The Predatory Lending Compliance Trap: A New Survey of 27 Lending Executives Shows Predatory Lending Laws and Regulations Present Such Serious Compliance Challenges That Lenders Are Worried about How They Can Fully Comply with the Confusing Maze of Rules. the Industry Has Already Paid Roughly $1 Billion in Penalties and Settlements. No Wonder Lenders Are Worried

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MORTGAGE LENDING HAS ALWAYS BEEN SUBJECT TO REGULATORY AND LEGAL hurdles and challenges. Over the years, most lenders found ways to adapt to the combination of federal fair lending and state consumer protection laws. However, in the specialized world of antipredatory lending compliance, a veritable minefield of potential problems exists for the unwary.


What once was handled by a relatively simple Section 32 compliance check has, over the last few years, evolved into a highly specialized multijurisdictional review, with lenders, brokers, investors and servicers facing stiff penalties if they overlook even the smallest detail.

AppIntell Inc., Weldon Spring, Missouri, recently conducted an informal survey of chief executive officers and other top executives of 27 mortgage lenders and brokers, banks and investors to hear about the impact antipredatory lending laws have had on the industry. This article shares some of the results, along with additional discussion and insight about some of the current issues facing the industry.


People are worried

Eighty-eight percent of those surveyed expressed serious concerns about the issue of predatory lending compliance. These executives are trying to find foolproof ways to stay compliant, and are worried about potential liability and their ability to remain profitable in an era of confusing antipredatory lending laws. Brokers appear to be the least worried; some stated that the lenders they deal with and "market forces" are all the predatory lending compliance they need.

It is interesting to note that executives of the banks we surveyed expressed concern, despite a common sentiment that banks are largely not typically the ones responsible for predatory lending abuses. This view was echoed in a statement made last year by the Comptroller of the Office of the Comptroller of the Currency (OCC), as published in the Aug. 1, 2003, issue of Banks typically originate high-quality loans to moderate- to low-risk borrowers; but then, why are bank executives so worried?

For starters, they still must concern themselves with the Home Ownership and Equity Protection Act (HOEPA)--the federal abusive lending law that requires loan-level annual percentage rate (APR) and points/fees threshold reviews. They must also concern themselves with the OCC's antipredatory lending guidelines (the Office of Thrift Supervision [OTS] and the National Credit Union Association [NCUA] have also issued antipredatory lending guidelines for their member institutions). Banks that sell rather than portfolio their loans must concern themselves with investor requirements (which typically incorporate the requirements of the state and local antipredatory lending laws), ratings agency standards and government-sponsored enterprise (GSE) points/fees limitations.

Although nationally chartered financial institutions enjoy exempt status from many state laws by virtue of federal pre-emption claimed by their oversight agencies, there's no assurance that the same can be said for servicers and investors that eventually touch or take possession of their loans in the secondary market.

What are they worried about?

In informal discussions with mortgage executives, general patterns have emerged. From a predatory lending perspective, they are genuinely concerned about being sued. This raises several questions--such as what will their company's liability be and what will it cost in terms of litigation, bad press and collateral damages? What will their personal liability be?

It's easier now to pursue claims of abuse. Until the proliferation of state- and local-level abusive lending laws, it was somewhat of a challenge for regulators and aggrieved borrowers to pursue claims of abusive lending practices. In response to this, most of the state and local antipredatory lending laws have codified fraudulent lending practices that are already prohibited under existing federal or state fair lending or consumer protection laws, thereby linking the abuses to much more severe penalties for noncompliance. The net result is that the stakes have been raised and the floodgates may have been opened, as it is now easier for state agencies and individual borrowers to pursue claims of abuse than ever before.

Many laws are untested. State- and local-level antipredatory laws are still a new phenomenon, and are subject to change and interpretation by judicial or administrative bodies. This leaves lenders, brokers and investors vulnerable to lawsuits based on alleged abuses of laws that are poorly worded and difficult to interpret, and that can change on a dime.

Lenders are vulnerable. These untested laws also leave companies vulnerable to accusations of fraud and abuse and to collateral damages, which can have more bite than statutory penalties. Bad press, reduced company stock valuations, loan buy-backs, legal expenses and boycotts, and even bankruptcy and liquidation are rarely made public, but can be more damaging than any settlement or judgment.

Reports of declines in stock value were common during the investigation (and eventual multistate settlement) of a major subprime lender, according to, and some companies have been forced into bankruptcy or out of business. To make matters worse, some state laws even contemplate personal liability for company executives and offending loan officers by providing for criminal penalties for intentional violations.

Looking for cases

Law firms and others have created Web sites looking for borrowers who think they have been victims of predatory lending abuses. For example, has a listing of pending lawsuits and other information regardding predatory lending abuses, and is actively seeking aggrieved borrowers. Although it is not known whether any of these cases have merit, the companies named are still vulnerable in an age where an appearance of impropriety sometimes speaks more loudly than truth.

