National Consumer Law Center Testimony on Mortgage Reform

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 ):

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. 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.


  1.  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.


  1. 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.


  1. 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.


  1. 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

home equity.


  1. 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.


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