Blown Mortgage

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Housing Wire reported earlier this week that they had received an advanced draft of California Legislation that would rewrite major sections of the California Financial Code to include eliminating negative amortization loans, stated income loans and put major caps on yield spread premiums, pre-payment penalties and balloon payments.

The sweeping changes, not yet announced on the legislature floor, would dramatically alter the lending landscape in California and set a substantial new precedent for future state and federal regulatory changes.

From the article:

In addition to outlawing option ARM mortgages altogether, the bill would essentially eliminate stated-income lending for high-cost, subprime and non-traditional mortgages — the bill’s language says stated income applications must be “verified,” which really means they aren’t stated at all. The bill would also outlaw YSP as a method of compensation for high-cost, subprime and non-traditional mortgages.

The use of YSP in all other mortgages (including, ostensibly, prime originations) would be limited by establishing a rate ceiling of 200 basis points above par, and only permitting the use of YSP whenever it is the broker’s sole form of compensation on a loan.

For high-cost mortgages in particular, the bill would outlaw balloon payments and prepayment penalties, as well as requiring full borrower documentation. The bill would also require certification of third-party counseling “on the advisability of the loan transaction” from a HUD-approved agency prior to origination.

Better Late then Never?

California has been woeful at addressing the housing boom over the last half-decade.  Content to fill the state coffers with ever-rising property tax assesments, the state has done little to curb illegal lending and to enforce the existing real estate and finance law.  As we reported last year the state’s department of real estate employed a 33-person regulatory team to handle more than 500,000 real estate licensees (in California a licensee can sell real estate as well as originate and fund mortgage loans).

Now that the tide has turned they are apparently trying to launch the most comprehensive reform in the country.  Of course, this reform could only be supported by a massive surge in enforcement funding; and with the state looking at massive debt issues already, the likelihood of seeing ample enforcement for this type of initiative seems scant at best.

Revisions to New Mortgage Legislation are a Given

It is probably safe to say that a law as sweeping as the one proposed will be emasculated by various special-interest lobbies and assemblymen with ties to financial institutions; however, there is some precedent for the elimination of stated income loans in Minnesota and Colorado that may get that piece through.  Undoubtedly this legislation will get through in one form or another as legislators from the heavily-affected areas of the state will want to do “something.”

More Pain for the California Housing Market

What is for certain is that passage of this type of legislation will exacerbate the fall of California real estate value - steepening the slope of its current decline.  In a state where Countrywide and other lenders have underwritten the bulk of their option arm and stated income mortgages eliminating those products would further reduce the qualified buying pool of people able to afford the inflated prices seen throughout the state.

It would also cut off refinance options for people in those loan types when they begin to “explode” at the end of their teaser-rate and neg-am terms on their current loans.  Even with some mitigation via the increased federal conforming loan amount and FHA programs a large portion of homeowners in these type of loans will not be able to qualify for new financing under these new guidelines.

This can only portend more pain for the California housing market.

A Needed Change?

There is no doubt that some curbing of the lending practices in California is required; however, legislation like this will send the market reeling.  It is incumbent upon legislators to look closely at all laws enacted to ensure that existing laws that are on the books are inadequate to meet the demands of there new requirements.  I personally believe that many of the existing laws could handle the majority of the abuses we’ve seen over the last boom with proper enforcement.  It is shameful that a state with 500,000 licensees has a regulatory staff of 33.  We’ll see how the new bill addresses enforcement.

Federal Institutions Affected?

Of course the state-licensed folks first question will be “what about the federally chartered banks?”  Housing Wire doesn’t address the topic in their article; but I would imagine that federal institutions would claim exemption under superceding federal laws.  As brokers and mortgage banks peter-out; a sweeping reform such as this one without concomitnat impact on federal entities would further tip the balance of power to the big banks.

If the new bill goes for all funding in the state regardless of entity the next question will become reporting requirements and other mandated expenses to stay in compliance with new laws.  It’s anyone’s guess at this point.

Stay Tuned

No doubt, this bill will get plenty of attention when brought to the state senate floor.  We’ll be on top of it as its implications go far beyond lending in California.  They could certainly set the stage for lending regulation across the country.

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