Following the lead of federal regulations, numerous states, counties and cities have enacted laws designed to reduce predatory lending. There is at least anecdotal evidence that predatory or abusive mortgage lending is primarily concentrated in the subprime market. However, the impact of these local predatory lending laws on the subprime mortgage market is unknown. The primary questions we examine are: do these laws affect the supply and flow of subprime mortgage credit and does the experience in North Carolina, the first state to enact a local predatory lending law, apply to other local laws

Ho, Giang

Pennington-Cross, Anthony

English

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Marquette Universitye-Publications@MarquetteFinance Faculty Research and Publications Business Administration, College of10-1-2005Local Predatory Lending Laws: Going BeyondNorth CarolinaAnthony Pennington-CrossMarquette University, anthony.pennington-cross@marquette.eduGiang HoFederal Reserve Bank of St. LouisPublished version. Bridges (Autumn 2005): 5-7. Permalink. Originally published in Federal ReserveBank of St. Louis Bridges. © 2005 by the Federal Reserve Bank of St. Louis. All views expressedherein are those of the authors and not necessarily those of the Federal Reserve Bank of St. Louis orthe Federal Reserve System.Anthony Pennington-Cross was affiliated with the Federal Reserve Bank of St. Louis at the time ofpublication.Bridges : Local Predatory Lending Laws: Going Beyond North Carolinafile:///I|/Projects/IR/Justin_working/Bridges   Local Predatory Lending Laws  Going Beyond North Carolina.htm[7/13/2011 1:26:36 PM] Home > Publications > Bridges > Autumn 2005 > Local Predatory Lending Laws: Going Beyond North C...PublicationsShow AllAbout the FedResearch and DataCommunity DevelopmentBankingEducationConsumer InformationBridges | Autumn 2005Local Predatory Lending Laws: Going BeyondNorth CarolinaBy Anthony Pennington-Cross and Giang Ho Following the lead of federal regulations, numerous states, counties and cities have enacted laws designedto reduce predatory lending. There is at least anecdotal evidence that predatory or abusive mortgagelending is primarily concentrated in the subprime market. However, the impact of these local predatorylending laws on the subprime mortgage market is unknown. The primary questions we examine are: dothese laws affect the supply and flow of subprime mortgage credit and does the experience in NorthCarolina, the first state to enact a local predatory lending law, apply to other local laws?Defining Predatory LendingAs discussed in a Housing and Urban Development (HUD)-Treasury report, defining predatory lending canbe problematic.1 This difficulty arises because predatory lending depends on the inability of the borrower tounderstand the loan terms and the obligations associated with them. For example, some borrowers mightbe willing to accept a prepayment penalty in exchange for lower interest rates or fees because they do notexpect to move in the near future. Or, the borrower might plan to diversify his or her portfolio away from ahome and therefore would like an interest-only loan with a balloon payment in 10 years. However,interviews conducted by HUD, the Treasury Department and the Federal Reserve Board indicate that some,perhaps many, borrowers using high-cost loans might not have understood that the loan had a prepaymentpenalty or that it did not amortize through time, leading to a balloon payment.Federal and Local LawsBridges : Local Predatory Lending Laws: Going Beyond North Carolinafile:///I|/Projects/IR/Justin_working/Bridges   Local Predatory Lending Laws  Going Beyond North Carolina.htm[7/13/2011 1:26:36 PM]At the national level, the Home Ownership and Equity Protection Act (HOEPA) and the regulationspromulgated under it define a class of loans that are given special consideration because they are morelikely to have predatory features and require additional disclosures. Loans covered under HOEPA includeonly closed-end home equity loans that have an annual percentage rate (APR) and/or finance feesexceeding a certain threshold. Specifically, the APR trigger is 8 percent and 10 percent above the Treasuryrate for first and second lien loans, respectively. The fee trigger is inflation-adjusted and includes dollarspaid at closing for optional insurance programs, such as health, credit life, accident, loss of income andother debt protection programs. Home purchase loans and other types of lending backed by a home, suchas lines of credit, are not covered by HOEPA.Local authorities have gone beyond HOEPA by introducing their own predatory lending laws that extend therestrictions on credit to an even broader class of mortgages. These restrictions include limits on allowableprepayment penalties and balloon payments, prohibitions of joint financing of various insurance productswith the mortgage (such as credit, life and unemployment) and requirements that borrowers participate inloan counseling.For example, North Carolina—the first state to enact predatory lending restrictions—expands the coverageof HOEPA by including both closed-end and open-end mortgages. However, reverse mortgages are notincluded and loan size is limited to the conventional conforming limit (loans small enough to be purchasedby Fannie Mae and Freddie Mac and therefore not considered part of the jumbo market). North Carolina didleave the APR triggers the same as the HOEPA triggers, although the points and fees triggers were reducedfrom the HOEPA 8 percent of the total loan amount to 5 percent for loans under $20,000. For loans$20,000 or larger, the same 8 percent trigger is used or $1,000, whichever is smaller. The North Carolinalaw also prohibits prepayment penalties and balloon payments for most covered loans. The law prohibits thefinancing of credit life, unemployment, disability or other life and insurance premiums, while HOEPAincludes them only as part of the trigger calculation.Variation in the strength of local predatory laws typically