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The NYS Senate Banks Committee Hearing
Evaluating the Governor's Program Bill to Address Mortgage Foreclosures and Subprime Lending Practices in New York State
May 12, 2008
I would like to thank Senator Farley and his committee for inviting us to this hearing. And I’d like to take this opportunity to thank all the committee members for their support over the last 20 years of our effort to require accountability and ongoing education for all mortgage originators. We were all proud on December 6, 2006 when the then Governor George Pataki signed S7431 into law. It was a long time coming but worth the wait.
We will be focusing our comments on the sections that directly impact our business. There are sections of this Bill that address servicing and foreclosure issues which are outside our scope of business. Mortgage brokers are solely involved in the origination side of the industry and we will be commenting only on sections of this proposed legislation addressing origination.
This proposal defines a standard of practice for which mortgage brokers are to be held to. The New York Association of Mortgage Brokers has been promoting ethical standards for our members to follow since our inception. Legislating a standard of practice in addition to the accountability and education requirements that are now required will go a long way in preventing criminals from entering the business. We are hopeful we can enact this requirement more quickly than the 20 years it took to pass the education requirement!
We are concerned with the creation of a new category of mortgage, the “Non-conventional home loan”. The intent is to separate sub-prime mortgages from prime mortgages through the use of a rate and/or fee trigger modeling it after the existing high cost mortgage trigger approach.
Our Association worked closely with the Banking Department during the period they were writing Part 41. This is the regulation that was written to bring the industry into compliance with Section 6 of the Banking Law. This section created the trigger points for high cost mortgages. The presumption was that any mortgage that crossed the threshold for a high cost mortgage was a mortgage that really shouldn’t be made. If lenders decided not to write mortgages that qualified as a high cost mortgage, so be it. The mortgage probably shouldn’t have been written anyway.
This is exactly what happened. Few if any lenders are willing to close on a high cost mortgage. It is our opinion that many lenders will take the same position with “Non-conventional home loans”.
The trigger model as used to define high cost mortgages works. It’s not a perfect solution but works adequately for high cost loans. We took almost all high costs mortgages out of the marketplace. The law worked as intended. We don’t believe that the intention of this Legislation is to eliminate the origination of all “Non-conventional home loan”.
Using the same approach to define a “Non-conventional home loan” just doesn’t work. Taking the yield on Treasury Bills and adding 3 percent to create the trigger will bring many prime loans into the “Non-conventional home loan” category.
The price for a mortgage consists of 2 components; the market price for mortgage money and the additional cost the lender is imposing to address the specific attributes of the application package. For example, there may be an add-on for credit grade (risk based pricing). Another example would be an add-on for property type. There is currently an add-on for a mortgage on a 2-family property. It’s not uncommon to see an add-on based on loan to value. The higher the loan to value, the larger the add-on. This is in addition to any Mortgage Insurance charges.
Let’s look at the yield on 30 year T-Bills as published on May 1, 2008. That rate was 4.49%. If we add 3% to that we end up with a trigger point of 7.49%. The rate for an FHA mortgage on May 1, 2008 was 6.5%, putting us within 1% of being a “Non-conventional home loan”. If our borrower has a 600 score the rate would be 7.0%. The rate test is based on the APR of the mortgage. All FHA mortgages carry an ongoing MIP Premium of 0.5% bringing the APR up to at least 7.5%.
The FHA program was specifically written for consumers with one or more of the following conditions: poor credit, low down payment or low/moderate income. A borrower with poor credit could easily find himself closing on a non-conventional home loan.
If lenders decide that the risk exposure in originating “Non-conventional home loans” is too great, this borrower will not be able to get financing. We will have ended up preventing this borrower from becoming a homeowner. The same borrower we were looking to protect with this Legislation.
A FNMA conforming rate is at 6% but if a “my community” product is used the rate is increased to 6.75%. Today neither of these loans would trigger, but after seeing what has happen in the bond market since August 2007 would anyone be truly surprised if mortgage rates moved up more? If this law was already passed and mortgage rates continued to trend up we could be facing all FHA and FNMA conforming loans being categorized as “Non-conventional home loans”.
If this law was already in place, all mortgages between $417,000 and $750,000 that closed since August 2007 would be “Non-conventional home loans” since the jumbo fixed rate mortgage has been over 7.50% every day. Do we see a need to protect high net-worth individuals from themselves? This is an immediate, unintended consequence of the Bill.
Any lender that elects to write “Non-conventional home loans” to high net-worth individuals would be exposed to “predatory borrowers”. Borrowers who have the knowledge and the deep pockets to utilize the same consumer protections written to protect the average consumer to relieve themselves of their financial obligations to their lender, whenever they feel they can obtain a financial benefit.
