Subprime and Mortgage ReformJanuary 24, 2008Real Estate Finance Housing Opportunity Federal IssuesThe following is for study only and has NOT been approved by the RealEstate Finance Committee or the Board of Directors.Issue: Should C.A.R., in conjunction with the National Association of REALTORS® (NAR), increase the REALTORS® presence on Capitol Hill while Congress is debating the issue of subprime and mortgage reform? This would Include utilizing NAR’s and C.A.R.’s existing policy to advocate for or against individual provisions within the bill.Action: OptionalChoices: 1. Take a “Support” Position 2. Take “No Action,” NAR’s actions thus far have been sufficient in expressing to Congress the REALTORS®’ views on the issue of subprime andmortgage reform. 3. OtherSummary: The past year saw what has been perceived as a collapse of both the Subprime and Alt-A mortgage markets. While not every city has been impacted, a number of communities across the country and in California are feeling the fallout.Many home buyers were driven to subprime and Alt-A mortgages by skyrocketing home prices that forced them to look for this type of alternative financing. Thiswas due to the Federal Housing Administration (FHA) and Government Sponsored Enterprises (GSE) not being viable options because of their low loan limits. Subprime and Alt-A products presented appealing and affordable financing options with low teaser-rates and easy underwriting standards (often requiring no income or asset verification). Many home owners and lenders assumed refinancing these loans would be an option once the teaser rate period was over and the interest rate reset. However, home owners soon discovered that many of their loans had excessive prepayment penalties that deterred refinancing. As home prices came down and sales decreased over the last year, these same home owners are now unable to sell their homes.Realizing a high percentage of home owners in subprime and Alt-A loans will be unable to make their mortgage payments and are likely for default on their loan; lenders, loan servicers, consumer groups, Wall Street, Regulators, the White House and Congress are looking at what can be done to stem the current and future waves of foreclosure.Complicating the issue further are opinion polls that show Americans are split as to what action thegovernment should or should not take to help home owners and lenders in trouble.Legislative Response The continued crisis in the subprime market has caused both the Senate and the House to introduce subprime and mortgage reform bills to address what many politicians and consumer groups perceive as predatory practices. The hope of the legislation is to protect consumers while not crippling the subprime market; which, when properly utilized by home buyers serves as a valuable resource for home ownership opportunities to those not able to procure prime rated financing.The House bill, H.R. 3915, was passed on November 15, 2007, by a vote of 291 – 127 and sent to the Senate. The House bill primarily proposes the following:
Create minimum standards for state licensing of “mortgage loan originators” and create a federal registration for them. This would not include real estate agents; and is intended for mortgage brokers and bank employees who originate mortgages.
Require creditors to ensure the borrower has a reasonable ability to repay the loan, and for refinancing there must be a net tangible benefitto the consumer.
Tighten Home Owners Equity Protection Act (HOEPA) requirements so the APR and fee triggers are reduced.
Prohibit the financing of points and fees, balloon payments, or excessive fees for payoff information, modifications, and/or late payments.
The Senate bill, S. 2542, which was introduced at the end of 2007 by Senator Dodd is waiting to be heard in the Senate Banking, Housing, and Urban Affairs Committee.While both Democrats and Republicans will make recommendations and amendments to Dodd’sbill, as introduced it would:
Redefine a HOEPA loan to 8% above Treasury on the first, 10% for the second, or 5% of fees (including YSP),
Define a “subprime mortgage” as 3% above Treasury on the first, 5% for the second,
Prohibit any Yield Spread Premium (YSP) and prepayment penalties on HOEPA, subprime, and nontraditional mortgages,
Give borrowers the ability to “unwind” or rescind a loan that violates provisions laid out in the legislation (it would actually be up to the note holder to help make the home buyer whole; we will have to see the actual text of the legislation to better understand this provision),
Require mortgage brokers to have a fiduciary duty to their customers and hold them accountable under the Truth in Lending Act (TILA),
Allow “YSPs only in the case of no-cost loans” that are prime (Where YSPs are paid, brokers may not receive any other compensation from any other source and prepayment penalties are prohibited), and
Address appraisals, loan servicers, and foreclosure prevention.
