Risky Loans
Federal regulators recently suggested new guidelines for banks that originate certain types of high-risk mortgages. The banks, predictably, were not enthusiastic about the regulators' suggestions. But the regulators have it right: It's high time for banks to limit access to these mortgages and disclose the real risks to borrowers.
The suggested guidelines would require banks to qualify borrowers for financing on the basis of fully indexed interest rates for interest-only and payment-option loans and to consider the borrower's ability to repay not only the original loan amount, but also any additional principal that may result if interest-only or minimum payments are made.
Banks have objected that these guidelines would limit the number of people who can qualify for these loans. That's true and it's exactly the point. The borrower's ability to repay the loan should be a basic component of loan underwriting and to ignore it defies common sense. A borrower's ability to manage no more than just the interest-only or minimum payments should disqualify him or her from this type of loan since the payments will escalate when the loan is recast. Reasonable guidelines will not keep everyone from obtaining these loans, but rather the loans will be reserved for those borrowers who have the ability to manage and repay the debt.
Banks also have suggested that borrowers may be frightened by disclosures that reveal how much higher their monthly payments would be in certain circumstances. Again, that's exactly the point: Borrowers who are frightened off by those higher payments shouldn't have these types of loans. Most home buyers naturally experience some anxiety about the financial commitment, but it's irresponsible to help people buy a home they are truly frightened they won't be able to afford.
Banks also have argued that the suggested disclosures should be required of all lenders, not just federally insured institutions. That's a good point too -- and a compelling argument for more regulation, not less. Once federal regulators set appropriate standards, state regulators can and should follow that lead. Some state-level regulatory groups already have signaled an intention to do so.
Interest-only and minimum-payment loans have helped many people purchase homes, but who benefits if those homeowners can't afford the higher payments and the property ends up in foreclosure? The homeowners lose while the lenders and mortgage brokers make out like proverbial bandits. The brokers have collected their commissions; the lenders have sold the loans, and the investors who purchased them are protected by mortgage insurance, which is, of course, paid for by the homeowners.
Interest-only and payment-option loans were supposed to be intended for sophisticated borrowers who could take advantage of the greater flexibility. The fact that so many of these loans were sold to people for whom they weren't intended begs an obvious yet important question: Why didn't regulators insist on tougher guidelines a long time ago?
It's equally easy to point an accusatory finger at supposedly greedy mortgage brokers, but neither the regulators nor the brokers are solely responsible. After all, the lenders created these loans and set up the compensation systems that rewardbrokers who push borrowers into these riskiest of mortgages.
It's fair to argue as well that some of the blame lies with the borrowers. Willful ignorance, irresponsible decisions, house envy, an insatiable desire for immediate gratification, blind trust and a sign-it-now-and-read-it-later-if-ever mentality have been magnified to an astounding degree and aren't a smart way to borrow hundreds of thousands of dollars.
Since those borrower frailties are apt to undo the benefits of additional disclosures, tighter underwriting guidelines are crucial. Those who are able to qualify will be able to obtain these loan products while those who can't, won't. It's really that simple, and the regulators, lenders, brokers and borrowers should make it happen. To mix a few metaphors, it's time for everyone to step up to the plate, be the first line of defense and get the responsibility ball rolling because it's the right thing to do.
The suggested guidelines would require banks to qualify borrowers for financing on the basis of fully indexed interest rates for interest-only and payment-option loans and to consider the borrower's ability to repay not only the original loan amount, but also any additional principal that may result if interest-only or minimum payments are made.
Banks have objected that these guidelines would limit the number of people who can qualify for these loans. That's true and it's exactly the point. The borrower's ability to repay the loan should be a basic component of loan underwriting and to ignore it defies common sense. A borrower's ability to manage no more than just the interest-only or minimum payments should disqualify him or her from this type of loan since the payments will escalate when the loan is recast. Reasonable guidelines will not keep everyone from obtaining these loans, but rather the loans will be reserved for those borrowers who have the ability to manage and repay the debt.
Banks also have suggested that borrowers may be frightened by disclosures that reveal how much higher their monthly payments would be in certain circumstances. Again, that's exactly the point: Borrowers who are frightened off by those higher payments shouldn't have these types of loans. Most home buyers naturally experience some anxiety about the financial commitment, but it's irresponsible to help people buy a home they are truly frightened they won't be able to afford.
Banks also have argued that the suggested disclosures should be required of all lenders, not just federally insured institutions. That's a good point too -- and a compelling argument for more regulation, not less. Once federal regulators set appropriate standards, state regulators can and should follow that lead. Some state-level regulatory groups already have signaled an intention to do so.
Interest-only and minimum-payment loans have helped many people purchase homes, but who benefits if those homeowners can't afford the higher payments and the property ends up in foreclosure? The homeowners lose while the lenders and mortgage brokers make out like proverbial bandits. The brokers have collected their commissions; the lenders have sold the loans, and the investors who purchased them are protected by mortgage insurance, which is, of course, paid for by the homeowners.
Interest-only and payment-option loans were supposed to be intended for sophisticated borrowers who could take advantage of the greater flexibility. The fact that so many of these loans were sold to people for whom they weren't intended begs an obvious yet important question: Why didn't regulators insist on tougher guidelines a long time ago?
It's equally easy to point an accusatory finger at supposedly greedy mortgage brokers, but neither the regulators nor the brokers are solely responsible. After all, the lenders created these loans and set up the compensation systems that rewardbrokers who push borrowers into these riskiest of mortgages.
It's fair to argue as well that some of the blame lies with the borrowers. Willful ignorance, irresponsible decisions, house envy, an insatiable desire for immediate gratification, blind trust and a sign-it-now-and-read-it-later-if-ever mentality have been magnified to an astounding degree and aren't a smart way to borrow hundreds of thousands of dollars.
Since those borrower frailties are apt to undo the benefits of additional disclosures, tighter underwriting guidelines are crucial. Those who are able to qualify will be able to obtain these loan products while those who can't, won't. It's really that simple, and the regulators, lenders, brokers and borrowers should make it happen. To mix a few metaphors, it's time for everyone to step up to the plate, be the first line of defense and get the responsibility ball rolling because it's the right thing to do.
posted by Ken Calhoon at 5:50 AM
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