Betting the House

How bad is the subprime crisis in Philly?

by Ted Hesson

Initially, Leslie Thomas didn't want to take out a home equity loan. The then-30-year-old was legally blind and suffering from kidney failure, diabetes and congestive heart failure, so nearly all of her income came from her $572-a-month Social Security check, which barely covered gas, electricity and food. Despite financial problems, she owned her home in Southwest Philly — she had inherited it from her father in 1997 — and didn't want to add a mortgage payment. In late 2001, she twice spurned a broker from Security Mortgage, a company based in Newtown. But on the third visit from the broker, Thomas agreed to borrow $30,000 to pay off debts, fix a hole in the kitchen ceiling and buy diapers and clothes for her adopted daughter, Mercy.

She decided to take out the loan, she says, because the broker had told her that she would have to pay only $256 a month at an 8 percent interest rate. According to Thomas, the broker also said her Social Security check wasn't enough to qualify her. She claims that he asked her to get a letter stating that she received extra money from baby-sitting — a letter that she chose to fabricate in the hopes of getting the mortgage. She wanted the money and thought the payments were manageable. "When he said it was $256, it was cool for me," she says. "I could afford it."

"If I lose my house, so be it," Thomas says. "But they won't get me again."

At closing, Thomas had to rely on the broker and Murray Levin, the lawyer present at the settlement, to explain the terms of the mortgage because of her impaired vision. She signed the papers, but the loan wasn't what she expected. Instead of paying $256 a month at 8 percent interest, this loan would charge her $353 a month at a 13.19 percent. For her income level, those terms would be considered "high cost," according to housing groups. She paid the bill for months, but then started to miss payments and defaulted in 2005. The current holder of her loan, Wells Fargo, has moved to foreclose on her two-story home.

Neither Security Mortgage Broker owner Steve Rosen nor Levin have any recollection of Thomas' mortgage. The original lender, Delta Funding Corp., could not address Thomas' mortgage for privacy reasons, and Wells Fargo declined comment on the foreclosure proceeding. In court, however, Thomas and her lawyer from Community Legal Services hope to prove that she was the victim of predatory lending, the practice of deceiving a borrower into accepting a high-cost loan or a loan they can't afford (legally or illegally), and stave off her foreclosure.

"If I lose my house, so be it," Thomas says. "But they won't get me again."

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Predatory lending has recently come under scrutiny since economists have directly linked failed loans to this year's major economic downturn, the subprime crisis. Since the beginning of the year, the word "subprime" has been haunting just about everyone. It routinely spooks global markets, fells mortgage companies and bleeds red ink on any homeowner foolish enough to get too close. Experts from the Center for Responsible Lending, a nonprofit based in North Carolina, predict that one out of five subprime loans will fail, leading million of Americans to lose their homes. But what actually is the subprime crisis?

The imbroglio all started about seven years ago with an innovation in the loan industry to allow people to borrow greater amounts than their financial condition would normally permit, according to Joseph Mason, finance professor at Drexel University. The term subprime refers to the size of the loan relative to the borrower's credit. Just because a loan is subprime doesn't mean a borrower is low-income or has terrible credit; it just means that the borrower took out more than he or she normally could afford, Mason says. Other industries, like credit cards and automobiles, had already moved to the subprime market, and real estate followed suit. Competition brought more and more companies into the fray.

"There's this belief that everyone should have a home," Mason says. But he doesn't think that makes sense. "Some people in homes right now would be better off renting." Houses shouldn't simply be bought as investments, Mason says; you should buy a house to live in, and if you do buy, you should be sure the property isn't too expensive. "Two and a half times your income was the old rule of thumb," he offers.

Different types of subprime loans emerged: some with low payments for the first few years, followed by dramatic increases, and others that just had high interest rates and exorbitant fees. People got their homes, brokers earned their fat commissions, and the mortgage companies sold off the loans to investors who were interested in the high-risk securities because they brought a bigger return. Everyone was happy until late 2006, when a farrago of climbing interest rates, payment defaults, unstable adjustable mortgages and a glut of unsold houses combined to freeze the subprime market.

Philadelphia hasn't suffered from devalued homes and jobs losses like other parts of the country, Mason says, but many people with poor credit who bought homes will soon be struggling to pay their mortgages, if they aren't already.

"You better get that raise and you better get that better job in the next two years if you're going to make the payment," Mason says. Foreclosure filings are up by 47 percent in the city from April 2006 to April 2007, especially in North and Southwest Philly, according to the Association of Community Organizations for Reform Now (ACORN), a national housing group.

Housing groups like ACORN claim that many people stuck with these high-cost loans are victims of predatory lending: The borrowers were either deceived, ill-informed or not economically qualified. In addition, the mortgage industry has been loosely regulated in past years by the Pennsylvania Department of Banking. Before the subprime fallout, a broker applying for a license might not even undergo a criminal background check.

