The Impact of Local Predatory Laws on the Flow of Subprime Credit

An 84-year-old home owner in East St. Louis, Ill., faced foreclosure recently because an unscrupulous lender talked her into refinancing her mortgage at exorbitant interest rates. When she could not make the payments, it took a local legal assistance organization 400 hours to straighten out the mess.

In the last decade, as anecdotal evidence of predatory lending has grown, governments have responded by enacting laws to protect consumers. The laws exist at federal, state and local levels.

Anthony Pennington-Cross, an economist at the Federal Reserve Bank of St. Louis, has been studying the effect of the state and local laws on the number of loans made to borrowers in the subprime market. Typically, these laws have little impact on the flow of credit, he said.

On March 16, Pennington-Cross presented his study, "The Impact of Local Predatory Laws on the Flow of Subprime Credit: North Carolina and Beyond," at a meeting sponsored by the Federal Reserve Bank of St. Louis.

After the presentation, Diane Thompson and Keith Ernst participated in a panel discussion. Thompson is an attorney with the Land of Lincoln Legal Assistance Foundation in East St. Louis, and Ernst is senior policy counsel at the Center for Responsible Lending in Durham, N.C. Approximately 100 lenders, community leaders, academicians and others attended.

The study focuses on the subprime market, where most predatory loans are thought to exist. Pennington-Cross and coauthor Giang Ho compared mortgage market conditions in states that have anti-predatory lending laws to those in neighboring states without such laws.

They found that the laws typically extend the coverage of the federal Home Ownership and Equity Protection Act (HOEPA). Enacted by Congress in 1994, the act protects consumers entering into a specific class of high-cost home-equity loans. Starting in 1999 with North Carolina, 24 states and various local governments also enacted laws, which extend HOEPA’s coverage by including home purchase and open-end mortgage credit.

Although Pennington-Cross’s study shows minimal impact on the flow of credit in the subprime market, it found that rejections do decline by more than 10 percent for the typical law. This may be the result of less aggressive marketing and more prescreening by lenders and increased self-selection by borrowers, he said.

“Accounting for a relationship between laws and lending patterns is really important,” Ernst said. His Center for Responsible Lending has also conducted studies that show the laws do not have a strong impact on the number of loans made.

Thompson said her office currently represents more than 100 home owners facing foreclosure—all of whom have subprime loans. She says lawmakers must enact laws that reduce these kinds of predatory loans. However, they need to ensure that credit is still available for low-income people who need to make house repairs.

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