Since the first days of Wall Street Reform lenders have complained that the standards are too tight. Even minor clerical errors, they say, can force them to buy-back loans from investors and governmental agencies. Such repurchases not only produce big losses but have forced lenders to document everything remotely associated with the borrower’s finances in an effort to prevent future repurchase claims.
There’s evidence that on the paperwork front lenders may well be right: Loan applications are certainly getting bigger. A recent study by VirPack found that it’s not usual to find mortgage applications running a hefty 1,000 pages — and even 2,000 pages.
The catch is that the buy-back debate raises tough issues: First, why change something that works?
Second, if you’re a borrower do you really care about mortgage technicalities? The answer is yes but only if you get some benefit such as easier loan applications, lower interest rates or fewer foreclosures.
Will you get such benefits under the new rules? Not likely. Here’s why.
Foreclosure rates by loan vintage have fallen back to the levels seen in 2000, according to RealtyTrac vice president Daren Blomquist. Such miniscule loss rates mean investors worldwide want to put cash into the U.S. marketplace and that’s part of the reason mortgage rates are now so low.
The loan industry argues that we could do even better. With a little government tinkering could we make the system even better. Critics worry — with recent financial history on their side — that reduced regulation might set off another round of toxic loan products, more foreclosures and home price declines.
Now the government has stepped in and decided to push new regulations which will ease loan standards, regulations designed to end big penalties for minor mortgage flaws.
Representations and Warranties
When lenders sell mortgages to investors and insurers they don’t just sell such paper “as is.” Part of the deal are so-called “representations and warranties,” promises that the loans meet certain standards, say a particular credit score level, debt-to-income ratio or average down payment. Most of the huge settlements with lenders — settlements worth more than $100 billion — have been based on allegations that the loans sold to investors and insurers were defective, that they didn’t meet promised representations and warranties.
FHFA — the Federal Housing Finance Agency, the regulators that sets the rules for Fannie Mae and Freddie Mac — agrees that some of the rules are too tough and as a result has announced new “life-of-loan representation and warranty exclusions.”
In basic terms here’s what happening:
Importance: Not all mistakes are a big deal. There is now a “significance test” so that a minor cleric error cannot result in a buy-back demand.
Fraud still counts: If a loan was originated on the basis of fraud all bets are off, the significance test gets tossed.
Timing: The new rules are retroactive. They cover mortgage originations going back to January 1, 2013, a big win for lenders.
The significance test gives lenders a way to dispute buy-back claims with Fannie Mae and Freddie Mac, the two biggest loan buyers. If the borrower has been making full and timely payments and the loan documents contain a typo or other minor error the essential rule is no harm, no foul.
Who Wins With The New Rules?
Will the new standards result in fewer paperwork demands for borrowers? The answer is probably “no” and here’s why: Loan originators still want fully-documented mortgage files so they can fight potential buy-back claims. More paperwork may give them the evidence they need to prove that an application was fraud-free and done by the book.
Will the new standards lower mortgage rates? Not directly. Mortgage rates reflect the supply of money versus loan demand and right now the marketplace is loaded with cash. That’s why mortgage rates have been at or near record lows in recent years.
Will the changes proposed by FHFA reduce foreclosure levels? We don’t know. What we do know is that the paperwork standards from the past few years have resulted in remarkably-low foreclosure rates.
Think of the mortgages originated each year as a “vintage.” The loans originated in 2000 had a foreclosure rate of .39 percent according to RealtyTrac. In other words, if there are 50 million mortgages we could expect about 195,000 foreclosures. By 2007 the foreclosure rate was 2.42 percent, six times higher. Now the foreclosure rate are actually lower than in 2000 — just .20 in 2013 and .31 percent so far in 2014.
Low foreclosure rates are one of the surest ways to attract investor capital while at the same time lowering potential lender losses. According to the Mortgage Bankers Association, “independent mortgage banks and mortgage subsidiaries of chartered banks reported a net gain of $954 on each loan they originated in the second quarter of 2014, up from a reported loss of $194 per loan in the first quarter of 2014.”
Maybe Paperwork Isn’t So Bad?
The conclusion which comes out of the paperwork debate is that a little less paperwork and some regulatory softness likely won’t have much impact on mortgage rates or foreclosure levels. There’s little incentive for lenders to ask for less paperwork but a lot of liability for loans which are not fully documented. As a result one would expect to see no let-up in the endless lender search for more documents and verifications.
The good news — in a sense — is that while paperwork demands can be irritating, they actually protect consumers. Better documentation and careful adherence to lending rules has led to a huge foreclosure decline. Fewer foreclosures draw in more investor capital and that pushes down loan rates. Lower rates mean greater affordability, enhanced home sales and perhaps higher real estate values. With growing profits per loan lenders have more incentive to compete for borrowers and that too keeps down rates.
In the end it turns out that lots of paperwork is not such a bad thing. Just aggravating.