NC law did little to curb predatory lending

From the Wall Street Journal:

Predatory Lending: Hard to Tame
North Carolina Has Mixed Results Protecting Subprime Borrowers
By CHRISTOPHER CONKEY
May 7, 2007; Page A5

eight-year-old North Carolina statute has become a model for federal lawmakers who want to protect borrowers from predatory mortgage lenders. But the state’s experience demonstrates the difficulties of protecting unwary consumers in a fast-evolving marketplace.

The law is designed to prevent lenders from coaxing subprime borrowers — those with spotty credit histories or high debt-to-income ratios — into taking mortgages they can’t afford. Among other things, the statute places a duty — known as a “suitability” requirement — on subprime lenders akin to the one that requires stock brokers to recommend investments that are in clients’ best interest.

Lenders must avoid issuing high-interest mortgages, generally defined as instances where points and fees paid by the borrower exceed 5% of the total loan, unless they “reasonably believe at the time the loan is consummated” that the borrower will be able to repay. Borrowers must receive independent counseling before taking a high-interest loan and can sue lenders if they are steered into an inappropriate mortgage. The law outlaws refinancing a mortgage unless it has a “reasonable, tangible net benefit” to the borrower.
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North Carolina’s experience illustrates how tricky it is to strike that balance. The law’s suitability requirement hasn’t spurred a rash of borrower lawsuits, as critics suggested it might. Nor has it restricted credit as much as opponents feared. “There was a hue and cry about us shutting down the market and people not doing business here,” said Joseph Smith Jr., the state banking commissioner. “It’s pretty clear it didn’t really run anybody off.”

But neither has it shielded borrowers from unsavory practices as much as proponents hoped. Some practices and loan types vanished after the law was passed, but lenders adapted and replaced them with other products, some of which create similar problems for borrowers.

After the 1999 law took effect, subprime-mortgage originations in the state rose, as they did nationally. In 2001, subprime originations rose 32% from the previous year in North Carolina, according to data provided by the banking commissioner’s office. Subprime lending flattened and then nearly doubled from 2004 to 2005 as the housing market surged. North Carolina’s home-ownership rate fell slightly following passage of the law but has leveled off to about 70%, slightly above the national average, according to U.S. Census Bureau data.

A 2004 study by researchers at the University of North Carolina at Chapel Hill found a decline in refinancing activity. “The law is doing what it was intended to do: eliminate abusive loans without restricting the supply of subprime mortgage capital for borrowers with blemished credit records,” the researchers concluded.

But lenders quickly found ways to offer loans the law didn’t anticipate. Some avoided North Carolina’s prohibitions through moves by federal regulators that pre-empted state law from covering some federally regulated lenders. Other lenders rolled out adjustable-rate mortgages that weren’t proscribed by the law. One popular form was a 30-year loan that offers an introductory “teaser” rate for two years but can reset to higher levels thereafter, up to a given maximum. By offering the low initial rate, lenders could issue loans that stayed below the threshold set in North Carolina’s law.