Consumer Protection: Federal and State Agencies Face Challenges in Combating Predatory Lending
Published: 2004-01-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: 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) 512- 8678 if you or your staff have any questions about this report.  Major  contributors to this report are listed in appendix VI.
subsections: section_title: Introduction
paragraphs: 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.  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.
subsections: section_title: The Nature and Attributes of Predatory Lending
paragraphs: 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:  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.
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 risk- based 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.
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  amount of the loan unnecessarily raises the amount of interest  borrowers pay, single-premium credit insurance is generally considered  inherently abusive.
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.
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.
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.
Prepayment penalties.  Penalties for prepaying a loan are not  necessarily abusive, but predatory lenders may use them to trap  borrowers in high-cost loans.
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.
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.  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.
section_title: Emergence of Subprime Mortgage Market
paragraphs: 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.  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  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.
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.”  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.
section_title: The Extent of Predatory Lending Is Unknown
paragraphs: 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.  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:  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.
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  Associates) engaged in systematic and widespread deceptive and  abusive lending practices.  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.
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. 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.
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  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.
Federal officials and consumer advocates maintain that predatory lenders  often target certain populations, including the elderly and some low- income 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.
section_title: Emergence of Predatory Lending As Policy Issue
paragraphs: The federal government began addressing predatory home mortgage  lending as a significant policy issue in the early 1990s. In 1994, the Congress  passed the Home Ownership and Equity Protection Act (HOEPA), an  amendment to the Truth in Lending Act that set certain restrictions on  “high-cost” loans in order to protect consumers. In 1998, as part of an  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.  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, 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.
section_title: Objectives, Scope, and Methodology
paragraphs: 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.
HUD-Treasury Task Force on Predatory Lending, Curbing Predatory Home Mortgage  Lending: A Joint Report, June 2000.
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.
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  with generally accepted government auditing standards in Atlanta, Boston,  New York, San Francisco, and Washington, D.C.
section_title: Federal Agencies Have Taken Steps to Address Predatory Lending, but Face Challenges
paragraphs: 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.  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.
subsections: section_title: Federal Agencies Use a Variety of Laws to Address Predatory Lending Practices
paragraphs: 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.  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.
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.
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.  HOEPA covers only a limited portion of all  subprime loans, although there is no comprehensive data on precisely what  that portion is.  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.   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  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.
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.  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.
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.
The following other federal laws have been used to a lesser extent to  address abusive lending:  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.
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.
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.
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.
Finally, FTC and the banking regulators can also use the Fair Debt  Collection Practices Act and Fair Credit Reporting Act in enforcement  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.   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.
section_title: Federal Agencies Have Taken Some Enforcement Actions, but Banking Regulators Have Focused on Guidance and Regulatory Changes
paragraphs: FTC, DOJ, and HUD have taken enforcement actions to address violations  related to abusive lending.  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.  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.
subsections: section_title: FTC Has Played the Predominant Federal Role in Enforcement Actions Related to Predatory Lending
paragraphs: 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.  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:  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.
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  million in consumer redress and to refrain from making  misrepresentations about future offers of credit.
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.
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.
section_title: DOJ Has Enforced Fair Lending Laws in Connection with Predatory Lending
paragraphs: 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.
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.  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.
Long Beach Mortgage. In 1996 DOJ settled a complaint alleging  violations of the Fair Housing Act and ECOA against Long Beach  Mortgage Company.  According to the complaint, the company’s loan  officers and brokers charged African American, Hispanic, female, and  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.
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.
section_title: HUD’s Enforcement Activities Focus on FHA Loans
paragraphs: 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.  The fraudulent  activities sometimes involve property flipping schemes, which can harm  borrowers by leaving them with mortgage loans that may far exceed the value of their homes.  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.
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.   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.   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.
section_title: Federal Banking Regulators Have Issued Guidance and Made Regulatory Changes
paragraphs: 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.
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.  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.  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.”
subsections: section_title: Guidance
paragraphs: 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 engaging in predatory lending through brokered or purchased loans.  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.
In 1999 and 2001, the Board, FDIC, OCC, and OTS issued joint guidance to  their institutions on subprime lending in general.  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.  Federal banking regulators have also previously issued guidance about abusive lending  practices, unfair or deceptive acts or practices, and other issues related to  predatory lending.
section_title: Regulatory Changes
paragraphs: 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    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, require that fees paid for credit insurance and similar debt protection  products be included when determining whether loans are subject to  HOEPA,  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  clarify the prohibition against engaging in a “pattern or practice” of  lending without regard to borrowers’ ability to repay.
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  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;   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  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.
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.  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.  Under the McCarran  Ferguson Act, 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 single- premium 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  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.
section_title: Agencies Have Coordinated on Enforcement Actions and Participated in Interagency Groups
paragraphs: 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  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.  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.
