Loan “flipping”

Background

Loan flipping generally refers to repeated refinancing of a mortgage loan within a short period of time with little or no benefit to the borrower. Loan flipping typically occurs when borrower is unable to meet scheduled payments, or repeatedly consolidates other unsecured debts into a new, home-secured loan at the urging of a lender. Lenders who flip loans tend to charge high origination fees with each

successive refinancing, and may charge these fees based on the entire amount of the new loan, not on just the incremental amount (if any) added to the loan principal through the refinancing. In addition, each refinancing may trigger prepayment penalties, which could be financed as part of the total loan amount,

adding to the borrower’s debt burden.

One lender may be responsible for flipping a loan multiple times, or one or more mortgage brokers may engage in flipping a borrower’s loan among different lenders. There is no existing federal-law

prohibition on loan flipping per se. HOEPA attempts to curb the flipping of high-cost loans by restricting the terms that may make such loans unaffordable in the first place (such as prepayment penalties, short-term balloon payments and negative amortization), and that can also add to refinancing costs.

What is the Problem?

When a loan is flipped, a borrower refinances on terms that are not economically beneficial to him or her, due to the financing of points, fees and prepayment penalties that accompany such loans. A borrower may receive modest additional funds or a slight reduction in the interest rate, but the points and fees that accompany such transactions in the end make the total transaction more costly to the consumer. For example, reducing a borrower’s monthly payment by a small amount, say $30 may cost the borrower thousands of dollars in up-front costs and interest over the life of the loan. The high fees derived from flipping attract unscrupulous originators who deceive borrowers about the true cost of the loan. Borrowers who have been victimized by predatory lending in the past often find themselves victimized yet again by flipping, when they are flipped into a new loan in an attempt to avoid default.

Each time the loan is flipped, more equity is lost in the home. Several witnesses at the regional forums (including Ms. H. in Baltimore – see Section II for description) had refinanced more frequently than once every two years.

Moreover, some creditors may extend credit knowing that the consumer cannot afford the scheduled monthly payments or a large balloon payment due at the end of the relatively short loan term. This practice guarantees that the loan will have to be refinanced within a short time and thereby initiates a cycle of successive refinancings that either erode the borrower’s equity, or in the worst cases, simply delay inevitable default while increasing the borrower’s debt.

Challenges for Reform

Proposals to address loan flipping should promote borrower options and continued access to credit through loan refinancing. For instance, blanket prohibitions on financing points and fees on a loan refinance may discourage refinancing that is beneficial to the borrower.

Policy Recommendations

a) Congress should require a borrower to derive a tangible net benefit from short-term refinancing into a HOEPA loan – The crux of the problem with loan flipping is that the borrower derives no economic benefit from the refinanced loan. Therefore, lenders should be prohibited from refinancing any mortgage into a HOEPA loan within 18 months of the mortgage closing unless there is a tangible net benefit to the borrower. The Board should be given the authority to define an appropriate safe harbor where a net tangible benefit is assumed. In defining the safe harbor, the

Board should consider items such as a minimum necessary decrease in APR, or limits on points and fees charged for loans where the APR does not reflect such a decrease.

b) Congress should specify that for refinances of any loan into a HOEPA loan within 18 months, creditors are permitted to charge points and fees only on the amount of the new advance, if any – Evidence from the regional forums demonstrated that some borrowers were charged exorbitant fees upon refinancing into a high-cost mortgage, even if the creditor was adding only a small amount of principal to the existing mortgage. Creditors should be permitted to charge points and fees only on the amount of the new advance; this will prevent creditors who charge expensive origination fees from evading HOEPA by calculating points and fees as a percentage of the entire principal.

c) Congress should restrict modification or deferral fees on HOEPA loans – Unscrupulous brokers and lenders might seek to evade flipping restrictions by modifying the terms, instead of refinancing a borrower’s loan and charging high fees to do so. If the modified loan is a HOEPA loan, creditors should be prohibited from levying modification or deferral fees, unless the APR on the loan decreases by 1.5 percentage points.

d) The Federal Reserve Board should consider using its authority to define loan flipping as an unfair, deceptive or abusive practice – HOEPA expressly grants the Board broad authority to issue rules to regulate unfair, abusive, or deceptive acts or practices. The Board is required by HOEPA to: (1) “prohibit acts or practices in connection with mortgage loans that the Board finds to be unfair, deceptive, or designed to evade” HOEPA’s provisions; and (2) “prohibit acts or

practices in connection with…refinancing of mortgage loans that [it] finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower.” 15 U.S.C. § 1639(l)(2).

The Board could adopt a rule forbidding refinancings within a specified time period that are not of tangible net benefit to the borrower. The Board should require that the determination of tangible net benefit take into account specified circumstances of the loan, such as the terms of the new and the refinanced loans, the cost of the new loan, and the ability of the consumer to repay the new loan. A safe harbor under the tangible net benefit test might be constructed by considering the factors outlined in recommendation (a).⁷³

73 The HOEPA Conference Report acknowledged the testimony Congress had heard “concerning the use of refinancing as a tool to take advantage of unsophisticated borrowers. Loans were ‘flipped’ repeatedly, spiraling up the loan balance and generating fee income through the prepayment penalties on the original loan and fees on the new loan.” Conf. Report, No. 103-652, 103d Cong., 2d sess. (Aug. 2, 1994), p. 162. Importantly, the report declared that “[s]uch practices may be appropriate matters for regulation under this subsection.” Id.

3. Lending to Borrowers without the Ability to Repay: Asset-Based Lending