Sue Kirchhoff and Judy Keen


April 26, 2007

Charles Davis bought his home on the South Side of Chicago in 2003 using
adjustable-rate, high-interest loans and betting an improving economy would
help him handle rising payments ahead. Things didn’t go as planned.

Davis, 54,
has struggled to stave off foreclosure on the brick ranch-style house where he
lives with his wife, Valerie, and three teenage kids. He financed his home with
a $200,000 mortgage at 8.5% interest, and a second $50,000 loan at nearly 12%.
Those rates were fixed for only two years, and payments are escalating.

YOUR EXPERIENCE: Are you having trouble keeping up with
your mortgage payment?

Davis went to
his bankers to refinance. They said no. Over the past year or so, he talked to
four or five companies and was turned away. His bank has him on a
“forbearance” plan, which lowers his payments, but has also started
foreclosure proceedings. If he misses a payment, he fears, he could lose his

“I got into a bad deal,” says Davis, an
African-American, adding that no one told him about help for first-time home
buyers or warned him about the risks of adjustable loans.

| Federal Reserve | Charles Davis

Across the nation, black and Hispanic borrowers helped
fuel a multiyear housing boom, accounting for 49% of the increase in homeowners
from 1995 to 2005, says Harvard’s Joint
Center for Housing Studies. But
Hispanics and African-Americans were far more likely to leverage the American
dream with subprime loans — higher-cost products for buyers with impaired
credit — that are now going bad at an alarming rate.

About 46% of Hispanics and 55% of blacks who took out purchase
mortgages in 2005 got higher-cost loans, compared with about 17% of whites and
Asians, according to Federal Reserve data. The South Side of Chicago, with a
large concentration of minority borrowers, has a high concentration of subprime
loans and the state’s highest foreclosure rate. In Boston,
where defaults are rising — especially in minority areas — 73% of high-income
black buyers (those making $92,000 to $152,000) and 70% of high-income
Hispanics had subprime loans in 2005, compared with 17% of whites.

Concentrated foreclosures in minority neighborhoods could
reduce property values. The NAACP, National Council of La Raza and other civil
rights groups recently called for a six-month moratorium on subprime home
foreclosures. Problems are centered on subprime borrowers who took out
adjustable-rate mortgages, which are now resetting at higher rates, increasing
the monthly payments.

One of those swept up in the subprime frenzy was Paris
Alston, 35, of Boston, who moved
from a homeless shelter to a steady job and hard-to-get federally subsidized
housing. Last year, after seeing an ad targeted at first-time buyers, she
jumped into a subprime adjustable-rate loan that started with a 9.95% interest
rate that could jump to as much as 15.25%.

“I was getting older in my life, I wanted to have
something for my kids,” says Alston, adding that the lender made the
process easy — until it came time to sign the documents.

“They inflated everything. … My income was more than
what I expected. When I asked to go over the loan application, they said, ‘You
don’t need to. All you need to do is sign it,’ ” Alston says.

Instead of the $1,200 monthly payments she expected,
Alston faced $3,000 in loan, tax and condo fee bills. That was not only more
than her monthly income, it was more than she had paid for an entire year’s
rent on her subsidized apartment. Alston lost her home. With the help of Boston
non-profit ESAC, Alston recently moved into a rental apartment.

Targeting minority borrowers

There are many reasons minorities turn to subprime
lenders. Firms have aggressively marketed their products to populations that
have long been underserved by, and often don’t trust, traditional banks.

Recent immigrants lack credit histories, and 35% of
Latino families don’t have checking accounts. Hispanic families are more apt to
have undocumented income, leading them to lenders who make loans without income
verification, according to the National Council of La Raza. Lower rates of
minority homeownership mean less wealth to draw on.

Regulation has been spotty. Federal data on race or
ethnicity and lending were recently expanded by regulators. But they don’t
include credit scores, making it difficult to easily ferret out reasons for
pricing disparities.

Independent analyses and government investigations
indicate that minority borrowers are steered to higher-cost loans even when
they qualify for cheaper products. Countrywide (CFC) Home Loans settled a New
York lawsuit over racial disparities in lending last
year, compensating some Latino borrowers and setting up a $3 million education

Many subprime lenders, who operate through loosely
regulated mortgage brokers, aren’t covered by federal banking laws that provide
consumer protections and are designed to prevent discriminatory lending. The
non-profit National Community Reinvestment Coalition, in a recent study of the
25 top U.S.
metro areas, found fewer commercial bank branches in minority and working-class

Doug Duncan, chief economist of the Mortgage Bankers
Association, points out that voluntary data by lenders show many minority
applicants who are turned down for loans are denied due to poor credit. Federal
data also don’t take into account such things as collateral, property values
and borrower debt-to-income ratio.

