States Respond to Predatory Lending

By Gregg D. Killoren, J.D., State Banking Law Reporter and Individual Retirement Plans Guide. 

At year end 2007, 36 states had enacted some form of legislation to outlaw predatory lending practices.  Most recently, an Illinois law established a predatory lending database program, requiring, in part, that mortgage brokers provide information with regard to every loan application they take on property within the program area. Based on the information provided, certain borrowers will be required to receive credit counseling as part of the loan approval process.

Though the term “predatory lending” is widely used to describe unscrupulous practices in consumer lending, it escapes easy definition.  The types of lending practices that may be considered to be “predatory” are as varied as the measures enacted by states to combat the problem.  However, the range of practices may be condensed to four general categories:

1. Loans that result in unreasonable net harm to borrowers (for example, lending to borrowers who cannot reasonably afford the payments, steering borrowers to higher rate, higher cost mortgage loans for increased yield spread premium, and equity stripping);
2. Loans involving fraud or deceptive practices;
3. Other forms of lack of transparency in loans that are not actionable as fraud (for example, structuring costs to avoid their inclusion in the annual percentage rate calculation); and
4. Loans that require borrowers to waive legal remedies.

Predatory loans are most prevalent in the subprime mortgage lending market. However, predatory and subprime loans are not synonymous. Subprime loans are those made to borrowers whose credit has been impaired or who otherwise do not qualify for a conventional prime loan. In fact, subprime lending has been credited with opening avenues to homeownership for certain borrowers who had previously been shut out of the market. The presence of one or more of the above-listed practices is the difference between a predatory loan and a subprime loan. Thus, while many of the prohibitions and remedies enacted by states with regard to predatory lending target subprime loans, it is important to be mindful of the difference between the two. Moreover, predatory loans are not confined to the subprime market. A prime or conventional loan may also be predatory if one or more of the above-listed practices is present.

Because the targeted practices are not specific to any type of loan, predatory lending laws may apply to any form of consumer lending, such as car title, payday and refund anticipation loans. Predatory lending concerns have also arisen in connection with concerns over abusive practices involving high-cost loans. High-cost loans are defined in terms of threshold levels for interest rates, points and fees. Like subprime loans, high-cost loans are not necessarily predatory. However, a number of states have laws and that, once triggered, prohibit or restrict credit terms that are common to high-cost loans. Key protections that are triggered for these loans include restrictions on the financing of points and fees, limitations on the payment of prepayment penalties and a strict prohibition on the use of balloon payments.