How to fix predatory lending

05.04.09
By Randy Johnson

Large numbers of mortgage brokers and loan officers employed by direct lenders engaged in many different types of unethical and dishonest activities over the past decade. They were egged on by bigger fish up the food chain that were drunk on the volume of high-profit loans. Unfortunately, industry malpractices resulted in abused borrowers.

Imposing higher ethical and legal standards on loan officers regardless of where they are employed would be excellent as an industry standard. But it will not accomplish the objectives Congress or the New York Times thinks it will. For example, mortgage brokers in California have been legally required to act as fiduciaries for their borrowers for thirty years, and there has probably been more borrower abuse in that state than any other. Why? Because there is no enforcement by the regulators.

What happens when loan officers lie about rates? Nothing. No enforcement. What happens to lenders who produce phony good faith estimates of closing costs that greatly understate costs? Nothing. No enforcement.  

There probably won’t be much enforcement of any new laws either. It is simply too difficult for any one agency to police 40,000 transactions per day. So how do we fix this accountability and enforcement conundrum?

The root of the problem is the yield spread premiums offered to lenders by Fannie Mae and Freddie Mac. When they started offering them in the early 1990s it created a great opportunity for unsavory people to enter the mortgage business. They saw an ease-of-entry business where they could make big incomes. They could hire young people and train them how to deceive their customers, and they could do it with impunity because there was no enforcement.  

Borrowers often do not understand the poorly labeled Truth-in-Lending form. They often do not understand that the good faith estimate is not binding. They may not understand rate versus fee trade-off in pricing. And they may not even understand most of the other forms they are given either.

They start asking more penetrating questions when they have to write a check. But when the lender or broker is allowed to hide his compensation, borrowers won’t be able to follow the ant trail so easily.

In February, FHFA (Federal Housing Finance Agency) announced that 47 percent of homebuyers paid no points. The lenders were able to hide income from borrowers on these transactions. That’s maybe 250,000 transactions in just that month in which lender compensation was disguised or hidden.

If you force Fannie and Freddie to do away with yield spread premiums (YSPs), you remove the ability of a lender to hide his income, even if he wants to do so. Making borrowers pay the costs of their loans is not unreasonable. They pay for it one way or another anyway, either up front or in a higher interest rate. When they pay for it upfront, at least they can see it.
 
And Fannie and Freddie’s current pricing formula has made zero-point loans extremely expensive. A buyer who gets a $250,000 loan and doesn’t pay one point of $2,500 up front will pay almost $1,700 per year in added interest. That’s $17,000 over ten years. THAT is what ought to be outlawed. If a borrower doesn’t have the $2,500, the seller can raise the price of the home by $2,500 and he can pay it, a common and allowable practice. That alone saves borrowers tens of thousands of dollars.

You don’t need a new law. You just need to call James Lockhart, chairman of FHFA and regulator of Fannie Mae and Freddie Mac, and tell him to direct Fannie and Freddie to stop offering yield spread premiums. It’s as simple as that. And while you’re at it, if you’re buying a home in this wide-open real estate market, be very wary of zero-point loans. Read the fine print and pay a point – doing so will likely save you thousands of dollars in the end.

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What happens when loan officers lie about rates?