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cr C O M M U N I T Y REINVESTMENT forum FALL 2002 PUBLISHED BY T H E F E D E R A L R E S E R V E B A N K O F C L E V E L A N D WHO HAS THE AUTHORITY TO REGULATE PREDATORY LENDING? Reports of fraudulent lending practices have proliferated in recent years, along with testimonies of its destructive effects on many low- and moderate-income neighborhoods. Although predatory lending is a thorny issue—complicated by the absence of a consistent, shared definition—it is generally agreed that the term refers to abusive or deceptive mortgage lending practices, which may result in homeowners losing their homes in foreclosure.1 C O N T I N U E D O N N E X T PA G E AN EXCHANGE OF COMMUNITY DEVELOPMENT ISSUES AND IDEAS 10 In My Opinion Predatory Lending: Legitimate Lenders Can Be a Part of the Solution 12 4th District Profile Local Programs Work on Predatory Lending from the Ground Up 14 Compliance Corner Changes to HOEPA Regulations Aim to Protect Consumers from Home Equity Fraud > EDITOR’S NOTE > CONTINUED This issue of CR Forum investigates who has the authority to address predatory Although it is difficult to available for home improve- lending in the Fourth Federal Reserve District. Regulatory agencies, including measure the size or impact of ments, home equity can be the problem without a precise used to finance everything— the Federal Reserve, are concerned about abusive lending practices that may be COMMUNITY REINVESTMENT FORUM 2 F R O M PA G E 1 lending. When credit is not definition, according to one often, much more than the corroding some of the positive impacts of CRA-related lending in low- and moderate- estimate, U.S. borrowers lose owner intends or can repay. income neighborhoods over the last decade. $9.1 billion annually to preda- Chances are, this is exactly the Many financial institutions, government, private, and nonprofit players that cross local, state, and federal jurisdictions are dedicated to ameliorating the 2 tory lending. It is a market reason predatory lenders target failure that cannot be ignored. these individuals. What is driving the surge Unscrupulous loans can be problem—a testament to its severity and complexity, its cost to society, and the in unethical lending practices? found in the prime mortgage extent to which it has captured the attention of community economic development Many attribute it to the growth market, though the greater practitioners. But to many, the regulatory landscape is becoming more ambiguous of subprime lending, which competition among lenders extends legitimate credit to and greater standardization as new laws are enacted and others are preempted. A better understanding of each borrowers with less-than- in loan terms—both of which Fourth District state’s current legal and regulatory framework may clarify how to perfect credit histories. The are lacking in predatory loan address the problem without adversely impacting legitmate subprime lending. subprime lending market— schemes—make it unlikely. which ballooned from virtually Furthermore, most prime nothing in 1994 to $500 billion lenders are commercial banks, In My Opinion, penned by Kathleen Engel from Cleveland State University’s Cleveland-Marshall School of Law, discusses how financial institutions can help in 1999—has, in fact, provided savings institutions, and credit solve the problem, and 4th District Profile highlights grassroots efforts to combat greater access to credit to unions, all of which are tightly predatory lending across the Fourth District. Compliance Corner details recent those who otherwise might regulated at the federal and 3 4 not qualify. But questionable state levels. Although unregu- lenders are also most likely lated nonbank lenders, such as to flourish in this market: It mortgage brokers and lenders, is subject to fewer regulatory finance companies, and home the scope and impact of predatory lending in the Fourth District, and we thank them controls, less information is improvement contractors, may for their expertise and insight. We welcome your comments on this edition of available to consumers, and originate loans once licensed, most borrowers use the they are not subject to the same collateral in their homes to scrutiny, and there may be consolidate debt, make home pressure to complete as many improvements, or satisfy other transactions as possible, with credit needs. little concern for their appropri- amendments to the federal Home Ownership Equity and Protection Act that became effective this fall. A number of individuals have helped our Community Affairs staff to understand CR Forum ; please e-mail them to virginia.l.hopley @ clev.frb.org Ruth Clevenger Virginia Hopley Community Affairs Officer Research Analyst and Managing Editor Subprime lending tends ateness. Because these loans are to correlate with low- and bundled, securitized, and sold moderate-income individuals on the secondary market, the who cannot qualify for conven- loan originators can relinquish tional loans and may not their responsibility for the understand the complex docu- integrity of the loans. mentation involved in mortgage credit providers. In cases where Governor Edward Gramlich Addressing Fraudulent discrimination or targeting can has observed, “attempts to Lending Practices? be proven, state human or civil deal with predatory lending are hampered by two broad phenomena: ■ Predatory lending often promises that can be of value to many borrowers. Predatory lending seems to occur most commonly in the unregulated sector of the loan market by lending institutions that are not forced to undergo periodic compliance exams.” ver the last decade, 5 The growth in subprime lending is, of course, not the only cause behind the rise of deceptive lending practices. Our investigation here seeks a better understanding of who has the authority to address such practices in the Fourth Federal Reserve District, and where consumers may turn when saddled with a bad loan. called to task. O hio’s Division of Financial Institutions, housed in the state’s Department of Commerce, Several municipalities have regulates state-chartered banks Reserve District—Ohio, also proposed or enacted local and oversees consumer