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Chapel Hill, N.C. — Anti-predatory lending laws enacted by some states in the past decade to protect consumers from abusive and unfair mortgage practices saved many people from losing their homes during the foreclosure crisis, according to new research findings from the UNC Center for Community Capital.

But their impact was undermined by the action of federal regulators who preempted state laws in 2004, exempting national banks from the tougher state laws. As a result of preemption, foreclosures and riskier lending increased significantly among the exempt lenders, the center’s research shows.

“Our research confirms that state consumer protection laws work, but that when one group of lenders is handed a regulatory free pass, they are going to take advantage of it,” says Center for Community Capital Director Roberto G. Quercia. “In this scenario, unfortunately, we see preemption shifting the activities of federally insured banks to riskier activities than they would otherwise have pursued.”

The research findings are the result of two companion reports that offer the first comprehensive look at loan quality and performance following the federal preemption of state laws in states with and without strong anti-predatory lending laws.

One report, “The APL Effect: The Impacts of State Anti-Predatory Lending Laws on Foreclosures,” examined the quality of loans in states with and without these laws, controlling for a wide range of borrower, neighborhood and economic characteristics. The research team’s findings were consistent whether the comparison was done at the loan level or at the neighborhood level:

  • States with strong anti-predatory lending laws exhibited significantly lower foreclosure risk than other states. A typical state law reduced neighborhood default rates as much as 18 percent.
  • Loans made by lenders covered by tougher state laws had fewer risky features and better underwriting to ensure that borrowers could repay. For instance, borrowers in states with strong anti-predatory lending laws were 13 percent less likely to receive loans with prepayment penalties than borrowers elsewhere.

Risky features include prepayment penalties, balloon payments, interest-only loans or negative amortization (those that lower monthly payments to a point that causes the loan balance to increase rather than decrease). Research shows that these types of features contribute to higher default rates.

A second report, “The Preemption Effect: The Impact of Federal Preemption of State Anti-Predatory Lending Laws on the Foreclosure Crisis,” analyzed data from 2.5 million mortgages before and after federal preemption in states with and without anti-predatory lending laws. After controlling for other factors that could have caused higher loan default rates and isolating the impact of preemption, center researchers found that:

  • Mortgage defaults increased significantly more among exempt OCC lenders in states with strong anti-predatory lending laws than lenders that were still subject to tougher state laws. For instance, default rates of fixed-rate refinance mortgages exempt OCC lenders made in 2004 were 41 percent more likely to default and fixed-rate purchase mortgages 7 percent more likely to default than those they made before preemption. Further, mortgage default rates for exempt OCC lenders increased as much as 20 percent more after preemption than those made by independent mortgage companies, which remained subject to state laws.
  • Risky lending also increased among OCC banks because of preemption. Before preemption, 11 percent of the fixed-rate refinance loans made by OCC lenders in states with anti-predatory lending laws had at least one risky feature. After preemption, in 2005-2006, 29 percent of those loans had risky features.

Taken together, the findings from these studies show that state laws provided an important level of consumer protection, reducing the origination of loans with risky terms and reducing the risk of default. Conversely, preemption of those laws resulted in higher rates of default and riskier lending among exempt lenders, researchers said.

The findings come as Congress prepares to enact sweeping financial system reforms and determine whether federal regulators can continue exempting its lenders from tougher state regulations.

“Policy makers should understand the damage caused by the ill-conceived policy of preemption as they work to create an effective federal regulatory system,” Quercia said. “The results clearly indicate that financial reforms aimed at lessening the risk of systemic failure in our financial system must include as a key component the ability for states to enact tougher consumer protections for their markets beyond those provided by any federal regulatory floor.”

The studies are funded by the National State Attorneys General Program at Columbia University.

Home ownership finance is a key area of research and analysis for the UNC Center for Community Capital, the leading center for research and policy analysis on the transformative power of capital on households and communities in the United States. The center, part of the University of North Carolina at Chapel Hill’s College of Arts and Sciences, provides in-depth analysis and research to help policymakers, advocates and the private sector find sustainable ways to expand economic opportunity to more people, more effectively. For more information, visit


Topics(s): Affordable Homeownership, Consumer Protections, Financial Inclusion, Mortgage Finance
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