Because the worst of the option ARM loans begin to mature through the last half of 2007 and all of 2008 there is more bad news coming.
Real estate professionals could be punished if Rep. Barney Frank, D-Mass, has his way. He wants to let delinquent subprime borrowers sue the investment bankers who bought the loans and turned them into securities. A major sea-change in mortgage lending would follow.
Big secondary market players like Lehman Brothers, Goldman Sachs and Merrill Lynch have largely escaped a full-blown consumer assault on them through the Tort Reform Act. A legal maneuver called “implied cause of action” has provided some protection. Congressman Frank would take the protection away and the trial lawyers of America would be forever grateful. Mortgage brokers and many wholesale lenders don’t have the deep pockets the plaintiff’s bar needs.
If delinquent borrowers are allowed to sue their way out of foreclosure, you can bet the loan terms for marginal borrowers and first-time homeowners will tighten considerably. But there’s more to worry about. Housing needs a constant stream of mortgage money to stay healthy, and the latest subprime burnout has investors running for cover.
The real estate market will be left with three money sources for marginal home buyers: the Fannie Mae/Freddie Mac duo; the Federal Housing Administration (FHA); and finance companies. Mortgage brokers will sell to any of them but will operate under many added federal restrictions.
Regulators are pushing to require mortgage brokers be able to defend their recommended loan choice, similar to the standard of care a licensed securities dealer must maintain. Brokers are insisting only the borrower can make that decision. It’s unlikely the regulators will win this one. But a broker crackdown is coming and everyone knows it.
Fannie Mae and Freddie Mac are essentially the same company. They are joined at the hip when it comes to underwriting risk and neither will have the same appetite for low scorers. Both are just coming out of big accounting scandals and they fear another round of bad publicity would sink the unique status they enjoy. Their borrowers will need to have some equity, and pricing will be no bargain.
FHA needs to revamp its entire single-family program. It’s doubtful that Congress will allow 100 percent LTVs (loan-to-value ratios), which they’ve asked for. Keep in mind that while Fannie, Freddie and FHA are touting their efforts to save the hapless consumers now facing foreclosure, this is done on a one-on-one basis. There will be no across-the-board mass reduction in rates.
FHA wants to get into the act because their market share plummeted when subprime came on the scene. Three things would have to happen: 1) Congress would have to raise the loan ceilings to match Fannie and Freddie; 2) FHA premiums need to be adjusted to the increased risk, possibly making them less competitive; and 3) FHA has to be easy to do business with. The bureaucracy lives there.
Finance companies who operate under a consumer loan license can charge considerably more than banks because they will take more risks. But their record isn’t a good one. Some heavy fines have been levied to big players who admitted cheating their customers. Because they would undoubtedly turn their “new subprime loan” into a portfolio product they would have the edge needed to gain loan volume.
Add to this the fact that they can also sell into the secondary market and maybe even offer some FHA products and you have a powerful market force. But it is a force that is least concerned with consumer satisfaction. It is more like a sales organization than any other: pushing credit insurance and making personal annual visits to sell borrowers on refinancing existing debt using their equity. Worse, finance companies may not come under the jurisdiction of any regulator who keeps everything honest.
For real estate professionals, this means using greater care in recommending lending sources to clients not qualifying for prime rates. In spite of government calls for reform of predatory lending, history has shown that by the time all of the players are heard from and the final rules are published we’ll get less than half of what is really needed. We can only hope that the lawmakers will provide enough money for the enforcement of the new rules.
Gordon Schlicke is a consultant and expert witness on predatory lending and mortgage fraud, RESPA, the HUD-1 Settlement Statement, federal and state lending compliance, and RESPA-compliant Affiliated Business Arrangements. He is affiliated with BPI Consulting Group and Ethical Lending Foundation.
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