North Carolina's predatory mortgage lending law: 1999 N.C. Sess. Laws Chap. 332.

THE ACT'S GOALS

* Prohibit prepayment penalties on first-lien mortgages of less than $150,000.

* Prohibit lenders from refinancing an existing home loan when there is no reasonable, tangible net benefit to a borrower (commonly referred to as flipping).

* Require that would-be borrowers of high-cost loans receive financial counseling before entering into the transaction.

* In high-cost home loan transactions, prohibit the financing of fees, balloon payments, negative amortization, and lending without regard to a homeowner's ability to repay. A high-cost home loan is defined generally as a loan with fees in excess of 5 percent, or annual percentage rates over the federal law trigger level, which is currently more than 8 percent above comparable U.S. Treasury securities.

* Prohibit the financing of single premium credit insurance.

* Prohibit lenders from recommending that a borrower who is attempting to refinance a home loan default on an existing loan.

Senate Bill 1149 passed both houses of the North Carolina General Assembly by an overwhelming majority in July 1999. The law addresses unfair and deceptive practices in the prime and subprime mortgage lending industry. Prime loans are granted to people with good credit histories; subprime loans go to individuals with limited credit histories or problem credit.

"Our goal was to protect consumers from abusive practices that can rob them of their homes without restricting consumers' access to credit," says North Carolina Attorney General Roy A. Cooper III, former Senate majority leader who sponsored the law.

FIVE YEARS LATER

Mortgage lenders have been operating under the law for five years, yet there are still questions about how well the law is working for subprime borrowers. Four studies have examined the effects of the law, and each agrees that, overall, subprime loans decreased after the law went into effect. But whether that is because the law is achieving its goal of protecting North Carolina citizens from abusive mortgage lending practices, or merely limiting access to mortgage loans for subprime borrowers remains unclear.

Two studies found that the law is protecting North Carolina citizens from predatory loan practices and two others found that the law restricts the flow of credit in the state.

"The data are good, but not perfect," says North Carolina Commissioner of Banks Joseph A. Smith, in explaining the conflicting results. "There is a good faith disagreement whether having an anti-predatory mortgage lending law is good public policy."

The Center for Responsible Lending (CRL), an organization that supported the new law, came out with the first study concluding that the law prevented abuses in 31,S00 subprime loans and saved borrowers at least $100 million.

Although CRL did find an overall decline in the subprime market, it also found that North Carolina was the sixth most active state for subprime lending in 2000, measured as a percentage of all loans classified as subprime in each state. Furthermore, the percentage of subprime loans to low-income borrowers did not change after the law's enactment. One in every three loans to low-income borrowers (annual incomes of less than $25,000) in North Carolina was subprime, according to this study.

But the Credit Research Center at the McDonough School of Business at Georgetown University arrived at a different conclusion: The North Carolina law did limit access to mortgage loans for higher-risk borrowers (down 14 percent after the law was enacted), and any reductions in predatory mortgage lending occurred at the expense of legitimate home loans. There were no corresponding declines in comparison states, and the declines only occurred among lower-income borrowers, according to that study.

The Center for Community Capitalism (CCC) at the University of North Carolina at Chapel Hill's Kenan-Flagler Business School weighed in arguing that an overall decline in subprime lending should have been expected since the purpose of the law was to reduce such loans with abusive terms. Its study found that the total number of subprime loans did decline, but that was due to a reduction in the number of refinance loans.

The study also found that there were approximately 2,800 fewer loans with prepayment penalties. Loans with balloon payment clauses and those loan-to-value ratios greater than 110 percent also declined. Subprime purchase loans actually increased, according to the study.

"The study shows that since the North Carolina law went into full effect, the subprime market has behaved just as the law intended," says Michael A. Stegman, director of CCC.

"The number of loans with predatory characteristics has fallen without either restricting access to loans to borrowers with blemished credit or increasing the cost of these loans," he says.

YET ANOTHER STUDY

The Mortgage Bankers Association contracted a study that found that fewer loans are granted in low-income neighborhoods to purchase or refinance a home loan, and fewer refinance loans are given in predominately minority neighborhoods than before the law. This study found that North Carolina lenders did not keep pace with lenders in Tennessee and South Carolina in subprime refinance loans.

"The study reveals, vis-a-vis the anti-predatory lending bill, the North Carolina legislature has imposed a modem-day form of redlining on its citizens by choking off mortgage credit to minority and low-income neighborhoods," says MBA Chairman Robert M. Couch, president and chief executive officer of Birmingham, Ala.-based New South Federal Savings Bank.

"Despite the good intentions of its supporters, the North Carolina law has choked off credit to large numbers of North Carolina residents," he says. "We know fraudulent operators exist, and we abhor abusive lending practices. While no one has been able to quantify the size of the abusive lending problem, beyond citing anecdotes, this study shows that the size of the problem was nowhere near the size of the reduction in lending that has taken place in North Carolina."

State bank commissioner Smith argues that the law has successfully eliminated abuses without reducing liquidity in the marketplace. "I have yet to hear a single person in North Carolina complain that they were unable to get a loan. And, if credit was drying up in the state, then legislators would be hearing about it from their constituents."

THE FEDERAL IMPACT

Because of a federal rule issued by the Office of the Comptroller of the Currency in January that preempts state laws as they apply to national banks and their subsidiaries, analyzing the impact of North Carolina's law becomes more difficult. Now, national banks are subject only to federal laws, which are substantially less restrictive than state laws such as North Carolina's. Several states have extended the preemption to state-chartered banks to level the regulatory field between state chartered and federally chartered financial institutions. At this point, the North Carolina law only applies to non-bank companies and banking affiliates.

"The success of our predatory lending law and similar laws in other states is now threatened by these new federal banking rules. These rules intend to keep national banks and their subsidiaries from having to comply with state laws that curb predatory lending," says Attorney General Cooper.

Heather Morton covers banking and financial services for NCSL.