Novel Solution to Mortgage Problems for the Individual

Dear Senator Mikulski,

As per your request I have compiled a couple notes on the bill S. 1299 for Borrowers Protection. In general I support the bill and it’s intent. However it needs tweaked and it is important to note; the last thing you want to do is pass a law that is so rigid it stifles the mortgage industry, which after all is a free market based economic phenomenon with some quasi and direct government backed institutions to provide liquidity and set guidelines for a properly functioning market.

I have set out below, at the end of these notes, what I believe is a NOVEL approach to solving this problem for many Americans that has not been considered to this point. Please review after noting the comments below.

I would like to call on you and your colleges to alter the wording in the bill with respect to qualifying a customer on the highest interest rate attainable within the first 7 years of a loan. Your text under `(c) Assessment of Ability to Repay- reads:

`(2) VARIABLE MORTGAGE RATES- In the case of a home mortgage loan with respect to which the applicable rate of interest may vary, for purposes of paragraph (1), the ability to pay shall be determined based on the maximum possible monthly payment that could be due from the borrower during the first 7 years of the loan term, which amount shall be calculated by--

`(A) using the maximum interest rate allowable under the loan; and
`(B) assuming no default by the borrower, a repayment schedule which achieves full amortization over the life of the loan.

I understand the intent. Many if not most of the bad loans were made to people who could only qualify for the “teaser rate” or an exceptionally low rate of interest that often resulted in negative amortization and was drastically lower than the prevailing 30 year loan rate. However, this wording is weak and potentially stifling to the market. Most people with adjustable rate loans would not qualify if they had to based on the highest possible interest rate. For example, a normal adjustable rate loan (with no “teaser rate”) could start at say 5.5% with a maximum life of loan rate of say 11.5%. In addition, most loans adjust after a period of 1-5 years from the initial loan and adjustments are capped at say 2% per year to the maximum.

To make a lender qualify at 11.5% (the maximum rate could potentially be reached if after an initial 3 year term the rate adjusted to 7.5% then 9.5% then to 11.5% in year six given high inflation pushing discount rates high enough to result in such a rate) would be prohibitive to most borrowers. The real risk of such a rate rising so fast is minimal historically. However, with the Fed pushing discount rate to near zero after the recession in the early part of this decade resulting in adjustable rates dropping to a historical low of 3% for the initial term then boosting them at a record pace shortly thereafter it is not impossible for this kind of thing to happen. Having said this, these kinds of rapid macro swings in interest rates affect the markets in total. Trying to protect one segment of the overall economy from problems under this scenario is nearly impossible with legislation.

So, what should this bill be concentrating on? I say first you must put some language in the bill which forces adjustable mortgage rate products to 1) be based on an AMERICAN interest rate index of which you could either give choices or not. I don’t think basing American mortgage products on LIBOR (London Interbank Offer Rate) rates does the American borrower any good. If the Fed moves rates one expects US mortgage rates to move as well. Using LIBOR does not guarantee this correlation. 2) You should focus on the spread charged over base interest rates, how this is calculated and rules there should be to protect the borrower. What is happening now is people get a loan based on an index they do not understand with spreads up to several points above the base rate that cause some of the dramatic jumps in rates on the loan after the initial terms. For example, an adjustable loan with a “teaser rate” of 3% for 2 years when the prevailing 30 year mortgage rate is 6% could be based on LIBOR, which at say 4.25% plus 2.75% or 7% at the time of the loan. The customer would be receiving negative amortization of 4% if they paid interest only for the first 2 years adding substantially to the principal mortgage amount. The consumer should have this kind of product explained in plain English in clear terms with numbers they understand so they can SEE what they could be facing over the next 7 years in the worst circumstance and be able to make an educated decision on whether they should take the adjustable rate or not.

If the mortgage industry is stupid enough to create such a product and there are “investors” willing to purchase these products we have a real problem in general and once again legislation will not solve this problem because more creative products will evolve.

Basically force some selection of US based indexes, regulate the spreads allowable and force lenders to spell out in plain English exactly, in large font format, what the payment could be in each of the 7 years AFTER the initial loan term.

Under the section titled `(d) Rate Spread Mortgages-

`(1) ESCROW ACCOUNT REQUIRED- In the case of a rate spread mortgage transaction, the obligor shall be required to make monthly payments into an escrow account established by the mortgage originator for the purpose of paying taxes, hazard insurance premiums, and, if applicable, flood insurance premiums.

I suggest that Escrow Account payments as stated above should not be required under the terms of the loan. However, these amounts MUST be included in QUALIFING the borrower to receive the loan.

Otherwise I agree with the terms in this bill.

Thank you for your support.

Sincerely,


Patrick


Below is a short novel approach to solving this problem not yet addressed:

In a free market system, the kind of wreck-less activities seen in the mortgage market of late seem almost impossible. Very smart people made very poor decisions and created poorly designed products for short term profits and very smart people who manage large pools of money (much of this money in UNREGULATED markets I might add) were duped into borrowing short term money, often also creating high amounts of leverage (encouraged by the same banks Mr. Paulson so urgently requested self regulate months ago) to purchase these esoteric and poorly designed products which all depended on an unsustainable and extremely hyped market bubble in the underlying housing market and associated mortgages.

