State law tackles predatory lending

The Illinois legislature this month passed a law that goes to the heart of the global subprime lending mess that is rattling the housing industry and shaking financial markets from Wall Street to Hong Kong.

The new law will require people in the Chicago area who want to take out a home loan with nontraditional terms -- such as prepayment penalties or interest-only payment options -- to spend an hour or two with a credit counselor so they won't be hoodwinked at the closing table.

President Bush has endorsed such educational efforts, noting in a recent press conference that in many cases "people aren't sure what they're signing up for." The new law, which would go into effect next July, comes as states across the country are rushing to address the rising foreclosure rates that threaten to expel hundreds of thousands of people from their homes.

Yet Illinois's experience to date shows how difficult it is to create even modest safeguards in the home-buying process. A previous pilot program similar to the new law was viciously attacked and rescinded in January, after only a few months. Instead of winning plaudits, the pilot program quickly became mired in charges that it would make it harder for minorities to buy homes. Mortgage brokers, fearing a loss of business, claimed that access to credit would tighten in the neighborhoods targeted by the law. Rumors flew that dozens of lenders had pulled out of the area.

One woman filed a lawsuit saying the program scared away buyers for her home in a working-class neighborhood in the city's so-called Bungalow Belt. A pastor called it "the most racist piece of legislation that we have ever experienced in Illinois."

Now that the new law is expanding the program, the nearly one dozen Department of Housing and Urban Development-approved counseling groups who will be responsible for the measure's success aren't sure they have enough resources to handle the thousands of mortgages they will be expected to review.

At least 30 states, including Illinois, have predatory-lending laws that outlaw or limit specific loan terms, fees and practices. Such laws target practices including "balloon mortgages," which are payable in full after a period of low monthly payments, and "steering," in which a broker profits by recommending a loan with unnecessarily tough terms. But there still are many abuses, and some lenders have adapted to skirt the laws.

The turmoil in the subprime-mortgage market may temporarily suppress the riskiest loan provisions, says Geoff Smith, research director of the Woodstock Institute, a Chicago-based research organization focused on housing and economic-development issues. But in the long term, he says, "you need strong consumer protections because eventually the market will correct itself, and people will start to make speculative loans again and take much more risk."

The original law, known as HB 4050, was promoted by Illinois House Speaker Michael Madigan. "Counseling clearly works," he said. "Our goal is to stop the abuse of unsophisticated people."

Introduced at the end of the 2005 legislative session, HB 4050 was intended as a four-year pilot program. The law applied to loans taken out through mortgage brokers, but not with banks or savings-and-loan associations, which are subject to federal regulation. The law passed May 31, 2005.

The response was vitriolic. Some in the mortgage industry claimed business would dry up in the pilot area. Some community organizers and religious leaders raised concerns about discrimination. At least two lawsuits alleging discrimination and civil-rights violations were filed. In January, Gov. Rod Blagojevich suspended the law.

Frustrated his plan was blocked, Madigan this spring pushed an expanded counseling program as part of a broad new bill to combat predatory lending. It passed Aug. 7.

The bill extends the counseling program to all of Cook County, an area of 5.3 million residents, removing concerns that the original pilot boundaries created an extra hardship for minorities. Among other measures, the bill requires all first-time homebuyers and borrowers refinancing their homes to attend a counseling session if the mortgage contains certain provisions, such as a rate that adjusts within three years or a penalty for borrowers who want to pay down their loan principal ahead of schedule.

One early estimate indicates the new program will cover 19,000 loans each year. However, the subprime mortgage market has changed so drastically in recent weeks it's difficult to gauge how big the counseling program might be next year. Mortgage lenders are currently tightening their standards and eliminating certain types of loans, as fewer investors are willing to hold the riskiest loans in their portfolios.