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4800 Overton Plaza, Suite 400
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Don Kelly

Mortgage

Arlington Texas

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Don Kelly Blog

CFPB to the rescue!

Don Kelly

Economic-Jenga.jpg

If you have not heard of the Consumer Financial Protection Bureau, or CFPB for short, get ready - you will.  

But first, a quick bit of history...

After the mortgage and real estate crash of 2007, Congress was quick to jump to the consumer's rescue and passed a law known as the Dodd - Frank Act.   It is interesting in my opinion that the same regulators and lawmakers that fostered the guidelines and mortgage products that got us in the mess are now the same "experts" who are attempting to save us from ourselves, but more on that in a minute.  Dodd-Frank was sweeping in it's increased regulation of financial institutions and a major thrust of the Act was the protection of consumers.  Don't get me wrong, I have no issue whatsoever in arming the consumer with as much information as possible, but I believe the unintended consequences of this effort will be significant.  As a side note, check out what Milton Friedman had to say about market failures/government rescues.   The CFPB was borne from this thrust to 1) protect the consumer and 2) to penalize lenders.  Take a look at the Newsroom tab on the CFPB website and you should quickly get a feel for the "trophies" they are starting to hang on their walls. 

The primary focus of the new mortgage regulation centers on the new Ability to Repay Rule.   According to the CFPB website, the rule is intended to protect consumers from debt traps by requiring mortgage lenders to evaluate whether borrowers can afford to pay back the mortgage before signing them up.   Now for most of us this sounds absolutely logical and in fact, it is both logical and prudent and is exactly how we have been underwriting loans for almost 20 years.  According to the CFPB, 92% of  mortgages in the current marketplace meet this requirement.  In other words, before this new sweeping regulation was implemented, 92% of all outstanding mortgages already met this requirement.  As a side note, an analysis of my loan portfolio generated over the past 5 or 6 years reflects that close to 100% of my loans would meet the current requirement.  The types of loans that constitute the remaining 8% of loans that do not meet the rule include loans with terms greater than 30 years, interest only loans, loans with negative amortization and loans with excessive fees.   Most, if not all of these types of loans disappeared from the marketplace several years ago.  Amazingly, the free market, if left to function properly, finds and creates ways to self-correct.   In my opinion, the mortgage industry has largely self-corrected it's bad behavior 3 or years ago, long before the CFPB rode into town.   There is absolutely no doubt that there were bad actors in the mortgage meltdown and some consumers were harmed, but the vast majority of lenders were originating mortgages to traditional standards that stood the test of time long before CFPB.  Of those consumers that were harmed, it is my opinion through experience, that the vast majority of those borrowers knew exactly what they were doing when they signed up for these "debt trap" mortgages.  Let me provide an example.   Back in 2006, home prices in California were so high that the average consumer had difficulty affording the mortgage payment that went along with the home price.  Because mortgage investors largely thought home prices would always increase,  they came up with a loan they called a Pay Option ARM.   Here's how that loan worked.   Let's say the current interest rate at the time was 5%.   The Pay Option Arm allowed the consumer to pay the loan back at the stated interest rate of 5% or take the "option" of paying at a rate below the stated rate.   If the borrower took the option of paying the mortgage at say 1%, his or her payment would be drastically reduced.   The difference in the monthly payment at the pay rate of 1% and the current rate of 5% would be added to the loan balance each month.  This type of loan is generally referred to as a negative amortization loan.   In other words, the loan increases over time, not down as is the case on a traditional mortgage.   So we ask ourselves, why would any borrower do this?  Certainly a small percentage of borrowers took these loans and were duped or purposely misled as to the real terms of the mortgage.   A sizable group of borrowers took these loans with the full knowledge their loan balance was actually increasing, they accepted the risk because they believed their home value would continue to rise quicker than the value of their mortgage.   Most borrowers who took out this type of loan were convinced (not coerced) that why should I care if my loan balance is actually going up by 5% per year when the value of my house is going up 20% year - net on net I'm 15% ahead.   Another important reason consumers took this loan was it may have been the only way to create a mortgage payment they could afford.  At the end of the day, they should have only purchased homes they could afford with traditional, properly underwritten mortgages.   Hindsight is always 20/20 but obviously this strategy proved to be very risky for those borrowers but most knew what they were doing and chose to look the other way when it came to any downside risk. 

Now back to today's market and the new regulations imposed by the new Ability to Repay regulations.   I am absolutely convinced that 99% of my mortgage clients will not find these new regulations prohibiting them for obtaining mortgages in the short term.   What worries me most is that the regulations have become so burdensome and costly for mortgage lenders that those increased costs will be passed on to consumers, making the cost and hassle of obtaining a mortgage much greater.   I also expect that many lenders may finally say enough is enough and be forced out of the market, not because they were not competitive or competent, but because the cost of hiring auditors and compliance staff made it economically unfeasible to originate mortgages.  PHH Mortgage, one of the largest private label mortgage lenders in United States and a lender of good reputation (they are the mortgage arm of real estate companies like Century 21 and Coldwell Banker)  was made the target of a CFPB investigation on January 29th.  It was announced yesterday that the shareholders of PHH had made public their intention to consider selling the company.   Now the stockholders of PHH were likely considering such a move long before the CFPB investigation but it is hard to imagine that it was not part of their decision.   Should be interesting to follow the unintended consequences of the CFPB.

I will now climb off my soapbox.

Feel free to call or email me with your questions or if you would like to discuss this post further.

Don Kelly

NMLS #445473