New law bans some predatory lending practices that had hurt vulnerable communities

New law bans some predatory lending practices that had hurt vulnerable communities

The practice of giving high risk home loans to minorities and financially vulnerable communities is alive and well, says a legislator behind a bill that seeks to ban two types of tricky lending practices.

SB1692, passed in May and signed by Gov. Pat Quinn on July 25th, would ban prepayment penalties and balloon payments.

Written with the Attorney General's office, it amends the existing Illinois High Risk Home Loan Act and seeks to bring it in line with federal housing legislation.

To understand SB1692, the loan practices it seeks to ban and the bills it amends, it might help to start with a quick ABCs of high risk home loans:

High risk home loans, otherwise known as predatory loans, were one of the most infamous practices of the banking industry to come to light after the mortgage crisis. Homeowners with bad credit were offered a mortgage, but the interest rate was usually several percentage points above comparable mortgages and benchmark U.S. Treasury rates. This kind of lending often targeted those who could least afford it.

Balloon payments hit homeowners who perhaps were enticed by lenders to pay a lower-than-normal monthly rate--often just interest--with the understanding that at the end of the term of the mortgage, or if the home were sold or refinanced, the difference would be made up in one big 'balloon' payment.

They were made for "borrowers in a strong housing market who are planning to move or refinance in a relatively short time, before the balloon came through," said Tom Feltner, vice president of the Woodstock Institute.

Prepayment penalties are even trickier--they impose a fee if a borrower manages to pay the loan in full ahead of the agreed-upon term. This is "to compensate for the loss of interest" lenders won't receive, said Feltner. The fee, which is often in the thousands, could keep homeowners from selling or refinancing a loan that might be a financial burden. A 2007 Reporter investigation found that brokers were offered bonuses if they got lenders into products with pre-payment penalties.

A 2005 study by the Center for Community Capital at the University of North Carolina has linked both prepayment penalties and balloon payments to higher foreclosure rates--20 percent and 46 percent higher chance of foreclosure, respectively--and the communities that have suffered from them are primarily low-income and people of color.

"We know that certain communities were targeted with these predatory loans, and [this bill] is to put some kind of safeguards to ensure that individuals who might have a high risk loan are not boxed in or put in a position where it's made difficult for them to repay their homes," said 16th District state Sen. Jacqueline Y. Collins, a main sponsor of the bill.

By banning prepayment penalties and balloon payments in high risk home loans, Collins says she hopes the legislation will mitigate the continuing effects of the mortgage crisis.

"Many of the practices are still being carried out, and that's why it was important to pass this legislation," she said.

The 2003 High Risk Home Loan Act which SB1692 amends was signed into law before the mortgage crash of 2008 revealed the extent of predatory loans. It was written to require mortgage lenders and brokers in Illinois to register and have a criminal background check before they were certified to give out loans.

In the bill, the limits on prepayment penalties were 36 months, and if a borrower repaid before then, there was a maximum fine of 3% of the total loan amount, if it was paid in one year.

For balloon payments, the old legislation mandated that a section on balloon payment awareness be included in a Mortgage Awareness Program, and that a third-party review of high-risk home loans would look critically at balloon payments.

Reports back in 2005 told of insufficient examiners in place to implement the act, and few mortgage brokers reported to the agency being prosecuted.

Now in 2012, with the state in a budget crisis and foreclosures continuing, the addition of another area to regulate may not produce results as quickly as hoped.

If the amendment is passed, it will bring Illinois' own statute in line with the consumer protections in its federal counterpart, the Homeowner's Equity Protection Act (HOEPA).

SB1692's travelling liability could also minimize high risk home loans altogether, said Maura Possley, a spokeswoman with the Attorney General.

"A subsequent purchaser of the loan – such as a Wall Street investor – can be held liable for any violations of the Act committed by the originator," said Possley. "The mortgage lending industry depends on the secondary market (investors) to generate capital to make more loans. Because investors do not want to take on the risk of a lawsuit with every loan they buy, there is essentially no secondary market for high risk loans."

© Community Renewal Society 2012

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