Philadelphia has tried to curb irresponsible lending in the past. Led by 9th District Councilwoman Marian Tasco in 2001, the city passed a law that required borrowers to get counseling before signing off on a high-cost loan, but the local ordinance was soon pre-empted by a much weaker state law.

The recent crisis, however, has politicians thinking about reform. On the national level, U.S. Sen. Bob Casey has introduced anti-predatory lending legislation, and the state banking department is currently supporting six different mortgage lending bills that address issues like broker regulation and foreclosures. The bills are currently in the House Commerce Committee, headed by Rep. Peter Daly, a Democrat representing Fayette and Washington counties.

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"We really want to send a message to mortgage brokers in Pennsylvania that we mean business," says Daly, who expects the bill to leave committee this month. "There have been mortgage brokers who have been doing things that are out-and-out fraud. We're not going to let these shenanigans continue."

One bill would require all brokers, loan officers or anyone else who deals directly with consumers in the mortgage process to be licensed by the banking department. Currently, the state licenses mortgage companies, not individuals, which leaves companies in charge of monitoring the behavior of brokers. Another bill would force all mortgage companies to submit foreclosure notices to the Department of Banking, so that statewide foreclosure trends can be easily tracked.

"We encourage the state to pass these bills and also help cities that may suffer from high defaults and foreclosures," Democratic mayoral candidate Michael Nutter said through a spokesperson last week. "This is about people possibly losing their homes — their greatest economic asset."

Still, Mason says he thinks that many of the people who bought homes or refinanced never should have borrowed money in the first place. And if someone is going to take out a mortgage, then they should have a lawyer present at the closing.

"[Brokers] are not your friends, they're not your pals, they're not giving you the home of your dreams," Mason says. "They're earning their commission."

Mike Cleveland, a 39-year-old who recently bought a house in Mount Airy, is one of the homeowners stuck with a high-interest loan, only he doesn't blame a broker or a loan officer for deceiving him.How could he?He is one himself.

In 2006, Cleveland decided to leave his job as a loan officer and become a broker, attracted by the allure of the new subprime market. While a loan officer works directly for a mortgage company and can often wring only a limited commission from a mortgage, a broker can earn more per deal by adding fees, raising the interest rate and selling certain types of loans. "Whoever came up with the subprime concept made it so that it can be a moneymaker for the broker," Cleveland says. "You're not necessarily looking to do the best loan for that customer."

As a broker for several different companies, Cleveland, like most people in the mortgage business, was a slave to quotas. His entire salary was based on commission. Bosses would dangle daily $1,000 bonuses for the first person to process 20 loan applications, and good sales numbers might earn workers a free cruise. Since his days as a linebacker at Kutztown University or as a stand-up comedian in New York, Cleveland has always been able to perform, but occasionally he felt stressed out. To relax, he coached a youth football team in Mount Airy, the neighborhood where he grew up.

"My job is pressure-driven, expectation-driven, minute by minute, so this is kind of a good release. Sometimes I get to yell," he says. But if the job was tense, it was also financially rewarding. "There were times when I was making 20 grand a month — when the getting was good."

The introduction of subprime borrowing to the mortgage market meant that tons of people with poor credit were now potential customers. Those new opportunities translated into quick cash. He knew colleagues who would drop tens of thousands of dollars gambling at the Borgata in Atlantic City while outfitting themselves in $500 pairs of shoes. Cleveland — who says he was restrained in his spending — even leased a new Lincoln Navigator.

"I had no choice but to get caught up in it," he now says. In two years at Nations Home Mortgage, he had seen more than 100 people lose their jobs after falling short on quotas. It was survival of the fittest.

In 2005, Cleveland went to work for Ameriquest, a California-based mortgage giant specializing in subprime loans. He was told to cover Mount Airy, where he had a strong network of potential customers. However, most of the mortgages he was selling had ballooning adjustable rates and fees he knew weren't necessary.

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"I saw a lot of people who just needed genuine help and I thought, 'You didn't do the best thing for them,'" he says. He even found himself brokering deals with the grandparents of the 12-year-old football players he coached. "You know, I believe in karma. It was getting to the point when I couldn't consciously do it anymore."

Cleveland left the Ameriquest job after six months and became a loan officer again for another company. In May 2006, while he was still settling in to his new job, he decided to buy a house in Mount Airy with his fiancée, Bernadette. The house was a bargain: A friend of his wanted to unload it and asked Cleveland for $140,000, although the market value was much higher. However, since he had just switched jobs and Bernadette was still in school, the only loan they qualified for was an 11.1 percent adjustable-rate mortgage that would change in two years. But he planned to refinance for a fixed rate before then.

Within six months of the closing, however, the subprime market began to falter. News organizations warned consumers not to get stuck with bad loans; investors lost their appetite for securities backed by subprime loans. Suddenly, no one wanted to refinance.

Cleveland's salary went from $6,000 a month to $2,300. Bernadette didn't have any income — she was still studying to become a teacher. They had fallen behind on the mortgage by March and they couldn't refinance after that because the missed payments had hurt their credit.

