THE $60 million "predatory lending" settlement reached last week with a once-powerful home mortgage lender should set off alarm bells around the country.
The allegations against California-based First Alliance Co. were chilling: The lender was charged with intentionally misleading thousands of its customers into believing they were signing up for low- or no-fee mortgages, while in fact some loans had as much as $25,000 in fees tucked away per $100,000 of principal.
First Alliance also was accused of misleading its customers about interest rates. Though some borrowers were told that the rate adjustments on their mortgages were tied to well-known financial indexes, in fact they rose by 1 percent every six months, according to federal and state legal authorities.
Many of these loans were ticking time bombs. Ultimately the combination of fees and rates proved unaffordable to the homeowners who applied for them.
But rather than foreclose, officials say, First Alliance refinanced them at progressively higher costs, eating further into homeowners' equity stakes. This house of cards only began to fall when a handful of customers woke up, hired lawyers and complained to state and federal regulators.
Last week's settlement was with the Federal Trade Commission, six state attorneys general, and the AARP. First Alliance's former CEO, Brian Chisick, agreed to personally pay $20 million into a national "redress fund" for 18,000 of his erstwhile customers. Up to another $40 million will be deposited into the redress fund from the remaining assets of his now-bankrupt company, and from insurance policy payouts.
The average victim is expected to receive just $2,500 to $3,300. As is customary in such settlements, none of the defendants admitted any wrongdoing.
How could so many homeowners have signed up for loans that, based on federal and state allegations, were so toxic, so abusive? A former First Alliance employee, who spoke with me after the settlement, put it this way: The company developed "a very sophisticated marketing plan" that was known inside First Alliance as "the track." All sales employees were trained intensively to follow the track, which was in effect a series of scripts designed to persuade homeowners to apply for a loan from First Alliance.
Prospective borrowers - often homeowners in their 50s or older with plenty of equity and little debt - were lured to the company's offices through telemarketing pitches that promised "big money at low rates and no fees," said the former employee. In reality, however, the "track was designed to squeeze [customers] for every last buck you could get out of them." Loan officers' commissions were tied to the number of "points" - 1 percent of the loan amount - they could tack onto the deal.
The verbal pitch to the customer was "you're getting a great deal here, you're paying nothing and getting a ton of money out of us," said the former employee.
Jean Davis, a senior litigation attorney for AARP, says the marketing script used in the "track" showed loan officers how to deflect customers' legitimate questions about terms such as "APR" (annual percentage rate) and "points."
If people asked about APR, according to Davis, the loan officer would tell them, "Oh, that's just something the government cares about, it's nothing that should concern you."
If applicants asked about "points," she said, the script directed loan officers to tell the applicant, "Don't worry, it's all taken care of in the loan amount you're getting." The firm also "played with" federal truth-in-lending requirements, said Davis, misleading customers into thinking that the "amount financed" - which is the principal balance minus points and fees - was what they were actually borrowing.
Joel Winston, the FTC's consumer protection bureau director, called First Alliance's loan-production system "psychologically sophisticated" and "powerful." It allegedly targeted people who had minimal experience in applying for credit, then convinced them "that they were getting no-fee loans with nothing out of their pockets."
The fees typically were disclosed in the final loan documents that borrowers were handed at closing. They were in a stack of papers that many people do not read or understand.
Winston and Davis warned that the techniques allegedly used by First Alliance are still alive and well in the mortgage industry. And standing behind those high-cost loan factories is a group of people not yet widely recognized as part of the problem: pinstriped Wall Street investment bankers who package toxic loans into high-yielding bonds that they peddle to eager investors.
The bottom line? Borrowers, beware. Don't be beguiled by slick-talking loan salesmen who promise you low fees and rates. Get it all in writing. Then review it with a lawyer, a financial adviser or friend or family member knowledgeable about mortgage money.
Kenneth R. Harney is a syndicated columnist. Send letters in care of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071. Or e-mail him at email@example.com.