Blown Mortgage

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A recent post “Dead Man Walking” highlighted the quiet moves that banks had made to slowly abandon the wholesale business model as a flight to quality through retail originations. There was some heated debate and the general consensus was that while wholesale will be reduced it will never be eliminated as part of the home financing firmament. While I still feel that brokers are the home loan ‘dodo’ I could see the validity of arguments being made for retaining the wholesale model. However, if the newest proposed legislation from Barney Frank (D-Mass) titled “The Mortgage Reform and Anti-Predatory Lending Act of 2007” passes brokers will be under extreme duress to continue operating. In an earlier post I promised a more in-depth review of the legislation; and here it is.

Section 102 - Licensing for All Mortgage Originators

The bill calls for the licensing of all mortgage originators either on the state or federal level as well as providing that unique originator’s ID on all relevant loan documents associated with loan files originated by that licensee. It does not stipulate how all mortgage originators will be licensed or whether it will fall under state or federal jurisdiction which could get messy. As I’ve voiced here before, a national registry similar to the NASD (National Association of Securities Dealers a/k/a stock brokers) is a model that seems to be working and could easily be replicated across the mortgage origination field.

The section does not create a fiduciary responsibility which is something that groups like the Ethical Lending Foundation have been pushing for; but does call for the originator to act in the best interest of the borrower. To learn more about fiduciary relationships listen to my podcast with Jillayne Schlicke, founder of the Ethical Lending Foundation.

My Take: National licensing or registration is a great idea; doling it out to the states is not. State licensing is a disaster as it sits right now; and trying to upgrade the disparate systems will be nightmarish. A national level registry privately funded by mortgage companies on behalf of new hire employees is the way to go. It minimizes government overhead and expense to the public while providing a necessary oversight agency self-funded by the industry. A big win for all around in my opinion.

Fiduciary responsibility is a completely different animal. You have those that argue for and against. I say that those that want to be fiduciaries should have that opportunity; but should all originators be held to a fiduciary standard? I’m leaning towards yes on that one as well. Unless someone can give me a good reason why mortgage originators should not carry fiduciary responsibility I’m going with the argument that this section of the bill doesn’t go far enough to improve the quality of the relationship between originator and borrower.

Section 103 - Anti-Steering

Here’s where brokers need to take notice and realize that this bill will effectively eliminate your ability to make any compensation on mortgage loans from banks based on the terms of the loan. This includes the elimination of yield spread premium (YSP). Brokers can still finance closing costs, but will no longer be allowed to charge YSP on loans.

There is no clear language in the document about either brokers making a fixed spread on interest rates (a la correspondent lenders) and/or banks charging undisclosed YSP or SRP upon sale of the loan to a securitizer, etc.

My Take: This is disastrous section for brokers. With out the ability to make yield spread premium brokers will be unable to offer low and no-cost loans to compete with similar offers from banks and correspondent lenders that don’t need to disclose YSP. Obviously this depends on what the bill qualifies as a broker vs. correspondent lender, and if the bill specifies whether SRP and other related interest rate premiums are included in the definition of YSP. Alas, the breakdown of this bill is woefully inadequate in that department.

Further, this could be inadvertently disastrous to consumers who will be unable to find no-cost financing through brokers and be subject to hidden YSP and SRP charges at the bank level resulting in higher rates paid on no-cost loans. It could squeeze consumers a second way as well. If fees are only allowed to be financed at a time when home prices are dropping precipitously in relation to existing loan balances fewer home owners will qualify for financing from brokers because the costs of a new loan financed with existing mortgage debt will be higher (and potentially outside of current loan-to-value limits) than they would be if closing costs were covered out of YSP.

I agree with the principle behind the banishment of YSP; it is hard to think of too many industries where you are financially rewarded for giving customers less-than-optimal product qualities, but this move could backfire on consumers who suddenly find themselves faced with higher interest rates on no-cost loans. To my second point the elimination of YSP is essentially wiping out up to an additional 5% of home equity in any refinance transaction as fees will need to be financed in to new loan amounts. Does Barney Frank want to take your home equity from you? It seems like it to me.

There has to be a better way to handle this problem, and I believe it is with transparency in the lending process. Let borrowers clearly see the YSP for all institutions and make a nice clear document which shows available interest rates at available premiums. Let them choose the best combination between rate and fees, have them sign it and include it as part of the loan file. That way consumers can choose the best solution for their particular situation, novel idea, right?

Section 105 - Enforcement

This section triples the existing penalties for violations under the Truth in Lending Act (TILA) from one-year imprisonment to three years and up to 3 times the total fees charged by the originator plus attorney’s fees in any monetary damages settlement.

My Take: It’s not how strongly worded the law is, it’s how strongly enforced the law is. We have good laws now that are woefully enforced. This law changes nothing with out proper enforcement.

Title II - Section 201 The Ability to Repay

This section states that all loans should be made on the verified basis of the borrower’s ability to repay the loan. It essentially eliminates stated and no income type loans. From the bill summary:

Provides that no creditor may make a residential mortgage loan unless the creditor makes a reasonable and good faith determination based on verified and documented information that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan (including all applicable taxes, insurance, and assessments).

