Tuesday, December 18, 2007

Hey! The Fed's Ready to Regulate!

by Tanta on 12/18/2007 10:04:00 AM

Only a mere fifteen months after the eagerly-awaited Nontraditional Mortgage Guidance began closing the barn door slowly enough that the entire wretched 2006 subprime and Alt-A loan vintage still managed to get out, the Fed has deemed the time right to take decisive action on mortgage regulation:

Dec. 17 (Bloomberg) -- The Federal Reserve will make it harder for lenders to charge fees for early repayment of subprime mortgages, according to consumer advocates and a regulator.

The change will probably be one of several recommendations from the Fed's Board of Governors when it gathers in Washington tomorrow to respond to the collapse in the market for subprime home loans. . . .

Fed staff, with input from policy makers, will propose as many as four new requirements for lenders tomorrow before a Board of Governors meeting scheduled for 10 a.m. They may also set two new standards for disclosure.

The proposal will suggest limiting prepayment penalties for most high-cost loans, while giving lenders some flexibility through several exceptions.

``The consensus seems to be that they are going to do something on no-documentation loans, and they are going to ban prepayment penalties,'' said Brenda Muniz, legislative director in Washington at Acorn, a community advocacy group. ``The devil is in the details,'' she said. There may be several loopholes for lenders, Muniz added.

The staff memorandum will also probably recommend lenders be forced to include property taxes and insurance in monthly payments. They are already included in payments on most prime home loans, which banks make to their best customers. The proposal will also address standards for measuring whether borrowers can afford a loan for the duration of the mortgage, instead of just for an initial period of lower interest rates. . . .

"It is a common practice for these payments to be escrowed in the prime markets, and I see no reason that escrows should not be standard practice in the subprime markets too," Kroszner said in a Nov. 5 address in Washington.
In the real world, it is common practice for tax and insurance escrows to be required on prime loans only when the LTV is greater than 80%; if there's still a lender around who won't waive escrows for lower-LTV loans (usually for an additional 0.25% in points), I haven't heard about it. I can tell you that nobody complains more bitterly than a prime borrower with a low LTV forced to escrow; these are responsible folks who quite rightly consider escrows on a par with excess tax withholding. It is particularly galling when servicer escrow processes, in this day and age of frequent loan servicing transfers and stripped-down operations, are such a mess in so many respects. Escrowing your tax and insurance payments should at least guarantee that you'll never have a policy cancelled or get a late notice from the county assessor, but too many people are finding that not to be the case.

Practically speaking, what changed in the world of the last several years was the explosion of the piggyback loan. Purchase mortgages, especially for first-time homebuyers, that would a few years ago have had high LTVs and mortgage insurance (which is always escrowed), became 80% first mortgages and therefore fell under the escrow waiver rules. So at some level this problem is going to solve itself, as second-lien lenders exit the game and low-down loans have to secure mortgage insurance, which then require escrow accounts. I will be quite interested to see what gets proposed here by the Fed, however, as a rule.

The interesting thing is that the industry never knows what to think about escrow rules. Servicers like them, since in addition to the obvious risk reduction, escrow balances are a profitable source of float. Originators, however, have two important reasons to resist giving up escrow waivers: you lose low-LTV refi business (it's hard to talk a low-LTV borrower into refinancing an existing loan that doesn't require escrows into a new loan that does, if the low-LTV borrower wants to manage her own T&I), and you just can't play qualifying games with stretched borrowers. A high-DTI loan without T&I included in the payment is more than usually likely to fail eventually, but often not until the first or second tax bill comes due. A high-DTI loan with T&I included in the payment is more than usually likely to fail early, while it's in that nasty early default warranty period. So I expect the usual schizoid response from the lobbyists.

One thing that has been a particular problem lately is estimated tax payments--escrowed or just calculated for qualifying purposes--on new construction. A perfectly common slimy origination practice is simply to use the last actual tax bill on the parcel to calculate next year's tax bill, even though a moderately alert cub scout could tell you that as the property was unimproved acreage last year and will be assessed next year with a 3,000 square foot home on it, last year's tax bill is going to be a tiny fraction of what the borrower will actually have to pay. Every underwriter knows this practice is creating loan failure; every loan officer knows this practice is shoe-horning in marginal borrowers who wouldn't meet DTI requirements using sane numbers and hence is a way of keeping the party going.

I certainly wouldn't expect Fed regulations on mortgage escrows to include drilled-down rules on how to calculate taxes on recently improved property. But that's kind of the point: the industry has behaved in such perverse, self-defeating ways lately that you probably do have to actually write legislation including the kind of blindingly obvious rules on tax calculation that underwriter trainees used to master by the end of their first week. If you don't, then these self-defeating practices will continue as long as the industry is structured so that someone profits from it.

There's also the chronic problem of "de minimus" HOA assessments and ground rents. Servicers hate having to manage escrow accounts for HOA assessments of $50 a year, not to mention those $1.00 ground rents. Those things never get escrowed. But that means that the increasing number of loans with quite significant assessments are also going un-escrowed, as servicers just decide not to handle HOA dues across the board. That wasn't a huge problem back when we didn't put first-time homebuyers with no savings into gated communities with an absurd DTI. Now that we do, we're seeing the first foreclosure notice coming from the HOA, not the lender or the tax assessor.

The safe prediction is that as soon as the draft rules are announced, we'll get a press release from the MBA decrying the additional cost of mortgage financing that will result. What with the add-ons from cram-down legislation and prepayment penalty restrictions and eliminating no-docs and ending appraiser-shopping and everything else they've warned us about in dire tones, we can (should we choose to believe them) prepare for 12.00% mortgage rates by about March. Of course, by then your tax bills might actually start dropping a bit, once the assessor gets the new comps . . .