finance Kentucky, Pennsylvania, and ordinances against predatory licensees, including mortgage West Virginia—have acknowl- lending practices. Grassroots brokers. State-chartered banks edged the rise of questionable and nonprofit organizations must comply with state and lending practices and their are aggressively lobbying to federal statutes and regulations potentially ruinous consequences protect their constituents and governing their operations and on residents and neighborhoods. offering credit counseling and those of their subsidiaries. the states of the Fourth Federal involves the abuse of credit ■ O rights commissions also may be Ohio Across the Fourth District, financial literacy education (see 6 Two laws took effect in a host of players are actively 4th District Profile, page 12). Ohio in 2002, giving the state’s pursuing remedies to protect Legal aid societies and attorneys Department of Commerce consumers and drive out the are representing victims and additional authority to halt bad actors. At the state level, co-counseling with private predatory lending. In May, some agencies have authority attorneys to provide adequate the Ohio General Assembly and enforcement powers to representation and legal exper- passed Senate Bill 76—an address the problem from tise. And law enforcement agen- amendment to the Mortgage various angles. Often, a state’s cies are realizing they can play Broker Law—to strengthen ability to protect citizens from a proactive role in preventing the regulation of the mortgage unethical lenders rests in the such criminal activity. There broker industry. The bill’s attorney general’s office and are also many federal-level provisions require loan officers the state banking department. laws and regulatory agencies working for mortgage brokers to Typically, the attorney general’s that have authority to curb be licensed by the Department’s office protects consumers from fraudulent lending. Division of Financial Institutions dishonest or fraudulent business and subject to criminal back- transactions, while the banking ground checks, and loan officers department regulates financial must pass a knowledge test institutions and mortgage within 90 days of becoming 7 licensed. COMMUNITY REINVESTMENT FORUM How Are the States As Federal Reserve Board 3 H.B. 386 contains no although a pattern of such have been violated, the office provision for an individual’s practice must first be estab- may initiate enforcement action private cause of action. Under lished, which is cumbersome on behalf of the consumer and the current statute, private and time consuming. In cases refer criminal cases to the citizens cannot ask a court to where individuals can demon- police and county prosecutors. find a broker (or other lender) strate they have been the target In cases in which the county in violation of the law—only of discrimination, the attorney prosecutor chooses not to pursue the Department of Commerce general may file a charge with the defendant, the Department can pursue this avenue of the Ohio Civil Rights Commis- of Commerce may refer the action. Some consider such a sion for further investigation. case to the attorney general provision critical for consumer for prosecution. protection, and advocates hope If licensing requirement laws COMMUNITY REINVESTMENT FORUM EDUCATIONAL RESOURCES FOR CONSUMERS 4 Ohio Department of Commerce Borrow Smart Campaign “Predatory Lending: Tricks of the Trade and How to Recognize Them” “Don’t Become a Victim: A Guide to Predatory Lending” the Predatory Lending Study A second statute, House Committee (another outcome of Bill 386, resembles HOEPA 8 Kentucky H omeownership rates Attorney General’s Office and preempts local ordinances. the bill) will recommend such “Tips to Avoid Predatory Practices” The legislation created within action to the legislature in 2003. Pennsylvania the Department of Commerce a Although Ohio’s consumer Office of the Attorney General new Office of Consumer Affairs, protection laws are designed to that have been in their family which serves as an ombudsman prohibit deceptive, unfair, and for generations—often, the West Virginia for consumers who believe unconscionable sales practices, property is the family’s only Office of the Attorney General they have been victimized by the Ohio Attorney General’s asset. Coupled with the fact abusive lenders. Consumers Office plays a limited role that many borrowers are under- may file a complaint by calling in mitigating allegations of employed, undereducated, and “Loan Smarts: What Every Borrower Should Know” “Not in My House! Help ‘Judge’ McGraw Stop Predatory Lenders from Stealing the American Dream” Division of Banking “Know Your Mortgage” Kentucky 9 10 in Kentucky are higher than the national average, and many residents own homes 12 a centralized telephone number predatory lending. The state’s have low incomes, unscrupulous and mailing a form. The office Consumer Sales Practices Act lenders have plenty of fodder will examine each complaint regulates unfair and deceptive for equity stripping and asset- “Home Repairs and Improvement” and refer borrowers to credit acts and practices, but it based lending schemes. Although Department of Financial Institutions counseling organizations that exempts transactions made predatory lending is most often can assist them. In cases where by financial institutions as a considered a problem in urban it has regulatory authority, the “dealer of intangibles,” thus and high-density areas, rural Office of Consumer Affairs tries excluding most mortgage and suburban areas with a Office of the Attorney General “Don’t Fall Prey to Predatory Lending” 11 to act as a mediator between the lending. Ohio is one of the few prevalence of homeownership consumer and lender, with the states where financial institu- are just as prone to such activity. intent of avoiding legal action tions are exempt from this law. unless necessary. The office The attorney general may In Kentucky, fraudulent lending is not yet well policed, may refer matters to the super- get involved with cases of abu- and few laws regulate the intendent of the Department sive lending that are referred to mortgage industry. The Depart- of Financial Institutions, which