Consumer Protection: Federal and State Agencies Face Challenges
in Combating Predatory Lending (30-JAN-04, GAO-04-280).
While there is no universally accepted definition, the term
"predatory lending" is used to characterize a range of practices,
including deception, fraud, or manipulation, that a mortgage
broker or lender may use to make a loan with terms that are
disadvantageous to the borrower. No comprehensive data are
available on the extent of these practices, but they appear most
likely to occur among subprime mortgages--those made to borrowers
with impaired credit or limited incomes. GAO was asked to examine
actions taken by federal agencies and states to combat predatory
lending; the roles played by the secondary market and by consumer
education, mortgage counseling, and loan disclosure requirements;
and the impact of predatory lending on the elderly.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-04-280
ACCNO: A09188
TITLE: Consumer Protection: Federal and State Agencies Face
Challenges in Combating Predatory Lending
DATE: 01/30/2004
SUBJECT: Consumer education
Consumer protection
Elderly persons
Federal law
Fraud
Information disclosure
Lending institutions
Loan interest rates
Mortgage loans
State law
Truth-in-lending law
******************************************************************
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** No attempt has been made to display graphic images, although **
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GAO-04-280
United States General Accounting Office
GAO
Report to the Chairman and Ranking
Minority Member, Special Committee on Aging, U.S. Senate
January 2004
CONSUMER PROTECTION
Federal and State Agencies Face Challenges in Combating Predatory Lending
a
GAO-04-280
Highlights of GAO-04-280, a report to the Chairman and Ranking Minority
Member, Special Committee on Aging, U.S. Senate
While there is no universally accepted definition, the term "predatory
lending" is used to characterize a range of practices, including
deception, fraud, or manipulation, that a mortgage broker or lender may
use to make a loan with terms that are disadvantageous to the borrower. No
comprehensive data are available on the extent of these practices, but
they appear most likely to occur among subprime mortgages-those made to
borrowers with impaired credit or limited incomes. GAO was asked to
examine actions taken by federal agencies and states to combat predatory
lending; the roles played by the secondary market and by consumer
education, mortgage counseling, and loan disclosure requirements; and the
impact of predatory lending on the elderly.
GAO suggests that Congress consider providing the Federal Reserve Board
with the authority to routinely monitor and, as necessary, examine nonbank
mortgage lending subsidiaries of financial and bank holding companies to
ensure compliance with federal consumer protection laws applicable to
predatory lending. Congress should also consider giving the Board specific
authority to initiate enforcement actions under those laws against these
nonbank mortgage lending subsidiaries.
www.gao.gov/cgi-bin/getrpt?GAO-04-280.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact David G. Wood at
202-512-8678 or [email protected].
January 2004
CONSUMER PROTECTION
Federal and State Agencies Face Challenges in Combating Predatory Lending
While only one federal law-the Home Ownership and Equity Protection Act-is
specifically designed to combat predatory lending, federal agencies have
taken actions, sometimes jointly, under various federal consumer
protection laws. The Federal Trade Commission (FTC) has played the most
prominent enforcement role, filing 19 complaints and reaching multimillion
dollar settlements. The Departments of Justice and Housing and Urban
Development have also entered into predatory lending-related settlements,
using laws such as the Fair Housing Act and the Real Estate Settlement
Procedures Act. Federal banking regulators, including the Federal Reserve
Board, report little evidence of predatory lending by the institutions
they supervise. However, the nonbank subsidiaries of financial and bank
holding companies-financial institutions which account for a significant
portion of subprime mortgages-are subject to less federal supervision.
While FTC is the primary federal enforcer of consumer protection laws for
these entities, it is a law enforcement agency that conducts targeted
investigations. In contrast, the Board is well equipped to routinely
monitor and examine these entities and, thus, potentially deter predatory
lending activities, but has not done so because its authority in this
regard is less clear.
As of January 2004, 25 states, as well as several localities, had passed
laws to address predatory lending, often by restricting the terms or
provisions of certain high-cost loans; however, federal banking regulators
have preempted some state laws for the institutions they supervise. Also,
some states have strengthened their regulation and licensing of mortgage
lenders and brokers.
The secondary market-where mortgage loans and mortgage-backed securities
are bought and sold-benefits borrowers by expanding credit, but may
facilitate predatory lending by allowing unscrupulous lenders to quickly
sell off loans with predatory terms. In part to avoid certain risks,
secondary market participants perform varying degrees of "due diligence"
to screen out loans with predatory terms, but may be unable to identify
all such loans.
GAO's review of literature and interviews with consumer and federal
officials suggest that consumer education, mortgage counseling, and loan
disclosure requirements are useful, but may be of limited effectiveness in
reducing predatory lending. A variety of factors limit their
effectiveness, including the complexity of mortgage transactions,
difficulties in reaching target audiences, and counselors' inability to
review loan documents.
While there are no comprehensive data, federal, state, and consumer
advocacy officials report that the elderly have disproportionately been
victims of predatory lending. According to these officials and relevant
studies, older consumers may be targeted by predatory lenders because,
among other things, they are more likely to have substantial home equity
and may have physical or cognitive impairments that make them more
vulnerable to an unscrupulous mortgage lender or broker.
Contents
Transmittal Letter 1
Executive Summary 3
Purpose 3
Background 3
Results in Brief 4
Principal Findings 7
Matters for Congressional Consideration 15
Agency Comments and Our Evaluation 16
Chapter 1 18
The Nature and Attributes of Predatory Lending 18
Introduction Emergence of Subprime Mortgage Market 21
The Extent of Predatory Lending Is Unknown 23
Emergence of Predatory Lending As Policy Issue 25
Objectives, Scope, and Methodology 26
Chapter 2
Federal Agencies Have
Taken Steps to Address
Predatory Lending, but
Face Challenges
30 Federal Agencies Use a Variety of Laws to Address Predatory Lending
Practices 30 Federal Agencies Have Taken Some Enforcement Actions, but
Banking Regulators Have Focused on Guidance and Regulatory
Changes 36
Jurisdictional Issues Related to Nonbank Subsidiaries Challenge
Efforts to Combat Predatory Lending 49
Conclusions 54
Matters for Congressional Consideration 55
Agency Comments and Our Evaluation 55
Chapter 3
States Have Enacted
and Enforced Laws to
Address Predatory
Lending, but Some
Laws Have Been
Preempted
58
States and Localities Have Addressed Predatory Lending through
Legislation, Regulation, and Enforcement Actions 58
Activities in North Carolina and Ohio Illustrate State Approaches to
Predatory Lending 63
Regulators Have Determined That Federal Law Preempts Some
State Predatory Lending Laws, but Views on Preemption Differ
68
Contents
Chapter 4
The Secondary Market
May Play a Role in
Both Facilitating and
Combating Predatory
Lending
72 The Development of a Secondary Market for Subprime Loans Can Benefit
Consumers 72 The Secondary Market for Subprime Loans Can Facilitate
Predatory Lending 76 Due Diligence Can Help Purchasers Avoid Predatory
Loans, but Efforts Vary among Secondary Market Participants 77 Assignee
Liability May Help Deter Predatory Lending but Can Also Have Negative
Unintended Consequences 82
Chapter 5
The Usefulness of
Consumer Education,
Counseling, and
Disclosures in
Deterring Predatory
Lending May Be
Limited
88
Many Consumer Education and Mortgage Counseling Efforts Exist, but Several
Factors Limit Their Potential to Deter Predatory Lending 88
Disclosures, Even If Improved, May Be of Limited Use in Deterring
Predatory Lending 96
Chapter 6 99 Elderly Consumers A Number of Factors Make Elderly Consumers
Targets of Predatory
Lenders 99 May Be Targeted for Some Education and Enforcement Efforts
Focus on Elderly
Predatory Lending Consumers 102 Appendixes
Appendix I: Appendix II:
Appendix III: Appendix IV:
Appendix V:
FTC Enforcement Actions Related to Predatory Lending 106
Comments from the Board of Governors of the Federal
Reserve System 108
Comments from the Department of Justice 111
Comments from the Department of Housing and Urban
Development 114
Comments from the National Credit Union
Administration 118
Contents
Appendix VI: GAO Contacts and Staff Acknowledgments 120
GAO Contacts 120
Staff Acknowledgments 120
Table 1: Preemption Determinations Issued by OCC,
Table OTS, and
NCUA Related to Predatory Mortgage Lending Laws
Figure 1: Federal Laws and Statutes Used to
Figures Address Lending Practices Generally Considered to
be Predatory 31
Figure 2: Structure and Federal Oversight of 50
Mortgage Lenders
Figure 3: States and Localities That Have Enacted
Predatory
Lending Laws 59
Figure 4: Steps in the Securitization of 74
Residential Mortgages
Abbreviations
CRA Community Reinvestment Act
DOJ Department of Justice
ECOA Equal Credit Opportunity Act
FDIC Federal Deposit Insurance Corporation
FHA Federal Housing Administration
FTC Federal Trade Commission
GAO General Accounting Office
GSE government-sponsored enterprise
HMDA Home Mortgage Disclosure Act
HOEPA Home Ownership and Equity Protection Act
HUD Department of Housing and Urban Development
NCUA National Credit Union Administration
OCC Office of the Comptroller of the Currency
OTS Office of Thrift Supervision
RESPA Real Estate Settlement Procedures Act
TILA Truth in Lending Act
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
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copyright holder may be necessary if you wish to reproduce this material
separately.
A
United States General Accounting Office Washington, D.C. 20548
January 30, 2004
The Honorable Larry E. Craig
Chairman
The Honorable John Breaux
Ranking Minority Member
Special Committee on Aging
United States Senate
This report responds to your request that we evaluate issues related to
predatory home mortgage lending. As you requested, this report reviews
(1) federal laws related to predatory lending and federal agencies'
efforts to
enforce them, (2) actions taken by states to address predatory lending,
(3)
the secondary market's role in facilitating or inhibiting predatory
lending,
(4) how consumer education, mortgage counseling, and loan disclosures
may deter predatory lending, and (5) the relationship between predatory
lending activities and elderly consumers. This report includes a Matter
for
Congressional Consideration.
As agreed with your office, we plan no further distribution of this report
until 30 days from its issuance date unless you publicly release its
contents
sooner. We will then send copies of this report to the Chairman and
Ranking Minority Member of the Senate Committee on Banking, Housing,
and Urban Affairs; the Chairman and Ranking Minority Member of the
House Committee on Financial Services; the Secretary of the Department
of Housing and Urban Development; the Secretary of the Department of the
Treasury; the Chairman of the Federal Trade Commission; the Chairman of
the Board of Governors of the Federal Reserve System; the Chairman of the
Federal Deposit Insurance Corporation; the Comptroller of the Currency;
the Director of the Office of Thrift Supervision; the Chairman of the
National Credit Union Administration; and other interested parties. Copies
will also be made available to others upon request. In addition, this
report
will be available at no charge on the GAO Web site at http://www.gao.gov.
This report was prepared under the direction of Harry Medina, Assistant
Director. Please contact Mr. Medina at (415) 904-2000 or me at (202)
5128678 if you or your staff have any questions about this report. Major
contributors to this report are listed in appendix VI.
David G. Wood Director, Financial Markets and Community Investment
Executive Summary
Purpose Each year, millions of American consumers take out mortgage loans
through mortgage brokers or lenders to purchase homes or refinance
existing mortgage loans. While the majority of these transactions are
legitimate and ultimately benefit borrowers, some have been found to be
"predatory"-that is, to contain terms and conditions that ultimately harm
borrowers. Loans with these features, often targeted at the elderly,
minorities, and low-income homeowners, can strip borrowers of home equity
built up over decades and cause them to lose their homes.
The Chair and Ranking Minority Member of the Senate Special Committee on
Aging asked GAO to examine the efforts under way to combat predatory
lending. GAO reviewed (1) federal laws related to predatory lending and
federal agencies' efforts to enforce them, (2) actions taken by states to
address predatory lending, (3) the secondary market's role in facilitating
or inhibiting predatory lending, (4) how consumer education, mortgage
counseling, and loan disclosures may deter predatory lending, and (5) the
relationship between predatory lending activities and elderly consumers.
The scope of this work was limited to home mortgage lending and did not
include other forms of consumer loans. To address these objectives, GAO
reviewed data and interviewed officials from federal, state, and local
agencies and from industry and consumer advocacy groups; examined federal,
state, and local laws; and reviewed relevant literature. At GAO's request,
federal agencies identified enforcement or other actions they have taken
to address predatory lending. GAO also obtained data from publicly
available databases; the data were analyzed and found to be sufficiently
reliable for this report. Chapter 1 provides the details of the scope and
methodology of this report. The work was conducted between January 2003
and January 2004 in accordance with generally accepted government auditing
standards.
Background While there is no uniformly accepted definition of predatory
lending, a number of practices are widely acknowledged to be predatory.
These include, among other things, charging excessive fees and interest
rates, lending without regard to borrowers' ability to repay, refinancing
borrowers' loans repeatedly over a short period of time without any
economic gain for the borrower, and committing outright fraud or
deception-for example, falsifying documents or intentionally
Executive Summary
misinforming borrowers about the terms of a loan.1 These types of
practices offer lenders that originate predatory loans potentially high
returns even if borrowers default, since many of these loans require
excessive up-front fees. No comprehensive data are available on the
incidence of these practices, but banking regulators, consumer advocates,
and industry participants generally agree that predatory loans are most
likely to occur in the market for "subprime" loans. The subprime market
serves borrowers who have limited incomes or poor or no credit histories,
in contrast with the prime market, which encompasses traditional lenders
and borrowers with credit histories that put them at low risk of default.
Originators of subprime loans most often are mortgage and consumer finance
companies but can also be banks, thrifts, and other institutions.
Serious data limitations make the extent of predatory lending difficult to
determine. However, there have been a number of major settlements
resulting from government enforcement actions or private party lawsuits in
the last 5 years that have accused lenders of abusive practices affecting
large numbers of borrowers. For example, in October 2002, Household
International, a large home mortgage lender, agreed to pay up to $484
million to homeowners to settle states' allegations that it used unfair
and deceptive lending practices to make mortgage loans with excessive
interest and fees. In addition, the rate of foreclosures of subprime loans
has increased substantially since 1990, far exceeding the rate of increase
for subprime originations. Some consumer groups and industry observers
have attributed this development, at least in part, to an increase in
abusive lending, particularly of loans made without regard to borrowers'
ability to repay. Additionally, groups such as legal services agencies
have reported seeing an ever-greater number of consumers, particularly the
elderly and minorities, who are in danger of losing their homes as a
result of predatory lending practices.
Results in Brief Federal agencies have addressed predatory lending under a
variety of federal laws, including the Home Ownership and Equity
Protection Act (HOEPA), which was an amendment to the Truth in Lending Act
(TILA) designed specifically to combat predatory lending, and other
consumer protection laws such as the Federal Trade Commission Act (FTC
Act), TILA generally, and the Real Estate Settlement Procedures Act
(RESPA). The
1Throughout this report, the terms "predatory lending" and "abusive
lending" are used to refer to such practices.
Executive Summary
Federal Trade Commission (FTC) has played a prominent role because it is
responsible for implementing and enforcing certain federal laws among
lending institutions that are not supervised by federal banking
regulators. As of December 2003, FTC reported that it had taken 19
enforcement actions against mortgage lenders and brokers for predatory
practices, including some actions that have resulted in multimillion
dollar settlements. The Department of Housing and Urban Development's
(HUD) enforcement activities related to abusive lending have focused on
criminal fraud in its Federal Housing Administration (FHA) loan insurance
program. The federal banking regulators-the Federal Deposit Insurance
Corporation (FDIC), Board of Governors of the Federal Reserve System (the
Board), Office of the Comptroller of the Currency (OCC), Office of Thrift
Supervision (OTS), and National Credit Union Administration (NCUA)-report
little evidence of predatory lending by the depository institutions that
they supervise. However, concerns exist about nonbank mortgage lending
companies that are owned by financial or bank holding companies, which
have been involved in several notable enforcement actions involving
allegations of abusive lending practices. While FTC has clear authority to
conduct investigations and enforce consumer protection laws among these
nonbank mortgage lending companies, as a law enforcement agency its role
is to investigate possible violations rather than to act as a supervisory
agency with routine monitoring and examination responsibilities. The Board
may be better equipped to monitor and examine these subsidiaries'
compliance with federal consumer protection laws and thus to deter
predatory lending, but it does not have clear authority to do so.
According to a database that tracks state and local legislation, 25
states, 11 localities, and the District of Columbia have passed their own
laws addressing predatory lending.2 While these laws vary, most of them
restrict the terms or provisions of mortgage loans originated within their
jurisdictions. In addition, some states have strengthened the regulation
and licensing of mortgage lenders and brokers, and state law enforcement
agencies and banking regulators have taken a number of enforcement actions
under state consumer protection and banking laws. Some federal regulators
have asserted that federal law preempts some state predatory
2Information relating to state and local laws and their provisions is from
a database maintained by Butera & Andrews, a Washington, D.C., law firm
that tracks predatory lending legislation, and is current as of January 9,
2004. These laws only include state and local laws that placed actual
restrictions on lending. For example, they do not include local ordinances
that consisted solely of a resolution that condemned predatory lending.
Executive Summary
lending laws for the institutions they regulate, stating that federally
chartered lending institutions should be required to comply with a single
uniform set of national regulations. Many state officials and consumer
advocates, however, maintain that federal preemption interferes with the
states' ability to protect consumers.
The secondary market for mortgage loans-which allows lenders and investors
to sell and buy mortgages and mortgage-backed securities- provides lenders
with an additional source of liquidity and may benefit borrowers by
increasing access to credit and lowering interest rates. But the secondary
market may also inadvertently serve to facilitate predatory lending, both
by providing a source of funds for unscrupulous originators to quickly
sell off loans with predatory terms and by reducing incentives for these
originators to ensure that borrowers can repay their loans. Secondary
market participants may use varying degrees of "due diligence"-a review
and appraisal of legal and financial information-to avoid purchasing loans
with abusive terms. Fannie Mae and Freddie Mac- which are relatively
recent entrants in the subprime market-have due diligence processes that
are designed, in part, to avoid purchasing loans that may have been
harmful to consumers. Other firms may use due diligence not necessarily to
avoid loans that may have harmed consumers but to avoid loans that are not
in compliance with applicable law or that present undue financial or
reputation risks. Some states have passed laws making secondary market
buyers liable for violations by loan originators, although such laws may
have the unintended consequence of reducing the availability of legitimate
credit to consumers.
A number of federal, state, nonprofit, and industry-sponsored
organizations offer consumer education initiatives designed to deter
predatory lending by, among other things, providing information about
predatory practices and working to improve consumers' overall financial
literacy. GAO's review of literature and interviews with consumer and
federal officials suggest that while tools such as consumer education,
mortgage counseling, and disclosures are useful, they may be of limited
effectiveness in reducing predatory lending. For instance, consumer
education is hampered by the complexity of mortgage transactions and the
difficulty of reaching the target audience. Similarly, unreceptive
consumers and counselors' lack of access to relevant loan documents can
hamper the effectiveness of mortgage counseling efforts, while the sheer
volume of mortgage originations each year makes providing universal
counseling difficult. And while efforts are under way to improve the
federally required disclosures associated with mortgage loans, the
complexity of mortgage transactions
Executive Summary
also hinders these efforts, especially given the lack of financial
sophistication among many borrowers who are targeted by predatory lenders.
While there are no comprehensive data, government officials and consumer
advocacy organizations have reported that elderly consumers have been
disproportionately targeted and victimized by predatory lenders. According
to these officials and organizations, elderly consumers appear to be
favored targets for several reasons-for example, because they may have
substantial equity in their homes or live on limited incomes that make
them susceptible to offers for quick access to cash. Further, some seniors
have cognitive or physical impairments such as poor eyesight, hearing, or
mobility that may limit their ability to access competitive sources of
credit. Most consumer financial education efforts seek to serve the
general consumer population, but a few education initiatives have focused
specifically on predatory lending and the elderly. Most legal assistance
related to predatory lending aims at assisting the general population of
consumers, although some is focused on elderly consumers in particular.
Principal Findings
Federal Agencies Have Taken Enforcement and Other Actions to Address
Predatory Lending, but Face Challenges
Federal agencies and regulators have used a number of federal laws to
combat predatory lending practices. Among the most frequently used
laws-HOEPA, the FTC Act, TILA, and RESPA-only HOEPA was specifically
designed to address predatory lending. Enacted in 1994, HOEPA places
restrictions on certain high-cost loans, including limits on prepayment
penalties and balloon payments and prohibitions against negative
amortization. However, HOEPA covers only loans that exceed certain rate or
fee triggers, and although comprehensive data are lacking, it appears that
HOEPA covers only a limited portion of all subprime loans. The FTC Act,
enacted in 1914 and amended on numerous occasions, authorizes FTC to
prohibit and take action against unfair or deceptive acts or practices in
or affecting commerce. TILA and RESPA are designed in part to provide
consumers with accurate information about the cost of credit.
Other federal laws that have been used to address predatory lending
practices include criminal fraud statutes that prohibit certain types of
fraud sometimes used in abusive lending schemes, such as forgery and false
Executive Summary
statements. Also, the Fair Housing Act and Equal Credit Opportunity Act-
which prohibit discrimination in housing-related transactions and the
extension of credit, respectively-have been used in cases against abusive
lenders that have targeted certain protected groups.
Using these or other authorities, federal agencies have taken a number of
enforcement actions and other steps, such as issuing guidance and revising
regulations.
o Among federal agencies, FTC has a prominent role in combating predatory
lending because of its responsibilities in implementing and enforcing
certain federal laws among lending institutions that are not depository
institutions supervised by federal banking regulators. FTC has reported
that it has filed 19 complaints-17 since 1998-alleging deceptive or other
illegal practices by mortgage lenders or brokers and that some actions
have resulted in multimillion dollar settlements. For example, in 2002 FTC
settled a complaint against a lender charged with engaging in systematic
and widespread deceptive and abusive lending practices. According to FTC
staff, close to 1 million borrowers will receive about $240 million in
restitution under the settlement.
o DOJ, which is responsible for enforcing certain federal civil rights
laws, has filed an enforcement action on behalf of the FTC and identified
two additional enforcement actions it has taken that are related to
predatory mortgage lending practices. The statutes DOJ enforces only
address predatory lending practices when they are alleged to be
discriminatory.
o HUD has undertaken enforcement activities related to abusive lending
that primarily focus on reducing losses to the FHA insurance fund, most
notably violations of criminal fraud statutes and FHA regulations through
"property flipping" schemes, which in some cases can harm borrowers by
leaving them with mortgage loans that may far exceed the value of their
homes.3 HUD has also taken three enforcement actions in abusive mortgage
lending cases for violations of RESPA's prohibitions on certain types of
fees.
3HUD's FHA mortgage insurance program makes loans more readily available
for low-and moderate-income families by providing mortgage insurance to
purchase or refinance a home. Lending institutions such as mortgage
companies and banks fund the loans.
Executive Summary
o Federal banking regulators have stated that their monitoring and
examination activities have uncovered little evidence of predatory lending
in federally regulated depository institutions. Four of the five federal
banking regulators reported taking no formal enforcement actions involving
predatory mortgage lending against the institutions they regulate, while
the fifth-OCC-reported that it has taken one formal enforcement action
against a bank engaged in abusive mortgage lending. Regulators noted that
they have taken informal enforcement actions to address questionable
practices raised during the examination process and required their
institutions to take corrective action.
o The banking regulators have also issued guidance to the institutions
they supervise on avoiding direct or indirect involvement in predatory
lending. In addition, the Board has made changes to its regulations
implementing HOEPA that, among other things, increase the number of loans
HOEPA covers. The Board also made changes to its regulations implementing
the Home Mortgage Disclosure Act that make it easier to analyze potential
patterns of predatory lending.
Federal agencies and banking regulators have coordinated their efforts to
address predatory lending on certain occasions through participation in
interagency working groups and through joint enforcement actions. For
example, FTC, DOJ, and HUD coordinated to take an enforcement action
against Delta Funding Corporation, with each agency investigating and
bringing actions for violations of the laws within its jurisdiction.
Issues related to federal oversight and regulation of certain nonbank
mortgage lenders may challenge efforts to combat predatory lending.
Nonbank mortgage lending companies owned by financial or bank holding
companies (nonbank mortgage lending subsidiaries), such as finance and
mortgage companies, account for an estimated 24 percent of subprime loan
orginations, according to HUD, and some have been the target of notable
federal and state enforcement actions involving allegations of abusive
lending.4 FTC is the primary federal enforcer of consumer protection laws
for these nonbank subsidiaries, but it is a law enforcement rather than
supervisory agency. Thus, FTC's mission and resource allocations are
focused on conducting investigations in response to consumer complaints
and other information rather than on routine monitoring and examination
4These nonbank subsidiaries are owned by the financial holding companies
or bank holding companies and are not the direct operating subsidiaries of
the bank itself.
Executive Summary
responsibilities. In contrast, the Board conducts periodic examinations of
financial and bank holding companies and, under the Bank Holding Company
Act, is authorized to monitor and examine the subsidiaries of a bank
holding company under certain circumstances. However, this authority does
not clearly extend to routine examinations of nonbank subsidiaries of
these holding companies with regard to laws pertinent to predatory
lending. In addition, the Board does not have specific authority under
pertinent federal consumer protection laws to institute an enforcement
action against a nonbank subsidiary of a financial or bank holding
company. Granting the Board concurrent enforcement authority with the FTC
for these nonbank subsidiaries of holding companies could help deter some
predatory lending.
Many States Have Passed Laws Addressing Predatory Lending, but Federal
Agencies Have Preempted Some Statutes
In response to concerns about the growth of predatory lending and the
limitations of existing laws, 25 states, the District of Columbia, and 11
localities have passed their own laws addressing predatory lending
practices, according to a database that tracks such laws. Most of these
laws regulate and restrict the terms and characteristics of high-cost
loans- that is, loans that exceed certain rate or fee thresholds. While
some state statutes follow the thresholds for covered loans established in
HOEPA, many set lower thresholds in order to cover more loans than the
federal statute. The statutes vary, but they generally cover a variety of
predatory practices, such as balloon payments and prepayment penalties,
and some include restrictions on such things as mandatory arbitration
clauses that can restrict borrowers' ability to obtain legal redress
through the courts.
Some states have also increased the regulation of and licensing
requirements for mortgage lenders and brokers, in part to address concerns
that some unscrupulous lenders and brokers have been responsible for
lending abuses and that these entities have not been adequately regulated.
