Thursday, February 9, 2006

Third of three parts

Federal banking agencies, concerned about the potential for abuses in mortgage lending, are going after the worst practices in the industry.

A directive last month from the Federal Reserve and four other federal agencies targets the proliferation of loans offering interest-only payments for extended periods and adjustable-rate mortgages that offer the option of paying interest only, making a minimum payment each month or adding in principal. That includes about half of all mortgages made last year.

Regulators say they are particularly concerned that some loans not only do not pay down principal, like a traditional mortgage, but they also increase the amount of principal that a consumer must pay by as much as 100 percent through “negative amortization.”

The regulators also expressed concern about the growing practice of “layering” risky mortgages on top of already dicey lending practices, such as requiring no down payment or proof of income from borrowers.

The regulators said banks that offer such loans will be held accountable for making full disclosure of the risks to consumers.

But many inside and outside the mortgage industry question how much impact the banking directive will have, because so many mortgage brokers operate outside the banking system. Only those that are subsidiaries of banks would seem to be affected.

“Banking regulators actually have fairly minimal control or even influence over a huge portion of our economy,” said Christopher Cruise, a Washington mortgage broker and trainer for the Mortgage Training Institute.

“I’m not saying we’re thumbing our nose at the regulators,” he said. But “if I’m a street-level originator licensed by the state of Maryland generating 20,000 loans in a year, and I find rich investors to buy them, nothing the [Office of the Comptroller of the Currency] says has any impact on me.”

Mortgage companies such as Countrywide, the biggest nonbank lender in the country, appear to be unaffected, he said.

“I think they own a bank, I don’t think the bank owns them. They sell their mortgages to Wall Street,” he said.

‘Empire of debt’

Although mortgage brokers perceive few limits on current practices, many nevertheless are concerned about the massive debts they see borrowers take on to buy houses and maintain affluent lifestyles.

Mortgage brokers in California report that some borrowers in recent years have been making a living by taking advantage of soaring housing prices and “flipping” real-estate investments — buying and selling them in rapid succession — while using equity loans on the properties as “income.”

The practice could amount to mortgage fraud if the borrowers disguised the source of their “income” on their loan applications, the brokers said.

Mr. Cruise noted that debt appears to be addictive for some consumers who simply cannot save or go without lavish things. Some will refinance their mortgage at Christmastime, for example, so they can splurge on expensive presents.

“I feel like a drug dealer,” he said. “I’m horrified at the empire of debt we’re creating.”

Mr. Cruise said some of his customers are so intent on getting loans, they won’t take “no” for an answer. “We’re enablers. We’re just middlemen. In a sense, we profit from their foolishness.”

Most mortgage brokers follow the disclosure requirements of the Truth In Lending Act, which specifies, among other things, that the full cost of the loan — principal plus interest — must be clearly spelled out to consumers before they sign the mortgage contract.

But Mr. Cruise said many consumers never bother to read the disclosures. With today’s complex and sophisticated loan instruments, the old guidelines are inadequate and consumers are not getting the disclosures they need to make well-informed decisions, he said.

The law does not specify, for example, that lenders must disclose how much monthly payments may rise when rates are fully adjusted and principal is added under a worst-case scenario.

Most mortgage brokers today are in their 20s or early 30s and have not lived through a deep recession or other “worst-case scenario” in their adult lives, Mr. Cruise said.

“I’m not sure the loan officers themselves know what could happen” if rates rise precipitously or the economy plunges, he said.

Distant control

The federal banking directive specifies that lenders should disclose the terms of fully indexed loans to borrowers.

But Jack M. Guttentag, a retired professor from University of Pennsylvania’s Wharton School of Business who sponsors a mortgage education Web site,, said it’s not clear whether the guidelines will change anything.

“What a broker or loan officer tells a borrower is pretty much up to them, so long as they comply with the disclosure laws,” which don’t prohibit most current practices, he said. “That is part of the market culture, and the regulators would have their hands full trying to change it.”

Mortgage brokers also are right to question whether the directive applies to them, because the Federal Reserve has, at best, distant control over what the nonbank subsidiaries of bank-holding companies do, he said.

Deborah Lagomarsino, a Fed spokeswoman, declined to say whether or how the Fed would ensure that its directive is followed by the many mortgage companies not directly regulated by the Fed.

In any case, the guidance is too vague to be of much help to lenders that have established guidelines that detail the credit scores, loan-to-value ratios and other standards that borrowers must meet for loans.

“Sending me a bunch of homilies about how important it is to be careful of this or that will leave me unimpressed,” Mr. Guttentag said. “If you really want me to take notice, show me where my guidelines fall short.”

Because of the light regulation and demonstrated abuses, Mr. Guttentag has established a program to certify mortgage brokers and lenders in order to separate the unethical ones from “upfront” ones who disclose their fees and essential borrowing information.

“Many potential borrowers are shocked to discover that there is no registry of bad apples — and no system to certify good ones,” he said.

One of the commitments a mortgage lender must make to be certified under Mr. Guttentag’s program is to disclose what will happen to monthly payments in worst-case scenarios.

Some financial analysts say the banking directive will have a definite impact on banks as well as on investors who have been using interest-only loans to purchase property.

David Lereah, chief economist with the National Association of Realtors, says he expects the directive particularly to discourage speculators who “flip” properties in transactions that require minimal down payments and liberal loan terms.

“There will be fewer investors in the market this year,” he said.

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