that office for prosecution from ment of Financial Institutions has the discretion to investigate the Department of Commerce’s is responsible for chartering, and impose fines. Office of Consumer Affairs. licensing, and registering The same is true when outright fraud and forgery are alleged, The Department of Finan- and contractors involved in Pennsylvania P firms, and professionals oper- cial Institutions has recently originating unconscionable loans, ating in the state, including begun working closely with two the attorney general frequently mortgage loan companies and agencies that have some juris- attempts to mediate rather brokers. Kentucky has tried diction over dishonest lenders: than pursue legal action. These Consumer Equity Protection to pass a licensure law that the Real Estate Appraisers cases are handled under the Act—also known as the would register and regulate Board and the FBI. Unethical Consumer Protection Division, Predatory Lending Law— the state’s mortgage brokers, mortgage brokers may work which enforces the Consumer closely resembles HOEPA and but legislative attempts to do in collusion with appraisers to Protection Act and holds busi- preempts local municipalities so have been unsuccessful. inflate property values and/or nesses accountable for unfair from regulating lending. The It is anticipated that licensure alter loan documents. When and deceptive acts and prac- law requires lenders to assess efforts will continue in 2003 appraisers are identified as tices. However, without some consumers’ ability to repay loans as problematic loans increase being involved with a deceptive evidence of a pattern of mis- before closing, thus averting in severity. lending scheme, their license conduct, the attorney general’s the consequences of asset-based may be revoked. The FBI has office cannot issue subpoenas lending. Mortgage brokers are are identified primarily by state become involved with predatory to investigate brokers. subject to additional disclosures regulators during exams that lending efforts in parts of take place every 18 months. Kentucky, especially with loans to address predatory lending penalties for violating the law, If abusive practices are found, that involve falsified information, in Kentucky. The Department in addition to suspension of examinations of that lender are fraud, and conspiracy. When of Financial Institutions began licenses and other measures scheduled more frequently. cases involve criminal activity an aggressive financial literacy designed to discourage preda- When egregious practices are and felony indictments, they campaign targeting high schools, tory lending. identified, the Department of are often too big for the state and the state enacted a “no-call Financial Institutions may file to address single-handedly, and law” in July 2002 to limit the to regulate fraudulent lenders an administrative complaint, to federal enforcement becomes number of telemarketing phone resides in the Department of which the licensee has 20 days necessary. calls residents receive at home, Banking and the Office of the unless there is an existing Attorney General. The Depart- 13 Potentially predatory lenders Two initiatives are under way ennsylvania’s Mortgage Bankers and Brokers and 14 and specific monetary civil Pennsylvania’s authority to respond with a request for a Kentucky’s attorney general hearing. If there is no response, may bring cases against ques- business relationship (more ment of Banking regulates state- fines may be imposed and tionable lending practices when than 700,000 have signed up chartered institutions and many licenses revoked. At that point, fraud is involved and when a to date). This law indirectly nondepository financial institu- licensees’ appeals are referred pattern of behavior can be deters predatory lenders, many tions and licensees, including to the circuit court system. demonstrated. But because it of whom use aggressive tele- first-mortgage bankers and has no direct regulatory author- marketing to target borrowers. brokers, secondary-mortgage ity over many of the businesses lenders, and brokers and COMMUNITY REINVESTMENT FORUM financial institutions, securities 5 14 COMMUNITY REINVESTMENT FORUM 6 brokers’ agents. Consumer uphold the rights of consumers mediation program seeks resti- complaints are addressed by in business and service transac- tution, refund, or other relief. the department’s Consumer tions and to protect citizens’ 16 In cases of alleged discrimi- West Virginia A s in Kentucky, home- Services Division, which uses civil rights. Within this division, nation, the Civil Rights Enforce- information obtained from the the Bureau of Consumer ment Section of the Attorney are high, with the added demo- borrower to resolve complaints Protection enforces the Unfair General’s Office may investigate graphic of a large elderly popu- and to determine legal or Trade Practices and Consumer complaints, possibly resulting in lation. The elderly often are regulatory violations. Violations Protection Law and “investi- formal legal action or referral targeted by predatory lenders may result in the revocation of gate[s] fraud and deception in to the Pennsylvania Human because they have high medical licenses and/or fines. The Divi- the sale, servicing and furnish- Relations Commission (or other bills, need home repairs, and sion also attempts to mediate ing of goods and products, and government agency), which has have fixed incomes. Home between the consumer and the strives to eliminate such illegal some authority to enforce civil equity is one way for elderly institution/licensee, and prospec- actions.” It may take formal rights laws. Like Kentucky, residents to pay for such tive borrowers are referred to legal action against persons Pennsylvania’s attorney gen- expenses. consumer advice organizations and organizations engaging in eral has launched a statewide through the Pennsylvania unfair and deceptive conduct “do not call” program that small state, government officials Housing Finance Agency. in the sale of goods or services allows consumers to reduce are keenly aware of the increas- within the state. Because of the unsolicited and unwanted ing scale of unethical lending in