The Impact of State and Local Predatory Lending Laws (Not All Laws Are Created Equal)

Strict predatory lending laws—are they enough to protect borrowers? Not always, according to Anthony Pennington-Cross, a senior economist with the Federal Reserve Bank of St. Louis.

Pennington-Cross spoke Jan. 27 at a “Breakfast with the Fed” event sponsored by the Federal Reserve Bank of St. Louis’ Little Rock Branch. The event was held at the Little Rock Branch, with more than 25 bankers, government officials and community development leaders in attendance.

Pennington-Cross has conducted extensive research on the effects of federal, state and local laws that restrict some types of high-cost and high-risk lending, such as the Home Ownership and Equity Protection Act (HOEPA), the Federal Reserve’s Regulation Z and the Arkansas Home Loan Protection Act.

Predatory lending most often occurs in the sub-prime mortgage market, which serves borrowers who are less financially secure than those served by the prime market. Predatory loans are most often home-equity (refinance) loans and are found predominantly in low-income and minority households.

Borrowers can become victims of predatory lenders when they don’t fully understand the documents associated with their loan. “For all practical purposes, the seller, buyer and refinancer rely on the representations and interpretations of closing agents,” Pennington-Cross says. “This makes it possible for unscrupulous agents to take advantage of that information gap. Such abuses are more likely when the borrower is perceived as vulnerable because of age, economic circumstances, education or disability.”

According to data from the Mortgage Bankers Association of America, sub-prime loans experience significantly more foreclosures than do prime mortgages or Federal Housing Authority (FHA) loans. From 1998 to 1999, sub-prime foreclosures increased from 2 percent to nearly 10 percent, while prime mortgages and FHA loans stayed relatively the same. Basically, one out of 10 homes in the sub-prime market were foreclosed, a statistic that sub-prime lenders often use to justify their higher rates.

In his paper, “The Impact of Local Predatory Lending Laws” Pennington-Cross measures the strength of state predatory lending laws with a comparative index that captures differences among the various state laws. While there is substantial variation in the laws, they typically extend the coverage of HOEPA by including home purchase and open-end mortgage credit, by lowering interest rates and fees, and by restricting the use of balloon payments and prepayment penalties.

Arkansas’ Home Loan Protection Act went into effect in July 2003. Pennington-Cross said lowering the act’s annual percentage rate trigger would help strengthen the law and further restrict predatory lending in the state.

During a question-and-answer session after Pennington-Cross’ presentation, Jim DePriest, assistant attorney general for the state of Arkansas, said that banks and finance companies don’t like to make high-risk loans available.

Pennington-Cross countered that the sub-prime market may involve lenders that don’t fall into traditional banking and finance categories. “There are numerous John’s Tackle Shops that give loans… but are they regulated?” he asked.

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