Sensible Consumer Protections

The abuses in the Sub-prime market fall into two categories. The first category is the situation when borrowers are paying too much for their financing needs because they were placed in a mortgage that was over-priced, yielding higher profits to the broker and/or lender. This is called “Upselling”, the practice of increasing the interest rate charged on the mortgage that entitles the originating entity a fee that is reflective of the higher interest rate. This additional fee is paid as part of the Yield Spread Premium (YSP).

The solution to this would be to require the broker to identify his total compensation, from all sources, at first contact with the applicant through the Fee Agreement. This way the applicant knows exactly what the broker is earning. If the YSP turns out to be greater than the agreed upon fee, then the broker would be required to credit that excess to the borrower’s remaining closing costs. If the YSP is less than the agreed upon fee, then the borrower would have to pay the shortfall as part of his direct out-of-pocket closing costs.

There would be no economic incentive for a broker to increase the interest rate on a mortgage in order to increase his profit on that mortgage. The broker would still be able to offer the applicant a 0 point mortgage as well as giving the applicant the option to reduce his out-of-pocket closing costs by accepting a higher interest rate on the mortgage. New York State has the highest closing costs in the country. The biggest hurdle for the first time homebuyer today is saving enough cash to purchase a home. The proper use of YSP can help out this buyer.

This revision would eliminate all incentives to a mortgage broker to Upsell his applicants. Lenders taking applications directly from the public have much to lose if they continue to permit their staff the freedom to Upsell. Routine audits will expose different pricing to different applicants with the same credit profiles. It wasn’t that long ago when Ameriquest paid dearly for allowing their originators the freedom to price mortgages (and their commissions) on a case-by-case basis. With lenders being held accountable and mortgage brokers being required to commit to a fee structure at application, we not only protect consumers in the Sub-prime market but all applicants.

Before we can address the second category of abuse we need to identify the basic characteristics of the typical Sub-prime borrower. An applicant that needs to use a Sub-prime mortgage to fulfill his borrowing needs will be dealing with one or more of the following issues:

1. A high loan-to-value (LTV) or a high combined-loan-to-value. Whether it’s a first mortgage, second mortgage or a combination of both (a piggyback) the vast majority of the equity of the subject property is taken out in a mortgage or mortgages.
2. Temporary financial setback. A loss of job, a divorce, medical problems or any other unexpected financial setback can temporally cause delays in bill payments, adversely affecting the credit profile.
3. Applicant is living “paycheck to paycheck” and is forced to accumulate additional debt. They then look to their home to restructure their debt, lowering their monthly payments with the goal of getting their monthly expenses in line with their monthly income.
4. Bad payment habits. A total disregard to paying bills on time, resulting in a poor credit profile yet the applicant still needs mortgage financing.

The applicants we are looking to protect are the same people that are placed into a Sub-prime mortgage, not by their choice or financial circumstance, but with the banker/broker’s encouragement. We don’t want to prevent people from making their own decision, even if we disagree with that decision. We are all given the right to make our own choices. Given 10 minutes, any one of us can put together a list of examples illustrating properly thought out decisions that didn’t work out as planned as well as a list of poor decisions that turned out just fine. Our intention is to create a system whereby we can protect applicants from being taken advantage of, yet maintain each person’s right to choose.

First time homebuyers with limited cash assets or homeowners looking to take most of the equity out of their home, are the most susceptible to abuse. Their financial position puts them in what is considered the middle class. I propose the following criteria as trigger points:

A first time homebuyer that is financing greater than 80% of the purchase price, or appraised value, whichever is lower, through any combinations of liens on the subject property, and
The property is being used (if it is a refinance) or will be used (if it is a purchase) as a primary residence, and
A homeowner who is looking to take cash out of the current appraised value of their residence leaving a total value of liens on the residence greater than 80%, and
Any one borrower whose income is equal to or less than the “HUD area median income” for the area where the subject property is located. The median annual income for downstate New York is currently $71,300.

If an application package meets these combined conditions, then the following requirements will need to be met:

1. Once the loan is underwritten, a preliminary commitment is issued, subject to credit counseling. The counselor needs to receive the commitment as well the completed application that was used to underwrite.
2. The counseling is to give the borrower(s) a full understanding as to what to expect after closing.

This empowers the borrower, who may not have access to professional financial opinions, givng him the knowledge to make an informed decision going forward with closing.

Higher-income individuals looking to go high leverage will more likely do it by choice rather than by need. They are deciding to use the money to invest elsewhere. They are also more likely to do their own research or ask the advice of co-workers and family to supplement the information received from the industry. A repeat buyer has first hand experience at being a homeowner, so is well aware of what being a homeowner entails.

We should be looking to empower the applicant with the tools necessary to make an informed decision regarding his personal financing needs. If we try to protect the applicant from himself, playing the role of big brother or mother, we are actually doing the applicant a disservice. It is impossible to write rules that can address all the various situations that an applicant can be faced with. Inexperienced applicants deserve the power that knowledge affords them. It’s the best long-term solution in preventing a recurrence of this mortgage crisis.