With subprime lending on the rise, there is a strong argument for lenders to get involved in credit counseling.
Government agencies continue to challenge the fairness of the terms on which residential mortgage lenders extend credit to minority subprime borrowers. These enforcement actions echo a theme in the current mortgage reform debate-a call for a prohibition on predatory lending.
The claim is twofold:
First, lenders, not borrowers, are better able to evaluate the risks to the borrower of alternative loan products and prices, regardless of the number, simplicity, or timing of borrower disclosures.
Second, as a result of this superior knowledge, lenders should be prohibited from extending credit to unsophisticated borrowers on terms that the lenders know or should know are unfavorable to borrowers.
This approach disregards the fact that a lender is prepared to make the loan for its own account based on its own eligibility criteria. The focus is on what is best for the borrower, not the lender. Ironically, claims of predatory lending arise principally regarding refinancings, when the borrower has already been through the loan-application process.
Claims of predatory lending are premised on perceptions of poor choices made by borrowers. For example, it is claimed, the lender should not have permitted the borrower:
To select an adjustable-rate loan based on a particular index.
To consolidate higher-cost, but unsecured, consumer debt into a home equity loan.
To accept an offer of credit on terms that appear more onerous than those for which the borrower could have qualified.
Or to pay more up-front points than the anticipated term of the loan would have justified.
The most extreme example of the "wrongful mortgage" theme is that no loan should have been made at all. In this view, borrowers lack the ability to make rational economic choices, and lenders should be prohibited from taking advantage of their helplessness.
The difficulties of this approach are obvious. Imagine the outcry if a lender told a minority borrower that it would be willing to make the desired loan for its own account but declines to extend credit in order to protect the borrower.
Today's fair-lending criticisms by government agencies and consumer groups would not turn into tomorrow's thank-you notes. Moreover, loan officers clearly lack the capacity to assume this counseling function when the consequence of bad advice is lender liability.
Yet often borrowers make bad choices. Particularly in the subprime market, the tendency to shop only for reduced monthly payments may produce an unreasonable increase in the total cost of credit or the risk of foreclosure. The approach of the industry should not be to deny that consumers may make bad choices but to debate whether a public policy of paternalism should oblige lenders to protect borrowers from themselves.
One proactive approach would be to help borrowers help themselves.
Most homeowners have the capacity to make reasonable choices regarding refinancings. Consumer education could improve this capacity. Virtually every major metropolitan area has one or more HUD-approved, non-profit credit counseling agencies.
Prepurchase counseling for first-time homebuyers is recognized as a successful tool for converting consumers from a renter's mentality to an owner's mentality. Credit counseling can be equally beneficial to homeowners who are thinking about refinancing.
Credit agencies, however, may have a knowledge gap regarding the intricacies of home financings that may impair their efficacy as consumer counselors. The arts of underwriting eligibility, product selection, and price negotiation are learned skills. Knowledge gaps only widen as the market innovates.
I suggest that the industry develop a Swat team of teachers to train and provide technical assistance to credit counseling agencies so their clients might learn to shop competently for credit.
Most trade associations have education departments to train the employees of their members. Why not extend this to nonprofit groups? Most mortgage lenders make charitable contributions. Why not join with local credit counseling agencies to assure their viability and vitality?
Most of the industry believes that borrowers should have some responsibility to protect themselves in the marketplace by reading the exhaustive disclosures that they are given and by comparison shopping. Why not help them become better consumers by offering them a discount if they have completed a credit counseling course?
An educated consumer does not always mean a better consumer. Some lenders may lose loans; presumably these losses lead to another lender's gain. Some lenders may retain their better-informed customers but at a lower profit margin.
The alternative, however, may be less palatable. Giving your customers credit counseling is cheaper than paying your legal counselors to litigate.