Editor’s note: This is Part 2 of a two-part series. Read Part 1.

A competitive mortgage market that would work for borrowers requires an effective system of mortgage disclosures and a set of transaction simplification rules to equalize the playing field between borrowers and loan originators.

As indicated last week, an effective disclosure system would require that Congress remove itself from disclosure operations, eliminate all existing congressionally mandated disclosures, which are largely useless, and entrust sole responsibility to one agency that would set and revise the required disclosures as needed. Last week, I lamented that HR 1728 did not fix any of the deficiencies in the system of mandatory disclosures, but simply added more disclosures to an already excessive pile.

Transaction simplification rules are needed to separate third-party service transactions from the mortgage transaction; to sharply reduce the number of lender charges that can vary from loan to loan; and to assure the validity of price quotes. These rules would empower borrowers to protect themselves from abuse by loan providers.

Rule 1, as simple as it is obvious, is that any third-party service required by lenders must be paid for by lenders. The cost of these services would be embedded in the mortgage price, in the same way that the cost of automobile tires is embedded in the price of an automobile. But the price would be much lower because lenders can buy the services for less than borrowers, and it would no longer needlessly complicate the mortgage transaction.

Rule 2 would limit lender charges to points, expressed as a percent of the loan amount, which are traded off against the interest rate; and one fixed-dollar fee, that must be posted and the same for all transactions. This rule would eliminate fee escalation, which is common practice.

Rule 3 would require that the prices that lenders lock be the same as the prices they quote to a borrower shopping the identical loan on the same day. This rule would eliminate lowball price quotes, which pervade the market.

Not surprisingly, none of these rules are found in HR 1728, which is aimed not at empowering borrowers to protect themselves, but at replacing private decision-making by lenders with government-imposed rules.

Some of the rules in HR 1728 are sensible, such as the requirement that mortgage originators be licensed. It would also prohibit the sale of single-premium credit insurance, which would be barred by my more comprehensive Rule 1. But other rules in HR 1728 — which are essentially knee-jerk reactions to abuses that arose during the go-go years prior to the crisis — are toxic. …CONTINUED

One involves mandating detailed underwriting rules and procedures, the Congress in effect telling lenders how they must assess risk. This is the same kind of legislative overreach that Congress embedded in Truth in Lending, where it itemized the specific items that had to be disclosed, with the disastrous results discussed last week.

A second toxic rule requires that lenders be responsible for assuring that borrowers who refinance obtain a "tangible net benefit." An article on www.mtgprofessor.com shows that in every refinance, the net benefit depends on something known only to the borrower. Making the lender liable for what is in the borrower’s head is bad policy.

A third rule would require that all mortgage lenders retain 5 percent of the credit risk on any loan they sell. I am not sure if this rule will prove toxic or not, but it will raise costs, especially those of the smaller lenders who sell all the loans they write. A major consequence of this rule is discussed below.

HR 1728 provides an escape hatch from these three rules. The rules are in effect waived on "qualified mortgages." A qualified mortgage is one that has an annual percentage rate (APR) no more than 1.5 percent above that of a "prime" transaction, on which the borrower’s total payment obligation does not exceed some maximum to be prescribed by regulation, has a 30-year term, and fully documents the borrower’s financial status.

The qualified mortgage escape hatch from these rules will divide the market between qualified and nonqualified mortgages. The nonqualified group will be larger, because it will include all loans with terms other than 30 years; loans with debt-to-income ratios above the level deemed prime by the regulators; loans to borrowers having FICO scores below about 660, which pay a rate premium of about 1.5 percent in the current market; most loans to self-employed borrowers; most loans for investment purposes or on other than single-family houses; and all loans with risk variables that in combination require a risk premium of more than 1.5 percent. In the current market where risk premiums are extremely high, that covers a lot of ground.

HR 1728 says nothing about the down payment, the most important risk variable of all. If prime loans are viewed as having down payments of 20 percent or more, which is consistent with the concept of "prime," mortgage insurance on loans with smaller down payments will increase their APRs, pushing many of them into the nonqualified sector as well.

Borrowers taking nonqualified loans will pay a price increment charged by lenders to cover the additional liabilities they assume under HR 1728. This will be an addition to the large risk premiums they already pay in a highly risk-averse market. Prime borrowers get a pass.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.


What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.

Show Comments Hide Comments


Sign up for Inman’s Morning Headlines
What you need to know to start your day with all the latest industry developments
Thank you for subscribing to Morning Headlines.
Back to top
Log in
If you created your account with Google or Facebook
Don't have an account?
Forgot your password?
No Problem

Simply enter the email address you used to create your account and click "Reset Password". You will receive additional instructions via email.

Forgot your username? If so please contact customer support at (510) 658-9252

Password Reset Confirmation

Password Reset Instructions have been sent to

Subscribe to The Weekender
Get the week's leading headlines delivered straight to your inbox.
Top headlines from around the real estate industry. Breaking news as it happens.
15 stories covering tech, special reports, video and opinion.
Unique features from hacker profiles to portal watch and video interviews.
Unique features from hacker profiles to portal watch and video interviews.
It looks like you’re already a Select Member!
To subscribe to exclusive newsletters, visit your email preferences in the account settings.
Up-to-the-minute news and interviews in your inbox, ticket discounts for Inman events and more
1-Step CheckoutPay with a credit card
By continuing, you agree to Inman’s Terms of Use and Privacy Policy.

You will be charged . Your subscription will automatically renew for on . For more details on our payment terms and how to cancel, click here.

Interested in a group subscription?
Finish setting up your subscription