on, minus its fee, to the MBS investors.

Under normal circumstances, there is no problem for the borrower with this process. On the other hand, if the loan is predatory, the process can give rise to significant borrower concerns. For example, suppose the loan (1) charged an interest rate that was overpriced relative to the borrower’s risk of default, given that the borrower qualified for a prime loan, (2) charged an excessive origination fee and additional discount points, (3) was a brokered loan that was originated at a higher interest rate than the lender required—thus netting a (yield spread) premium for the broker (4) contained an abusive subprime prepayment penalty, and (5) charged an interest rate that was increased further still by mortgage servicing rights that were overpriced relative to the expected costs of servicing the loan, given that the borrower qualified for a loan in the prime market, where servicing fees are lower. (Typical prime servicing fees are 25 basis points (0.25 percent), while subprime fees (including fees on FHA/VA loans) are typically much higher.) Who profits excessively from this loan? The answer is, of course, everyone. Let us divide the spoils:

• The lender gets a higher selling price for the loan in the secondary market as a result of the higher interest rate and extra profit from the excessive front- and back-end fees.
• The broker gets the yield-spread premium and possibly some of the excessive fees paid.
• The secondary market purchaser of the loan/MBS security issuer gets additional income from investors for being able to securitize a higher-yielding MBS or passthrough security.
It is also possible, but perhaps less likely, that:
• The loan servicer gets a higher servicing fee than otherwise and frequently will retain late fees.
• The MBS investors get a higher risk-adjusted return on their investment than if the loan had been properly originated in the prime market and was not overpriced.

Here, typical deductive reasoning might suggest that if one were asked “Who is liable for the harm caused to this borrower of the predatory loan?,” the answer would logically be, at least to some extent, everyone, because all parties had a hand in the excessive charges from the loan. In fact, however, under the “holder in due course” doctrine, a borrower typically could only pursue a claim of abusive lending practices against the original broker. Borrowers should be especially concerned when the sole liable party is the broker.

Mortgage Brokers and Third-Party Lending

Mortgage brokers reportedly account for one-half of all subprime home loan originations. Mortgage brokers usually choose the mortgage lender and the terms of the mortgage for the customer. For this reason, customers typically perceive mortgage brokers as their “agent” and expect their broker to act in their best interests.

Brokers introduce the opportunity for yet another market imperfection, what is referred to as the “principal-agent problem” in economics. The agency problem in this case is that the customer (principal) pays the broker (agent) either directly or indirectly, or both, to act in her best interest by securing a suitable mortgage loan, yet the customer cannot completely monitor the actions of the broker. This lack of monitoring provides the broker with an opportunity to operate in conjunction with a third party (the lender) to take advantage of the customer. An additional complication is that the amount of payment the broker receives is determined not by the borrower but by the lender, through the payment of a yield-spread premium. While it is preferable (in theory) from an efficiency standpoint to allow customers to “contract out” the job of obtaining the mortgage to professionals with greater expertise than theirs, this arrangement allows abusive brokers to steer unsuspecting borrowers into bad loans, aided and abetted by lenders willing and able to pay extravagant yield-spread premiums. Furthermore, in reality, brokers probably see themselves as agents of the lender rather than the broker, thus leaving the consumer even more vulnerable to abuse, as the consumer has no one to act reliably in her best interest.

This example illustrates how the specialization of tasks involved in the mortgage process can lead to larger and more efficient credit markets, on one hand, but at the same time create greater pitfalls and problems for vulnerable borrowers. Consequently, not only do mortgage brokers represent a double-edged sword in the home ownership battle, but they make it more difficult to hold accountable the perpetrators of predatory lending. Borrowers seeking a remedy find that brokers typically have substantially fewer assets than lenders (one recent study put the average size of brokerages at ten employees) and are more likely to go out of business and be judgment proof. When this is combined with the holder-in-due-course doctrine, borrowers may find themselves without the ability to hold anyone responsible for the damages they have suffered.

The unintended consequences of deregulation and increased market efficiency create a legal conundrum. Deregulation and specialization in modern capital markets push economies toward even more specialization, which economic theory suggests will lead to greater market efficiency because deregulation presumably gives each participant in the market the latitude to do what it does best. Yet specialization also makes it harder to track down the sources of abuse in capital markets because everyone can point the finger at someone else. Laws help, of course, but to be most effective, they have to be tailored to the ways in which lending markets operate in particular submarkets.

If you are facing foreclosure, chances are you are a victim of fraud by the mortgage company or your mortgage broker. Contact an experienced Herriman Utah foreclosure lawyer today to know how you can protect your rights.

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