This would be reason enough for a lender to make the prudent business decision and not be involved in originating “Non-conventional home loans”.
We predict that if the Bill passes with this language, lenders will immediately stop writing mortgage between $417,000 and $750,000 until the secondary market sets the yield on jumbo mortgages to some percentage less than 7.5%. If the market for mortgage-backed securities continues to worsen, we could see lenders halting all mortgage originations in New York State. This cannot be what the author of this Bill intended.
A more troublesome response from the lenders may follow this logic. The penalties for non-compliance for a “Non-conventional home loan” are of the same magnitude as those of a High-cost home loan. If the difference in yield between a “Non-conventional home loan” and a High-cost home loan is 5% and the penalties for non-compliance are the same why not just price any Non-conventional home loan as a High-cost home loan? You end up with the same risk exposure for non-compliance and have a 5% higher yield on your investment. This can’t possibly be in the consumer’s best interest but the lender’s reasoning here is understandable.
This proposed legislation mirrors a proposal that is currently being discussed in Washington that creates a new category of mortgage, “Higher-cost mortgage” with the same triggers as “Non-conventional home loan”. Should this legislation be signed into law on the Federal level the issues we’re raising here today will be a national problem. However, should New York State decide to enact its proposal and the Federal version not become law we’ll be facing a new unintentional consequence. Lenders operating under a New York State charter will either change to a Federal Charter or elect not to originate “Non-conventional home loans”. New York State will be surrendering control of a greater percentage of the mortgage marketplace regardless of what path the lenders take. This certainly is not the intention of this proposal.
We need to develop a “Non-conventional home loan” test that truly captures the mortgages that this Bill intended.
If we must use a rate-based trigger, the NYAMB would like to propose two suggestions that can be used as a starting point to address this issue. Current events in the financial marketplace have shown that the spread between conforming loan size pricing and jumbo loans can vary greatly. No longer can we assume that jumbo pricing will consistently be 0.25% to 0.50% higher than a conforming mortgage. With this in mind, our first suggestion is to use different rate-based trigger points for conforming and jumbo mortgages.
We feel it would be reasonable to use a 1 percentage higher trigger point for jumbo mortgages. This will allow the secondary market pricing to respond to investor demand without capturing mortgages under the “Non-conventional” category that needn’t be. A closer investigation into the abuses in the sub-prime market over the last several years will show that the vast majority of these loans fall under the conforming loan limit.
Our second suggestion is to raise the rate-trigger from 3 to 4 percent for conforming loan sizes. As we have illustrated in the above example, the 3% margin over T-Bills doesn’t allow for secondary market to demand a higher yield on mortgage backed securities over T-Bills that is currently being used without capturing prime loans in the “Non-conventional” category. In capturing prime loans we draw attention away from the issue that “Non-conventional” home loans require special protection and at the same time we run the risk that lenders will become reluctant to conduct business in New York State. Reduced availability of mortgage money into our economy will cause additional damage to our housing market.
T-Bill rates are published in every major newspaper daily, making it readily accessible to the consumer. Unfortunately, as recent events have shown us, the spread between T-Bill interest rates and prime mortgages is erratic. An alternative to increasing the margin for the rate trigger that we considered was to use the FNMA mandatory 60-day delivery rate instead of the T-Bill. In this way we would be using a base rate that is representative of prime mortgages. Our conclusion was that the superior distribution of the T-Bill was too valuable an asset to the consumer. This is why we have recommended the higher margin as opposed to a different index rate.
It is our opinion that the best approach doesn’t involve a rate or fee test. What we are proposing maintains the availability of mortgage financing for those with special needs yet provides adequate safeguards to the consumers that really need the extra protection.
An applicant that needs to use a Sub-prime mortgage to fulfill his borrowing needs will be dealing with one or more of the following issues:
1. A high loan-to-value or a high combined loan-to-value. Whether it’s a first mortgage, second mortgage or a combination of both (a piggyback) the vast majority of the equity of the subject property is taken out in a mortgage or mortgages.
2. Temporary financial setback. A loss of job, a divorce, medical problems or any other unexpected financial setback can temporarily cause bills not to be paid on time, adversely affecting the credit profile.
3. Applicant is living “paycheck to paycheck” and is forced to accumulate additional debt. They then look to their home to restructure their debt, lowering their monthly payments with the goal of getting their monthly expenses in line with their monthly income.
4. Bad payment habits. A total disregard to paying bills on time resulting in a poor credit profile yet the applicant still needs mortgage financing.
