How Financial Overhaul Changes the Mortgage Market



Original Post Date: July 16, 2010

By: Nick Timiraos

The financial-regulatory overhaul promises some big changes concerning how Americans go about getting a mortgage.

The bill will offer more protections for consumers against risky or complex mortgages, but bankers say that with fewer choices and more safeguards, loans could be slightly more expensive. The upshot, says Howard Glaser, an industry consultant and Clinton administration housing official, is that consumers will have “safer” loans, but fewer of borrowers will qualify.

Some of the provisions of the bill will take effect immediately, but many of the effects won’t be noticed right away. That’s partly because many of the exotic mortgages that fueled the subprime bubble were swept away when the market melted down three years ago.

Mortgage bankers say that lending standards are tighter today than at any time in the past two decades, and most loans being made today are conventional fixed-rate loans that are backed in some way by the federal government.

Here’s a look at some of the main changes for mortgages:

  • The bill requires lenders to have “skin in the game” on certain loans that are bundled and sold to investors as securities. The provision requires lenders to retain at least 5% of the loans that are securitized. The bill exempts certain “safe” classes of mortgages, such as fixed-rate loans that require borrowers to fully document their incomes.
  • The bill sets stricter limits on prepayment penalties, or fees charged when borrowers pay a loan off early.
  • Lenders will have to take greater steps to ensure that borrowers have the ability to repaythe loan they’re receiving. That means consumers will be required to show lots of paperwork—pay stubs, bank account statements, tax forms—to prove that they can afford the loan. (That could cause problems for some self-employed borrowers).
  • One key provision tries to improve transparency of compensation for loan officers and mortgage brokers. Brokers and loan officers can’t be paid based on steering the customer to a particular type of loan or rate.
  • Other changes will modify new appraisal regulations that have been put in place in the aftermath of the mortgage crisis. Lenders will have to compensate appraisers at a “customary and reasonable” rate, and new appraisal management companies that facilitate the ordering of appraisals will have to be registered with state agencies.

The upshot of these rules, says Mr. Glaser, is a smaller mortgage market that exercises far greater caution:

The new law places significant hurdles to offering any mortgage products outside the “plain vanilla” category. Regulators must define what is inside or outside the plain-vanilla box. Clearly, firm regulation of mortgage products is necessary in light of the subprime meltdown.  But exactly where regulators draw the line will have a substantial impact on what kind of mortgages are available and which borrowers will qualify for a mortgage.

The bill, he argues, also will favor the big banks over smaller lenders:

Thus risk retention requirements, compensation rules and licensing standards are all tilted toward large banks. The result is that the big will get bigger—and the level of mortgage risk will concentrate further—though the administration argues that more competent regulators and safer mortgage products alleviate the concern about “too big to fail.”

But the biggest “winner” could be the government, which during the first quarter backed or bought more than nine in 10 new loans:

Private securitizations will be helped by new rules that create transparency and requirements that rating agencies do their homework before rating a mortgage security. But other parts of the bill impose new liability on securitizers for the underlying mortgages originated by third parties, and requirements to retain capital when transferring risk. The full contours of these rules won’t be issued by regulators for 2-3 years—extending a period of uncertainty that has dissuaded private investors from restarting the flow of mortgage capital. Meanwhile, the federal footprint in mortgages will become deeper and deeper in order to keep the housing market from the dreaded double dip—and making the unwinding of federal intervention that much more difficult.

An Obama administration official yesterday called the mortgage provisions of the bill an important “first step” but said that additional measures were needed to ensure better oversight of areas that had been at the root of the foreclosure crisis, such as nonbank lenders.

And of course, the bill is largely silent on how to remake the broader mortgage market, including what to do with Fannie Mae and Freddie Mac. Stay tuned—the bill requires the administration to outline its plan by early next year.