volume of complaints filed each telemarketing calls. the state, and, since 2000, the The attorney general’s Public Protection Division works to ownership rates in West Virginia Although West Virginia is a year, the bureau’s statewide What Characterizes a Predatory Loan? Organizations, trade associations, and government agencies have varying definitions and perspectives on what constitutes predatory lending, and they do not necessarily agree with one another. Here we cite a sample of organizations and the lending practices they consider predatory. MORTGAGE BANKERS ATheS SMortgage O C I Bankers AT I OAssociation N O Fof America A M Ebelieves R I CthatAsignificant steps can be taken to combat abusive lending practices. Prohibited practices should include: ■ Steering borrowers to high-rate loans and lenders ■ Intentionally structuring high-cost loans with payments the borrower cannot afford ■ Falsifying loan documents ■ Making loans to mentally incapacitated home owners ■ Forging signatures on loan documents ■ Changing the loan terms at closing ■ Requiring credit insurance ■ Falsely identifying loans as lines of credit or open-end mortgages ■ Increasing interest charges when loan payments are late ■ Charging excessive prepayment penalties ■ Failing to report good payment on borrowers’ credit reports ■ Failing to provide accurate loan 1 balance and payoff amount. FA N NtoIaErecentMreport A Eby theF OFannie U NMaeDFoundation AT I O ,N“Generally speaking, According three features—alone or in combination—define predatory lending practices. Those features include targeted marketing to households on the basis of their race, ethnicity, age or gender or other personal characteristics unrelated to creditworthiness; 2 unreasonable and unjustifiable loan terms; and outright fraudulent behavior…” U.S. D E PA R T M E N T O F H O U S I N G A N D U R B A N D E V E LO P M E N T A N D TAHjointEreportD EissuedPAby RtheTU.S.MDepartment E N T Oof FHousing T HandE Urban T RDevelopment EASURY and the Department of the Treasury identifies four categories of predatory abuses: ■ Loan flipping ■ Excessive fees and packing ■ Lending without regard to the borrower’s ability to repay ■ Outright fraud. 3 legislature has enacted legislation of state law; exams for mortgage West Virginia’s Office of being proposed and passed. to outlaw dishonest lenders. For companies thus incorporate the Attorney General, too, is The AARP, various housing example, all mortgage lenders federal and state regulations. concerned about unscrupulous counseling agencies, and lending practices in the state. Its Mountain State Justice (a legal The Division of Banking West Virginia must be licensed works directly with consumers, Consumer Protection Division services organization) are dedi- and registered with the state maintaining a consumer com- enforces the Consumer Credit cated to remediating predatory (unless otherwise exempt). The plaint process to mediate and Protection Act, which lending, but also face resource 18 initial licensing of loan origina- between borrowers and com- guards residents against fraud. constraints. Private attorneys, tors took effect in July 2002 and panies under its regulatory The attorney general may too, may represent clients with includes seven hours of contin- authority. If mediation is suc- pursue cases on behalf of con- allegations of fraudulent loans— uing education every year, as cessful, consumers may see any sumers, and it investigates this is probably where most well as regular examinations. number of remedies, including companies suspected of engaging litigation is occurring, though refunds of overcharges, account in deceptive tactics to the extent it is costly and unaffordable to and lenders are supervised by adjustments, or a payment plan. its resources permit. those most likely to be targeted the West Virginia Division of If there is no response from Currently, mortgage brokers 17 Like Kentucky, West Virginia by unconscionable lenders. The Banking. According to state the company, the division may has no local ordinances, and complexities of the cases do not statute, a violation of federal open an investigation, and there is no preemptive language lend themselves to simplified law is tantamount to a violation licenses may be revoked by the to prevent such ordinances from legal procedures. state, among other injunctions. FFreddie R E DMac’s D IDon’t E MBorrow A CTrouble Campaign cites the following abusive lending practices: ■ ■ Repeatedly refinancing a loan within a short period of time and charging high points and fees with each refinance ■ Charging excessive rates and fees to a borrower who qualifies for lower rates and/or fees offered by 4 the lender. “Packing” a loan with singlepremium credit insurance products, such as credit life insurance, and not adequately disclosing the inclusion, cost, or additional fees ATheMAmerican E R I CBankers A N Association B A N KdoesE notR S“condone A S anyS Opractices C I AT ION that deceive, defraud or otherwise take unfair advantage of consumers.” It follows the distinctions that regulators make between subprime and predatory loans: ■ Making unaffordable loans based on the borrower’s assets ■ ■ Inducing a borrower to repeatedly refinance a loan 5 Engaging in fraud or deception. A S S O C I AT I O N O F C O M M U N I T Y OTheRAssociation G A N IofZ Community AT I O NOrganizations S F O Rfor RReform E F Now O R(ACORN) M Nidentifies OW the following predatory lending practices: ■ Excessive fees ■ Loan flipping—successive, repeated refinancing of loan that incurs high-cost fees ■ Higher interest rates than are warranted by the borrower’s credit ■ Disregard for the borrower’s ability to pay (known as “asset-based lending”) ■ Property flipping ■ Aggressive and deceptive marketing ■ Prepayment penalties ■ ■ Greater than 100 percent loan-tovalue ratio ■ Home-improvement scams Yield-spread premiums— compensation paid to mortgage brokers for coercing borrowers to accept higher interest rates ■ ■ Single-premium credit insurance financed into the home loan Falsified loan applications, including inflated incomes and forgeries ■ Balloon payments Inflated appraisals ■ ■ ■ Negative amortization Mandatory arbitration clauses. NOTES 1. See www.mbaa.org/resources/predlend/. 