The applicants we are looking to protect are people that are placed into a Sub-prime mortgage not by their choice but with the banker/broker’s encouragement. We don’t want to prevent people from making their own decision, even if we disagree with that decision.
We are all given the right to make our own choices. Given ten minutes, any one of us can put together a list of examples illustrating properly thought out decisions that don’t work out as planned as well as a list of poor decisions that turn out just fine. Our intention is to create a system whereby we can protect applicants from being taken advantage of, yet maintain each person’s right to choose.
First time homebuyers with limited cash assets or homeowners looking to take most of the equity out of their homes are the most susceptible to abuse. Their financial position puts them in what is considered the middle class. The NYAMB proposes the following trigger for an applicant to warrant an additional level of consumer protection:
1. A first time homebuyer that is financing greater than 80% of the purchase price, or appraised value, whichever is lower, through any combinations of liens on the subject property.
2. The property is being used (if it is a refinance) or will be used (if it is a purchase) as a primary residence.
3. A homeowner who is looking to take cash out of the current appraised value of their residence leaving a total value of liens on the residence greater than 80%.
4. Any one borrower whose income is equal to or less than the “HUD area median income” for the area where the subject property is located.
If an application package meets these conditions then the following requirements will need to be met:
1. Once the loan is underwritten, a preliminary commitment is issued, subject to credit counseling. The counselor needs to receive the commitment as well the completed application that was used to underwrite.
2. The counseling is to give the borrower(s) a full understanding as to what to expect at and after closing.
This empowers the borrower, who may not have access to professional financial opinions, with the knowledge to make an informed decision going forward with closing.
Higher income individuals looking to go high leverage will more likely do it by choice rather than by need. They are deciding to use the money to invest elsewhere. They are also more likely to do their own research or ask the advice of co-workers and family to supplement the information received from the industry. A repeat buyer has hands on experience of being a homeowner so is well aware of what being a homeowner entails.
The NYAMB believes that using this approach will afford adequate protections for those that need it most yet at the same time doesn’t impose the restrictions of legislation on an evolving mortgage industry.
The Bill as written confuses the definition of “Yield Spread Premium” and “Upselling”. The proposed definition of “Yield Spread Premium” reads’ “compensation that a mortgage broker receives from a lender for originating a home loan that is more costly than that for which the consumer qualifies, or that is based on, or varies with, the terms of the home loan.” The term that is being defined here is “Upselling”.
Wholesale lenders, that are lenders dealing with mortgage brokers, recognize the cost benefits to themselves when originating mortgages in this manner. They routinely price their mortgages lower to a mortgage broker than they do to the public, that’s the reason the term “wholesale” is used in the definition.
For example, a lender prices a mortgage directly to the consumer at 6.0% with 0 points and to the broker at 6.0% with a 1 point yield spread premium. The broker offers the product to the consumer at 6.0% with 0 points. The broker is being compensated 1 point for placing the mortgage but the consumer is paying the same regardless of which channel is chosen.
Going back to our example, the broker offers the mortgage to the consumer at 6.25% with 0 points. Here the broker has increased the interest rate in return for higher profits. This practice called Upselling, is what we want to address, not the concept of “Yield Spread Premium”. We also need to recognize that brokers, in designing the right mortgage for the client, will at times take this additional point as a credit to the borrower to offset closing costs.
Our suggestion is to change the term “Yield Spread Premium” to “Upselling”. Instead of banning “Yield Spread Premium” on “High cost” and “Non-conventional home loans” we suggest that any “Yield Spread Premium” generated due to “Upselling” be credited back to the borrower. This still leaves the broker the ability to use “Yield Spread Premium” to offset the borrower’s closing costs yet takes all potential economic gain to the broker out of the equation.
This proposal attempts to write a set of underwriting standards into State Law. We feel this is bad public policy. Underwriting standards are modified in the industry to reflect market conditions and needs. Once something is written into Law it becomes inflexible.
We suggest that restrictions regarding income documentation be implemented through regulation, not Law. This will afford the consumer protections that are needed today but allow for changes to meet markets needs in the future without having to draft new legislation. We are all well aware of the time involved in reaching consensus on pending legislation and how rapidly the mortgage market can change. It is not in the best interests of New York residents to create a set of standards that cannot evolve with market conditions.
In closing I would like to again thank the members for this opportunity to present the views of the New York Association of Mortgage Brokers. The Association looks forward to working with the committee in any way possible in drafting Legislation that improves the quality of service to the public and at the same time expands the availability of mortgages to all residents.
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