California disclosure loan mortgage

Abstract This paper examines the effects of predatory lending laws in the cities of Chicago and Philadelphia. The level of mortgage activity in each of the cities is compared during the pre- and post-legislative periods relative to other parts of the state to assess the impact of localized legislation. In Chicago, where the predatory lending law focused on banks, a subprime origination in the city was found to be more likely to be made by a non-bank after the passage of the law. In Philadelphia, however, where the predatory legislation was aimed at all financial service providers, a decline was observed in the likelihood of a subprime loan being originated in the city during the post-legislation period, with the minority and low-income market segments experiencing the largest reduction.

Introduction

Over the past decade the subprime mortgage market grew dramatically, increasing from $34 billion in 1994 to over $160 billion in 1999.1 Concurrent with this expansion, there is a growing body of anecdotal evidence suggesting that a subset of lenders involved in the subprime market are engaging in abusive or "predatory" lending practices. To deal with these abuses, regulators recently implemented revisions to Regulation Z, a disclosure law that increased the number of loans covered by the Home Equity Protection Act (HOEPA).2 These revisions to HOEPA, however, did not prohibit any lending practices. In recent months, however, several states and cities have gone beyond increased disclosure and implemented legislation that prohibits or penalizes certain "predatory practices."3 Federal policymakers have also proposed legislation on predatory lending that would preempt state laws and prohibit certain predatory practices on a nationwide basis.4

This study examines the impact of predatory lending legislation in two cities, Chicago and Philadelphia, which were the first to enact predatory lending laws. Because subprime lenders tend to focus their activity in low-income and minority applicant areas, examining the impact of predatory legislation in these two cities is extremely important.5 In Chicago, the impact of the predatory lending law on both borrowers and lenders in that city is examined relative to other borrowers in the state from the pre- to post-legislation period. The impact of the city of Philadelphia's predatory lending ordinance on subprime lending in the city is also examined, although the law was later rescinded by state-level legislation. Philadelphia is included because according to popular press reports the passage of the law led several lenders to exit the city.6

The study focuses on several important questions. First, did the restrictions imposed in Chicago and Philadelphia affect the availability of credit to subprime borrowers? Second, if so, what types of borrowers and lenders felt the greatest impact? Finally, given that the laws have different restrictions and penalties, how did they affect different types of lenders? It should be noted from the outset, however, that the data do not permit us to ascertain what part of any decline in mortgage lending was predatory in nature. The data employed in the study do not have information on pricing or other terms of the loans, and even if they did it would have required a value judgment to decide whether these terms were onerous enough to consider the loans to be predatory.7 Although it is very likely the predatory lending laws reduced or eliminated some predatory practices, policymakers need also be concerned about their impact on legitimate subprime lending.

The article is organized as follows. First there is a review of the literature on subprime and predatory lending. Second, there is a brief overview of the Chicago and Philadelphia predatory legislation. Third, there is a description of the data and descriptive statistics on mortgage lending activity in Chicago and Philadelphia compared to the rest of Illinois and Pennsylvania, respectively. Fourth, empirical tests examine the changes in mortgage flows following the implementation of the city-level predatory lending laws. Specifically, the impact of the legislation on denial probabilities and changes in the likelihood of a loan being originated by a subprime versus a traditional lender, or a bank (depository) versus a non-bank lender are examined. Fifth, the results of the multivariate analysis are discussed. Finally, there is a summary conclusion with policy implications and areas of future research.

Literature Review

The term predatory lending, while commonly used, does not have a unique or agreed upon definition. Engel and McCoy (2001), however, broadly define a predatory loan as one that meets one or more of the following conditions: loans with no net benefit to the borrower, loans designed to earn supranormal profits, loans involving fraud or deceptive practices, loans involving other misleading nondisclosures that are nevertheless legal and loans that require the borrower to waive meaningful redress. Some of these practices include high points, high interest rates, high or duplicative closing costs and fees, loan-to-value ratios (LTV) in excess of 100% of the underlying collateral, loan flippings, loan steering, excessive prepayment penalties, abusive collection and foreclosure practices and loan features such as negative amortization, balloon payments and unnecessary credit insurance.8

Loans with high interest rates, however, are not all necessarily predatory in nature. The higher interest rates charged on these loans may simply reflect higher risks and costs associated with "subprime" lending. Subprime loans are higher rate loans designed for borrowers with impaired or limited credit histories that make it difficult for them to secure credit from the prime market or traditional lenders.9 Lenders argue that these higher rates are justified by the need to be compensated for the greater risk that these borrowers pose.10 They also argue that the higher rates charged reflect a lack of standardization in underwriting that makes it more costly to originate and service loans to borrowers with blemished credit histories, limited discretionary income and cash-flow concerns.11 Predatory lenders, however, may be denned as those that go beyond risk-based pricing and set loan terms high above what is necessary to offset costs and earn a return that compensates them for their risk. Given the lack of publicly available information on loan terms and practices, however, it is very difficult to distinguish between the two. It is generally agreed, however, that predatory lenders constitute a segment of the subprime market.

A significant amount of research on subprime lending activity has been conducted at the Department of Housing and Urban Development (HUD) where for the past several years researchers have compiled a list of subprime lenders.12 Using this list, HUD and other researchers have documented the high rates of subprime lending in low-income and minority communities. For example, in 2000, HUD issued a report entitled "Unequal Burden: Income and Racial Disparities in Subprime Lending in America" documenting the concentration of these lenders in low-income and minority communities in five cities including Atlanta, Los Angeles, Baltimore, New York and Chicago. They found that subprime loans were three times more likely in low-income neighborhoods than in high-income neighborhoods and five times more likely in black neighborhoods than in white neighborhoods. More recently, the Bradford (2002) study on subprime lending patterns in all of the nation's 331 metropolitan areas found that there are "widespread" racial disparities in subprime lending activity nationwide, and the top six areas with the most widespread disparities are all in California.13

Several other researchers have examined subprime lending. Immergluck (1999) focused on the growth rate of subprime lending in Chicago's minority and lowincome community. He found that prime lenders active in white and upper-income communities tended to be less active in minority and lower-income neighborhoods and that subprime lenders have filled this vacuum. Marsico (2001) examined 1999 Home Mortgage Disclosure Act (HMDA) data for New York and found similar patterns with subprime lenders having a greater presence in low-income and minority communities. Finally, Canner, Passmore and Laderman (1999) demonstrated that subprime lenders are oriented more toward low-income and minority applicants and that changes in denial rates over the 1993 to 1998 time period can be partially attributed to the increase in the number of subprime lenders.