Ebook Illinois’ New Approach to Regulating Predatory Lending: Unintended Consequences of Borrower Triggers and Spatial Targeting
Predatory lenders use misinformation, fraud and racial targeting to trap vulnerable homeowners into unaffordable debt. Predatory loans may be characterized by negative amortization, unexpected balloon payments, flipping and excessive or duplicate fees.
Estimates of the costs of predatory lending exceed $9 billion in lost equity, and several studies indicate that predatory lending disproportionately affects minority families and older urban neighborhoods (Richardson, 2002; Bocian, Ernst and Li, 2006; Bradford, 2002; ACORN, 2000; Fishbein and Woodall, 2006b). Financial services experts identify predatory lending as one of the most salient issues facing the financial services industry today (Carr and Kolluri, 2001; Squires, 2005).
As the occurrence of predatory lending increased and negative impacts became apparent during the late 1990s, state legislatures responded accordingly. Since the passage of North Carolina’s anti-predatory lending law in 1999, nearly 30 states have followed suit, adding protections against high-costs loans, unnecessary fees, and pre-payment penalties. But legislation can be a blunt instrument, and regulating predatory lending requires a fine touch to avoid restricting the flow of legitimate subprime loans to higher-risk borrowers (Quercia, Stegman and Davis, 2004).
This paper considers the most recent legislation, Illinois HB 4050, which to a high level of lending fraud and foreclosure in Chicago. Passed in mid-2005, Illinois HB 4050 took effect on September 1, 2006, adding to other anti-predatory legislation in effect since 2004. The Residential Real Property Disclosure Act-Predatory Lending Database Pilot Program (hereafter referred to as HB 4050) is intended to curb high rates of predatory lending and foreclosures in ten Chicago zip codes. While almost all state laws are triggered by the terms of the loan, HB 4050 is triggered by borrower characteristics. Borrowers with low credit scores who are seeking loans for properties in the specified neighborhoods are required to undergo one-hour counseling sessions offered by counselors certified under the program.
Reaction to the legislation has been both immediate and extreme, particularly from lenders and industry groups affected by the legislation as well as residents of affected areas. Several lenders suspended lending in the targeted areas, citing concerns about liability. Sales in the area have dropped off substantially, causing some to question the long-term consequences for neighborhood demographic shifts. Although the reduction in sales volume may suggest that the law is effectively reducing the number of predatory loans being made, buyers and sellers are concerned about the availability of credit, as well as the impact on home values in these areas. Further, civil rights groups, community organizations and consumer advocates call the law racist, saying it disproportionately impacts African-Americans and Latinos (Umberger, 2006).
The newness of this approach, combined with the apparent severity of its impact, warrants further investigation into both the effects of implementing borrower-triggered mandatory counseling as an anti-predatory lending strategy as well as the unintended consequences of implementing it as a spatially-imited pilot program. This paper compares and contrasts key provisions of HB 4050 to other state anti-predatory lending laws; provides an early account of the concerns voiced by the mortgage industry, consumer groups and civil rights organizations; and offers a preliminary analysis of sales data to show that borrower-triggered interventions are having a dramatic negative effect on housing sales in neighborhoods that are predominantly minority with low to moderate incomes.
Additional analysis of lending patterns in Cook County suggests that while the targeted areas have exhibited unusual lending patterns, high foreclosure rates are by no means exclusive to the targeted zip codes. While further analysis is needed, the selection of these zip codes exacerbates the appearance of discriminatory intent and may lead to a disparate negative impact on minority and lower-income populations.
Although findings presented here are preliminary and suggestive, they may be instructive for policy makers trying to formulate effective regulatory approaches to address predatory lending. High foreclosure rates and concerns over predatory activities by lenders might have been addressed by correcting deficiencies in the scope of loans covered by Illinois’ pre-existing predatory lending laws rather than the introduction of borrower triggers and spatial targeting. Avenues for needed research are identified, including tracking sales patterns and changes in buyer demographics in the target zip codes in comparison to non-covered areas of Chicago.
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