"We've got all this equity, but we can't access it," Cleveland recalls.

Suddenly, he found himself in the same situation as many of his former clients.

This June, they applied for a homeowner's loan from the state that would pay off the $10,000 in arrears that he owed to the mortgage company, but were initially denied. They are currently in the process of appealing the decision, but they also hope that housing groups like the Philadelphia Unemployment Project (PUP), a local nonprofit, might be able to get them into a fixed-rate mortgage by negotiating with the mortgage company.

Since July, PUP has resolved 23 cases, ranging from mortgage problems to unemployment compensation, and 20 of them have had a positive outcome.

But if groups like PUP can't help, they may have to sell the house — that's Plan D, he says.

Cleveland doesn't blame predatory brokers — although he admits that they exist — because no one could have foreseen this sort of market crash, he maintains. Before the crisis, many people in his situation would have been able to refinance, but now they're falling behind on payments and their credit scores are suffering.

Ian Phillips, ACORN's state legislative director, reviews dozens of similar subprime mortgages each month and tries to rework the terms of the loan. ACORN has leverage against some lenders because they can organize rallies and protests against the companies, triggering negative publicity. High-cost loans, however, aren't usually sold to knowledgeable borrowers like Cleveland.

"In low- and moderate-income communities, where they have very little experience with homeownership on the whole, you see brokers taking advantage of that," Phillips says.

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One of the borrowers Phillips hopes to help is Jean Smith, a 69-year-old grandmother who only recently realized the terms of her loan and now fears losing her home.

In 1994, Smith was living in an apartment at Seventh and Fairmount when a neighbor told her about a new housing development for first-time homeowners being built in Northern Liberties. She contacted the developer and realized that she qualified for the fixed mortgage based on what she earned at her data entry job at Strawbridge's. So at the age of 55, she decided to buy a home.

She watched an empty lot below Girard Avenue become a development reminiscent of a suburban community. Smith visited the site so often that contractors let her walk around the shell of the house.

"I was here every week, watching what they were doing," she recalls.

In July 1996, however, two months before the house would be finished, Smith realized she was going to lose her job due to a corporate merger. Still, she signed the lease and moved into the house in August.

A few weeks later, while her time at Strawbridge's was coming to a close, she learned that she wouldn't be alone in the new three-bedroom house. Her youngest son and his wife were addicted to crack and too embroiled with legal problems to care for their two 5-year-old daughters, Desiree and Ronda. She was now going to be responsible for raising two children, despite having just lost her job.

Smith made ends meet over the years through a combination of Social Security, money from the Department of Human Services for the girls and odd jobs like sweeping a nearby church. She never missed a mortgage payment and managed to provide for the girls.

But in spring 2006, she started hearing friends talk about refinancing, and by July she decided to take out a loan to replace her bay window, redo her kitchen and pay off $6,000 in credit card debt. She spoke to a cousin who was a broker and he offered to help her refinance. "I thought my cousin knew what he was talking about," she now says.

The money went quickly. Within a year, she had spent the $31,000 from the loan on home improvements, debt and her granddaughters. She also plays the lottery and visits a casino once a month. She wouldn't say how much she spends, except that it is within her budget.

She still hadn't missed a payment when she noticed something odd on her monthly statement. The total cost of her refinanced mortgage was originally $90,000, but after making every monthly payment for a year, she actually owed $93,000. Her bill was going up.

She eventually took her statement to ACORN, where Phillips told her that under her current payment plan, she was paying only part of the interest and none of the principle each month. If she kept this plan, she would continue to owe more and more. There were other payment options, but none of them were reasonable considering that she receives only $1,900 a month to support herself and the girls. Phillips also told her that the interest rate was adjustable and that even the minimum payment could go up in the future, threatening her with the possibility of foreclosure.

At the moment, Smith is working with ACORN and Legal Aid, hoping to reach an agreement with her mortgage company, World Savings. She hasn't confronted her cousin yet, and she can't believe that he would have purposefully deceived her.

"I don't even think he knew what he was doing," Smith says. "I don't think he would have set me up with that, knowing my income."

Smith wouldn't divulge her cousin's name because she first wants to speak with him about the loan. But even if he did understand the terms of the loan, many experts would blame Thomas for trusting a broker, regardless of their relationship.

"People don't educate themselves and they sign things and they don't know what they're signing," says Cleveland, based on his experience as a broker. "All they see is the short term — I'm in trouble today; I need to pay my bills today."

Ian Phillips thinks organizations should try to halt foreclosures in advance by using preventive outreach, targeting people who might be susceptible to predatory lending. However, it's hard for nonprofits to compete with mortgage companies and brokers who engage in the practice, he says. Not only would Phillips like to see laws put in place to address the problem, he would like to see a foreclosure moratorium on all predatory loans.

"We think that the foreclosure rate is going to get a lot worse before it gets better," says Phillips.

(ted.hesson@citypaper.net)