Dodd’s bill was drafted and introduced with little to no consultation from many within the industry and appears to be more of a wish list for consumer groups. If Dodd is serious about moving his bill there will be many amendments made.As 2008 has already begun with no sign of a housing turnaround, many members of Congress are looking to introduce even more legislation to addressthis issue. Congressman Kanjorski has been quoted as supporting Alan Greenspan’s idea of having the government give cash to homeowners in trouble. Greenspan stated, “cash is available and we should use that in larger amounts, as is necessary, to solve the problems of the stress of this. It’s far less damaging to the economy to create a short-term fiscal problem, which we would, than to try to fix the prices of home or interest rates. If you do that, it’ll drag this process out indefinitely.”Passing anything through Congress is always a long shot and the addition of presidential campaign politics won’t help. However, what is certain is that more bills will be introduced, and as the market continues to decline and foreclosures increase Congress will be more likely to move a bill.Regulatory Response Many regulators have responded by waiting to see what the market would do. Not wanting to slow the flow of capital any further to an already hurting real estate market, most regulators felt they could protect consumers by going after predatory lenders one at a time and issue “guidelines” on what safe lending practices should be.Congress has been quick to criticize regulators for what they perceived as a lack of action, especially by the Federal Reserve Board who is charged with protecting consumers form unfair or deceptive practices.On December 18, 2007, the Federal Reserve Board finally took action and proposed a rule for changes to Regulation Z “to protect consumers from unfair or deceptive home mortgage lending and advertising practices.” The proposal would define “higher-priced mortgage loans” as a first-lien mortgage with an Annual Percentage Rate (APR) three percentage points or more, or a subordinate-lien mortgage with an APR five percentage points or more above the comparable Treasury notes. The intent of this rule is to not only capture subprime loans, but the Alt-A loans as well. These high-priced mortgages would have new restrictions and rules placed on them, including:
Requiring creditors to take into consideration the ability of a borrower to repay the loan at the fully amortized rate,
Requiring escrow for taxes and insurance,
Requiring income and asset verification, and
Restricting prepayment penalties, and prohibit them for at least sixty days before any reset.
Additionally, the proposal would create rules for all loans secured by a principal residence. These rules are:
Prohibiting YSP without a written disclosure agreement with the consumer,
Prohibiting coercion of a real estate appraiser,
Regulating mortgage loan servicers so payments are credited when received, and
Banning seven deceptive or misleading advertising practices.
The comment period for the rule is 90 days. (Federal Reserve Press Release)White House Response President Bush has put forth a plan to “freeze” some subprime loans’ interest rates at their initial teaser rates for five years. This plan has drawn cheers for taking action to prevent and stem a tide of foreclosures. This plan has also drawn criticism for being proposed too late and not being broad enough. Some estimate the number of loans that will actually qualify for the rate freeze will only be 150,000 – 360,000. The Bush rate freeze would only impact subprime loans with adjustable rates, (nearly half of all subprime loans are fixed rates), borrowers with credit scores below 660, loans taken out between January 1, 2005, and July 30, 2007, and are scheduled to reset in 2008 or 2009.Wall Street Response Unlike past down markets when Fannie and Freddie were the primary suppliers of capital and liquidity, a number of factors have led to an increase in private capital from large investors both domestic and abroad in Mortgage Backed Securities (MBS). With the increase in subprime mortgages and higher home prices, Fannie and Freddie were limited as to how much capital they could supply the market. Because of this, more and more home owners have found their notes sold off to Wall Street and held by a foreign country, a pension fund, or a private investor. The loans Wall Street was funding included subprime loans, Alt-A loans, conventional jumbo and conforming.When the subprime market began to falter,it wasn’t only subprime and Alt-A MBS that Wall Street shied away from, but also conventional jumbo loans. Beginning in the summer of 2007, Wall Street stopped purchasing non-GSE MBS. As a result of this, interest rates on non-conforming loans spiked as less capital became available. In some areas of California, interest rate spreads between 30-year conforming and 30-year