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February 28, 2006
State Laws Effectively Curb Predatory Lending Without Stifling Subprime Market, Study Finds
    by Bill Baue

The Center for Responsible Lending study rebuts opponents of state anti-predatory lending laws, and suggests significant implications for the two competing anti-predatory bills now in Congress.

Low-income home-shoppers are vulnerable to (and hence very reliant on laws protecting them from) "predatory lending," which includes exorbitant fees or subprime prepayment penalties as well as steering borrowers to higher priced loans when they could qualify for better terms.
A new study from the Center for Responsible Lending (CRL), a nonprofit, nonpartisan research organization affiliated with the Self-Help community development financial institution (CDFI), is the first to examine in-depth the effectiveness of state-level anti-predatory lending laws.

"For years, the debate over predatory lending has been conducted in an information vacuum," said Keith Ernst, senior policy counsel at CRL, who supervised the study, entitled The Best Value in the Subprime Market: State Predatory Lending Reforms. "Now we know, beyond a doubt, that these laws work, and that they don't harm consumers."

The study, which examines more than 6 million subprime mortgages in 28 states with various reforms against predatory lending from 1998 through 2004, finds predatory lending in many of these states dropped by almost a third.

"States with the strongest laws--Massachusetts, New Jersey, New Mexico, New York, North Carolina, and West Virginia--showed the largest declines in loans with predatory terms," states the report.

The study also reveals unexpected findings.

"A central goal of predatory lending reform has been to shift lender compensation away from fees--both front-end charges and back-end prepayment penalties--into more transparent interest rates, since a borrower can refinance out of a high rate loan but cannot escape from high fees," write Wei Li and Keith Ernst in the report they authored "With this in mind, we expected to find a combination of fee reductions accompanied by offsetting marginal interest rate increases."

"We did find that fees in the form of prepayment penalties were reduced, but, to our surprise, we also found that many families paid lower interest rates," they continued. "Among states with reforms, interest rates on fixed-rate mortgages showed no statistically significant difference in eight states and actually were lower in 19."

These findings offer a strong rebuttal to industry nay-sayers who claim that these laws stifle the subprime market where low-income borrowers, who are often strapped with credit problems, must operate.

"This study demonstrates that critics who claim anti-predatory lending laws will dry up people's access to credit are just plain wrong," said Tom Miller, Attorney General of Iowa, a state with strong anti-predatory lending laws. "This research shows that sound legislation curbs abusive lending, and it does not reduce responsible lending . . . [and] that leads to one more conclusion: consumers would be harmed if federal law preempted state regulation."

Mr. Miller refers to two competing bills currently making their way through Congress. HR 1182, or the Miller-Watt-Frank bill, seeks to strengthen existing federal legislation while allowing states to extend further protections, while HR 1295, or the Ney-Kanjorski bill, which would erase state laws without strengthening federal laws. Needless to say, CRL supports the Miller-Watt-Frank bill and opposes the Ney-Kanjorski bill.

While the study focuses on the state level, it extrapolates its findings to the national level

"[T]here are strong indications that state reforms are having a positive effect on the national subprime market," the report states. "For example, over the course of our study, the overall incidence of prepayment penalties peaked at 67.7 percent and then dropped to 51 percent by December 2004."

"For balloon payments, the corresponding figures went from 13.6 percent to zero," it continues.

The study concludes by advancing two significant implications for state and federal policymakers confronted with choices on how best to address predatory lending.

"First, the findings suggest that strong state laws like those in place in New Mexico, Massachusetts and North Carolina can serve as successful models," the report states. "Second, the findings call into question the advisability of federal proposals that would nullify state efforts and substitute a weak national standard."

"In fact, this study shows that overriding state laws would be harmful--and costly--to consumers, since states are successfully cutting back on predatory loans without cutting off access to credit," the report continued. "From a homeowner's perspective, it appears that mortgages protected by strong state laws may be the best deal in the real estate market."


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