The Home Equity HustleGeoffrey Smith
John F. Storms thought he had no choice. Boston city home inspectors said he needed a new porch and a wheelchair ramp for his 21-year-old adopted daughter, who suffers from cerebral palsy.
So the 82-year-old Storms, who says he lives on $2,200 a month, hired a contractor who offered to do the work for $23,000 if it was financed with a $32,000 home equity loan from Money Tree Inc., a second-mortgage broker and lender. The extra $9,000 paid for $6,300 in up-front fees, plus $2,700 to consolidate debts. When combined with earlier home-improvement debt, Storms's monthly payments soared to $1,340.96, $425.96 to Money Tree alone.
SHADOW PLAY. If it seems curious that a lender would make a loan when so much of the borrower's income was already tied up in debt service, Storms discovered the hitch 15 months later. That's when Chrysler First Inc., the Chrysler Corp. unit that bought the loan from Money Tree, repossessed Storms's home. He had missed 10 payments after his daughter's disability payments fell victim to state budget cuts. Now, Storms is suing Money Tree and Chrysler, among others, for fraud. His lawyer, Donald Brown, contends that Money Tree knew before it extended the loan that Storms couldn't meet his "unconscionably high" monthly payments and thus defrauded him of his house. Money Tree is contesting the suit; Chrysler had no comment.
Storms may be the victim of an increasingly common hustle in the shadows of the second-mortgage industry, which has $330 billion in loans outstanding. Robert Hobbs, deputy director of the National Consumer Law Center, says there are no statistics documenting the extent of the home-equity lending to obviously unqualified borrowers. But he believes it now exceeds even car-repair fraud as the nation's largest consumer problem, based on anecdotal evidence from consumer lawyers. "There are lawsuits all across the country," Hobbs says.
According to cases brought around the country by law enforcement officials or aggrieved borrowers, some unscrupulous lenders, usually working with contractors, are targeting the poor, elderly, and minorities. Many victims have large untapped home equity, little knowledge of finance, and don't qualify for financing from a major bank. The lenders offer to do home repairs or provide money for debt consolidation and then talk customers into signing loan documents for financing. The loans turn out to be time bombs. Some lenders don't provide promised services or money. The payoff is big: high monthly payments and the loss of the borrower's house in case of default.
Borrowers are fighting back. In Alabama, a jury on July 24 awarded $45 million to five families who allege they were victimized by home-equity swindlers. The suit accused Dallas-based Union Mortgage Co., a unit of Finland-based Skopbank, of encouraging the families to take out $20,000 home-equity loans and never fixing their homes or providing them money. In Los Angeles, the district attorney has charged 31-year-old Kevin S. Merritt, president of Univest Home Loan Corp., with 32 felony counts alleging he bilked mostly black and poor homeowners out of their homes by charging exorbitant rates and using phony paperwork to foreclose on their homes. Merritt wouldn't comment, but he has entered an innocent plea.
Similar suits have been filed in New York, Illinois, Georgia, and Arizona. Concern over second-mortgage fraud is so high in Massachusetts that the legislature in June placed a 120-day moratorium on home foreclosures.
PLENTY OF CASH. The latest effort to tackle the problem is shaping up on Capitol Hill, part of the debate over the Bush Administration's sweeping bank reform bill. When the full Senate debates the bill in September, Senator John F. Kerry (D-Mass.) wants to propose an amendment to strengthen the Community Reinvestment Act of 1977, which encourages banks to lend in poor areas. Senator Kerry thinks the presence of large banks in poor and minority neighborhoods would help keep all lenders in those communities on the straight and narrow.
The American Bankers Assn., the industry's main lobbying group, opposes any efforts to bolster the Community Reinvestment Act. Anyway, Congress alone can't stop second-mortgage scams by encouraging competition. Commercial banks are cutting back on lending to the high-risk customers who are often victims of mortgage fraud, and demand for home-equity credit is still high. What's more, second-mortgage lenders have access to plenty of capital.
Much of that capital comes from large banks that buy second mortgages from the loan originators. Last year, nearly 10% of all second mortgages were pooled for the secondary market, providing a rich source of capital for lenders.
The problem with pooling is that some questionable loans get into the mix. For much of the 1980s, Citibank financed Dartmouth Plan, a New York-based second-mortgage lender, by buying many of the loans Dartmouth originated. In 1985, Dartmouth, without admitting or denying wrongdoing, paid $3 million to settle charges of misleading lending practices brought by the Connecticut Attorney General. Citibank continued to buy Dartmouth second mortgages but stopped in 1989, "after it became clear there were problems with Dartmouth's lending practices," says a Citibank spokesman. Dartmouth attorney David H. Peirez, who claims his client never made a fraudulent loan, says Dartmouth went out of business in January, 1990, after big banks stopped buying its paper.
CLOSER SCRUTINY. Second-mortgage purchasers say they're not to blame. "There are bad apples in every industry, and we can't control them," says B. David Scruggs, executive vice-president of Fleet Finance Inc., the nation's largest buyer of second mortgages. Indeed, some second-mortgage purchasers have been credited with helping uncover fraud by carefully reviewing the paperwork on the loans they buy, according to a study by the American Association of Retired Persons. Still, Fleet/Norstar Financial Group, New England's largest banking company, has pledged $11 million to victims of second-mortgage fraud. And Kerry thinks some buyers haven't been so diligent. "During the real estate boom," he says, "some banks were zealously buying up packages of loans which in normal times they would have looked at more closely."
Whatever legislative changes are made to stifle second-mortgage fraud, they won't come soon enough to help John Storms. He's renting an apartment near his old home, which he has no hope of living in again. "I've devoted my life to my daughter," he says, "and this is what I get." Sadly, he won't be the last to succumb to the lure of easy money and easy terms.
SWEPT UP IN A MORTGAGE SCAM
FLEET/NORSTAR FINANCIAL GROUP, PROVIDENCE Pledged $11 million toward reimbursing up to 300 victims of fraudulent home-equity loans made by a mortgage company it financed
COMMUNITY BANK OF GREATER PEORIA To settle a class action
with 6,200 plaintiffs, bank agreed to refund up to $4 million to victims of deceptive home-equity loans it bought
UNION MORTGAGE CO., DALLAS Alabama jury awarded $45 million to five plaintiffs who accused company of deceptive marketing of home improvement loans