The Washington Post
By: Dina ElBoghdady
May 27, 2010
Tucked into the landmark financial legislation making its way through Congress are little-publicized provisions aimed at preventing a repeat of the mortgage meltdown that ultimately doomed global financial markets.
The measures are designed to curb abusive lending practices that lured people into ill-suited loans prone to foreclosure. The overarching goal is to align the financial incentives of lenders with the financial well-being of consumers.
The provisions would change the way loan officers are compensated, hold lenders responsible for the loans they make, require them to extend mortgages only to borrowers who can repay them and limit penalties for those who pay off their loans early.
"It would have been unthinkable to get through financial reform without addressing the mortgage market because this is why were are in the mess we're in," said Julia Gordon, senior policy counsel at the Center for Responsible Lending, which supports the provisions.
Advocates for the mortgage industry, who have resisted federal regulation in the past, are likely to push back on some of the finer points of the measures. But the industry has accepted that some of the changes are inevitable. The measures are included in both the House and Senate versions of the financial overhaul legislation, and a final bill is scheduled to reach President Obama for his signature this summer.
One of the key provisions deals with the compensation of loan officers and mortgage brokers, who act as middlemen between borrowers and lenders. Loan officers and brokers have often been rewarded with extra fees for placing borrowers in loans with higher interest rates than they qualified for.
The House and Senate bills would end that practice by barring lenders from sweetening compensation for loans with higher rates or other features, such as prepayment penalties. The Federal Reserve has been working on a similar proposal since summer.
Consumer advocates have long argued that incentive-based pay contributed to the mortgage meltdown by encouraging brokers and loan officers to steer borrowers toward mortgages they wouldn't be able to keep paying. Critics say many borrowers did not understand they were being sold loans that were bad for them but good for the lenders.
"The consumer and the lender often were not acting with the same information and the same sophistication," said Barry Zigas, housing policy director at the Consumer Federation of America.
Industry representatives deny that the extra fees motivated lenders to betray the borrower's best interest. Industry officials say higher-rate loans can be justified if a lender is willing to close on a loan more quickly than a competitor or if a lender accepts lower credit scores or higher debt loans.
"But the reality is that when you have the Senate, the House and the Fed all looking at compensation, we will see a change in compensation," said John A. Courson, chief executive of the Mortgage Bankers Association.
Loan officers also would not be paid extra for issuing mortgages with prepayment penalties, large fees imposed on borrowers who pay off their original loans early. Those loans were considered more valuable to investors because they crimped a borrower's ability to refinance when they got a cheaper offer.
But when subprime loans started to unravel, many borrowers were trapped in loans they could not afford. They had taken out mortgages with low teaser rates that later surged, and they could not refinance into better terms in part because of expensive prepayment penalties.
Both versions of the legislation would bar those penalties on adjustable-rate mortgages, subprime mortgages and mortgages, for instance, that have excessively high fees or interest rates. For standard fixed-rate mortgages, the penalties would be allowed only in the first three years and their size would be limited.
Both bills also would bar lenders from making loans without verifying if the borrowers can repay them. Lenders would have to document a borrower's income and assets, a once common practice that fell by the wayside during the housing boom when "liar loans" became widespread.
Gauging ability to pay
Lenders would now have to assess the borrower's ability to pay the highest scheduled monthly payment for five years out. Previously, lenders had considered only the ability to repay low teaser rates.
The Federal Reserve rolled out similar provisions two year ago governing subprime lending, and market pressures have eliminated some of the practices targeted by the legislation. But lawmakers said they wanted to codify the rules so they are not tinkered with in the future.
"It's a much stronger structure to have it in statute than a regulation that can be changed any time," said Sen. Jeff Merkley (D-Ore.), who co-wrote the provisions in the Senate.
What most alarmed the industry was a House provision that would require lenders to retain at least a 5 percent stake in mortgages until the loans are paid off.
The Senate bill would apply a similar requirement to the Wall Street firms that pool the loans and sell them to investors.
In the past, many lenders sold the loans they originated and were off the hook if they went bad. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, has said that requiring lenders to retain some risk would encourage prudent lending.
Industry officials said the provision could destroy smaller lenders, including mortgage banks that do not take deposits and do not hold on to large amounts of cash. They said many lenders, even large ones, might respond by making fewer loans, raising interest rates or both.
"It increases the overall cost burden to the mortgage issuers, which in turn will be passed onto consumers," said Tom Deutsch, executive director of the American Securitization Forum.
The Senate bill would mandate that regulators exempt some types of loans from this requirement and would offer factors for regulators to consider. The House bill has no such mandate but would allow regulators to increase or decrease the capital holdback requirements based on the safety of the loan.
The Mortgage Bankers Association said it is aggressively lobbying for the Senate version. "That is No. 1 on our list," Courson said. "We do not see the purpose for restrictions on loans that have not posed problems for the marketplace or the consumer."