Given these realities it is important to understand that:

a) Government cannot stop the markets and should not try and “catch a falling knife” by “rescuing” markets. In this case “homeowner borrowers”, “lenders”, “purchasers of Structured Products”, “packagers of esoteric derivatives”, “financial institutions”, “hedge funds”, “off balance sheet Structured Investment Vehicles” amongst others are the “market” here.

b) There are Four General Categories of mortgage borrower I have identified and it is important to understand these categories in order to attempt a solution to our current problem.

1) The First Category is dominated by Investors who invested in one or many properties at once trying to capitalize on a rising housing price market and took whatever financing they could get their hands on to finance their speculation.
2) The Second Category is dominated by “homeowners” who over the past several years, with rising house prices and low interest rates initially (2002-4), decided to take Bush’s advise after 9/11 and go on a spending frenzy. They financed their spending addiction with their home equity by constantly refinancing their property (often not only their primary residence but a second home or investment property) even after rates rose substantially by taking risky loans with artificially low teaser rates.

Neither of these categories of borrower need or should be given any help. Those who made the loans and those who purchased the loans should all take their losses on the chin. However there are two more categories of people who should be assisted any way we can and I have figured out some ways to do this. They are:

3) Less than financially savvy people who actually “purchased” (not refinanced) their primary residence and were duped into taking more debt to purchase more expensive houses than they should have been able to (often they had no initial interest in the level of house they were “sold”) by unscrupulous lenders pushing teaser rates and telling them they could refinance later etc. They would have never qualified for the loan or the house they purchased under traditional circumstances, but the “industry” (and I know this industry from the real estate agent to the lender and appraiser were all in the game here driving people who had not a clue about the process of buying a home or the real estate markets) pushed them into a bigger house and loan obligations.

4) Finally the fourth category is people who once again purchased (not refinanced) their principal residence and could have qualified for a traditional loan under traditional loan terms close to what they purchased and the amount of debt they took on but where steered in the direction of sub-prime products for the benefit of the seller of the loan and the coffers of the parent company (increasingly Wall Street firms who purchased mortgage companies to gain access to the entire stream of revenues generated by mortgages) who could more profitably sell or package the loan for sale to investors.

Categories 3 & 4 need help.

Again, I will repeat, the Government CANNOT bail out any of these people or correct the markets that have already been created i.e.; loans made. This is not what I advocate in any way. This animal is too large and growing right now for direct government action to make a difference. Mr. Paulson and Mr. Bernanke have come up with more dramatic attempts to create liquidity and they fail more spectacularly each time.

However, the government MUST take one path: Make sure a market exists for the people who want to purchase a home TODAY!

America moves. American’s move more than people in any other industrialized nation. We have a very flexible and diverse labor market and people will go where the opportunities lie and a fully functioning mortgage market is essential to this economic fact. We must have a market for legitimate home purchases, first time buyers etc. It is the government’s obligation to make sure Fannie Mae, Freddie Mac, the Federal Home Loan Bank and FHA are all liquid and properly functioning institutions that are well capitalized for Today’s homebuyer. Their status must be monitored and actions taken to ensure their health.

My novel approach is to address the real problem the American Individual faces if they are forced in to foreclosure. Foreclosures often result in bankruptcies, which further disrupts the life and credit of the individual. At this time increasing bankruptcies may cause great strain on other credit institutions in the US. These are other types of financing i.e.; credit cards, auto loans, retail loans, health insurance etc. The list goes on. We don’t want a dramatic rise in foreclosures to result in a dramatic rise in bankruptcies.

We need to take Category 1 & 2 people and write them and the lending / financing institutions off. We need to take category 3 & 4 people and create a scheme to allow them to restructure or refinance their homes at the most favorable prevailing rates at a minimal cost out of pocket for them, say $500.00 Max. Bush’s plan is moving in this direction but did not dictate strong enough terms to allow this to happen. This should be mandated. As long as they are performing on their loan within the past 90 days they should be able to restructure and banks and lenders should be DIRECTED to allow them to do so.

If Category 3 & 4 people cannot be restructured or refinanced because their property value is to far under water and or they simply cannot make any prevailing mortgage payment because they were simply sold more money than they could reasonably pay back, then the Government should allow those foreclosures to happen but the individual citizen will immediately have the foreclosure expunged from their credit history.

That is what I said, have the foreclosure expunged from their credit history immediately so they do not have to declare bankruptcy and they can move back into a lifestyle fit for their income and move back to the housing market as soon as they are ready.

To qualify for this to happen, they will need to be qualified by a set of rules / tests set up by the Congress and implemented either by lenders or through an online site created specifically to process such requests. Credit bureaus would have to conform to the rules and play a part in making sure they are followed. Some of the rules would be the mortgage was for a principal residence, the consumer can show reasonable income at the time they obtained the loan i.e.; tax returns etc., the consumer can show they did not lie or inflate their income when obtaining the loan, the consumer can show they did not use the loan to refinance or otherwise borrow to meet other debt obligations with the mortgage loan etc.

Let Wall Street take the losses!! They drove the market to where would up. Let’s save the honest working American and allow them to get on with life after being unscrupulously taken advantage of by a very powerful and money hungry mortgage industry.

Patrik