For example, some states have increased the educational requirements that
lenders and brokers must meet in order to obtain a license. In recent
years, state law enforcement agencies and banking regulators have also
taken a number of actions against mortgage lenders involving predatory
lending. For example, an official from Washington State's Department of
Financial Institutions reported that the department had taken several
enforcement actions to address predatory lending, including one that
resulted in a lender being ordered to return more than $700,000 to 120
Washington borrowers for allegedly deceiving them and charging prohibited
fees.
Executive Summary
Three federal banking regulators-NCUA, OCC, and OTS-have issued opinions
stating that federal laws preempt some state predatory lending laws for
the institutions that they regulate. The regulators note that such
preemption creates a more uniform regulatory framework, relieves lending
institutions of the burden of complying with a hodgepodge of state and
federal laws, and avoids state laws that may restrict legitimate lending
activities. State officials and consumer advocates that oppose preemption
argue that federal laws do not effectively protect consumers against
predatory lending practices and that federal regulators do not devote
sufficient resources toward enforcement of consumer protection laws for
the institutions they oversee.
The Secondary Market May Benefit Consumers but Can Also Facilitate Predatory
Lending
In 2002, an estimated 63 percent of subprime loans, worth $134 billion,
were securitized and sold on the secondary market.5 The existence of a
secondary market for subprime loans has benefited consumers by increasing
the sources of funds available to subprime lenders, potentially lowering
interest rates and origination costs for subprime loans. However, the
secondary market may also inadvertently facilitate predatory lending by
providing a source of funds for unscrupulous originators, allowing them to
quickly sell off loans with predatory terms. Further, originators of
subprime mortgage loans generally make their profits from high origination
fees, and the existence of a secondary market may reduce the incentive for
these lenders to ensure that borrowers can repay.
Purchasers of mortgage loans undertake a process of due diligence designed
to avoid legal, financial, and reputational risk. Prior to the sale,
purchasers typically review electronic data containing information on the
loans, such as the loan amount, interest rate, and credit score of the
borrower. Purchasers also often physically review a sample of individual
loans, including such items as the loan application and settlement forms.
However, the degree of due diligence purchasers undertake varies. Fannie
Mae and Freddie Mac-which are estimated to account for a relatively small
portion of the secondary market for subprime loans-told us that they
undertake a series of measures aimed at avoiding the purchase of
5Originators of mortgage loans-which can include banks, other depository
institutions, and mortgage lenders that are not depository
institutions-may keep the loans or sell them on the secondary market.
Secondary market purchasers may then hold the loans or pool together a
group of loans and issue a security that is backed by a pool of mortgages
(a "mortgage-backed security").
Executive Summary
loans with abusive characteristics that may have harmed borrowers. In
contrast, according to some market participants, the due diligence of
other secondary market purchasers of residential mortgages may be more
narrowly focused on the creditworthiness of the loans and on their
compliance with federal, state, and local laws. However, even the most
stringent efforts cannot uncover some predatory loans. For example, due
diligence by secondary market purchasers may be unable to uncover fraud
that occurred during the loan underwriting or approval process, some
excessive or unwarranted fees, or loan flipping.
Under some state and local legislation, purchasers of mortgages or
mortgage-backed securities on the secondary market may be liable for
violations committed by the originating lenders-referred to as "assignee
liability" provisions. HOEPA contains such a provision for loans above
certain thresholds, as do the antipredatory lending laws in at least eight
states and the District of Columbia, according to a database that tracks
state predatory lending laws. Assignee liability is intended to discourage
secondary market participants from purchasing loans that may have
predatory features and to provide an additional source of redress for
victims of abusive lenders. However, according to some secondary market
participants, assignee liability can also discourage legitimate lending
activity. Secondary market purchasers that are unwilling to assume the
potential risks associated with assignee liability provisions have stopped
purchasing, or announced their intention to stop purchasing, mortgages
originated in areas covered by such provisions. Credit rating agencies-
whose decisions influence securitizers' ability to sell the
securities-have asserted that assignee liability provisions can make it
difficult for them to measure the risk associated with pools of loans.
Assignee liability provisions of the Georgia Fair Lending Act were blamed
for causing several participants in the mortgage lending industry to
withdraw from the market, and the provisions were subsequently repealed.
The Usefulness of Consumer Education, Counseling, and Disclosures in
Deterring Predatory Lending May Be Limited
In response to widespread concern about low levels of financial literacy
among consumers, federal agencies have conducted and funded financial
education for consumers as a means of improving consumers' financial
literacy and, in some cases, raising consumers' awareness of predatory
lending practices. For example, FDIC sponsors a financial literacy
program, MoneySmart, which is designed for low- and moderate-income
individuals with little banking experience. Other federal agencies,
including the Board, FTC, HUD, and OTS, engage in activities such as
distributing educational literature, working with community groups, and
Executive Summary
providing institutions they regulate with guidance on encouraging
financial literacy. Federal agencies have also taken some actions to
coordinate their efforts to educate consumers about predatory lending. For
example, in October 2003, the Interagency Task Force on Fair Lending,
which consists of 10 federal agencies, published a brochure that alerts
consumers to the potential pitfalls of home equity loans, particularly
high-cost loans. A number of states, nonprofits, and trade organizations
also conduct consumer financial education activities, which sometimes
focus specifically on raising awareness about predatory lending.
While representatives of the mortgage lending industry and consumer groups
have noted that financial education may make some consumers less
susceptible to abusive lending practices, GAO's review of literature and
interviews with consumer and federal officials suggest that consumer
education by itself has limits as a tool for deterring predatory lending.
First, mortgage loans are complex financial transactions, and many
different factors-including the interest rate, fees, provisions of the
loan, and situation of the borrower-determine whether a loan is in a
borrower's best interests. Even an excellent campaign of consumer
education is unlikely to provide less sophisticated consumers with enough
information to properly assess whether a loan contains abusive terms.
Second, predatory lenders and brokers tend to use aggressive marketing
tactics that are designed to confuse consumers. Broad-based campaigns to
make consumers aware of predatory lending may not be sufficient to prevent
many consumers-particularly those who may be uneducated or unsophisticated
in financial matters-from succumbing to such tactics. Finally, the
consumers who are often the targets of predatory lenders are also some of
the hardest to reach with educational information.
Prepurchase mortgage counseling-which can offer a "third party" review of
a prospective mortgage loan-may help borrowers avoid predatory loans, in
part by alerting consumers to predatory loan terms and practices. HUD
supports a network of approximately 1,700 HUD-approved counseling agencies
across the country and in some cases provides funding for their
activities. While beneficial, the role of mortgage counseling in
preventing predatory lending is likely to be limited. Borrowers do not
always attend such counseling, and when they do, counselors may not have
access to all of the loan documents needed to review the full final terms
and provisions before closing. In addition, counseling may be ineffective
against lenders and brokers engaging in fraudulent practices, such as
falsifying applications or loan documents, that cannot be detected during
a prepurchase review of mortgage loan documents.
Executive Summary
Finally, disclosures made during the mortgage loan process, while
important, may be of limited usefulness in reducing the incidence of
predatory lending practices. TILA and RESPA have requirements covering the
content, form, and timing of the information that must be disclosed to
borrowers. However, industry and consumer advocacy groups have publicly
expressed dissatisfaction with the current disclosure system. HUD issued
proposed rules in July 2002 intended to streamline the disclosure process
and make disclosures more understandable and timely, and debate over the
proposed rules has been contentious. Although improving loan disclosures
would undoubtedly have benefits, once again the inherent complexity of
loan transactions may limit any impact on the incidence of predatory
lending practices. Moreover, even a relatively clear and transparent
system of disclosures may be of limited use to borrowers who lack
sophistication about financial matters, are not highly educated, or suffer
physical or mental infirmities. Finally, as with mortgage counseling,
revised disclosure requirements would not necessarily help protect
consumers against lenders and brokers that engage in outright fraud or
that mislead borrowers about the terms of loans in the disclosure
documents themselves.
Predatory Lenders May Target Elderly Consumers
Consistent observational and anecdotal evidence, along with some limited
data, indicates that, for a variety of reasons, elderly homeowners are
disproportionately the targets of predatory lending. Abusive lenders tend
to target homeowners who have substantial equity in their homes, as many
older homeowners do. In addition, some brokers and lenders aggressively
market home equity loans as a source of cash, particularly for older
homeowners who may have limited incomes but require funds for major home
repairs or medical expenses. Moreover, diseases and physical impairments
associated with aging-such as declining vision, hearing, or mobility-can
restrict elderly consumers' ability to access financial information and
compare credit terms. Some older persons may also have diminished
cognitive capacity, which can impair their ability to comprehend and make
informed judgments on financial issues. Finally, several advocacy groups
have noted that some elderly people lack social and family support
systems, potentially increasing their susceptibility to unscrupulous
lenders who may market loans by making home visits or offering other
personal contact.
Because the elderly may be more susceptible to predatory lending,
government agencies and consumer advocacy organizations have focused some
of their education efforts on this population. For example, the
Executive Summary
Justice Department offers on its Web site the guide "Financial Crimes
Against the Elderly," which includes references to predatory lending. The
Department of Health and Human Services' Administration on Aging provides
grants to state and nonprofit agencies for programs aimed at preventing
elder abuse, including predatory lending practices targeting older
consumers. The AARP, which represents Americans age 50 and over, sponsors
a number of financial education efforts, including a borrower's kit that
contains tips for avoiding predatory lending.
Consumer protection and fair lending laws that have been used to address
predatory lending do not generally have provisions specific to elderly
persons, although the Equal Credit Opportunity Act does prohibit unlawful
discrimination on the basis of age in connection with any aspect of a
credit transaction. Federal and state enforcement actions and private
classaction lawsuits involving predatory lending generally seek to provide
redress to large groups of consumers. Little comprehensive data exist on
the age of consumers involved in these actions, but a few cases have
involved allegations of predatory lending targeting elderly borrowers. For
example, FTC, six states, AARP, and private plaintiffs settled a case with
First Alliance Mortgage Company in March 2002 for more than $60 million.
An estimated 28 percent of the 8,712 borrowers represented in the
classaction suit were elderly. The company was accused of using
misrepresentation and unfair and deceptive practices to lure senior
citizens and those with poor credit histories into entering into abusive
loans. In addition, some nonprofit groups-such as the AARP Foundation
Litigation, the National Consumer Law Center, and South Brooklyn Legal
Services' Foreclosure Prevention Project-provide legal services that
focus, in part, on helping elderly victims of predatory lending.
Matters for Congressional Consideration
To enable greater oversight of and potentially deter predatory lending
from occurring at certain nonbank lenders, Congress should consider making
appropriate statutory changes to grant the Board of Governors of the
Federal Reserve System the authority to routinely monitor and, as
necessary, examine the nonbank mortgage lending subsidiaries of financial
and bank holding companies for compliance with federal consumer protection
laws applicable to predatory lending practices. Also, Congress should
consider giving the Board specific authority to initiate enforcement
actions under those laws against these nonbank mortgage lending
subsidiaries.
Executive Summary
Agency Comments and Our Evaluation
GAO provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and comment.
The agencies provided technical comments that have been incorporated where
appropriate. In addition, the Board, DOJ, FDIC, FTC, HUD, and NCUA
provided general comments, which are discussed in greater detail at the
end of chapter 2. The written comments of the Board, DOJ, HUD, and NCUA
are printed in appendixes II through V.
The Board commented that, while the existing structure has not been a
barrier to Federal Reserve oversight, the approach recommended in our
Matter for Congressional Consideration would likely be beneficial by
catching some abusive practices that might not be caught otherwise. The
Board also noted that the approach would pose tradeoffs, such as different
supervisory schemes being applied to nonbank mortgage lenders based on
whether or not they are part of a holding company, and additional costs.
Because nonbank mortgage lenders that are part of a financial or bank
holding company currently can be examined by the Board in some
circumstances, they are already subject to a different supervisory scheme
than other such lenders. We agree that the costs to the lenders and the
Board would increase to the extent the Board exercised any additional
authority to monitor and examine nonbank lenders, and believe that
Congress should consider both the potential costs and benefits of
clarifying the Board's authorities.
The FTC expressed concern that our report could give the impression that
we are suggesting that Congress consider giving the Board sole
jurisdiction-rather than concurrent jurisdiction with FTC-over nonbank
subsidiaries of holding companies. Our report did not intend to suggest
that the Congress make any change that would necessarily affect FTC's
existing authority for these entities, and we modified the report to
clarify this point.
DOJ commented that the report will be helpful in assessing the
department's role in the federal government's efforts to develop
strategies to combat predatory lending. DOJ disagreed with our inclusion
in the report of "property or loan flips," which it said was a traditional
fraud scheme but not a type of predatory lending. As we noted in our
report, there is no precise definition of predatory lending. We
incorporated a discussion of property flipping-quick resales of recently
sold FHA properties-because HUD officials characterize some of these
schemes as involving predatory practices that can harm borrowers. We
included loan
Executive Summary
flipping-the rapid and repeated refinancing of a loan without benefit to
the borrower-in our report because this is widely characterized in the
literature and by federal, state, and nonprofit agency officials as a
predatory lending practice.
FDIC noted that our Matter for Congressional Consideration focuses on
nonbank subsidiaries of holding companies even though these entities
comprise, according to HUD, only about 20 percent of all subprime lenders.
We recognize that our Matter does not address all subprime lenders or
other institutions that may be engaging in predatory lending, but believe
it represents a potential step in addressing predatory lending among a
significant segment of mortgage lenders. NCUA said that the report
provides a useful discussion of the issues and the agency concurs with our
Matter for Congressional Consideration. HUD, in its comment letter,
described a variety of actions it has taken that it characterized as
combating predatory lending, particularly with regard to FHA-insured
loans.
Chapter 1
Introduction
In recent years, abuses in home mortgage lending-commonly referred to as
"predatory lending"-have increasingly garnered the attention and concern
of policymakers, consumer advocates, and participants in the mortgage
lending industry.1 Once relatively rare, government enforcement actions
and private party lawsuits against institutions accused of abusive home
mortgage lending have increased dramatically in the last 10 years. In 2002
alone, there were dozens of settlements resulting from accusations of
abusive lending. In the largest of these, a major national mortgage lender
agreed to pay up to $484 million to tens of thousands of affected
consumers.
The Nature and Attributes of Predatory Lending
Predatory lending is an umbrella term that is generally used to describe
cases in which a broker or originating lender takes unfair advantage of a
borrower, often through deception, fraud, or manipulation, to make a loan
that contains terms that are disadvantageous to the borrower. While there
is no universally accepted definition, predatory lending is associated
with the following loan characteristics and lending practices:
o Excessive fees. Abusive loans may include fees that greatly exceed the
amounts justified by the costs of the services provided and the credit and
interest rate risks involved. Lenders may add these fees to the loan
amounts rather than requiring payment up front, so the borrowers may not
know the exact amount of the fees they are paying.
o Excessive interest rates. Mortgage interest rates can legitimately vary
based on the characteristics of borrowers (such as creditworthiness) and
of the loans themselves. However, in some cases, lenders may charge
interest rates that far exceed what would be justified by any riskbased
pricing calculation, or lenders may "steer" a borrower with an excellent
credit record to a higher-rate loan intended for borrowers with poor
credit histories.
o Single-premium credit insurance. Credit insurance is a loan product
that repays the lender should the borrower die or become disabled. In the
case of single- premium credit insurance, the full premium is paid all at
once-by being added to the amount financed in the loan-rather than on a
monthly basis. Because adding the full premium to the
1Throughout this report, the terms predatory lending and abusive lending
are used interchangeably.
Chapter 1 Introduction
amount of the loan unnecessarily raises the amount of interest borrowers
pay, single-premium credit insurance is generally considered inherently
abusive.
o Lending without regard to ability to repay. Loans may be made without
regard to a borrower's ability to repay the loan. In these cases, the loan
is approved based on the value of the asset (the home) that is used as
collateral. In particularly egregious cases, monthly loan payments have
equaled or exceeded the borrower's total monthly income. Such lending can
quickly lead to foreclosure of the property.
o Loan flipping. Mortgage originators may refinance borrowers' loans
repeatedly in a short period of time without any economic gain for the
borrower. With each successive refinancing, these originators charge high
fees that "strip" borrowers' equity in their homes.
o Fraud and deception. Predatory lenders may perpetrate outright fraud
through actions such as inflating property appraisals and doctoring loan
applications and settlement documents. Lenders may also deceive borrowers
by using "bait and switch" tactics that mislead borrowers about the terms
of their loan. Unscrupulous lenders may fail to disclose items as required
by law or in other ways may take advantage of borrowers' lack of financial
sophistication.
o Prepayment penalties. Penalties for prepaying a loan are not
necessarily abusive, but predatory lenders may use them to trap borrowers
in high-cost loans.
o Balloon payments. Loans with balloon payments are structured so that
monthly payments are lower but one large payment (the balloon payment) is
due when the loan matures. Predatory loans may contain a balloon payment
that the borrower is unlikely to be able to afford, resulting in
foreclosure or refinancing with additional high costs and fees. Sometimes,
lenders market a low monthly payment without adequate disclosure of the
balloon payment.
Predatory lending is difficult to define partly because certain loan
attributes may or may not be abusive, depending on the overall context of
the loan and the borrower. For example, although prepayment penalties can
be abusive in the context of some loans, in the context of other loans
they can benefit borrowers by reducing the overall cost of loans by
reducing the lender's prepayment risk.
Chapter 1 Introduction
According to federal and industry officials, most predatory mortgage
lending involves home equity loans or loan refinancings rather than loans
for home purchases. Homeowners may be lured into entering refinance loans
through aggressive solicitations by mortgage brokers or lenders that
promise "savings" from debt consolidation or the ability to "cash out" a
portion of a borrower's home equity. Predatory lending schemes may also
involve home improvement contractors that work in conjunction with a
lender. The contractor may offer to arrange financing for necessary
repairs or improvements, and then perform shoddy work or fail to complete
the job, while leaving the borrower holding a high-cost loan. Abuses in
loan servicing have also increasingly become a concern. Abusive mortgage
lenders or servicing agents may charge improper late fees, require
unjustified homeowner's insurance, or not properly credit payments. In
November 2003, the Federal Trade Commission (FTC) and the Department of
Housing and Urban Development (HUD) reached a settlement with a large
national mortgage servicer, Fairbanks Capital, after the company was
accused of unfair, deceptive, and illegal practices in the servicing of
mortgage loans. The settlement will provide $40 million to reimburse
consumers.
Originating lenders or brokers that engage in abusive practices can make
high profits through the excessive points and fees that they charge,
particularly when borrowers make their payments regularly. Even when a
loan enters foreclosure, the originator of a predatory loan may still make
a profit due to the high up-front fees it has already collected. Moreover,
a lender that sells a loan in the secondary market shortly after
origination no longer necessarily faces financial risk from foreclosure.2
Similarly, a mortgage broker that collects fees up front is not affected
by foreclosure of the loan.
According to HUD and community groups, predatory lending not only harms
individual borrowers but also can weaken communities and neighborhoods by
causing widespread foreclosures, which reduce property values. Predatory
lending also serves to harm the reputation of honest and legitimate
lenders, casting them in the same suspicious light as those making unfair
loans and thus increasing their reluctance to extend credit to the
traditionally underserved communities that are often targeted by abusive
lenders.
2As discussed in chapter 4, the secondary market is where existing
mortgage loans and mortgage-backed securities are sold and purchased.
Chapter 1 Introduction
Emergence of Subprime Mortgage Market
The market for mortgage loans has evolved considerably over the past 20
years. Among the changes has been the emergence of a market for subprime
mortgage loans. Most mortgage lending takes place in what is known as the
prime market, which encompasses traditional lenders and borrowers with
credit histories that put them at low risk of default. In contrast, the
subprime market serves borrowers who have poor or no credit histories or
limited incomes, and thus cannot meet the credit standards for obtaining
loans in the prime market.3 It is widely accepted that the overwhelming
majority of predatory lending occurs in the subprime market, which has
grown dramatically in recent years. Subprime mortgage originations grew
from $34 billion in 1994 to more than $213 billion in 2002 and in 2002
represented 8.6 percent of all mortgage originations, according to data
reported by the trade publication Inside B&C Lending. Several factors
account for the growth of the subprime market, including changes in tax
law that increased the tax advantages of home equity loans, rapidly
increasing home prices that have provided many consumers with substantial
home equity, entry into the subprime market by companies that had
previously made only prime loans, and the expansion of credit scoring and
automated underwriting, which has made it easier for lenders to price the
risks associated with making loans to credit-impaired borrowers.
Originating lenders charge higher interest rates and fees for subprime
loans than they do for prime loans to compensate for increased risks and
for higher servicing and origination costs. In many cases, increased risks
and costs justify the additional cost of the loan to the borrower, but in
some cases they may not. Because subprime loans involve a greater variety
and complexity of risks, they are not the uniformly priced commodities
that prime loans generally are. This lack of uniformity makes comparing
the costs of subprime loans difficult, which can increase borrowers'
vulnerability to abuse.
However, subprime lending is not inherently abusive, and certainly all
subprime loans are not predatory. Although some advocacy groups claim that
subprime lending involves abusive practices in a majority of cases, most
analysts believe that only a relatively small portion of subprime loans
3There is no uniform definition across the lending industry for what
characterizes a loan as subprime. Subprime loans are generally given to
borrowers with credit scores that are below a certain threshold, but that
threshold can vary according to the policies of the individual lender.
Chapter 1 Introduction
contain features that may be considered abusive. In addition, according to
officials at HUD and the Department of the Treasury, the emergence of a
subprime mortgage market has enabled a whole class of credit-impaired
borrowers to buy homes or access the equity in their homes. At the same
time, however, federal officials and consumer advocates have expressed
concerns that the overall growth in subprime lending and home equity
lending in general has been accompanied by a corresponding increase in
predatory lending. For example, lenders and brokers may use aggressive
sales and marketing tactics to convince consumers who need cash to enter
into a home equity loan with highly disadvantageous terms.
Originators of subprime loans are most often mortgage and consumer finance
companies, but can also be banks, thrifts, and other institutions. Some
originators focus primarily on making subprime loans, while others offer a
variety of prime and subprime loans. According to HUD, 178 lenders
concentrated primarily on subprime mortgage lending in 2001. Fifty-nine
percent of these lenders were independent mortgage companies (mortgage
bankers and finance companies), 20 percent were nonbank subsidiaries of
financial or bank holding companies, and the remainder were other types of
financial institutions. Only 10 percent were federally regulated banks and
thrifts.4
About half of all mortgage loans are made through mortgage brokers that
serve as intermediaries between the borrower and the originating lender.
According to government and industry officials, while the great majority
of mortgage brokers are honest, some play a significant role in
perpetrating predatory lending. A broker can be paid for his services from
up-front fees directly charged to the borrower and/or through fees paid
indirectly by the borrower through the lender in what is referred to as a
"yield spread premium."5 Some consumer advocates argue that compensating
brokers this way gives brokers an incentive to push loans with higher
interest rates and fees. Brokers respond that yield spread premiums in
fact allow them to reduce the direct up-front fees they charge consumers.
4HUD annually identifies a list of lenders that specialize in either
subprime or manufactured home lending. HUD occasionally updates data
related to past years. The information provided here was based on data
available as of November 7, 2003.
5A "yield spread premium" is a payment a mortgage broker receives from a
lender based on the difference between the actual interest rate on the
loan and the rate the lender would have accepted on the loan given the
risks and costs involved. The higher the actual loan rate compared with
the acceptable loan rate, the higher the yield spread premium.
Chapter 1 Introduction
The Extent of Predatory Lending Is Unknown
Currently no comprehensive and reliable data are available on the extent
of predatory lending nationwide, for several reasons. First, the lack of a
standard definition of what constitutes predatory lending makes it
inherently difficult to measure. Second, any comprehensive data collection
on predatory lending would require access to a representative sample of
loans and to information that can only be extracted manually from the
physical loan files. Given that such records are not only widely dispersed
but also generally proprietary, to date comprehensive data have not been
collected.6 Nevertheless, policymakers, advocates, and some lending
industry representatives have expressed concerns in recent years that
predatory lending is a significant problem. Although the extent of
predatory lending cannot be easily quantified, several indicators suggest
that it may be prevalent. Primary among these indicators are legal
settlements, foreclosure patterns, and anecdotal evidence.
In the past 5 years, there have been a number of major settlements
resulting from government enforcement actions and private party lawsuits
accusing lenders of abusive lending practices affecting large numbers of
borrowers. Among the largest of these settlements have been the following:
o In October 2002, the lender Household International agreed to pay up to
$484 million to homeowners across the nation to settle allegations by
states that it used unfair and deceptive lending practices to make
mortgage loans with excessive interest and charges.
o In September 2002, Citigroup agreed to pay up to $240 million to
resolve charges by FTC and private parties that Associates First Capital
Corporation and Associates Corporation of North America (The
6One of the few studies that sought to quantify the extent of predatory
lending was "Quantifying the Economic Cost of Predatory Lending," E.
Stein, Coalition for Responsible Lending, July 25, 2001 (revised Oct. 30,
2001). We were not able to verify the reliability of the study's data,
which were based on several sources. Other empirical data appears in a
study by Freddie Mac on its automated underwriting system, "Automated
Underwriting: Making Mortgage Lending Simpler and Fairer for America's
Families," September 1996. The company evaluated a sample of 15,000
subprime mortgage loans originated by four financial institutions and
provided preliminary estimates that between 10 and 35 percent of the
borrowers who received these loans could have qualified for a loan in the
prime market. Some consumer advocates have said these data suggest that
some borrowers may be "steered" to high-cost loans even though they
qualify for conventional loans with better terms. A Freddie Mac official
told us that the data are insufficient to necessarily draw that
conclusion.
Chapter 1 Introduction
Associates) engaged in systematic and widespread deceptive and abusive
lending practices.7 According to FTC staff, under the settlement close to
1 million borrowers will receive compensation for loans that
misrepresented insurance products and that contained other abusive terms.
o In response to allegations of deceptive marketing and abusive lending,
First Alliance Mortgage Company entered into a settlement in March 2002
with FTC, six states, and private parties to compensate nearly 18,000
borrowers more than $60 million dollars.