4. See www.dontborrowtrouble.com/dontborrow/anti_ predatory.html. 2. James H. Carr and Lopa Kolluri, “Predatory Lending: An Overview,” Fannie Mae Foundation, 2001. 5. See www.aba.com/industry+issues/predatorylendingmenu.htm. 3. HUD/Treasury Task Force, “Curbing Predatory Home Mortgage Lending,” June 2000. 6. Excerpted from www.acorn.org/acorn10/predatorylending/practices.htm. 6 COMMUNITY REINVESTMENT FORUM and brokers doing business in 7 Dishonest lenders often can As in the other Fourth District COMMUNITY REINVESTMENT FORUM 8 WHERE CONSUMERS CAN TURN FOR HELP Ohio Department of Commerce, Office of Consumer Affairs 866/278-0003 www.com.state.oh.us/ODOC/dfi/ consumeraffairs.htm Attorney General’s Office Consumer Protection 800/282-0515 www.ag.state.oh.us Pennsylvania Department of Banking 800/PA BANKS (for consumer complaints and inquiries) www.banking.state.pa.us find more loopholes through must assume a legal respon- most consumers do not turn which to escape victims’ legal sibility to refrain from anywhere for help and go recourse. This is a result of the making unsuitable loans unrepresented when faced with current regulatory framework: (that is, asset-based lending). a questionable mortgage lender. Many agencies have some Many victims of abusive lending authority over certain players terms end up in bankruptcy and practices involved in court or in foreclosure, only to deceptive lending practices; in damage their credit and lose turn, the lending and financial their homes. services industries are changing What More Can Be Done? T his examination of the Often, it is within these gaps Fourth District states illustrates that criminal and unconscion- that fraudulent lending practices able actions take place. Although predatory lending are not being addressed or 800/441-2555 www.attorneygeneral.gov some unregulated (and regu- incomplete, a range of solutions lated) players to operate to mitigate its severity have West Virginia unchecked. In fact, much of been offered by government 800/642-9056 www.wvdob.org/general/index.html what is considered “predatory officials, community-based lending” is actually permitted organizations, and trade asso- Office of the Attorney General Consumer Hotline by law unless there is evidence ciations that we interviewed. 800/368-8808 www.state.wv.us/wvag of fraud or nondisclosure. Some of these include: 800/223-2579 www.dfi.state.ky.us Office of the Attorney General Consumer Protection Division 888/432-9257 www.law.state.ky.us and illegal conduct in the origination of loans; lenders must recognize and take The very nature of predatory lending makes it difficult—if not impossible—to regulate comprehensively: Many individuals and organizations—often linked by schemes—may be involved in booking unethical loans. Interjurisdictional and interagency cooperation and responsibility have become convoluted, legal authority is scattered, and desperate consumers don’t know where to turn; it is then too late to save their homes. responsibility for the conduct of the brokers they deal with. Secondary- uals and players involved. and our understanding of it is Department of Financial Institutions liable for fraud, deception, regulate the number of individ- legal and regulatory structure in ■ market participants must guard against purchasing loans containing questionable business practices. ■ included in loan documentation, which prevent enforcement of the law, should be prohibited. ■ More training should be made available to attorneys (private, pro bono, and legal aid societies) to tackle fraudulent lending cases. apples” account for the bulk ■ Financial institutions should consider creative refinancing the individuals, institutions, for predatory lending victims, and organizations involved which could prove to be in the mortgage lending profitable for the institution. process—lenders, mortgage brokers, real estate appraisers, Mandatory predispute arbitration clauses that are While only a few “bad of abusive loans, all of Holders and assignees of mortgages must be held enacted in time to adequately state or federal level, allowing Kentucky ■ so quickly that laws cannot be is a fairly recent phenomenon Division of Banking Mortgage lenders and brokers states and across the country, enforced systematically at the Office of the Attorney General Consumer Protection Hotline ■ ■ All states should create a loan originators, holders statewide clearinghouse— of loans, banks, and non- such as the Ohio Department depository institutions— of Commerce’s Office of need to be examined and Consumer Affairs—to regulated for the suitability streamline the treatment and soundness of their home equity and mortgage loans. agencies (and attorneys) have been designed for dedicate to deter abusive lending home equity fraud cases. to navigate. If penalties are home buyers and financial practices among the many other This office would diagnose stiff, deceptive lenders and institutions by Freddie Mac, demands they face in a tight the problem and direct brokers will be pushed out— The Neighborhood Reinvest- budgetary climate. victims to mediation or legal or have enough disincentives ment Corporation, and the recourse. For consumers to stay out—of the legitimate American Bankers Association, interest that unethical and considering mortgages or subprime market. to name a few. dishonest lending does not Consumer education is Solutions cannot be made continue unabated, and the home equity loans, this office could recommend certified housing counselors and educate borrowers about the documentation they will be signing and their obligations. This office could also support research, advocacy, and policy to better regulate unethical lending practices. ■ ■ critical to prevent unscru- hastily, as legitimate lenders pulous lending. As Governor may pull back mortgage credit Gramlich states, “Educated if regulations become too borrowers who understand cumbersome. A balance must their rights under lending be struck between assuring contracts and who know access to mortgage credit and how to exercise those rights covering the cost of that credit put up the best defense risk to lenders. Expectations 19 against predatory lenders.” of state