Duncan warns
that efforts to tighten lending laws to protect borrowers, including
minorities, could end up constricting credit and preventing people from
refinancing. At a recent meeting, subprime lenders told the Mortgage Bankers
Association they expect loan volume to fall 30% to 40% next year.

“This is before any regulatory action,” Duncan
says. “This is the reason why we’re cautioning regulators and lenders to
be very careful.”

In Denver,
Gaby Sanchez, 33, found her lender through her Realtor and was given a
high-cost loan she couldn’t afford when the interest rate reset.

“They said our credit wasn’t that great, so the loan
we were given was two-year, interest-only. … To refinance we were going to go
through them again,” Sanchez says. “We had the number; we kept trying
and trying until we found out they were no longer in business.”

Sanchez tried other lenders who also offered high-rate
loans, until she found non-profit group Del Norte Neighborhood Development
Corp. The group helped her and her husband, Fabian Lopez, 36, get an affordable
fixed-rate loan.

Another reason for the subprime surge: Lenders have been
supported by politicians and community leaders eager to promote minority
homeownership, which remains about 25 percentage points below that of white

“Access became such a buzzword that people forgot about
basic lending practices,” says Keith Corbett, executive vice president of
the Center for Responsible Lending. “You are really in debt servitude,
having a loan with a loan-to-value ratio of 100% or greater.”

How to regulate

Trying to protect borrowers or neighborhoods targeted by
high-cost lenders can be challenging.

last year created a program of mandatory financial counseling for borrowers
taking out certain high-cost loans. It was implemented in 10 ZIP codes, focused
on Chicago’s South Side. The
program was a boon to John McKinley, 70. After fielding marketing calls from
mortgage firms, McKinley decided to use a company promising a 30-year,
fixed-rate product. Before closing, he met with a financial counselor at the
Greater Southwest Development Corp. who discovered the rate was set for just 10
years, with rising interest and payments thereafter. He got out of the loan.

“I’m disgusted with all these people,” says
McKinley, an African-American, of lenders he believes are trying to scam their

“These lenders are thinking, ‘If you pay three or
four payments then stop, we’ll repossess it,’ ” McKinley says, adding that
the problem is fueled by willing borrowers, many with poor credit or low
savings, who want a cheap deal.

From Sept 1, 2006,
to Jan 19, 2007, a dozen
federally certified counseling groups worked with 1,200 borrowers, most on loan
refinances, not initial purchases. They found signs of fraud in about 9% of the
cases. In about half, they said borrowers could not afford the home or were
perilously close to not being able to afford the loan.

The state has proposed changes to the program, which was
suspended after tension with community leaders who called it racist for
singling out minority ZIP codes, privacy concerns and data showing a large drop
in home sales in neighborhoods where it was in effect. The changes would widen
the program to all of Cook County
and change the focus to loan terms viewed as predatory, rather than borrowers’
credit history.

“On the southwest side … there’s more mortgage
brokers than there are doctors and lawyers and grocery stores. It’s like the Las
Vegas strip of mortgage brokers,” says Illinois
Democratic state Sen. Martin Sandoval, who sponsored the law, though not with
the idea of singling out minority borrowers.

Federal regulators have tightened lending standards. But
the record is muddy regarding whether they have done enough to go after
possible lending discrimination.

A Fd analysis of higher-cost loans, defined as those 3
percentage points above select Treasury bill rates, shows a good chunk — but
not all the difference in lending among races and ethnic groups — can be
explained by other factors, such as borrower income.

The Fed two years ago said its analysis of 2004 data
indicated that 200 lenders might be making too many high-cost loans to
minorities who might be able to qualify for better deals; 35 of those lenders
are overseen by the central bank. The 2005 data raised red flags about 270
lenders, 45 under Fed oversight. It conducted follow-up examinations and has
referred one lender to the Justice Department.

The Office of the Comptroller of the Currency, another
bank regulator, based on an analysis of the 2004 data, did a number of targeted
exams. But the OCC says the vast amount of day-to-day OCC supervision does not
involve public enforcement actions, and it doesn’t keep data on enforcement
actions based on the lending information.

“There’s a real lack of transparency,” says Marva
Williams, senior vice president of the non-profit Woodstock
Institute in Chicago and a member
of the Fed’s community advisory panel. “It’s difficult or impossible to
know which institutions have received complaints, the nature of those
complaints and the status of any investigation.”

Looking to a tough future

Going forward, Congress is debating national standards
for lending, while regulators and lenders are setting up multibillion-dollar
programs to help people get out of bad loans. Robert Pulster, executive
director of Boston’s ESAC, says
recovery will be tough.

“These are poor communities. … (Homeowners) were
borrowing money. They did everything they could to sustain them for as long as
they could, so any resources they have are depleted,” Pulster says.
“There’s no quick fix.”