Mortgages Face New Rules

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The Wall Street Journal
By: Nick Timiraos and James R. Hagerty
June 28, 2010

Some Worry About Higher Costs, Fewer Choices for Borrowers

The Dodd-Frank financial-regulatory overhaul, which Democrats hope will win final Congressional approval this week, offers greater protections for consumers against riskier and more complicated types of home mortgages. But some in the industry warn the legislation also may lead to higher costs and fewer choices for consumers.

"The kinds of mortgages you see today--fixed-rate loans [or] if it's an adjustable rate, it's pretty conservative in its terms--those are going to be the loans you see for a long time in the future," said Glen Corso, managing director of the Community Mortgage Banking Project, which represents small, independent mortgage lenders. "There's not going to be any room for experimentation or trotting out loans that have new features."

The mortgage rules are part of the most extensive remapping of U.S. financial rules since the 1930s, which would put U.S. banks and markets under tighter government control for years to come.

A homeowner seeks assistance to avoid foreclosure in Daly City, Calif., in October. The bill intends to protect consumers from risky mortgages.

The bill is expected to pass the House this week, with a vote anticipated as soon as Tuesday. But Democrats are running into unexpected problems securing 60 votes in the Senate.

Sen. Scott Brown (R., Mass.) supported the bill when an earlier version passed the Senate floor in May, but he said on Friday he has major concerns with a provision adding assessments on large banks. The deteriorating health of Sen. Robert Byrd (D., W.Va.) is also a factor, because if he remains hospitalized this week he won't be able to vote for the bill.

Complex loans that allowed borrowers to make low initial payments that adjust sharply higher later helped to fuel the housing bubble and lead to today's foreclosure crisis.

The lending industry already has moved away from option adjustable-rate loans, or option ARMs, which allow borrowers to defer principal and interest payments to keep initial costs low.

Julia Gordon, a senior policy counsel at the Center for Responsible Lending, a nonprofit research group that has long campaigned against what it sees as predatory mortgage-lending practices, says borrowers "are still going to have to be careful that they understand all the terms of their loans" but "there are going to be fewer moving parts."

The bill requires lenders to have "skin in the game" on riskier types of loans--such as option ARMs or loans that don't require full documentation of income--that are bundled and sold to investors as securities. The provision requires lenders to retain at least a 5% stake on such loans that are securitized.

But the mortgage industry won a provision that directs regulators to exempt certain lower-risk mortgages, such as those backed by government agencies and those that involve verification of the borrower's financial situation and don't allow deferral of principal payments.

The bill sets stricter limits on prepayment penalties, fees for paying off a loan early. The legislation also forces lenders to ensure that borrowers have the ability to repay loans and gives borrowers greater scope to seek damages or contest a foreclosure if they are given a loan that they can't afford.

What's Made It Into the Bill?

For consumers, for investors, for banks and for the government.

Banks say that potential for greater legal liability could lead to higher costs for borrowers, but consumer advocates say the legal rights are narrowly tailored so worries are exaggerated.

Provisions that require stricter checks on a borrowers' ability to pay could make it harder or more expensive for self-employed borrowers or those who rely on commission or seasonal income to qualify for loans.

Another key provision of the bill tries to make compensation of mortgage brokers and loan officers more transparent. It bans any sort of payment based on steering the consumer to a particular type of loan or rate. During the housing bubble, loan officers and mortgage brokers often could get higher compensation if they persuaded borrowers to go with option ARMs or subprime loans.

Home appraisers, who have complained that downward pressure on their fees has hurt quality, may get some help from the bill. It stipulates that lenders must compensate appraisers "at a rate that is customary and reasonable."

The bill also mandates regulation of appraisal-management companies, firms that order appraisals on behalf of lenders. Lenders often own stakes in these firms, allowing the lenders to get a cut of the fee that borrowers pay for appraisals. Appraisals are value estimates designed to ensure that there is enough collateral behind loans to protect lenders.

Mortgage brokers pushed for a provision that would allow consumers to use the same appraisal in applying for loans from more than one lender. That would reduce the risk that borrowers might have to pay for more than one appraisal if they switch from one lender to another while shopping for a loan.

But the bill says only that regulators "may" issue regulations on the "portability" of appraisals from one lender to another. The rule would make it easier for brokers to compete with retail banks as they rely on customers shopping around for rates.

The legislation includes $1 billion to establish a program that would offer short-term loans to unemployed homeowners at risk of foreclosure. Even borrowers who didn't accept high-risk loans now frequently are in danger of losing homes to foreclosure because of job losses or reduced income. The bill also provides an additional $1 billion in funding for the Neighborhood Stabilization Program, which helps local organizations buy and repair foreclosed and vacant homes.

Write to Nick Timiraos at nick.timiraos@wsj.com and James R. Hagerty at bob.hagerty@wsj.com

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