Group warns against return of ‘dual credit’ mortgage market

Center for Responsible Lending: Homeownership helps families build wealth

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The spillover impacts of foreclosures have wiped out nearly $2 trillion in household wealth, and the housing downturn resulted in the largest documented wealth gap between white households and families of color, the Center for Responsible Lending says in a report released today.

The report also maintains that homeownership remains one of the most accessible ways to build wealth, and that home equity has been critical to helping American families to pay for retirement, education and health care.

So while federal and state policies should address the "true causes of the crisis" — abusive loan terms and irresponsible underwriting practices — it’s important to maintain a stable supply of mortgage financing that ensures access to credit for qualified borrowers, the report concludes.

The report, "The State of Lending in America and its Impact on U.S. Households," estimates that 12 million homes entered the foreclosure process between January 2007 and June 2012. While it’s difficult to pin down how many of those homes completed the foreclosure process, CoreLogic has put the number of completed foreclosures between September 2008 and December 2011 at 3.2 million.

The report estimates the "spillover" impacts of foreclosures alone — the decrease in value of homes near foreclosed properties — at $1.95 trillion, or more than $21,000 per affected household. (The Federal Reserve Board has estimated that $7 trillion in total home equity was lost in the housing downturn.)

The majority of families who have lost their homes have been middle- or higher-income and white, the report noted. But the crisis affected borrowers of color disproportionately, with 14 percent of Latino and 11 percent of African-American borrowers losing their homes to foreclosure, compared with 8 percent of Asian borrowers and 6 percent of non-Hispanic whites.

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That’s a reflection of the fact that African-American and Latino borrowers "were far more likely to receive higher-rate and other risky loan terms than white borrowers," the report said, noting that African-American borrowers were 2.8 times as likely to receive a higher-rate loan as white borrowers, and Latino borrowers were 2.3 times as likely to receive a loan with a prepayment penalty.

The report puts most of the blame for the bust on subprime and "Alt-A" loans often originated by mortgage brokers and financed by "private-label" mortgage-backed securities (MBS) not guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Between 2001 and 2006, the market share of subprime and Alt-A mortgages grew from 10 percent to 39 percent, the report noted.

It was not until July 2008 — 14 years after it was given the authority to do so, and two years after the foreclosure crisis began — that the Federal Reserve implemented rules to ban some abusive, unfair or deceptive practices, the report said.

The report urges policymakers not to weaken or undermine subsequent reforms established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as "returning to the pre-crisis status quo would have long-term costs for both the economy and individual families."

While a borrower’s ability to repay a mortgage "is such a basic tenet of sound lending that, historically, most lenders would not have dreamed of deviating from it," the "originate-to-securitize" model rewarded loan originators for generating large volumes of loans, regardless of their performance.

The Dodd-Frank bill sets an ability-to-repay standard, and creates a preference for a category of less risky loans called "Qualified Mortgages" (QMs). Lenders who originate QMs will get some protection from lawsuits that are based on Dodd-Frank’s ability-to-repay provision. To qualify as a QM loan, mortgages must be:

  • Fully amortizing, with no deferment of principal or interest.
  • No balloon payments.
  • Points and fees no greater than 3 percent of the total loan amount.
  • Loan term not to exceed 30 years.
  • For adjustable-rate mortgages, lenders must evaluate the borrower’s ability to repay based on the
    maximum rate permitted during the first five years.

Another category of loans — "Qualified Residential Mortgages," or QRMs — would be exempt from risk retention requirements. Lenders making non-QRM loans would be required to retain a 5 percent stake in those loans, exposing them to risk if the loans default.

Like a number of real estate industry groups, the Center for Responsible Lending is opposed to proposals to establish minimum down payment requirements for QRM loans.

Although borrowers making less than the required down payment would still be able to obtain non-QRM mortgages, opponents say it would be more difficult for lenders to securitize those loans, and so borrowers would pay higher interest rates on them.

The report warns against recreating a "dual credit market that characterized lending during the subprime crisis," noting that the impact of even a 10 percent down payment QRM standard "would be particularly acute for communities of color, as 60 percent of African-American and 50 percent of Latino borrowers who are currently successfully paying their mortgages would have been excluded from the mainstream mortgage market had such a requirement been in place."

As policymakers get ready to determine the fate of Fannie Mae and Freddie Mac and the government’s role in secondary mortgage markets, the report advocates mortgage finance reform that prioritizes "broad market access" for borrowers.

"While housing policy must strike the right balance between homeownership and affordable rental housing goals, it is essential that lower-income borrowers and borrowers of color regain access to credit for homeownership and not remain blocked out of the market," the report recommends. "Federal and state policies should continue to address the true causes of the crisis — abusive loan terms and irresponsible underwriting practices — while also helping families still facing foreclosure and facilitating a stable supply of mortgage financing that ensures access to credit for qualified borrowers."

To ensure a "robust and secure" secondary mortgage market, the report envisions a cooperative run by a single non-lender entity, owned in equal shares by member-users. The cooperative would issue guaranteed mortgage-backed securities, correcting "the shortcomings of Fannie Mae and Freddie Mac’s past and also prevent(ing) a further concentrated lending marketplace in the future."

To further that goal, the report recommends that:

  • The government provide an explicit guarantee for mortgages that is "actuarially sound" (it pays its own way, through fees collected from lenders that are passed on to borrowers).
  • Secondary market players that benefit from federal guarantees be required to serve all qualified homeowners, rather than preferred market segments.
  • That the mortgage finance system encourage competition and further broad market access to the secondary capital markets for both small and large lenders.


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