and federal regulatory Educational campaigns powers should be realistic, Congress and the states balancing the resources that need strong, uniform laws legislatures and agencies can It is in everyone’s best Fourth District states are increasing their awareness of the problem and its harmful outcomes. An effective network must participate in its prevention, regulation, and correction. Initiatives to develop education, advocacy, and enforcement are all steps in the right direction. to redress predatory lending and to prevent such lenders from slipping through the NOTES cracks of the myriad federal, 1. Here we discuss predatory lending as it pertains to mortgage credit only; other areas of concern include check-cashing establishments and payday lenders, among others. state, and local laws. With 2. See Eric Stein, Quantifying the Economic Cost of Predatory Lending, Coalition for Responsible Lending, July 25, 2001. stricter laws, municipalities 3. See Anna Beth Ferguson, “Predatory Lending: Practices, Remedies and Lack of Adequate Protection for Ohio Consumers,” Cleveland State Law Review, 2000. will not need to enact their own legislation. This would avoid the current complex patchwork of federal, state, 4. See Center for Community Change, “Working to Curb Predatory Mortgage Lending,” available at www.communitychange.org/NRP/predlending.asp. An exception to this generalization may be unregulated affiliates of these institutions. 5. Testimony of Governor Edward M. Gramlich, May 24, 2000, www.federalreserve.gov/boarddocs/testimony/2000/20000524.htm. Federal Reserve Board examinations. The Dayton ordinance also prohibits specific unfair trade practices. The City of Dayton sued the State of Ohio, claiming the preemption provisions in H.B. 386 are unconstitutional. 9. See www.com.state.oh.us/odoc/dfi/consumeraffairs.htm. 10. See www.ag.state.oh.us/agpubs/conslaws.htm for more information. 11. However, home improvement loans and contractors may be covered by the Consumer Sales Protection Act, depending on whether they offer financing. For example, they may offer a retail installment sale, which is not considered a loan, and thus subject to the Act’s protections. 12. According to the Census Bureau, in 2000, Ohio’s homeownership rate was 69.1 percent, Kentucky’s, 70.8 percent, West Virginia’s 75.2 percent, and Pennsylvania’s, 71.3 percent. The national average was 66.2 percent. 13. See www.dfi.state.ky.us for more information. 14. Philadelphia passed an ordinance that was preempted by this statute. The Philadelphia City Council legislation was similar to Cleveland’s legislation. and local laws, which are 6. Please refer to www.com.state.oh.us/odoc/dfi/default.htm for more information. difficult for multistate lending 7. See Ohio Department of Commerce, “Regulation of Ohio’s Mortgage Broker Industry Strengthened,” press release, May 1, 2002. 16. See www.attorneygeneral.gov/ppd/bcp/index.cfm. 8. Two major local ordinances have passed in Ohio. In Cleveland, an ordinance prohibits lenders from making predatory loans, prohibits certain loan terms for high-cost loans, and requires new disclosures for home improvement loans. Dayton also passed a predatory lending ordinance restricting the origination of “high-cost loans,” with an exemption for banking and financial organizations with satisfactory or higher ratings on 18. See www.state.wv.us/wvag for more information. 15. See www.banking.state.pa.us/mission.htm for more information. 17. See www.wvdob.org/general/index.html for more information. 19. Remarks by Governor Edward M. Gramlich, January 18, 2002, www.federalreserve.gov/boarddocs/speeches/2002/20020118/default.htm. COMMUNITY REINVESTMENT FORUM of alleged mortgage or 9 in my COMMUNITY REINVESTMENT FORUM opi Predatory Lending: Legitimate Lenders Can Be a Part of the Solution 10 Kathleen C. Engel Assistant Professor of Law Cleveland-Marshall College of Law, Cleveland State University Kathleen C. Engel is on the faculty at the Cleveland-Marshall College of Law at Cleveland State University; previously she taught at Case Western Reserve University and Northeastern University. She holds a juris doctor degree from the University of Texas School of Law. Professor Engel’s primary research areas are predatory lending and housing discrimination. She has recently published articles on predatory lending in the Texas Law Review, the Fordham Urban Law Journal, and in Changing Financial Markets and Community Development, the proceedings of the 2001 Federal Reserve System Community Affairs Research Conference. P redatory lenders target Predatory lenders, in turn, people who are disconnected take advantage of the borrow- from credit markets and strike ers’ lack of sophistication by when they are most vulnerable. suggesting that their opportu- For example, abusive lenders nity to borrow is fleeting and identify areas where there is that they must commit quickly. limited legitimate mortgage The lenders then write loans that lending and approach home- contain padded fees, unneces- owners who have been cited sary insurance, loan terms that for housing code violations. are not based on the risk the These naive borrowers, who borrowers present, and many believe they are ineligible for other exploitative provisions. credit and are desperate to Legitimate lenders, by repair their homes, perceive failing to market their products the predatory lenders as their to the most inexperienced rescuers. borrowers, enable predatory lenders to dominate the market of all borrowers with subprime marketing strategies rely on the The municipalities could then for unsophisticated borrowers. loans actually qualify for prime Internet, in-office advertising, provide the names of these If legitimate lenders reached loans. Thus, if lenders limited and mass media. To the extent certified lenders to homeowners out to these borrowers, they their lending activity to prime- that borrowers are convinced with housing code violations. could create competition both eligible borrowers, they would they are ineligible for credit, this in terms of attracting borrowers not generate any safety and type of marketing is ineffective. and loan terms. This competi- soundness red flags, nor would Lenders need to develop