comes from two sources. The first is the extent towhich the law extends coverage beyond HOEPA. The second is the extent that the law restricts or requiresspecific practices. Law coverage is defined typically in terms of loan purpose, loan limit, APR and points-and-fees triggers. Broader coverage strengthens a law. On the other hand, the extent of a law's restrictionsis typically defined by prepayment penalty and balloon restrictions, counseling requirements, restrictions onmandatory arbitration, and other factors. Local laws, such as in Chicago and Cook County, Ill.; Colorado;and Washington, D.C., have relatively broader coverage than others, while Cleveland, Georgia and NewMexico laws can be said to be more restrictive.2Do Local Predatory Laws Impact the Flow and Supply of Credit?The widespread adoption of state and local predatory lending laws raises a natural question: What are thepotential impacts of the laws on the subprime mortgage market? Unfortunately, no research to date (to ourknowledge) has measured the costs and benefits of HOEPA and the state and local predatory lending laws.However, researchers have been able to measure how the volume of loans reacts to the introduction of alaw. This helps answer the question of whether the laws reduce the supply of credit. Prior research hasfound convincing evidence that the North Carolina predatory lending law did reduce the supply of high-costor subprime credit. There was some initial evidence that laws passed in Chicago and Philadelphia also hadan impact. The laws can also specifically impact the prevalence of targeted loan types or loan-relatedcharacteristics, such as balloon payments and prepayment penalties. Balloon payment loans andprepayment penalties tended to become a smaller portion of the market after the law in North Carolina wasintroduced. Other potential impacts include substitution by lenders from one product type to another andreduced liquidity in the secondary market.3By introducing geographically defined predatory lending laws, policy-makers have effectively conducted anatural experiment with well-defined control and treatment groups. Since state boundaries reflect politicaland not economic regions, we can compare mortgage market conditions in states with a law in effect (thetreatment group) to those in neighboring states currently without a predatory lending law (the controlBridges : Local Predatory Lending Laws: Going Beyond North Carolinafile:///I|/Projects/IR/Justin_working/Bridges   Local Predatory Lending Laws  Going Beyond North Carolina.htm[7/13/2011 1:26:36 PM]group).4 Specifically, using the treatment and control group framework, we tested to see whether localpredatory lending laws affect the application and origination of subprime loans. We also tested to see therates at which subprime loan applications are rejected. If volume is unaffected, then the flow and supply ofcredit to potential consumers has not been affected in the aggregate.We extended prior research by examining the impacts in a variety of locations to see if the North Carolinaexperience is representative or typical for other states. Using publicly available Home Mortgage DisclosureAct (HMDA) data, we examined the change in subprime originations in each state before and after the lawbecame effective. The loan samples were reduced by applying the prescribed loan limit (if any) under eachlaw.5 Growth rates were calculated for loans associated with a list of subprime lenders as identified in theHUD subprime lender list.6 In an attempt to create as similar comparison groups as possible, we sampledonly counties that border each other across state lines. Thus, a typical treatment group includes bordercounties in a state with a law in effect, and the corresponding control group includes border counties inneighboring states that do not have a law in effect during the observed time period (the year before andthe year after the introduction of the law). This contrasts with other studies (see footnote 3) that haveused whole neighboring states or regions to define both control and treatment groups. Our approachshould help to increase the comparability of the treatment group and the control group because they aregeographically closer and, as a result, likely to be more economically similar than full state and regioncomparisons. This approach and HMDA availability reduce the sample to 10 state predatory lending laws(California, Connecticut, Florida, Georgia, Maryland, Massachusetts, North Carolina, Ohio, Pennsylvania andTexas).Using North Carolina as an example, the results show that from the year before to the year after the lawbecomes effective, subprime originations decreased by 35.8 percent in the treatment counties comparedwith 18.9 percent in the control counties. In other words, consistent with previous research on the NorthCarolina predatory lending law, subprime originations decreased substantially more than would be expectedgiven the performance of the control counties. This finding also holds in four other states: Florida, Georgia,Massachusetts and Ohio. However, in the remaining five states—California, Connecticut, Maryland,Pennsylvania and Texas—we found that subprime originations increased more in the treatment locations.These results indicate that the experience in North Carolina might not extend to all other predatory lendinglaws, and that there might be sufficient variations in the laws that induce different responses in the flow ofhigh-cost credit.The relative changes in both subprime application and rejection rates are also examined. Again, theapplication results are mixed and very similar to the origination results. For example, four state laws—California, Maryland, Pennsylvania and Texas—experienced a relative increase in applications and six statelaws—Connecticut, Florida, Georgia, Massachusetts, North Carolina and Ohio—experienced a relativedecrease in applications. However, the rejection rates tell a much more consistent story. In most states,rejection rates declined more in