Reactions to the Fed's Subprime SolutionThe announcement that the Federal Reserve endorsed new rules for lenders of subprime mortgages, which includes banning low-documentation loans and setting limits on penalties for borrowers who want to repay their loans early, set off a debate about how effective the plan would be -- and who would really benefit from it.
Some experts say the proposed changes to the Regulation Z (Truth in Lending) and the Home Ownership and Equity Protection Act will not help to repair the failing housing market, but will just benefit lenders and lock-out some buyers. Others say homeowners should be encouraged by the plan. "Eliminating the prepayment penalties is great," says Steve Habetz, president of Threshold Mortgage in Westport, Conn. "Individuals that are ready to refinance out of these loans now can't because prepayment penalties make it very difficult for them to refinance. I've seen prepayments be as much as 5%. That changes the loan to value and makes it impossible to get out."
The Fed's proposal should eliminate such a bind in the future, but should people who didn't carefully read their mortgage contracts before signing them be bailed out? Yes, says Habetz. "Yes, people sign things when they don't completely understand them" -- just look at the three-page document you signed to get your gym membership, he says -- "but that's why people should have an independent source to go to for reliable information."
Regardless of industry, there have always been informed consumers and there have always been those who didn't take full advantage of their resources -- after all, that is what fuels the "Buyer Beware" mentality. It works itself out in the end without intervention, say some.
"Markets correct themselves without, and often despite, government's 'help,'" says Chuck Webber, a partner with Faegre & Benson who represents financial institutions. He believes that amid this subprime crisis, government regulation may do more harm than good for buyers with lower credit scores or hard-to-track income.
"Making it tougher for lenders to make loans means they will make fewer loans. And the loans they do make will go only to the well-to-do and people with perfect credit," he says. "That will take us right back to the environment that created the need for subprime lending in the first place. Less-than-perfect borrowers--the very people the government set out to help--will go back to having little ability to get credit."
University of St. Thomas professor Tom Musil agrees with Webber, but takes a positive spin on the tightening of lending to the less-than-perfect borrower.
"There will be fewer buyers if verification of income is required," says Musil, who is the director of a real estate appraisal program at the Minneapolis university's business school. "If [a consumer] didn't have an income and couldn't support the debt to income ratio they wouldn't get a loan. In the end, there will be a greater ratio of qualified buyers obtaining loans and people couldn't get into trouble. [The Fed's proposal] promotes solid lending criteria."
The effect of the Fed's proposal is more long-term, say some, and it will not do much to help improve the housing industry now.
"The ruling does nothing to help the housing and credit markets correct themselves. Realistic sellers and savvy buyers able to obtain solid financing are what will stabilize this mess," says Jay Dacey, a Plymouth, Minn., mortgage planner.
Dacey says that the politicians who back the Fed's proposal are the people who stand to gain the most from it "because they can tell their constituents they are trying." And in the end, he says that might help improve the housing situation simply because "if buyers view this as a sign the government will bail them out, they might be more likely to write [home purchase] offers."
Some consumers and some industry pundits agree that regulating the subprime market will only reduce access to credit, but Kurt Eggert, a law professor who has testified to Congress on predatory lending issues and is a past member of the Federal Reserve Board's Consumer Advisory Council, says data do not support that theory.
"We have seen that the opposite is true," says Eggert. "By establishing clear and effective rules that require effective underwriting, escrowing of tax and insurance, and requiring effective documentation of the ability to repay the loans, the Fed could increase the access of beneficial credit to borrowers and increase investor confidence in subprime loans."
Greg Womack of Womack Investment Advisers in Edmond, Okla., says he sees the Fed's move as just a bail-out that will only help very few mortgage holders. "I believe the real issue here is protecting the banks who sold the mortgages," says Womack, who points out that many of the mortgage securities in question are owned by different central banks, funds, pensions and investors all over the world. "Bond holders who aren't getting their interest will become more impatient [if mortgage defaults continue as home values continue to decline] . So, the biggest benefactor of the bail out will be the banking system."
After all, riskier lending means more bad loans are made, and lenders are thus likely to lose more money. Even without regulation, this might lead lenders to be more careful in the future, Webber predicts. "But if lenders get too cautious, they lose out on potential profits and become more liberal in their lending. A balance is struck, but it's a balance driven by real people making real-world decisions, not by the government's guesses about what the "right" result is."
"Our goal is to promote responsible mortgage lending, for the benefit of individual consumers and the economy," Federal Reserve Chairman Ben Bernanke said in a press release. "We want consumers to make decisions about home mortgage options confidently, with assurance that unscrupulous home mortgage practices will not be tolerated."
The Fed's proposal is "too little, too late," says consumer advocate Gerri Detweiler, author of The Ultimate Credit Handbook and the education director for FreeRateSearch.com, a mortgage search engine. "An estimated one-third to one-half of subprime loan holders could have qualified for better 'Alt A' or 'non-prime' loans. In addition, however, our review of our database of subprime loan rates and programs over the past two years showed that even subprime borrowers could have obtained less risky fixed rate loans for about the same monthly payment -- and sometimes even less."
The Fed's proposal, among other things, is supposed to prohibit seven misleading or deceptive advertising practices for some loans by requiring that all applicable rates or payments be disclosed in advertisements with equal prominence as advertised introductory or "teaser" rates. But Detweiler says that it does not significantly change how lenders user "lowball" rate quotes to lure borrowers in.
"While it sounds perfectly logical for lenders to be required to verify income and assets, a bigger problem is making sure lenders provide accurate loan information that borrowers can verify independently," Detweiler says. "Until that happens, we'll continue to see borrowers stuck with bad loans."
Highlights of Proposed Rule to Amend Home Mortgage Provisions of Regulation Z
The proposal would establish a new category of "higher-priced mortgages" that should include virtually all subprime loans.
The proposal would, for these loans:
- Prohibit a lender from engaging in a pattern or practice of lending without considering borrowers' ability to repay the loans from sources other than the home's value.
- Prohibit a lender from making a loan by relying on income or assets that it does not verify.
- Restrict prepayment penalties only to loans that meet certain conditions, including the condition that the penalty expire at least sixty days before any possible payment increase.
- Require that the lender establish an escrow account for the payment of property taxes and homeowners' insurance. The lender may only offer the borrower the opportunity to opt out of the escrow account after one year.
- Prohibit lenders from paying mortgage brokers "yield spread premiums" that exceed the amount the consumer had agreed in advance the broker would receive. A yield spread premium is the fee paid by a lender to a broker for higher-rate loans.
- Prohibit certain servicing practices, such as failing to credit a payment to a consumer's account when the servicer receives it, failing to provide a payoff statement within a reasonable period of time, and "pyramiding" late fees.
- Prohibit a creditor or broker from coercing or encouraging an appraiser to misrepresent the value of a home.
- Prohibit seven misleading or deceptive advertising practices for closed-end loans; for example, using the term "fixed" to describe a rate that is not truly fixed. It would also require that all applicable rates or payments be disclosed in advertisements with equal prominence as advertised introductory or "teaser" rates.
- Require truth-in-lending disclosures to borrowers early enough to use while shopping for a mortgage. Lenders could not charge fees until after the consumer receives the disclosures, except a fee to obtain a credit report.