Further it legislates that borrower ability to repay on all adjustable rate mortgages and exotic mortgages be calculated at the fully indexed rate at the time of underwriting.

To calculate monthly payments for principal and interest, creditors will make certain assumptions set forth in the legislation (including that the interest rate is a fixed rate equal to the fully indexed rate at the time of the loan closing).

My Take: I’m going to take some heat from this, but I don’t have a problem with either one of these items. The argument that stated income loans are good for self-employed people who use legal tax breaks to reduce their effective income for tax purposes (and therefore don’t qualify using their documented income) is a thin argument at best. Instead of allowing stated loans then (which have clearly been abused) why aren’t new underwriting guidelines established for self-employed people? Let’s fully document those loans and give them an allowance for written-off items as a credit to real income. This factor can be determined by Fannie or Freddie and used across the board.

We eliminate the abuses of the stated income products and still help self-employed people qualify even after their expenses - everyone wins, right?

Section 203 - Safe harbor and rebuttable presumption

The safe harbor provision allows securitizers of mortgage loans to rest easy regardless of the performance of the actual loan as long as the securitizer has bought loans for packaging from firms making loans that fall under a safe harbor. This will be explained below in an upcoming section about assignee liability; which is a big deal. But this section says that if securitizers buy loans that fit the safe harbor provisions that they will be exempt from liability claims from borrowers.

My Take: This is a fine regulation as it is intended to provide a reduction in oversight on the securitizers end vis-a-vis the representation that the seller makes to the securitizer. Safe harbor is a good idea; but its need is not - I’m no fan of assignee liability, and we get to that right…now.

Section 204 - Securitizer liability

For loans that violate the minimum standards for reasonable ability to repay and net tangible benefits as set forth by regulation, a consumer has an individual cause of action against assignees, including securitizers, for rescission of the loan and the consumer’s costs.

This consumer rescission is only valid if the securitizer does not modify the loan within 90-days or provides proof that the loan fit the safe harbor guidelines.

My Take: What a disaster. Individual homeowners can sue the person that bought the loan at any point in the loan life span to be let out of the contract. So let’s look at this. A bank decides to buy a loan that has been done with stated income (no documentation) with a loan application that is signed by a borrower stating that “the above information is correct and true under penalty of law” and if that stated income is false (even with the borrower’s knowledge) the BUYER of the mortgage is responsible? This doesn’t make much sense to me. Sue the seller of the mortgage for fraud, prosecute the borrower for fraud, but sue the buyer?

In a stated income loan that goes bad isn’t the buyer the big loser here? Aren’t they the ones left holding the bag? The homeowner is out of the property with a foreclosure but can still get financing in a few years; the buyer of the loan takes the loss - even if they were defrauded by the homeowner in the first place. Where is the logic in this? The homeowner lies on a stated income loan, and because the buyer of the mortgage has been defrauded intentionally by the borrower in regards to their ability to repay the buyer of the mortgage is liable? Seriously? I feel like I’m taking crazy pills.

Section 206 - Additional standards and requirements

This section prohibits the use of prepayment penalties that fall outside of the guidelines of section 203 in terms of the ability to repay the mortgages and requires that all loans facing adjustable rate periods have penalties that expire at least 3 months prior to the first adjustment.

My Take: This will certainly drive interest rates up; and doesn’t it seem a bit twisted to only allow prepayment penalties on those who can actually afford the mortgage via fully documented underwriting? It’s like “feel free to penalize the responsible, well-qualified folks, but no penalties on the people who use bogus income to qualify and are likely to default.” Is there common sense anywhere in this world? To me it should be reversed. Risky loans should have penalties in place to afford the lender some protection against a riskier investment. The plain-Jane loans should be the ones with the most favorable terms - am I missing something here?

Title III - Section 301 High Cost Loans

This section is an important one for brokers when tied in to the no YSP provision as this lowers the trigger for high-cost loans from 8% under HOEPA and Section 32 to 5%. It also puts in a trigger for prepayment penalties.

Lowers the points and fee triggers from 8% to 5% for most loans. Establishes a third trigger for loans with prepayment penalties that exceed 2% or 30 months duration. Expands the definition of points and fees to include all compensation paid directly or indirectly by a consumer or creditor to a mortgage broker from any source (including table-funded transactions), certain insurance premiums, prepayment penalty charges under the loan, and prepayment penalties actually charged in a refinance by the original lender or the original lender’s affiliate.

My Take: Eliminate YSP and reduce the tolerance for triggering high cost loans and you have the recipe for eliminating mortgage brokers. With the costs that go in to calculating high costs you’ll be hard pressed to find much room for loan origination for a mortgage broker.

In summary I think that Mr. Frank’s bill has decent intentions but does a bungling job of trying to execute on those intentions. The YSP and high-cost loan consequences would be disastrous to the broker community; stamping out competition and increasing the costs of borrowing money for homeowners while simultaneously eroding their equity with each refinance transaction. While I am no fan of brokers, I am a fan of competition and this legislation, coupled with the recent move by the banks away from wholesale is just another nail in the coffin for the broker-model.

Mr. Frank hopes to have this out of committee and in front of the House for a vote within 3 weeks; then it would be on to the Senate. Expect a vigorous debate from all corners of this issue.

What do you think?

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