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December 15th, 2011

Should lenders have a fiduciary obligation to borrowers?

by Peter Miller


Foreclosure Exit SignHow can we create a mortgage landscape with safer, better-performing loans? We can start by paying close attention to which mortgage products borrowers are approved for.

Currently, we’re still recovering from a mortgage meltdown that was at least partially cause by a lending environment that placed borrowers—many of whom qualified for more traditional mortgage products—into risky loans.

Minorities and risky loans

A study by the Center for Responsible Lending suggests that minority borrowers are much more likely to get risky loans, the very mortgages most closely associated with foreclosure.

“African Americans and Latinos across the credit score spectrum were more likely to receive a high-cost mortgage with risky features,” according to the report, Losing Ground, 2011. “African Americans and Latinos with good credit (a 660+ FICO score) received a high-cost loan more than three times as often as white borrowers.”

This is an amazing conclusion given that the first law condemning racial discrimination in housing was the Civil Rights Act–of 1866.

Are ARMs risky?

The Center defines “risky” ARMs as adjustable-rate mortgages which have any one of these features: “Interest rate resets of less than five years; negative amortization; or interest-only payment schedules.”

Risky ARMs had a 12.8 foreclosure rate between 2004 through 2008 according to the report, while fixed-rate and standard ARMs had a 3.3 percent foreclosure level. The overall foreclosure level was 6.4 percent for the period. Since minority borrowers were more likely to get risky loans, it follows that they have higher foreclosure percentages.

The report could be more specific.

For instance, many FHA, VA and conventional adjustable-rate mortgages reset in less than five years and are perfectly acceptable forms of financing with reasonable mortgage rates. While negative amortization is generally a bad idea, the FHA graduated payment mortgage is a self-amortizing loan over 30 years but does have negative amortization in its first few years. It’s not a great loan, but it’s not anywhere as risky as an option ARM.

Also, comparing “risky” ARMs to a pool that includes both fixed-rate and “standard” ARMs is not exactly apples to apples. How about risky ARMs compared to FHA, VA and conventional ARMs?

Why so many subprime loans in the first place?

With refinement, perhaps the Center could figure out why we have so many subprime loans in the first place. A student in one of the ethics classes I teach for real estate licensees brought up the point recently that many homes in his area had sold for $600,000 or so at the height of the real estate market. Also, he said, a large percentage was financed with subprime loans.

This makes no sense. Individuals with subprime credit should not be getting big mortgages.

The Wall Street Journal has raised this issue in a different way. It has reported that 61 percent of all subprime borrowers in 2006 actually qualified for FHA, VA and conventional financing–loans with lower costs, better terms and far fewer foreclosures than subprime mortgages.

Lenders should be more like lawyers

If we want to have better and safer mortgages, few groups have a better idea for achieving that goal than the UpFront Mortgage Brokers Association. Lenders who belong to this organization believe that borrowers should be represented by loan originators and that lenders should have a fiduciary obligation to borrowers in the same way that lawyers and real estate brokers must serve their clients.

The lending industry has been vehemently opposed to borrowers-as-clients, but given the damage done to the housing market and the economy by the present system, perhaps it’s time for a change.

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