For a little break from vitriol, let’s discuss some of the suggestions for regulatory reform, including the NCLC reservations regarding the proposed HR 1728: Mortgage Reform and Anti-Predatory Lending Act.
Margot Saunders, Counsel for the NCLC testified before the Committee on Financial Services in April regarding reservations about the current state of the reform bill and suggesting as follows (full testimony available at http://www.consumerlaw.org/issues/predatory_mortgage/content/Testimony-HR-1728-042309.pdf ):
At a hearing before the Subcommittee on Financial Institutions and Consumer Credit on
March 11, 2009, we provided a set of recommendations to reform the mortgage market which we
think are simple, inexpensive and would be very successful. Below these recommendations are
We propose a different orientation to the mortgage regulation conundrum: rather than
creating a complex set of rules which are enforceable some of the time by some of the players
against some of those involved in the process, create a system which creates incentives to accomplish sustainable and secure credit.
We propose to you an approach which carries the following three key characteristics:
1. Simplicity – The rules should be fairly easy for most people to understand. Multiple
categories of creditors, borrowers, and types of loans result in confusion, without
establishing a clear structure designed to facilitate fair, affordable, and safe mortgage
2. Transparency – The contracts and obligations of the parties should be simple. The
rules governing the transaction should not only be clearly disclosed, but also be easy
to understand. The disclosures governing today’s mortgages have become
increasingly complex and technical because they are attempting to describe
unbelievably complicated transactions. The disclosures must be correct – but if it is
too difficult to describe the transaction, perhaps the transaction is too complex to be
3. Appropriate Incentives – The current system rewards originators for making bad
loans – because the originators are paid regardless of whether the loan is unfair,
fraudulent, or unaffordable. Similarly, mortgage servicers are rewarded for servicing
practices which do not sustain homeownership or home-equity. Both the origination
and the servicing systems should be re-tooled so that the originators, the lenders, the
investors and the servicers all profit only from practices which promote sustainable, affordable
and safe home mortgages.
Outline of New Mortgage Regulatory Structure
1. Realigning Incentives – Pay Originators from Mortgage Payment Stream Only.
Insurance brokers are paid their commissions entirely from the stream of payments made by the
consumer for the insurance product. If the consumer can no longer afford the product and the
payments stop being made, the broker does not receive payment – so the insurance broker has every
incentive to ensure that the consumer is sold a product that is affordable. The insurance company
also has an incentive to ensure that the consumer can afford the insurance product: as soon as the
commissions are paid, the amount of the premiums that the company receives increases.
The insurance model of compensating brokers should be used for the mortgage industry:
require that both originators and lenders receive all of their costs associated with originating, making
and servicing the loan from the payment stream. A homeowner making payments on the mortgage is
the sign of an affordable, sustainable mortgage – the continued affordability of those payments
should be incentivized by the mortgage regulatory structure.
Currently, the origination process itself is the major source of profit. In fact, it is the only
source of profit for the mortgage broker and a not-insignificant source of profit for the mortgage
lender: both parties generally receive substantial up-front fees (almost always paid for from the
consumer’s home equity) at the origination of the mortgage. The lender, which then generally sells
the loan into a security, also receives compensation at that point. Neither party depends on the
payment stream to recover either their costs associated with making the loan, or for their profit. The
current system encourages loan churning – making new loans to homeowners over and over –
because the making of the loan is what generates the business and the profits in this market. This is the incentive that needs to be changed.
If instead the originator received a percentage of each payment for the first – say two – years
– of the loan, that originator would have a strong business incentive to ensure that the homeowner
would both be able to make the first two years’ payments, and that the homeowner would want to
continue making the first two years’s payments.
Even if the loan were affordable, if the homeowner refinanced it after the first few months –
say to obtain a lower interest rate – the originator would lose that part of the commission left
unpaid. To avoid this refinancing, at the time loan was first made, both the originator and the lender
would want to ensure that the loan were the best possible loan available at the time for the
This proposal would be structurally simple to implement: simply pass a federal law which
requires that all compensation to the mortgage broker, the originating lender, and the holder, be
recovered entirely through the regularly scheduled payment stream of the loan. Third party fees
necessarily incurred to close the loan would still be paid by the consumer at closing.
2. Making Simple, Fair Mortgages the Default Mortgage – Mandating the Offer of a Uniform Mortgage.
Originators should be required to offer every homeowner applicant for a Uniform Mortgage product. The Uniform Mortgage would be defined as a fixed rate, fully amortizing 30 year mortgage at a rate set by the lender in response to the perceived credit risk of the borrower, with no prepayment penalties.
Alternatives to the uniform loan can also be provided by the mortgage originator – but the
costs, risks and benefits would always have to be compared to the uniform mortgage that would be
offered. These comparisons – to be provided contemporaneously with the offer of the alternative
product would have to be provided at the same time as the alternatives are offered, and would be
provided via a simple format developed by the federal agency – presumably the Federal Reserve
Board – charged with developing the details of the new disclosure and transparency regulations.