Further, between January 1998 and September 1999, the foreclosure rate for
subprime loans was more than 10 times the foreclosure rate for prime
loans.8 While it would be expected that loans made to less creditworthy
borrowers would result in some increased rate of foreclosure, the
magnitude of this difference has led many analysts to suggest that it is
at least partly the result of abusive lending, particularly of loans made
without regard to the borrower's ability to repay. Moreover, the rate of
foreclosures of subprime mortgage loans has increased substantially since
1990, far exceeding the rate of increase for subprime originations. A
study conducted for HUD noted that while the increased rate in subprime
foreclosures could be the result of abusive lending, it could also be the
result of other factors, such as an increase in subprime loans that are
made to the least creditworthy borrowers.9
In the early 1990s, anecdotal evidence began to emerge suggesting that
predatory lending was on the rise. Legal services agencies throughout the
country reported an increase in clients who were facing foreclosure as a
result of mortgage loans that included abusive terms and conditions. These
agencies noted that for the first time they were seeing large numbers of
7Citigroup acquired Associates First Capital Corporation and Associates
Corporation of North America in November 2000 and merged The Associates'
consumer finance operations into its subsidiary, CitiFinancial Credit
Company.
8See HUD-Treasury Task Force on Predatory Lending, Curbing Predatory Home
Mortgage Lending: A Joint Report (June 2000), 34-35. The report noted that
from January 1998 through September 1999, foreclosure rates averaged 0.2
percent for prime mortgage loans and 2.6 percent for subprime mortgage
loans.
9Harold L. Bunce, Debbie Gruenstein, Christopher E. Herbert, and Randall
M. Scheessele, "Subprime Foreclosures: The Smoking Gun of Predatory
Lending?" Paper presented at the U.S. Department of Housing and Urban
Development conference "Housing Policy in the New Millennium," Crystal
City, VA, October 2000.
Chapter 1 Introduction
consumers, particularly elderly and minority borrowers, who were facing
the loss of homes they had lived in for many years because of a high-cost
refinancing. Similar observations were also reported extensively at forums
on predatory lending sponsored by HUD and the Department of the Treasury
in five cities during 2000, at hearings held in four cities during 2000 by
the Board of Governors of the Federal Reserve System (the Board), and at
congressional hearings on the issue in 1998, 2001, 2002, and 2003.10
Federal officials and consumer advocates maintain that predatory lenders
often target certain populations, including the elderly and some lowincome
and minority communities. Some advocates say that in many cases, predatory
lenders target communities that are underserved by legitimate
institutions, such as banks and thrifts, leaving borrowers with limited
credit options. According to government officials and legal aid
organizations, predatory lending appears to be more prevalent in urban
areas than in rural areas, possibly because of the concentration of
certain target groups in urban areas and because the aggressive marketing
tactics of many predatory lenders may be more efficient in denser
neighborhoods.11
Emergence of The federal government began addressing predatory home
mortgage
lending as a significant policy issue in the early 1990s. In 1994, the
CongressPredatory Lending As passed the Home Ownership and Equity
Protection Act (HOEPA), anPolicy Issue amendment to the Truth in Lending
Act that set certain restrictions on
"high-cost" loans in order to protect consumers.12 In 1998, as part of an
10Hearing on "Equity Predators: Stripping, Flipping and Packing Their Way
to Profits," Special Committee on Aging, U.S. Senate, March 16, 1998.
Hearing on "Predatory Mortgage Lending: The Problem, Impact and
Responses," Committee on Banking, Housing, and Urban Affairs, U.S. Senate,
July 26 and 27, 2001. Hearing on "Predatory Mortgage Lending Practices:
Abusive Uses of Yield Spread Premiums," Committee on Banking, Housing, and
Urban Affairs, U.S. Senate, January 8, 2002. Hearing on "Protecting
Homeowners: Preventing Abusive Lending While Preserving Access to Credit,"
Subcommittees on Financial Institutions and Consumer Credit and Housing
and Community Opportunity, Committee on Financial Services, House of
Representatives, November 5, 2003.
11A Rural Housing Institute report found that predatory lending did not
appear to have infiltrated rural counties in Iowa as much as urban
counties. However, the institute also noted there have been reports of
many cases of predatory lending in rural areas of the country overall,
with comparably severe effects on rural victims. See Rural Voices, Vol. 7,
No. 2, Spring 2002, 4-5.
12See Pub. L. 103-325 S:S: 151-158, 108 Stat. 2190-2198.
Chapter 1 Introduction
overall review of the statutory requirements for mortgage loans, HUD and
the Board released a report recommending that additional actions be taken
to protect consumers from abusive lending practices.13 HUD and the
Department of the Treasury formed a task force in 2000 that produced the
report Curbing Predatory Home Mortgage Lending, which made several dozen
recommendations for addressing predatory lending.14, 15
As discussed in chapters 2 and 3, a variety of federal, state, and local
laws have been used to take civil and criminal enforcement actions against
institutions and individuals accused of abusive lending practices. Various
federal agencies have responsibilities for enforcing laws related to
predatory lending. In addition, some state or local enforcement
authorities-including attorneys general, banking regulators, and district
attorneys-have used state and local laws related to consumer protection
and banking to address predatory lending practices. In addition, many
private attorneys and advocacy groups have pursued private legal actions,
including class actions, on behalf of borrowers who claim to have been
victimized by abusive lending.
Objectives, Scope, and Methodology
Our objectives were to describe (1) federal laws related to predatory
lending and federal agencies' efforts to enforce them; (2) the actions
taken by the states in addressing predatory lending; (3) the secondary
market's role in facilitating or inhibiting predatory lending; (4) how
consumer education, mortgage counseling, and loan disclosures may deter
predatory lending; and (5) the relationship between predatory lending
activities and elderly consumers. The scope of this work was limited to
home mortgage lending and did not include other forms of consumer loans.
To identify federal laws and enforcement activities related to predatory
lending, we interviewed officials and reviewed documents from HUD, the
13Board of Governors of the Federal Reserve System and Department of
Housing and Urban Development, Joint Report to the Congress Concerning
Reform to the Truth in Lending Act and the Real Estate Settlement
Procedures Act, July 1998.
14HUD-Treasury Task Force on Predatory Lending, Curbing Predatory Home
Mortgage Lending: A Joint Report, June 2000.
15During 2003, there were at least two bills introduced in Congress that
addressed predatory or abusive lending practices-the Responsible Lending
Act (H.R. 833, Feb. 13, 2003) and the Predatory Lending Consumer
Protection Act of 2003 (S. 1928, Nov. 21, 2003).
Chapter 1 Introduction
Department of Justice (DOJ), the Department of the Treasury, the Federal
Deposit Insurance Corporation (FDIC), FTC, the Board, the National Credit
Union Administration (NCUA), the Office of the Comptroller of the Currency
(OCC), and the Office of Thrift Supervision (OTS). We asked each agency to
provide us with the enforcement actions they have taken that-in their
assessment-were related to predatory home mortgage lending. We compiled
and reviewed data on these enforcement actions and other steps these
agencies have taken to address abusive lending practices. We also reviewed
and analyzed federal laws that have been used to combat these practices.
To identify actions taken by states and localities, we reviewed and
analyzed a publicly available database maintained by the law firm of
Butera & Andrews that tracks state and municipal antipredatory lending
legislation. We reviewed information related to this database and
conducted interviews with the person who maintains it. In order to
identify gaps in the completeness or accuracy of data, we compared data
elements from this database and from three similar databases maintained by
Lotstein Buckman, the National Conference of State Legislatures, and the
Mortgage Bankers Association of America. We determined that the data were
sufficiently reliable for use in this report. We also interviewed
officials representing a wide range of state and local government
agencies, lending institutions, and advocacy groups in a number of states
and municipalities. In order to illustrate approaches taken in certain
states with regard to predatory lending, we collected and analyzed
additional information from two states, North Carolina and Ohio. We chose
these states to illustrate the differing characteristics of two states'
approaches to addressing predatory lending-particularly with regard to
legislation restricting high-cost loans and tightening regulation of
mortgage lenders and brokers. We also conducted meetings with the
Conference of State Bank Supervisors and the National Association of
Attorneys General that included representatives from several states.
Additionally, we conducted interviews with OCC, OTS, and NCUA to
understand their policies and processes on federal preemption of state
antipredatory lending laws.
To describe the secondary market's role, we interviewed officials and
reviewed documents from the Bond Market Association, the Securities
Industry Association, Fannie Mae, Freddie Mac, a due diligence contractor,
and two credit rating agencies. We also spoke with officials representing
federal and state agencies, and with representatives of the lending
industry and consumer groups. In addition, we reviewed and analyzed
several local and state laws containing assignee liability provisions.
Chapter 1 Introduction
To describe the role of consumer education, mortgage counseling, and
disclosures in deterring predatory lending, we interviewed officials from
entities that engage in consumer financial education, including several
federal and state agencies, industry trade groups, and local nonprofit
organizations such as the Long Island Housing Partnership, the Greater
Cincinnati Mortgage Counseling Service, and the Foreclosure Prevention
Project of South Brooklyn Legal Services. We also reviewed and analyzed
the materials these entities produce. Additionally, we conducted a
literature review of studies that have evaluated the effectiveness of
consumer education and homeownership counseling.
To describe the impact on older consumers, we conducted a literature
review on predatory lending and the elderly and examined studies on
financial exploitation of the elderly. We also examined certain
enforcement activities and private party lawsuits in which elderly
consumers may have been targeted by abusive lenders. We interviewed
federal and state agencies that have addressed issues of financial abuse
of the elderly, including the Department of Health and Human Services'
Administration on Aging and the National Institute on Aging, as well as
nonprofit groups that have addressed this issue, including AARP (formerly
known as the American Association of Retired Persons).
In addressing all of the objectives, we met with a wide range of
organizations that represent consumers, among them the National Community
Reinvestment Coalition, the Coalition for Responsible Lending, the
National Consumer Law Center, the Association of Community Organizations
for Reform Now, and AARP. We also met with organizations representing
various aspects of the mortgage lending industry, among them the American
Financial Services Association, the Consumer Mortgage Coalition, the
Coalition for Fair and Affordable Lending, America's Community Bankers,
the National Association of Mortgage Brokers, the Mortgage Bankers
Association of America, and the National Home Equity Mortgage Association.
We provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and comment.
The agencies provided technical comments that have been incorporated, as
appropriate, as well as general comments that are discussed at the end of
chapter 2. The written comments of the Board, DOJ, HUD, and NCUA are
printed in appendixes II through V. We conducted our work between January
2003 and January 2004 in accordance
Chapter 1 Introduction
with generally accepted government auditing standards in Atlanta, Boston,
New York, San Francisco, and Washington, D.C.
Chapter 2
Federal Agencies Have Taken Steps to Address Predatory Lending, but Face
Challenges
While HOEPA is the only federal law specifically designed to combat
predatory mortgage lending, federal agencies, including federal banking
regulators, have used a number of federal consumer protection and
disclosure statutes to take actions against lenders that have allegedly
engaged in abusive or predatory lending.1 These statutes have enabled
agencies to file complaints on behalf of consumers over issues such as
excessive interest rates and fees, deceptive lending practices, and fraud.
FTC, DOJ, HUD, and federal banking regulators have taken steps to address
predatory lending practices through enforcement and civil actions,
guidance, and regulatory changes. In some cases, agencies have coordinated
their efforts through joint enforcement actions and participation in
interagency working groups or task forces. However, questions of
jurisdiction regarding certain nonbank mortgage lenders may challenge
efforts to combat predatory lending. While the Board has authority to
examine many such nonbank mortgage lenders under certain circumstances, it
lacks clear authority to enforce federal consumer protection laws against
them.
Federal Agencies Use a Variety of Laws to Address Predatory Lending Practices
As shown in figure 1, Congress has passed numerous laws that can be used
to protect consumers against abusive lending practices. Federal agencies
have applied provisions of these laws to seek redress for consumers who
have been victims of predatory lending. Among the most frequently used
laws are TILA, HOEPA, the Real Estate Settlement Procedures Act (RESPA),
and the FTC Act. 2 Congress has also given certain federal agencies
responsibility for writing regulations that implement these laws. For
example, the Board writes Regulation Z, which implements TILA and HOEPA,
and HUD writes Regulation X, which implements RESPA. Also, in some cases,
DOJ has brought actions under criminal fraud statutes based on conduct
that can constitute predatory lending.
1HOEPA amended various provisions of the Truth In Lending Act. In the
context of this report, the term "federal banking regulators" refers to
the Board, the federal supervisory agency for state-chartered banks that
are members of the Federal Reserve System; OCC, which supervises national
banks and their subsidiaries; FDIC, the federal regulator responsible for
insured state-chartered banks that are not members of the Federal Reserve
System; OTS, the primary federal supervisory agency for federally insured
thrifts and their subsidiaries; and NCUA, which supervises federally
insured credit unions.
2TILA, as amended, is codified at 15 U.S.C. S:S: 1601 - 1667f (2000 & Supp
2003). The pertinent consumer protection provisions of the FTC Act are
contained in 15 U.S.C. S:S: 41 - 58 (2000). RESPA is codified at 12 U.S.C.
S:S: 2601 - 2617 (2000 & Supp 2003).
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
Figure 1: Federal Laws and Statutes Used to Address Lending Practices Generally
Considered to be Predatory
Source: GAO.
aHOEPA covers only a limited portion of all subprime loans.
TILA, which became law in 1968, was designed to provide consumers with
accurate information about the cost of credit. Among other things, the act
requires lenders to disclose information about the terms of loans-
including the amount being financed, the total finance charge, and
information on the annual percentage rate-that can help borrowers
understand the overall costs of their loans. TILA also provides borrowers
with the right to cancel certain loans secured by a principal residence
within 3 days of closing or 3 days of the time at which the final
disclosure is made, whichever is later.3
3See 15 U.S.C. S: 1635.
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
In 1994, Congress enacted the HOEPA amendments to TILA in response to
concerns about predatory lending. HOEPA covers certain types of loans made
to refinance existing mortgages, as well as home equity loans, that
satisfy specific criteria.4 HOEPA covers only a limited portion of all
subprime loans, although there is no comprehensive data on precisely what
that portion is.5 The law is designed to limit predatory practices for
these so-called "high-cost" HOEPA loans in several ways. First, it places
restrictions on loans that exceed certain rate or fee thresholds, which
the Board can adjust within certain limits prescribed in the law. For
these loans, the law restricts prepayment penalties, prohibits balloon
payments for loans with terms of less than 5 years, prohibits negative
amortization, and contains certain other restrictions on loan terms or
payments.6 Second, HOEPA prohibits lenders from routinely making loans
without regard to the borrower's ability to repay. Third, the law requires
lenders to include disclosures in addition to those required by TILA for
consumer credit transactions to help borrowers understand the terms of the
high-cost loan and the implications of failing to make required payments.
Each federal banking regulator is charged with enforcing TILA and HOEPA
with respect to the depository institutions it regulates, and FTC is
primarily responsible for enforcing the statutes for most other financial
institutions, including independent mortgage lenders and nonbank
subsidiaries of holding companies. In enforcing TILA and HOEPA, FTC has
required violators to compensate borrowers for statutory violations. Under
certain
4HOEPA covers closed-end refinancing loans and home equity loans with
either (i) an annual percentage rate that exceeds the rate for Treasury
securities with comparable maturities by more than a specified amount, or
(ii) points and fees that exceed the greater of 8 percent of the loan
amount or $400, which is adjusted annually for inflation. 15 U.S.C. S:
1602(aa)(1), (3); see 12 C.F.R. S: 226.32 (2003). HOEPA does not apply to
purchase money mortgages (i.e., loans to purchase or construct a
residence), open-end credit (i.e., a line of credit), and reverse
mortgages. See, e.g., 15 U.S.C. S: 1639.
5The Board has cited a study conducted for the American Financial Services
Association that estimated that-using current triggers-HOEPA would have
covered nearly 38 percent of subprime first mortgage loans originated by
nine major national lenders from 1995-2000. See M. Staten and G.
Elliehausen, "The Impact of The Federal Reserve Board's Proposed Revisions
to HOEPA on the Number and Characteristics of HOEPA Loans" (July 24,
2001). In the past, the Board has also cited estimates from data from OTS
that, using the current triggers, HOEPA would cover roughly 5 percent of
all subprime loans, but the Board noted to us that this estimate may be
conservative. See 65 Fed. Reg. at 81441.
6Negative amortization occurs when loan payment amounts do not cover the
interest accruing on a loan, resulting in an increasing outstanding
principal balance over time. See 15 U.S.C. S: 1639(f).
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
circumstances, HOEPA provides for damages in addition to the actual
damages a person sustains as a result of a creditor's violation of the
act.7
RESPA, passed in 1974, seeks to protect consumers from unnecessarily high
charges in the settlement of residential mortgages by requiring lenders to
disclose details of the costs of settling a loan and by prohibiting
certain other costs.8 Among its provisions is a prohibition against
kickbacks- payments made in exchange for referring a settlement service,
such as lender payments to real estate agents for the referral of
business. RESPA also prohibits unearned fees such as adding an additional
charge to a third party fee when no or nominal services are performed.
These practices can unjustly increase the costs of loans and the
settlement process. HUD enforces RESPA, working closely with federal
banking regulators and other federal agencies such as the FTC and the
Department of Justice. HUD often brings joint enforcement actions with
these agencies, using RESPA and the statutes enforced by the other federal
agencies. In addition, the banking regulators may prohibit violations of
RESPA in their own regulations.
The FTC Act, enacted in 1914 and amended on numerous occasions, provides
the FTC with the authority to prohibit and take action against unfair or
deceptive acts or practices in or affecting commerce. FTC has used the act
to address predatory lending abuses when borrowers have been misled or
deceived about their loan terms.9
Various criminal fraud statutes prohibit certain types of fraud sometimes
used in abusive lending schemes, including forgery and false statements.
DOJ and HUD have used these statutes to fight fraudulent schemes that have
resulted in borrowers purchasing homes worth substantially less than their
mortgage amounts or borrowers being unfairly stripped of the equity in
their homes. HUD officials have described some of these fraudulent
activities as constituting predatory lending.
7See Pub. L. No. 103-325 S: 153(a), 15 U.S.C. S: 1640(a).
8Among other things, RESPA requires the good faith disclosure of estimated
settlement costs within 3 days after an application for a mortgage loan
and, at or before settlement, a uniform settlement statement (HUD-1) that
enumerates the final cost of the loan.
9Banking regulators are also authorized to enforce standards imposed
pursuant to the FTC Act with respect to unfair or deceptive acts or
practices by the institutions they supervise. See 12 U.S.C. S: 57a(f).
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
The following other federal laws have been used to a lesser extent to
address abusive lending:
o The Fair Housing Act prohibits discrimination based on race, sex, and
other factors in housing-related transactions, and the Equal Credit
Opportunity Act (ECOA) prohibits discrimination against borrowers in the
extension of credit. Federal agencies have used both laws in cases against
lenders that have allegedly targeted certain protected groups with abusive
loans.
o The Home Mortgage Disclosure Act (HMDA) requires lenders to make
publicly available certain data about mortgage loans. Federal agencies
have used the data provided by HMDA to help identify possible
discriminatory lending patterns, including those that involve abusive
lending practices.
o The Community Reinvestment Act (CRA) requires that banking regulators
consider a depository institution's efforts to meet the credit needs of
its community-including low- and moderate-income neighborhoods-in
examinations and when it applies for permission to take certain actions
such as a merger or acquisition. An institution's fair lending record is
taken into account in assessing CRA performance. CRA regulations state
that abusive lending practices that violate certain federal laws will
adversely affect an institution's CRA performance.10
o Also, federal banking regulators may rely on their supervisory and
enforcement authorities under the laws they administer, as well as on the
Federal Deposit Insurance Act, to enforce these consumer protections laws
and ensure that an institution's conduct with respect to compliance with
consumer protection laws does not affect its safety and soundness or that
of an affiliated institution.
o Finally, FTC and the banking regulators can also use the Fair Debt
Collection Practices Act and Fair Credit Reporting Act in enforcement
10On January 20, 2004, FDIC announced approval of a joint interagency
notice of proposed rulemaking regarding the Community Reinvestment Act.
The proposed rule would amend the act's regulations to expand and clarify
the provision that an institution's Community Reinvestment Act evaluation
is adversely affected when the institution has engaged in specified
discriminatory, illegal, or abusive credit practices in connection with
certain loans. FDIC said that the Board, OCC, and OTS were expected to
announce their approval of the proposed rulemaking shortly.
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
actions related to predatory lending that involve violations of credit
reporting and loan servicing provisions.
Although a number of federal laws have been used to protect borrowers from
abusive lending or to provide them redress, not all potentially abusive
practices are illegal under federal law. Enforcement officials and
consumer advocates have stated that some lenders make loans that include
abusive features but are designed to remain below the thresholds that
would subject them to the restrictions of HOEPA. For loans not covered
under HOEPA, certain lending practices many consider to be abusive are
not, depending on the circumstances, necessarily a violation of any
federal law. For example, it is not necessarily illegal to charge a
borrower interest rates or fees that exceed what is justified by the
actual risk of the mortgage loan. Nor is it per se illegal under federal
law to "steer" a borrower with good credit who qualifies for a prime loan
into a higher cost subprime loan.11 Finally, with the exception of loans
covered under HOEPA, there are no federal statutes that expressly prohibit
making a loan that a borrower will likely be unable to repay.12
11Even in instances where charging high interest rates or fees or steering
borrowers to subprime loans do not violate federal consumer protection
statutes, imposing such rates and fees on a discriminatory basis against
groups protected under the Fair Housing Act and ECOA could constitute
violations of those laws.
12A pattern of making loans without regard to the ability of borrowers to
repay can be considered a violation of the safety and soundness
requirements imposed on federally insured depository institutions and
could also reflect poorly on an institution's compliance with the
Community Reinvestment Act. See OCC Advisory Letter 2003-2 (Guidance for
National Banks to Guard Against Predatory and Abusive Lending Practices),
February 21, 2003. For loans that are covered under HOEPA, making a loan
without regard to a borrower's ability to repay is not prohibited unless
it can be demonstrated that an institution has engaged in a "pattern or
practice" of doing so. OCC in its recent rulemaking prohibited national
banks or their operating subsidiaries from making consumer loans based
predominantly on the foreclosure or liquidation value of a borrower's
collateral. See 69 Fed. Reg. 1904 (Jan. 13, 2004).
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
Federal Agencies Have Taken Some Enforcement Actions, but Banking Regulators
Have Focused on Guidance and Regulatory Changes
FTC, DOJ, and HUD have taken enforcement actions to address violations
related to abusive lending.13 As of December 2003, FTC reported that the
agency had taken 19 actions against mortgage lenders and brokers for
predatory practices. DOJ has addressed predatory lending that is alleged
to be discriminatory by enforcing fair lending laws in a limited number of
cases. HUD's efforts have generally focused on reducing losses to the
Federal Housing Administration (FHA) insurance fund, including
implementing a number of initiatives to monitor lenders for violations of
FHA guidelines.14 HUD reported having taken a small number of actions to
enforce RESPA and the Fair Housing Act in cases involving predatory
lending.
Federal banking regulators stated that their monitoring and examination
activities have revealed little evidence of predatory lending practices by
federally regulated depository institutions. Accordingly, most banking
regulators reported that they have taken no formal enforcement actions
related to predatory mortgage lending abuses by the institutions they
supervise. Regulators have addressed predatory lending primarily by
issuing guidance to their institutions on guarding against direct or
indirect involvement in predatory lending practices and by making certain
changes to HOEPA and HMDA regulations. In addition, several federal
agencies have coordinated certain efforts to pursue enforcement actions
related to predatory lending and have shared information on their efforts
to address fair lending and predatory lending.
13Most enforcement actions discussed in this chapter were civil judicial
actions brought and settled by FTC, DOJ, and HUD.
14HUD's FHA mortgage insurance program makes loans more readily available
for low-and moderate-income families by providing mortgage insurance to
purchase or refinance a home. Lending institutions such as mortgage
companies and banks fund the loans.
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
FTC Has Played the Predominant Federal Role in Enforcement Actions Related
to Predatory Lending
FTC is responsible for implementing and enforcing certain federal laws
among lending institutions that are not supervised by federal banking
regulators. FTC reported that between 1983 and 2003, it filed 19
complaints alleging deceptive or other illegal practices by mortgage
lenders and brokers, 17 of them filed since 1998.15 For a list of these
FTC enforcement actions, see appendix I. As of December 2003, FTC had
reached settlements in all but one of the cases. In most of these
settlements, companies have agreed to provide monetary redress to
consumers and to halt certain practices in the future. In some cases, the
settlements also imposed monetary penalties that the companies have paid
to the government. Among the recent enforcement actions related to
predatory lending that the FTC identified are the following:
o The Associates. In 2002, FTC settled a complaint against Associates
First Capital Corporation and Associates Corporation of North America
(collectively, The Associates), as well as their successor, Citigroup. The
complaint alleged that the lender violated the FTC Act and other laws by,
among other things, deceiving customers into refinancing debts into home
loans with high interest rates and fees and purchasing high-cost credit
insurance. The settlement, along with a related settlement with private
parties, provides for up to $240 million in restitution to borrowers.16
o First Alliance. In 2002, FTC, along with several states and private
plaintiffs, settled a complaint against First Alliance Mortgage Company
alleging that it violated federal and state laws by misleading consumers
about loan origination and other fees, interest rate increases, and
monthly payment amounts on adjustable rate mortgage loans. The company
agreed to compensate nearly 18,000 borrowers more than $60
15FTC has also recently addressed abuses in the mortgage loan servicing
industry. In November 2003, it announced settlements with Fairbanks
Capital Holding Corp., its wholly owned subsidiary Fairbanks Capital
Corp., and their founder and former CEO (collectively, Fairbanks) on
charges that Fairbanks violated the FTC Act, RESPA, and other laws by
failing to post consumers' mortgage payments in a timely manner and
charging consumers illegal late fees and other unauthorized fees. The
settlement will provide $40 million in redress to consumers. The case was
jointly filed with HUD. United States of America v. Fairbanks Capital
Corp. et al., Civ. Action No. 03-12219-DPW (D. Mass.)(filed 11/12/03).
16Citigroup, Inc., acquired The Associates in a merger that was completed
in November 2000. The FTC complaint named Citigroup and CitiFinancial
Credit Company as successor defendants.
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
million in consumer redress and to refrain from making misrepresentations
about future offers of credit.
o Fleet Finance and Home Equity U.S.A. In 1999, Fleet Finance, Inc., and
Home Equity U.S.A., Inc., settled an FTC complaint alleging violations of
the FTC Act, TILA, and related regulations. These violations included
failing to provide required disclosures about home equity loan costs and
terms and failing to alert borrowers to their right to cancel their credit
transactions. To settle, the company agreed to pay up to $1.3 million in
redress and administrative costs and to refrain from violating TILA in the
future.
o Operation Home Inequity. In 1999, FTC conducted "Operation Home
Inequity," a law enforcement and consumer education campaign that sought
to curb abusive practices in the subprime mortgage lending market. FTC
reached settlements with seven subprime mortgage lenders that had been
accused of violating a number of consumer protections laws, including the
FTC Act, TILA, and HOEPA. Six companies were required to pay $572,000 in
consumer redress, and all lenders were required to adhere to future
lending restrictions. FTC staff told us that the operation was intended in
large part to increase consumers' awareness of predatory lending and to
provide a deterrent effect by warning lenders that FTC is able and willing
to take action against them.
