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States Shelter Risky Borrowers

Legislatures Battle Predatory Lenders

As Washington Debates Issue

By CHRISTOPHER CONKEY

March 31, 2006; Page A4

With Congress divided over federal legislation to combat predatory mortgage
lending -- the practice of persuading borrowers into taking on fee-laden
loans they often can't afford -- more than half the states have passed laws
designed to protect riskier-than-average borrowers, and others are
contemplating action to curb abuse.

At least 10 states -- including New York, West Virginia and New Mexico --
have adopted comprehensive laws in the past few years crafted to curtail
tactics commonly used by unscrupulous lenders, including excessive penalties
for paying off a loan early, inflated interest rates and frequent
refinancing of a mortgage that does little to improve a buyer's finances but
generates fees for lenders and brokers. Other states are taking it one issue
at a time: Maryland has restricted prepayment penalties, for instance. And
still others are considering proposals to subject lenders to greater
liability if they are found to have duped home buyers.

The latest flashpoint is Ohio, which has the nation's highest
mortgage-foreclosure rate. State legislators there are weighing measures
that would allow the state attorney general to prosecute dubious lending
practices and would establish a new legal duty for lenders and middlemen to
look out for consumer's best interests, similar to the duty stock brokers
have. The Ohio House of Representatives passed a bill this week, but the
Senate, which passed its own version earlier this year, rejected it. The
chambers must reconcile the measures before they become law.
Mortgage-industry lobbyists are resisting.

In recent years, an expanding array of unconventional mortgages has made it
possible for "subprime" borrowers -- those with spotty credit histories and
lower credit scores -- to purchase or refinance homes. The Mortgage Bankers
Association says more than 13% of outstanding mortgages are subprime, up
from 2% seven years ago. Subprime borrowers pay higher interest rates on
mortgages to compensate lenders for the added risk. Prime borrowers today
typically face a 6.35% rate on a 30-year, fixed-rate mortgage. The Center
for Responsible Lending, an advocacy group affiliated with a Durham, N.C.,
community-development lender called the Center for Community Self-Help,
estimates a subprime borrower with a slightly worse-than-average credit
score would pay more than 7%, and one with a sharply lower score would pay
upward of 10%.

Industry officials say innovative mortgage products have helped millions of
low-income Americans buy homes for the first time. They warn that an onerous
mix of state rules is driving up costs and limiting mortgage availability,
and they are pushing strongly for federal legislation that would pre-empt
the rising number of state laws. "There's been this trend since 1999 for
states and localities to implement their own laws," says Steve O'Connor, a
lobbyist with the Mortgage Bankers Association. "It's effectively balkanized
the national mortgage-finance system. It adds costs and risks to operations
that are passed onto consumers."

Mr. O'Connor points to Montgomery County, Md., just outside Washington,
where a local law aimed at holding brokers and lenders liable for racial
discrimination prompted 50 lenders to leave the market, reducing
availability and driving up costs. A judge recently issued a temporary
injunction blocking the law, and Mr. O'Connor notes that some lenders since
have returned to the market.

Consumer advocates counter that deceptive subprime lenders defraud
homeowners out of billions of dollars each year by targeting potential
buyers with little ability to understand -- let along repay -- complex
loans. They cite a Center for Responsible Lending study that suggests credit
availability and pricing haven't been adversely affected in areas where
stringent restrictions have been enacted.

North Carolina sparked the current trend of state laws in 1999 with a
statute that limits a variety of fees and financing methods common to
subprime loans. "It's clear from studies that our predatory-lending law is
protecting consumers, while at the same time loans are still widely
available," said Roy Cooper, the state's attorney general.

In the U.S. House of Representatives, Rep. Spencer Bachus, an Alabama
Republican who heads a financial-services subcommittee, is holding talks
with a pair of North Carolina Democrats in an effort to model a federal
standard based on their state law. In recent years, Congress has been in a
stalemate over the question of whether to pre-empt state laws with a federal
standard.

Speaking to a gathering of mortgage brokers in Washington this week, Rep.
Barney Frank of Massachusetts, senior Democrat on the House Financial
Services Committee, said he supports a uniform standard. "But," he added, "I
don't want that to be a way of lowering consumer protection." Mr. Frank said
he expects the bipartisan talks to reach agreement soon.

Meanwhile, state attorneys general have been feuding with federal regulators
over whether they can enforce state lending laws against nationally
chartered banks, which are regulated by the Treasury's Office of the
Comptroller of the Currency. The Comptroller has said states can't use their
laws against those banks, and last year won an injunction halting a probe by
New York Attorney General Eliot Spitzer into the lending practices of
national banks in that state.

This week Mr. Spitzer appealed to the Second Circuit U.S. Court of Appeals
in New York. Spitzer spokeswoman Christine Pritchard said the OCC's
"anticonsumer agenda seeks to drastically alter the balance of federal-state
powers and would leave New York powerless to protect its residents from
unscrupulous practices." An OCC spokesman declined to comment.

Earlier this year, the attorneys general of 49 states reached a $325 million
settlement with Ameriquest Mortgage Co. over a variety of abusive-lending
charges. The states charged Ameriquest, the largest subprime lender at the
time, with a litany of transgressions. Among them: influencing and accepting
inflated appraisals, hiding fees and encouraging applicants to give
inaccurate employment or income information to obtain loans. Ameriquest
denied wrongdoing.

The Ameriquest payment was the second-largest consumer-protection settlement
in history. The largest was a $484 million settlement in 2002 between states
and Household International Inc. over alleged lending abuses. Household,
like Ameriquest, denied wrongdoing, but agreed to change some of its lending
practices. Household was acquired by HSBC Holdings PLC in 2003.

Write to Christopher Conkey at christopher.conkey@wsj.com1