The five banking regulators have conducted additional coordination  activities through the Federal Financial Institutions Examination  Council’s Task Force on Consumer Compliance.  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.
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.   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  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.
section_title: Jurisdictional Issues Related to Nonbank Subsidiaries Challenge Efforts to Combat Predatory Lending
paragraphs: 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.  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.
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.  Some representatives of state  banking regulators expressed concerns to us about this because of the  subsidiaries’ potential involvement in predatory lending practices.  OCC  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.  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.  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.  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  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.
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  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. 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.
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.
section_title: Conclusions
paragraphs: 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  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.
section_title: Matters for Congressional Consideration
paragraphs: 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.
section_title: Agency Comments and Our Evaluation
paragraphs: 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  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  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.
section_title: States Have Enacted and Enforced Laws to Address Predatory Lending, but Some Laws Have Been Preempted
paragraphs: 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. 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.
subsections: section_title: States and Localities Have Addressed Predatory Lending through Legislation, Regulation, and Enforcement Actions
paragraphs: 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.
subsections: section_title: A Growing Number of States and Localities Have Passed Laws to Address Abusive Lending
paragraphs: According to the database of state laws, as of January 9, 2004, 25 states and  the District of Columbia had passed laws that were specifically designed to  address abusive lending practices. (See fig. 3.) These laws were motivated,  at least in part, by growing evidence of abusive lending and by concerns  that existing laws were not sufficient to protect consumers against abusive  lending practices.
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.  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.  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.  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.  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.  Michigan’s law  prohibits the financing of single-premium credit insurance into loans.
According to the database, common provisions in state laws are designed  to address the following:  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.
Prepayment penalties.  Limitations on the amount of a prepayment  penalty, terms under which a penalty can be assessed, or both.
Balloon payments. Prohibitions on loans with balloon payments or  restrictions on their timing.
Negative amortization.  Prohibitions on loans where regularly  scheduled payments do not cover the interest due.
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.
Credit counseling.  Requirements that borrowers either receive or are  notified of the availability of loan counseling.
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.
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.  Some local laws are similar to state laws in that they define high- cost 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.
section_title: Some States Have Increased the Regulation of Lenders and Brokers and Undertaken Enforcement Activities to Combat Predatory Lending
paragraphs: 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  District of Columbia.  State agencies have also conducted investigations in  conjunction with the federal government.
section_title: Activities in North Carolina and Ohio Illustrate State Approaches to Predatory Lending
paragraphs: States have varied in their approaches to addressing predatory lending  issues.  We reviewed legislative and enforcement activities related to  predatory lending in two states, North Carolina and Ohio, to illustrate two  different approaches.
subsections: section_title: Impact of North Carolina’s Laws on High-Cost Loans and Licensing of Brokers and Originators Remains Uncertain
paragraphs: 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.  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.
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” loans and other “consumer home loans.”  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.
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. 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.  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  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.
section_title: Ohio Has Preempted Local Laws and Taken Action to Regulate Mortgage Brokers
paragraphs: In February 2002, the Ohio legislature enacted a law with the purpose of  bringing Ohio law into conformance with HOEPA.  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.  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.  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  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.  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.  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.
section_title: Regulators Have Determined That Federal Law Preempts Some State Predatory Lending Laws, but Views on Preemption Differ
paragraphs: 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.
subsections: section_title: OCC, OTS, and NCUA Have Determined That Federal Law Preempts Some State Predatory Lending Laws
paragraphs: 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.  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  states—Georgia, New Jersey, New Mexico, New York, and North Carolina.  (See table 1.)
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.  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.  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  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.
section_title: Views Differ on the Implications of Federal Preemption of State Predatory Lending Laws
paragraphs: 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.  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.  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  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.
section_title: The Secondary Market May Play a Role in Both Facilitating and Combating Predatory Lending
paragraphs: 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.
subsections: section_title: The Development of a Secondary Market for Subprime Loans Can Benefit Consumers
paragraphs: 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.
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  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.
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  about 14 percent of the subprime loans originated in 2002.  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.  HUD recommended that the GSEs consider enhancing their  roles in the subprime market—which often serves low- and moderate- income 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.
section_title: The Secondary Market for Subprime Loans Can Facilitate Predatory Lending
paragraphs: 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 up- front 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.  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.
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.
section_title: Due Diligence Can Help Purchasers Avoid Predatory Loans, but Efforts Vary among Secondary Market Participants
paragraphs: 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.
subsections: section_title: Due Diligence May Deter the Purchase of Some Predatory Loans but Has Limitations
paragraphs: 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  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:  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.
The data tapes used for loan reviews do not include point and fee  information.  Thus, securitizers typically cannot detect excessive or  unwarranted fees prior to purchasing a loan without a loan-level review.
