Lending regulation draws criticism, argument, lawsuits

From the Wall Street Journal:

Illinois Tries New Tack Against Predatory Loans
Its First Effort Drew Charges of Racism; Mortgage Brokers Revolt
August 21, 2007; Page A1

The Illinois legislature this month passed a law that goes to the heart of the global subprime lending mess that is rattling the housing industry and shaking financial markets from Wall Street to Hong Kong.

The new law will require people in the Chicago area who want to take out a home loan with nontraditional terms — such as prepayment penalties or interest-only payment options — to spend an hour or two with a credit counselor so they won’t be hoodwinked at the closing table.

President Bush has endorsed such educational efforts, noting in a recent press conference that in many cases “people aren’t sure what they’re signing up for.” The new law, which would go into effect next July, comes as states across the country are rushing to address the rising foreclosure rates that threaten to expel hundreds of thousands of people from their homes.

Yet Illinois’s experience to date shows how difficult it is to create even modest safeguards in the home-buying process. A previous pilot program similar to the new law was viciously attacked and rescinded in January, after only a few months. Instead of winning plaudits, the pilot program quickly became mired in charges that it would make it harder for minorities to buy homes. Mortgage brokers, fearing a loss of business, claimed that access to credit would tighten in the neighborhoods targeted by the law. Rumors flew that dozens of lenders had pulled out of the area.

One woman filed a lawsuit saying the program scared away buyers for her home in a working-class neighborhood in the city’s so-called Bungalow Belt. A pastor called it “the most racist piece of legislation that we have ever experienced in Illinois.”

Now that the new law is expanding the program, the nearly one dozen Department of Housing and Urban Development-approved counseling groups who will be responsible for the measure’s success aren’t sure they have enough resources to handle the thousands of mortgages they will be expected to review.

Yet even before the law went into effect on Sept. 1, the response was vitriolic. Dean Martinez, secretary of the Department of Financial and Professional Regulation, says he first began receiving angry calls and letters from people in the mortgage industry who claimed that business would dry up in the pilot area. Then, he says, he started hearing from community organizers and religious leaders who raised concerns about discrimination.

At least two lawsuits alleging discrimination and civil-rights violations were filed against the state that fall. One plaintiff was Tammy Peña, who says she put her house up for sale several months before the law took effect. She and her husband, Francisco, wanted to move to the suburbs to enroll their four children in better schools and cut down her 100-mile round-trip commute.

But they were unable to sell their house. One potential buyer who signed a contract to purchase the home couldn’t qualify for a loan because he was unwilling to attend the required counseling session, Ms. Peña asserts in her lawsuit. The suit argues that the law constitutes state-approved redlining — the refusal of lenders to work with borrowers in certain neighborhoods or ethnic groups — because it effectively prevents minorities from getting credit on the same terms as non-minorities.

Mr. Martinez, a former prosecutor, says he would have moved to strip the license of any lender that intentionally ditched the study area because of the new rules. Ms. Peña’s suit was dismissed after the pilot project was called off. Her home still hasn’t sold, her lawyer said.

Some people who received counseling are now believers in the program. Alvaro Cortez, a 38-year-old who works in sales for an automotive paint shop, found his dream home in December for $190,000 in a neighborhood near Midway Airport. Because the house was in the pilot area and he had a low credit score, his mortgage broker told him he had to go to a counseling session. The broker seemed angry, says Mr. Cortez, who is Hispanic.

“They were trying to tell me it was racist,” says Mr. Cortez, sitting in the cramped offices of the Resurrection Project, one of the groups providing the counseling. “When I came here, I saw it wasn’t that.”

Mr. Cortez pored over his loan documents with a counselor, who showed him how to verify his mortgage’s terms. He says the session helped him stand up for himself when he went to his closing. There, he says, the paperwork showed that he had an adjustable-rate loan, instead of the fixed-rate one he had been promised. The interest rate also was higher than he had agreed to pay. Mr. Cortez refused to sign.

On his second closing date, the documents still were wrong. Mr. Cortez exploded. Finally, on the third try, he signed for the loan he had been promised and moved into his brick, two-story row house the next day.

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