Lenders Target State Laws

A booming industry that makes home loans to people with fragile credit is lobbying Congress for nationwide rules that regulators and consumer advocates warn would roll back tougher state protections.

The debate comes as millions of Americans have taken out loans with higher fees and interest rates than the mortgages granted to people with solid credit. As these “sub-prime” loans have proliferated, so have complaints from borrowers who say they’ve been slammed by surprise fees and high-pressure salespeople.

More than two dozen states, led by North Carolina, have moved into a vacuum created by weak federal regulation, imposing their own laws targeting abusive practices. The industry’s five biggest players are based in California, and one, Orange-based Ameriquest Mortgage Co., is nearing a $325-million settlement with 33 states over allegations of bait-and-switch tactics, inflated appraisals and other issues.

Amid increasing scrutiny of their operations, lenders have rallied behind a bill sponsored by Reps. Bob Ney (R-Ohio) and Paul E. Kanjorski (D-Pa.) that would impose uniform national rules on the industry, which last year issued $530 billion in higher-cost mortgages.

Supporters say the measure is needed to replace a hodgepodge of state and local lending laws. Some of those laws, lenders say, make it costlier to extend credit to higher-risk borrowers. In at least one case, a lender says it cannot offer North Carolina customers the lowest possible interest rate because of restrictions in state law.

Kurt Pfotenhauer, vice president of government affairs at the Mortgage Bankers Assn., said the “predatory lending problem is frankly dwarfed” by the success story of people who can now buy homes through the use of higher-cost loans. Lenders themselves are typically in a better position than bureaucrats to tailor products for the needs of the marketplace, he said: “The market works because it regulates itself.”

Consumer groups say the Ney-Kanjorski bill is a thinly veiled attempt to undo tough state regulations where they exist, and to prevent new laws from being adopted.

“If we’ve done a public good here, why does that standard have to be diluted?” asked Joseph A. Smith Jr., North Carolina’s banking commissioner.

The national proposed standards, for example, would be more permissive than several state measures when it comes to the practice known as flipping, in which loan agents persuade borrowers to refinance after a short period, in some cases just months after they took out their existing loan.

Flipping generates new fees and commissions for lenders and loan agents and can put cash in the pockets of borrowers. But it also chips away at homeowners’ equity and may saddle them with costlier terms than they expected.

The practice has been abetted by rising housing prices which enable loan salespeople to tell borrowers that they can painlessly tap the added equity in their homes. But if home prices level off or decline, some debtors could find themselves with homes that are worth less than their mortgages, and they could face a heightened risk of foreclosure.

Consumer advocates are backing a bill by Reps. Brad Miller and Melvin L. Watt, both North Carolina Democrats, and Rep. Barney Frank (D-Mass.) that would parallel the North Carolina law by including a strict ban on flipping and requiring borrowers to get counseling before signing higher-cost loans. Unlike Ney-Kanjorski, it would not prevent states from imposing stricter requirements.

The mortgage banking industry has donated nearly $2 million to lawmakers in the current election cycle, according to the Center for Responsive Politics. Ney and Kanjorski led the pack, with each reporting the same amount -- $38,250 -- from the industry.

Ney, who has been subpoenaed as part of a widening federal criminal probe of lobbyist Jack Abramoff, was not available for comment. Kanjorski’s office did not respond to questions.

The industry is “hopeful there will be action early next year,” said Wright H. Andrews Jr., a lobbyist for the lenders.

North Carolina’s Miller expressed hope that “the planets are aligning” for significant compromise on the dueling bills in the coming months.

As the national debate unfolds, the experience of North Carolina looms as Exhibit A. Its 1999 predatory lending law is among the toughest, most scrutinized and most hotly debated of all the state efforts.

“It’s the law that everybody points to,” said Gregory D. Squires, an expert on predatory lending issues at George Washington University.

To prevent flipping, North Carolina forbids “knowingly or intentionally” refinancing a home loan in a way that does not give the borrower a “reasonable, net tangible benefit” considering “all the circumstances.”

For mortgages of $150,000 and less, the law also bans prepayment penalties, which in some cases lenders charge when borrowers pay off the entire loan amount early.

Lenders say these penalties are needed to preserve profits after they provide credit to risky borrowers, but critics say they are an unfair way of locking people into costly loans.

