Two reports by Harvard University academics conclude that a lack of uniform regulations allow independent mortgage lenders to operate with less oversight of their compliance with laws intended to prevent discriminatory and unfair lending practices
The aggressive marketing of subprime mortgage loans during the housing boom confused or misled many consumers about the terms offered by non-bank lenders and mortgage brokers, the reports said.
The use of incentives encouraged some mortgage brokers and loan officers to market more costly subprime products to less knowledgeable borrowers who lacked the ability to repay the loans, the reports found, with potentially disastrous consequences for poor and minority neighborhoods now being hit by foreclosures.
The reports’ recommendations include expanding federal guidelines for nontraditional “exotic” loans so that they apply not only to federally chartered banks but also to independent mortgage companies, and extending Community Reinvestment Act oversight to all lenders.
The reports also call for federal regulators to set licensing and performance standards for all mortgage brokers and loan officers who deal directly with consumers, and for increased oversight of investment firms that securitize and sell mortgage loans to Wall Street investors.
If secondary market investors were made liable to lawsuits by borrowers who are the victims of illegal or abusive lending practices, they would be less likely to purchase such loans, one report said. Existing laws protect investors from such lawsuits by limiting assignee liability.
In “Understanding Mortgage Market Behavior: Creating Good Mortgage Options for All Americans,” Ren S. Essene and William Apgar studied the behavior of borrowers and lenders in an “increasingly complex mortgage marketplace.”
Although economists assume that consumers can make choices that are in their best interest, Essene and Apgar said those choices depend on how their options are framed, the complexity of products, and the borrower’s ability to weigh their long-term interests against perceived short-term losses.
Borrowers have difficulty understanding the complexities and variable features of alternative mortgage loan products, they said, a problem compounded because pricing information provided to comply with disclosure requirements is often furnished late in the process.
When borrowers take out a loan that they later decide was a mistake, prepayment penalties and transaction costs make it difficult to correct the mistake, the report said.
What’s needed, Essene and Apgar said, is an opportunity for borrowers to obtain a second opinion. They recommend building a network of “trusted advisors” including nonprofit mortgage counseling services and for-profit “buyer’s mortgage brokers” who would represent their clients’ interests and be paid a flat fee.
“Community-based groups and national nonprofits can change the ‘default’ option and steer consumers to ‘good loans,’ ” they said.
“Understanding Mortgage Market Behavior” also calls for better information transparency and industry self-regulation. Borrowers should be provided Truth In Lending Act disclosures 3 to 7 days before closing, and good faith estimates should be binding earlier in the application process.
The second report, “Mortgage Market Channels and Fair Lending: An Analysis of HMDA Data,” provides another analysis of mortgage loan data collected by federal regulators under the Home Mortgage Disclosure Act.
Essene, Apgar and Amal Bendimerad use 2004 HMDA to make a case that the structure of the mortgage industry and the lack of uniform regulation are factors that allow unfair pricing of loans to minorities.
A Federal Reserve study of 2005 HMDA data found that minorities were more likely than whites to take out higher-priced home loans. The study said it was unclear whether minorities were targeted for such loans because loan-level information on factors used by lenders to underwrite and price loans, including loan-to-value ratios, debt-to-income ratios and credit history scores, is not collected.
Other groups, including the California Reinvestment Coalition, a nonprofit that promotes investment in low-income communities, maintain the HMDA data show lenders target minorities for higher-cost loans.
The Harvard study found that most lenders make relatively few higher-priced loans (defined as a first-lien loan with an APR that exceeds 3 percent of the rate for Treasury securities of comparable maturity). In 2004, the 4,154 lenders who made 40.7 percent of all lower-priced prime loans (2.7 million) made only 27,000 higher-priced loans, or 2 percent of that year’s total. There were 905 lenders that specialized in higher-priced lending, however, and just 17 large independent mortgage companies accounted for 39 percent of all higher-priced loans in 2004, the study found.
This “channel specialization” in the mortgage industry extends to the race and ethnicity of borrowers served, the report said. White borrowers were 50 percent more likely than African Americans to obtain their mortgage from a bank or thrift regulated by the Community Reinvestment Act. By comparison, 44.2 percent of blacks (compared with 30.1 percent of whites) obtained loans from more loosely regulated independent mortgage companies.
“The lack of uniform regulations and the correlation of mortgage channels with race and ethnicity results in a situation where many of the nation’s most vulnerable borrowers participating in the rapidly growing higher-priced market have less-than-equal access to the benefits of federally mandated consumer protections that are more commonly available in the lower-priced prime market,” the report said.
The report recommends applying guidance federal regulators have issued for banks that offer nontraditional mortgages to all mortgage lenders, including non-bank independent mortgage companies. Community Reinvestment Act oversight should also apply to all deposit-taking organizations wherever they originate loans, and non-bank mortgage lenders.
Although the Community Reinvestment Act was intended to prevent redlining, “CRA oversight has emerged as an important component of fair lending enforcement,” the report said, because CRA loan-level reviews are usually accompanied by fair lending reviews.
To reduce the state-by-state variations in the regulation of mortgage brokers, the Harvard study recommends that the federal government set minimum licensing and performance standards and require states to adopt them. The federal government should provide funding to support state enforcement and monitoring of mortgage brokers, appraisers and mortgage professionals.
Because most higher-priced loans are funded by Wall Street investors, the Securities and Exchange Commission should strengthen monitoring and oversight of securities used to finance such loans. Investors who buy those securities should be subject to legal action when the loans were originated through illegal or abusive lending practices, the report said.
“Such actions would substantially increase the incentives of secondary market investors to more carefully evaluate the loans that they purchase for fair lending and other abuses of best lending practices,” the report said.
Because government-sponsored mortgage repurchasers Freddie Mac and Fannie Mae are already subject to detailed review for compliance with fair lending requirements, they should be “encouraged to take a more active role in the acquisition of higher-priced whole loans and in doing so help establish a series of industry best practices to govern this important segment of the mortgage industry,” the report said.
