State-Based Predatory Lending Legislation - The Beginning or the Beginning of the End? (Summer '03)

by Edward W. Kirn, III
William M.E. Powers, Jr., Chartered — USFN Member (NJ)

As those in the mortgage servicing industry are no doubt painfully aware, the latest buzzword being bandied about by consumer advocacy groups is "predatory" lending. And it appears that state legislatures are listening. It’s getting really ugly out there, especially for our brethren on the sub-prime lending side of the industry. At last count, more than twenty states had passed some form of predatory lending legislation aimed at protecting its citizens from unscrupulous lenders. Since the beginning of 2003 alone, eleven states have enacted predatory lending bills, with New Jersey, Oklahoma and South Carolina becoming the most recent passengers on the bandwagon.

While some states are modeling their individual Acts after the version being touted by the AARP, no two states have measures that are exactly alike. As if this weren’t bad enough, New Jersey decided to add a "predatory servicing" section to its bill, which will affect all loans presently in existence, not just high cost loans (… not that anyone can figure out exactly what a high cost loan is).

Many of these bills contain vague, multi-tiered criteria based upon interest rate differentials and fee and point calculations that a lender or rating agency must use in order to determine whether any given loan is considered to be "high cost." And the penalties for violating one of these provisions? You don’t want to know — a lender caught with a predatory loan, whether it originated the loan or not, stands to lose the entire finance charge, a portion of the principal, plus attorneys’ fees and costs.

What do the various states hope to accomplish by all of this? Are the legislators unable to see that if they make it more difficult to determine what loans are high cost, that the rating agencies will simply refuse to rate any security containing a loan from their state? Despite the debacle in Georgia, New Jersey’s governor apparently didn’t see it coming.

With a fist raised in victory, New Jersey’s governor "triumphantly" signed his state’s predatory lending Act into law, vowing that the rating agencies have already assured him that they were okay with the Act. Shortly afterwards, however, Fitch Ratings announced that it would no longer rate any mortgage securities containing a New Jersey loan.

It appears that the states don’t realize that the heavy-handed legislation will force many lenders to stop lending in these states. More importantly, the very people that lawmakers wish to protect — i.e., those with middle to low incomes or with blemished credit — will no longer be able to obtain loans because legitimate lenders will be afraid of originating loans that might be considered high cost.

At least in New Jersey, default rates have been kept in check by the availability of relatively inexpensive loans. With property values on the rise, and the cost of lending money so cheap, a homeowner falling on difficult financial times is often able to pull his home out of default by either refinancing the defaulted debt or taking out a second mortgage to reinstate the first. That money is no longer going to be available in the age of predatory lending because those refinances and second loans will be considered high cost loans.

What’s a lender to do? With twenty or thirty different predatory lending Acts floating around out there, does a servicer build a good matrix and hope that it catches all of the bad loans? It’s a serious problem.

Believe it or not, the industry’s knight in shining armor may be the federal government. But wait, aren’t these the guys that helped us out before with bills like the Truth in Lending Act, the Home Ownership Equity Protection Act and the Real Estate Settlement Procedures Act? Yes, but the key point to remember is that only federal legislation can preempt state law, which is precisely what is needed to counteract the harsh requirements and results of the various states’ predatory lending regulations.

This area of the law is ripe for federal preemption, and we are witnessing the beginning of the end for state-based, predatory lending regulation. There are a couple of reasons this may be so.

First, predatory lending is a "hot" topic that has a certain degree of glamour. After all, the label consumer advocates have assigned to this subject conjures up images of some evil, fang-toothed lender, hungrily lurking in the shadows of his marble bank, waiting to pounce upon some unsuspecting senior who happens by. This image represents the very type of issue that appeals not only to the sensibilities of voters around the nation, but also to up-and-coming senators or congressmen and women who would be only too happy to stand before their constituents as vanguards of the "predatorily oppressed."

Further, it is likely a federal predatory lending bill that preempts state legislation would garner support from both sides of the issue, thus making it easier for the provision to pass through Congress and eventually become law. Such a bill would also garner the support of both consumer groups and political figures looking to protect their constituents from unscrupulous lenders. After all, wouldn’t it be what they’ve been fighting for all this time?

More importantly, by the time states such as Georgia, New York and New Jersey finish imposing their varied and draconian measures upon the mortgage lending industry, federal legislation preempting state law would be widely supported by the banking community.

A properly drafted federal measure may also receive support from the movers and shakers on Wall Street, whose mortgage-backed securities will be downgraded and stripped of their investing appeal when the rating agencies and bureaus refuse to rate them should they contain loans from certain states.

On February 13, 2003, House representatives Robert Ney (R-OH) and Ken Lucas (D-KY) introduced H.B. 833, "Responsible Lending Act of 2003," a federal bill that would preempt all state and local predatory lending laws. The bill proposes to guard against predatory lending by making several amendments to the HOEPA and TILA. Unlike the AARP measure and the legislation being passed at the state level, the proposed federal bill is much more lender friendly.

The draft defines a high cost loan as a "consumer transaction secured by a mortgage on the consumer’s principal dwelling where the annual percentage rate exceeds by more than 8 percentage points the yield on Treasury securities on a first mortgage and 10 percentage points on a second lien. It also considers a loan to be high cost if the fees and points charged exceed 6 percent of the total loan amount on loans of $30,000 or more, and 7 percent on loans of less than $30,000. These thresholds are two percentage points higher than those set by the AARP model, which will result in fewer loans being covered by the Act.

Much like the state-based measures, the Ney-Lucas bill sets restrictions on balloon payments, prepayment penalties, default interest rates and credit life insurance, and also requires lenders to demonstrate that the borrower has an ability to repay the debt. However, most or all of the restrictions have exceptions and are far less limiting than state legislation. More importantly, assignee liability only kicks in if the mortgagor can show that the alleged violation of the Act is clear on the face of the purchased loan.

Despite the favorable points of the Ney-Lucas bill, lenders and servicers shouldn’t get too excited just yet. H.B. 833 contains a couple of provisions that could prove to be problematic, such as one requiring a foreclosing mortgagee to refund to the mortgagor any profit realized on the sale, or resale, of the foreclosed home. Furthermore, the Ney-Lucas bill likely isn’t the only federal predatory lending bill being passed around Capitol Hill. Representative Paul Sarbanes (D-MD) introduced a bill in 2002 containing much more stringent provisions, which has received the endorsement of consumer advocacy groups such as AARP and ACORN. In any event, lenders and servicers can bet that federal relief will not come quickly. Until then, we should all be prepared to deal with the disparate predatory lending legislation passed at the state and local levels.

© Copyright 2003 USFN