You could hardly miss the headlines this week: More than 1,000 news outlets covered new rules from the Federal Reserve designed to “protect” America’s mortgage borrowers. At least that’s what the Fed’s news release said and many news reports did not delve much deeper.
That’s unfortunate because the new standards are a mixed bag: They provide more borrower protections in some situations but in other ways it’s the same old story: The most toxic loan formats remain largely untouched.
“The new rules,” says Michael Calhoun with the Center for Responsible Lending, “do not cover nontraditional or exotic loans that had a major role in today’s massive foreclosures, such as payment-option ARMs or interest only loans that don’t meet the subprime definition.”
And that’s not all.
The Right To Regulate
In 1994 Congress passed the Home Ownership and Equity Protection Act (HOEPA). Essentially HOEPA required disclosures for “high cost” loans. Lenders had to provide special paperwork when the APR for a first mortgage was at least 8 percentage points above certain Treasury rates or when fees and points for the loan equaled at least 8 percent of the principal amount.
The HOEPA requirements did not apply to most loans, including those with steep costs.
As the Federal Trade Commission explains, the 1994 HOEPA “rules do not cover loans to buy or build your home, reverse mortgages or home equity lines of credit.” For instance, a mortgage that was 14 percentage points higher than the Treasury rate wasn’t covered under HOEPA if the money was used to buy a home. Neither was a loan where points and fees equaled 7.99 percent of the loan amount.
Despite its shortcomings, buried within HOEPA is a potent form of consumer protection: The Federal Reserve has the right to ban “unfair and deceptive acts or practices (UDAP)” under section 129(1).
Now you might think, great, the Federal Reserve has the authority to help consumers. And in a way you would be right, the Fed has such power, but between 1994 and July 2008 — a period of 14 years — the Fed did not once invoke its UDAP authority in a way that would apply to all mortgages.
Last December, the Federal Reserve announced a series of proposed changes to HOEPA using its authority under Section 129. After hearing thousands of comments, the Fed published its final rules last week.
Higher Priced Loans
To start, the Fed effectively revised the definition of a “high cost” loans. They are now “higher priced” loans, a definition designed to be more inclusive.
A loan is higher-priced, says the Fed, if it’s a first mortgage or deed of trust and has an annual percentage rate that’s 1.5 percentage points or more above a Freddie Mac index. A second mortgage or trust that’s 3.5 percentage points above the index will also be regarded as a higher-priced loan.
In effect, the 8 percent standard is out, replaced by a tougher benchmark that will impact far more loans and borrowers.
The Fed says the new rules for high-priced loans are designed to “prohibit a lender from making a loan without regard to borrowers’ ability to repay the loan from income and assets other than the home’s value. A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan.”
“Verifying information is crucially important to borrowers, lenders and mortgage investors,” says James J. Saccacio, chief executive officer at RealtyTrac.com, the largest source of foreclosure properties and data. “No longer will lenders be able to qualify subprime borrowers on the basis of some fantasy low-ball number that rapidly changes and then leads to hardship and financial distress.”
“No less important,” says Saccacio, “the Fed has created a standard that could well lead to substantial claims against lenders who violate the rules. Lenders had wanted borrowers to first demonstrate a ‘pattern or practice’ of multiple violations under the new rules before they would be able to collect damages, a difficult and expensive claim to prove. The new standard effectively says any scammed borrower can go to court.”
Stated Income Loan Applications
The new standards for higher priced mortgages “require creditors to verify the income and assets they rely upon to determine repayment ability.” Stated-income loan applications — applications where the borrower estimates income and the lender doesn’t check are out, but only for borrowers who need “higher priced” loans.
Stiff prepayment penalties — often thousands of dollars for even a modest mortgage — have been a major problem for borrowers. The new standards for higher-priced loans “ban any prepayment penalty if the payment can change in the initial four years. For other higher-priced loans, a prepayment penalty period cannot last for more than two years.”