FTC staff expressed their belief that the agency's enforcement actions
over the years have been successful in deterring other lenders from
engaging in abusive practices. However, in a congressional hearing in 2000
FTC had requested statutory changes that would improve its ability to
enforce HOEPA. For example, FTC recommended that Congress expand HOEPA to
prohibit the financing of lump-sum credit insurance premiums in loans
covered by HOEPA and to give FTC the power to impose civil penalties for
HOEPA violations.17
17Prepared statement of the Federal Trade Commission before the House
Committee on Banking and Financial Services on "Predatory Lending
Practices in the Subprime Industry," May 24, 2000. Since then, many
mortgage lenders have said they are abandoning lump-sum credit insurance.
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
DOJ Has Enforced Fair Lending Laws in Connection with Predatory Lending
DOJ's Housing and Civil Enforcement Section is responsible for enforcing
certain federal civil rights laws, including the Fair Housing Act and
ECOA. DOJ identified two enforcement actions it has taken related to
predatory mortgage lending practices that it alleged were discriminatory.
18
o Delta Funding. In 2000, DOJ, in cooperation with FTC and HUD, brought
charges against Delta Funding Corporation, accusing the consumer finance
company of violations of the Fair Housing Act, HOEPA, ECOA, RESPA, and
related federal regulations. 19 Delta allegedly approved and funded loans
that carried substantially higher broker fees for African American females
than for similarly situated white males. Delta was also accused of
violating certain consumer protection laws by paying kickbacks and
unearned fees to brokers to induce them to refer loan applicants to Delta
and by systematically making HOEPA loans without regard to borrowers'
ability to repay. The settlement placed restrictions on the company's
future lending operations and victims were compensated from previously
established monetary relief funds.20
o Long Beach Mortgage. In 1996 DOJ settled a complaint alleging
violations of the Fair Housing Act and ECOA against Long Beach Mortgage
Company.21 According to the complaint, the company's loan officers and
brokers charged African American, Hispanic, female, and
18In addition to these cases, DOJ filed an amicus curiae brief in a
private case, Hargraves v. Capital City Mortgage Corp., Civ. Action No.
98-1021 (JHG/AK) (D DC), in which the department contended that certain
alleged predatory lending practices violated the Fair Housing Act and
ECOA. The case involved a mortgage lender that allegedly engaged in a
pattern or practice of deceiving African American borrowers about the
terms of their loans and other information, such as the total amount due.
In addition, DOJ filed a complaint in United States v. Action Loan, Civ.
Action No. 3:00CV-511-H (W.D. KY), which resulted from enforcement efforts
by the FTC and HUD and involved allegations of predatory mortgage lending.
19United States v. Delta Funding Corp., Civ. Action No. CV 00 1872 (E.D.
N.Y. 2000).
20Two monetary relief funds totaling over $12 million were set up under a
previous remediation agreement involving Delta and the New York State
Banking Department.
21United States v. Long Beach Mortgage Company, Case No. 96-6159 (1996).
Prior to December 1990, Long Beach Bank was a savings and loan
association, chartered by the state of California. Between December 1990
and October 1994, Long Beach Mortgage Company operated under the name of
Long Beach Bank as a federally chartered thrift institution. In 1999,
Washington Mutual, a federally chartered thrift, acquired Long Beach
Mortgage Company and owns it at the holding company level.
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
older borrowers higher loan rates than it charged other similarly situated
borrowers. The company agreed to set up a $3 million fund to reimburse
1,200 consumers who had received Long Beach loans.22
Representatives from both FTC and DOJ have stated that their enforcement
actions can be very resource intensive and can involve years of discovery
and litigation. For example, FTC filed a complaint against Capitol City
Mortgage Corporation in 1998 that is still in litigation more than 5 years
later. FTC staff told us that because cases involving predatory lending
can be so resource intensive, the agencies try to focus their limited
resources on the cases that will have the most impact, such as those that
may result in large settlements to consumers or that will have some
deterrent value by gaining national exposure. Similarly, DOJ officials
select certain discrimination cases, including those mentioned above, in
part because of their broad impact.
HUD's Enforcement Activities Focus on FHA Loans
HUD's enforcement and regulatory activity with regard to abusive mortgage
lending comes primarily through its management of the FHA single-family
mortgage insurance programs, its rule-making and enforcement authority
under RESPA, and its enforcement of the Fair Housing Act.
Most of HUD's enforcement activities related to abusive lending have
focused on reducing losses to the FHA insurance fund. Investigators from
HUD's Office of the Inspector General have worked with investigators from
U.S. Attorneys' Offices and the FBI in a joint law enforcement effort to
target fraud in the FHA mortgage insurance program, which can result in
defaults and thus in losses to the insurance fund.23 The fraudulent
activities sometimes involve property flipping schemes, which can harm
borrowers by leaving them with mortgage loans that may far exceed the
22DOJ has also taken enforcement actions to address other practices, such
as credit repair schemes, that do not involve abusive lending but that
nonetheless serve to illegally strip homeowners of their equity.
23GAO has issued a number of reports on the FHA single-family insurance
program, a highrisk program area. For example, see U.S. General Accounting
Office, Major Management Challenges and Program Risks: Department of
Housing and Urban Development,
GAO-03-103 (Washington, D.C.: January 2003).
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
value of their homes.24 Under certain circumstances, such activity can
involve predatory lending practices. To address these crimes,
investigators have presented evidence of false statements and other
criminal fraud and deception. In addition, representatives from HUD told
us that they have processes in place to ensure that lenders adhere to
agency guidelines and make loans that satisfy FHA requirements. The Office
of Lender Activities and Program Compliance approves, recertifies, and
monitors FHA lenders and works with them to ensure compliance. If
necessary, the office refers violating lenders to HUD's Mortgagee Review
Board, which has the authority to take administrative actions such as
withdrawing approval for a lender to make FHA-insured loans. HUD officials
told us that the board has taken many administrative actions to address
violations that could be indicative of predatory lending, such as charging
excessive and unallowable fees, inflating appraisals, and falsifying
documents showing income or employment. In an effort to address abusive
property flipping schemes involving homes secured by FHA-insured loans,
HUD issued a final rule in May 2003 that prohibits FHA insurance on
properties resold less than 90 days after their previous sale.
HUD officials say that programs they have in place to improve the
monitoring of FHA lenders also serve to deter predatory lending. For
example, HUD's Credit Watch Program routinely identifies those lenders
with the highest early default and insurance claim rates and temporarily
suspends the FHA loan origination approval agreements of the riskiest
lenders, helping to ensure that lenders are not making loans that
borrowers cannot repay. Also, the Neighborhood Watch program provides
information to FHA participants about lenders and appraisers whose loans
have high default and FHA insurance claim rates. HUD told us that it has
also taken a series of actions to better ensure the integrity of
appraisals used to finance FHA insured loans. As of December 2003, HUD was
in the final stages of issuing a rule that would hold lenders accountable
for appraisals associated with loans they make.
24In property flipping schemes, properties are purchased and quickly
resold at grossly inflated values. In some cases the inflated value is
established by an interim sale to a "straw buyer" and then flipped to an
unsuspecting purchaser. In other cases, first-time buyers who have been
turned down for home loans because of poor credit or low income are
targeted by flippers who arrange loans well in excess of the real value of
the property using fabricated employment and deposit records. These
schemes often involve many players, including mortgage lenders, mortgage
brokers, underwriters, and home-improvement workers. Almost all flipping
schemes involve false appraisals. While HUD categorizes property flipping
as a predatory lending practice, not all federal agencies concur with this
categorization.
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
HUD's Office of RESPA and Interstate Land Sales is responsible for
handling complaints, conducting investigations, and taking enforcement
actions related to RESPA. HUD has taken several enforcement actions
related to RESPA's prohibition of kickbacks and referral fees, three of
which related directly to abusive mortgage lending, as of December 2003.25
Also, as discussed above, in November 2003 HUD and FTC jointly filed a
case against and reached settlement with a mortgage loan servicing company
charged with violations of the FTC Act, RESPA, and other laws.26 HUD has
also recently hired additional staff to enhance its RESPA enforcement
efforts. Finally, in 2002, HUD issued a proposed rule designed to change
the regulatory requirements of RESPA to simplify and potentially lower the
costs of the home mortgage settlement process. According to HUD, as of
December 2003, the final rule had been submitted to the Office of
Management and Budget and was being reviewed.
HUD's Office of Fair Housing and Equal Opportunity is responsible for
enforcing the Fair Housing Act. HUD identified one action-a letter of
reprimand to a financial institution-related to enforcement of this act in
a case involving predatory lending.
Federal Banking Regulators Have Issued Guidance and Made Regulatory Changes
According to federal banking regulators and state enforcement authorities,
federally regulated depository institutions-banks, thrifts, and credit
unions-have not typically engaged in predatory lending practices. Federal
banking regulators have systems in place to track customer complaints and
reported that they have received few complaints related to predatory
lending by the institutions they supervise. The regulators conduct routine
examinations of these institutions and have the authority, in cases of
suspected predatory lending, to enforce a variety of fair lending and
consumer protection laws. Banking regulators noted that the examination
process, which involves routine on-site reviews of lenders' activities,
serves as a powerful deterrent to predatory lending by the institutions
they examine.
25For example, a complaint filed jointly by HUD, FTC, and Illinois
authorities against Mercantile Mortgage Company in 2002 alleged that for
almost 3 years, a broker referred virtually every one of his loan
customers to Mercantile in exchange for a fee as high as 10 percent. The
other two cases involving RESPA include Delta Funding (2000) and Action
Loan Company (2000).
26United States of America v. Fairbanks Capital Corp., 03-12219-DPW (D.
MA, filed Nov. 12, 2003).
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Officials of OTS, FDIC, the Board, and NCUA said that they had taken no
formal enforcement actions related to predatory mortgage lending against
the institutions they regulate. 27 Officials at OCC said they have taken
one formal enforcement action related to predatory mortgage lending to
address fee packing, equity stripping, and making loans without regard to
a borrower's ability to pay. In November 2003, the agency announced an
enforcement action against Loan Star Capital Bank seeking to reimburse 30
or more borrowers for more than $100,000 in abusive fees and closing costs
that violated the FTC Act, HOEPA, TILA, and RESPA.28 The bank also was
required to conduct a comprehensive review of its entire mortgage
portfolio and to provide restitution to any additional borrowers who may
have been harmed.
While most federal banking regulators stated that they have taken no
formal enforcement actions, representatives from some said they had taken
informal enforcement actions to address some questionable practices among
their institutions. For example, OTS has examined institutions that may
have charged inappropriate fees or violated HOEPA and resolved the
problems by requiring corrective action as part of the examination
process. In addition, most of the banking regulators have taken formal
enforcement actions, including issuing cease-and-desist orders, in
response to activities that violated fair lending and consumer protection
laws but were not necessarily deemed to constitute "predatory lending."
Guidance Federal banking regulators have issued guidance to their
institutions about both predatory lending and subprime lending in general.
In February 2003, OCC issued two advisory letters related to predatory
lending to the national banks and the operating subsidiaries it
supervises. One letter provided specific guidelines for guarding against
predatory lending practices during loan originations, and the other
alerted institutions to the risk of indirectly
27Banking regulators have broad enforcement powers and can take formal
actions (cease and desist orders, civil money penalties, removal orders,
and suspension orders, among others) or informal enforcement actions (such
as memoranda of understanding and board resolutions). Not all informal
actions are publicly disclosed.
28Matter of Clear Lake National Bank, AA-EC03-25 (OCC Nov. 7, 2003). The
lender that made the loans, Clear Lake National Bank of San Antonio,
Texas, merged with another bank in April 2003 to become Lone Star Capital
Bank, N.A. OCC brought the action under the enforcement authority provided
by Section 8 of the Federal Deposit Insurance Act, 12 U.S.C. 1818.
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Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
engaging in predatory lending through brokered or purchased loans.29 The
advisory letters described loan attributes that are often considered
predatory and established standards for policies and procedures for
monitoring loan transactions to avoid making, brokering, or purchasing
loans with such attributes. For example, the first letter stated that
banks should establish underwriting policies and procedures to determine
that borrowers have the capacity to repay their loans. The advisory letter
also stated OCC's position that predatory lending will also affect a
national bank's CRA rating. The advisories have also clarified ways in
which predatory practices can create legal, safety and soundness, and
reputation risks for national banks. For example, they laid out ways in
which the origination or purchase of predatory loans may constitute
violations of TILA, RESPA, HOEPA, the FTC Act, and fair lending laws. In
addition, in January 2004, OCC issued a rule adopting antipredatory
lending standards that expressly prohibit national banks from making loans
without regard to the borrower's ability to repay and from engaging in
unfair and deceptive practices under the FTC Act.30
In 1999 and 2001, the Board, FDIC, OCC, and OTS issued joint guidance to
their institutions on subprime lending in general.31 The guidance
highlighted the additional risks inherent in subprime lending and noted
that institutions engaging in such lending need to be aware of the
potential for predatory practices and be particularly careful to avoid
violating fair lending and consumer protection laws and regulations. The
NCUA issued similar guidance to insured credit unions in 1999.32 Federal
banking
29OCC Advisory Letter 2003-2 (Guidance for National Banks to Guard Against
Predatory and Abusive Lending Practices), February 21, 2003; and OCC
Advisory Letter 2003-3 (Avoiding Predatory and Abusive Lending Practices
in Brokered and Purchased Loans), February 21, 2003.
3069 Fed. Reg. 1904 (Jan. 13, 2004).
31The Board, FDIC, OCC and OTS, Interagency Guidance on Subprime Lending,
March 1, 1999; and Expanded Guidance for Subprime Lending Programs,
January 31, 2001. The 2001 guidance applies to institutions with subprime
lending programs with an aggregate credit exposure greater than or equal
to 25 percent of Tier 1 capital.
32NCUA Letter to Credit Unions No. 99-CU-05, Risk Based Lending, June
1999.
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regulators have also previously issued guidance about abusive lending
practices, unfair or deceptive acts or practices, and other issues related
to predatory lending.33
Regulatory Changes The Board is responsible for issuing regulations that
implement HOEPA and HMDA, two laws that play a role in addressing
predatory lending. In December 2001, in response to concerns that HOEPA
may not be adequately protecting consumers from abusive lending practices,
the Board amended Regulation Z, which implements HOEPA, to
o lower the interest rate "trigger" that determines whether loans are
covered under HOEPA in order to bring more loans under the protection of
the law,34
o require that fees paid for credit insurance and similar debt protection
products be included when determining whether loans are subject to HOEPA,
o prohibit creditors that make HOEPA loans from refinancing the loan
within one year of origination with another HOEPA loan, unless the
refinancing is in the borrower's interest, and
o clarify the prohibition against engaging in a "pattern or practice" of
lending without regard to borrowers' ability to repay.35
In February 2002, the Board also made changes to Regulation C, which
implements HMDA. The changes, which went into effect in January 2004,
require lenders to provide additional data that may facilitate analyses of
lending patterns that may be predatory. For example
33See OCC Advisory Letter 2000-7 (abusive lending practices); OCC Advisory
Letter 2000-10, OCC Advisory Letter 2000-11, OTS Chief Executive Officers
Letter 131, OTS Chief Executive Officers Letter 132, and NCUA Letter
01-FCU-03 (title loans and payday lending); OCC Bulletin 2001-47
(third-party relationships); and OCC Advisory Letter 2002-3 and FDIC
Financial Institution Letter 57-2002 (unfair or deceptive acts or
practices).
34The Board adjusted the annual percentage rate (APR) trigger from 10 to 8
percentage points above the rate for Treasury securities with comparable
maturities. The change applies only to first lien mortgages; the
subordinate lien mortgage APR trigger remained at 10 percent.
3566 Fed. Reg. 65604 (Dec. 20, 2001).
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Challenges
o if the costs to the borrower of financing a loan exceed a certain
threshold determined by the Board, the lender must report the cost of the
loan;36
o if an application or loan involves a manufactured home, the lender is
required to identify that fact, in part to help identify predatory
practices involving these types of homes; and
o if a loan is subject to HOEPA, the lender is required to identify that
fact in order to give policymakers more specific information about the
number and characteristics of HOEPA loans.37
Because HOEPA expressly grants the Board broad authority to issue rules to
regulate unfair or deceptive acts and practices, some consumer advocacy
organizations have argued that the Board should use its authority to do
more to curb predatory lending.38 For example, some consumer groups have
called on the Board to use its rule-making authority to prohibit the
financing of single-premium credit insurance-a product that is believed by
many to be inherently predatory.39 Under the McCarran Ferguson Act,40
unless a federal statute is specifically related to the business of
insurance, the federal law may not be construed to invalidate, impair, or
supercede any state law enacted to regulate the business of insurance.
Board officials say it is not clear the extent to which rules issued by
the Board under HOEPA seeking to regulate the sale of singlepremium credit
insurance would be consistent with that standard. The Board has previously
recommended that it would be more appropriate for Congress to address this
issue through changes in law. Some consumer groups also have argued that
the Board should increase the loan data reporting requirements of HMDA to
help detect abusive lending. The
36More specifically, lenders are required to report the difference or
spread between a loan's annual percentage rate (a value reflecting both
the interest rate and certain fees associated with a loan) and the yield
on a Treasury security of comparable maturity, for loans where this spread
exceeds certain thresholds set by the Board. See, generally, 67 Fed. Reg.
7222 (Feb. 15, 2002) and 67 Fed. Reg. 43218 (June 27, 2002).
37Id.
38See 15 U.S.C. S: 1639(l)(2).
39In its 2001 amendments to the HOEPA rules, the Board added
single-premium credit insurance to HOEPA's fee trigger.
40See 15 U.S.C. S: 1012.
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Federal Agencies Have Taken Steps to
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Challenges
Board has added certain loan pricing and other items to the HMDA reporting
requirements, effective in January 2004, but did not add other data
reporting requirements, such as the credit score of the applicant. Board
officials said this is based on the belief that the need for additional
loan data to ensure fair lending must be weighed against the costs and
burdens to the lender of gathering and reporting the additional
information.
Agencies Have Coordinated on Enforcement Actions and Participated in
Interagency Groups
Federal agencies have worked together to investigate and pursue some cases
involving predatory lending. For example, FTC, DOJ, and HUD coordinated to
take enforcement action against Delta Funding Corporation, with each
agency investigating and bringing actions for violations of the laws under
its jurisdiction. DOJ conducted its enforcement action against Long Beach
Mortgage Company in coordination with OTS, which investigated the initial
complaint in 1993 when the company was a thrift. Federal agencies have
also coordinated with state authorities and private entities in
enforcement actions. For example, in 2002, FTC joined six states, AARP,
and private attorneys to settle a complaint against First Alliance
Mortgage Company alleging that the company used deception and manipulation
in its lending practices.
Federal regulators have also coordinated their efforts to address fair
lending and predatory lending through working groups. For example
o In the fall of 1999 the Interagency Fair Lending Task Force, which
coordinates federal efforts to address discriminatory lending, established
a working group to examine the laws related to predatory lending and
determine how enforcement and consumer education could be strengthened.41
Because of differing views on how to define and combat predatory lending,
the group was unable to agree on a federal interagency policy statement
related to predatory lending in 2001. The Task Force then continued its
efforts related to consumer education and published a brochure in 2003 to
educate consumers about predatory lending practices.
o The five banking regulators have conducted additional coordination
activities through the Federal Financial Institutions Examination
41The agencies that participated in the working group were OCC, OTS, FDIC,
the Board, NCUA, DOJ, FTC, HUD, the Federal Housing Finance Board, and the
Office of Federal Housing Enterprise Oversight.
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Challenges
Council's Task Force on Consumer Compliance.42 The task force coordinates
policies and procedures for ensuring compliance with fair lending laws and
the Community Reinvestment Act, both of which have been identified as
tools that can be used to address predatory lending. The council publishes
a document that responds to frequently asked questions about community
reinvestment, including how examiners should consider illegal credit
practices, which may be abusive, in determining an institution's Community
Reinvestment Act rating.
o In 2000, HUD and the Department of the Treasury created the National
Task Force on Predatory Lending, which convened forums around the country
to examine the issue and released a report later in the year.43 The report
made specific recommendations to Congress, federal agencies, and other
stakeholders that were aimed at (1) improving consumer literacy and
disclosure, (2) reducing harmful sales practices, (3) reducing abusive or
deceptive loan terms and conditions, and (4) changing structural aspects
of the lending market.
Some of the recommendations made in the HUD-Treasury task force report
have been implemented. For example, as recommended in the report, the
Board has adopted changes to HOEPA regulations that have increased the
number of loans covered and added additional restrictions. In addition, as
the report recommended, FTC and some states have devoted more resources in
the past few years to actively pursuing high-profile enforcement cases. As
discussed in chapter 5, federal and state agencies have also worked to
improve one of the areas highlighted in the report: public awareness about
predatory lending issues. Other recommendations made in the report have
not been implemented, however. For example, Congress has not enacted
legislation to expand penalties for violations of TILA, HOEPA, and RESPA
or to increase the damages available to borrowers harmed by such
violations. HUD and the Department of the Treasury told us that they have
not formally tracked the status of the recommendations made in the report,
although HUD officials said they are
42The Federal Financial Institutions Examination Council is a formal
interagency body composed of representatives of each of the five federal
banking regulators. The council was established in 1979 and is empowered
to (1) prescribe uniform principles, standards, and report forms for the
federal examination of financial institutions and (2) make recommendations
to promote uniformity in the supervision of financial institutions.
43U.S. Department of the Treasury and U.S. Department of Housing and Urban
Development, Curbing Predatory Home Mortgage Lending: A Joint Report, June
2000.
Chapter 2
Federal Agencies Have Taken Steps to
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Challenges
informally monitoring the recommendations in the report that relate to
their agency. Officials at both agencies also noted that the report and
its recommendations were the product of a previous administration and may
or may not reflect the views of the current administration.
In addition to participating in interagency groups, agencies share
information related to fair lending violations under statutory
requirements and formal agreements. For example, since 1992 HUD and the
banking regulators have had a memorandum of understanding stating that HUD
will refer allegations of fair lending violations to banking regulators
and a 1994 executive order requires that executive branch agencies notify
HUD of complaints and violations of the Fair Housing Act. In addition,
whenever the banking regulatory agencies or HUD have reason to believe
that an institution has engaged in a "pattern or practice" of illegal
discrimination, they are required to refer these cases to DOJ for possible
civil action.
Jurisdictional Issues Related to Nonbank Subsidiaries Challenge Efforts to
Combat Predatory Lending
Jurisdictional issues related to the regulation of certain nonbank
mortgage lenders may challenge efforts to combat predatory lending. Many
federally and state-chartered banks and thrifts, as well as their
subsidiaries, are part of larger financial holding companies or bank
holding companies.44 These holding companies may also include nonbank
financial companies, such as finance and mortgage companies, that are
subsidiaries of the holding companies themselves. These holding company
subsidiaries are frequently referred to as affiliates of the banks and
thrifts because of their common ownership by the holding company. As shown
in figure 2, the federal regulators of federally and state-chartered banks
and thrifts also regulate the subsidiaries of those institutions. For
example, as the primary regulator for national banks, OCC also examines
operating subsidiaries of those banks. On the other hand, federal
regulators generally do not perform routine examinations of independent
mortgage lenders and affiliated nonbank subsidiaries of financial and bank
holding companies engaged in mortgage lending.
44A subsidiary of a bank, thrift, or credit union is controlled through
partial or complete ownership by the institution. Federal laws and
regulations set more specific requirements that dictate whether an
institution is a subsidiary. For the purposes of this report, the term
holding company refers to both (traditional) bank holding companies and
bank holding companies that qualify as financial holding companies as
defined by the Board.
Chapter 2
Federal Agencies Have Taken Steps to
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Challenges
Figure 2: Structure and Federal Oversight of Mortgage Lenders
Source: GAO.
Note: The primary federal agency for enforcement of the various federal
laws used to combat abusive or predatory lending activities is shown in
parentheses.
aFTC is responsible for enforcing federal laws for lenders that are not
depository institutions but it is not a supervisory agency and does not
conduct routine examinations.
Some disagreement exists between states and some federal banking
regulators over states' authority to regulate and supervise the operating
subsidiaries of federally chartered depository institutions. For example,
OCC issued an advisory letter in 2002 noting that federal law provides the
agency with exclusive authority to supervise and examine operating
subsidiaries of national banks and that the states have no authority to
regulate or supervise these subsidiaries.45 Some representatives of state
banking regulators expressed concerns to us about this because of the
subsidiaries' potential involvement in predatory lending practices. OCC
45OCC Advisory Letter 2002-9 (Questions Concerning Applicability and
Enforcement of State
Laws: Contacts From State Officials, November 25, 2002.); see also 69 Fed.
Reg. 1904
(Jan. 13, 2004).
Chapter 2
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Address Predatory Lending, but Face
Challenges
has stated that the subsidiaries of the institutions it regulates do not
play a large role in subprime lending and that little evidence exists to
show that these subsidiaries are involved in predatory lending. But some
state enforcement authorities and consumer advocates argue otherwise,
citing some allegations of abuses at national bank subsidiaries. However,
several state attorneys general have written that predatory lending abuses
are "largely confined" to the subprime lending market and to
non-depository institutions, not banks or direct bank subsidiaries.46 OCC
officials stated that the agency has strong monitoring and enforcement
systems in place and can and will respond vigorously to any abuses among
institutions it supervises.47 For example, OCC officials pointed to an
enforcement action taken in November 2003 that required restitution of
more than $100,000 to be paid to 30 or more borrowers for fees and
interest charged in a series of abusive loans involving small "tax-lien
loans."
A second issue relates to the monitoring and supervision of certain
nonbank subsidiaries of holding companies. As noted previously, many
federally and state-chartered banks and thrifts, as well as their
subsidiaries, are part of larger financial or bank holding companies.48
These holding companies may also include nonbank subsidiaries, such as
finance and mortgage companies, that are affiliates but not subsidiaries
of the federally regulated bank or thrift. Although these affiliates
engage in financial activities that may be subject to federal consumer
protection and fair lending laws, unlike depository institutions they are
not subject to routine supervisory examinations for compliance with those
laws. While the Board has jurisdiction over these entities for purposes of
the Bank Holding Company Act, it lacks authority to ensure and enforce
their compliance
46See Brief of Amicus Curiae State Attorneys General, National Home Equity
Mortgage Ass'n v. OTS, Civil Action No. 02-2506 (GK) (D D.C.) (March 21,
2003) at 10-11.
