Blown Mortgage

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The California Senate took a step towards tightening lending requirements for those that conduct business in the state by overwhelmingly approving bill SB 385 which calls for the adoption of the federal guidelines when providing non-traditional mortgage products (such as interest only, negative amortization and 2nd mortgage loans).

The bill boils down to ensuring that the DRE, DOC, and DFI (all who govern mortgage lending in California) [ASIDE: Do we really need 3 separate entities tracking down this problem?  Does this seem like inefficiency, bureaucracy and wastefulness at its deliciously ridiculous peak? I digress.] implement the following guidance to all of their respective licensees.  The legislation calls for the following:

1. Financial
   institutions’ analyses of borrowers’ repayment capacity should include an
   evaluation of the consumer’s ability to pay the fully indexed rate, not just
   the initial low introductory rate;

2. Institutions
   should avoid underwriting practices that will heighten the need for a borrower
   to rely on the sale or refinancing of the property once amortization begins;

3. Higher pricing of
   loans should not replace the need for sound underwriting;

4. Second mortgages
   with minimal or no owner equity should not have a payment structure that allows
   for delayed or negative amortization unless the risk is mitigated;

5. Institutions with
   high concentrations of nontraditional products should have good risk management
   practices and capital levels commensurate with risk; and,

6. Institutions that
   offer nontraditional mortgage products should inform the consumer of all
   possible risks in a clear, balanced and timely manner.

Let’s take a look at what this all means to those that transact mortgage business in my home state of California.

1. By requiring the lender to qualify the borrower to repay the fully amortized payment on negative amortization ARMs (and any ARM products for that matter) you’ll see a large drop-off in large loan amounts.  The large loan amounts, particularly in California, are at massive income multiples.  The prices are supported by these "affordability" loans.  This could eliminate credit to many people who currently enjoy homeownership on "affordability" loans.  It will however help reduce some of the foreclosure issues due to ARM resets.  It brings up an interesting quandry for current homeowners.  Say you qualified for your home loan (a short-term 2yr ARM) on the teaser rate.  Now, you have to refinance as the ARM becomes adjustable.  Under the new guidelines you’d be unable to qualify for the higher (fully indexed payments) so what do you do now?  I think it will place incremental pressure on the market by forcing people to sell homes that are too expensive for them based on true income.
2. This is a no-brainer.  These 2yr ARMs and negative amortization products factored home appreciation in to the equation.  2yr ARMs are known as a "mortgage broker’s annuity" in the industry.  It will again limit the amount and type of affordability ARM loan products out there.
3. This again makes sense.  No income documentation loans were simply priced higher to pay the lender the premium for the increased risk; but it did little to ensure that the person getting in to the loan was protected just like the lender was.  It will be interesting to see how this is implemented however.  Where do sound underwriting and no documentation intersect?  Isn’t that an oxymoron of the first degree?  This either points to an elimination of certain NINA products or a revamp of what reduced documentation loans mean.
4. blah
5. Another duh.  I think it has to start with financial institutions not counting equity acquired through negative amortization deferrment as profits.  Does anyone else have a problem with this accounting practice?  Just because the home is assigned a number doesn’t mean that the equity in that home goes directly to the bank’s bottom line.  That’s a good place to start if we’re talking about soundness and risk management.  Further I believe that companies that offer high LTV and negative amortization loans should have higher reserve requirements than those that don’t.
6. More disclosure is going to be tough.  These are complicated products with many options.  Making them easy to understand while fully disclosing everything is difficult.  My company has started issuing a non-traditional mortgage document that explains interest only and negative amortization loans in easier-to-understand language.  The whole disclosure practice needs to be revamped to make sure that the information is getting to the customer in a usable way - not in a manner that is overwhelming.  No one does well drinking from a fire hose.

In the end legislation is not the only answer.  These financial institutions need more money and more resources for ENFORCEMENT.  The existing laws that we have are good - they are just woefully enforced.  When the agencies are given the money and resources to enforce laws only then will we see an improvement in the type of loans being issued.  A perfect example of this was Quick Loan Funding who had 33 complaints against them with the California Department of Corporations but were never audited because the volume of complaints was not enough.  The DOC and other institutions need money so they can do their job of enforcing laws - not just administering new laws with out any teeth behind them.

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