Lawsuits don't appear overnight. Yet another significant cause for concern is the lag time between alleged predatory lending abuses and resulting litigation. Several years can elapse before investigations or actions are commenced, and more time can elapse before cases reach the point of final disposition. Thus, lenders and investors that may have abusive loans in their portfolios from years past, along with the loan servicers, may ultimately face liability for these abuses, even if the offending loan officers and management teams are long gone. And for every predatory lending violation committed today, substantial time may elapse before they are discovered and actions are brought and fully resolved.

Major predatory lending actions

In addition to many lesser-known actions, there have been more than two dozen well-publicized settlements, judgments and investigations over the last several years that involve allegations of predatory lending abuse by banks, lenders, brokers, servicers and investors. These actions involve litigation or investigations of predatory lending violations and/or violations of other federal or state fair lending laws that have since been codified in state antipredatory lending laws. The judgment or settlement amounts have reached staggering levels, totaling nearly $1 billion so far.

Many of the cases were pursued by the Federal Trade Commission (FTC) under the FTC Act and federal fair lending laws, and involved loans originated prior to the enactment of state antipredatory lending laws. As a result of the new laws, regulatory agencies that were once the industry's primary policemen may soon take a back seat to community and activist organizations and individual borrowers as more lawsuits based on state law claims take root.

Lenders have cut back in certain jurisdictions

Almost 20 percent of those surveyed stated that their companies have either reduced lending activities or completely pulled out of certain jurisdictions as a direct result of restrictive state and local antipredatory lending laws. States such as Georgia and New Jersey were at the top of their list, and a broker in Chicago stated that the city's antipredatory lending ordinance is literally driving him out of business.

This trend is consistent with several studies conducted over the last few years, such as a study of lending patterns in New Jersey that showed a marked decline in lending activity in the state after enactment of its antipredatory lending law. The study was done by Professor Richard F. DeMong of the University of Virginia's McIntire School of Commerce and published on March 26, 2004.

Wanted: A single, national standard

Several surveyed executives expressed dismay at the proliferation of state abusive lending laws and are hoping for a single, national standard that pre-empts state and local laws. However, it appears that the leading antipredatory lending bill in Congress that could do just that: H.R. 833--the Ney-Lucas Responsible Lending Act, introduced late in 2002--is unlikely to pass until 2005 at the earliest, assuming a Bush victory in November's presidential election.

(Democratic presidential candidate Sen. John Kerry [D-Massachusetts] co-sponsored a tough antipredatory lending bill last year--the Predatory Lending Consumer Protection Act of 2003--generally opposed by the industry, and his running mate, Sen. John Edwards [D-North Carolina], introduced legislation earlier this year designed to overturn the OCC's pre-emption of state law. These actions are strong indications of things to come if they are elected.)

When and if the Ney bill becomes law, the timing of its enforcement is very uncertain, in part due to the promises made by many states to challenge any such law by suing the federal government, which will undoubtedly cause substantial delays.

State challenges to federal law are not new, as evidenced by a recent challenge against the OCC's pre-emption of state law by New York Attorney General Eliot Spitzer. Regardless of what happens, the bottom line is that enforcement of a single, national standard may not happen until 2006 or beyond. Even then, lenders will still need to take proactive steps to comply with the provisions of the new standards.

What do lenders do in the meantime to stay compliant?

There are several methods for ensuring compliance with the laws, ranging from analysis using prepared spreadsheets to outsourcing compliance tasks to vendors. Following are the methods used by those surveyed and by others in the industry.

The Old Standby: Manual Spreadsheet Analysis

If your company creates compliance spreadsheets for use by underwriters or other personnel, you're not alone. Spreadsheet analysis is still frequently being used by lenders around the country. These documents, which contain anywhere from 10 to 30 (or more) data elements and can run in programs such as Microsoft[R] Excel, provide a makeshift method of complying with some of the laws. They usually contain a series of "yes/no" questions and a section for includable points and fees that, when used correctly, will help the lender stay in compliance.

Lenders must maintain these spreadsheets for compliance with HOEPA, as well as for every state and local jurisdiction in which they do business; thus, in many states, two or more such spreadsheets must be completed for each loan. As employees are responsible for properly calculating "includable" points and fees, which vary by jurisdiction, companies using spreadsheets must constantly train employees about the proper treatment of fees in the calculations.

Typically, the time spent completing these spreadsheets ranges from 30 to 45 minutes per loan, and the analysis is usually performed arguably at the worst possible time--just prior to or shortly after loan closing.

Many companies concede keeping up with the laws is extremely challenging, and are then concerned that employee training and data integrity are lacking. Also, many lenders can't afford the costs involved with having staff review every loan; thus, they may review only a sampling of loans, which exposes them to some level of compliance risk for the loans not reviewed.

