Mortgage Forms You Can Understand? Not Quite Yet
This week, new federal rules go into effect requiring mortgage lenders and brokers to clearly disclose to borrowers the actual costs of their mortgages, including interest rates, fees and penalties. Every borrower must now receive a standard, government-approved Good Faith Estimate, a form that's written in plain English and provides an insta-tutorial on how to comparison-shop for a loan. If a mortgage contains certain potentially radioactive features of the kind that set bubble borrowers up to fail - including adjustable rates, negative equity, prepayment penalties and balloon payments – the lender has to explicitly disclose it.
In addition, for the first time, you must be told if your mortgage broker received a fee, known as a yield spread premium, in exchange for setting you up with a higher interest rate.
Score one for the consumer, right? Not so fast. HUD has agreed to delay enforcement of the Good Faith Estimate and other elements of the new rules, under the Real Estate Settlement and Procedures Act (RESPA), until April 1. Mortgage industry lobbyists pressed HUD for the delay, asserting lenders and brokers needed more time to gear up.
If it were up to the National Association of Mortgage Brokers, the new rules wouldn't have gone into effect at all. It filed suit in federal court to block the new disclosures, on the premise that it would be unfair to force brokers to disclose their yield spread premium compensation while loan officers directly employed by lenders don't have to. In dismissing the suit, the judge noted that HUD put the new forms through extensive testing to make sure that they actually did what they were supposed to: steer consumers to the lowest-cost loan, whether that loan came from a broker or lender.
Don't feel too bad for brokers – the new rules include a consolation prize. Until now, they could only charge a maximum commission of 1 percent on FHA-insured mortgages. Now that brokers' fees are systematically disclosed, HUD has agreed to lift that limit. Brokers may charge borrowers as much as they want, as long as it's "reasonable compensation" for their services.
HUD reasoned that since the new form should lead to smart, money-saving choices – adding up to a projected average savings of $668 in closing costs per loan – increasing fees still leaves borrowers ahead of the game.
So for now, it's still borrower beware.
Consumers are in a tough position to argue with improvements that took more more than a decade to see the light of day. Back in 1996, when Congress first asked HUD and the Federal Reserve to look into creating standardized borrower documents, subprime mortgages represented a tiny sliver of the market, with less than 200,000 loans, and most mortgages were 30-year, fixed rate loans that conformed to the consumer-friendly standards of Fannie Mae and Freddie Mac. Greater clarity about the actual cost of non-conventional mortgages might have prompted some borrowers to back off.
But could it have stopped the stampede to subprime, negative amortization and other high-risk loans? Probably not. Remember that most subprime mortgages, and many other loans that got borrowers in trouble, were refinances of existing loans, often plain vanilla and fixed-rate. Borrowers took out the refinances to take advantage of lower interest rates and get cash out of rising home equity.
When borrowers in that situation look at the potential cost of their new mortgages, they're not comparing the prices between different quotes from lenders; they're comparing the refinance quotes to their current mortgage payments. Invariably, the new quotes will look better, even if the mortgages hold surprises down the road such as balloon payments. Many bubble borrowers had no idea what they were getting into. But quite a few others did, they just thought they could beat the system by refinancing or selling before getting into trouble. The problem wasn't that they didn't know, but that they knew too much. I call it the Edmund L. Andrews syndrome, after the New York Times economics reporter who repeatedly refinanced his Maryland home in a desperate attempt to avoid foreclosure.
The new Good Faith Estimate forms are a long-awaited breakthrough and a win for consumer transparency. "You cannot shop for a mortgage loan the same way that you can shop for a car or a loaf of bread," complained Margot Saunders of the National Consumer Law Center to Congress – back in 1998. Now you can. But what Saunders failed to mention is that you also can't make money by buying cars and bread. As long as borrowers hope a mortgage is a ticket to financial gain, and mortgage lenders and brokers get paid to indulge them, the temptations to ignore the numbers, and common sense, will remain.