State Consumer Protection Statutes: an Alternative Approach to Solving the Problem of Predatory Mortgage Lending

• Publication year: 2004

SEATTLE UNIVERSITY LAW REVIEWVolume 28, No. 2WINTER 2005

State Consumer Protection Statutes: An Alternative Approach to Solving the Problem of Predatory Mortgage Lending

Jessica Fogel(fn*)

I. Introduction

"Homeownership is the American dream. It is the opportunity for all Americans to put down roots and start creating equity for themselves and their families."(fn1) To finance that dream, Americans turn to mortgage brokers and lenders. Because homeownership represents the single most complicated and expensive investment for most Americans, individuals commonly place significant trust in their brokers and lenders to represent their best interests. Although most individuals in the mortgage industry work hard to obtain fair and reasonable financing for consumers, there are a number of predatory brokers and lenders who abuse their positions of trust and superior bargaining position by taking unfair advantage of the financial constraints and time pressures that often face borrowers.

Unscrupulous brokers and lenders sometimes employ tactics that deceive borrowers yet result in profitable business for the mortgage industry.(fn2) These practices, including partial disclosure or nondisclosure of material terms, or changing the loan type or interest rate as closing approaches, are commonly referred to as "predatory lending practices." Many of these practices, through which certain players in the mortgage industry take advantage of borrowers, are on the margins of legality.

Although federal statutes regulating the lending industry are supported by strong policy statements that appear to provide significant protection for borrowers,(fn3) ambiguous contract terms, weak enforcement provisions, and numerous statutory exceptions undermine the protective purposes of such statutes. In response to these federal loopholes and the recent increase in predatory lending practices, many states and municipalities have enacted more stringent regulations.(fn4) Despite the protective purpose of these regulations, however, many in the mortgage industry oppose these regulations and contend that state laws complicate the mortgage process, creating higher transaction costs and reducing access to credit.(fn5) Federal lawmakers have reacted to the industry's concerns by exempting federal banks from many state statutes. However, this type of federal preemption hinders state enforcement efforts and creates incentives for businesses to seek a regulatory structure that guarantees the fewest consumer protections.(fn6)

Consequently, federal and state regulations have consistently failed to adequately protect borrowers from predatory lenders. Some state consumer protection statutes, however, provide consumers with a private right of action, an expanded statute of limitations, and attorney's fees.(fn7) In the context of predatory lending, federal courts have recognized that certain violations of federal lending statutes, namely the Real Estate Settlement Procedures Act ("RESPA") and the Truth in Lending Act ("TILA"), amount to unfair and deceptive practices for purposes of meeting the "unfair and deceptive act or practice" element of certain state consumer protection statutes.(fn8) To further the purposes and policies of RESPA and TILA, consumers should utilize state consumer protection statutes(fn9) when practices in the mortgage transaction industry violate these federal lending statutes, thereby constituting unfair and deceptive conduct.

This article continues in Part II by defining predatory lending practices, identifying borrowers who are likely to face predatory lenders, and discussing the consequences of predatory lending. Next, Part III provides a background for existing federal regulation, again in reference to RESPA and TILA. Part IV discusses state legislative efforts to curb predatory lending and identifies the problems of inconsistency and federal exemptions that undermine these state statutes. Part V examines the elements of state consumer protection acts and unfair and deceptive acts or practices ("UDAP") statutes and their application to predatory practices. Part VI argues that, because consumer protection statutes have nearly uniform elements in all states, such statutes provide significant protection for borrowers and have a considerable effect on curbing abuses in the mortgage industry. Thus, consumer protection statutes represent an effective alternative to weakened federal and state predatory lending statutes. Part VII concludes this article with the recommendation that predatory lending victims utilize the protection afforded by state consumer protection and UDAP statutes to hold predatory brokers and lenders responsible for engaging in predatory practices.

II. Predatory Lending Practices

A. Predatory Lending in the Prime and Subprime Markets

A mortgage represents a transfer of a property interest by a borrower to a lender as security for payment of a debt.(fn10) Because a lender wants to guarantee repayment of the debt, it will usually perceive a borrower with a high credit rating to be a low risk investment; consequently, the lender will usually approve mortgages for such borrowers and provide them with favorable interest rates.(fn11) This market is primarily referred to as the prime market.(fn12) Although predatory lending does occur in the prime market,(fn13) such practices are often deterred by competition among lenders, greater homogeneity in loan terms, and prime borrowers' greater familiarity with complex financial transactions.(fn14)

Borrowers with lower credit ratings, however, purportedly represent higher risk investments.(fn15) Because many prime lenders are unwilling to take such investment risks, borrowers with low credit ratings tend to borrow from subprime lenders.(fn16) A subprime lender denotes a lender who provides loans to high risk consumers.(fn17) Although subprime lenders play an important role in financing home loans for those who likely would not qualify for prime rates, some lenders take advantage of sub-prime borrowers by charging higher rates than the increased risk justifies.(fn18)

In recent years, the subprime lending market has witnessed dramatic growth. In 2003, more than $332 billion in mortgage loans originated from subprime lenders, compared to $125 billion in 1997.(fn19) Compared with prime lending, subprime lending generally has the characteristics of higher risk, lower loan amounts, higher origination costs, and faster repayments.(fn20) Subprime lending is not, in itself, predatory lending.(fn21) The subprime market often provides an important source of credit for many borrowers who struggle to obtain economic opportunities.(fn22)

However, subprime lending becomes predatory when material terms are not timely and accurately disclosed, excessive fees are packed into the loan, large prepayment penalties lock the borrower into high rates, or monthly payments are much higher than the borrower can afford.(fn23) Predatory lending commonly occurs in markets where unscrupulous lenders prey on certain identifiable groups, such as the elderly, ethnic minorities, and individuals with lower incomes and less education.(fn24) These individuals may not be sufficiently experienced or knowledgeable about complex financial transactions to understand the potentially devastating implications of such transactions, or may not be offered the range of financial products available to other borrowers.(fn25) Even educated and financially savvy individuals facing financial pressures have become victims of predatory loan practices.

B. What Constitutes a Predatory Lending Practice

Although the term "predatory lending" does not have a precise definition, the most significant indicators of predatory practices are inaccurate disclosures, changes in loan types and interest rates, and dispro-portionately high fees(fn26) and points(fn27) financed by the borrower.(fn28) Most predatory practices are essentially a means by which to increase the fees and points for a loan.(fn29) As the fees and points increase, the likelihood that a borrower will not be able to afford the loan increases.(fn30) Brokers and lenders often have an incentive to lend without regard to the borrower's ability to repay because such nonperforming loans(fn31) usually result in refinancing, which increases the profit for the lender.(fn32)

In testimony before the Senate Committee on Banking, Housing, and Urban Affairs, Iowa's Attorney General characterized predatory lending as a mindset with the following operative principle: "Take as much as you think you can get away with, however you can, from whoever you think is a likely mark."(fn33) Although the prime market remains highly competitive, the subprime market has little competition, virtually no advertisements or other publicity about the price of loans, and limited access to information about the loans.(fn34)

Broad language and illustrative acts or practices are more effective in defining predatory practices than is a bright line definition "because the human imagination is a wondrous thing, and its capacity to invent new scams, new permutations on old scams, and new ways to sell those scams is infinite."(fn35) Similarly, the Washington State Department of Financial Institutions broadly defines predatory lending as "the use of deceptive or fraudulent sales practices in the origination of a loan secured by real estate."(fn36) Additionally, the...