Predatory Lending Practices Scrutinized by States

States are taking the lead to protect homeowners and homebuyers from deceptive and manipulative mortgage lending practices. So far this year, three states—Connecticut, Texas and Virginia—have enacted legislation to address the problem of "predatory lending." Two states adopted strong regulations against abusive lending practices within the nation’s booming "subprime" mortgage industry. Nineteen other states considered new laws in 2001.

Predatory Lending Explodes over the Last Decade

Predatory lending occurs predominantly in the subprime mortgage industry. Subprime loans have higher-than-normal interest rates, and are designed to serve Americans whose poor credit prevents them from qualifying for conventional mortgages. While subprime lenders fill a legitimate need, some are giving the industry a black eye with unscrupulous, predatory practices.

Predatory lenders provide high-cost loans to borrowers who they know qualify for conventional loans. The chairman of Fannie Mae estimated that as many as half of subprime borrowers could have qualified for traditional mortgages at lower interest rates. Predatory lenders also jack interest rates above what is reasonable within the industry and charge excessive fees, simply because they can get away with it.

The problem has increased as the subprime lending market has skyrocketed. Nationally, subprime lending grew 900 percent from 1993-99, and most dramatically in minority communities. Subprime loans now account for 51 percent of all refinancing mortgages in predominately African-American neighborhoods, compared to nine percent of loans made in predominantly white neighborhoods. Similarly, almost one in three refinancing loans made to low-income Latinos are subprime.

Many lenders believe that predatory lenders specifically target communities that tend to be less informed about the mortgage loan process, and those who lack the resources to fight back when they are cheated. "Predatory lending is a destabilizing force," declared Senator Vincent Fort, who cosponsored predatory lending legislation in Georgia. "In a very real sense, it is the most important battle we must fight today for civil rights, for senior’s rights, and for sustainable community development."

North Carolina Led the Way

North Carolina was the first state to address the problem of predatory lending with comprehensive legislation. That 1999 law prohibits subprime loans that include:

• balloon payments, call provisions and negative amortization;

• prepayment penalties for loans under $150,000, increased interest rates after a default, and improper payments to home improvement contractors; and

• "flipping" of home loans—where refinancing puts the borrower in a worse financial position.

State Action Against Predatory Lending in 2001

Connecticut enacted the Abusive Home Loan Lending Practices Act (HB 6131) this session which deals with predatory lending in a comprehensive manner. It restricts balloon payments, default charges, and prepayment penalties. It bans mandatory arbitration clauses, call provisions, and a series of other practices associated with predatory lending.

The Texas legislature passed SB 1581, which bans "single premium" insurance and prohibits refinancing a low-rate loan with a high-rate one. The legislation also restricts balloon payments and prepayment penalties.

Virginia enacted two laws against predatory lending. HB 2708 prohibits mortgage lenders from "flipping" loans, while HB 2787 stops lenders from encouraging homeowners to default and increases penalties for lenders who violate consumer protection laws.

In late April, Illinois Governor George Ryan’s tough predatory lending reforms were approved by the General Assembly’s bipartisan Joint Committee on Administrative Rules. The state’s new regulations establish criteria for high-cost mortgages and a series of penalties and requirements for when lending practices exceed the new thresholds.

In January, new predatory lending regulations took effect in Massachusetts. The state Division of Banks banned the financing of "single premium" credit insurance and expanded the category of loans protected against abusive practices.

The California Assembly also approved AB 489 that prohibits "flipping," "packing," and lending without regard to the borrower’s ability to repay. This legislation is now under consideration by the State Senate.

Like so many areas of consumer protection, predatory lending is not a black-and-white issue. Subprime lenders provide loans to some borrowers who otherwise could not qualify for a home mortgage. But legislators, activists and many in the home mortgage industry see too many borrowers victimized with unfair loan terms. So, legislation against predatory lending is likely to continue, and gain momentum, across the states.

Predatory Lending Practices Include: Steering—Deliberately directing borrowers who can qualify for conventional mortgages toward high-interest subprime loans. Packing—Packing excessive fees, including unnecessary insurance coverage, into the loan agreement without a borrower’s understanding. Flipping—Repeated refinancing of a loan by rolling the balance into a new loan, increasing both borrowers’ costs and lenders’ profits. Lending without regard to the borrower’s ability to repay—Offering mortgages based on borrowers’ equity in their homes, rather than their capacity to repay the loans, inevitably leading to default and forclosure.

For more information about predatory lending, including model policies and state resources, click here.