WASHINGTON — Patricia Clemons had a serious heart condition and she was living on a $1,094-a-month disability check when she answered a letter from a Florida mortgage broker in 2004. It promised what sounded like easy money and cash-back refinancing of her small home in St. Petersburg.
Financial planners warn against taking home loans whose monthly payments exceed 40 percent of income. Yet Clemons, 62, later learned that she'd signed up for a new loan whose costs exceeded 62 percent of her fixed income. To her horror, the loan from Advanced Funding didn't even have an escrow account to include taxes and insurance in her monthly payment.
"When it came in the mail, it was telling me how much my mortgage was . . . and they were saying we can refinance you for this much, and it was only up a few more dollars," Clemons said.
Weeks later, pressured by a loan officer, she signed the paperwork that began her nightmare. The ad that seemed too good to be true was.
"How did I qualify to pay $688 a month when I could barely pay $500? How could they take me up that far?" she asked in an interview, still angry. Add in insurance and taxes and her new monthly total was $813 — 74 percent of her monthly disability check.
Clemons became a victim of deceptive advertising that relied on bait-and-switch tactics. Fraudulent ads were used to hook many borrowers with weak credit histories such as Clemons.
"Unfortunately, it's not uncommon. It's a problem, and it happens a lot," said Jordan Ash, the director of the Financial Justice Center in St. Paul, Minn. So frequent a problem, in fact, that federal bank regulators are looking to tighten rules.
The center, part of the Association of Community Organizations for Reform Now (Acorn), helps thousands of low- and middle-income homeowners like Clemons fight back against predatory lending, which often begins with deceptive, targeted advertising.
Roughly 1 out of every 5 new home loans was sub-prime — targeted to people with very weak credit histories — during the boom year of 2005, according to the Mortgage Bankers Association.
Over the past decade, the biggest jump in home ownership has been among low-income Americans, most of them minorities such as Clemons, an African-American. The Center for Responsible Lending of Durham, N.C., estimates that more than 50 percent of African-American homeowners have sub-prime loans, like Clemons, and about 40 percent of Hispanic homeowners do.
"You combine that kind of racial steering with the type of advertising that's going on, it just compounds inequities," said Evan Fuguet, policy counsel for the center. "Whether someone needs the loan or not is not relevant to someone who needs (sales) volume."
Most deceptive ads featured loans for borrowers with spotty credit. They were given home loans with very low interest rates for one to three years, then the 30-year loans would adjust annually to rates that many borrowers couldn't afford. Advocacy groups also point to ads for option adjustable-rate mortgages as being rife with deception. These complicated loans typically have interest rates that adjust monthly and payment schedules that adjust annually.
The nation's top banker, Federal Reserve Chairman Ben Bernanke, promised Congress in July that he'll tighten rules for mortgage and refinancing ads by year's end. It was a tacit admission that the Fed, which the Truth in Lending Act charges with issuing the rules, has dropped the ball.
The Fed tightened "Regulation Z" rules against deceptive credit card advertising in recent years but not for mortgages, home-equity loans or other home loans. This failure became an important element behind today's meltdown in the sub-prime mortgage market, because a wide range of state and federal banking regulators follow Regulation Z rules.
But new Fed rules against deceptive home-loan ads may not be enough, according to Edward Gramlich, a former governor of the Federal Reserve and the author of "Subprime Mortgages: America's Latest Boom and Bust."
"Part of the problem until now is that the lenders have not had a supervisor," said Gramlich, whose specialty at the Fed from 1997 to 2005 was consumer credit and housing.
Absent a sheriff with influence over the entire mortgage industry, changes in the rules are likely to prove ineffective. "The enforcement process starts with supervisors. If you don't have the supervisors out there, then nothing gets going," Gramlich said.
Numerous federal and state regulators have responsibility for some parts of the mortgage market, but the very variety of overseers leads to huge gaps in enforcement.
For big national banks, the enforcer of Truth in Lending laws is the Federal Trade Commission. But the FTC said in a letter Jan. 23 to the Federal Reserve that it took only a single enforcement action in 2006 against unlawful sub-prime lending practices.
The Office of Thrift Supervision, which oversees big savings and loans, including now-troubled ones with huge sub-prime portfolios, is considering issuing its own new rules late this year against deceptive mortgage ads. It's looking at preventing ads that encourage repetitive refinancing of the same loan by the same lender, and those that encourage borrowers to default on existing loans to get refinancing.
The regulators' attention to deceptive ads is important because the ads are the first link in a chain of failures that brought about today's housing slump and Wall Street instability. Congress continues to probe these failures, which include insufficient federal regulation, weak lending standards and spotty state regulation of mortgage brokers and nonbank lenders.
Nonbank lending was what followed the deceptive ad that hooked Clemons. Her brokered loan was underwritten by New Century Financial Corp., a large national nonbank lender that federal bank regulators don't oversee.
Now bankrupt, New Century became a sub-prime heavyweight by advertising heavily and lending disproportionately to minorities and the elderly. Congress is looking at how to bring nonbank lenders under federal supervision. It's also considering a national licensing system for mortgage brokers.
Trickery was commonplace at New Century. Advanced Funding, the broker of Clemons' loan, confirmed to McClatchy Newspapers that it had received an extra $408 commission from New Century for getting Clemons into a loan that made her owe more, not less, than she did on her existing mortgage.
Such a commission is called a "yield spread premium." The practice, which New Century made famous, has drawn the scorn of lawmakers who liken it to legal kickbacks.
Clemons said her loan officer never disclosed that she was getting into a more expensive loan.
"He never had time to talk when I called," Clemons complained of the loan officer, who's no longer with Advanced Funding. She added that "they were just shoveling papers at me." When it was over, Clemons had refinanced her home with a 40-year mortgage at a high 8.4 percent interest rate, with an unusual $51,212 "balloon" payment due after 30 years.
If Clemons tried to refinance out of this loan within three years, she'd face a steep prepayment penalty, a practice that Congress also is looking at forbidding.
With the terms locked in, New Century quickly sold her loan to the secondary mortgage market, where it was packaged with others and resold to investors as a mortgage-backed security, a bond sold by Wall Street brokerages.
Such mortgage bonds effectively passed to investors the risk associated with the imprudent loan to Clemons. Investors weren't informed about the qualities of the loans. Congress is weighing whether to assign legal liability for home loans to the initial lenders to prevent this sort of pass-the-buck practice.
With help from Acorn, Clemons was able to refinance a second time with New Century shortly before it went bankrupt in April. She now pays a more modest interest rate, 6.5 percent, but still doesn't have taxes and insurance rolled into her monthly payments.
"Next time, I won't borrow any more money," she said.