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Best Interests: How Big Lenders Sell A Pricier Refinancing To Poor Homeowners

LEXINGTON, Ken. (Wall Street Journal) - Beverly and David Russell once had one of the best mortgage deals in America. Their interest rate: zero.

But last year, the Russells gave up that loan. With credit-card and other bills piling up and three children to support, they refinanced with an 11 percent mortgage from Countrywide Home Loans, one of the country's biggest lenders.

The Russells' monthly mortgage bill more than doubled. This year, Mr. Russell lost his job as a seasonal forklift driver and the couple has fallen three months behind on their payments. Ms. Russell, a disabled former hotel maid, is afraid they could lose their home. "It was the biggest mistake I ever made," she says.

With interest rates near historic lows, millions of Americans are refinancing their home mortgages to reduce their monthly payments. But federal officials and advocates of low-income housing are worried about those on the bottom rung of homeownership who are doing just the opposite: trading in sweet mortgage deals for higher-cost debt.

These low-income borrowers obtained their original zero- or low-interest mortgages thanks to government programs and private affordable-housing programs run by the likes of Habitat for Humanity, the original lender to the Russells. The boom in home prices in the 1990s gave these borrowers more home equity, enabling refinancing companies to offer them terms on which they could pull some cash out, an attractive lure. The companies generally charge sizable up-front fees and the high interest rates that are standard in the "subprime" market - the business of making loans to people with spotty credit or low incomes.

After hearings last year on home-lending practices, the Federal Reserve Board proposed a rule designed to discourage refinancing of no-interest or low-interest loans in nearly all circumstances, for the first five years of a mortgage. (A low-interest loan is defined as any loan made at two percentage points below the comparable-term Treasury bond.) The board is concerned that "unscrupulous lenders are targeting some consumers," says a Fed official. The board was scheduled to meet Friday to decide on the rule, one of many proposals to curb what it calls potential abuses in mortgage lending.

Consumer activists say the ban should be longer than five years and criticize the proposal's inclusion of an exception for any loans "in the interest of the borrower." They argue that the exception is so broad that it will enable most lenders to keep refinancing no-interest and low-interest loans. The Fed "shouldn't allow this loophole," says John Taylor, chief executive of the National Community Reinvestment Coalition, a nonprofit representing 800 community groups urging a ban for the full term of such favorable loans.

Some of the nation's biggest subprime lenders have refinanced zero-interest and low-interest loans from Habitat, including Countrywide, units of Citigroup Inc., Household International Inc., Ameriquest Mortgage Co. and a unit of tax giant H&R Block Inc. Some of these lenders and brokers say consumers benefit by consolidating their debts. They also argue that the refinancings can lower total monthly payments for consumers with very large credit-card bills because the interest rates on the new mortgages are lower than on credit-card debt - which can top 20 percent a year.

People with extremely shaky credit often aren't offered a second mortgage or home-equity loan, which would preserve their cheap financing and let them pay off bills. Lenders say second mortgages or home-equity loans for such borrowers are often too risky because the second lenders are also second in line in foreclosure proceedings and could lose much or all of their investment, after legal and other costs, if borrowers default early on their debt. If these lenders offered second mortgages, they probably would carry interest rates so high - to compensate for the risk - that they wouldn't be attractive to customers.

One of the things that alarms Habitat and some Fed officials is that customers who fall behind on their mortgages can lose their homes, while those who fall behind on credit cards and other types of unsecured consumer debt face only angry collectors and ruined credit.

"Nobody in their right mind would refinance a zero-percent-interest, 20-year mortgage with a 14 percent to 16 percent mortgage," although some borrowers have done just that, says Martin Eakes, chief executive of Self-Help, a Durham, N.C., credit union. At the urging of Mr. Eakes and others, North Carolina enacted a law designed in part to prohibit such refinancings.

Under pressure from activists and federal regulators, the biggest subprime player, Citigroup, said last November that it will no longer refinance subsidized loans. But the American Bankers Association opposes the Fed's plan, arguing that it would limit credit access for homeowners who need money in emergencies and would impose burdensome new paperwork requirements on banks.

"We don't think it's a good law to take a class of people and say you can't access the equity in your home for any reason for five years," says James Gazdecki, executive director for government relations at Option One Mortgage Corp., an H&R Block lending unit that also opposes the rule.

Habitat for Humanity, known for its association with former President Jimmy Carter, has long given poorer families an alternative to high-cost lenders. Through 1,600 chapters, the group enlists community volunteers to build houses. Borrowers who want to own them must invest 300 to 500 hours of "sweat equity" in building homes for other families.

The Russells moved into their cream-colored four-bedroom Habitat house in Lexington in 1998. They had a 20-year, $40,000 Habitat loan that required $200 a month in payments, including taxes and insurance. With such an attractive loan, housing costs no longer seemed a worry. At the time, Ms. Russell's disability payments totaled about $15,000 a year and Mr. Russell earned about $5,000 a year running a forklift in a tobacco warehouse for four months in tobacco season.

Then the family's car broke down. Credit-card bills piled up. "I had hit a hard spot at the time," says Ms. Russell, 35 years old. "The bill collector was on my back every minute."

Albert Presley, another Habitat homeowner and a family friend, told Ms. Russell about John Howard, branch manager at Collateral One Mortgage, a local broker. Mr. Presley said Mr. Howard had refinanced the Presley family's Habitat loan, too.

Ms. Russell says Mr. Howard told her he could lower her total monthly payments on all her debts, satisfying the collectors. She also says he told her she could get cash to fix up her house, buy Christmas gifts or take a vacation. Mr. Howard says he doesn't recall the details of his conversation with Ms. Russell. But he says that she and Mr. Presley benefited from lowering their monthly payments and paying off overdue bills.

Ms. Russell says she has trouble reading and writing and didn't understand the piles of loan documents she signed. But she says she was eager to get the $9,000 in cash from a $51,300 loan from Countrywide. The new adjustable-rate loan has an 11 percent interest rate, set for the first two years. Afterward, if rates rise, the mortgage can increase to as high as 18 percent - but won't fall below 11 percent if rates decline. The couple's new payment: about $500 a month. MORE

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