Groups Disagree About Regulation

Executives from key industry players such as Option One Mortgage Corp., Wells Fargo Home Mortgage and JPMorgan Chase suggested keeping prepayment penalties as long as the fees offer a benefit to consumers. In addtion, the group also backed, stated income loans with tighter restrictions, mandatory escrows for first-time home buyers and simpler disclosures. They warned that crafting regulatory standards to help determine a consumer’s ability to repay a mortgage is not an easy task.

Thursday’s hearings focused on prepayment penalties, stated income and low documentation loans, escrows and ability to repay standards at the Fed’s request. The Home Owners Equity Protection Act authorizes the Fed to regulate certain elements of the mortgage market.

The central bank held the hearing to determine how it can use its regulatory authority to stop abusive lending practices in the mortgage market.

Congress enacted HOEPA in 1994 in response to concerns about abusive lending in the home equity market. The Federal Reserve Board was given authority to implement HOEPA.

The National Association of Mortgage Brokers, saying that HOEPA isn’t the best way to eliminate unfair lending practices, suggested alternatives such as better disclosures and oversight of all mortgage originators.

Faith Schwartz, the senior vice president of enterprise risk management and public affairs at Option One, urged the Fed to be cautious in its rulemaking stance. She suggested that the Fed issue more regulatory guidance, craft rules targeted at abusive lending practices and strengthen disclosures.

Fed Governor Randall S. Kroszner said the central bank intends to take a comprehensive look at disclosures so as to improve their usefulness to consumers. He said the Fed will soon engage in consumer testing of mortgage disclosures. He said this methodology has been successfully used with credit card disclosures and that he is excited about doing the same thing with mortgage disclosures.

Pablo Sanchez, a national mortgage production executive for JPMorgan Chase, said Chase will soon be rolling out new disclosures of its own. “We call it our nutrition label,” he said.

In a written statement, Mortgage Bankers Association Chairman John Robbins also saw the need to examine disclosures, suggesting the Fed use its authority to simplify existing disclosures.

Mortgage lenders like prepayment penalties, while consumer advocates don’t.

Option One’s Schwartz reminded the board that prepayment penalties were designed to help preserve investor certainty. She spoke in favor of the fees and said that loans featuring the payout should offer a clear benefit to the consumer such as a lower interest rate in exchange for consumer acceptance of the early payment fee. She suggested the Fed issue guidance on the topic.

Susan A. Davis, an executive vice president, national consumer lending at Wells Fargo, also found value in prepayment penalties as long as the consumer is given a choice whether or not to accept the fee and it offers a clear benefit to consumers. Davis said prepayment penalties provide lower interest rates for consumers who keep their loans for a longer period. She suggested the fees be limited to the fixed term of the loan and said that without prepayment fees, investors might pull back from the market.

JPMorgan’s Sanchez agreed prepayment penalties should be of mutual benefit to the consumer and the lender.

But consumer advocates disputed the lenders’ assertions that consumer whose loans include prepayment penalties get the fee in exchange for a lower interest rate.

Martin Eakes, chief executive officer for the Center for Responsible Lending, said payment penalties should be banned on all subprime loans as borrowers don’t get a lower interest rate. He said that because 80 percent of loans refinance during the prepayment period, allowing prepayment penalties during the fixed term of a loan as was suggested by several of the lenders on the panel only gives the appearance of having done something about the fees.

Ira Rheingold, who is general counsel for the National Association of Consumer Advocates, agreed with Eakes, saying that prepayment penalties should not exist in the subprime market.

Iowa Attorney General Tom Miller, the lead attorney general in the Ameriquest settlement, said Iowa does not allow prepayment penalties, while Mark Pearce, deputy commissioner of banks for North Carolina, told the board the penalty should be banned.

Lenders Say Stated Income Loans Still Work

Kroszner said the Fed is considering issuing guidance or a rulemaking on stated income loans. The lenders urged caution in restricting or eliminating the controversial loan product because a curtailment could “negatively affect us all.” But consumer advocates and the state representatives at the hearing don’t favor the loans.

Davis said Wells offers the loans but has eliminated stated income loans for borrowers whose credit scores are less than 620. Explaining that she herself has one, Davis said the loans have merit and that regulatory restrictions should be tied to a “bright line test.”

Consumer advocate Eakes said stated income loans don’t work. Attorney General Miller, whose office has investigated many of the loans, said stated income loans are a “national scandal” that has to stop.

Mortgage bankers and advocates were able to find common ground regarding mandatory escrows.

Schwartz told the board that it should recommend escrowing property tax and hazard insurance payments although she admitted that her mortgage loan does not include this feature.

Presently, the majority of subprime mortgage borrowers pay those bills apart from their monthly mortgage payment, a practice that has been criticized by consumer advocates who feel that customers with weak credit and uneven credit payment histories are better served by having the fees added to their monthly mortgage payment so the lender can make the payments on the consumer’s behalf.

Sanchez said while all subprime borrowers should be offered the opportunity to escrow their property tax and hazard insurance payments, escrows should be mandatory for first-time homebuyers.

Janis Bowdler, senior housing policy analyst, National Council of La Raza, said she favors mandatory escrow if it is tied to something specific.

In response to a question from Fed Governor Kroszner asking if the Fed should adopt a “hard-and-fast” rule for ability to repay a mortgage loan, Schwartz said if the regulator chooses to do a rulemaking on the topic, it should do so carefully and should adopt a “bright-line” rule.

Sanchez said he didn’t want to see a rule around a 50 percent debt-to-income ratio. While William H. Brewster, director of anti-fraud initiatives for Fannie Mae, said it would be difficult to create a simple standard in that area.

But not all the panel participants believe rulemaking under HOEPA is the way to combat unfair lending practices.

NAMB President Harry Dinham said he wasn’t convinced that HOEPA is the best forum for addressing abusive mortgage lending practices. He offered alternative solutions to expanding HOEPA, including the creation and use of a consumer-tested, one page payment disclosure that would clearly communicate loan features, principle-based guidance, oversight of all mortgage originators and effective consumer education.

Dinham urged the Fed to regulate practices, not products and noted NAMB’s support for best practices that address ethics and financial literacy. “We also recommend that as a uniform, industrywide practice that all mortgage originators conduct their business and operate under a duty of good faith and fair dealing,” he said.

The Mortgage Bankers Association did not participate in Thursday’s hearing. But the group’s chairman, John Robbins, issued a written statement suggesting the Fed use its authority to simplify existing disclosures and to make the mortgage process more transparent.

MBA also urged caution in rulemaking, encouraging the board use its authority to narrowly address specific abuses in the market with clear and objective compliance standards.

Robbins said MBA will submit written comments to the Fed at a later date. The Fed will accept written comments from the public until August 15.

Although yesterday’s hearing is the fifth in a series of hearings by the Fed covering issues in the mortgage market such as nontraditional products and subprime foreclosures, in recent hearings on subprime lending held by the Senate Banking Committee, several senators accused the regulator of not doing enough to prevent the subprime lending crisis. The Democratic senators sent a letter in April to Fed Chairman Ben Bernanke, urging the board to fulfill its obligations under HOEPA and to issue regulations that address predatory lending practices in the subprime mortgage market.