Bulls & Blogs

A clever marketing company came up with the slogan "When Banks Compete, You Win." Makes sense. Every basic Economics book will tell you that competition keeps prices lower. Well, apparently Congress doesn't agree.

Under the guise of protecting consumers from "abuses in the mortgage lending market," Reps. Brad Miller (D-NC), Mel Watt (D-NC), and Barney Frank (D-MA) have introduced The Mortgage Reform and Anti-Predatory Lending Act of 2007 (HR 3915). But instead of protecting consumers, the effect of this bill will be to disqualify many people from receiving a mortgage. The bill, as crafted, also will force mortgage brokers, most of whom are small businesses, out of business.

The bill has several sections. The first establishes a national registry for all mortgage originators. This is a laudable goal and one for which mortgage brokers have been fighting for years. We see this as one of the best ways to eliminate the bad actors from the mortgage industry.

The third section establishes minimum underwriting standards for all mortgage loans. This may sound innocuous, but, if passed, will increase interest rates for all mortgages and eliminate loan programs that cater to the self-employed and those with less-than-perfect credit. (I'm self-employed and will not qualify for a mortgage under this bill. Despite the fact that I have never been late on my loan payment, Congress feels I don't deserve a mortgage.) I'll tackle this section in another article.

It's the second section I want to tackle today. This portion puts brokers on the endangered species list. Some of you who follow the popular press may be saying, "About time we got rid of those brokers." Well, before you start celebrating, I suggest you take a hard look at what this misguided, knee-jerk bill will do to your pocketbook.

Mortgage brokers originate more than 60% of all home loans. Brokers command this large percentage because, based on several independent studies, they offer better pricing and better service than the other players in the mortgage market, bankers.

Think about it. Mortgage brokers shop wholesale lenders for loan terms that best meet their customers' needs. Customers like choice. Not everyone wants "vanilla." Moreover, different lenders have different interest rates for the very same loan program. Mortgage brokers are able to choose among the lenders to find the best rate for their customers. And they have an incentive to do so because of competition. A competing broker or banker is just a click away on the Internet.

Obviously, if you get rid of brokers, you get rid of a lot of competition. (Think about who benefits from this, and you have a hint who's pushing this bill.)

The bill affects mortgage brokers by effectively banning yield spread premium (YSP). The term makes most people's eyes glaze over, but it's really not a difficult concept. The best way to understand YSP is to consider two loan options with different interest rates, 6.00% and 6.25%. The option with the higher interest rate makes the lender more money, so the lender will pay a premium for it. This premium is YSP.

The media, and now Congress, have tagged YSP as some sinister, hidden kickback paid to mortgage brokers. It's nothing of the sort. It serves a couple important purposes and by law MUST be disclosed to customers during every step of the loan process.

Brokers use YSP to help customers pay their closing costs. Let's say the premium on that 6.25% loan was $1,000. At closing, the broker can give that premium back to the customer to pay for lender fees, the appraisal, etc. This is how "No Cost" loans are possible. (Did you really think the bank was going to close your loan for free?) With the proposed bill, mortgage brokers will not be able to offer "No Cost" loans.

However, the ban will not apply to bankers, so brokers will be at a competitive disadvantage. You see, the banker's premium has a different name, servicing release premium (SRP). It is determined by the difference between a mortgage loan's interest rate and the interest rate the banker pays for the money it lends. If it costs the banker 5.75% for the money it lends to the consumer at 6.25%, the banker pockets a handsome premium. Unlike YSP, the servicing release premium is NEVER disclosed to the consumer.

The other way brokers use YSP is to pay the bills. All mortgage originators (brokers and bankers) typically charge 1% of the loan amount as an origination fee. For a $300,000 loan, that's a substantial paycheck. However, for a $60,000 loan, the origination fee ($600) doesn't cover the cost of doing business. So, originators (brokers and bankers) raise the rate a little to generate more income.

