Effort to Advise on Risky Loans Runs Into Snag

CHICAGO, June 7 - With a growing number of homeowners running into problems paying their mortgages, Illinois came up with an idea to protect people like Cassandra McKinney from lenders - and themselves.

Skip to next paragraph Multimedia Graphic Mortgage Troubles

A single mother and a homeowner on the city's south side, Ms. McKinney briefly entertained the idea of taking ,000 of equity out of her home to pay off debts, at an initial interest rate of 9.5 percent, sharply higher than her existing mortgage. But after attending a new mandatory state program to counsel borrowers on their mortgages, she realized the loan was too expensive and unnecessary.

"The counseling helped me understand that this was on the excessive side," said Ms. McKinney, a project manager for a telecommunications company.

It sounds like a success story. But in January, with the program in place a little more than three months, Gov. Rod R. Blagojevich suspended it after critics complained that the government was wading too deeply into the personal financial lives of its citizens.

Mortgage brokers, real estate agents and minority community leaders said that the effort, while well intentioned, put a damper on real estate transactions in the largely black and Hispanic neighborhoods in southwestern Chicago where the program operated. This amounted, they further argued, to redlining.

Now the state is considering expanding the counseling to all of Chicago and its suburbs to avoid charges of racial discrimination. But that too has been challenged by industry officials as unnecessary meddling that will severely slow real estate transactions.

Illinois' approach raises questions about how far lawmakers and regulators can go in trying to safeguard consumers from risky and expensive home loans before they are seen as overly intrusive.

So far, discussions in Washington and elsewhere have focused mostly on what should be done to help homeowners in foreclosure and how to rein in aggressive mortgage lenders. Illinois has been largely alone in focusing on trying to make sure borrowers fully understand the debts they are taking on.

Housing counselors, who supported the initial phase of the program, say it saved people like Ms. McKinney from taking on large debts on onerous terms. But they added that many financially pressured borrowers went ahead with loans even after excessive fees and interest rates had been clearly explained to them.

Critics, however, asserted that the counseling was yet another hurdle borrowers had to surmount. Brokers also said that the program was at best a half-measure because it did not cover loans made by federally chartered banks that the state could not regulate.

The plan's first iteration applied only to borrowers in 10 ZIP codes that had experienced the most significant increases in foreclosures. Borrowers with low credit scores or people who were taking out certain exotic mortgages were required to talk with a federally certified housing group. About 1,200 loans were vetted before the program was suspended.

Now, the state is retooling the program to include all of Cook County, which encompasses Chicago and many of its suburbs. Under the proposal, first-time home buyers and borrowers who are refinancing would be referred to counseling only if they selected certain loans like adjustable-rate mortgages that reset in five years or less, or loans that initially require only interest payments. A state agency is drafting the rules, which must be approved by a committee of lawmakers.

Even as that process plays out, the Illinois General Assembly is considering legislation that would enshrine the new counseling rules in law. In addition, the bill would require mortgage brokers to act in their clients' best interest and bar state-regulated lenders from making loans without verifying borrowers' income with tax returns, paycheck stubs or other documents.

The counseling sessions provide a rare and revealing window into lending to people with weak, or subprime, credit. Borrowers in this world are often in a financial bind, and loan brokers and officers who deal in these mortgages typically earn hefty commissions and know much more about the loans than their clients.

A report compiled by an advocacy group, Housing Action Illinois, shows that the majority of borrowers who were about take on adjustable-rate mortgages believed that they had fixed-rate loans. More than two-thirds of the borrowers were spending more than 60 percent of their take-home pay on housing expenses. And 75 percent of the borrowers were refinancing existing debts; the rest were buying a home.

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