You wouldn't think that we'd need such a law. After all, don't lenders want to make sure that they get their money back?
Not necessarily. These days front-line lenders who originate mortgages can sell them off to outfits that put them in huge pools which are turned into securities and resold to investors. Banks and other lenders may continue to service the loans -- collect monthly payments and so on -- but to the extent that they off-load these mortgages, their necks are not on the line. During the housing bubble, mortgage bankers and brokers, hot for commissions, looked the other way when signing homebuyers up for loans that were booby-trapped with balloon payments and escalating interest rates. The result: the foreclosure and financial crises, TARP and all that bad stuff. So, yeah, we need a law.
The Dodd-Frank Wall Street Reform and Consumer Protection Act, however, left translation of the affordability mandate to regulators. Yesterday, the Federal Reserve offered for comment four options for protecting consumers. And protecting banks, of course. The Federal Reserve, as you remember, is all about banks, and if banks comply with the regulations, they will be insulated from legal claims that loans were unfair or deceptive or don't comply with the law. The Fed is inviting comment, but it will pass the final rule-making on to the new Consumer Financial Protection Bureau Here are the proposals and my recommendations to the CFPB:
1. Create an ability-to-repay standard. Banks would have to examine and verify a borrower's income and assets, current employment, credit history and debt obligations. It would then look at how much the monthly mortgage would cost, add in any other mortgage debt (like a second mortgage or home equity loan) and any other mortgage-related obligations, for example, insurance and property taxes, and then look at the monthly debt-to-income ratio.
My take: The Fed doesn't specify what a reasonable debt-to-income ratio should be. Back in the Dark Ages, when I bought my first house, PITI (principal, interest, taxes and insurance) were supposed to be no more than 25 percent of the borrower's gross income. By 2005, many homebuyers were feeding 50 percent of their incomes into their houses. They had no extra money to save and no financial cushion when the economy soured. The result: The foreclosure and financial crises, etc., etc.2. Develop a "safe harbor" mortgage. To qualify, it would contain no interest-only payments, balloons or any other exotic gimmicks. Points and fees would not exceed 3 percent of the total loan amount, and the bank would have to verify a borrower's income and assets. In calculating ability to repay, the bank would have to use the maximum interest rate that would apply in the first five years. And, if the loan is for 20 years, payments would have to retire it in 20 years. No add-ons allowed.
My take: We need a plain-vanilla mortgage that banks would be required to offer to homebuyers as a default choice. I would opt for a 30-year, fixed rate loan with a 10 percent down payment and a tight limit on fees. The Fed's so-called qualified mortgage gets only partway there.3. Allow balloon-payment mortgages. Banks would be able to provide such loans in "rural or underserved areas," mostly to allow lenders to hedge against interest-rate risk. To set a balloon of five years or more, however, a bank would have to offer a safe-harbor mortgage and meet the ability-to-repay requirements.
My take: I don't care how rural or underserved the area. Balloon mortgages are beyond the ken of most consumers. And don't banks always have to hedge against interest-rate risks? I say: get rid of these monsters.4. Enable refinancing of non-standard mortgages. A lender would be able to refinance a mortgage with risky features, say, balloons and other features into a new, plain-vanilla loan if it meets the standards in proposals 1 and 2 above.
My take. This is all well and fine, but isn't much help for consumers who got stuck in freakish mortgages. By the time they realized they should bail out, the value of their houses had dropped, and they would have had to lay big out huge wads of cash to refinance. Banks shouldn't be making mortgage loans with risky features, period, end of story.
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