47Another jurisdictional issue is uncertainty as to whether the FTC shares
jurisdiction with federal banking regulators over bank subsidiaries that
are not themselves banks (operating subsidiaries). While OCC maintains it
has exclusive regulatory jurisdiction over the operating subsidiaries of
national banks, FTC argues that a provision of the Gramm-Leach-Bliley Act
provides for the two agencies to share jurisdiction. See Pub. L. No.
106-102 S: 133(a). A federal district court has upheld FTC's
interpretation. (See Minnesota v. Fleet Mortg. Corp., 181 F. Supp. 2d 995
(D MN 2001)). We are not aware of any instance in which this matter has
interfered with an FTC enforcement action.
48In addition to financial and bank holding companies, there are thrift
holding companies, which can include thrifts and other financial
institutions. Each thrift holding company is regulated and subject to
examination by OTS. See 12 USC S:1467a (b)(4).
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with federal consumer protection and fair lending laws in the same way
that the federal regulators monitor their depository institutions.
One reason for the concern about these entities is that nonbank
subsidiaries of holding companies conduct a significant amount of subprime
mortgage lending. Of the total subprime loan originations made by the top
25 subprime lenders in the first 6 months of 2003, 24 percent were
originated by nonbank subsidiaries of holding companies. In addition, of
the 178 lenders on HUD's 2001 subprime lender list, 20 percent were
nonbank subsidiaries of holding companies. These types of subsidiaries
have also been targets of some of the most notable federal and state
enforcement actions involving abusive lending. For example, The Associates
and Fleet Finance, which were both nonbank subsidiaries of bank holding
companies, were defendants in two of the three largest cases involving
subprime lending that FTC has brought.49
The Associates case illustrates an important aspect of the current federal
regulatory oversight structure pertinent to predatory lending. The Board
has authority under the Bank Holding Company Act to condition its approval
of holding company acquisitions. The Board used this authority in
connection with Citigroup's acquisition of European American Bank because
of concerns about the subprime lending activities of The Associates, which
Citigroup had acquired and merged into its CitiFinancial subsidiary. As a
condition of approving the acquisition of European American Bank, the
Board directed that an examination of certain subprime lending
subsidiaries of Citigroup be carried out to determine whether Citigroup
was effectively implementing policies and procedures designed to ensure
compliance with fair lending laws and prevent abusive lending practices.
However, the Board does not have clear authority to conduct the same type
of monitoring outside of the Bank Holding Company Act approval process.
Although the Board has the authority to monitor and
49Citigroup acquired The Associates in November 2000 and merged The
Associates' consumer finance operations into its subsidiary, CitiFinancial
Credit Company, a nonbank subsidiary of the holding company. In 1999,
Fleet Finance, Inc., and its successor company, Home Equity U.S.A., Inc.,
agreed to pay $1.3 million to settle an FTC complaint alleging deceptive
disclosures and TILA violations in conjunction with Fleet Finance, Inc.,
loans. At the time of the settlement, Fleet Finance had become Home Equity
U.S.A., Inc. Both Fleet Finance, Inc., and Home Equity U.S.A., Inc., were
nonbank subsidiaries of bank holding companies. At the time of the
settlement, the bank holding company was Fleet Financial Group, Inc.,
which has been renamed FleetBoston Financial Corporation. Home Equity
U.S.A., Inc., continues to operate as a nonbank subsidiary of FleetBoston
Financial Corporation, a bank holding company.
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Challenges
perform routine inspections or examinations of a bank holding company,
this authority apparently does not extend to routine examinations of
nonbank subsidiaries of bank holding companies with regard to compliance
with consumer protection laws. The Bank Holding Company Act, as amended by
the Gramm-Leach-Bliley Act, authorizes the Board to examine a nonbank
subsidiary for specific purposes, including "to monitor compliance with
the provisions of (the Bank Holding Company Act) or any other Federal law
that the Board has specific jurisdiction to enforce against such company
or subsidiary." Federal consumer protection laws do not give the Board
specific enforcement jurisdiction over nonbank subsidiaries.
For this reason, FTC is the primary federal agency monitoring nonbank
subsidiaries' compliance with consumer protection laws. FTC is the primary
federal enforcer of consumer protection laws for these nonbank
subsidiaries, but it is a law enforcement rather than supervisory agency.
Thus, FTC's mission and resource allocations are focused on conducting
investigations in response to consumer complaints and other information
rather than on routine monitoring and examination responsibilities.
Moreover, as discussed elsewhere in this report, states vary widely in the
extent to which they regulate practices that can constitute predatory
lending.
The HUD-Treasury report on predatory lending argued that the Board should
take more responsibility for monitoring nonbank subsidiaries of bank
holding companies, in part to ensure that consumer protection laws are
adequately enforced for these institutions. Similarly, in 1999, GAO
recommended that the Board monitor the lending activities of nonbank
mortgage lending subsidiaries of bank holding companies and consider
examining these entities if patterns in lending performance, growth, or
operating relationships with other holding company entities indicated the
need to do so.50 In its written response to GAO's recommendation, the
Board said that while it has the general legal authority to examine these
entities, it has neither the clear enforcement jurisdiction nor the legal
responsibility for engaging in such activities, as Congress has directly
charged FTC with primary responsibility over enforcement with regard to
these entities.
50See U.S. General Accounting Office, Large Bank Mergers: Fair Lending
Review Could be Enhanced With Better Coordination, GAO/GGD-00-16
(Washington, D.C.: Nov. 3, 1999), 20 and 47.
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Among federal agencies, the Board is uniquely situated to monitor the
activities of the nonbank mortgage lending subsidiaries of financial and
bank holding companies by virtue of its role as the regulator of holding
companies and its corresponding access to data (such as internal operating
procedures, loan level data, and current involvement in subprime lending)
that are not readily available to the public. In addition, the Board has
extensive experience monitoring and analyzing HMDA data. The recent
changes in HMDA reporting requirements will increase the Board's ability
to effectively monitor nonbank mortgage lending subsidiaries of holding
companies for lending abuses.
In contrast to the specific limits on the Board's examination authority,
its authority to enforce the federal consumer protection laws against
nonbank subsidiaries is somewhat less clear. The laws themselves specify
the institutions subject to enforcement by the Board, but those
institutions generally do not include nonbank subsidiaries. The Board has
concluded that it must defer enforcement action at least where, as here, a
statute specifically prescribes its enforcement jurisdiction to cover only
certain entities and specifically grants enforcement authority for other
entities to another agency.
Conclusions Under a number of laws, federal agencies have taken action to
protect consumers from abusive lending practices. While FTC has taken a
number of significant enforcement actions to battle abuses in the
industry, its resources are finite and, as a law enforcement agency, it
does not routinely monitor or examine lenders, including the mortgage
lending subsidiaries of financial and bank holding companies.
Congress provided banking regulators with the authority to ensure
compliance with consumer protection laws by the institutions they
regulate, in part because it recognized the efficiencies of having banking
regulators monitor for compliance with these laws while examining their
institutions for safety and soundness. The Board is in a position to help
ensure compliance with federal consumer protection laws by certain
subsidiaries of financial and bank holding companies if it were clearly
authorized to do so. While concerns about predatory lending extend well
beyond the activities of the nonbank subsidiaries of holding companies,
these entities represent a significant portion of the subprime mortgage
market. Monitoring the mortgage lending activities of the nonbank
subsidiaries would help the Board determine when it would be beneficial to
conduct examinations of specific nonbank subsidiaries. The Board could
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
then refer its findings to DOJ, HUD, or FTC or take its own enforcement
action if a problem exists. Granting the Board concurrent enforcement
authority-with the FTC-for these nonbank subsidiaries of holding companies
would not diminish FTC's authority under federal laws used to combat
predatory lending.
The significant amount of subprime lending among holding company
subsidiaries, combined with recent large settlements in cases involving
allegations against such subsidiaries, suggests a need for additional
scrutiny and monitoring of these entities. The Board is in an optimal
position to play a larger role in such monitoring but does not have clear
legal authority and responsibility to do so for these entities with regard
to monitoring compliance of consumer protection laws.
Matters for Congressional Consideration
To enable greater oversight of and potentially deter predatory lending
from occurring at certain nonbank lenders, Congress should consider making
appropriate statutory changes to grant the Board of Governors of the
Federal Reserve System the authority to routinely monitor and, as
necessary, examine the nonbank mortgage lending subsidiaries of financial
and bank holding companies for compliance with federal consumer protection
laws applicable to predatory lending practices. Also, Congress should
consider giving the Board specific authority to initiate enforcement
actions under those laws against these nonbank mortgage lending
subsidiaries.
Agency Comments and Our Evaluation
GAO provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and comment.
The agencies provided technical comments that have been incorporated, as
appropriate. In addition, the Board, DOJ, FDIC, FTC, HUD, and NCUA
provided general comments, which are discussed below. The written comments
of the Board, DOJ, HUD, and NCUA are printed in appendixes II through V.
The Board commented that, while the existing structure has not been a
barrier to Federal Reserve oversight, the approach recommended in our
Matter for Congressional Consideration would likely be beneficial by
catching some abusive practices that might not be caught otherwise. The
Board also noted that the approach would pose tradeoffs, such as different
supervisory schemes being applied to nonbank mortgage lenders based on
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
whether or not they are part of a holding company. Because nonbank
mortgage lenders that are part of a financial or bank holding company are
already subject to being examined by the Board in some circumstances, they
are already subject to a different supervisory scheme than other such
lenders. For example, in its comments the Board noted that it may on
occasion direct an examination of a nonbank lending subsidiary of a
holding company when necessary in the context of applications that raise
serious fair lending or compliance issues. Accordingly, we do not believe
that clarifying jurisdiction as contemplated in the Matter would result in
a significant departure from the current supervisory scheme for nonbank
mortgage lenders. The Board also noted that that there could be some
additional cost to the nonbank mortgage lending subsidiaries of financial
or bank holding companies, as well as to the Board, if the Board were to
exercise additional authority. We agree and believe that Congress should
consider both the potential costs as well as the benefits of clarifying
the Board's authorities.
The FTC expressed concern that our report could give the impression that
we are suggesting that Congress consider giving the Board sole
jurisdiction-rather than concurrent jurisdiction with FTC-over nonbank
subsidiaries of holding companies. Our report did not intend to suggest
that the Congress make any change that would necessarily affect FTC's
existing authority for these entities and we modified our report to
clarify this point. To illustrate the difference in regulatory and
enforcement approaches, our draft report contrasted the Board's routine
examination authority with the FTC's role as a law enforcement agency. In
its comments, FTC noted that it uses a number of tools to monitor nonbank
mortgage lenders, of which consumer complaints is only one. The agency
also commented that a key difference between the FTC and the Board is that
the Board has access to routine information to aid in its oversight as
part of the supervisory process. Our report did not intend to suggest that
the FTC's actions are based solely on consumer complaints, and we revised
the report to avoid this impression.
DOJ commented that the report will be helpful in assessing the
department's role in the federal government's efforts to develop
strategies to combat predatory lending. DOJ disagreed with our inclusion
in the report of "property or loan flips," which it characterized as a
traditional fraud scheme rather than an example of predatory lending. As
our report states, there is no precise definition of predatory lending. We
included a discussion of efforts to combat "property flipping" because HUD
officials told us that these schemes sometimes involve predatory practices
that can
Chapter 2
Federal Agencies Have Taken Steps to
Address Predatory Lending, but Face
Challenges
harm borrowers. As we note in the report, while HUD categorizes property
flipping as a predatory lending practice, not all federal agencies concur
with this categorization. Distinct from property flipping is "loan
flipping"- the rapid and repeated refinancing of a loan without benefit to
the borrower. This practice is widely noted in literature and by federal,
state, industry, and nonprofit officials as constituting predatory
lending.
FDIC noted that our Matter for Congressional Consideration focuses on
nonbank subsidiaries of financial and bank holding companies even though
these entities comprise, according to HUD, only about 20 percent of all
subprime lenders. We acknowledge that our Matter does not address all
subprime lenders or institutions that may be engaging in predatory
lending, but believe it represents a step in addressing predatory lending
among a significant category of mortgage lenders. NCUA said that the
report provides a useful discussion of the issues and that the agency
concurs with our Matter for Congressional Consideration. HUD, in its
comment letter, described a variety of actions it has taken that it
characterized as combating predatory lending, particularly with regard to
FHA-insured loans.
Chapter 3
States Have Enacted and Enforced Laws to Address Predatory Lending, but Some
Laws Have Been Preempted
In part because of concerns about the growth of predatory lending and the
limitations of existing state and federal laws, 25 states, the District of
Columbia, and 11 localities had passed their own laws addressing predatory
lending practices as of January 9, 2004.1 Most of the state laws restrict
the terms or provisions of certain high-cost loans, while others apply to
a broader range of loans. In addition, some states have taken measures to
strengthen the regulation and licensing of mortgage lenders and brokers,
and some have used existing state consumer protection and banking laws to
take enforcement actions related to abusive lending. However, regulators
of federally chartered financial institutions have issued opinions stating
that federal laws may preempt some state predatory lending laws and that
nationally chartered lending institutions should have to comply only with
a single uniform set of national standards. Many state officials and
consumer advocates have opposed federal preemption of state predatory
lending laws on the grounds that it interferes with the states' ability to
protect consumers.
States and Localities Have Addressed Predatory Lending through Legislation,
Regulation, and Enforcement Actions
Since 1999, many states and localities have passed laws designed to
address abusive mortgage lending by restricting the terms or provisions of
certain loans. In addition, states have increased the registration or
licensing requirements of mortgage brokers and mortgage lenders and have
undertaken enforcement activities under existing consumer protection laws
and regulations to combat abusive lending.
1Except where citations to provisions of state laws are provided, all
information relating to state and local laws and their provisions is from
a database maintained by Butera & Andrews, a Washington, D.C., law firm
that tracks predatory lending legislation. These laws include only state
and local laws that place actual restrictions on lending and do not
include, for example, local ordinances that consist solely of a resolution
that condemned predatory lending. As noted in chapter 1, we took measures
to verify the reliability of these data.
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
but Some Laws Have Been Preempted
A Growing Number of According to the database of state laws, as of January
9, 2004, 25 states and States and Localities Have the District of Columbia
had passed laws that were specifically designed to Passed Laws to Address
address abusive lending practices.2 (See fig. 3.) These laws were
motivated,
at least in part, by growing evidence of abusive lending and by
concernsAbusive Lending that existing laws were not sufficient to protect
consumers against abusive lending practices.
Figure 3: States and Localities That Have Enacted Predatory Lending Laws
Source: Butera & Andrews.
2North Carolina enacted the first state law (N.C. Gen. Stat.
24-1-.1E[1999]) in 1999; it took effect on July 1, 2000. Nearly all the
other state laws were enacted between 2001 and 2003.
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted
Based on our review of the database of state laws, the predatory lending
statutes in 20 of the 25 states regulate and restrict the terms and
characteristics of certain kinds of "high-cost" or "covered" mortgage
loans that exceed certain interest rate or fee triggers.3 Some state laws,
such as those in Florida, Ohio, and Pennsylvania, use triggers that are
identical to those in the federal HOEPA statute but add provisions or
requirements, such as restrictions on refinancing a loan under certain
conditions.4 Other state laws, such as those of Georgia, New Jersey and
North Carolina, use triggers that are lower than those in HOEPA and
therefore cover more loans than the federal legislation.5 Some states
design their triggers to vary depending on the amount of the loan. For
example, in New Mexico and North Carolina, covered loans greater than
$20,000 are considered high cost if the points and fees on the loan exceed
5 percent of the total loan amount (North Carolina) or equal or exceed it
(New Mexico). In these states, loans for less than $20,000 are considered
high cost if the points and fees exceed either 8 percent of the total or
$1,000.6 In the remaining 5 states, the predatory lending laws apply to
most mortgage loans; there is no designation of loans as high cost. For
example, West Virginia's law in effect generally prohibits lenders from
charging prepayment penalties on any loans and restricts points and fees
to either 5 or 6 percent, depending on whether the loan includes a yield
spread premium.7 Michigan's law prohibits the financing of single-premium
credit insurance into loans.8
According to the database, common provisions in state laws are designed to
address the following:
o Lending without regard to the ability to repay. Restrictions on the
making of loans without regard to the borrower's ability to repay the
loan, sometimes referred to as asset-based lending.
3Massachusetts has imposed similar restrictions on high-cost loans, but it
was done through regulatory changes rather than legislation.
4See, e.g., Fla. Stat. Ann. S:S: 494.0079, 494.00791 (2003); Ohio Rev.
Code Ann. S:S: 1394; Ohio Rev. Code Ann. S: 1349.25 (2003); 63 PA Stat. S:
456.503 (2003).
5See GA Code Ann. S: 7-6A-2(2003); N.J. Stat. Ann. S: 46:10B-24 (West
2003); N.C. Gen. Stat. S: 24-1.1E (2003).
6N.C. Gen. Stat. S: 24-1-1E; N.M. Stat. Ann S: 58-21A-3 (2003).
7W. VA. Code S:S: 46A-3-110, 31-17-8 (2003).
8See Mich. Comp. Laws S: 445.1634 (2003).
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted
o Prepayment penalties. Limitations on the amount of a prepayment
penalty, terms under which a penalty can be assessed, or both.
o Balloon payments. Prohibitions on loans with balloon payments or
restrictions on their timing.
o Negative amortization. Prohibitions on loans where regularly scheduled
payments do not cover the interest due.
o Loan flipping. Restrictions or prohibitions on the repeated refinancing
of certain loans within a short period of time if the refinancing will not
benefit the borrower.
o Credit counseling. Requirements that borrowers either receive or are
notified of the availability of loan counseling.
o Arbitration clauses. Restrictions on mandatory arbitration clauses,
which limit a borrower's right to seek redress in court. Some laws
prohibit mandatory arbitration clauses altogether, while others require
compliance with certain standards, such as those set by a nationally
recognized arbitration organization.
o Assignee liability. Provisions that expressly hold purchasers or
securitizers of loans liable for violations of the law committed by the
originator, under certain conditions. (See ch. 4 for more information on
assignee liability.)
In addition, according to the database we reviewed, 11 cities and counties
have passed laws of their own designed to address predatory lending since
2000.9 Some local laws are similar to state laws in that they define
highcost loans and restrict their provisions, such as in Los Angeles,
California. Other localities, such as Oakland, California, have passed
resolutions prohibiting lenders that engage in predatory lending practices
from doing business with the locality.
9In some cases, these laws were enacted but pending litigation stayed
enforcement.
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
but Some Laws Have Been Preempted
Some States Have Increased the Regulation of Lenders and Brokers and
Undertaken Enforcement Activities to Combat Predatory Lending
In general, states have regulated mortgage lenders and brokers, although
to varying degrees. Some state officials told us that because of concerns
that unscrupulous mortgage lenders and brokers were not adequately
regulated and were responsible for lending abuses, some states have
increased their regulation or licensing requirements of lenders and
brokers. As part of their licensing requirements, states sometimes require
that these companies establish a bond to help compensate victims of
predatory lenders or brokers that go out of business, and some states also
require that individuals working for or as mortgage lenders and brokers
meet certain educational requirements.
Some states have also reorganized their agencies' operations to better
address abuses by lenders and brokers. For example, an official with the
Kansas Office of the State Banking Commissioner told us that in 1999 the
Kansas legislature created the Division of Consumer and Mortgage Lending,
which provides additional staff for examination and enforcement
activities. Similarly, an official from the Idaho Department of Finance
told us that the state created the Consumer Finance Bureau in 2000 to
oversee and conduct routine examinations of mortgage brokers and mortgage
lenders.
State law enforcement agencies and banking regulators have also taken a
number of actions in recent years to enforce existing state consumer
protection and banking laws in cases involving predatory lending. For
example, an official from the Washington Department of Financial
Institutions reported that it has taken several enforcement actions in
recent years to address predatory lending. In one such action, a
California mortgage company that allegedly deceived borrowers and made
prohibited charges was ordered to return more than $700,000 to 120
Washington State borrowers. According to officials of the Conference of
State Bank Supervisors, states reported that in addressing predatory
lending they have usually relied on general state consumer protection laws
in areas such as fair lending, licensing, and unfair and deceptive
practices. In some states, consumer protection statutes do not apply to
financial institutions, so state banking regulators, rather than the
attorneys general, typically initiate enforcement activities. Because
allegations of predatory practices often involve lending activities in
multiple states, states have sometimes cooperated in investigating alleged
abuses and negotiating settlements. For example, in 2002 a settlement of
up to $484 million with Household Finance Corporation resulted from a
joint investigation begun by the attorneys general and financial
regulatory agencies of 19 states and the
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
but Some Laws Have Been Preempted
District of Columbia. State agencies have also conducted investigations in
conjunction with the federal government.
Activities in North States have varied in their approaches to addressing
predatory lending
issues. We reviewed legislative and enforcement activities related
toCarolina and Ohio predatory lending in two states, North Carolina and
Ohio, to illustrate two Illustrate State different approaches.
Approaches to
Predatory Lending
Impact of North Carolina's Laws on High-Cost Loans and Licensing of Brokers
and Originators Remains Uncertain
North Carolina has enacted two separate laws to address concerns about
predatory lending. In 1999, the legislature passed a law that attempted to
curb predatory lending by prohibiting specific lending practices and
restricting the terms of high-cost loans.10 In 2001, North Carolina
supplemented its predatory lending law by adopting legislation that
required the licensing of mortgage professionals (mortgage lenders,
brokers, and loan officers), defined a number of prohibited activities
related to the making of residential mortgages, and enhanced the
enforcement powers of the banking commissioner.11
According to the North Carolina Commissioner of Banks, the North Carolina
laws applicable to predatory lending were the product of a consensus of
banks, mortgage bankers and brokers, nonprofit organizations, and other
stakeholders and were intended to address lending abuses that were not
prohibited by federal statutes and regulations. Among other things, the
1999 legislation, known as the North Carolina Anti-Predatory Lending Law,
imposes limitations specific to both "high-cost"
10N.C. Session Law 1999-332. 11N.C. Sessions Laws 2001-393 and 2001-399.
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted
loans and other "consumer home loans."12 North Carolina's predatory
lending law did not restrict initial interest rates but instead focused on
prohibiting specific lending practices and restricting the terms of
high-cost loans. In conjunction with other North Carolina laws, the 1999
legislation contains four key features. First, it bans prepayment
penalties for all home loans with a principal amount of $150,000 or less.
Second, it prohibits loan flipping-refinancings of consumer home loans
that do not provide a reasonable, net tangible benefit to the borrower.
Third, it prohibits the financing of single-premium credit life insurance.
Finally, it sets a number of restrictions on high-cost loans, including
making loans without regard to borrowers' ability to repay; financing
points, fees, and any other charges payable to third parties; or setting
up loans with balloon payments. Further, the law prohibits home
improvement contract loans under which the proceeds go directly to the
contractor, and requires that borrowers receive financial counseling prior
to closing.
Although the North Carolina predatory lending law governs the practices of
lenders and mortgage brokers, some groups questioned whether it provided
for effective enforcement. Specifically, concerns were focused on the lack
of state licensing and oversight of all segments of the mortgage lending
profession, including mortgage brokers and bankers. Additionally, some
critics asserted that the statute provided the state banking commissioner
with limited and uncertain authority to enforce the predatory lending
provisions. As a result, even before the predatory lending legislation
passed, stakeholders worked on a measure to fill the gaps left by the
state's predatory lending law.
12The North Carolina predatory lending law defines a high-cost loan as a
home loan of $300,000 or less that has one or more of the following
characteristics: (1) points, fees (excluding certain amounts specified in
the law), and other charges totaling more than 5 percent of the borrowed
amount if the loan is $20,000 or more, or the lesser of 8 percent of the
amount borrowed or $1,000 if the loan is less than $20,000; (2) an
interest rate that exceeds by more than 10 percent per annum the yield on
comparable Treasury bills; or (3) a prepayment penalty that could be
collected more than 30 months after closing or that is greater than 2
percent of the amount prepaid. According to the North Carolina
Commissioner of Banks, the $300,000 cap is based on the presumption that
those able to borrow $300,000 or more are able to adequately protect
themselves. "Consumer home loans" are loans in which (i) the borrower is a
natural person, (ii) the debt is incurred by the borrower primarily for
personal, family, or household purposes, and (iii) the loan is secured by
a mortgage or deed of trust upon real estate upon which there is located
or there is to be located a structure or structures designed principally
for occupancy of from one to four families which is or will be occupied by
the borrower as the borrower's principal dwelling.
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted
North Carolina's second statute, the Mortgage Lending Act, was signed into
law on August 29, 2001. Prior to the act, some mortgage banking firms and
all mortgage brokerages domiciled in the state had been required to
register with the state's banking regulator, but individual loan
originators were not. The Mortgage Lending Act imposed licensing
requirements on all mortgage bankers and brokers, including individuals
who originate loans, and added continuing education and testing
requirements for mortgage loan officers. The provisions of the act mean
that individuals as well as firms are now subject to regulatory
discipline. According to the North Carolina Commissioner of Banks, the act
has been effective in reducing the number of abusive brokers and
individual loan originators. The commissioner noted that a large number of
applications for licenses have been denied because the applicants did not
meet basic requirements or did not pass the required background check.
Studies on the impact of North Carolina's Anti-Predatory Lending Law have
offered conflicting conclusions. For example, one study found an overall
decline in subprime mortgages and concluded that any reductions in
predatory lending had been attained at the expense of many legitimate
loans.13 Some have pointed to this evidence as suggesting that the law has
reduced legitimate credit to those who most need it. Another study found a
reduction in subprime originations but attributed the decline to a
reduction in loans with abusive or predatory terms.14 Consumer advocates
and state officials have cited this study as evidence that the law has
worked as intended.
Our review of the five studies available on the impact of the North
Carolina predatory lending law suggested that data limitations and the
lack of an accepted definition of predatory lending make determining the
law's impact difficult. For example, information about borrowers' risk
profiles, the pricing and production costs of the loans, and the lenders'
and borrowers' behaviors was not available to the study researchers. In
addition, the extent to which any potential reductions in predatory loans
13Elliehausen and Staten, Regulation of Subprime Mortgage Products: An
Analysis of North Carolina's Predatory Lending Law, Georgetown University
School of Business (November 2002).
14Quercia, Stegman, and Davis, The Impact of North Carolina's
Anti-Predatory Lending Law: A Descriptive Assessment, Center for Community
Capitalism, The Frank Hawkins Kenan Institute of Private Enterprise,
University of North Carolina at Chapel Hill (June 25, 2003).
