Don't Get Trampled by Loan Steering

If you're shopping for a home loan, make sure you're not being steered down the wrong path.

Last week, the National Training and Information Center, a resource center for community organizations, released a study of Citigroup's (C) lending practices during the year 2000 and found that borrowers who qualified for low-cost prime loans were more likely to receive high-cost subprime loans -- a practice known as loan steering.

Loan steering occurred, says Jason Kiely, author of the study, because borrowers who walked into one of Citigroup's 2,095 subprime lending branches nationwide weren't being referred to one of its 458 prime lending branches.

"Citigroup is almost exclusively pushing high-interest loans," he says.

According to the study, in Cleveland, Ohio, where there's just one prime lending branch and 37 subprime lending branches, only 7% of Citigroup's loans were prime. But in Washington, D.C., which has 16 prime branches and 22 subprime branches, 66% of loans were prime -- despite the fact that subprime lending branches outnumbered prime lending branches.

"The bottom line is that what type of loan you get, be it prime or subprime, should be determined by creditworthiness," Kiely says. "But we found the numbers don't bear that out. Primarily, the determining factor in what loan you got was based on [how close you were] to a prime lending branch."

However, if you have your hands on the necessary information, you can limit your chances of getting a high-cost loan when you might in fact be able to get a better rate.

A Tale of Two Cities If you live near a Citibank branch, you're far more likely to get a prime loan than if you live in an area dominated by subprime branches. The upshot? Where you live may be more important than your credit score in determining what kind of loan you receive.
Location	# of Prime Branches	# of Subprime Branches	% of Prime Loans	% of Subprime Loans
Cleveland, Ohio	1	37	7.0%	93.0%
Washington, D.C.	16	22	66.4	33.6
Source: NTIC

A Steering Problem

While the NTIC's study may not reflect Citigroup's current lending practices, since it was based on the company's lending practices during the year 2000, it highlights the subtle, yet costly, problem of loan steering. (A Citigroup representative couldn't be reached for comment.)

Fannie Mae (FNM) estimates that nearly half of all subprime borrowers would qualify for lower-cost mortgages. Nearly 600,000 American borrowers are affected by this practice each year, according to a July 2001 study by the Coalition for Responsible Lending, a nonprofit group formed in 1999 to help solve lending problems.

"We estimate that the cost to American families is $2.9 billion a year [because] the rate on a subprime loan is about 4% more than a prime loan," says Eric Stein, author of Coalition's study. "So, if you have that loan for three years, you're talking about paying far more to a lender your credit would qualify for."

Lenders rely on the FICO score, a numerical reflection of credit risk created by Fair Isaac & Co. (FIC), to determine the rate borrowers should receive on a loan. A score of 850 is highest and would entitle a borrower to low rates, while a score of 500 is considered quite low and would result in a higher rate.

Consider the difference credit scores have on a $100,000 30-year fixed-rate mortgage. According to Fair Isaac, borrowers with a credit score of 560 would receive a subprime loan rate of 9.605% while borrowers with a credit score of 720 would receive a prime rate of 6.628%. Over the life of the loan, the borrower at 9.605% would pay $75,000 more in interest costs.

Many borrowers who qualify for prime loans, especially those in low-income areas, end up with more expensive subprime loans because the number of prime lenders have been shrinking, says Allen Fishbein, general counsel for the Center for Community Change, low-income public advocacy group.

Even if borrowers shop around and visit a variety of lenders in their area, some won't know they can receive better loan terms elsewhere, since subprime lenders dominate low-income neighborhoods.

"If those are the only lenders that appear to be available, then those are the only options they think they have," Fishbein says.

Since there's no law on the books requiring lenders to inform borrowers that they qualify for a better loan, Fishbein says many take what they can get, relieved to receive a loan and overwhelmed by the confusing mortgage application paperwork.

Grab the Wheel

Smart shoppers can avoid being steered toward subprime loans by knowing their credit score and how it affects their loan rate. In the past, this was impossible to determine because lenders and credit rating agencies wouldn't reveal how scores influenced rates.

This situation changed four months ago when Fair Isaac quietly began allowing people to see how credit scores affect interest rates for the first time at its consumer Web site, MyFico.com. The site shows how the interest rates for eight different home loan types and four automobile loan types change as credit scores rise and fall.

For example, someone with a credit rating of 850 would have a rate of 6.674% on a 36-month new car loan. But someone with a rating of 500 would get a rate of 18.597%.

Know the Score One way to prevent loan steering is to know how your credit score influences the interest rates across different types of loans.
Loan Type	Credit Score
	500-559	560-619	620-674	675-699	700-719	720-850
30-year fixed-rate mortgage	10.148%	9.605%	8.440%	7.290%	6.753%	6.628%
Home equity loan	12.978	11.728	10.228	9.453	8.953	8.653
36-month new auto	18.597	16.206	12.225	9.498	7.386	6.674
48-month used auto	18.386	16.949	12.746	10.147	7.995	7.348
Source: MyFico.com

"This information is free, updated every day and has information for every state in the union as well as the national averages," says Craig Watts, consumer affairs spokesperson for Fair Isaac.

While knowing the link between rates and credit scores can help borrowers ensure they receive appropriate loan terms, they should still read the fine print when signing a mortgage.

"You should really have an expert looking at every page that's in front of you, because you can be told that the interest rate is one thing and on the paper it's something else," says David Swanson, communications coordinator for the Association of Community Organizations for Reform Now, a community organization for low and middle-income families. "It's not all about the interest rate. They could finance in huge fees into the loan or add in a prepayment penalty that could trap you into the loan."

The bottom line: Borrowers must shop around and educate themselves before signing a mortgage. There's nothing illegal about offering unfavorable loan terms to someone eager to accept them.

"Isn't that the American way? To charge people as much as you can get away with?" asks Margot Saunders, managing attorney with the National Consumer Law Center, an advocacy group for low-income consumers. "The whole problem with loan steering is that there's nothing illegal about it. It's buyer beware out there."

>To order reprints of this article, click here: Reprints