The Fed's Proposal To Tighten Up Lending Standards

Dear Readers and Bloggers,


The recent rash of proposed regulations and legislation regarding the mortgage industry is dizzying! It goes to demonstrate the sort of mishmash of oversight that mortgage lenders, brokers and conduit lenders have dealt with in the past! Perhaps, as it has been suggested many times recently, we need to get all these agencies together with professionals from the lending industry and create a uniform code that avoids confusion and diluted oversight. In the meantime, however, I will try to address each set of new proposed or enacted regulations as they come. Please read the respective statements of Chairman Bernanke and Fed. Governor Kroszner's : http://www.federalreserve.gov/newsevents/press/bcreg/bernankehoepa20071218.htm and

http://www.federalreserve.gov/newsevents/press/bcreg/krosznerhoepa20071218.htm

This full press release from the Fed, http://www.federalreserve.gov/newsevents/press/bcreg/20071218a.htm , is a pretty simple synopsis of what Chairman Bernanke and his brethren are proposing to prevent the current crisis from happening again.


The Fed is allowing 90 days for "Public Comment" and will then tinker with the proposal as it deems fit. I am hopeful that all of my readers will read the information carefully and and recognize both the positives and the negatives. It is important that all of you contact the Fed with your comments and concerns at:

http://www.federalreserve.gov/generalinfo/foia/usr_agrmt.cfm?url=ElectronicCommentForm.cfm?doc_id=R-1305%26doc_ver=1%26name=Regulation Z - Truth in Lending%26date=20071218a

The following is the text of a Fed press release entitled "Highlights of Proposed Rule to Amend Home Mortgage Provisions of Regulation Z" as released by the Fed on December 18, 2007. Please note my comments/analysis in YELLOW CAPS.

"The proposal would establish a new category of “higher-priced mortgages” that should include virtually all subprime loans. (Higher-priced mortgages would be those whose annual percentage rate (APR) exceeds the yield on Treasury securities of comparable maturity by at least three percentage points for first-lien loans, or five percentage points for subordinate-lien 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. EXCELLENT.

*Prohibit a lender from making a loan by relying on income or assets that it does not verify. THIS CAN REALLY HURT LENDING AND REAL ESTATE SALES. WHILE I UNDERSTAND THE ABUSES THAT HAVE OCCURRED IN LENDING, THE FED IS NOT CONSIDERING HOW MANY OF THESE "SUBPRIME" BORROWERS ARE ACTUALLY SELF EMPLOYED, HAVE GREAT CPA'S, GREAT WRITE-OFFS, AND LOW BOTTOM LINE EARNINGS! IF WE CURTAIL THE ABILITY OF THE SELF EMPLOYED TO BORROW BY LIMITING THEM TO DEBT RATIOS BASED ON NET INCOME, WE ARE LIMITING THEIR PURCHASING POWER. THE PROPOSAL DOES NOT INDICATE IF COMPENSATING FACTORS ARE TAKEN INTO CONSIDERATION. FOR EXAMPLE, A BORROWER CLAIMS $10,000.00 IN INCOME, BUT HIS NET INCOME REFLECTS $7,000.00 PER MONTH. THE SAME BORROWER, HOWEVER, HAS $300,000.00 IN ASSETS IN THE BANK AFTER PUTTING DOWN 30% ON A PURCHASE. THE BORROWERS CREDIT IS A BIT "DINGED-UP" BECAUSE HE OWNS HIS OWN BUSINESS AND HAS TAKEN SOME HITS IN THE PAST. BASED ON THIS PROPOSAL, THE BORROWER LOSES ROUGHLY $1,200.00 A MONTH IN ABILITY TO PAY ($3K X .40 =1200) OR $200,000.00 IN PURCHASING POWER! IT IS CRITICAL THAT "STATED" PROGRAMS STAY IN PLACE. REQUIRING COMPENSATING FACTORS (SAVINGS, LTV, ETC), THOROUGH UNDERWRITING PROCEDURES, ALTERNATIVE FORMS OF INCOME VERIFICATION, ETC., CAN ALLOW THESE PROGRAMS TO STAY INTACT WHILE MINIMIZING ABUSE.