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
but Some Laws Have Been Preempted
can be attributed to the Mortgage Lending Act as opposed to the
Anti-Predatory Lending Law is unclear. Additional experience with the
North Carolina laws may be needed in order to properly assess them.
Ohio Has Preempted Local Laws and Taken Action to Regulate Mortgage Brokers
In February 2002, the Ohio legislature enacted a law with the purpose of
bringing Ohio law into conformance with HOEPA.15 Among other things, the
legislation preempted certain local predatory lending ordinances. The law
was passed in response to an ordinance enacted in the city of Dayton,
which was designed to fight predatory lending by regulating mortgage loans
originated in that city. Proponents of the state law argued that
regulating lenders is a state rather than municipal function and that
lending rules should be uniform throughout the state. Some advocates
argued that the state law prevents cities from protecting their citizens
from abusive lending practices.
The Ohio law imposes certain restrictions on high-cost loans as defined by
HOEPA. These include additional restrictions on credit life or disability
insurance beyond those imposed by HOEPA. The law also prohibits the
replacement or consolidation of a zero-interest rate or other low-rate
loan made by a governmental or nonprofit lender with a high-cost loan
within the first 10 years of the low-rate loan unless the current holder
of the loan consents in writing to the refinancing.16 Because the purpose
of this law was to bring Ohio's law into conformance with HOEPA, the law
applies only to loans that qualify as mortgage loans subject to HOEPA.
Thus, like predatory lending laws in some other states, the Ohio law
applies to relatively few loans.
In May 2002, the Ohio legislature passed another piece of legislation,
designed in part to address abusive lending-the Ohio Mortgage Broker
Act-that imposed requirements on the state's mortgage brokers and loan
officers.17 Among other things, this law required state examination,
education, and licensing of loan officers, and prohibited brokers from
engaging in certain deceptive or fraudulent practices. It also required
that
15See Ohio Rev. Code. Ann. S: 1349.32 (2003).
16Ohio Rev. Code Ann. S: 1349.27 (2002).
17See Ohio. Rev. Code Ann. S:S: 1322.01 - 1322.12 (2003).
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted
mortgage brokers and loan officers receive continuing education and take
prelicensing competency tests.
In the act adopting HOEPA standards, the Ohio legislature also established
a Predatory Lending Study Committee, which was charged with investigating
the impact of predatory lending practices on the citizens and communities
of Ohio.18 The study committee consisted of 15 members, including
representatives from state agencies, consumer groups, and the lending
industry. The act required the committee to submit a report to the
governor and legislators by the end of June 2003. The committee reached
consensus on two major issues. First, it recommended that all appraisers
in the state be licensed and subject to criminal background checks, and
second, it recommended increased enforcement of the Ohio Mortgage Broker
Act. The Division of Financial Institutions, which is responsible for
enforcing the Ohio Mortgage Broker Act, has hired additional staff to
ensure compliance with the law. The report and recommendations have been
forwarded to the governor and the committee suggested that the Ohio
General Assembly consider all recommendations.
Other local ordinances have been passed in Ohio to address predatory
lending. One of these ordinances, passed in November 2002 by the Toledo
City Council to regulate mortgage lending practices, was challenged, and
its enforcement stayed, because of the state HOEPA law passed in February
2002.19 One provision of that ordinance prohibited making an abusive loan
by "taking advantage of a borrower's physical or mental infirmities,
ignorance or inability to understand the terms of the loan." This
provision drew criticism from the mortgage industry, which said the
language was vague and difficult to comply with. For example, one
secondary market participant noted that it would be nearly impossible to
assess borrowers' mental capabilities for loans they did not originate in
the first place. Violating the law was made a criminal offense, and
convicted offenders could not receive city contracts or conduct other
business with the city.
182002 Ohio Laws HB 386 S: 5.
19Ordinance No. 271-03. As of November 17, 2003, the City of Toledo was
temporarily enjoined from enforcing application, enforcement, or other
effectuation of this ordinance as a result of a lawsuit asserting that the
ordinance is preempted by the Home Ownership and Equity Protection Act of
Ohio. AFSA v. City of Toledo, Ohio, No. C10200301547 (Lucas County).
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
but Some Laws Have Been Preempted
Regulators Have Determined That Federal Law Preempts Some State Predatory
Lending Laws, but Views on Preemption Differ
Significant debate has taken place as to the advantages and disadvantages
of state and local predatory lending laws. In several cases, regulators of
federally supervised financial institutions have determined that federal
laws preempt state predatory lending laws for the institutions they
regulate. In making these determinations, two regulators-OCC and OTS-have
cited federal law that provides for uniform regulation of federally
chartered institutions and have noted the potential harm that state
predatory lending laws can have on legitimate lending. Representatives of
the lending industry and some researchers agree with the federal banking
regulators, arguing that restrictive state predatory lending laws may
ultimately hurt many borrowers by reducing the supply of lenders willing
to make subprime loans, creating undue legal risks for legitimate lenders,
and increasing the costs of underwriting mortgage loans. Moreover,
industry representatives have said that most predatory lending practices
are already illegal under federal and state civil and criminal laws and
that these laws should simply be more stringently enforced. In contrast,
many state officials and consumer advocates are opposed to federal
preemption of state predatory lending laws. They maintain that federal
laws related to predatory lending are insufficient, and thus preemption
interferes with their ability to protect consumers in their states,
particularly from any potential abuses by the subsidiaries of federally
chartered institutions.
OCC, OTS, and NCUA Have Determined That Federal Law Preempts Some State
Predatory Lending Laws
Because both the federal and state governments have roles in chartering
and regulating financial institutions, questions can arise as to whether a
federal statute preempts particular state laws.20 Affected parties may
seek guidance from federal agencies requesting their views on whether a
particular federal statute preempts a particular state law; in these
instances, the agency may issue an advisory opinion or order on the issue.
Because the courts are ultimately responsible for resolving conflicts
between federal and state laws, these advisory opinions and orders are
subject to court challenge and review. As of November 2003, one or more
federal regulators had determined that federal laws preempted the
predatory mortgage lending laws of the District of Columbia and five
20See U.S. General Accounting Office, Role of the Office of Thrift
Supervision and Office of the Comptroller of the Currency in the
Preemption of State Law, GAO/GGD/OGC-00-51R (Washington, D.C.: Feb. 7,
2000) for additional information on federal preemption of state banking
laws.
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted
states-Georgia, New Jersey, New Mexico, New York, and North Carolina. (See
table 1.)
Table 1: Preemption Determinations Issued by OCC, OTS, and NCUA Related to
Predatory Mortgage Lending Laws
OCC OTS NCUA
Georgia (2003) Georgia (2003) Georgia (2002)
New York (2003) New York (2000)
New Mexico (2003) North Carolina (2002)
New Jersey (2003) District of Columbia (2003)
Source: GAO.
Preemption of state law is rooted in the U.S. Constitution's Supremacy
Clause, which provides for the supremacy of federal law. Over the years,
the courts have developed a substantial body of precedent that has guided
the analysis of whether any particular federal law or regulation overrides
or preempts state law. The courts' analysis of whether federal law
preempts state law has fundamentally centered on whether Congress intended
for the federal law or regulation to override state law, either from the
face of the statute itself (express preemption) or from the structure and
purpose of the statute (implied preemption.) In their preemption opinions,
OCC, OTS, and NCUA have cited a variety of legislation and legal
precedents. Since 1996, OTS has had regulations in place that describe its
preemption of state lending laws.21 In January 2004, OCC issued a rule
amending its regulations in a similar manner, clarifying what types of
state laws federal law preempts in the context of national bank lending.22
OCC stated that it issued the rule in response to the number and
significance of the questions that have arisen with respect to the
preemption of state laws and to reduce uncertainty for national banks that
operate in multiple states. In its rulemaking, OCC stated that it was
seeking to provide more comprehensive standards regarding the
applicability of state laws to lending, deposit taking, and other
authorized activities of national banks. The regulations
212 C.F.R S: 560.2(a).
2269 Fed. Reg. 1904 (Jan. 13, 2004).
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
but Some Laws Have Been Preempted
list examples of the types of state statutes that are preempted (such as
laws regulating credit terms, interest rates, and disclosure requirements)
and examples of the types of state laws that would not be preempted (such
as laws pertaining to zoning, debt collection, and taxation). When OCC
first proposed these rules, one news article stated that it "triggered a
flood of letters and strong reactions from all corners of the predatory
lending debate." States and consumer groups were critical of the proposal.
In contrast, the Mortgage Bankers Association of America and some large
national banking companies wrote comment letters in support of OCC's
proposed rules.
Views Differ on the Implications of Federal Preemption of State Predatory
Lending Laws
Federal banking regulators point out that preemption of states'
antipredatory lending laws applies only to institutions chartered by the
agency issuing the preemption order. For example, OTS's preemption opinion
served to preempt New Jersey's predatory lending statute for federally
chartered thrifts but did not affect the statute's applicability to
independent mortgage companies, national banks, and state-chartered banks
and thrifts. In preempting the New Jersey Home Ownership Security Act of
2002, OTS's Chief Counsel noted that requiring federally chartered thrifts
to comply with a hodgepodge of conflicting and overlapping state lending
requirements would undermine Congress's intent that federal savings
institutions operate under a single set of uniform laws and regulations
that would facilitate efficiency and effectiveness.23 Federal banking
regulators have said that they have found little to no evidence of
predatory lending by the institutions they regulate, pointing out that
federally supervised institutions are highly regulated and subject to
comprehensive supervision.24 They have also noted that they have issued
guidance and taken numerous other steps to ensure that their institutions
do not engage in predatory lending. Further, OCC has stated that state
predatory lending laws, rather than reducing predatory lending among
federally supervised institutions, can actually restrict and inhibit
legitimate lending activity. The lending industry has generally supported
preemption. For example, the Mortgage Bankers Association of America has
argued
23Office of Thrift Supervision, P-2003-5, Preemption of New Jersey
Predatory Lending Act (July 22, 2003).
24Several state law enforcement authorities have also said that predatory
lending generally occurs outside of banks and direct bank subsidiaries.
See Brief of Amicus Curiae State Attorneys General, National Home Equity
Mortgage Ass'n v. OTS, Civil Action No. 02-2506 (GK) (D D.C.) (March 21,
2003) at 10-11.
Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted
that uniformity in lending regulations is central to an efficient and
effective credit market.
In contrast, many state officials and consumer advocates have opposed
federal preemption of state predatory lending laws, for several reasons.
First, they contend that state predatory lending laws are necessary to
address gaps in relevant federal consumer protection laws. For example,
one state official said that the predatory lending legislation adopted by
his state was more focused and effective than the provisions of the
Federal Trade Commission Act. In addition, opponents of preemption claim
that federal regulators may not devote the necessary resources or have the
willingness to enforce federal consumer protection laws relevant to
predatory lending by federally chartered institutions and their
subsidiaries. In response to OCC's and OTS's statements that there is no
evidence of predatory lending among subsidiaries of federally regulated
depository institutions, opponents of preemption noted that there are
several cases in which allegations of abusive lending practices involving
some of these subsidiaries have been raised.25
25 For example, see Comments on OCC Working Paper, Center for Responsible
Lending, 7-10, October 6, 2003,
http://www.predatorylending.org/pdfs/CRLCommentsonOCCWorkingPaper.pdf.
Chapter 4
The Secondary Market May Play a Role in Both Facilitating and Combating
Predatory Lending
By providing lenders with an additional source of liquidity, the secondary
market can benefit borrowers by increasing the availability of credit and,
in general, lowering interest rates. While a secondary market for prime
mortgage loans has existed for decades, a relatively recent secondary
market for subprime loans now offers these potential benefits to subprime
borrowers as well. However, the secondary market may also serve to
facilitate predatory lending, as it can provide a source of funds for
unscrupulous originators that quickly sell off loans with predatory terms.
Secondary market participants may use varying degrees of due diligence to
avoid purchasing loans with abusive terms. In addition, some states have
enacted legislation with assignee liability-potentially holding purchasers
liable for violations of abusive lending laws that occurred in the loan
origination. However, extending liability to secondary market purchasers
may cause lenders and other secondary market participants, such as credit
rating agencies, to withdraw from the market, as occurred in Georgia.
The Development of a Secondary Market for Subprime Loans Can Benefit Consumers
Originators of mortgage loans-which can include banks, other depository
institutions, and mortgage lenders that are not depository institutions-
may keep the loans or sell them in the secondary market. Secondary market
purchasers may then hold the loans in their own portfolio or may pool
together a group of loans and issue a mortgage-backed security that is
backed by a pool of such loans. The securitization of mortgage loans
became common during the 1980s and, by the 1990s, had become a major
source of funding in the prime mortgage market. According to the Office of
Federal Housing Enterprise Oversight, by the end of 2002 more than 58
percent of outstanding U.S. single-family residential mortgage debt was
financed through securitization. Two government-sponsored enterprises-
Fannie Mae and Freddie Mac-represented nearly 40 percent of the amount
securitized.1
The securitization of subprime mortgage loans did not become common until
the mid-1990s. The development of a secondary market for these loans has
been an important factor in the growth of subprime lending, expanding
subprime lenders' access to funds and thus increasing the availability of
subprime credit. The trade journal Inside B&C Lending estimated that in
2002 approximately 63 percent of new subprime
1A government-sponsored enterprise (GSE) is a congressionally chartered,
publicly owned corporation established and accorded favored regulatory
treatment to increase access to the capital market for specific economic
sectors, including housing.
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
mortgages, representing $134 billion, were securitized. The originators of
subprime loans are often nonbank mortgage and finance companies. As
secondary market participants-such as the Wall Street investment firms
that have been the major underwriters for subprime securities-have grown
more willing to purchase these instruments, subprime originators have
gained access to an important source of liquidity that has allowed them to
make more subprime loans.
As shown in figure 4, the process of securitization starts with borrowers
obtaining mortgages either directly from a lender or through a broker. The
lender then creates a pool-a separate legal entity that purchases the
mortgages and issues securities based on them. The lender hires a credit
rating agency, which has no direct financial interest in the deal, to
confirm the value of the securities based on the expected return and risks
of the underlying mortgages. At the same time, the lender hires an
underwriter to sell the securities to investors. The value of the
securities is based exclusively on the mortgages themselves and is
separate from the financial condition of the original lender. Finally, a
servicer is hired to collect mortgage payments from the borrowers and
disburse interest and principal payments to the investors. The process
described above is for securitizations performed via private conduits-that
is, without the participation of government-sponsored enterprises.
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
Figure 4: Steps in the Securitization of Residential Mortgages
Source: GAO.
Note: This chart represents the process for fully private securitizations
and not for governmentsponsored enterprises.
Freddie Mac and Fannie Mae are relatively recent entrants into the
subprime market; Freddie Mac began purchasing subprime loans in 1997 and
Fannie Mae in 1999. Both companies have moved slowly and have limited
their purchases to the segment of the subprime market with the most
creditworthy of subprime loans. At present, the companies are believed to
represent a relatively small portion of the overall secondary market for
subprime loans. The exact portion they represent is not clear, but a study
conducted for HUD estimated that the companies purchased
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
about 14 percent of the subprime loans originated in 2002.2 Both Fannie
Mae and Freddie Mac have stated publicly that they plan on expanding their
role in the subprime market in the future. In part, this may be a result
of the affordable housing goals that HUD set for the GSEs in October 2000,
which increased the goals for loans made to low- and moderate-income
borrowers.3 HUD recommended that the GSEs consider enhancing their roles
in the subprime market-which often serves low- and moderateincome
borrowers-to help standardize mortgage terms in that market and
potentially reduce interest rates for subprime borrowers. While the GSEs
are currently believed to represent a small portion of the secondary
market for subprime lending, some market observers believe their share
will grow.
The growth of the secondary market for subprime loans has potentially
benefited some consumers. By providing subprime lenders with a new source
of liquidity, these lenders face lower funding costs and reduced interest
rate risk, in part because the supply of lenders willing to make loans to
borrowers with impaired credit has increased. Many analysts say that, as a
result, mortgage loans are now available to a whole new population of
consumers and interest rates on subprime loans made by reputable lenders
have fallen. In addition, increased securitization of subprime lending may
lead to more uniform underwriting of subprime loans, which could further
reduce origination costs and interest rates to consumers.
2K. Temkin, J. Johnson, D. Levy, "Subprime Markets, the Role of GSEs, and
Risk-Based Pricing," prepared by The Urban Institute for the U.S.
Department of Housing and Urban Development, March 2002. Other estimates
of the GSEs' share of securitization of the subprime market have varied,
in part because-as noted earlier-there is no consistent industry
definition of what constitutes subprime.
3The Federal Housing Enterprises Financial Safety and Soundness Act of
1992 requires Fannie Mae and Freddie Mac to meet annual
percent-of-business housing goals established by HUD for three categories:
low-and moderate-income, underserved, and special affordable. HUD set the
following goals for 2001 through 2003: low- and moderate-income- 50
percent of the total number of units financed; underserved-31 percent of
the total number of units financed; and special affordable-20 percent of
the total number of units financed.
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
The Secondary Market for Subprime Loans Can Facilitate Predatory Lending
While the development of a secondary market for subprime loans may have
benefits for borrowers, it can also provide a source of funds for
unscrupulous originators that quickly sell off loans with predatory terms.
The secondary market can complicate efforts to eliminate predatory lending
by separating ownership of a loan from its originator. This separation can
undermine incentives to reduce risk in lending and create incentives that
may increase the attractiveness of making loans with predatory terms. As
noted earlier, some originators of subprime mortgage loans make their
profits from high origination fees. The existence of a market that allows
originating lenders to quickly resell subprime loans may reduce the
incentive these lenders have to ensure that borrowers can repay. Further,
lenders often market their products through brokers that do not bear the
risks associated with default, as brokers are compensated in upfront fees
for the loans they help originate. Some lenders and state officials told
us that unscrupulous brokers sometimes deceive originating lenders
regarding borrowers' ability to repay. Even if deceived, lenders who
originate the loans and then sell them in the secondary market ultimately
may not bear the risk of a loan default. Taken together, these
circumstances can undermine efforts to combat predatory lending practices.
Market forces provide some incentives to deter secondary market purchasers
from purchasing predatory loans because these loans create both credit and
reputation risk.4 However, predatory loans do not in all cases create
unusual financial risks or losses for secondary market purchasers. For
example, in most states loan purchasers are generally not liable for
damages that may have resulted from the origination of abusive loans that
they purchased, mitigating much of the legal risk of buying loans that may
have violated laws addressing predatory lending. Moreover, loans with
predatory features may carry very high interest rates and have barriers to
prepayment, which may more than compensate for the increased credit risks
associated with subprime loans.
However, investors' insistence on the use of credit enhancements in the
securitization process may offset or mitigate the incentives to engage in
predatory lending of originators who sell loans to the secondary market.
4Reputation risk is the current and prospective impact on a company's
earnings and capital arising from negative public opinion from other
market participants. This risk may expose a misbehaving originator or
lender to litigation, financial loss, and a decline in its customer base
if its behavior injures its customers or clients.
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
Credit enhancements, which refer to a variety of approaches used to reduce
the credit risk of an obligation, are common in securitization
transactions, in part because of concerns that originators may try to pass
on lower-quality loans. Because the price investors will pay for
securities is based on risk as well as return, sellers use the
enhancements to lower the risk and thus raise the price of securities. For
example, the securities may be overcollateralized by ensuring that the
value of the collateral backing the securities-in the case of mortgage
backed securities, the face value of the loans-exceeds the value of the
securities being offered for sale. The difference provides a "cushion" or
reserve against possible credit losses and permits a higher loss rate on
the total mortgage pool without endangering payments to the owners of the
securities. Securitizers can also include recourse provisions in their
loan purchases that require sellers to take back loans in the event of
borrower default. As a result of these factors, the degree to which
originators of loans sold in the secondary market-including loans with
abusive terms-are insulated from credit risks associated with those loans
varies, and the profits from selling the loans may vary with the costs of
credit enhancement.
Due Diligence Can Help Purchasers Avoid Predatory Loans, but Efforts Vary
among Secondary Market Participants
Secondary market purchasers of residential mortgage loans undertake a
process of due diligence designed to minimize legal, financial, and
reputation risk associated with the purchase of those loans. Due diligence
can play an important role in avoiding the purchase of abusive loans, but
cannot necessarily identify all potentially abusive loans. Officials of
Fannie Mae and Freddie Mac-which, as noted previously, are relatively
recent entrants in the subprime market-are also concerned about risks but
say that their due diligence processes are also designed to avoid
purchasing loans that may have been harmful to consumers. Other firms' due
diligence is not necessarily specifically intended to avoid loans that may
have harmed consumers but rather to avoid purchasing loans that are not in
compliance with applicable law or that present undue financial or
reputation risks.5
5OCC has issued guidelines stating that national banks are expected to
undertake appropriate due diligence to avoid purchasing predatory loans.
See OCC Advisory Letter 2003-3 (Avoiding Predatory and Abusive Lending
Practices in Brokered and Purchased Loans), February 21, 2003.
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
Due Diligence May Deter the Purchase of Some Predatory Loans but Has
Limitations
Loans purchased in the secondary market are usually not purchased
individually but rather as a pool of many loans. Purchasers or
securitizers of residential mortgage loans try to ensure that the loans in
a particular pool are creditworthy and in compliance with law. Purchasers
perform a general background and financial review of the institutions from
which they purchase loans. In addition, secondary market purchasers of
loans nearly always conduct due diligence, or a review and appraisal of
confidential legal and financial information related to the loans
themselves. Before or after the sale, purchasers may review electronic
data containing information on the loans, such as the loan amount,
interest rate, and borrower's credit score. Purchasers also may physically
review a sample of individual loans, including items such as the loan
applications and settlement forms.
Some industry representatives and federal agencies say that appropriate
due diligence can play an important role in deterring predatory lending.
Participants in the secondary market have an interest in not purchasing
loans that may be considered predatory because such loans can create
unwarranted legal, financial, and reputation risk. For example, if such
loans violate relevant municipal, state, or federal laws, purchasing them
could, in some cases, expose the buyers to legal risks such as lawsuits,
fines, and penalties. Moreover, predatory loans may be more likely to go
into default, increasing financial risk without a commensurate increase in
expected returns. In addition, many industry officials told us that
reputation risk is a major reason why they want to avoid purchasing
predatory loans. Firms involved in the securitization process do not want
to be associated with predatory lending activity that could affect their
relationships with other firms, community groups, and government agencies.
Due diligence reviews for residential mortgage loans are designed to
determine the financial characteristics of the loans and to ensure
compliance with applicable federal, state, and municipal laws, including
those designed to prohibit predatory lending. The reviews also can be
designed to detect loans that have potentially abusive terms but are not
necessarily violating any law. For example, an electronic review of loan
data can flag characteristics such as interest rates that appear excessive
but are nonetheless legal. A loan-level file review, in which a purchaser
reviews the physical loan origination documents, offers access to more
information and can highlight items such as points and fees and the
borrower's capacity to repay. While nearly all purchasers of loans use due
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
diligence to check for legal compliance, purchasers set their own
guidelines for what other loan characteristics meet their standards.
While due diligence in the secondary market is important, the role that it
can play in deterring predatory lending by performing due diligence is
limited. For one thing, more than one-third of all new subprime loans are
not securitized in the first place but are held in the portfolio of the
originating lender and thus do not face securitizers' due diligence
reviews. In addition, even the most thorough due diligence will not
necessarily catch all abusive loans or abusive lending practices. For
example:
o Due diligence may not detect fraud in the underwriting or approving of
a mortgage. For instance, if a mortgage broker includes false information
in a loan application to ensure that a borrower meets an originator's
income requirements, the process of due diligence may not detect it.6
o The data tapes used for loan reviews do not include point and fee
information.7 Thus, securitizers typically cannot detect excessive or
unwarranted fees prior to purchasing a loan without a loan-level review.
o Loan flipping (repeated refinancings) can be difficult to detect
because loan files do not necessarily include information on previous
refinancings.
Fannie Mae and Freddie Mac Appear to Perform Extensive Due Diligence to
Avoid Buying Loans with Abusive Terms
Fannie Mae and Freddie Mac have relatively strict criteria for the loans
they purchase, particularly subprime loans. As noted, both companies limit
their purchases to the most creditworthy subprime loans. In April 2000,
Fannie Mae issued guidelines to sellers of subprime loans that set
criteria designed to help the GSE avoid purchasing loans with abusive
features. For example, the guidelines state that Fannie Mae's approved
lenders may not "steer" a borrower who qualifies for a standard loan to a
higher cost
6Some securitizers have begun to use fraud detection software as part of
their due diligence of residential mortgage loans. Such software analyzes
specific data fields within a loan file and looks for characteristics and
inconsistencies that may signal fraud in the appraisal, loan application,
or loan itself. In some cases, a fraud review can also be incorporated as
part of the regular due diligence process.
7A prepurchase financial due diligence review may not look at point and
fee data because the risks and returns to the loan purchaser depend not on
payments that were made at origination but rather on future payments by
the homeowner. However, a review of points and fees is often done during a
subsequent loan-level file review.
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
product, may not make loans without regard to the borrower's ability to
repay, and may not in most instances charge more than 5 percent of the
loan amount in points and fees. Freddie Mac issued similar guidelines to
its sellers and servicers in December 2000. Further, both companies, like
other secondary market purchasers, rely on a system of representations and
warranties, under which sellers contractually agree to buy back loans they
sell that turn out not to meet the terms of the contract.
Fannie Mae and Freddie Mac officials told us that they undertake a series
of measures aimed at avoiding the purchase of loans with predatory
characteristics. Approved sellers and servicers undergo a background check
and operational review and assessment that seeks, in part, to determine
whether lenders are able to comply with their guidelines. Fannie Mae and
Freddie Mac also require that special steps, such as additional due
diligence measures, be taken in purchasing subprime loans. For example,
Fannie Mae requires that subprime loans be originated using the company's
automated desktop underwriting system, which helps ensure that borrowers
are not being steered to a more expensive loan than they qualify for.8
Fannie Mae officials say that the automated desktop underwriting system
also facilitates traditional lenders that serve subprime borrowers.
