Effect of Predatory Lending Laws
on Mortgage Credit

In a thoughtful article in the Wall Street Journal, Patrick Barta examines the effect of anti-predatory lending laws on mortgage credit. He bases his analysis on an anti-predatory lending law in Georgia that took effect on October 1, 2002. The legislators' intent was to bar "unwarranted fees," and "unfair interest rates for unsophisticated borrowers." The Georgia law follows the legislative template introduced in the Federal Home Ownership and Equity Protection Act (HOEPA). That is, the law prohibits certain contractual terms, such as balloon payments, on loans defined as "high cost." Among the features that cause a mortgage loan to be defined as "high cost" under the new Georgia law are fees that exceed 5 percent of the total amount of the loan. In addition, lenders who make high-cost loans must adjust some of their lending and underwriting procedures. For example, providers of "high cost" loans in Georgia must arrange for their borrowers to obtain credit counseling from a nonprofit third party. Perhaps the most significant feature of the Georgia law is that it holds buyers of high-cost loans in the secondary market (e.g., Fannie Mae and Freddie Mac) liable for violations by lenders and brokers.

The response of mortgage lenders in Georgia was predictable. For example, "Chase Manhattan Mortgage Corp., a unit of J.P. Morgan Chase & Co., and Countrywide Credit Industries Inc. Calabasa, Calif., have said they will stop offering high-cost loans altogether, even though they remain legal under the law. Freddie Mac has said it will stop buying high-cost loans in Georgia.

Even subprime loans that are not designated as high-cost loans under the statute are being affected. Ameriquest Mortgage Co., the seventh-largest subprime originator in the nation, told the American Banker that the anti-flipping provision in the Georgia statute has convinced it to cease making all subprime loans in Georgia. The anti-flipping provision requires that when refinancing borrowers who have loans less than five years old, lenders must ensure the borrower receives a "net tangible benefit." Ameriquest senior executive vice-president Adam J. Bass told the American Banker "Nobody has explained that to me. . . I haven't seen anything from the Georgia department of banking that defines what that is and how you comply." Robley S. Rigdon, deputy commissioner with the mortgage division of the Georgia Department of Banking and Finance told the American Banker that the agency "made some attempt at trying to define that—we looked at a number of states and what they had out there," but acknowledged "nothing is going to protect lenders from being sued."

Consumer activists apparently welcome the decline in subprime lending. In response to these reports, William Brennan, director of the Home Defense Program of the Atlanta Legal Aid Society is quoted as saying, 'Borrowers don't need high-cost loans. When you hear lenders are pulling out of the state because they can't make high-cost loans, we say, great, we'll buy your bus ticket out of here."

Not to be outdone, the New York legislature has jus passed a bill that has been signed by Governor Pataki that is "designed to curb predatory lending." Mortgage lenders are accused of making loans that are "unaffordable to the borrowers" As in Georgia, the law applies only to "high cost" loans; that is, those with interest rates more than 8 percentage points above the interest rate on Treasury bills of comparable maturity or where points and fees exceed 5 percent of the amount of the loan. The bill was strongly supported by the American Association of Retired Professors and the New York Public Interest Research Group.

Sentiment among regulators in Washington may be tilting toward some form of federal preemption of laws like those in Georgia and New York. At a recent predatory lending conference sponsored by the American Enterprise Institute, a Washington DC-based think-tank, Federal Reserve Board Governor Edward Gramlich remarked of the current patchwork quilt of state and local regulations, "If I were a national lender, I would find it to be a zoo. I don't think anybody would agree that the current situation is optimal."