PREDATORY SALES AND LENDING

[Bill Gulley]

I recently posted that some lending and sales schemes were predatory.

First, predatory practices does not have a legal definition, generally you will find examples of strategies or activities that are deemed to be predatory rather than one simple definition.

Simply put, predatory activities place a buyer or borrower at a financial disadvantage. The severity of such activities will often be viewed not under one law or regulation but in concert with many regulatory requirements and in light of other alternatives that may exist.

Targeting a particular race or economic strata of the population is one of the red flags indicating predatory practices.

People of color have been identified by HUD and the Department of the Treasury as being victims of predatory practices, these are the more commonly identified and well known matters involving institutional lenders. Much of the housing bubble was about providing loans, usually refinanced mortgages to lower income persons. This is just one aspect of predatory lending.

Investors or real estate dealers become more involved when they deal with consumers. Consumers are viewed much differently than would be another investor dealing in a commercial transaction but predatory dealings is not limited to consumers alone.

Those who engage in selling a property above its market value and financing the deal are engaging in predatory practices. A loan made above 100% of the market value is predatory lending. "Market value" is not necessarily up to you as an investor to determine, the term has a legal definition and accepted meaning that will be used to determine what that value may be.

One issue is with flipping, buying at what may be defined as market value and then shortly thereafter selling for significantly more and financing that higher amount is a form or equity stripping future equity and anything over 100% LTV can be predatory.

Making improvements to a property certainly justify a higher price, but to what extent? There have been profit margins established to allow for properties being upgraded. The cost of materials and reasonable management fees as a contractor will be allowed and pose no real issue, so long as the amount is reasonable for the improvements.

Predatory dealing comes into play when loans have unjustified higher rates than what a buyer may qualify for. That means that interest rates to consumers should not be set arbitrarily but justified as to risk. Frankly, this is beyond the ability of small lenders and real estate investors as they lack the data required to justify risk. If they can locate statistical data that pertains to their borrower few have the knowledge and experience to apply prudent risk assessments to set interest rates. What is customary for the type of loan made becomes more of the standard locally. You'll also see that predatory lending rates are those more than 6% above treasury securities having a similar term, this is irrelevant to the type of lender, it's simply a metric as a base line for any loan.

There are aspects of predatory dealing. Failing to disclose all relevant facts and alternatives available to a buyer can trigger predatory activities. The issue in reality is that real estate investors who lack specific knowledge and experience will not likely be aware of what may be available to a buyer or what all the alternatives might be. Trained loan officers or mortgage brokers may be totally unaware of this aspect as most are limited to those loan products they or their sponsor lender may offer. So this is really a difficult requirement to meet, especially if a borrower is close to qualifying for other financing.

But, again, predatory means that the borrower or buyer is placed at a financial disadvantage. A high interest rate or 5 points does nor necessarily indicate predatory dealing. It's when the borrower may have had a better alternative available to them and that alternative was not disclosed to them that the predatory intent can be an issue. Another aspects is that the lender must gain financially from that activity, if the lender receives more in compensation arising from the loan or transaction than the alternative then predatory dealing can be shown.

Any loan in excess of 55% of a borrowers income will be considered predatory. The thinking of a borrower having a higher income where 45% of their income is sufficient to live on is not a consideration in keeping the loan from being predatory. The lower the income may be the more critical or server the issue becomes.

There are many aspects to predatory dealing. Most states have anti-predatory lending or dealing laws. Other related laws also may be applied to transactions as well. An investor who actively seeks a buyer and promotes the value of a property above its market value is predatory dealing, indicating a significantly higher value has been prosecuted as fraud.

What to do? Investors must be making their profit on the purchase side, buying those properties in distressed situations that do not meet the definition of market value. In doing so, to stay away from that predatory dealing aspect, the seller needs to be aware of values, shown why a fair price is lower or that their situation and acceptable price are agreeable.

Buying low, making improvements, repairs or bringing the property into meeting the definition of market value provides the spread available for profit. If you buy anything at market value and find some uninformed buyer that you can sell the buyer into paying twice as much, keeping that buyer uninformed, you are dealing in a predatory manner, you aren't some investor super star, you're a crook!

Here are just a few sites I located rather quickly on this matter. Some of the points I mentioned here are rather deeply embedded in the information, so keep reading. You will notice that financing a property at a higher price, as some like to do, is predatory lending. Financing does not add value to any property.

http://www.houstontx.gov/housing/predatorylending.html

http://www.msjlaw.org/what_we_do/predatory_mortgage.html

https://www.americanbar.org/newsletter/publications/law_trends_news_practice_area_e_newsletter_home/0509_business_predatorylending.html