Loan flipping (repeated refinancings) can be difficult to detect because  loan files do not necessarily include information on previous  refinancings.
section_title: Fannie Mae and Freddie Mac Appear to Perform Extensive Due Diligence to Avoid Buying Loans with Abusive Terms
paragraphs: 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  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.  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  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.
section_title: Other Purchasers Vary in the Extent of Their Due Diligence
paragraphs: 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.  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.
section_title: Assignee Liability May Help Deter Predatory Lending but Can Also Have Negative Unintended Consequences
paragraphs: 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.
subsections: section_title: Several States Hold Secondary Purchasers Liable for Predatory Lending Violations
paragraphs: 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  to claims regarding monies owed on a loan) or can also be assessed for  damages directly, including punitive damages.  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 high- cost 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. 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.
section_title: Assignee Liability May Help Combat Predatory Lending but May Also Hinder Legitimate Lending
paragraphs: 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.
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:  Ambiguous language.  Credit rating agencies and other secondary  market players seek clear and objective descriptions of the loans  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.  Secondary market  participants noted that without objective criteria, there is no way to  ensure that an originator has complied adequately with the law.
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.
section_title: Georgia’s Statute Illustrates Possible Effects of Assignee Liability Provisions
paragraphs: 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.  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.
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 “high-  cost” 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  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.
section_title: The Usefulness of Consumer Education, Counseling, and Disclosures in Deterring Predatory Lending May Be Limited
paragraphs: 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.
subsections: section_title: Many Consumer Education and Mortgage Counseling Efforts Exist, but Several Factors Limit Their Potential to Deter Predatory Lending
paragraphs: 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.
subsections: section_title: Some Federal Agencies Have Initiatives to Promote Awareness of Predatory Lending
paragraphs: 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.   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.  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:  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.
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.
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.
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.
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.
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.
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 low- income 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  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.
section_title: State Agencies, Nonprofits, and Industry Organizations Have Also Initiated Consumer Education Efforts
paragraphs: 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.
Some industry trade organizations and companies also have consumer  education initiatives related to predatory lending:    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.
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 at- risk 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.
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.
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.
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.
The American Financial Services Association’s Education Foundation  develops educational materials designed to improve consumers’ use of  credit and overall financial literacy.
section_title: Mortgage Counseling Can Warn Borrowers of Predatory Lending and Can Offer a “Third Party” Review of Proposed Mortgage Loans
paragraphs: 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.  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.
section_title: A Variety of Factors May Limit the Effectiveness of Consumer Education and Mortgage Counseling in Deterring Predatory Lending
paragraphs: 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.  However, none of the studies measured the  effectiveness of consumer information campaigns specifically on deterring  predatory lending practices.
subsections: section_title: Limitations of Consumer Education
paragraphs: 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:   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.
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.
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  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.
section_title: Limitations of Mortgage Counseling
paragraphs: Consumer education campaigns have encouraged borrowers to seek  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.  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  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.  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 HUD- insured reverse mortgages were originated in fiscal year 2003.
section_title: Disclosures, Even If Improved, May Be of Limited Use in Deterring Predatory Lending
paragraphs: 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  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.
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  firmer and more usable, facilitate  shopping for mortgages, make mortgage transactions more transparent,  and prevent unexpected charges to consumers at settlement.”  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  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.
section_title: Elderly Consumers May Be Targeted for Predatory Lending
paragraphs: 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.   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.
subsections: section_title: A Number of Factors Make Elderly Consumers Targets of Predatory Lenders
paragraphs: 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.  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  of the home equity loan.  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  make older persons more vulnerable to financial abuse and exploitation.   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 high- cost 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  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.
section_title: Some Education and Enforcement Efforts Focus on Elderly Consumers
paragraphs: Because elderly people appear to be more susceptible to predatory lending,  government agencies and consumer advocacy organizations have focused  some educational efforts and legal assistance on this population.  Several  booklets, pamphlets, and seminars are aimed at helping inform elderly  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.
subsections: section_title: Federal and Nonprofit Agencies Sponsor Some Financial Education Efforts Targeted at Older Consumers
paragraphs: 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:  DOJ has published a guide entitled Financial Crimes Against the  Elderly, which includes references to predatory lending.  In 2000, the  agency cosponsored a symposium that addressed, among other topics,  financial exploitation of the elderly.
OTS has produced an educational training video addressing financial  abuse of the elderly.
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.
FTC publishes a number of consumer information products related to  predatory lending and home equity scams that discuss abusive practices  targeted at the elderly.
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.
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.
section_title: Some Legal Assistance Is Aimed Specifically at Helping Older Victims of Predatory Lending
paragraphs: Federal consumer protection and fair lending laws that have been used to  address predatory lending do not generally have provisions specific to  elderly persons.  For example, age is not a protected class under the Fair  Housing Act, which prohibits discrimination in housing-related  transactions.  In addition, HMDA—which requires certain financial  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:  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.
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.
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.