conventional jumbo loans was up to one-and-a-half percent.Beyond creating a capital shortage, Wall Street is weighing the impact from the down housing market, including the collapse of the subprime market and spikes in foreclosures. Many Wall Street investors and consumers believe this falloutmay potentially lead the country into a recession.Lenders Response Unable to as easily unload their non-conforming loans on the secondary market to replenish capital, lenders have been forced to hold moreloans in portfolio. This has caused a shortage in capital, thus increasing interest rates on non-conforming loans and tighter underwriting standards. Many REALTORS® have watched as deals have fallen through because of this tighter underwriting. Many borrowers with good credit who would qualify for a loan under normal market conditions are now being denied financing.On the legislative front, lenders are finding themselves on the defensive from a Congress that is being pushed to act by consumer advocates and home owners who have been or are facing foreclosure. Historically, lenders have had trouble securitizing “high-cost” loans and have therefore looked to avoid doing these types of loans. Often lenders will adjust subprime loans so they don’t fall within the definition of a “high-cost” loan. However, regulators and legislators are purposefully trying to expand HOEPA loans to bring not only the subprime, but Alt-A loans under the “high-cost” classification as well. This will subject more loans to tighter rules and regulations if Congress and/or the Federal Reserve Board have their way. This would potentially include no yield-spread-premiums, no prepayment penalties, fully amortized underwriting, assignee liability and other restrictions.Mortgage Brokers Response According to the California Association of Mortgage Brokers (CAMB), more than 80 percent of mortgage loans in California are provided by mortgage brokers. Along with lenders, many legislators have looked at mortgage brokers for answers andto blame for helping to finance home owners who should not have qualified for a loan. Mortgage brokers have drawn this scrutiny because some, not all, unscrupulous mortgage brokers helped home owners with “liar loans,” to get them into a home they could not afford. Mortgage broker associations such as CAMB are working with Congress to create a national loan originator registry for not only brokers, but lenders and agents working for banks.On the legislative and regulatory front, mortgage brokers are on the defensive from attacks on the practice of YSP. Many legislators and regulators would like to eliminate the practice of YSP on subprime and Alt-A mortgages; while some legislators wish to eliminate YSP all together.Currently on the Hill: As H.R. 3915 moved through the House in late October and early November, lenders, consumer groups, mortgage servicers, Wall Street, and other major players were active in negotiations. NAR, though issuing a letter of support for the concept of mortgage reform, was relatively silent on the details of the bill itself.C.A.R.emphasized the importance of consumer protections that did not hinder or deter the flow of capital into the housing market. This includes allowing underwriters to take into consideration assets and future earnings potential, and not relying solely on a hard debt-to-income ratio. C.A.R. also worked closely with NAR in ensuring real estate agents were not classified as “mortgage originators,” a classification Congress intended for mortgage brokers and lenders.Senator Dodd, who has dropped out of the Presidential race following a dismal showing in the Iowa caucus, and chairs the Senate Banking, Housing, and Urban Affairs Committee, has stated his intent to address the issue of subprime and mortgage reform early in 2008.C.A.R. Policy: C.A.R. has addressed subprime and predatory lending issues multiple times, as well as the opposition to federal preemption of state laws and the creation of a separate mortgage brokerage license requirement. Additionally, C.A.R. supports strong consumer protection laws, but those laws must not be so stifling as to hinder the flow of capital to the markets.NAR Policy: NAR has a Subprime Lending Work Group that continually reviews the issue and has put forth a number of policy recommendations adopted by the NAR BOD. Even though NAR has drafted detailed policy on this issue; they were not as active as other real estate interests were while H.R. 3915 was passed. NAR supported the concept of subprime reform but failed to support or oppose the majority of provisions with the bill specifically. (Subprime Lending Work Group Final Report)Should C.A.R., in conjunction with NAR, increase the REALTORS® presence on Capitol Hill while Congress is debating the issue of subprime and mortgage reform? This would Include utilizing NAR’s and C.A.R.’s existing policy to advocate for or against individual provisions within the bill.