"Predatory Lending: Undermining Economic Progress in Communities of Color,"by Mike Calhoun & Nikitra Bailey January/February 2005 issue of Poverty & Race
Only a few years ago, one of the most notorious and pernicious practices in American lending was redlining – the practice of systematically restricting mortgage lending in minority communities. Redlining served as a major barrier to homeownership and wealth among communities of color. Today, access to credit has improved, but race still matters in a lending environment where abusive lending practices are rampant. Predatory lending restrains economic progress among vulnerable communities and helps preserve a troubling and persistent wealth gap between whites and people of color.
Predatory lending occurs when loan terms or conditions are abusive or when borrowers who could qualify for credit on better terms are steered into higher-cost loans. This type of abusive lending has found fertile soil for growth in today’s two-tiered, separate-but-unequal financial services system. Wealthier borrowers, mainly white, are served by banks and other conventional financial institutions. Lower-income borrowers and persons of color are targeted by higher-cost lenders, including subprime mortgage lenders, check cashers, payday lenders and other fringe bankers.
Not all of these lenders are predatory, but nearly all predatory lending occurs in these markets. In some cases, lenders find ways to circumvent existing consumer protection laws. In most cases, current federal law provides insufficient protections against abusive practices.
A number of states have enacted anti-predatory mortgage lending laws in response to unscrupulous mortgage lenders who engage in lending practices that fall just below the thresholds set in 1994 by the federal Home Ownership and Equity Protection Act (HOEPA). In 1999, North Carolina became the first state to do so, and its landmark legislation became a model for many other state anti-predatory mortgage lending laws. The North Carolina law, which reflects a consensus built among bankers, consumer advocates and civil rights leaders, provides meaningful protections for high-cost loans while preserving access to credit.
Today, such state laws are in danger of being preempted by weaker national legislation. Several proposals were floated in Congress during 2004, including a bill sponsored by Representative Robert Ney (R-Ohio) that seeks to override existing state laws and, on balance, weaken existing protections for borrowers.
If Congress revisits the issue of predatory lending, the stakes will be high for borrowers in the subprime market. The Center for Responsible Lending (CRL) estimates that predatory lending of all kinds costs low-income borrowers over $16 billion each year — comparable to the amount spent by the U.S. government on funding for Community Development block grants, Head Start and public housing programs combined. A disproportionate number of these borrowers are African-Americans, Latinos, women and rural residents. As described below, the majority of the money siphoned from these communities occurs in the subprime mortgage market and through payday lending.
The Wealth–Ownership Connection
In America, wealth (versus simple income) is critical to a family’s economic stability and security. The wealth gap between whites and people of color is well established and growing. According to a recent report by the Pew Hispanic Center, in 2002 African-Americans and Latinos had respective median net worths of $5,998 and $7,932 — shockingly low, all the more so compared to whites’ median net worth of $88,651. Moreover, the figures for African-Americans and Latinos represent a decline from their median net worth levels in 2000, which were $7,500 and $9,750, respectively, compared to $79,400 for whites.
Homeownership is one of the most reliable and accessible ways for economically disadvantaged populations to close the wealth gap and obtain a secure position in the middle class. However, despite homeownership gains in recent years, less than 50% of African-American and Latino families have achieved homeownership, compared to roughly 75% of white families. This gap is significant, especially given the importance of home equity as a component of wealth. For example, when home equity is excluded from 2000 data, the median net worth of African-American and Latino families drops drastically, down to $1,160 and $1,850, respectively. In other words, of the wealth that African-Americans and Latinos possess, nearly two-thirds consists of home equity, compared to only one-third of the wealth of white Americans. These figures illustrate the fragile financial position of families in communities of color, and also the vital importance of home equity to their wealth.
Predatory Mortgage Lending
Because of pervasive predatory mortgage lending practices, the slender home equity gain made in communities of color is under attack. Unscrupulous lenders operating in the subprime mortgage market target the most vulnerable borrowers for costly refinances that strip home equity while providing no net benefit. CRL estimates that predatory mortgage lending costs borrowers approximately $9.1 billion every year.
The threat posed by predatory lending is severe. Home equity is the only savings account that many low-wealth families possess. The rise in homeownership among women, African-Americans and Latinos has resulted from great effort and sacrifices. This progress can be wiped away quickly by unscrupulous lenders who strip equity savings in order to collect exorbitant fees, lock borrowers in over-priced loans and close access to the judicial system through mandatory arbitration requirements.
African-Americans and Latinos are overrepresented in the subprime mortgage market and have borne the brunt of abusive practices. According to a 2004 study published by ACORN, African-Americans were 3.6 times as likely as whites to receive a home purchase loan from a subprime lender and 4.1 times as likely as whites to receive a refinance loan from a subprime lender in 2002. In 2002, for both home purchase and refinance loans, Latinos were 2.5 times as likely as whites to receive a loan from a subprime lender.
