Mortgage-Trapped

The question is whether some consumers can adequately protect themselves in the complex financial transactions of the new mortgage marketplace.

A Tough Price to Pay

Willie Webb Jr. of Lauderdale Lakes, Fla., was pleased for his daughter at first when she told him she had refinanced the home she had inherited from her grandparents, reducing her interest rate and allowing her to pay off some bills. He assumed she had gotten a fixed-rate mortgage, the kind of loan with which he is most familiar. A few months later, she called him in a panic. It turned out that she had an adjustable-rate mortgage in which the payments starting rising almost immediately, and when Webb investigated further, he learned that she can't get out of the loan without paying a $6,000 prepayment penalty.

Webb is angry that his daughter, Keisha Smith, a single mother with four children, agreed to take a loan she did not understand. He has made the payments for her some months because otherwise she would risk losing her home.

Many newer mortgage products make it difficult and costly for borrowers like Smith to extricate themselves. The mortgage bankers group recently reported that more than 50 percent of some kinds of adjustable-rate loans contain prepayment penalties, which require borrowers to shell out big bucks to break free. A prepayment penalty of about 3 percent of the mortgage loan -- about $9,000 on a $300,000 mortgage -- is not unusual, according to the Federal Reserve.

A study by the Center for Responsible Lending, a consumer-advocacy group, said last year that about two-thirds of Virginians with high-interest, subprime loans also have prepayment penalties. In Maryland, where prepayment penalties are restricted by law, about a quarter of subprime borrowers have them. (Comparable figures were not available for the District.)

The biggest risk lurking behind all these loans is the threat of foreclosure. Last month, the Mortgage Bankers Association reported that mortgage delinquencies were on the rise, particularly for costly subprime loans. Likewise, the Center for Responsible Lending said in a recent report that more than 19 percent of subprime loans made in 2005 and 2006 are at risk of foreclosure.

Federal and state banking regulators have instructed lenders to make sure before issuing a loan that borrowers can keep up if payments are adjusted upward. Consumer advocates and some members of Congress have asked that the guidance also include what is called a 2-28 mortgage, under which borrowers have low, teaser rates during the first two years, after which payments increase.

Consumer groups also say they would like to see a "suitability" standard imposed on mortgages whereby lenders would be required to show that people got loans appropriate for them. Sugarman, for example, thinks putting Howard into an interest-only loan left the man with a "horrible situation." But banking trade groups oppose these proposals, saying they could curtail lending to some people who would otherwise have trouble getting loans they need.

Additional government regulation "could impede the ability of the market" to change to meet demand, said Doug Duncan, the chief economist at the Mortgage Bankers Association.

But Fishbein, the consumer activist, said legislators, regulators and lenders need to do more to protect consumers.

"We're not confident buyers are getting all the information they need," he said. "They don't understand the toxic environment."