Predatory Lending

Predatory lending describes a range of abusive mortgage origination practices in which lenders exploit borrowers through deceptive terms, excessive costs, or loan structures designed to fail. Common characteristics include inflated interest rates bearing no relationship to the borrower's risk profile, origination fees and points well beyond market norms, undisclosed prepayment penalties, and the bundling of unnecessary insurance products. For mortgage note investors operating in the secondary market, the concern is not the origination itself — that happened years ago, between a lender and a borrower — but the assignee liability that can follow the loan into new hands.

What Makes a Loan Predatory

There is no single legal definition of predatory lending. Instead, it is identified by a pattern of characteristics that, taken together, indicate the loan was designed to benefit the lender at the borrower's expense:

Assignee Liability: Why It Matters to Note Buyers

When you purchase a mortgage note on the secondary market, you step into the shoes of the original lender — and in certain circumstances, you inherit liability for origination defects. Federal and state laws create varying levels of assignee exposure:

• Truth in Lending Act (TILA). Borrowers can assert TILA claims against assignees for certain disclosure violations. The right of rescission (on refinance transactions) can be raised as a defense in foreclosure proceedings.
• Dodd-Frank Act / Ability-to-Repay. Loans that fail the Qualified Mortgage (QM) standard may expose the current holder to ability-to-repay challenges. A borrower facing foreclosure can counterclaim that the original lender never verified their capacity to repay, and this defense travels with the loan.
• State consumer protection laws. Many states have their own anti-predatory-lending statutes with explicit assignee liability provisions. Some states impose strict liability on assignees regardless of knowledge, while others require a showing that the assignee knew or should have known about the predatory terms.
• CFPB enforcement. The Consumer Financial Protection Bureau has authority to pursue enforcement actions related to unfair, deceptive, or abusive practices — and that authority can reach current holders of loans with predatory origination histories.

Red Flags During Due Diligence

Note investors should screen for predatory lending indicators during the collateral file audit and loan-level review:

• Origination date. Loans originated between 2002 and 2008 — the peak of subprime and alt-A lending — carry elevated predatory lending risk. This era produced the highest concentration of no-doc, stated-income, and high-fee originations.
• Interest rate vs. credit profile. Compare the note rate to prevailing rates at the time of origination. A 12% rate on a 2005 loan to a borrower with a 700 credit score is a red flag.
• Points and fees on the HUD-1. If the closing disclosure or HUD-1 settlement statement is in the file, review total origination charges. Fees exceeding 5% of the loan amount warrant scrutiny.
• Prepayment penalty terms. Multi-year prepayment penalties with harsh step-down schedules suggest the loan was structured to prevent the borrower from refinancing into better terms.
• Loan-to-value at origination. A high-LTV loan with minimal documentation and a high rate is a classic predatory profile.

Protecting Yourself as a Buyer

Assignee liability cannot be entirely eliminated, but it can be managed:

• Thorough due diligence. Review every document in the collateral file — not just the note and mortgage, but the origination disclosures, HUD-1, and any modification agreements.
• Representations and warranties. Ensure the LPSA includes seller representations that the loan was originated in compliance with applicable laws and that no predatory lending claims are pending.
• Pricing for risk. If a loan shows borderline predatory characteristics but is otherwise attractive, price it to account for the legal risk. A deeper discount compensates for the possibility of a borrower defense.
• Legal counsel. For loans with clear predatory indicators, consult an attorney before purchasing. The cost of a legal review is negligible compared to the cost of defending an assignee liability claim.