A Better Way: 'DIY' Automated Compliance

Recognizing the many flaws inherent in the manual process, many companies have advanced to more sophisticated compliance techniques via automation. These companies have built their own systems (do-it-yourself [DIY] automation) that are typically able to provide high-level analysis, such as HOEPA threshold tests, in real time.

These systems can be, on the front end, an inexpensive and convenient way to check for some predatory abuses, and can be used to stop the production process when a threshold has been exceeded. In addition, lenders can reduce their dependence on employees for proper fee interpretations by controlling the fees that are being included in the calculations. However, many such systems tend to create unintended risks, as they frequently fail to cover all state and local jurisdictions with adequate levels of detail. They also tend to create unintended costs in terms of ongoing maintenance. By potentially giving lenders and investors a false sense of security, these systems may do lenders more harm than good if not used properly.

The Newest Wave: Outsourced Compliance

Several lenders indicated they believe they can no longer navigate the compliance landscape alone. To comply with the requirements of federal, state and local laws, these companies outsource their compliance by taking advantage of services offered by vendors that provide quality assurance reviews or by outsourcing to third-party companies that specialize in automated compliance solutions.

Using sophisticated technology, the best of these offerings represent a concerted effort by vendors and veteran industry attorneys to develop the most robust systems. The systems, which are continuously updated by compliance and legal professionals, automatically analyze 75 or more data elements per loan. Most systems offer additional compliance checks like Home Mortgage Disclosure Act (HMDA) rate spread calculations, APR and finance charge validations, rescission period verifications, GSE points/fees approximations and Office of Foreign Assets Control (OFAC) checks.

In the world of predatory lending, where accusations fly and allegations of impropriety lead to class-action lawsuits, appearances matter. In the eyes of a jury, when a lender has outsourced predatory lending compliance to an objective third party, it is evident that it has clearly taken proactive steps to ensure compliance. As a result, it becomes that much more difficult to prove the lender, investor or servicer possessed the element of intent required to obtain maximum statutory damages in many jurisdictions. This reduction in liability may be the biggest benefit from outsourcing, and can easily offset the costs associated with it.

The bottom line

Predatory lending compliance is a difficult matter. Regardless of whether you are a broker, lender, servicer or investor, compliance requires enormous attention to detail, control over the origination process and flawless quality-assurance processes. Perhaps nothing can protect you completely from accusations of engaging in abusive lending practices, even if they are baseless. But a documented system of compliance checks performs the vital role of helping to reduce your company's liability in the event of an investigation or lawsuit. Just as outsourcing has become a popular alternative in preparation of loan documents, companies appear more willing to allocate precious resources to ensure predatory lending compliance.

It's not against the law to maximize profit, and lenders should be empowered to do so within the constraints of the antipredatory lending laws. However, with the numerous roadblocks that exist in the current lending environment, legislators must become more aware that their respectable quest to enact consumer protection laws cannot be allowed to interfere with legitimate lending activities and the consumer's ability to obtain credit.

The fight to end predatory lending will be good for everyone if the mortgage industry, consumer groups and legislators can find common ground, workable solutions and well-rounded outcomes. Unfortunately, if they fail, all will be affected by unintended consequences and the serious problems that may result.


AS COMPLIANCE AND INFORMATION technology personnel recover from the adoption of the new Home Mortgage Disclosure Act (HMDA) requirements that took effect earlier this year, mortgage executives are now turning their attention to the impact this change will have on the industry.

Lenders are now required to report Home Ownership and Equity Protection Act (HOEPA) loan status and loan pricing, by reporting rate spreads for loans where the rate is equal to or greater than 3 percent (5 percent for subordinate liens) over the yield of a Treasury bill of comparable maturity. The Federal Reserve and the Federal Financial Institutions Examination Council (FFIEC)--the commission assigned the task of implementing HMDA regulations--point out that the information is needed to address fair lending concerns related to loan pricing and to better understand the mortgage market, especially in the subprime market.

From an industry perspective, lenders are ultimately being forced to disclose pricing information, including data for loans that are predatory under applicable state laws.

HMDA data, even the revised data, does not contain enough information to determine whether or not the loan terms were reasonably based upon a legitimate and fair review of the borrower's situation.

Lenders often use risk-based pricing models to determine interest rates and loan fees as a hedge against their potential future liability. Their models are based on a variety of factors; so, for example, borrowers who are statistically more likely to default on their loans or who put less money down are offered loan products with higher rates that correspond to and compensate for the lender's risk. With the revised HMDA data, the public is not afforded the opportunity to look beyond the annual percentage rate (APR) to see these legitimate underlying factors, so correlations like this can't be made.