In addition, both companies said that they undertake extensive and costly
due diligence that goes well beyond simple legal compliance and is aimed
at avoiding loans that may potentially be considered abusive or
detrimental to the borrower. Both companies use an outside contractor to
conduct their loan-level due diligence reviews on subprime loans. The
contractor has a standard "script" that reviews a large number of data
elements related to legal compliance and creditworthiness. However, the
contractor told us that Fannie Mae and Freddie Mac add elements to the
script to make the review more stringent with regard to identifying
potentially abusive practices. For example, Freddie Mac requires the
contractor to check whether the lender has gathered evidence of a
borrower's income information directly or relied on self-verification,
which can raise uncertainty about a borrower's capacity to repay. In
addition, the
8Fannie Mae and Freddie Mac officials note that their antipredatory
lending policies and compliance measures are only one element in their
efforts to fight predatory lending. For example, both companies also have
special programs that provide appropriately priced loans to
credit-impaired borrowers and other consumers who tend to be targeted by
predatory lenders; support homebuyer education and counseling for at-risk
individuals; and have special loan programs designed for borrowers who
have been targeted or victimized by predatory lenders.
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
contractor told us that Fannie Mae and Freddie Mac are more likely than
other firms to reject or require a repurchase if evidence exists that the
loan may involve a predatory practice-even if the loan is otherwise
legally compliant.
Other Purchasers Vary in the Extent of Their Due Diligence
According to industry representatives, all purchasers of mortgage loans
undertake a process of due diligence, but the process can vary in its
degree of stringency and comprehensiveness. For example, while most firms
typically pull a sample of loans for a loan-level file review, companies
may review anywhere between a few percent and 100 percent of the loans. In
addition, companies vary in terms of the data elements they choose to
review. Some firms review prior loans made to the borrower in an effort to
detect loan flipping, while others do not. Further, some companies may be
more willing than others to purchase loans that are considered
questionable in terms of legal compliance, creditworthiness, or other
factors.
As noted earlier, loans that have harmed consumers and that may be deemed
"predatory" by some observers are not necessarily against the law, nor do
they necessarily increase the risk of the loan.9 Industry officials told
us that while securities firms are concerned with the reputation risk that
may come with purchasing abusive loans, the primary function of their due
diligence is to ensure compliance with the law and to protect investors by
ensuring that loans are creditworthy.10
9One example would be steering borrowers to higher-cost loans than is
justified by their credit histories. This practice is often considered
abusive but is not per se a violation of federal law, nor does it
necessarily increase credit risk to the lender.
10Reputation risk can also be an issue for sellers of loans to the
secondary market. Regularly selling loans that later create risks and
costs for secondary market purchasers may close off the seller's access to
the secondary market.
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
Assignee Liability May Help Deter Predatory Lending but Can Also Have Negative
Unintended Consequences
Some states have enacted predatory lending laws that have assignee
liability provisions under which purchasers of secondary market loans may
be liable for violations committed by the originators or subject to a
defense by the borrower against collecting the loan. Assignee liability is
intended to discourage secondary market participants from purchasing loans
that may have predatory features and to provide an additional source of
redress for victims of abusive lenders. However, depending on the specific
nature of the provision, assignee liability may also have unintended
consequences, including reducing access to or increasing the cost of
secondary market capital for legitimate loans. For example, assignee
liability provisions of a predatory lending law in Georgia have been
blamed for causing several participants in the mortgage lending industry
to withdraw from the market, and the provisions were subsequently
repealed.
Several States Hold Secondary Purchasers Liable for Predatory Lending
Violations
Antipredatory lending laws in several states have included some form of
assignee liability. Typically, with assignee liability, little or no
distinction is made between the broker or lender originating a loan that
violates predatory lending provisions and the person who purchases or
securitizes the loans. Under these provisions, secondary market
participants that acquire loans may be liable for violations of the law
committed by the original lenders or brokers whether or not the purchasers
were aware of the violations at the time they bought the loans. Further,
borrowers can assert the same defenses to foreclosure against both
originating lenders and entities in the secondary market that hold the
loans (the assignees). Depending on the specific provisions of the law,
assignees may have to pay monetary damages to aggrieved borrowers.
As of December 2003, at least nine states and the District of Columbia had
enacted predatory lending laws that expressly included assignee liability
provisions, though the nature of these provisions varies greatly,
according to the database of state and local legislation we reviewed.
Other states have passed predatory lending laws that do not explicitly
provide for assignee liability, but debate has occurred in some of these
states about whether assignee liability can be asserted anyway under
existing laws or legal principles. The federal HOEPA statute includes an
assignee liability provision, but, as noted in chapter 2, only a limited
number of subprime loans are covered under HOEPA.
Assignee liability can take a variety of forms. For example, an assignee
can be held liable only in defensive claims (defense to foreclosure
actions and
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
to claims regarding monies owed on a loan) or can also be assessed for
damages directly, including punitive damages.11 Similarly, some laws
include "safe harbor provisions," under which assignee liability may not
arise if the assignee has taken certain measures to avoid obtaining a
highcost loan. For example, under New Jersey law, no assignee liability
arises if the assignee demonstrates, by a preponderance of evidence, that
a person exercising reasonable due diligence could not determine that the
mortgage was a high-cost home loan.12 However, many secondary market
participants told us that the value of these safe harbor provisions is
limited, in part because of difficulties in demonstrating compliance with
safe harbor standards. For example, some secondary market participants say
that the New Jersey law does not adequately define what constitutes
"reasonable" due diligence.
Assignee Liability May Help Combat Predatory Lending but May Also Hinder
Legitimate Lending
The issue of whether to include assignee liability provisions in state and
local predatory lending laws has been highly controversial, because such
provisions can potentially both confer benefits and cause problems.
Assignee liability has two possible primary benefits. First, holding
purchasers and securitizers of loans liable for abusive lending violations
provides them with an incentive not to purchase predatory loans in the
first place. If secondary market participants took greater action-through
policy decisions or stricter due diligence-to avoid purchasing potentially
abusive loans, originators of predatory loans would likely see a steep
decline in their access to secondary market capital. Second, under some
forms of assignee liability, consumers who have been victimized by such
lenders may have an additional source of redress. In some cases,
originators of abusive loans that have been sold in the secondary market
are insolvent or cannot be located, leaving victims dependent on assignees
for relief from foreclosure or other redress.
11Under New York's law, an assignee seeking to enforce a loan against a
borrower in default or in foreclosure is subject to the borrower's claims
and defenses to payment that the borrower could assert against the
original lender. See NY Banking Law S: 6-l (2003). Under Maine's law, an
assignee may be subject to all claims and defenses that the borrower may
assert against the creditor of the mortgage. See Maine Rev. Stat. Ann.
Title 9-A S: 8-209 (2003).
12See, e.g., N.J. Stat. Ann. S: 46:10B-27 (West 2003); see also, 815 Ill.
Comp. Stat. 137/135 (2003).
Chapter 4
The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
However, assignee liability provisions may also have the serious if
unintended consequence of discouraging legitimate secondary market
activity. Secondary market participants say that because they do not
originate the loans they purchase, even the most stringent due diligence
process cannot ensure that all loans comply with applicable law. In
addition, some secondary market participants state that assignee liability
provisions require them to make subjective determinations about whether
the loans are in compliance with law, and this ambiguity can create legal
and financial risk. These factors, industry participants say, can actually
end up harming consumers by raising the costs of ensuring compliance with
the law and thus increasing the cost of loans to borrowers. Further, if
secondary market participants are not willing to risk having to assume
liability for violations committed by originators, they may pull out of
the market altogether, reducing the availability and increasing the costs
of legitimate subprime credit. Finally, if states' predatory lending laws
have different terms and provisions regarding assignee responsibilities,
the secondary market as a whole could become less efficient and liquid,
further increasing rates on legitimate subprime mortgages.
Credit rating agencies have been among the secondary market players that
have expressed concern about assignee liability provisions in state
predatory lending laws. When a residential mortgage-backed security is
created from a pool of loans, an independent credit rating agency examines
the security's underlying loans and assigns it with a credit rating, which
represents an opinion of its general creditworthiness. Credit rating
agencies need to monetize (measure) the risk associated with the loans
underlying a security in order to assign a credit rating. Because assignee
liability can create additional legal and financial risks, the major
credit rating agencies typically review new predatory lending legislation
to assess whether they will be able to measure that risk adequately to
rate securities backed by loans covered under the law.
We talked with representatives of two major credit rating agencies, firms
that issue mortgage-backed securities, and the GSEs Fannie Mae and Freddie
Mac to better understand how specific assignee liability provisions might
affect their ability to conduct secondary market transactions. In general,
the representatives told us that the most problematic assignee liability
provisions for secondary market participants are those with two
characteristics:
o Ambiguous language. Credit rating agencies and other secondary market
players seek clear and objective descriptions of the loans
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The Secondary Market May Play a Role in
Both Facilitating and Combating Predatory
Lending
covered by the statutes and the specific actions or omissions that
constitute a violation. For example, some participants cited concerns
about an ordinance enacted in Toledo, Ohio, that prohibited taking
advantage of a borrower's "physical or mental infirmities" but did not
define what constituted such infirmities.13 Secondary market participants
noted that without objective criteria, there is no way to ensure that an
originator has complied adequately with the law.
o Punitive Damages. Under some assignee liability provisions, the
potential damages a borrower can receive are restricted to the value of
the loan, while other provisions allow for punitive damages, which are not
necessarily capped. Secondary market participants say that the potential
for punitive damages can make it very difficult to quantify the risk
associated with a security.
Georgia's Statute Illustrates Possible Effects of Assignee Liability
Provisions
According to officials of industry and consumer advocacy organizations,
the Georgia Fair Lending Act, which became effective on October 1, 2002,
was one of the strictest antipredatory lending laws in the nation.14 It
banned single-premium credit insurance and set restrictions on late fees
for all mortgage loans originated in the state and, for a special category
of "covered loans," prohibited refinancing within 5 years after
consummation of an existing home loan unless the new loan provided a
"tangible net benefit" to the borrower. The act also created a category of
"high-cost loans" that were subject to certain restrictions, including
limitations on prepayment penalties, prohibitions on balloon payments, and
prohibitions on loans that were made without regard to the borrower's
ability to repay.
13City of Toledo Ordinance No. 291-02 (Oct. 4, 2002).
14The Georgia Fair Lending Act is codified at GA Code Ann. S:S: 7-6A-1 et.
seq. OTS, NCUA, and OCC have determined that the Georgia law does not
apply to the institutions they supervise because it is preempted by
federal law. See Office of Thrift Supervision, P-2003-1, Preemption of
Georgia Fair Lending Act (Jan. 21, 2003); National Credit Union
Administration, 02-0649, Applicability of Georgia Fair Lending Act to
Federal Credit Unions (July 29, 2002); National Credit Union
Administration, 03-0412, NCUA Preemption of the Georgia Fair Lending Act
(Nov. 10, 2003); and OCC Preemption Determination and Order, Docket No.
03-17 (July 30, 2003). Because Georgia law contains a parity provision
under which its state-chartered banks are treated similarly to national
banks, Georgia's Commissioner of Banking and Finance ruled that
Georgia-chartered banks also are not subject to the Fair Lending Act. See
Declaratory Ruling: Effect of Preemption of Georgia Fair Lending Act by
the OCC on July 30, 2003 (Aug. 5, 2003).
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The act also included fairly strict assignee liability. Secondary market
participants that purchased high-cost loans were liable for violations of
the law committed by the originator of the loans they purchased, while
purchasers of covered loans were subject to borrower defenses and
counterclaims based on violations of the act. The act also expressly made
mortgage brokers and loan servicers liable for violations. Remedies
available to borrowers included actual damages, rescission of high-cost
loans, attorney fees, and punitive damages. Most of the violations were
civil offenses, but knowing violations constituted criminal offenses.
Shortly after the Georgia Fair Lending Act took effect, several mortgage
lenders announced that they would stop doing business in the state due to
the increased risk they would incur. In addition, several secondary market
participants stated their intention to cease doing business in Georgia. In
January 2003, the credit rating agency Standard & Poor's announced it
would stop rating mortgage-backed securities in Georgia because of the
uncertainty surrounding potential liability under the act. Standard &
Poor's decision extended to securitizations of virtually all loans in the
state, not just those of covered or high-cost loans. The company said that
because the act did not provide an unambiguous definition of which loans
were covered (and therefore subject to assignee liability), it could not
adequately assess the potential risk to securitizers. In addition, the
company said that it was concerned about an antiflipping provision that
did not adequately define what constituted the "net tangible benefit" to
borrowers that certain refinancings had to provide. The two other major
credit rating agencies, Moody's and Fitch, also said that the law would
limit their ability to rate mortgage-backed securities in Georgia.
In response to these events, the Georgia legislature amended the Georgia
Fair Lending Act on March 7, 2003. The amendments eliminated the category
of "covered home loans" and the restrictions that had existed for that
category of loans. In addition, the amendments greatly reduced the scope
of assignee liability under the law, restricting such liability to
"highcost" loans, and then only when the assignee is unable to show that
it has exercised reasonable due diligence to avoid purchasing them. In
addition, the amendments capped the amount of damages an assignee can face
and prohibited assignee liability in class-action lawsuits. Once these
amendments were passed, credit rating agencies announced that they would
once again rate securities backed by mortgage loans originated in Georgia,
and lenders said they would continue to do business in the state.
Advocates of the original Georgia law argued that the legislature
overreacted to actions by some members of the lending industry, and many
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The Secondary Market May Play a Role in
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Lending
activists said that Standard & Poor's and others had engaged in an
orchestrated effort to roll back the Georgia Fair Lending Act. Industry
representatives said that the response by lenders and others was a
reasonable response to a statute that created unacceptable risks of legal
liability for lenders and assignees.
Policymakers and industry representatives have frequently cited the events
in Georgia as a lesson in what can happen when secondary market
participants are held liable for violations by the original lender.
Industry representatives assert that assignee liability creates undue
risks to the secondary market, or makes assessing risks difficult, and
ultimately reduces borrowers' access to credit. In the case of Georgia,
however, it is unclear whether the problem was assignee liability itself
or the scope and characteristics of the specific assignee liability
provisions contained in the original law. Georgia's original law created
concern in large part because of perceived ambiguities in defining which
loans were subject to assignee liability and because assignees' liability
was subject to unlimited punitive damages. Not all states with
antipredatory lending statutes that include assignee liability provisions
have had lenders and credit agencies threaten to withdraw from the market
to the same extent, largely because these laws generally cap an assignee's
liability, create a safe harbor, or contain less ambiguous language. The
challenge to states that choose to impose assignee liability is to craft
provisions that may serve their purpose of deterring predatory lending and
providing redress to affected borrowers without creating an undue adverse
effect on the legitimate lending market.
Chapter 5
The Usefulness of Consumer Education, Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
A number of federal, state, nonprofit, and industry-sponsored
organizations offer consumer education initiatives designed to deter
predatory lending by, among other things, providing information about
predatory practices and working to improve consumers' overall financial
literacy. While consumer education efforts have been shown to have some
success in increasing consumers' financial literacy, the ability of these
efforts to deter predatory lending practices may be limited by several
factors, including the complexity of mortgage transactions and the
difficulty of reaching the target audience. Similarly, unreceptive
consumers and counselors' lack of access to relevant loan documents can
hamper the effectiveness of mortgage counseling efforts, while the sheer
volume of mortgage originations each year makes universal counseling
difficult. While efforts are under way to improve the federally required
disclosures associated with mortgage loans, their potential success in
deterring predatory lending is likewise hindered by the complexity of
mortgage transactions and by the lack of financial sophistication among
many borrowers who are the targets of predatory lenders.
Many Consumer Education and Mortgage Counseling Efforts Exist, but Several
Factors Limit Their Potential to Deter Predatory Lending
In response to widespread concern about low levels of financial literacy
among consumers, federal agencies such as FDIC, HUD, and OTS have
conducted and funded initiatives designed in part to raise consumers'
awareness of predatory lending practices. In addition, a number of states,
nonprofits, and trade organizations have undertaken consumer education
initiatives. Prepurchase mortgage counseling-which can include a third
party review of a prospective mortgage loan-may also help borrowers avoid
predatory loans, in part by alerting them to the characteristics of
predatory loans. In some circumstances, such counseling is required.
However, a variety of factors limit the potential of these tools to deter
predatory lending practices.
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Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
Some Federal Agencies Have Initiatives to Promote Awareness of Predatory
Lending
A number of federal agencies and industry trade groups have advocated
financial education for consumers as a means of improving consumers'
financial literacy and addressing predatory lending. The Department of the
Treasury, as well as consumer and industry groups, have identified the
lack of financial literacy in the United States as a serious, widespread
problem.1 Studies have shown that many Americans lack a basic knowledge
and understanding of how to manage money, use debt responsibly, and make
wise financial decisions.2 As a result, some federal agencies have
conducted or funded programs and initiatives that serve to educate and
inform consumers about personal financial matters. For example:
o FDIC sponsors MoneySmart, a financial literacy program for adults with
little or no banking experience and low to moderate incomes. FDIC
officials told us that the program, in effect, serves as one line of
defense against predatory lending. The MoneySmart curriculum addresses
such topics as bank services, credit, budgeting, saving, credit cards,
loans, and homeownership. MoneySmart is offered free to banks and others
interested in sponsoring financial education workshops.
o The Federal Reserve System's Community Affairs Offices issue media
releases and distribute consumer education publications to financial
institutions, community organizations, and to consumers directly. These
offices also have hosted conferences and forums on financial education and
predatory lending and have conducted direct outreach to communities
targeted by predatory lenders.
1The Fair and Accurate Credit Transactions Act of 2003 (Pub. L. No.
108-159), which was enacted on December 4, 2003, addresses financial
literacy in a number of its provisions. Among other things, it establishes
a financial literacy and education commission consisting of
representatives of FTC, the federal banking regulators, HUD, the
Department of the Treasury, and other federal agencies.
2See National Endowment for Financial Education, "Financial Literacy in
America: Individual Choices, National Consequences," report based on the
symposium "The State of Financial Literacy in America: Evolutions and
Revolutions," October 2002 (Greenwood Village, Colorado, 2002), 1 and 6;
Maude Toussaint-Comeau and Sherrie L.W. Rhine, "Delivery of Financial
Literacy Programs," Policy Studies, Consumer Issues Research Series,
Consumer and Community Affairs Division, Federal Reserve Bank of Chicago
(2000), 1; Marianne A. Hilgert, Jeanne M. Hogarth, and Sondra Beverly,
"Household Financial Management: The Connection between Knowledge and
Behavior," Federal Reserve Bulletin, July 2003, 309 and 311.
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Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
o OTS and NCUA have worked with community groups on financial literacy
issues and have disseminated financial education materials, including
literature on predatory lending issues, to their respective regulated
institutions.
o HUD has developed and distributed a brochure titled Don't Be a Victim
of Loan Fraud: Protect Yourself from Predatory Lenders, which seeks to
educate consumers who may be vulnerable to predatory lending, especially
the elderly, minorities, and low-income homeowners.
o Federal banking regulators give positive consideration in Community
Reinvestment Act performance reviews to institutions for providing
financial education to consumers in low- and moderate-income communities.
o OCC issued an advisory letter in 2001 providing detailed guidance for
national banks, encouraging them to participate in financial literacy
initiatives and specifying a range of activities that banks can provide to
enhance their customers' financial skills, including support for
educational campaigns that help borrowers avoid abusive lending
situations.3
o FTC and DOJ disseminate information designed to raise consumers'
awareness of predatory lending practices, particularly those involving
fraudulent acts. Brochures and other consumer materials are distributed on
the agencies' Web sites, as well as through conferences and seminars,
local consumer protection agencies, consumer credit counselors, state
offices, and schools. FTC has also supported public service announcements
on radio and television, including Spanish-speaking media.
Some of these initiatives are general financial education programs that do
not specifically address predatory home mortgage lending, some address
predatory lending practices as one of a number of topics, and a few focus
specifically on predatory lending. Some of these initiatives are directed
to a general audience of consumers, while others are directed toward
lowincome or other communities that are often the targets of predatory
lenders. A number of different media have been used to deliver the
messages, including print and online materials, speeches and spot
3OCC Advisory Letter 2001-1, Financial Literacy, January 16, 2001.
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Predatory Lending May Be Limited
announcements, and materials for the hearing- and visually impaired. In
some cases, consumer financial education materials have been produced in a
variety of languages, including Arabic, Chinese, Korean, and Spanish.
Federal agencies' consumer education campaigns typically take place in
partnership with other entities, including community and nonprofit groups
and state and local agencies.
Federal agencies have taken some actions to coordinate their efforts
related to educating consumers about predatory lending. For example, in
October 2003, the Interagency Task Force on Fair Lending, which consists
of 10 federal agencies, published a brochure that alerts consumers to
potential pitfalls of home equity loans, particularly high-cost loans. The
brochure Putting Your Home on the Loan Line is Risky Business describes
common predatory lending practices and makes recommendations to help
borrowers avoid them.
State Agencies, Nonprofits, and Industry Organizations Have Also Initiated
Consumer Education Efforts
Some state agencies have also sponsored consumer education initiatives
that address predatory lending. For example, the Connecticut Department of
Banking offers an educational program in both English and Spanish that
partners with neighborhood assistance groups and others to promote
financial literacy and educate consumers on the state's antipredatory
lending statute. The Massachusetts Division of Banks maintains a toll-free
mortgage hotline to assist homeowners about potentially unethical and
unlawful lending practices. The hotline helps consumers determine whether
loan terms may be predatory and directs them to other sources of
information and assistance. The New York State Banking Department
distributes educational materials, including a video, that describe
predatory lending practices. The department has also conducted educational
outreach programs to community groups on the issue.
Nonprofits provide a significant portion of consumer financial education
on predatory lending, sometimes with support from federal, state, or local
agencies. These efforts include both general financial literacy programs
with a predatory lending component and initiatives that focus specifically
on predatory lending issues. For example, the National Community
Reinvestment Coalition, with funding support from HUD, distributes a
training module to help communities across the country educate consumers
about predatory lending.
Chapter 5
The Usefulness of Consumer Education,
Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
Some industry trade organizations and companies also have consumer
education initiatives related to predatory lending:
o Freddie Mac has developed the CreditSmart program in partnership with
universities and colleges. CreditSmart is a curriculum on credit education
that is available online and has been used in academic programs and in
community workshops, seminars, and credit education campaigns. Freddie Mac
also helps fund and promote the "Don't Borrow Trouble" campaign, a
comprehensive public education campaign with counseling services that is
designed to help homeowners avoid falling victim to predatory lenders. The
campaign uses brochures, mailings, posters, public service announcements,
transit ads, and television commercials. Its media toolkit and marketing
consultant services have been provided to the U.S. Conference of Mayors
for use in local communities.
o Fannie Mae supports financial literacy programs through its Fannie Mae
Foundation, which sponsors homeownership education programs that focus on
improving financial skills and literacy for adult students and atrisk
populations, such as new Americans and Native Americans. Fannie Mae also
offers a Web-based tool that allows home-buyers to compare loan products
and prices.
o The Jump$tart Program for Personal Financial Literacy, sponsored by a
coalition of corporations, industry associations-such as the Insurance
Education Foundation and the American Bankers Association Education
Foundation-and several government and nonprofit agencies, includes a
series of modules covering topics such as managing debt and shopping for
credit that are designed to improve the personal financial literacy of
young adults.
o The Mortgage Bankers Association of America, a trade association
representing mortgage companies and brokers and the real estate finance
industry, disseminates a package of information describing some common
warning signs of mortgage fraud and predatory lending, a consumer's bill
of rights, and appropriate contacts for consumers who believe they have
been victimized by predatory lenders.
o The National Association of Mortgage Brokers makes presentations to
first-time homebuyers to educate them on the mortgage process and credit
reports, among other topics.
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The Usefulness of Consumer Education,
Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
o The American Financial Services Association's Education Foundation
develops educational materials designed to improve consumers' use of
credit and overall financial literacy.
Mortgage Counseling Can Warn Borrowers of Predatory Lending and Can Offer a
"Third Party" Review of Proposed Mortgage Loans
Mortgage counseling can be part of general "homeownership counseling" for
new homeowners but may also be offered prior to a refinancing. It gives
borrowers an opportunity to receive personalized advice from a
disinterested third party about a proposed mortgage or other loan. In
addition to providing general advice about the mortgage process and loan
products, counselors typically review the terms of proposed loans for
potentially predatory characteristics. Studies evaluating the impact of
homeownership counseling have found that it helps homeowners maintain
ownership of their homes and avoid delinquencies, particularly when the
counseling is provided one on one.4 HUD supports a network of
approximately 1,700 approved counseling agencies across the country. The
agencies provide a wide variety of education and counseling services,
including homebuyer education and prepurchase counseling. HUD makes grant
funds available to some of these agencies, and a portion of these funds
has been earmarked exclusively for counseling for victims of predatory
lending.
A number of state antipredatory lending laws, such as those in New Jersey
and North Carolina, require some lenders to document that a borrower has
received counseling before taking out certain types of high-cost loans. In
a few cases, however, borrowers may waive their right to receive such
counseling. Several states, including Colorado, New York, and
Pennsylvania, require lenders to provide notice to borrowers of certain
loans that mortgage counseling is available and encourage them to seek it.
4See, for example, Abdighani Hirad and Peter M. Zorn, "A Little Knowledge
is a Good Thing: Empirical Evidence of the Effectiveness of Pre-Purchase
Homeownership Counseling," in Low-Income Homeownership: Examining the
Unexamined Goal, ed. Nicolas P. Retsinas and Eric S. Belsky (Washington,
D.C.: Brookings Institution Press and Harvard University Joint Center on
Housing Studies, 2001), 2.
Chapter 5
The Usefulness of Consumer Education,
Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
A Variety of Factors May Limit the Effectiveness of Consumer Education and
Mortgage Counseling in Deterring Predatory Lending
Limitations of Consumer Education
In testimony before Congress and elsewhere, representatives of the
Mortgage Bankers Association, the Consumer Mortgage Coalition, and other
industry organizations have promoted the view that educated borrowers are
more likely to shop around for beneficial loan terms and avoid abusive
lending practices. In searching the literature for studies on the
effectiveness of consumer financial education programs, we found evidence
that financial literacy programs may produce positive changes in
consumers' financial behavior.5 However, none of the studies measured the
effectiveness of consumer information campaigns specifically on deterring
predatory lending practices.
The majority of federal officials and consumer advocates we contacted said
that while consumer education can be very useful, it is unlikely to play a
substantial role in reducing the incidence of predatory lending practices,
for several reasons:
o First, mortgage loans are complex financial transactions, and many
different factors-including the interest rate, fees, specific loan terms,
and borrower's situation-determine whether the loan is in a borrower's
best interests. Mortgage loans can involve dozens of different documents
that are written in highly technical language. Even an excellent campaign
of consumer education is unlikely to provide less sophisticated consumers
with enough information to properly assess whether a proffered loan
contains abusive terms.
o Second, abusive lenders and brokers may use high-pressure or "push
marketing" tactics-such as direct mail, telemarketing, and door-to-door
contacts-that are unfair, deceptive, or designed to confuse the consumer.
