While Washington continues to debate how to rein in the risky lending practices that fueled the foreclosure crisis, states are taking action. Earlier this week the North Carolina General Assembly became the first in the nation to ban "yield-spread premiums"—kickbacks that encourage brokers to overcharge—on subprime mortgages. These kickbacks, which brokers received for delivering subprime loans with higher interest rates than the lender had set, are one of the main reasons that subprime borrowers have typically paid thousands of dollars in unnecessary costs on brokered loans.
"Consumers can't afford to wait on Washington for help, so states like North Carolina are taking action now," said North Carolina Attorney General Roy Cooper. "We're putting strong new laws in place to fight the abusive lending practices that have cost so many families their homes."
If enacted (the Governor is expected to sign the bill), North Carolina will join about a dozen other states that have passed significant new lending protections since the start of the foreclosure crisis. New state protections are particularly significant as the Federal Reserve Board prepares to issue new rules this Monday.
Michael Calhoun, president of CRL, noted that the Federal Reserve Board has an important opportunity to make up for years of weak regulation and inaction on the federal level. "The states will always be in the best position to act more quickly to help homeowners in their own backyards," said Calhoun. "But we hope the forthcoming Federal rules will match protections that are already available in many states and help restore lasting stability in the housing market."
The FRB is considering many of the same problematic lending practices that a number of states have already addressed, including:
Prepayment penalties that trap homeowners in bad loans and make foreclosure more likely. CRL research has found that prepayment penalties and foreclosure go together, since penalties raise the risk of foreclosure from 19% to 70%. Recently Connecticut and New York acted to ban prepayment penalties on subprime loans, and since 2006, at least eight other states have already taken action to ban or restrict penalties. In April, Maryland joined several states that have banned prepayment penalties on any type of mortgage, both prime and subprime.
Failing to assess ability to repay. During the subprime heyday, many lenders essentially stopped underwriting the loans they marketed. Beginning in 2006 with Ohio, 10 states now have adopted new laws that require lenders to assess whether borrowers can repay their loans. Three states (CT, NY and NC) apply this requirement to subprime loans, while seven states (CO, IL, ME, MD, MA, MN and OH) cover all mortgages.
Steering into abusive loans and excessive broker compensation. The Wall Street Journal has reported that many people who could have qualified for prime loans (61% in 2006) received high-cost, foreclosure-prone subprime loans.* North Carolina's ban on yield-spread premiums will discourage overcharging, as will a rule in Massachusetts that bans YSPs if there is a conflict of interest. At least a dozen states specifically include yield-spread premiums in assessing whether a loan is designated as "high cost," which also serves to discourage overcharging.
Failing to include taxes and insurance. By not including taxes and insurance in monthly mortgage payments, lenders can make payments seem deceptively low. Many foreclosures are triggered when taxes and insurance come due on loans that had already stretched homeowners to their maximum. Recently New York and Connecticut became the first two states to protect homeowners by requiring lenders to include taxes and insurance in subprime mortgage payments—a practice that is already routine for most prime loans.
The Federal Deposit Insurance Corporation, chaired by Sheila Bair, sent a letter to the Federal Reserve Board last April, noting the "systematic breakdown in lending standards" in recent years, and urging the Fed to take strong action to prevent more problems in the future. The FDIC supports strong rules requiring lenders to assess ability to repay, and the agency also favors eliminating prepayment penalties and yield-spread premiums on subprime loans. (See the FDIC letter at www.federalreserve.gov/SECRS/2008/April/20080409/R-1305/R-1305_1075_1.pdf.)
Meanwhile, a number of states are poised to follow the lead of the states named above in protecting borrowers and restoring common-sense lending principles to the mortgage market. Noteworthy is California—one of the country's largest markets and arguably the epicenter of the foreclosure crisis, where state-regulated lenders accounted for 60 percent of all subprime mortgage loans made in 2006.
"Decades of experience show that states can be much more nimble and targeted to local needs than Washington," said Paul Leonard, director of CRL's California office. "If we are to avoid another crisis in the future, it is critical that state legislatures accept their rights and responsibilities to act, and not rely on one-size fits all federal rules," Leonard said.
North Carolina HB 2188
CRL research on brokers, "Steered Wrong: Brokers, Borrowers, and Subprime Loans"
CRL comment to the Federal Reserve Board on pending rules aimed against abusive lending practices (PDF)