Mortgage Reform Faces Uphill Battle on Capitol Hill

Stashed away on Capitol Hill’s back burners has been the emerging idea that the mortgage lending process has to be changed. Not around the edges and not something here or there, but the entire process.

The legislation taking dead aim at current mortgage practices is H.R. 1728, a 151-page bill introduced last week by Rep. Brad Miller, D-N.C., and co-sponsored by a number of House members, including Rep. Barney Frank, D-Mass., chairman of the House Financial Services committee.

The bill is based on lending standards adopted by the state of North Carolina. While it may seem good that North Carolina has strongly written mortgage origination rules, the reality is that state standards are essentially useless because such benchmarks, whatever they are, simply don’t apply to loans generated through federally regulated lenders.

The federal rules have precedence over state rules under a concept called “pre-emption,” a fancy term which means that when state and federal rules conflict the federal standards must be used.

In effect, what Miller is proposing is legislation which would make the North Carolina rules the basis for national lending standards, a proposal which is certain to be opposed by lender groups and their lobbyists.

In the usual situation a borrower goes to a lender seeking the best possible rates and terms to finance or refinance real estate. The borrower is entirely dependent on the loan officer for information regarding programs, rates and terms. Going to another lender does not change the situation; it simply means that the borrower is now relying on still-another loan officer.

Federal regulations do not obligate lenders or loan officers to act in an “agency” or “fiduciary” capacity and seek the best interests of the borrower. In particular, it’s not clear that mortgage brokers represent borrowers or even the lenders or investors who buy mortgages. Except for fraud, if a borrower makes payments for 120 days the loan originator typically has no obligation to assure that the mortgage will be repaid. This is the equivalent of buying a used car with a three-hour warranty.

New Rules
If passed the Miller bill would change the way lenders do business. New protections would be granted to borrowers, and lenders would have new standards of conduct. Here are the major points:

The borrower must have a “reasonable ability to repay the loan” at its fully indexed, fully amortizing rate. Translation: Lenders will not be allowed to qualify borrowers on the basis of start rates.

The loan cannot have “predatory characteristics” such as excessive fees and abusive terms. Translation: Despite speeches to the contrary, there is currently no federal rule or regulation which outlaws “predatory” lending. This provision would break new ground if passed.

The lender must verify and document the consumer’s credit history, current income and expected income. Translation: Stated-income loan applications — the applications where lenders do not verify income — are dead if the Miller bill passes. The liability will be so great that no lender will want to offer such processing.

No property can be refinanced unless the new loan produces a “net tangible benefit.” Translation: This provision is aimed at “loan flipping,” a process where a property is repeatedly refinanced with little benefit to the borrower but big fees to the lender with each new loan.

Yield-spread premiums (YSPs), a source of considerable loan officer and lender profits, are largely out. The legislation would prohibit YSPs and other forms of compensation which would “steer” borrowers to more expensive loans. Translation: YSPs are created by selling a loan above the actual price for which a borrower qualifies. The result is that the loan can be re-sold for a higher price than would otherwise be the case. However, yield-spread premiums can also be used to create “no cost” closings, a result achieved when the lender pays some or all of the settlement costs if the borrower will accept a somewhat higher rate. It’s probable that “no cost” closings would continue to be allowed under the Miller bill because they produce a “net tangible benefit” to the borrower in the form of lower closing costs.

The bill does not create an agency or fiduciary obligation to the borrower “if the originator does not hold himself or herself out as such an agent or fiduciary.” Translation: If a lender says he will get you the best possible rates do you expect him to be anything but your agent? This provision will create a lot of liability for lenders who promise the “best” rates and produce something less.

Lenders who violate the rules will face penalties of up to three times their brokerage fees plus the borrower’s legal costs. Translation: This provision essentially creates a penalty for lender malpractice.

The legislation establishes a “safe harbor” for lenders who offer prime loans which are fully documented, fixed-rate, 30-year mortgages without negative amortization or interest-only features. Qualified mortgages must have an APR that “does not exceed an average prime offer rate, published by the Federal Reserve, by more than 1.5 percentage points for a first lien and 3.5 percentage points for a subordinate lien.” Translation: A lot of lenders are going to exit the subprime and Alt-A markets where there is no safe harbor against claims of lender abuse. Also, this provision will create a new standardized loan product, the safe-harbor mortgage.

The bill would prohibit certain prepayment penalties; the use of loan proceeds to finance single-premium credit insurance annuities) and any requirement for mandatory arbitration. Translation: The legislation would expand the annuities ban passed last year from FHA reverse mortgage products to all loans. It would limit prepayment penalties but not get rid of them entirely and it would ban mandatory arbitration, in part because lenders often required the use of their arbitrators as well as big up-front fees from borrowers.

A consumer may be able to stop a foreclosure if the loan was not properly originated and even seek damages from creditors, assignees, or securitizers. Translation: Wall Street is going to have to look at the loans it packages into securities with great care. One could actually see separate underwriting requirements for lenders, mortgage insurers and, now, securities firms before a loan could be approved.

What Next?
Regardless of the specific provisions in the Miller bill, the important question is whether or not it will pass. Similar legislation passed in the House during the last term by a vote of 291 to 14 but died in the Senate where it did not come up for a vote.

This year, however, there is a new House, a new Senate and a new President. No less important, mortgage meltdown news is on the front page every day and the political heft of the lending community ebbs with each bailout and bonus. While the legislation as written is unlikely to pass, for the first time in years substantial mortgage reform at the federal level is no longer unthinkable.

“The political landscape is plainly in flux,” says Jim Saccacio, Chairman and CEO at, the leading online source for foreclosure properties and data. “The trick will be to produce legislation which addresses the lending abuses that have become so visible while preserving the bulk of a structure that has worked well for the majority of borrowers.’
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site,

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