Anti-Predatory Lending Laws
and Unintended Consequences

Consumer credit has provided numerous examples of unintended consequences of government regulations designed to "protect" consumers. Currently, many legislators in American cities and states seem intent on supplementing federal regulations on home mortgages with their own regulations. Many of their proposals to halt "predatory tactics" appear to ignore existing regulations of the Federal Reserve and Department of Housing and Urban Development (HUD). Most important, some of these legislative efforts, specifically those that would limit the rates that subprime lenders can charge on residential mortgages are likely to have unintended and harmful effects on the very consumers that the legislators seek to protect. This lesson should have been learned long ago.

Subprime loans and predatory loans are not synonymous

HUD has documented the benefits to consumers of subprime mortgage loans as follows:

Subprime mortgage lending provides a source of funds for credit-impaired borrowers and other borrowers that are unable to obtain credit in the prime market. While subprime lending often involves lending to borrowers with past credit problems, the subprime market is more than that. A borrower may not qualify for a prime loan, yet may be eligible for a subprime loan, for reasons other than past credit performance. For example, a borrower may have a good credit history but have high monthly debt payment relative to income. Or, a borrower may have few or no assets other than current income to support loan payments. Borrowers may also be self-employed, have variable income, or simply want to limit disclosure of their financial situation. These conditions may make it difficult for a borrower to obtain credit at prime rates, yet a subprime lender may be willing to take the added risk in exchange for a higher interest rate. Consequently, there is no standard industry definition of a subprime loan, and the market may be defined in different ways by different analysts.

(Source: HUD, Curbing Predatory Mortgage Lending, August, 2000. p. 27)

While it is fairly simple to define a subprime loan, the HUD paper observes: "Defining the practices that makes a loan predatory, however, is a problematic task . . . .a list of predatory tactics does not consider the context in which the alleged abuse occurs." (HUD, p. 17). In a symposium on subprime lending, Stephen F. J. Ornstein observed that in a recent proposal to amend HOEPA, the Federal Reserve Board noted that its proposal did not "define 'predatory lending.' The Board acknowledges that information about predatory lending is essentially 'anecdotal,' and that there are no precise data and no ready means for measuring its presence." (Conference on Consumer Finance Law, Subprime Lending and Finance, March1-2, 2000) In short, predatory loans are largely in the eyes of the beholder and may be either prime or subprime. This fact has been obscured in the city and state legislation that has been proposed or passed in recent years.

Current laws: proposed and enacted

There are already three major laws that regulate the market for home mortgages: the Truth in Lending Act (TILA), the Home Ownership and Equity Protection Act (HOEPA) and the Real Estate Settlement Procedures Act (RESPA). HOEPA "covers closed-end loans to refinance existing mortgages and closed-end home equity loans that charge either (i) an annual percentage rate (APR) of more than 10 percentage points above the yields on Treasury securities of comparable maturities . . . , or (ii) points and fees . . . that exceed the greater of 8 percent of the loan amount or $400 (adjusted for inflation)." (HUD, p. 51) Currently, a proposed Federal Predatory Lending Consumer Protection Act (H.R. 4259) would change the APR threshold to 6 percent on first mortgages and 8 percent on second mortgages. Thus, more loans would be subject to the federal HOEPA.

In spite of widening federal statutes, legislators in cities and states across the country have been rushing in to "protect" consumers. So many laws have been proposed or enacted that only a small sample can be reviewed here. At a recent law conference, Franzen and Salzand provided a tabulation of 35 states and cities that had introduced or enacted "anti-predatory" lending initiatives. (Conference on Consumer Finance Law, Real Estate Finance, May 17-18, 2001.) The thrust of these statutes has been to lower the threshold at which mortgage loans are defined as subprime. For example, legislators in Pennsylvania and Massachusetts have introduced bills setting the "trigger" rate at 5 percent over comparable Treasury yields. The City of Chicago has adopted an ordinance that would set the trigger at 6 percent above comparable treasury yields.

What happens if a lender is found to have made "predatory" loans? Stephen F.J. Ornstein reports that in North Carolina, "A high cost home loan that violates one of the (prohibited acts and practices) is subject to penalties for usury (e.g. forfeiture of interest, and return of twice the interest paid) and is considered a deceptive act or practice, subjecting the holder to treble damages" (CCFL, Subprime Lending and Finance, March 1-2, 2001). An ordinance in Chicago states that in order to "act as a depository for the City" or to "bid on any contract with the City", home mortgage lenders in Chicago "are required to pledge that neither they or any affiliates are or will become predatory lenders." (CCFL, Subprime Lending and Finance).

What are the unintended consequences of this nationwide crusade to stop providing mortgage loans that are defined variously by legislators in cities and states across the country? If you were a local mortgage lender, you would avoid making subprime loans that have the "predatory" features as defined by your local statutes. The tougher the statutes, the larger the portion of the subprime market that falls into the "predatory" umbrella. If you are a national lender, you might be wise to pull out of states such as North Carolina that subject mortgage lenders to potentially heavy penalties if they should trip on the rules defining predatory lending. These laws may make the clergy and loan sharks happy. But they don't do much for consumers who know that a subprime lender "provides a source of funds for credit-impaired borrowers and other borrowers that are unable to obtain credit in the prime market."

[The papers cited here were presented at one or the other of two conferences sponsored by the Conference on Consumer Finance Law. They are contained in two very large loose-leaf notebooks that may be obtained from the conference for $195 each: c/o School of Law, Oklahoma City University, Box 117-A, Oklahoma City, OK 73106]