H.R. 3915: Mortgage Reform and Anti-Predatory Lending Act of 2007, a review and commentary

On October 22, 2007, mortage reform legislation was introduced by Democratic Representative Bradley Miller of North Carolina. Here is a brief synopsis of that legislation, and my opinion of its pros and cons.

I think it would be safe to say that everyone, who has a mortgage and is keeping up with the recent news concerning the US Housing Market and the current mortgage market, would agree that there needs to be a change in the current lending industry. Let me recap briefly how we've gotten where we are.

For the past 3-5 years, anyone with a pulse and a semi-decent credit score (at times as low as 580) could get a loan, zero down, without even proving their income and assets! These loans, known as "Stated Income & Stated Asset" loans have been the bane of our industry, wreaking havoc among the international credit markets and increasing delinquincies on a rapid scale. Other weird loans were "No Income & No Asset" loans. These differ from the "Stated" documentation loans in that the borrower wasn't even required to list their income!

These loans were the ethical alternative to the stated documentation loans because oftentimes loan offices would grossly overstate someone's income in order to obtain a loan for them. The recourse here is that the lender could pull the borrower's tax returns and charge the original loan officer with fraud if they saw that the loan officer had lied about the borrower's income. Now, although these No Income loans were an ethical alternative, they didn't much help the industry because there was no repayment ability determined at all.

And the loans kept getting worse and worse. They were then packaged together, with attractive loans (good credit, income, assets), and sold on Wall Street to hedge funds, private equity investors, and others. The issue here is that when these packaged loans were sold on Wall Street, investors simply didn't know what they were getting. This resulted in many people thinking they had "AAA" investment ratings, then holding the bag when the credit hit the fan.

This is the scenario that legislators walked into this year, which has resulted in HR 3915. People, for better or worse, are looking to the government to bail them out and help them. What's worse is that the investor-minds who devised these original plans for these subprime loans (subprime is defined as above by and large) are now also seeking the government to bail their banks out! But, that's life, right?

Let's jump right in. HR 3915 is divided into 7 titles. I will be discussing the first two, which are the more immediately relevant. Title I covers the method that loan officers are to practice when originating loans. Title II establishes a minimum standard for mortgages. Title III covers and defines high-cost mortgages. Title IV covers homebuyer counseling. Title V discusses a universal way of disclosing fees (currently known as the Good Faith Estimate). And, Title VI & VII go on to describe servicing and appraisal standards.

I will cover my main concerns with titles I & II below.

Title I has "Anti-Steering" language. What does this mean? Essentially, the title requires that banks do not provide incentives to loan officers for certain products. For instance, banks were paying loan officers up to 4.75% of the loan amount (this is known as Yield-Spread-Premium/YSP or Rebate). Imagine that! You have a loan of $300,000, and the bank is paying the loan officer $14,250 to do the loan! This would be one of those negative interest/amortization loans where the payment rate is 1% but the actual interest rate is 8-10%. If you have one of these, you've probably noticed that your loan balance is continually going up each month, and on top of that, you likely have a 2-3 year prepayment penalty that will penalize you 3% of the loan amount if you refinance within the 2-3 year period. (The YSP has to be paid for somehow, and the bank will charge YOU for it if you refinance before they can make their money) Interesting eh?

I am in favor of Title I's 'anti-steering' language as long as it affects these negative interest loans. However, the problem is that the language is so vague that any good lawyer can make a case that YSP shouldn't be paid at all. If that happens, the borrower's closing costs will go up because YSP is a legitimate way to make 1%-2% of the loan in order to reduce the borrower's closing costs. The problem here is that consumers have been lied to for too long. Consumers think that banks/brokers only make 1% or they don't charge me anything at all (yay!). Not even close. The average total compensation on a loan is 2-3%. Brokers typically charge 1.5-2% total, and banks top it off around 2-3%.

Ultimately, while I'm in favor with the spirit of the anti-steering language found in Title I, I am a bit skeptical how it will play out. I'm afraid that the spirit will be overcome by weighty lawsuits, and YSP may be done away with entirely, thus resulting in higher borrowing costs. We'll see what happens.

Title II establishes a minimum standard. This establishes a determination that the borrower has the 'ability to repay' the loan. Ultimately, this would phase out many subprime mortgage lenders, which can be a good thing, and will make conventional lending beneath a 680 credit score more and more difficult. I believe the FHA will step in and loosen their guidelines in order to pick up the subprime mess here, but we'll see. I'm largely in favor of this title. The fun one here is that prepayment penalties will essentially be illegal....this is good!


Ultimately, the spirit of the legislation is simply this. The government wants loan officers to put the interests of the consumer above their own interests, but isn't every long-standing business run this way??? The government wants the consumer to be educated about the product they're buying, but is this a new thing???

I am a little afraid though that this will increase the closing costs due to increased disclosures. After all, who pays for increased costs in the end? You think the business does? Not so! The consumer will pay for these additional disclosures, the additional time it takes to underwrite these files, etc.

Also, we might see a reduction of competitors in the industry. If this happens, the costs will go up because there will be fewer people offering the same product. This is basic economics, folks.

On a more personal note, regarding subprime mortgages, I cut my teeth on these loans. These are the first loans I ever knew existed, and I oftentimes did zero down 2 year fixed mortgages at 5.75-6.25%. Why? This is because the only alternative was a 30 year fixed at 6.75-7.25%. This is how I bought my first house. These were all Fully Documented loans (income and assets proven). The problem is found in the overstatement of income on stated income loans and these negative interest loans where the consumer thought he had something too good to be true. These loans, ironically, do have their place as well for people needing immediate cashflow to fix a current/short-lived situation. But, these are few and far between. The point is this: we must not be hasty in our judgment of subprime and negative interest mortgages, although I personally don't want one if there is a viable alternative. If there is no alternative, well...that's another story.

For now, we are in a holding pattern, waiting to see what the government will decide. Chances are, this legislation will pass (which is actually a good thing for those of us who are already licensed and in the industry long-term as much as we can).

One thing is for sure; there will be a huge reduction of loan officers in the industry, come1/1/2008.