Real Estate & Mortgage Insights

Lending Industry Gets Its 'Due' for Mortgage Mess

Both houses of the U.S. Congress are currently working on financial legislation in order to prevent future market meltdowns. And while not the focus of the bills, new rules and restrictions on the mortgage lending industry are included in each, as many people lay the blame for the current recession at the feet of the housing industries excesses and failures.

"It would have been unthinkable to get through financial reform without addressing the mortgage market because this is why were are in the mess we're in," said Julia Gordon, senior policy counsel at the Center for Responsible Lending, as quoted in a Washington Post article.

The new legislation makes at least four key changes to the way mortgage lenders currently do business. First, it would do away with prepayment penalties on certain types of loans. These substantial fees have discouraged borrowers from refinancing into cheaper loans, which has contributed to the continued foreclosure avalanche as troubled borrowers have been financially unable to get out of their risky, high-interest loan because of the prohibitive cost of the prepayment penalties. The new potential law would prevent these penalties from being attached to adjustable rate mortgages and subprime loans as well as other mortgages with extremely high interest rates. Neither would loan officers be able to receive greater compensation for issuing prepayment penalties.

Second, the bills proposes to severely limit mortgage broker fees and incentives, making it illegal for them to give borrowers higher interest rate loans than they qualify for. Some argue that incentive-based pay was a big part of the mortgage meltdown, as brokers and loan officers let their greed determine what type of loan to give, not what was most financially sound. The mortgage industry defends itself however, saying that higher interest rates are a trade off for consumers when they get to close a loan faster or if they have lower credit scores.

Third, lenders will be required by law to verify that borrowers can afford to pay for the mortgages they get. This has typically been the practice of lenders, but standards became lax during the housing boom when mortgage credit was so readily available. "No-doc" loans (no documentation) will be illegal, requiring borrowers to now provide proof of income and assets. (Most loans and lenders already require this.) For those getting adjustable rate loans, lenders will also have to calculate whether borrowers can afford the monthly payments at the highest interest rate possible, not just at the initial teaser rate level.

Lastly, and perhaps most controversial, is a provision in the House bill that calls for lenders to hold on to a part of each loan, instead of selling off the entire thing to investors on the secondary market. The wordage says that lenders would have to be responsible for at least 5 percent of each mortgage until it's paid off. The Senate targets Wall Street investors, however, requiring those who bundle and sell the mortgage pools to investors to retain some financial responsibility. The hope is that this major debt obligation will encourage safer lending practices, but lenders say this could cripple the smaller mortgage firms as they do not have the resources to back part of the loans. The end result will be fewer loans and higher interest rates, they say.

"It increases the overall cost burden to the mortgage issuers, which in turn will be passed onto consumers," said Tom Deutsch, executive director of the American Securitization Forum in that same Washington Post article.

And it is very likely that such will be the case. Apparently, Washington just believes it more important to be safe than cost effective at this point.

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