These figures are even more disturbing when one considers the high prevalence of “steering” and “push marketing.” Predatory lenders are known to steer borrowers into subprime mortgages, even when the borrowers could qualify for a mainstream loan. Vulnerable borrowers are subjected to aggressive sales tactics and sometimes outright fraud. Studies show that 30-50% of borrowers with subprime mortgages could have qualified for loans with better terms. This point is further illustrated by joint U.S. Department of Housing and Urban Development - Treasury Department research showing that upper-income African-American homeowners in predominantly African-American neighborhoods are twice as likely as low-income white borrowers to have subprime loans.
Similarly, borrowers in rural areas appear to be more vulnerable to predatory lenders. A recent CRL study showed that rural borrowers are more likely than similar urban borrowers to have subprime mortgages with prepayment penalties imposed for three years or longer. Such penalties force borrowers who later qualify for more affordable loans to give up equity or remain trapped in a higher-cost mortgage. Preliminary research by CRL shows that prepayment penalties occur disproportionately in zip code areas with a higher concentration of minority residents. When finalized, the study will contribute to growing evidence that predatory lending imposes proportionately higher economic burdens on the most vulnerable communities.
Payday Lending — Who Pays?
Payday lending is another form of predatory lending that greatly affects communities of color. This type of lending, sometimes called cash advance, is the practice of making small, short-term loans (typically two weeks or less) using a check dated in the future as collateral. Usually borrowers cannot repay the full loan amount by their next payday, so they are forced to renew the loan repeatedly for additional two-week terms, paying new fees with each renewal. Over 5 million American families are caught in a cycle of payday debt each year, paying $3.4 billion in excess fees.
Payday lending targets people with steady but limited incomes, such as service workers, soldiers, government employees, clerical workers and retirees. According to a study published by researchers at North Carolina A&T State University, payday lenders tend to locate in urban areas with high minority concentrations. A recent analysis by the New York Times reveals that at least 26% of military households have been caught up in payday lending. This has strong implications for African-Americans and other non-white groups, since people of color make up well over one-third of enlisted military personnel.
Payday lending is generally marketed as quick cash for a short-term emergency. However, only 1% of all loans go to one-time emergency borrowers. The typical structure allows only two weeks for repayment, fails to consider the borrower’s ability to repay, and operates on back-to-back transactions that can easily confuse borrowers into believing they are receiving additional funds when they actually are paying fees repeatedly on the same loan principal.
CRL research shows that borrowers who receive five or more loans a year account for 91% of payday lenders’ business. The fees are high, but it is the debt trap that makes payday lending a faulty form of credit and a poor substitute for legitimate banking services in communities of color.
Access to healthy credit contributes to sustainable prosperity; destructive debt and equity-draining loans impose hardships on families and ultimately harm entire communities. Greater awareness of predatory lending and increased focus on financial education are helpful, but education campaigns alone are not enough. Borrowers need strong protections eliminating most predatory lending before it happens.
A number of states are successfully addressing predatory lending issues through laws that curb specific abusive practices while preserving access to credit in the subprime market. Federal legislation that nullifies these existing laws would seriously impair progress already made. Any new national mortgage legislation should provide a floor, not a ceiling, on consumer protections. It should eliminate excessive fees, broker kickbacks, “flipping” and abusive prepayment penalties. It should also require mandatory counseling for all high-cost loans and preserve a borrower’s ability to seek legal remedies in a court of law. Advocates and concerned citizens can play a key role by urging their representatives to oppose the Ney bill referred to above (H.R. 833) and support legislation that preserves state laws and strengthens protections, such as “The Prohibit Predatory Lending Act” (H.R. 3974), sponsored by North Carolina Representatives Mel Watt and Brad Miller.
As long as predatory lending is permitted, much of the economic progress made in communities of color will be largely wiped out. To the extent that families own property, they have many more options and opportunities to build a better future. To the extent that hard-earned equity and other assets are stripped away, opportunities vanish, and the negative ripple effects are passed down to the families’ future generations and the wider communities in which they live.
Mike Calhoun is General Counsel for Self-Help and the Center for Responsible Lending: he was a lead drafter of North Carolina's landmark predatory lending law. firstname.lastname@example.org
Nikitra Bailey is a Policy Associate for the Center. email@example.com
The Center for Responsible Lending (www.responsiblelending.org) is a national nonprofit, nonpartisan research and policy organization in Durham, NC, dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. It is affiliated with Self-Help, one of the nation's largest community development financial institutions.
See Why the Poor Pay More: How to Stop Predatory Lending, ed. Gregory D. Squires (Praeger, 2004).
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