Virtues of Subprime Lending

The letter, sent by the Mortgage Bankers Association Wednesday to the Secretary of the board of governors of the Federal Reserve System, was a response to the Fed’s request for feedback on the 2002 revisions to the Home Ownership and Equity Protection Act.

Some of the most important changes made to the HOEPA included lowering the annual percentage rate trigger on first-lien mortgages to 8 percentage points from 10 percentage points; adjusting fee-based triggers to include amounts paid at closing for optional credit life, accident, health, or loss-of-income insurance and other debt-protection products; and treating assignees holding or servicing a HOEPA loan like original creditors, according to the letter.

“The exiting HOEPA regime is working well in the marketplace to protect consumers and should not be changed,” MBA said.

While the 2002 revisions did cut an increased share of lending above the new triggers, considerable lending activity beneath the triggers has occurred, MBA explained.

As a result of the changes, the availability of credit in the subprime market has increased and, as a result of competition, differences between prime interest rates versus subprime have compressed or narrowed considerably — weighted average coupons on prime loan pools is recently only 200 basis points lower than subprime loan pools, compared to a spread of about 300 BPS in 1999.

“Since 2002, the nation’s homeownership rate has risen to nearly 70 percent as a result of the growth of the nonprime mortgage market,” MBA added.

The major factor accounting for the compression between subprime and prime spreads is competition, and “MBA cautions against increasing existing federal regulation in this market as it could decrease competition and increase rates that the subprime market offers consumers.”

MBA also said it did not agree that prepayment penalties, which have become common in the subprime market, are abusive because investors are typically willing to pay more for loans with this feature and the premium is passed on borrower in the form of a lower rate. Plus, because some investors are unwilling to buy loans without the protection against prepayment, the penalty expands availability of subprime financing.

MBA’s position on the 30 anti-predatory lending standards that have been enacted at state and local levels is that, although “well intended, the creation of widely disparate and overbroad standards limits mortgage lending and loan terms, creates a significant compliance burden on lenders, increases their exposure to liability and increases the cost of homeownership.”

Studies that have shown the different laws have helped reduce predatory terms, have resulted in lower rates for borrowers and have not had an effect on subprime volume are flawed, MBA said, noting that mortgage volumes have, in fact, declined where there are state ‘predatory lending laws’ reducing the availability of credit not just limiting ‘predatory’ features.” Additionally, research on the North Carolina law, which has been cited by some as the most successful of anti-predatory laws, has caused “a decline in lending in minority and low-income neighborhoods and has had negative effects on the availability of credit to all income and racial groups.”

MBA advised the Fed to avoid the path some states have taken of lowering federal HOEPA triggers in their predatory lending laws, including the point and fee threshold, to prevent cash-poor borrowers from facing higher up-front closing costs and/or higher interest rates and monthly payments, which in turn pose risks that lessen the credit supply, make it more difficult for borrowers to access equity in their homes and force borrowers to seek financing from expensive and sometimes questionable sources.

Another approach MBA strongly cautioned against was the imposition of a suitability standard on mortgage lenders that some states have been considering.

“A suitability requirement or standard would mandate that a lender not offer a loan product to a borrower unless the lender determines that the particular product with its features is suitable for that borrower,” MBA said. “This would force lenders to make decisions on non-financial information, which a lender is just not equipped to do. At the same time, because of the subjective nature of such a standard, the lending industry would be exposed to significant liability by virtue of its imposition.”

To empower borrowers to make such determinations themselves, MBA urged the Fed to create a simple, one page disclosure of material mortgage terms; commit resources to financial literacy; and encourage borrowers to shop and compare mortgages. These steps would ultimately enable the borrower to be more informed and reduce their chances of getting into a higher priced loan.

A national anti-predatory standard would also reduce the limitations that compliance with a patchwork of non-federal laws places on financing options, facilitate both consumer and lender education, and result in market efficiencies and streamlined processes that would increase competition and lower the cost of homeownership, MBA suggested.

As for whether consumers have sufficient information about nontraditional mortgages to understand associated risks, MBA said that, since there is not a single, uniform mandated disclosure for such products, “mortgage lenders that successfully offer these products constantly review the performance of these loans [and] make changes as warranted to credit policies and other practices to improve performance and to facilitate customer understanding.”

“It is in the interest of mortgage lenders to assure that their customers are provided necessary information to facilitate their understanding of these products,” MBA added.

The trade group recommended that the Fed work on streamlining and improving borrower information provided under RESPA Regulation X and TILA Regulation Z, which require the provision of borrower information including the Special Information Booklet and the CHARM booklet, as well as disclosures at the time of mortgage application and settlement. MBA also thinks there should be an update to provide all borrowers information on nontraditional mortgage products.

Among other recommendations, MBA supports the allocation of additional resources for reverse mortgage counseling.

MBA also used the letter to emphasize other positive factors amongst homeowners. For example, it noted that the value of residential real estate assets owned by households has increased to $20.4 trillion as of the first quarter 2006 from $10.3 trillion in 1999, and that homeowners’ aggregate equity now exceeds $10 trillion and their median net worth in 2004 was $184,000, compared to renters’ $4,000.

The group also assured the Fed that, contrary to belief that default and foreclosure rates are at crisis levels and a greater percentage of borrowers are losing homes, MBA data showed first quarter delinquency had improved from the fourth quarter, as well as the foreclosure inventory rate. While the aging of the loan portfolio and increasing short-term interest rates will put upward pressure on delinquency rates, there will only be modest increases in delinquency and foreclosure rates in the quarters ahead as a strong economy and labor markets will offset the negative factors.