Debate Brews Over Pre-Empting State Laws on Subprime Lending

Surprised and frustrated by the success of consumer groups in lobbying for state predatory-lending laws, the business community is turning to Congress, seeking a federal law that would override state standards. Both Democrats and Republicans are bracing for a debate over a national law sometime next year.

"There is a detriment to consumers by not having a national standard. ... In some states, the protections that have been implemented are so stringent that they are driving business out of the market," says Rep. Paul Kanjorski, D-Pa., working with Rep. Robert Ney, R-Ohio, on a bill.

While Kanjorski is working with Republicans, other House Democrats are coalescing around a separate bill based on North Carolina's predatory-lending law. They worry that Republicans, who often champion states' rights, will weaken state laws to help business.

Some state officials point to a surge in subprime lending as evidence the industry is thriving under current state regulation.

"There have been these Chicken Little pronouncements about the end of funding for New Mexico mortgages," says Attorney General Patricia Madrid about her state's 2004 predatory-lending law. "It's proven to be just that, Chicken Little. The last I looked, our beautiful New Mexico sky is still here."

Under a 1994 federal law, first mortgage loans with interest more than 8 percentage points above Treasury bond rates or containing points and fees that exceed 8% of the loan amount are subject to additional safeguards. Lenders avoid such loans.

North Carolina is probably the state that has been most scrutinized. Its 1999 law bars financing credit insurance as part of a mortgage and prohibits loan flipping, a practice in which loans are repeatedly refinanced with high fees and other charges that strip out equity but provide no real benefit to the borrower. The law prevents prepayment penalties on certain loans.

A 2004 study by the University of North Carolina showed that the number of loans carrying penalties if they were repaid within the first three years dropped 72% after the state predatory-lending law took effect, while rising in nearby states. Subprime home purchase loans increased 43%, and other loans to those with poor credit rose 31%.

A separate 2004 study for the Mortgage Bankers Association found some erosion in lending to minority neighborhoods in North Carolina, compared with an increase in nearby states. Lending by independent subprime firms dropped 41.5%, but lending by subsidiaries of bank- or thrift-owned companies was up 110.5%, suggesting the increase came mainly from national banks exempt from state law.

Lenders pulled back in some states, such as Georgia, after they passed predatory-lending laws that the industry called too restrictive. Georgia rewrote its law.

Lenders are concerned about state laws that impose liability on individuals or institutions for dealing in mortgage-backed bonds that are found to contain predatory loans — even if the bond holders or underwriters were not engaged in predatory lending. Standard & Poor's, which rates the quality of bonds, has refused to rate mortgages from some states with tough laws.

The Office of the Comptroller of the Currency, which oversees national banks, exempted them from state laws in recent rules opposed by state governors and attorneys general. The OCC, which created its own predatory-lending rules, has a staff of about 40 in its Houston office to police consumer complaints. OCC officials say concerns are overblown, pointing to its large staff of examiners. It sees little evidence of predatory loans in its banks.