The concern about YSP is that brokers may abuse it to pad their pockets. The mainstream media and consumer groups have used this concern to demonize YSP and brokers who receive it. What both forget is that you cannot abuse YSP without increasing the loan's interest rate. If the consumer believes the rate is too high, a competing broker or banker is just a click away. (Remember the slogan? "When Banks Compete, You Win?")

Also forgotten is that bankers have the same incentive for abuse. The big difference is that brokers, by law, must disclose their YSP. Bankers hide their premiums. As a result, bankers' premiums typically dwarf those paid to brokers. (We won a customer away from a banker who we calculated was charging a $10,000 premium. Fortunately, the customer stepped away from the closing and called us.)

Congress says it's aim is to protect consumers from this abuse. So why aren't they focusing on making the industry more competitive and transparent? Instead, they want to put "price controls" on mortgage brokers. Do we really want Congress regulating how much money businesses can make?

Think of it this way. When you buy a car, do you ask the salesman, "How much money is Ford making on this car?" Of course not. You ask how much it costs. When you buy a new computer, do you ask, "What's Dell's margin on this computer?" Heck no. You ask how many bills you're going to have to pull out of your wallet.

We should have the same focus for mortgages. What's important is how much it costs. But mortgages can be confusing, so how do you know how much one costs? Years ago, federal law mandated that all mortgage originators disclose the annual percentage rate (APR) on every loan. The APR is the loan's effective interest rate that accounts for closing costs, discount points, and the premium paid to the originator (YSP or SRP). Borrowers can avoid YSP abuse by carefully going over any offer they receive and comparing the APR.

But you say comparing offers can be difficult because of all the forms and legal mumbo-jumbo. Well, mortgage brokers agree and have proposed simplifying mortgage disclosures to make comparisons easier. Unfortunately, this proposal has gained little support in Washington (for reasons I cannot fathom).

The goal of the proposed bill is laudable: protecting consumers from bad mortgages. However, this bill really is the wrong way to do it. In its attempt to prevent the abuses of a small number of originators, it will dramatically reduce loan options and lead to increased interest rates for those who still can qualify for a mortgage. It will eliminate an entire business class (mortgage brokers) that has largely been responsible for creating the competitive mortgage market we enjoy today.

Please tell your Congressman you want banks to compete and to vote against HR 3915.

With alacrity unbecoming of this Congress, the House of Representatives passed the Expanding American Homeownership Act of 2007 in September. After passage of the bill, Rep. Maxine Waters, Chairwoman of the Subcommittee on Housing and Community Opportunity stressed its critical nature. "There is an affordable housing crisis in America. In recent months, that crisis has exploded beyond the poorest renters and homeowners to threaten the domestic economy." said Chairwoman Waters.

The Senate Banking Committee promptly passed its own version of FHA reform the very next day by a 20-to-1 bipartisan vote. Chairman Christopher Dodd promised to "fight for swift passage so that homeowners can get the relief they deserve."

But here we are more than a month later, and all that urgency seems to have dissipated. According to the Washington Post's Kenneth Harney in a 10/27 column, "the Senate FHA bill doesn't even have a number and has not been sent to the majority leader's office for scheduling a floor vote. A spokesman for Dodd, Marvin Fast, said committee staff work on the bill is underway, but he had no explanation about what happened to earlier promises of quick action to aid homeowners in distress."

Congress must have breathed a sign of relief when foreclosure filings dropped 8% last month. I hope they caught their breath again when it read that the September reading is still double the number reported a year ago and is the second highest monthly total on record.

The problem is still very real. HUD Secretary Alphonso Jackson estimates that 500,000 subprime mortgage borrowers could wind up in foreclosure when their interest rates adjust upward over the next 18 months. A consumer advocacy group pegs the number two to four times higher.

The FHA reform legislation would provide relief by raising loan limits in high-cost areas of the country, reducing required down payments, and opening up FHA lending to more competition. Many consider it a crucial relief measure for homeowners who need to refinance out of adjustable-rate loans to avoid foreclosure.

