Effects of Predatory Lending Laws on High-Cost Mortgage Applications Vary by State: St. Louis Fed Analysis


ST. LOUIS — Predatory lending laws designed to help potential homebuyers from being taken advantage of may help stimulate demand and lead to an expansion in the high-cost segment of the mortgage market in some states, but they may have the opposite effect in others.

That analysis comes from researcher Giang Ho and economist Anthony Pennington-Cross, who looked at the effects of predatory lending laws on high-cost mortgage applications for the January/February issue of The Review, the Federal Reserve Bank of St. Louis' bimonthly publication of economic and business issues. The publication is also available online at the St. Louis Fed's web site.

As any homeowner or prospective homebuyer will attest, buying a home is one of the most important, complex and frequently frustrating financial transactions that many Americans will ever make.

"Even highly educated professionals have trouble understanding all the obligations and warranties included in buying a home with a mortgage," said Ho and Pennington-Cross. "As a result, most people rely on real estate agents and others to help them understand their obligations and what will happen if they don't meet them, as well as the rights of the lending institution."

They also noted that "the current mixture of traditional and non-traditional mortgages, a lack of full or easily understood documents, and buyers with limited education has led to some abuses of homebuyers and homeowners."

As a result of these deficiencies, many cities, states and even counties have passed laws to protect consumers. Ho and Pennington-Cross analyzed the effects of these laws across the United States to see what the overall impact has been to date. They outlined lending abuses or predatory practices in four groups, as defined by the U.S. Department of Housing and Urban Development (HUD) and the U.S. Treasury:

  • loan "flipping": loans repeatedly refinanced in a short period of time. With each refinance, high fees are incorporated into the new loan amount, reducing the homeowner's equity in the home.
  • imposition of excessive fees;
  • lending without regard to the ability to repay; and
  • fraud, including appraisers and brokers conspiring to inflate prices or property values above the market price.

Ho and Pennington-Cross found that empirical evidence supports the idea that predatory lending laws can help enhance demand and stimulate mortgages in the high-end segment of the market. At the same time, however, they found that some laws can reduce it, depending on how the law is structured. For example, predatory lending laws passed in California and Pennsylvania were associated with an increase in high-cost mortgage applications and originations, while laws in Georgia, Massachusetts and North Carolina were linked with a reduction in those categories. They theorized that in some cases the increase in loan applications could be attributed to a predatory lending law reducing potential homebuyers' fears of being taken advantage of.

With such wide variance in the impact of predatory lending laws on the market, Ho and Pennington-Cross concluded that their analysis indicates that "policymakers and legislators may want to pursue further research to focus on the particular factors that could make predatory lending laws perform as intended."

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, and provides payment services to financial institutions and the U.S. government.

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