Broad-based campaigns to make consumers aware of predatory lending may not
be sufficient to prevent many consumers- particularly those who may be
uneducated or unsophisticated in financial matters-from succumbing to
aggressive sales tactics.
o Third, the consumers who are often the targets of predatory lenders are
also some of the hardest to reach with educational information. Victims of
predatory lending are often not highly educated or literate and may
5See for example, B. Douglas Mernheim, Daniel M. Garrett, and Dean M.
Maki, Education and Saving: The Long-Term Effects of High School Financial
Curriculum Mandates
(Cambridge, Mass.: National Bureau of Economic Research, 1997), 29-30.
Chapter 5
The Usefulness of Consumer Education,
Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
not read or speak English. Further, they may lack access to information
conveyed through the Internet or traditional banking sources, or they may
have hearing or visual impairments or mobility problems.
Limitations of Mortgage Consumer education campaigns have encouraged
borrowers to seek
Counseling counseling before entering into a mortgage loan, particularly a
subprime refinancing loan. However, unreceptive consumers, lack of access
to loan documents, fraudulent lending practices, and the uneven quality of
counseling services can affect the success of these counseling efforts.
For instance, some consumers may simply not respond to counseling.
Officials at HUD have noted that not all first-time homebuyers avail
themselves of prepurchase counseling, and that some consumers who do
attend counseling sessions ignore the advice and information given to
them. Further, counselors may not have access to loan documents containing
the final terms of the mortgage loan. Although lenders are required to
provide a good-faith estimate of the mortgage terms, they are not required
to provide consumers with the final and fixed terms and provisions of a
mortgage loan until closing.6 Moreover, predatory lenders have been known
to manipulate the terms of a mortgage loan (sometimes called "bait and
switch") so that the terms of the actual loan vary substantially from that
contained in the good faith estimate.
In addition, counseling may be ineffective against lenders and brokers
that engage in fraudulent practices, such as falsifying applications or
loan documents, that cannot be detected during a prepurchase review of
mortgage loan documents. Finally, the quality of mortgage counseling can
vary because of a number of factors. For example, one federal official
cited an instance of a mortgage company conducting only cursory telephone
counseling in order to comply with mandatory counseling requirements.
Although some states have mandated counseling for certain types of loans,
serious practical barriers would exist to instituting mandatory
prepurchase mortgage counseling nationally. HUD officials have noted that
instituting a mandatory counseling program for most regular mortgage
transactions nationwide would be an enormous and difficult undertaking
that might not
6For example, TILA requires federal lenders to make certain disclosures on
mortgage loans within 3 business days after the receipt of a written
application. It also requires a final disclosure statement at the time of
closing that includes the contract sales price, principal amount of the
new loan, interest rate, broker's commission, loan origination fee, and
mortgage and hazard insurance, among other things.
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The Usefulness of Consumer Education,
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Predatory Lending May Be Limited
be cost-effective. Lenders originated about 10 million mortgage loans in
2002 in the United States. The cost of providing counseling for all or
many of these loans would be high, and it is unclear who would or should
be responsible for paying it. In addition, there is a need for trained,
qualified counselors, according to federal officials and representatives
of consumer and advocacy groups, and currently no system exists for
effectively training large numbers of counselors while maintaining quality
control.
HUD requires counseling for its reverse mortgages. These mortgages allow
homeowners to access the equity in their home through a lender, who makes
payments to the owner.7 Borrowers who receive a home equity conversion
mortgage insured through FHA must attend a consumer information session
given by a HUD-approved housing counselor. Mandatory counseling for
reverse mortgages may be reasonable because these products are complex and
subject to abuse. However, reverse mortgages are also relatively uncommon;
only approximately 17,610 HUDinsured reverse mortgages were originated in
fiscal year 2003.
Disclosures, Even If Improved, May Be of Limited Use in Deterring Predatory
Lending
Federally mandated mortgage disclosures, while helpful to some borrowers,
may be of limited usefulness in reducing the incidence of predatory
lending practices. TILA and RESPA have requirements concerning the
content, form, and timing of information that must be disclosed to
borrowers. The goal of these laws is to ensure that consumers obtain
timely and standardized information about the terms and cost of their
loans. Federal agencies, advocacy groups, and the mortgage industry have
said that mortgage disclosures are an important source of information for
borrowers, providing key information on loan terms and conditions and
enabling borrowers to compare mortgage loan products and costs.
Representatives of the lending industry in particular have said that
disclosures can play an important role in fighting predatory lending,
noting that clear, understandable, and uniform disclosures allow borrowers
to understand the terms of their mortgage loans and thus make more
informed choices when shopping for a loan.
However, industry and advocacy groups have publicly expressed
dissatisfaction with the current scheme of disclosures as mandated by TILA
and RESPA. A 1998 report by the Board and HUD concluded that
7The loan is not repaid in full until the homeowner permanently moves out
of the home, passes away, or other specified events have occurred.
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Counseling, and Disclosures in Deterring
Predatory Lending May Be Limited
consumers cannot easily understand current disclosures, that disclosures
are often provided too late in the lending process to be meaningful, that
the information in disclosures may differ significantly from the actual
final loan terms, and that the protections and remedies for violations of
disclosure rules are inadequate.8
Improving the disclosure of pertinent information has been part of efforts
under way over the last few years to streamline and improve the real
estate settlement process. HUD issued proposed rules in July 2002 to
simplify and improve the process of obtaining home mortgages and reduce
settlement costs for consumers. HUD stated that the proposed changes to
its RESPA regulations would, among other things, "make the good faith
estimate [settlement cost disclosure] firmer and more usable, facilitate
shopping for mortgages, make mortgage transactions more transparent, and
prevent unexpected charges to consumers at settlement."9 Debate over the
proposed rules, which as of December 2003 were still under review, has
been contentious. Industry groups claim that the proposal would help fight
predatory lending by helping consumers understand loan costs up front and
thus enable consumers to compare products, or comparison shop. Several
advocacy organizations and an industry group say the proposed rules would
still allow unscrupulous mortgage originators to hide illegal or
unjustified fees.
Although streamlining and improving mortgage loan disclosures could help
some borrowers better understand the costs and terms of their loans, such
efforts may play only a limited role in decreasing the incidence of
predatory lending practices. As noted above, mortgage loans are inherently
complex, and assessing their terms requires knowing and understanding many
variables, including interest rates, points, fees, and prepayment
penalties. Brokers and lenders that engage in abusive practices may target
vulnerable individuals who are not financially sophisticated and are
therefore more susceptible to being deceived or defrauded into entering
into a loan that is clearly not in their interests. Even a relatively
clear and transparent system of disclosures may be of limited use to
borrowers who lack sophistication about financial matters, are not highly
educated, or suffer physical or mental infirmities. Moreover, as with
prepurchase counseling, revised
8Board of Governors of the Federal Reserve System and the Department of
Housing and Urban Development, Joint Report to the Congress Concerning
Reform to the Truth In Lending Act and the Real Estate Settlement
Procedures Act (Washington, D.C.: July 1998).
9See 67 Fed. Reg. 49134 (Jul. 29, 2002).
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The Usefulness of Consumer Education,
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Predatory Lending May Be Limited
disclosure requirements would not necessarily help protect consumers
against lenders and brokers that engage in outright fraud or that mislead
borrowers about the terms of a loan in the disclosure documents
themselves.
Chapter 6
Elderly Consumers May Be Targeted for Predatory Lending
Although little data is available on the incidence of predatory lending
among the elderly, government officials and consumer advocacy
organizations have reported consistent observational evidence that elderly
consumers have been disproportionately victimized by predatory lenders.1
Abusive lenders are likely to target older consumers for a number of
reasons, including the fact that older homeowners are more likely to have
substantial equity in their homes and may be more likely to have
diminished cognitive function or physical impairments that an unscrupulous
lender may try to exploit. Most educational material and legal activity
related to predatory lending targets the general population rather than
elderly borrowers in particular. Some federal agencies and nonprofit
organizations provide consumer education materials on predatory lending
that specifically target the elderly.
A Number of Factors Make Elderly Consumers Targets of Predatory Lenders
Nearly all federal, state, and consumer advocacy officials with whom we
spoke offered consistent observational and anecdotal information that
elderly consumers have disproportionately been victims of predatory
lending. Little hard data exist on the ages of victims of predatory
lending or on the proportion of victims who are elderly. Nonetheless,
several factors explain why unscrupulous lenders may target older
consumers and why some elderly homeowners may be more vulnerable to
abusive lenders, including higher home equity, a greater need for cash to
supplement limited incomes, and a greater likelihood of physical
impairments, diminished cognitive abilities, and social isolation.
On average, older homeowners have more equity in their homes than younger
homeowners, and abusive lenders could be expected to target consumers who
have substantial home equity. 2 By targeting these owners, unscrupulous
lenders are more easily able to "strip" the equity from a borrower's home
by including unjustified and excessive fees into the cost
1No clear agreement exists on the age at which someone is considered
"elderly." While we do not designate any specific age in this report with
reference to the terms "older" or "elderly," we are generally referring to
persons over the age of 65.
2For example, a study by the Board found that in 1997, some 55 percent of
the homeowners who had fully paid off their mortgage were 65 years of age
or older. See Glenn B. Canner, Thomas A. Durkin, and Charles A. Luckett,
"Recent Developments in Home Equity Lending," Federal Reserve Bulletin,
April 1998, 241-51. Borrowers may have substantial equity in their homes
but still not qualify for a prime loan because their capacity to repay the
loan is limited or their credit score is beneath a certain threshold.
Chapter 6
Elderly Consumers May Be Targeted for
Predatory Lending
of the home equity loan.3 Federal officials and consumer groups say that
abusive lenders often try to convince elderly borrowers to repeatedly
refinance their loans, adding more costs each time. "Flipping" loans in
this way can over time literally wipe out owners' equity in their homes.
In addition, some brokers and lenders aggressively market home equity
loans as a source of cash, particularly for older homeowners who have
limited cash flows and can use money from a home equity loan for major
home repairs or medical expenses. In the overall marketplace it is common,
and can be advantageous, to tap into one's home equity when refinancing.
However, unscrupulous brokers and lenders can take advantage of an elderly
person's need for cash to steer borrowers to loans with highly unfavorable
terms.
Further, diseases and physical impairments associated with aging can make
elderly borrowers more susceptible to abusive lending. For example,
declining vision, hearing, or mobility can restrict elderly consumers'
ability to access financial information and compare credit terms. In such
situations potential borrowers may be susceptible to the first lender to
offer what seems to be a good deal, especially if the lender is willing to
visit them at home or provide transportation to the closing. Physical
impairments like poor hearing and vision can also make it difficult for
older borrowers to fully understand loan documents and disclosures.
Similarly, while many older persons enjoy excellent mental and cognitive
capacity, others experience the diminished cognitive capacity and judgment
that sometimes occurs with advanced age. Age-related dementias or mental
impairments can limit the capacity of some older persons to comprehend and
make informed judgments on financial issues, according to an expert in
behavioral medicine at the National Institute on Aging. Furthermore, a
report sponsored by the National Academy of Sciences on the mistreatment
of elderly persons reported that they may be more likely to have
conditions or disabilities that make them easy targets for financial abuse
and they may have diminished capacity to evaluate proposed courses of
action. The report noted that these impairments can
3For example, a loan might be offered to a borrower who owns a home worth
$100,000 and owes $20,000 from a previous mortgage. An abusive lender
might refinance the loan for $25,000 (providing the borrower with a $5,000
"cashout") but then charge fees of $15,000, which are financed into the
loan. The borrower then would owe $40,000, but might not be aware of the
excessive fees that were charged because the monthly repayment schedule
had been spread over a much longer period of time.
Chapter 6
Elderly Consumers May Be Targeted for
Predatory Lending
make older persons more vulnerable to financial abuse and exploitation. 4
Representatives of legal aid organizations have said that they frequently
represent elderly clients in predatory lending cases involving lenders
that have taken advantage of a borrower's confusion and, in some cases,
dementia.
Finally, both the National Academy of Sciences report and representatives
of advocacy groups we spoke with noted that elderly people-particularly
those who live alone-may feel isolated and lonely, and may lack support
systems of family and friends who could provide them with advice and
assistance in obtaining credit. Such individuals may simply be more
willing to discuss an offer for a home equity loan made by someone who
telephones or knocks on their door, makes personal contact, or makes an
effort to gain their confidence. These personalized marketing techniques
are common among lenders and brokers that target vulnerable individuals
for loans with abusive terms.
Federal officials, legal aid services, and consumer groups have reported
that home repair scams targeting elderly homeowners are particularly
common. Elderly homeowners often live in older homes and are more likely
to need someone to do repairs for them. The HUD-Treasury report noted that
predatory brokers and home improvement contractors have collaborated to
swindle older consumers. A contractor may come to a homeowner's door,
pressure the homeowner into accepting a home improvement contract, and
arrange for financing of the work with a highcost loan. The contractor
then does shoddy work or does not finish the agreed-on repairs, leaving
the borrower to pay off the expensive loan.
The result of lending abuses, such as losing a home through foreclosure,
can be especially severe for the elderly. The National Academy of Sciences
report noted that losing financial assets accumulated over a lifetime can
be devastating to an elderly person, and that replacing them is generally
not viable for those who are retired or have physical or mental
disabilities. The financial losses older people can suffer as a result of
abusive loans can result in the loss of independence and security and a
significant decline in quality of life. Moreover, older victims of
financial exploitation may be
4Richard J. Bonnie and Robert B. Wallace, eds., "Elder Mistreatment:
Abuse, Neglect, and Exploitation in an Aging America," Panel to Review
Risk and Prevalence of Elder Abuse and Neglect, National Research Council
(Washington, D.C.: National Academies Press, 2003), 393.
Chapter 6
Elderly Consumers May Be Targeted for
Predatory Lending
more likely to become dependent on social welfare services because they
lack the funds to help compensate them for their financial losses.
Elderly consumers represent just one of several classes of people that
predatory lenders appear to target. The HUD-Treasury task force report
noted that many predatory lenders also specifically target minority
communities. Consumer advocacy and legal aid organizations have reported
that elderly African American women appear to be a particular target for
predatory lenders. This population may be targeted by predatory lenders at
least in part because of their relatively low literacy levels-the result
of historical inequalities in educational opportunities-which, as
discussed earlier, may increase vulnerability to abusive lending.5
Some Education and Because elderly people appear to be more susceptible to
predatory lending,
government agencies and consumer advocacy organizations have
focusedEnforcement Efforts some educational efforts and legal assistance
on this population. Several Focus on Elderly booklets, pamphlets, and
seminars are aimed at helping inform elderly Consumers borrowers about
predatory lending. In addition, while most legal activities
related to predatory lending practices are designed to assist the general
population of consumers, some have focused on elderly consumers in
particular.
Federal and Nonprofit Agencies Sponsor Some Financial Education Efforts
Targeted at Older Consumers
Consumer financial education efforts of government and nonprofit agencies
and industry associations generally seek to serve the general consumer
population rather than target specific subpopulations. However, some
federal and nonprofit agencies have made efforts to increase awareness
about predatory lending specifically among older consumers. For example:
o DOJ has published a guide entitled Financial Crimes Against the
Elderly, which includes references to predatory lending. In 2000, the
5For example, about 25 percent of elderly black Americans had graduated
from high school in 1992, compared with about 58 percent of elderly white
Americans, and about 57 percent of elderly black Americans were reported
to have had fewer than 9 years of formal education. See Robert Joseph
Taylor and Shirley A. Lockery, "Socio-Economic Status of Older Black
Americans: Education, Income, Poverty, Political Participation and
Religious Involvement," African American Research Perspectives 2 (1): 3-4.
Chapter 6
Elderly Consumers May Be Targeted for
Predatory Lending
agency cosponsored a symposium that addressed, among other topics,
financial exploitation of the elderly.
o OTS has produced an educational training video addressing financial
abuse of the elderly.
o The U.S. Department of Health and Human Services' Administration on
Aging provides grants to state and nonprofit agencies for programs aimed
at preventing elder abuse, including predatory or abusive lending
practices against older consumers. Supported activities include senior
legal aid programs, projects to improve financial literacy among older
consumers, and financial educational materials directed at senior
citizens.
o FTC publishes a number of consumer information products related to
predatory lending and home equity scams that discuss abusive practices
targeted at the elderly.
o AARP, which represents more than 35 million Americans age 50 and over,
offers a borrowers' kit containing consumer tips for avoiding predatory
lenders, supports a toll-free number to call for assistance regarding
lending issues, and distributes fact sheets on predatory lending. Some of
these materials are provided in Spanish and in formats accessible to the
hearing- and visually impaired. AARP also provides information on its Web
site that is designed to educate older Americans on predatory lending
issues. In addition, the organization has conducted focus groups of older
Americans to gather data on their borrowing and shopping habits in order
to better develop strategies for preventing older people from becoming the
victims of predatory lending.
o The National Consumer Law Center has developed a number of consumer
materials aimed in part at helping elderly consumers recover from abusive
loans, including a brochure titled Helping Elderly Homeowners Victimized
by Predatory Mortgage Loans.
Some Legal Assistance Is Federal consumer protection and fair lending laws
that have been used to Aimed Specifically at address predatory lending do
not generally have provisions specific to Helping Older Victims of elderly
persons. For example, age is not a protected class under the Fair
Housing Act, which prohibits discrimination in housing-relatedPredatory
Lending transactions. In addition, HMDA-which requires certain financial
Chapter 6
Elderly Consumers May Be Targeted for
Predatory Lending
institutions to collect, report, and disclose data on loan applications
and originations-does not require lenders to report information about the
age of the applicant or borrower. However, ECOA does specifically prohibit
unlawful discrimination on the basis of age in connection with any aspect
of a credit transaction. In the case against Long Beach Mortgage Company
noted earlier, the lender was accused of violating ECOA by charging
elderly borrowers, among other protected classes, higher loan rates than
it charged other similarly situated borrowers.
Federal and state enforcement actions and private class-action lawsuits
involving predatory lending generally seek to provide redress to large
groups of consumers. Little hard data exist on the age of consumers
involved in these actions, but a few cases have involved allegations of
predatory lending targeting elderly borrowers. For example, FTC, six
states, AARP, and private plaintiffs settled a case with First Alliance
Mortgage Company in March 2002 for more than $60 million. According to
AARP, an estimated 28 percent of the 8,712 borrowers represented in the
class-action suit were elderly. The company was accused of using
misrepresentation and unfair and deceptive practices to lure senior
citizens and those with poor credit histories into entering into abusive
loans. The company used a sophisticated campaign of telemarketing and
direct mail solicitations, as well as a lengthy sales presentation that
FTC said was designed to mislead consumers in general and elderly
consumers in particular about the terms of its loans.
Some nonprofit groups provide legal services focused on helping elderly
victims of predatory lending:
o The AARP Foundation Litigation, which conducts litigation to benefit
Americans 50 years and older, has been party to 7 lawsuits since 1998
involving allegations of predatory lending against more than 50,000
elderly borrowers. Six of these suits have been settled, and the other is
pending.
o The National Consumer Law Center has a "Seniors Initiative" that seeks
to improve the quality and accessibility of legal assistance with consumer
issues for vulnerable older Americans. One focus of the initiative is
preventing abusive lending and foreclosure. The center publishes a guide
for legal advocates to help them pursue predatory lending cases, and has
been involved in litigation related to cases of predatory lending against
senior citizens.
Chapter 6
Elderly Consumers May Be Targeted for
Predatory Lending
o Some local legal aid organizations that help victims of predatory
lending have traditionally served older clients. For example, the majority
of clients assisted by South Brooklyn Legal Services' Foreclosure
Prevention Project are senior citizens.
The limited number of education and enforcement efforts related to
predatory lending that specifically target older consumers-as opposed to
the general population-is not necessarily problematic. Given limited
resources, the most efficient and effective way to reach various
subpopulations, including the elderly, is often through general education
and information campaigns that reach broad audiences. Similarly,
enforcement actions and private lawsuits that seek to curb the activities
of the worst predatory lenders in general are likely to aid the elderly
borrowers that these lenders may be targeting.
Appendix I
FTC Enforcement Actions Related to Predatory Lending
Primary Date of Federal laws Alleged unfair or deceptive
defendant settlementa cited practices
FTC Act, Using
Capital City (litigation TILA, ECOA, deception/misrepresentation to
Mortgage ongoing) Fair manipulate
Debt borrowers into loans, ECOA
Corporationb Collection recordkeeping and
Practices
Act notice violations, unfair and
deceptive loan
servicing violations
OSI Financial Using
Services, November 2003 FTC Act deception/misrepresentation to
charge
Inc., and Mark excessive loan fees
Diamondc
Using
First Alliance March 2002 FTC Act, deception/misrepresentation to
Mortgage TILA charge
Companyd excessive loan fees
Associates First September FTC Act, Using deception/misrepresentation to
Capital 2002 TILA, manipulate
ECOA,
Corporation, FCRA borrowers into loans, packing
Associates undisclosed
Corporation of products (insurance) into loans,
North unfair debt
America, Citigroup collection
Inc., and
CitiFinancial
Credit
Company
Mercantile July 2002 FTC Act, Using deception/misrepresentation
Mortgage TILA, HOEPA, to manipulate
Company, Inc.e RESPA, Credit borrowers into loans, illegal
Practices kickbacks, HOEPA
Rule disclosure violations, taking
unlawful security
interests
Action Loan August FTC Act, Packing undisclosed products
Company, Inc.f 2000 TILA, RESPA, (insurance) into
Credit loans, kickbacks for the referral
Practices of loans, ECOA
Rule,
ECOA, FCRA violation for failing to meet
requirements upon
adverse actions, taking unlawful
security interest
FirstPlus
Financial August Using deception/misrepresentation
Group, 2000 FTC Act, TILA to manipulate
Inc. borrowers into home equity loans,
TILA
disclosure violations
FTC Act, HOEPA disclosure violations,
Nu West, Inc. July 2000 TILA, HOEPA right of rescission
violations
Delta Funding March 2000 HOEPA, RESPA, Pattern or practice of
Corporation ECOA, asset-based lending and
and Delta Financial Fair Housing other HOEPA violations,
Act paying kickbacks and
Corporationg unearned fees to brokers,
intentionally charging
African American females
higher loan prices than
similarly situated white
males
Fleet Finance, Inc. Failure to provide, or
and October 1999 FTC Act, TILA provide accurately, (1)
timely
Home Equity USA, disclosures of the costs
Inc. and terms of home equity
loans and/or (2)
information to consumers
about
their rights to cancel
their credit transactions
Barry Cooper FTC Act, Pattern or practice of
Properties July 1999 HOEPA asset-based lending and
other HOEPA violations
HOEPA disclosure
FTC Act, violations, right of
Capitol Mortgage July 1999 TILA, HOEPA rescission
Corporation violations
CLS Financial FTC Act, Pattern or practice of
Services, July 1999 HOEPA asset-based lending and
Inc. other HOEPA violations
Granite Mortgage, FTC Act, Pattern or practice of
LLC and July 1999 TILA, HOEPA asset-based lending and
others other HOEPA violations
Appendix I
FTC Enforcement Actions Related to
Predatory Lending
(Continued From Previous Page)
Primary defendant Federal laws Alleged unfair or deceptive practices
Date of settlementa cited
Interstate Resource FTC Act, HOEPA disclosure violations
July 1999 HOEPA
Corporation
LAP Financial FTC Act, Pattern or practice of asset-based
Services, July 1999 TILA, HOEPA lending and
Inc. other HOEPA violations, right of
rescission
violations
Wasatch Credit FTC Act, Pattern or practice of asset-based
Corporation July 1999 TILA, HOEPA lending and
other HOEPA violations, right of
rescission
violations
R.A. Walker and FTC Act Using deception/misrepresentation to
Associates July 1991 convince
borrowers to transfer title to
defendant
Nationwide Mortgage Using deception/misrepresentation to
May 1988 FTC Act, TILA manipulate
Corporation borrowers into unaffordable loans with
balloon
payments
Source: FTC.
Note: In addition to the cases listed, FTC has also recently addressed
abuses in the mortgage loan servicing industry. In November 2003, it
announced settlements with Fairbanks Capital Holding Corp., its wholly
owned subsidiary Fairbanks Capital Corp., and their founder and former CEO
(collectively, Fairbanks) on charges that Fairbanks violated the FTC Act,
RESPA, and other laws by failing to post consumers' mortgage payments in a
timely manner and charging consumers illegal late fees and other
unauthorized fees. The settlement will provide for $40 million in redress
to consumers. The case was jointly filed with HUD. United States of
America v. Fairbanks Capital Corp. et al., Civ. Action No. 0312219-DPW (D.
Mass.)(filed 11/12/03).
aIn some cases, the date of settlement listed is the date of the press
release announcing the settlement.
bDOJ filed an amicus curiae brief in a private suit alleging
discrimination in violation of the ECOA and Fair Housing Act, which was
joined with the FTC case, but settled separately.
cThe state of Illinois was also a plaintiff in this case.
dThe states of Arizona, California, Massachusetts, Florida, New York,
Illinois, AARP, and private attorneys were also plaintiffs in this case.
eHUD and the state of Illinois were also plaintiffs in this case.
Violations of Illinois state law were also claimed.
fHUD was also a plaintiff in this case, and DOJ formally filed the
complaint on behalf of FTC and HUD.
gDOJ and HUD were also plaintiffs in this case.
Appendix II
Comments from the Board of Governors of the Federal Reserve System
Appendix II
Comments from the Board of Governors of
the Federal Reserve System
Appendix II
Comments from the Board of Governors of
the Federal Reserve System
Appendix III
Comments from the Department of Justice
Appendix III
Comments from the Department of Justice
Appendix III
Comments from the Department of Justice
Appendix IV
Comments from the Department of Housing and Urban Development
Appendix IV
Comments from the Department of Housing
and Urban Development
Appendix IV
Comments from the Department of Housing
and Urban Development
Appendix IV
Comments from the Department of Housing
and Urban Development
Appendix V
Comments from the National Credit Union Administration
Appendix V
Comments from the National Credit Union
Administration
Appendix VI
GAO Contacts and Staff Acknowledgments
GAO Contacts David G. Wood, (202) 512-8678 Harry Medina, (415) 904-2000
Staff Acknowledgments
(250118)
Jason Bromberg
Emily R. Chalmers
Randall C. Fasnacht, Jr.
Rachelle C. Hunt
Alison J. Martin
Marc W. Molino
Elizabeth Olivarez
Carrie Puglisi
Mitchell B. Rachlis
Peter Rumble
Paul Thompson
James D. Vitarello
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