Borrowers don't have a clue
It would be an easy fix if we could assign the ultimate blame for the current subprime loan fiasco to a single event or party. Regulations could then be adopted that would correct the problem from happening again. But like other misfortunes, there is never a single event that is totally accountable but a series of happenings leading to the fateful conclusion. Here is a few which contributed to our current subprime fallout:
Investors and their money abandoned the stock market in 2000 seeking higher returns on less volatile and more secure real estate. The Federal Reserve lowered interest rates in an attempt to stimulate a sagging economy. Tax cuts boosted consumer spending which resulted in job growth and historically low unemployment. Builders had a historical low inventory of finished houses and buildable lots since recovering from the last market correction. California real estate and banking regulators adopted legislation that exempted lenders from the formality of having a real estate license. Housing demand drove home values to unaffordable levels.
Borrowers were not exempt from contributing to this perfect storm. Many made poor credit choices or based their housing decisions upon investment expectations rather than lifestyle considerations. Somewhere along this trail, the family home became a discretionary investment tool. Builders, lenders and real estate agents helped facilitated the whole process.
Now that we have time to reflect upon our current circumstances, the loan regulators are attempting to discern what changes need to be made in the lending process by the purveyors of credit. One change that would help future borrowers would be to revise or eliminate the plethora of loan documents into something understandable. Federally mandated mortgage disclosures, forced upon lenders and borrowers for the past 30 years, “are confusing and do not address the variety and complexity of today’s mortgage products,” said Federal Trade Commissioner (FTC) Deborah Platt Maqjoras after reviewing the recent FTC study which demonstrated that most borrowers don’t have a clue about the details of their mortgage.
The report released last month by the FTC, shows how unaware borrowers are regarding the details of a mortgage loan. In the study, 800 borrowers who had recently obtained a mortgage loan, were provided typical loan documents on a hypothetical fixed rate loan and then asked a series of questions. Half the borrowers could not identify the correct loan amount. Nine out of ten could not figure the total upfront cost of the loan. Two-thirds did not recognize a pre-payment penalty and 95 percent could not figure out the amount of the penalty. Eighty percent did not know why the interest rate and the Annual Percentage Rate (APR) of the loan were different. One in five could not identity the interest rate of the loan, monthly payment or the amount of cash due at closing. If a typical borrower can’t figure out the loan amount, how can they be expected to know anything about: indexes, margins, points and neg arms?
The FTC study confirmed what I have been telling readers for years, “More is less.” The more standardized loan papers are provided to borrowers, the more likely they are to become confused and chose the wrong, more expensive loan. Borrowers are buried in meaningless loan papers. Alex Pollock, former president of the Federal Home Loan Bank of Chicago put it this way. “Most of us had the experience of being overwhelmed and befuddled by the huge stack of documents full of confusing language in small print, presented to us for signature at a mortgage closing. The complexity results from legal and compliance requirements. Ironically, past regulatory attempts to insure full disclosure have made the problem worse.” Ah Ha! Finally the problem reveals itself, too much information.
Mr. Pollock, who is now in private practice, has proposed a simple, one-page disclosure document that states in simple English (or national language of choice) the “essential” of the loan. For example: If the loan was an Adjustable Rate Mortgage, the disclosure would say what the beginning interest is, how long it will stay in effect and what the maximum possible rate would be. The form would also show a “fully-indexed housing ratio,” which would show what percentage of a person’s income would go toward a mortgage payment. The greater expense ratio, the riskier the loan.
A simplified, easy to read mortgage loan disclosure will help future borrowers but more needs to be done. Predatory lenders need to be put out of business. Anyone originating a mortgage loan in California should have a state license with some educational requirements. Mandatory educational requirements with regards to financing and owning a home should be a requirement for first time buyers applying for a government insured loans. An unknowledgeable borrower who defaults on a mortgage has no affect on the economy or real estate values. A million defaulting borrowers is a wake-up call. Borrowers need more facts and less paper.
Investors and their money abandoned the stock market in 2000 seeking higher returns on less volatile and more secure real estate. The Federal Reserve lowered interest rates in an attempt to stimulate a sagging economy. Tax cuts boosted consumer spending which resulted in job growth and historically low unemployment. Builders had a historical low inventory of finished houses and buildable lots since recovering from the last market correction. California real estate and banking regulators adopted legislation that exempted lenders from the formality of having a real estate license. Housing demand drove home values to unaffordable levels.
Borrowers were not exempt from contributing to this perfect storm. Many made poor credit choices or based their housing decisions upon investment expectations rather than lifestyle considerations. Somewhere along this trail, the family home became a discretionary investment tool. Builders, lenders and real estate agents helped facilitated the whole process.
Now that we have time to reflect upon our current circumstances, the loan regulators are attempting to discern what changes need to be made in the lending process by the purveyors of credit. One change that would help future borrowers would be to revise or eliminate the plethora of loan documents into something understandable. Federally mandated mortgage disclosures, forced upon lenders and borrowers for the past 30 years, “are confusing and do not address the variety and complexity of today’s mortgage products,” said Federal Trade Commissioner (FTC) Deborah Platt Maqjoras after reviewing the recent FTC study which demonstrated that most borrowers don’t have a clue about the details of their mortgage.
The report released last month by the FTC, shows how unaware borrowers are regarding the details of a mortgage loan. In the study, 800 borrowers who had recently obtained a mortgage loan, were provided typical loan documents on a hypothetical fixed rate loan and then asked a series of questions. Half the borrowers could not identify the correct loan amount. Nine out of ten could not figure the total upfront cost of the loan. Two-thirds did not recognize a pre-payment penalty and 95 percent could not figure out the amount of the penalty. Eighty percent did not know why the interest rate and the Annual Percentage Rate (APR) of the loan were different. One in five could not identity the interest rate of the loan, monthly payment or the amount of cash due at closing. If a typical borrower can’t figure out the loan amount, how can they be expected to know anything about: indexes, margins, points and neg arms?
The FTC study confirmed what I have been telling readers for years, “More is less.” The more standardized loan papers are provided to borrowers, the more likely they are to become confused and chose the wrong, more expensive loan. Borrowers are buried in meaningless loan papers. Alex Pollock, former president of the Federal Home Loan Bank of Chicago put it this way. “Most of us had the experience of being overwhelmed and befuddled by the huge stack of documents full of confusing language in small print, presented to us for signature at a mortgage closing. The complexity results from legal and compliance requirements. Ironically, past regulatory attempts to insure full disclosure have made the problem worse.” Ah Ha! Finally the problem reveals itself, too much information.
Mr. Pollock, who is now in private practice, has proposed a simple, one-page disclosure document that states in simple English (or national language of choice) the “essential” of the loan. For example: If the loan was an Adjustable Rate Mortgage, the disclosure would say what the beginning interest is, how long it will stay in effect and what the maximum possible rate would be. The form would also show a “fully-indexed housing ratio,” which would show what percentage of a person’s income would go toward a mortgage payment. The greater expense ratio, the riskier the loan.
A simplified, easy to read mortgage loan disclosure will help future borrowers but more needs to be done. Predatory lenders need to be put out of business. Anyone originating a mortgage loan in California should have a state license with some educational requirements. Mandatory educational requirements with regards to financing and owning a home should be a requirement for first time buyers applying for a government insured loans. An unknowledgeable borrower who defaults on a mortgage has no affect on the economy or real estate values. A million defaulting borrowers is a wake-up call. Borrowers need more facts and less paper.
posted by Ken Calhoon at 7:38 AM
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