Industry trade group leaders raise concerns

Understandably, industry leaders are concerned. Last May, H.R. Lively Jr., president and chief executive officer of the American Financial Services Association (AFSA), Washington, D.C., outlined AFSA's concerns in a letter to the Federal Reserve. In the letter, he pointed out that the revised HMDA data "... does not permit a meaningful inquiry into whether an institution's mortgage lending pricing policies and practices are rationally correlated to the risk factors of the mortgage loans being made--the data will not include the controlling factors that make up the cost equation." The bottom line is that the disclosed data can damage a lender's reputation even though the institution is complying with the law.

The same rationale applies with regard to allegations of predatory lending, and many fear that allegations of abuse will abound.

For example, a study was done in 2002 titled North Carolina's Subprime Home Loan Market After Predatory Lending Reform. It was authored by keith Ernst, John Farris and Eric Stein of Durham, North Carolina-based Self-Help, a nonprofit community economic development lender, and was funded by the Center for Responsible Lending (CRL), Durham, North Carolina, a community-based organization vocal in its strong support of the North Carolina law.

This particular study concluded that the 1999 North Carolina antipredatory lending law (the first state antipredatory lending law) reduced the incidence of predatory lending in the state without substantially reducing the availability of credit to those who needed it the most. Thus, the authors surmised, the law (which has been used as a blueprint for similar laws subsequently crafted by many states) may have achieved a desirable balance of consumer protection without causing harm to legitimate lending activities. The report's conclusions were based in part on HMDA data reported between 1998 and 2002.

One might wonder how HMDA data, especially the pre-2004 variety, could be used to identify patterns or practices of predatory lending abuses. It can't. After the CRL-funded study was released, other studies, including The Impact of North Carolina's Anti-Predatory Lending Law: A Descriptive Assessment, a 2003 report by R.G. Quercia, M.A. Stegman and W.R. Davis, professors at the University of North Carolina's Frank Hawkins Kenan Institute of Private Enterprise's Center for Community Capitalism, Chapel Hill, North Carolina, and financed in part by the CRL, showed the inconclusive nature of the previous study.

In fact, many studies have shown that the North Carolina law may have had a negative impact on the industry and in fact reduced the availability of credit to those who need it the most.

No one disagrees with the good intentions of the community-based organizations and others leading the charge for more restrictive antiabusive lending laws. It is clear their goal is to protect the uninformed and otherwise vulnerable among us from lending abuses. However, it is the unintended consequences of these laws that are creating costly roadblocks for the industry and consumers alike.

The fundamental problem with the new loan pricing data in terms of predatory lending is that there are no predatory lending rate thresholds based on the "T-bill + 3 percent" formula required in the HMDA data anywhere in the country. For example, the HOEPA rate trigger is substantially higher at "T-bill + 8 percent" (10 percent for subordinate liens), and many states with antipredatory laws have similar thresholds in place.

Even in states such as New Jersey that enacted some of the toughest antipredatory laws in the nation, the rate threshold after the July 6 amendment is 1.5 percentage points higher than the HMDA rate spread. As a result of this misalignment, there will be countless loans across the country with "HMDA-reportable" rate spreads that do not violate any federal, state or local rate threshold.

2005 and beyond

What is going to happen with the release of the 2004 HMDA data next year? We know that some people who misunderstand HMDA data may try to identify patterns or practices of predatory lending abuse using the new loan pricing data. So the real question is: What can lenders do to protect their institutions from allegations of impropriety?

Institute a Zero-Tolerance Policy

If you haven't already done so, your company should institute a written "zero-tolerance" policy for lending abuses. It should clearly outline prohibited practices along with penalties for violations. The policy will send a clear message to your employees that predatory lending abuses will not be tolerated, and to regulators, investors and consumers that you have taken an affirmative step to keep it from happening.

Training and Education

Another important step is to train your employees on antipredatory lending laws and prohibited practices, and to educate your borrowers so they can become informed consumers. An excellent example of a consumer education program is Freddie Mac's "Don't Borrow Trouble" campaign (, designed to teach, inform and increase awareness about predatory lending and how to spot it when it occurs.

Track Your Compliance

A third step is to implement a tracking system that documents compliance of your HMDA-reportable loan applications with applicable antipredatory lending laws. That way, if regulators, community activists or investigative reporters come knocking, you can provide them with a report proving that every loan they are questioning is, in fact, compliant. Case closed.

Get the Word Out

Finally, more industry leaders need to get involved in informing the public about the proper use and interpretation of HMDA data. This means a concerted attempt to get the word out that HMDA data does not provide needed information to identify predatory lending abuses and should not be used for that purpose.

Roger Fendelman is an attorney and director of compliance for AppIntell Inc., Weldon Spring, Missouri. He can be reached at AppIntell is a provider of fraud prevention and antipredatory lending compliance solutions.


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