tion would have the desirable they need to develop expertise innovative marketing strategies possible—and maybe even effect of driving out predatory in subprime loan collections. to reach these customers. For probable—that the return lenders. It is conceivable that their example, lenders could set up would be worth the investment. These strategies would require significant expenditures of money; however, it is Lenders could increase their “Legitimate lenders, by failing to market their products to the most inexperienced borrowers, enable predatory lenders to dominate the market for unsophisticated borrowers.” prime lending and, in the process, generate more clients for banking services such as checking accounts and auto loans. They could refer higherrisk borrowers to their affiliates that make legitimate subprime Some lenders may argue mere presence in the market small storefront offices in that these borrowers are eligible would help to stimulate other neighborhoods and grocery only for subprime loans and legitimate lenders to come in stores. They could work with community issue, and legitimate that they are reluctant to make to meet the needs of higher-risk local churches and community lenders have an interest in such loans because of safety borrowers who otherwise would centers to develop educational sustaining communities. They and soundness issues, and lack obtain predatory loans. information. They could ask can and should be part of the municipalities to create lists of solution, and it is time for them to act. of experience in collecting on A more difficult issue is subprime loans. These concerns the cost of marketing loans to certified lenders that do not are overstated: Fannie Mae has prime-eligible borrowers who engage in predatory lending. estimated that up to 50 percent are isolated from the legitimate credit system. Lenders’ current loans. Predatory lending is a COMMUNITY REINVESTMENT FORUM nion 11 4th district COMMUNITY REINVESTMENT FORUM 12 prof Local Programs Work on M any local and grassroots efforts are under CHIP was organized as a public–private partner- way in the Fourth District to guard residents against ship in 1994 in response to several Wheeling-area predatory lenders. Here, we highlight just a few of housing studies that evidenced a need for such services. these innovative programs. Representatives of local lenders, realtors, municipalities, public housing authorities, and nonprofit organizations Serving the Underserved Based in Wheeling, West Virginia, the Community Homebuyer Investment Program (CHIP) promotes home ownership through outreach and education geared toward low- and moderate-income individuals and families in the northern panhandle of West Virginia and eastern Ohio. Recognizing that its clients have been largely untouched by traditional lenders, realtors, and government programs, CHIP’s outreach efforts are proactive. Many residents are intimidated by the home buying and home financing process. CHIP’s free education program follows the Department of Housing and Urban Development model: It consists of approximately eight hours of instruction and covers budgeting, credit, home selection, home financing, home repair, and managing home ownership. Local housing and credit professionals serve as volunteer instructors. formed CHIP’s board of directors and cooperatively developed its program. In 1995, CHIP conducted its first education program in Wheeling, and by 1998, the program—still based in Wheeling—expanded to serve the four counties of the northern panhandle of West Virginia and two bordering Ohio counties. Don’t Borrow Trouble In early 2002, the Lexington–Fayette Urban County Human Rights Commission held a free community workshop to discuss the depth of the predatory lending problem in the Kentucky county. Speakers included affordable housing activists, housing counselors, fair housing specialists, state regulators, and federal enforcement agencies, who defined predatory lending in national terms while examining it from a local perspective. Specifically, panelists shared their experiences with predatory lending and remedies available to combat the problem. Predatory Lending from the Ground Up The commission continues to be active in The project’s aggressive strategy comprises four addressing predatory lending concerns. In June, components: ■ Community outreach and education, which involves a hotline for consumer inquiries, distribution of brochures and educational materials, and consumer education and outreach workshops. Executive Director William Wharton testified before the Kentucky State Treasurer’s Commission on Personal Savings and Investment. The public hearing aimed to assist ■ Intervention and rescue services, which have been provided to 1,703 clients since 2001. ■ Local community impact research better informs the project’s activities. A study released last year from the Center for Business and Economic Research closely examined the extent of predatory lending in Montgomery County. ■ Legislative support, including participation in the Ohio Coalition for Responsible Lending, which advocates statewide comprehensive legislation to address predatory lending in Ohio. in the study predatory lending practices in Kentucky and to strategize how to help lower-income families become more financially independent through existing savings programs. Community Homebuyer Investment Program P.O. Box 162 Wheeling, West Virginia 26003 304/232-6733 www.chipeducation.org Lexington – Fayette Urban County Human Rights Commission 162 East Main Street, Suite 226 Lexington, Kentucky 40507-1315 859/252-4931 www.lfuchrc.org Predatory Lending Solutions Project c/o Miami Valley Fair Housing Center 21–23 East Babbitt Street Dayton, Ohio 45405 937/223-6035 www.mvfairhousing.com Seeking Solutions for At-Risk Housing In Ohio, the Predatory Lending Solutions project— the first of its kind in the nation—brings together the Miami Valley Fair Housing Center, Consumer Credit Counseling Service, and the Legal Aid Society of Dayton and Montgomery County to address predatory lending in Montgomery County. Since January 2001, cases handled by these agencies have identified more than $119.8 million in affordable housing that is currently