the treatment locations than in the control locations, indicating that theintroduction of predatory lending laws was associated with a disproportionate reduction in the rate thatsubprime applications were rejected. For example, California, Florida, Georgia and North Carolinaexperienced a relative decrease in rejection rates of at least 14.9 percentage points. At the other extreme,Pennsylvania and Connecticut experienced almost no relative change.These results do not provide any indication that predatory lending laws systematically reduce the flow ofsubprime credit. However, the results do show that predatory lending laws tend to be associated with lowerrejection rates of subprime mortgage applications. It can be expensive just to apply for a mortgage: thenonrefundable application fee usually runs from $200 to $300, not to mention other unobserved ornonpecuniary costs. Thus, while reducing rejection rates might not have been the primary purpose of thelaws, a reduction in rejections can represent substantial savings to consumers and potentially lenders, too.SummaryStarting with North Carolina in 1999, states and other localities across the United States have introducedlegislation intended to curb predatory and abusive lending in the subprime mortgage market. These lawsusually extend the reach of HOEPA by including home purchase and open-end mortgage credit, lowering theBridges : Local Predatory Lending Laws: Going Beyond North Carolinafile:///I|/Projects/IR/Justin_working/Bridges   Local Predatory Lending Laws  Going Beyond North Carolina.htm[7/13/2011 1:26:36 PM]APR and fees-and-points triggers, and prohibiting or restricting the use of balloon payments andprepayment penalties on covered loans.Using HMDA data on subprime loans and a sample of state laws, we found that the typical law has littleimpact on the flow of subprime credit as measured by loan originations, but is usually associated with lowerrejection rates. In particular, local predatory lending laws can be associated with either increases ordecreases in applications and originations for subprime loans. Earlier research on North Carolina law hadfound that the supply and flow of credit was reduced when the law became effective. We replicated thisfinding but did not find any evidence that the North Carolina experience applies to all other local predatorylending laws. It is likely that the exact nature of the law will impact the supply and flow of credit differently.For example, some laws are designed to provide broad coverage of the mortgage market (Chicago andCook County laws) while other laws are more restrictive (Georgia and New Mexico laws) in terms ofprohibiting or requiring certain practices.To help identify why fewer subprime loans are being originated under some laws but not others, futureresearch needs to examine how the coverage of the law and the restrictions imposed by the law impact theflow and cost of credit. Analysis should attempt to control for not only time and location but also lawcharacteristics, borrower and loan characteristics, and economic conditions in both the control group andthe treatment group. In addition, research should examine to what extent there is a regulatory costassociated with the laws that is passed on to borrowers through higher fees or interest rates.Beginning with North Carolina in 1999, at least 23 states have passed predatory lending laws that are styledafter the federal Home Ownership and Equity Protection Act. That law features triggers based on fees andthe annual percentage rate. The states include Arkansas, California, Colorado, Connecticut, Florida, Georgia,Illinois, Kentucky, Maine, Maryland, Massachusetts, Nevada, New Jersey, New Mexico, New York, NorthCarolina, Ohio, Oklahoma, Pennsylvania, South Carolina, Texas, Utah and Wisconsin.Endnotes1. Department of Housing and Urban Development and the Treasury Department. "Curbing PredatoryHome Mortgage Lending." June 2000, p. 17. Available atwww.huduser.org/publications/hsgfin/curbing.html. [back to text]2. For a detailed description of the local laws, see Pennington-Cross, Anthony and Giang Ho, "TheImpact of Local Predatory Lending Laws." The Federal Reserve Bank of St. Louis Working PaperSeries, WP 2005-049A. Available at www.research.stlouisfed.org. [back to text]3. See, for example: Quercia, Roberto, Michael A. Stegman, and Walter R. Davis. (2003). "The Impact ofNorth Carolina's Anti-predatory Lending Law: A Descriptive Assessment." Durham, N.C.: Center forCommunity Capitalism, University of North Carolina at Chapel Hill; Harvey, Keith D. and Peter J. Nigro.(2003). "How Do Predatory Lending Laws Influence Mortgage Lending in Urban Areas? A Tale of TwoCities." Journal of Real Estate Research, V25, N4, pp. 479-508; Harvey, Keith D. and Peter J. Nigro.(2004). "Do Predatory Lending Laws Influence Mortgage Lending? An Analysis of the North CarolinaPredatory Lending Law." Journal of Real Estate Finance and Economics, V29, N4, pp. 435-456;Elliehausen, Gregory and Michael E. Staten. (2004). "Regulation of Subprime Mortgage Products: AnAnalysis of North Carolina's Predatory Lending Law." Journal of Real Estate Finance and Economics,V29, N4, pp. 411-434. [back to text]4. Laws are first enacted by the local legislature and become effective typically at a later date. It is notuntil the law becomes in effect that lenders are required to follow the new rules and restrictions.[back to text]5. The results are very similar if the loan limits are not applied to reduce the sample. [back to text]6. www.huduser.org/datasets/manu.html, accessed on 2/1/05. HUD generates a list of subprime lendersfrom industry trade publications and Home Mortgage Disclosure Act data analysis, and phone calls tothe lender confirm the extent of subprime lending. [back to text]RATE THIS ARTICLE: 

Local Predatory Lending Laws: Going Beyond North Carolina

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Local Predatory Lending Laws: Going Beyond North Carolina

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