A Cautionary Tale: How Quickly Mortgage Products Can Disappearby Tim Manni
Here’s a cautionary tale about how a last minute amendment to a larger financial bill could have change the face of the mortgage market as you know it.
The U.S. Senate voted and passed a bill yesterday that’s intended to overhaul our nation’s financial system. This legislation is designed to prevent another financial disaster like the one that occurred in 2008. The sweeping bill — which is being referred to as ‘the largest, most far-reaching regulation of U.S. banks since the Great Depression’ — may among other things, alter the landscape of the mortgage market.
A last-minute amendment to the bill voted on by the Senate, proposed by Senator Jeff Merkley, could have eliminated quite a few mortgage loan products and lending practices that have been a part of the mortgage market for decades.
While we tend not to break down and analyze pending legislation (because of its propensity to change), the point here is that we have to pay attention to the reforms and the amendment that come along to better understand what the final law may look like. Some of Merkley’s amendments included:
“Full Doc” Loans Only: While the mortgage market is basically already enforcing this, “it suggests that alt-doc and lite-doc products would be banned by law,” said HSH VP Keith Gumbinger.
What does this mean? Borrowers with regular (consistent) income streams would always be required to present a laundry list of documentation (income verification, tax returns, assets, your debt-to-income ratio, etc.) in order to be approved for a home loan.
Say Goodbye to (Some) ARMs: Under the Merkley amendment, a lender could not qualify a borrower for a loan using an initial discounted interest rate, nor even a fully-indexed one, but instead a worst-case interest rate to determine how great a loan a borrower could get. In effect, lenders will have to reckon a borrower’s ability to repay against the highest interest rate that the loan product may rise to in the next five years.
“Say goodbye to ARMs with less than an initial five-year fixed period,” said Gumbinger. The products may still exist, but qualifying for them will be nearly impossible, he says.
For example, a borrower that’s interested in a 3/1 ARM with a 4% interest rate (with a 6% lifetime cap), would have to qualify at a 10% interest rate.
No More Negative Amortization (Neg-Am) Products: Merkley’s text would have banned products which allow for increasing loan balances over time. All products would have to be fully-amortizing.
In such an arrangement, the differential between what you actually owe and what you are paying is added onto the outstanding loan balance each month, a condition known as “negative amortization.”
A negative amortization mortgage isn’t something that most people would ask for by name, but they can be attracted to ultra-cheap monthly payments. Call them what you will — “Option ARM”, “PayOption ARM”, “Pick-a-Payment”, “Cash-flow ARM”, or other descriptive term — one thing is certain: these products all feature a payment method where the interest you pay is based on an artificially low contrived interest rate based not on market conditions, but on nothing more than a lender’s marketing ability.
Bans Interest-Only (IO) Loans: On the surface, this sounds like a beneficial improvement — IO loans allow borrowers to pay only the loan’s interest (no principal) for the first five, seven or ten years (some typical options).
The housing crisis has given IO loans a bad reputation because borrowers who haven’t paid any of their loan’s principal for the first several years, and then have experienced severe home-price declines, have found themselves deeply underwater, to the point that refinancing has become nearly impossible due to their negative equity position.
However, our resident expert says he doesn’t agree with this exclusion at all. “IO products have a valid place in the market, especially among jumbo borrowers,” said Gumbinger. “I could see limiting the use, but an outright ban seems like overkill.”
Bans Loans with a “Balloon” Provision: First off, what is a balloon mortgage? According to HSH.com, “A Balloon Mortgage is a fixed rate mortgage with monthly payments which are not large enough to pay off the loan during the term. Balloons end after a specific time, usually five to seven years, after which the entire remaining balance must be paid in a lump sum.”
“There will be little effect here,” says Gumbinger. “Not that many loans came with balloon provisions.
Creating a New Mortgage Landscape
From what we have read and processed thus far, and without even examining the entire version of the Senate’s overhaul, many in Congress wish to create only a “plain-vanilla” mortgage market; one that limits loan products to anything that’s not a fixed-rate, fully-amortizing and/or full-doc loan.
For now, it’s hard for us to make the claim that financial overhaul, any amendments in particular, is entirely good or bad. Only time would tell. However, if these are the types of changes that the financial reform will produce, with the crisis mostly behind us, the road ahead appears to be one of fewer borrowers who can qualify for financing.
To the extent that mortgage availability is diminished, “That means on-going sluggishness for the housing market due to a slower absorption rate of ‘excess’ housing stock,” explains Gumbinger. “Yet, Congress would be able to call it a success since fewer buyers would get in, and the ones which do would be better able to manage their financial commitment for longer, meaning fewer failures over time.”
Like we said, this is only a typical amendment to a pending legislation. Lawmakers must now mesh both the House and Senate versions in order to present a uniformed bill to the president. Hopefuls say the bill could reach President Obama’s desk before July 4. We’ll keep you posted.