The rules also say the penalty will not apply if the source of the prepayment funds is a refinancing by the creditor or its affiliate. This is important because “loan-to-own” lenders frequently charge prepayment penalties to refinance their own toxic mortgages.
The Fed says its prepayment rule for high-priced loans “is substantially more restrictive than originally proposed.” That’s true. What’s also true is that prepayment penalties are allowed whether a borrower simply refinances (a “soft” prepayment penalty) or is forced to move (a “hard” prepayment penalty). If someone in the military is relocated they could face a massive prepayment penalty under the new Fed guidelines.
The rules for higher-priced loans will “require creditors to establish escrow accounts for property taxes and homeowner’s insurance for all first-lien mortgage loans.” Since unpaid taxes can result in foreclosure this is an excellent standard because typically it’s easier to pay taxes over the course of a year than in a single huge sum.
The standards above all apply to “higher-priced” mortgages, meaning they do not apply to Alt-A or prime financing. Whatever the benefits of the 2008 standards, the reality is that they do not apply to millions of loans made before the new rules go into effect.
The higher-priced benchmarks will also never apply to the overwhelming majority of loans to be made in the future and they will not apply to any loans for at least a year because the new standards only become effective on October 1, 2009. The escrow account standards do not kick-in until April 1, 2010, for higher-priced mortgage loans secured by manufactured housing.
While the Fed changes largely deal with higher-priced mortgages, broader regulations that apply to all loans have also been developed.
“Companies that service mortgage loans are prohibited from engaging in certain practices, such as pyramiding late fees,” says the Fed. “In addition, servicers are required to credit consumers’ loan payments as of the date of receipt and provide a payoff statement within a reasonable time of request.”
This rule surely makes sense but it also raises a point: Does the Fed mean lenders were ever allowed to pyramid late fees?
The Fed also says that “creditors must provide a good faith estimate of the loan costs, including a schedule of payments, within three days after a consumer applies for any mortgage loan secured by a consumer’s principal dwelling, such as a home improvement loan or a loan to refinance an existing loan. Currently, early cost estimates are only required for home-purchase loans. Consumers cannot be charged any fee until after they receive the early disclosures, except a reasonable fee for obtaining the consumer’s credit history.”
In addition to expanding the use of good faith estimates, the 2008 standards will impact lenders who charge “application” fees. The reason for an application fee, often $300, is that the lender can keep the money if the borrower goes elsewhere or decides not to get a loan. However, the new language says that application charges are prohibited before the delivery of a good faith estimate, meaning that borrowers will have a better chance to understand their loans before writing a check.
When the Fed proposals were first put up for comment last December, Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, said the suggested rules confirmed two facts: “one, the Federal Reserve System is not a strong advocate for consumers, and two, there is no Santa Claus. People who are surprised by the one are presumably surprised by the other.”
The final Fed rules are objectively better than the December proposals. That said, they leave huge gaps:
- Why should rules limiting prepayment penalties not apply to all loans? Why should prepayment penalties be allowed at all? Why not prohibit the imposition of prepayment penalties at least 60 days before loans re-set? Why not bar prepayments because a borrower must move, especially for a job change or military re-assignment?
- Why not ban stated-income loan applications? Borrowers with exotic finances and complex tax returns were able to get mortgages before stated-income applications were developed, so surely lenders can handle such applications now.
- Why do the new rules largely exclude reverse mortgages? Are seniors not a target for scammers and predatory lenders?
- Why delay the application of the new rules for more than a year?
- Why do the rules for good faith estimates only apply to principal residences? Why shouldn’t individuals with second homes or investment property also get a fair shake in the marketplace?
- Why allow lenders to qualify Alt-A and prime borrowers without verifying income and job claims? Given that a growing number of million-dollar homes are now in foreclosure it should be fairly obvious that even well-heeled borrowers are defaulting.
The list could go on but the point is this: Look for Congress to revamp loan standards further, if not now then after January 1st.
Peter G. Miller is the author of the Common-Sense Mortgage and is syndicated in more than 100 newspapers.