April 13, 2012
Transactions and Regulatory Committee (lead committee)
Legislative
Homeowners Mortgage Relief Act – Mandatory interest rate reductions in ARMs
This material is for discussion purposes only and has not been approved by the Transactions and Regulatory, Legislative or Executive Committees or the Board of Directors.
Issue:
Should C.A.R. SPONSOR legislation to require all lenders to reduce the interest rate on ARMs (Adjustable Rate Mortgages) to 0.25% above the cost of funds index in the loans?
Action:
Optional
Options:
1. Do Nothing
2. Sponsor legislation
3. Support similar legislation of others
4. Other
Status/Summary:
The Bay East Association of REALTORS
® has requested that C.A.R. "seek a sponsor and support the Homeowners Mortgage Relief and Home Protection Act." The proposal suggested would force an interest rate adjustment on all ARMs in California, and is designed to avoid foreclosures and stabilize values by making home ownership more attractive to home owners.
Discussion:
An adjustable rate mortgage is one whose payments can be changed, usually annually, based on movement up or down of an index or benchmark plus a set amount or "margin." Common interest rate indexes might include LIBOR (London Interbank Offer Rate), a federal Treasury Bill interest rate quoted at a given date each year or some other rate that reflects the cost of borrowing to a lender. An example of such a loan term might be "LIBOR plus 2.5%," which in today's environment would generate an interest rate of 1.05% + 2.5% = 3.55% interest on the mortgage note. If the proposed rule was enacted, this hypothetical loan's rate would drop to 1.40% (1.05% + 0.25%).
Note: APR (annual percentage rate), is often different, especially during the first year, than the simple interest rate because of an esoteric mix of factors used in the calculation. It is designed to give borrowers an ability to compare "apples to apples" when shopping, much like the EPA mileage rating on a new car.
Adjustable rate and adjustable payment loans are already addressed in considerable detail by Civil Code Sections 1916.5 and 1916.7, but no wholesale write-down like this proposal are included. They may also be restricted by so-called predatory lending provisions if their costs and fees, or interest rates, exceed statutory thresholds.
Presumptions in the proposal. The proposal suggested for legislation assumes three critical points:
1. It assumes that interest cost is what is leading home owners to default, rather than loss of equity, and rather than the difficult economy. However, given that interest rates are at almost historic lows (indeed, federal funds cost is almost zero!) it is unclear that reducing servicers profits on a note is the key to restoration of the real estate economy.
2. It assumes that any "solution" must avoid both any principal reduction and any need for federal dollars to fund it. It is commonly asserted by the lending community that they are increasingly faced with "strategic" defaults, where borrowers are able to make their payments, but decide instead that their home has lost so much equity and is so "underwater" that it simply makes no sense to continue to pay on the loan. In anti-deficiency states like California, where it is difficult or impossible to pursue the borrower for damages beyond the property financed, negative equity is a compelling argument. For how many borrowers will an interest rate reduction change that mental calculation?
Note: the proposal is aimed only at the index of ARMs, and would not address fixed rate mortgages.
3. It assumes that the proposal is feasible within the current political, and C.A.R. policy, environment. C.A.R. has historically refrained from attempting to regulate the fees or the profits of related industry groups, both in deference to free market pricing of services, and in part out of concern that other groups might one day attempt to regulate real estate compensation. Since the "margin" of the ARM contains both the overhead costs and profit structure of lenders and servicers, the proposal is really to set their compensation and overhead to no more than a combined .25%. Such an initiative would be a new policy position for C.A.R. and requires careful review. Feasibility requires careful review as well, as one can only imagine that the financial industry would react in the same as REALTORS
® would if told that commissions were going to be reduced to one tenth of existing levels.
Additional Political Considerations
1. The legislative calendar is such that the proposal, even if adopted by C.A.R. or NAR, could not be introduced until next year.
2. While the proposal is for California notes only, the lenders, investors and servicers that would be affected are protected from much of California law by preemptive federal legislation. As such, it would almost certainly have to be pursued at the federal level.