THERE ARE MANY, MANY SELF-EMPLOYED BORROWERS AND THIS PART OF THE PROPOSAL WILL REALLY AFFECT THEIR ABILITY TO BORROW AND, CONSEQUENTLY, THEIR ABILITY TO PURCHASE/REFINANCE HOMES. THIS IS NOT GOOD FOR THE REAL ESTATE MARKET.

*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. THE CONDITIONS HAVE NOT BEEN CLARIFIED. THE PURPOSE OF THE PREPAYMENT PENALTY (PPP) IS TO INSURE THAT THE LENDER MAKES A CERTAIN YIELD. YES, THE PPP CAN BE ADDED TO A LOAN TO LET THE LENDER RECOUP MONIES THAT THE LENDER PAID THE BROKER IN EXCHANGE FOR A HIGHER INTEREST RATE. THE PPP CAN ALSO BE APPLIED BECAUSE THE LENDER GAVE THE BORROWER A BETTER INTEREST RATE AND WANTS TO MAKE SURE THEY STAY IN THE LOAN FOR A WHILE, THUS INSURING AN ADEQUATE RETURN. THE PPP CAN BE APPLIED IN ORDER THAT THE BORROWER CAN DO A "NO POINT, NO FEE" LOAN. THE PPP CAN BE APPLIED TO HELP THE BORROWER MAXIMIZE THEIR DOWN PAYMENT BY WAY OF BROKER CREDITS. AS YOU CAN SEE, THE PPP CAN WORK FOR OR AGAINST THE BORROWER. BY POTENTIALLY DISALLOWING THE PPP, THE FED IS FORCING LENDERS TO RAISE RATES (TO INSURE DESIRED YIELDS). THIS PROPOSAL WILL REMOVE SOME KEY DECISION-MAKING OPTIONS FROM THE BORROWERS IN ADDITION TO LOWERING THE LOAN AMOUNTS BORROWERS CAN QUALIFY FOR. AGAIN, NOT NECESSARILY A GOOD THING FOR THE BORROWERS, THE LENDERS, OR THE REAL ESTATE MARKET.

*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.

THIS IS RIDICULOUS. BORROWERS OUGHT TO BE ABLE TO DECIDE WHETHER THEY WANT THEIR MONEY IN THEIR ACCOUNTS EARNING INTEREST OR IN AN ESCROW ACCOUNT. TRADITIONALLY, IF THE LOAN AMOUNT IS OVER 80% LOAN-TO-VALUE, THE LENDERS HAVE REQUIRED IMPOUNDS. THIS PROPOSAL IS OVERKILL.

The proposal would, for these and most other mortgages:

*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. GREAT. THE CALIFORNIA "MORTGAGE LOAN DISCLOSURE STATEMENT " ALREADY DOES THIS. IT IS A GOOD IDEA TO ADD TO THE HUD "GOOD FAITH ESTIMATE".

*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. EXCELLENT.

*Prohibit a creditor or broker from coercing or encouraging an appraiser to misrepresent the value of a home. EXCELLENT.

*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. EXCELLENT.

*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." EXCELLENT.

I am concerned that, in an effort to protect the consumer, the Fed is drafting good politics and bad policy. Unfortunately, most government entities know little about the finer points of the businesses that they regulate. The lending industry is taking some very serious blows (fatal for many!) and is losing billions of dollars. The viciousness and efficiency of the market will naturally create the necessary changes to lending. I believe that the survivors are already changing or have changed their procedures to reflect a more responsible and ethical lending environment. For the most part, I do not believe too much government involvement will help the matters. That being said, the lenders cannot expect a bailout, either.