Tuesday, June 12, 2007

Borrower Counseling: Where the Rubber Meets the Road

by Tanta on 6/12/2007 11:00:00 AM

I thought we might look at some details in this piece in the New York Times by our dependable Vikas Bajaj, "Effort to Advise on Risky Loans Runs Into Snag." As usual, Bajaj pulls together enough information to allow us to get past the spin, without actually crossing the line into editorializing. But hey! I'm a blogger. About editorializing I have no scruples.

I strongly encourage you to read the whole thing. A few choice bits:

Now, the state is retooling the program to include all of Cook County, which encompasses Chicago and many of its suburbs. Under the proposal, first-time home buyers and borrowers who are refinancing would be referred to counseling only if they selected certain loans like adjustable-rate mortgages that reset in five years or less, or loans that initially require only interest payments. A state agency is drafting the rules, which must be approved by a committee of lawmakers.

Even as that process plays out, the Illinois General Assembly is considering legislation that would enshrine the new counseling rules in law. In addition, the bill would require mortgage brokers to act in their clients’ best interest and bar state-regulated lenders from making loans without verifying borrowers’ income with tax returns, paycheck stubs or other documents.

Interesting, is it not? Illinois is taking the position that certain kinds of mortgage transactions are so risky--so, shall we say, likely to be "non-economic" for the borrower--that the fact that the borrower elected to apply for such a loan is a presumption that counseling is appropriate. Someone needs to alert the hedge funds.

Furthermore, Illinois is connecting the dots between the fiduciary duty of the broker and the terms of the loan. The implication is that a stated income loan is simply not sufficiently in any borrower's best interest such that it is presumptively a failure of fiduciary duty to originate one. I haven't seen the text of the Illinois statute and I'm prepared to be as disappointed as I usually am once this stuff gets out of committee, but let me say good on Illinois for having advanced the ball this far. I'm rather hoping ISDA is taking notes.

And while we're on the subject of brokers earning their fees by providing services to borrowers:
A report compiled by an advocacy group, Housing Action Illinois, shows that the majority of borrowers who were about take on adjustable-rate mortgages believed that they had fixed-rate loans. More than two-thirds of the borrowers were spending more than 60 percent of their take-home pay on housing expenses. And 75 percent of the borrowers were refinancing existing debts; the rest were buying a home.

If I'm reading this correctly, these folks have already talked to a mortgage broker and they're still this confused. Do I believe this data? With all my heart and all my soul and all the decades I've spent trying to explain how ARMs work to people with bachelor's degrees in financial fields. Of course an advocacy group might have an interest in portraying these borrowers as more ignorant than they are. Did anyone else see this little survey that Lending Tree published recently?
81% of on-line consumers who are paying a mortgage or are planning on buying a home in the next 12 months say they understand how an ARM works. (See q31.)
−Young Singles are the least likely to understand how an ARM works.

On-line consumers are not as informed about their ARM as they first indicated. When asked what they know about their ARM, the majority did not know the interest rate cap, the adjustment schedule, the index their ARM was tied to, or the interest rate ceiling. (See q46.)

Most on-line consumers (91%) with an ARM are aware that their rate will adjust. (See q41.)

In what was quite possibly a sample of savvier-than-usual borrowers, you could still find 9% who are not aware that their ARM will adjust. You can also get a bunch of people to say "yes" to the question "Do you understand ARMs?" But if you ask them any trick questions involving, you know, how ARMs work, the majority has no idea. The usual justification of collecting an origination fee from a borrower involves at least some implicit claim that part of the effort of originating a loan is explaining it to the borrower.

Back to the Times:
The president of the Illinois Association of Mortgage Brokers, Bill McNamee, said the nonprofit agencies’ analysis could not be trusted because they have an incentive to play up problems — they receive $300 for each counseling session, which is paid for by brokers and lenders. “They are going to want to justify their existence so they can continue to collect their fees,” he said.

Delicious. Irony, with a touch of vermouth. My favorite cocktail.

But don't think those brokers are just anti-education:
John West, a mortgage broker, said the government should emphasize first-time home buyer classes and a more rigorous financial education curriculum in public schools. “People want government to safeguard them,” Mr. West said. “But I don’t want to be turning my head and seeing the government saying, ‘We think you should make another decision.’ ”

You know, one of these days, someone is going to explain to Mr. West the connection between public schools and the government. It won't be me, though; I can see a losing battle coming.

Not that the local regulator comes off sounding that much brighter:
Dean Martinez, secretary of the state’s Department of Financial and Professional Regulation, says that the uproar is missing the point and suggests that the term “counseling” may be the problem. He views the sessions as akin to state driving tests. They are there to make sure borrowers fully comprehend what they are doing, not to watch over their every action.

“Mario Andretti has to take a driver’s license test,” Mr. Martinez said, “even though he is one of the best drivers in the world. No one disputes that.”

Well, forgive me for having thought that the point of a driver's license test was to make sure you know how to drive, not to make sure you understand why the hell anyone would want to drive in the first place. What a terrible analogy. The issue is not that Mario Andretti has to have a driver's license; the issue is that not even Mario is allowed to drive an Indy 500 race car on the suburban streets at 150 mph, whether he is considered "capable" or not.

Mr. Martinez is letting himself fall into the trap here. The state of Illinois appears to be on the verge of declaring certain loan types to be so dangerous that anyone offering to get one is going to have to prove to the party who is going to have to pay the eventual bar tab--and that'll be the states, the counties, and the townships, not the NAMB--that it is "informed consent." And the very fact that we don't seem to be able to find many people who can pass the quiz at the end of class ought to be telling us that there's something markedly wrong with these loan products. Any good teacher will tell you that it isn't always the students' fault or the teachers' fault; sometimes it's the material.

Possibly you do not understand your mortgage loan because you keep trying to tell yourself that it benefits you somewhere. Free yourself of that a priori problem, and the pieces might fall into place for you.