Congress Overhauls Mortgage Lending; How will it Affect You?

After weeks of heated debate and rewrites, the two houses of Congress have finally come to agreement on how best to implement mortgage relief for the millions of Americans facing foreclosure. A bill was initially approved by the House of Representatives last week, but several additional days of tinkering were needed before Wednesday’s approval by the Senate.

The explicit goals of are to raise standards for future mortgages, as well as to make it easier for homeowners already to trouble to have their loans modified. “If the protections in this bill had been in place, we would not have had the foreclosure crisis, we would not have had the financial crisis,” offered one Representative.

Towards this end, “The measure would require mortgage lenders to ensure a borrower has a ‘reasonable ability to repay‘ the loan products offered to them. For refinancings, the lender has to believe the transaction provides a ‘net tangible benefit’ to the borrower.” In addition, loans repackaged as CDOs and sold to investors will face new restrictions, in order to give originators more of a stake in ensuring loan quality. Accordingly, originators will be required to maintain at least a 5% equity stake in all securitized mortgages.

There is also a subtext in the bill designed to steer all participants back towards plain-vanilla lending practices, since esoteric and complex mortgage products are near the heart of the crisis. For example, lenders will be encouraged to promote traditional 30-year fixed-rate mortgages- generally viewed as the safest and most transparent type of mortgage- by way of a “safe-harbor” clause “to protect mortgage-holders from investor lawsuits if they modify the terms of a home loan.” Regulators have been authorized to expand the scope of the safe-harbor program to other types of qualifying mortgages as well.

As one columnist pointed out, this program does contain an inherent conflict of interest, since many of the financial institutions with the power to modify loans are also those with a financial stake in doing so. He argues that there is a “huge incentive for self-dealing by servicers to rewrite the investor-owned first mortgages in ways that increase the value of their affiliated bank-owned second mortgages.” Regardless of whether it’s fair for banks and investors, all homeowners need to know is that it makes it more likely that the terms of their loans will be modified.

As the Mortgage Calculator reported last week, the cram-down clause was officially rejected by the Senate, despite having been approved by the house. This would have authorized judges to to lower mortgage payments for homeowners involved in bankruptcy proceedings. “Judges handling bankruptcy cases can already reduce the principal — and thus the size of the payments — on a vacation home, car or boat, but not on a mortgage for a primary residence.”

Less visible components of the legislation include a “measure that would allow renters of foreclosed properties to stay through their lease, or be given 90 days to vacate” as well as “capital to be allocated to provide borrowers with independent counseling on their mortgages.” In this way, renters won’t be punished for their landlords’ misjudgment, and homeowners will have access to more resources so that they can make more informed decisions. Finally, “The legislation would also ban yield-spread premiums, payments to mortgage brokers or loan officers for steering borrowers to high-cost loans.”

These last few rule changes, while small, encapsulate the overarching purpose of the legislation, which is to place the burden of mortgage origination firmly on the shoulders of lenders as well as to improve the transparency of the entire mortgage process. In short, borrowers will be protected against “predatory” lenders that seek to exploit their ignorance, as well as from themselves, by making it more difficult for them to take on mortgages that they cannot reasonably afford.