For the American mortgage market, it could be the buzzword of the year: Suitability.
That's because Congress has a new top lawmaker for mortgage matters, Rep. Barney Frank, who says "you shouldn't lend [home buyers or refinancers] more than they can afford to pay back, and you don't lend them more than their house is worth."
Frank, a 14-term Massachusetts Democrat, is the new chairman of the House Financial Services Committee, the primary originator of banking legislation. In an interview, he made it clear that a top priority will be enactment of a nationwide lending-standards law.
With foreclosures rising and many credit-stressed homeowners facing imminent rate resets on controversial "payment-option" and other adjustable-rate loans, pressure is building on Capitol Hill for tougher rules for mortgage brokers and lenders.
A recent study by the Center for Responsible Lending predicted that as many as one of five subprime borrowers who took out reduced-payment, low-documentation mortgages between 1998 and mid-2006 could lose their homes because of steep payment increases and penalties.
Proponents of a suitability standard would require loan officers to make certain that applicants can financially handle a particular loan before and after payment increases--and that they fully understand the costs of the mortgage type they select.
"It's nothing more than an appropriateness test," said John Taylor, CEO of the National Community Reinvestment Coalition. "Lenders need to be absolutely certain that the loan they're putting somebody into really makes sense ... not just that it makes money for the lender or broker."
Stockbrokers have been required for decades to determine suitability when customers seek a specific trade or investment. Under securities-market rules, even if a brokerage customer has expressed interest in a transaction, the broker should not recommend it if the broker knows it is too high-risk for the client's financial situation or sophistication.
The analog for the mortgage market might be: Even if applicants are willing to sign up for home loans that are clearly beyond their means or knowledge, the loan officer should not go along.
According to a white paper issued by the nonprofit Northeast-Midwest Institute, a new national standard might require loan officers to determine an applicant's suitability for a particular loan program based on:
- Employment status, income level, assets and likelihood that income or employment could change.
- Other recurring expenses and the effect they could have on the borrower's capacity to repay.
- The potential for higher future monthly payments based on the structure of the loan program.
A suitability standard might also prohibit brokers and others from steering less-sophisticated borrowers to higher-cost mortgages than those for which they could otherwise qualify, such as pushing them into risky and complicated subprime loans when they could qualify for prime rates and simpler programs.
While many consumer advocates favor adoption of a suitability standard, lenders generally think the idea is fraught with negatives. Steve O'Connor, a senior vice president for the Mortgage Bankers Association, says that while "every loan officer has the responsibility to make sure a borrower has the capacity to repay the loan," a federally imposed suitability standard inherently would be "vague and subjective," and would limit borrowers' ability to shop for mortgages that fit their objectives as they--not a loan officer--see them.
Roy DeLoach, executive vice president of the National Association of Mortgage Brokers, said "the consumer ultimately is the only person able to choose the mortgage most suitable to [his or her] specific and unique circumstances." Worse yet from a mortgage lending perspective, DeLoach said, a suitability test "could lead to accusations of discrimination. [It] would blanket mortgage originators with the fear of being sued, cause a number of good loans to be declined and lead to limiting access to credit."
Chairman Frank said the elements and tests involved in creating national consumer protection standards for the mortgage field are under discussion by the Financial Services Committee. One principle he thinks will be essential, however: Stricter liability for brokers, lenders and the bond investors who buy pools of mortgages.
According to Frank, "You can't just make a loan and then sell it" to investors, forget about it and expect no liability for putting people into a mortgage that never made sense for their situation.
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