These two changes – requiring that all profits from the origination process be paid through
the payment stream, plus requiring that homeowners always be offered the uniform fixed rate, fully
amortizing 30 year mortgage, with no prepayment penalty – would be relatively simple to mandate,
simple to implement, simple to comply with, and simple for consumers to understand.
There would essentially be just one variable in the uniform mortgage that would change in
response to the homeowner’s particular circumstances – the fixed rate applicable for the full term.
These changes would make the process of obtaining a mortgage, as well as the mortgage itself,
3. Common Sense Rules Should Be Required. Deregulation of the mortgage origination
and servicing process has produced some strikingly absurd situations: lenders making loans without
determining the borrowers’ ability to make the scheduled mortgage payments, who then find that
those homeowners cannot in fact afford the increasing payments; foreclosures on homes when the
investors, the communities, as well as the homeowners would benefit from loan modifications
Common sense rules for sustainable long-term home ownership help not only homeowners
but also investors. Federal law should require that those making the decisions about the origination
and foreclosure of home mortgages must include some basic, common-sense requirements. For
example, the following rules should be applicable to all home mortgages made in the future:
- 1. Mandate that Originators Find that the Homeowners Can Afford All
Payments Due on Loan. Originators must be required to determine that the
homeowners’ income will be sufficient to afford all of the payments due on the loan.
This includes separate components:
• All scheduled payments due under the terms of the loan, including any
potential increases in the interest rate or principal, must be found to be
• All other housing debt, as well as monthly contribution requirements for
property insurance and taxes, must be included in the sum of housing debt.
• All income must be verified through independent means, either using wage
statements, bank account and deposit records, or tax information.
- Mortgage Loans Above Value of Home Should be Prohibited. Originators
should be prohibited from making a mortgage loan for more than the home is worth
at the time the loan is made. Similarly, the terms of the mortgage loan should not
contemplate that the principal of the loan will climb to an amount over the value of
the home. In the current marketplace lenders have made hundreds of thousands of
Payment Option Arm Loans (see next section for more discussion about the dangers
of these loans) which included basic loan terms contemplating that the principal of
the loans would climb above the home’s value at origination. This is a recipe for
foreclosure – which is exactly what we are seeing. Similarly, inflated appraisals have
become commonplace in states which did not experience the steep increases in real
estate values – and homeowners and investors are both suffering. To counter these
inflated appraisals, originators should be held fully responsible.
- No Foreclosures Permitted without Modification of Loans. Federal law should
impose one critical requirement before lenders are permitted to foreclose on a
primary residence: the servicer must evaluate the homeowner’s situation and offer an
affordable loan modification where it will produce more income for the investor
than a foreclosure. Currently servicers make more money from a foreclosure than a
loan modification. Moreover, the income structure for servicer fees encourages them
to pad loans with high servicer fees, pushing more homeowners into foreclosure.
The servicer fee structure also needs to be changed.
- Full Enforcement Should be Incentivized – While relying on enforcement of the rules
through government administrative action or private litigation is not a sufficient means of making
the market successful, public and private enforcement are essential back-ups which serve two
essential purposes: 1) they ensure compliance with the rules, and 2) they allow the individuals
actually harmed by the violations of the rules to use those rules to protect themselves.
All rules should be enforceable by federal regulators and state attorneys general, as well as by
private lawyers. Attorneys’ fees and costs should be recoverable by prevailing homeowners.
Additionally there should be a general prohibition against unfair, unconscionable or deceptive acts
and practices applicable to all involved in the loan origination, servicing and holding. Statutory
damages, along with actual damages should be awardable for violation of these rules, up to the value
of the combination of the amount remaining due on the loan, plus what has been paid.
- Full Responsibility – No one involved in the creation, the funding of, or the
enforcement of a mortgage loan which violates the rules should be permitted to profit from a loan
made in violation of the established rules. Here, again, the complexity and negative incentives in the
current mortgage marketplace have allowed too many entities to make money from activities which
support fraudulent practices, faulty underwriting, and anti-homeowner practices. This needs to be
changed, so that everyone in the process profits from practices which sustain homeownership and
- No preemption – In the current mortgage debacle, it has become clear that the state
laws protecting consumers are the last bastion of redress for those homeowners who are fortunate
enough to find an attorney able to protect them from foreclosure. State laws on fraud, unfair trade
practices, unconscionability, foreclosure defenses, good faith and fair dealing, conspiracy, joint
venture, as well as other torts and contract defenses, have been the primary way many individual
homes have been saved. The rich and textured common law in the states has been particularly useful
to the courts as they craft appropriate responses to the new and complex set of problems that have
arise in recent years.