Low-income lending doubles from 1993 to 2000

(Editor's Note: The following is ex-cerpted from the remarks of Federal Re-serve Board Governor Edward M. Gramlich's March 1 speech to the Na-tional Community Reinvestment Coali-tion at NCRC's 11th annual conference in Washington, D.C.)

The National Community Reinvest-ment Coalition has been one of the strongest supporters of (the Community Reinvestment Act). As you know, the four banking agencies are working through various issues in this year's review of the Community Reinvestment Act regulations.

In recent years, March has become as-sociated with March madness college basketball. As every participant in the NCAA office pool knows, a good team must have an offense and a defense. In the world of housing finance, the Com-munity Reinvestment Act, your consistent concern, might be thought of as the offense encouraging financial institutions to do more lending to low- and moderate-income borrowers. But we have to worry about defense, too once the loans are made and people settle in their homes, we don't want these houses lost to foreclosure or other forms of forced sale.

For the past decade, the offense has performed very well, spurred by the development of the subprime loan market, along with the Community Rein-vestment Act and the efforts of the Neighborhood Reinvestment Corpora-tion and other groups. Not only has lending to low-income households grown significantly, it has also grown much more than other lending. For example, the number of conventional home-purchase loans to lower-income borrowers nearly doubled between 1993 and 2000, whereas the number of loans to upper-income borrowers rose 66 percent. Over the same period, the number of conventional mortgage loans increased 122 percent to African-American borrowers and 147 percent to Hispanic borrowers, compared with an increase of 35 percent to white borrowers.

But this rise in mortgage credit extended to lower-income households has not come without cost. We have all heard the numerous stories about predatory lending asset-based lending, loan-flipping, insurance packing, fraud and abuse.

Some of these practices are already il-legal. Some can be combated with tighter regulations, and some can be only combated with financial literacy, consumer education, and housing counseling. Again, as you all know, the Congress has given the Federal Reserve a role to play in this process, and we have recently used our rulemaking authority.

HOEPA

Enacted in 1994, the Home Own-ership and Equity Protection Act shines a bright spotlight on loans defined as "high- cost." For these high-cost loans HOEPA bans balloon payments in the first five years, prepayment penalties generally after five years, and a pattern or practice of asset-based lending. Cred-itors must give disclosures in advance of closing, so consumers have a longer time to consider whether to complete the transaction. HOEPA also requires the Federal Reserve to hold periodic public hearings and gives it the authority to strengthen the act with additional rules to prohibit unfair practices.

We issued new HOEPA regulations in December 2001 to curb some of the most flagrant predatory lending abuses without impairing the growth of legitimate subprime lending. Since HOEPA was passed, the number and the value of HOEPA loans have increased just as rapidly as the number and the value of non-HOEPA subprime loans. Because the imposition of HOEPA protections has not impeded the growth of that segment of the subprime market, one can reasonably expect that a modest tightening of the HOEPA terms should not impede it either.

HOEPA defines "high-cost" loans in two ways:

the APR exceeds the rate on a Trea-sury bond of comparable maturity (called the APR spread) by 10 percentage points or more

the points and fees exceed 8 percent of the value of the loan, or $480 (in-dexed with consumer prices).

The Fed is given authority to lower the APR spread trigger from 10 percentage points to 8 percentage points. We did this for first-lien mortgage loans, increasing the share of subprime loans getting HOEPA protection from the estimated present rate of 12 percent to about 26 percent. Because second-lien mortgage loans typically have higher APRs, we did not make a change for second-lien mortgage loans, keeping this HOEPA coverage share of subprime loans at its present level of about 50 percent.

One of the leading sources of concern in the predatory lending area is single premium credit insurance (SPCI), a mortgage insurance product that adds significantly to the cost of the loan, is often included without the consumer's request or even knowledge, and where the insurance coverage often does not last as long as the loan. The Fed placed SPCI in the points and fees test, upping the HOEPA coverage ratios to about 38 percent for first-lien mortgages and 61 percent for second-lien mortgages. But these estimates are static if lenders respond to our change by giving up SPCI and selling mortgage insurance on a pay-as-you-go basis, the coverage shares should fall back toward 26 percent for first-lien mortgages and 50 percent for second-lien mortgages.

Home Mortgage Disclosure Act

HMDA was passed in 1975, preceding the Community Reinvestment Act by two years. It involves data collection banks and other lenders must submit and make available data on race, ethnicity, income, and gender. They must also collect and make available data on loan applications, even if credit is not granted. Just this past month, the Fed revised the regulation that implements HMDA. Our goal was to modernize the reporting requirements in line with developments in the mortgage market over the past 27 years and to minimize the reporting burdens of financial institutions.

To modernize HMDA reporting, we made several changes:

We now require lenders to report whether a loan is subject to HOEPA,

We require nonbank lenders to file HMDA reports if they make mortgage loans that total more than $25 million,

To deal with the increasing rationing of credit by price rather than by outright denials, we require all lenders to report the APR spread over Treasuries of comparable maturity if it exceeds 3 percentage points for first-lien mortgages and 5 percentage points for second-lien mortgages,

We now require lenders to report whether a loan involves a manufactured home for which loans are generally underwritten differently with much higher denial rates.

Financial literacy

Almost everybody who has listened to predatory-lending anecdotes comes away with the feeling that, if consumers really knew what was in their long-term financial interests, the problem of predatory lending would be substantially reduced, perhaps eliminated.

NCRC has a new financial literacy campaign. The Federal Reserve's Com-munity Affairs and Public Information Offices have recently embarked on a national initiative to highlight the importance of financial literacy. The NRC, a publicly funded entity known for its community training and home buyer counseling programs, now offers lending counseling along with alternative sources of loan funds. The American Bankers Association has formed a working group to educate bankers and local communities about predatory lending. Freddie Mac has a program that promotes consumers' understanding of building and maintaining better credit.

Of course, even with all these programs, the remaining challenges are significant. Effective programs will need to combine the training with housing counselors who will analyze prospective loan contracts and give advice to consumers on where to get loans with reasonable terms. But however hard it is to accomplish, financial literacy remains our best defense, and we must develop it.