“The incidence of predatory lending in North Carolina has almost disappeared,” said North Carolina Atty. Gen. Roy Cooper. “Lenders are abiding by the law, and consumers are getting fairer loans.”

The legislative solution has not been free of controversy. Michael E. Staten, director of the Credit Research Center at Georgetown University, maintains that sub-prime home loans to low-income minorities dropped by more than 20% in North Carolina after its predatory lending law was passed.

“The very borrowers that the law was intended to protect get squeezed out,” he said.

Still, University of North Carolina professor Michael A. Stegman said his research showed that much of the initial drop in lending to poor minorities was for loans with features that had become illegal. Major lenders have remained active in the state, and there is little evidence that borrowers have been pushed out of the market, Stegman said.

Elsewhere in the nation, the record is mixed. Consumer groups say most of the laws passed in other states, including California, are not as strong as North Carolina’s.

California’s flipping restriction, for example, applies only to the costliest of high-cost loans, leaving most borrowers unprotected.

Beyond that, California requires that refinancings provide simply “an identifiable benefit” to the borrower. Critics say that standard leaves room for abuse. For instance, someone who refinances to pay off high-interest credit cards would have an identifiable benefit, even if the mortgage costs more than it should.

“North Carolina and some of the other state laws provide greater protections than those afforded California homeowners,” said Kevin Stein, associate director of the California Reinvestment Coalition, a nonprofit group that promotes access to credit and economic development in low-income communities.

Stein noted that mortgage companies heavily lobbied for the 2001 California law.

“The lending industry has aggressively fought efforts to provide even modest enhancements to our state law’s protections,” Stein said.

Lenders say higher-cost sub-prime loans -- which accounted for 20% of home mortgages issued last year -- have helped make homeownership possible for more Americans. Consumer advocates, however, say the industry is tainted by slipshod marketing and “boiler room” practices in which loan agents lure borrowers into repeated refinancings or surprise them with obscure fees at closing time.

“We started hearing borrowers come to us saying they had horrible experiences,” recalled Martin Eakes, founder of the Center for Community Self-Help in Durham, N.C. “No person of fair mind could look at these loans and not feel like tens of thousands of people in one small state were being taken advantage of.”

By some accounts, lenders have compensated for fee restrictions by charging slightly higher interest rates in North Carolina compared with the same loans in other states.

For example, on certain loans, Irvine-based Option One recently was charging an interest rate about two-tenths of a percentage point higher in North Carolina than in other states. That difference amounts to about $20 to $25 a month for a $140,000 loan, said Steve Nadon, the company’s chief operating officer.

An attorney who represents mortgage brokers agreed that the industry’s greatest concerns about the law had yet to be realized. “The fear of rampant litigation running out the lenders -- it may happen, but it hasn’t happened yet,” said William S. Bost III.

Indeed, Smith, North Carolina’s banking commissioner, said his own eyes and ears told him the law was working just fine.

“In the actual world I actually live in, I don’t get complaints -- and I get complaints about everything in the universe.”

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Lending laws

Here are highlights of North Carolina’s and California’s predatory lending laws, as well as rival measures in Congress.

North Carolina

* Loans cannot be refinanced at any time unless the lender can show a “reasonable, net tangible benefit to borrower.”

* No prepayment penalty for home loans of $150,000 or less.

* Borrowers getting certain high-cost loans must be counseled about their full costs.

California

* Prepayment penalties are allowed for the first five years of traditional loans and for the first three years of higher-cost sub-prime loans.

* The most expensive high-cost loans can’t be refinanced without an “identifiable benefit” to borrower, such as eliminating credit card debt.

* No “balloon” payments at the end of a loan’s term for a sub-prime loan of five years or less.

Ney-Kanjorski bill

* Would set uniform national standards that would replace state laws.

* The most expensive high-cost loans could not be refinanced without a reasonable, net tangible benefit to the borrower within the first 24 months of loan.

* Prepayment penalties could be imposed for the first three years of loan.

Miller-Watt-Frank bill

* No refinancing at any time without reasonable, net tangible benefit to the borrower.

* Would set minimum national standards that states could exceed.

* Borrowers getting the most expensive loans would have to receive counseling on their full costs.

Source: Times research