One cannot help but wonder if the Democratic Congress is more interested in manufacturing a campaign issue than in helping strapped homeowners.

The Democratic leadership held a news conference on 10/3 to bash the President for his handling of the mortgage crisis. Senate Majority Leader Harry Reid said, "This is a national crisis. Too bad it's taken so long to realize that we have a crisis." He joined Dodd and House Speaker Nancy Pelosi in calling for President Bush to make an emergency appointment of a "mortgage czar" to respond to rising delinquencies and foreclosures.

Where have these guys been? For two years, President Bush has sought legislation revamping the Federal Housing Administration but Congress has done nothing, according to Housing and Urban Development Secretary Alphonso Jackson. "To place even one family at risk is irresponsible, and Congress should stop playing politics with homeowners' financial security," Jackson said.

Almost everyone agrees that foreclosures are not in the best interest of anyone. However, a solution to the elevated number of mortgage delinquencies is complex. Many mortgage loans are packaged and sold as securities, and this limits the flexibility of the lender to restructure the loan terms.

The latest foreclosure statistics from RealtyTrac Inc. show that foreclosure filings rose 7% from Feb to Mar. Of the 149,000 filings posted nationwide in Mar, five states - CA, FL, TX, MI, and OH - accounted for half the total. The Feb number was down 4% from Jan but up 12% from Jan 2006. (RealtyTrac provides a "Heat Map" that shows the relative foreclosure activity across the U.S.)

Solutions

Can anything be done to stave off a rise in foreclosures? Most politicians, Democrat and Replublican, agree that a federal bailout of delinquent mortgages is not the answer.

The mortgage industry has responded with some creative solutions that will provide flexibility and allow borrowers to rework the terms of their mortgages. These initiatives come from a broad spectrum of players in the mortgage market.

FannieMae

FannieMae, the largest purchaser of home mortgages, is rolling out the "HomeStay" program, which will relax underwriting standards to help refinance homeowners who are facing payment shock due to resetting adjustable rate mortgages (ARMs). Fannie will overlook unpaid bills on borrowers' credit reports and offer 40-year terms to lower payments. Fannie Mae CEO Daniel Mudd said about 1.5 subprime borrowers could qualify in the next year to refinance under the program.

FreddieMac

FreddieMac, the second largest purchaser, is developing loan products for subprime borrowers that will limit payment shock by offering reduced margins, longer reset periods, and longer fixed-rate terms. Freddie expects to roll out the products by midsummer. Freddie Mac CEO Richard Syron said the company will purchase $20 billion in loans to help subprime borrowers refinance into more affordable mortgages.

NeighborWorks

The Mortgage Bankers Association (MBA) has partnered with NeighborWorks America, a national nonprofit organization, to help borrowers in danger of foreclosure stay in their homes. The partnership will support a national campaign that links homeowners to free counseling and establishes foreclosure intervention programs in cities with high rates of foreclosure.

Mod Squad

EMC Mortgage has created the "Mod Squad," a 50-member team of loan modification experts that creates custom solutions for borrowers who no longer can afford their mortgages. The team reaches out to individual EMC borrowers, publicizing their work through consumer and credit counseling organizations and educational meetings in cities where delinquencies are rising. The object is to search for changes in rates and terms that will permit the borrowers to remain in their homes, pay down their loans, and avoid foreclosure.

Washington Mutual

In an effort to help WaMu borrowers with subprime mortgages avoid foreclosure, Washington Mutual has committed to refinance up to $2 billion in subprime loans at discounted interest rates. The company said, "WaMu subprime borrowers who remain current on their existing loans and anticipate pending payment increases may apply for new discounted fixed-rate loans."

All these solutions have been announced in the last few weeks, and it is likely that others will appear in the coming weeks. If you are having trouble managing your mortgage payment, the bottom line is contact your lender or one of the organizations offering free homeowner counseling, such as the Homeownership Preservation Foundation. Alternatives are available, and people are available to help.