at risk. Community response to the project has been overwhelming: Despite all of the planning that went into the project, the partners significantly underestimated the widespread need for the project’s services. To date, the project has accepted and begun investigating 241 meritorious predatory lending complaints. In addition, staff have analyzed and addressed more than 970 complaints to secure relief or resolution for clients. The collaborative effort among the three agencies has assisted in handling the high number of open cases. COMMUNITY REINVESTMENT FORUM ile 13 corn compliance COMMUNITY REINVESTMENT FORUM 14 Changes to HOEPA Regulations Aim to Protect Consumers from Home Equity Fraud Regulatory changes to the Home Ownership and Equity Protection Act have taken effect, giving consumers greater protection against home equity fraud and predatory lending practices. Since October 2002, HOEPA regulations require lenders making first-lien mortgages with interest rates more than 8 percentage points above comparable Treasury securities to adhere to stricter consumer protections and disclose more information to borrowers. In response to consumer complaints, the Board of Governors of the Federal Reserve System also voted to prohibit the refinancing of high-cost loans within the loan’s first year-known as “loan flipping”—unless it is in the borrower’s best interest. The Federal Reserve’s final rule is similar to the initial proposed rule, with two exceptions. Based on staff recommendations, the Board did not lower the APR trigger for subordinate-lien mortgages, and it dropped a proposal to restrict refinancing of subsidized zero-interest-rate or low-interest-rate loans. The final rule implements the following changes: ■ The APR trigger for first-lien mortgage loans decreases from 10 percentage points to 8 percentage points above the rate for Treasury securities with comparable maturities. The APR trigger for subordinate-lien loans remains at 10 percentage points. However, HOEPA does not cover first-lien loans when the borrower is making an initial purchase. ■ The fee-based trigger has been adjusted to include amounts paid at closing for optional credit life, accident, health, or loss-of-income insurance and other credit-protection products. ■ Creditors that make HOEPA loans to borrowers in the preceding 12 months are prohibited from refinancing another HOEPA loan to the same borrower. However, creditors will be permitted to make such a loan if it is in the borrower’s interest. Assignees holding or servicing HOEPA loans are covered by this rule. COMMUNITY REINVESTMENT FORUM er 15 ■ Creditors are prevented from evading HOEPA, which covers only closed-end loans, by prohibitions against wrongfully documenting loans as open-end credit. ■ To ensure that lenders do not accelerate HOEPA loan payments without cause, creditors are prohibited from exercising due-on-demand or call provisions in HOEPA loans, unless the clause is exercised in connection with the consumer’s default. A similar rule applies to home-secured lines of credit. ■ Creditors are presumed to have violated the statutory prohibition on making HOEPA loans without regard to repayment ability if the creditor does not verify and document the consumer’s repayment ability. ■ HOEPA disclosures require three days’ notice before closing for loan refinancings in order to alert consumers to the total amount borrowed. This amount may be substantially higher than the amount requested by the borrower because it may include insurance, points, and fees. HOEPA disclosures must specify whether the total amount borrowed includes the cost of optional insurance. The full text of the final HOEPA rule can be found at www.federalreserve.gov/boarddocs/press/boardacts/2001/200112142/attachment.pdf. CR FORUM ACKNOWLEDGMENTS of interest Please contact the following members of the Community Affairs staff if you have questions or would like additional copies of this publication. upcoming conferences CLEVELAND Mark Sniderman Senior Vice President and Director of Research 216/579-2044 Microenterprise in Ohio: Where Do We Go from Here? Microenterprise Organization of Ohio February 27, 2003 Hyatt on Capital Square, Columbus, Ohio Call 614/279-3323 for details and registration information. Ruth Clevenger Vice President and Community Affairs Officer 216/579-2392 Mark Batson Community Affairs Advisor 216/579-2903 Sustainable Community Development: What Works, What Doesn’t, and Why Federal Reserve System’s Third Community Affairs Research Conference March 27–28, 2003 The Capital Hilton, Washington, DC 312/322-8232 Virginia Hopley Research Analyst 216/579-2891 Laura Kyzour Administrative Assistant 216/579-2846 CINCINNATI Jeff Gatica Senior Advisor Candis Smith Community Affairs Liaison 513/455-4350 CR Forum Special Report Financial Literacy Programs in the Fourth Federal Reserve District: Results from the Federal Reserve Bank of Cleveland’s Survey. The Community Affairs To obtain a copy of this report, please contact Virginia Hopley at 216/579-2891 or virginia.l.hopley@clev.frb.org. PITTSBURGH Althea Worthy Community Affairs Liaison 412/261-7943 Visit us on the World Wide Web www.clev.frb.org We welcome your comments and suggestions. Materials may be reprinted provided that the source is credited. Please send copies of reprinted materials to Community Affairs, Federal Reserve Bank of Cleveland, P.O. Box 6387, Cleveland, Ohio 44101-1387. Perspectives on Credit Scoring and Fair Mortgage Lending The Federal Reserve System’s Credit Scoring Committee has produced a five-part series that presents a variety of perspectives on the credit scoring process and identifies areas where credit may create disparities in the home mortgage process. Available online at www.clev.frb.org/CommAffairs/index.htm. Office has surveyed financial literacy providers in the Fourth District. This report summerizes their curricula, impact, evaluation, and financial literacy subjects of greatest need. 513/455-4281 The views stated in Community Reinvestment Forum are those of the individual authors and are not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. new publications coming this fall and winter
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