By Ruth Simon
From The Wall Street Journal Online
As more homeowners fall behind on their mortgage payments, the debate is heating up over whether lenders should be required to ensure that the loans they issue are suitable for their customers.
Just what is a suitable mortgage is likely to depend on a borrower's circumstances. But already, some states, including Ohio and Pennsylvania, are calling on mortgage lenders and brokers to do their best to put borrowers in loans that they are able to repay. Toward that goal, federal banking regulators last week proposed guidelines for lenders who issue adjustable-rate mortgages to subprime borrowers. Congress also is taking a close look at mortgage lending practices, with consumer groups pressing lawmakers to impose a suitability standard on lenders.
The Mortgage Bankers Association, which says a suitability requirement would make mortgages more costly, is working on voluntary disclosure standards for its members aimed at making it easier for borrowers to understand the pros and cons of various loans. But mandating lenders to consider a loan's suitability likely would force them to make only the most conservative loans, says Kurt Pfotenhauer, a senior vice president of the association. Lenders will "deny credit...to people who deserve credit," he says.
Suitability standards exist elsewhere in the financial-services industry: Securities brokers and brokerage firms are required to have reasonable grounds for believing that investments such as stocks and bonds are suitable for their customers' financial status and investment objectives.
Imposing similar requirements on mortgage lenders, proponents say, would help homeowners such as Joseph Ripplinger, a former construction worker. Mr. Ripplinger was happy to refinance when his mortgage broker late last year offered a loan that would lower the Minneapolis resident's monthly payments. "He told me he could get me a good deal because my credit is a lot better," says Mr. Ripplinger.
What Mr. Ripplinger wound up with was a loan called an option adjustable-rate mortgage, which offers a low introductory interest rate but the loan balance can grow over time if the borrower regularly makes the minimum payment. Given his monthly income from Social Security and disability payments, Mr. Ripplinger says it will be hard to keep current on his loan as his payments begin to climb over the next few years. "I believed him when he told me it was a good deal, but I guess it wasn't," Mr. Ripplinger says. He plans to testify on Friday before the Minnesota House of Representatives, which is considering mortgage legislation.
"It's not suitable to put someone in a loan they can't pay back or if it's going to be unaffordable in two years," says Jordan Ash, director of the Acorn Financial Justice Center in St. Paul, Minn., an advocacy group.
The heightened focus on mortgage suitability comes as delinquencies are on the rise. Some 2.51% of mortgages were delinquent in the fourth quarter, the highest level since early 2002, according to Equifax Inc. and Moody's Economy.com Inc. Lenders also are being affected. A growing list of lenders that cater to borrowers with scuffed credit records have shut their doors. Other lenders are tightening their standards, making it harder for some individuals to refinance into new mortgages or buy a home.
Roughly two-thirds of mortgages are now packaged into securities and sold to investors world-wide. That and other innovations have made credit cheaper and more available, helping more people to afford a home. The national homeownership rate stood at 68.9% in the fourth quarter, according to the U.S. Census Bureau. That's up from about 65% in 1996.
But many borrowers still think they are dealing with a "paternal" lender "who wouldn't put me in a loan I can't repay," says Ohio Attorney General Marc Dann. An Ohio law that took effect in January requires mortgage brokers and loan officers to make "reasonable efforts" to secure a loan with terms that are "advantageous" to the borrower.
Pennsylvania's Department of Banking will in the next few weeks publish proposed rules that would require mortgage lenders to discern whether borrowers will be able to repay their loan over its life, rather than just make the introductory payment.
In Iowa, Attorney General Tom Miller is proposing legislation that would require mortgage brokers to place customers in loans that are in the "best interests of the borrower and not ... the mortgage lender." North Carolina already requires that mortgage brokers "make reasonable efforts ... to secure a loan that is reasonably advantageous to the borrower."
Consumer groups say they are looking to ensure that borrowers aren't put into mortgages that are destined to fail. "At its very core, suitability is about the borrower's ability to repay the loan," says Deborah Goldstein, executive vice president of the Center for Responsible Lending, a nonprofit research and lobbying group. A recent study by the center estimated that about 20% of subprime loans originated in 2005 and 2006 will end in foreclosure.
Borrowers who took out exotic mortgages also are running into trouble. Felipe Duluna, a landscaper, bought a house in Watsonville, Calif., in 2005. Mr. Duluna used his life savings of $75,000 as a down payment and took out a first and second mortgage to finance the balance of the $729,000 purchase price. Less than two years later, as his interest rate reset higher and his loan balance grew, Mr. Duluna is unable to make even the minimum payment on the option adjustable-rate mortgage he received.
Speaking through a translator because he is fluent only in Spanish, Mr. Duluna says he was told that the loan was something he could afford. Mr. Duluna says he trusted the mortgage broker, who was also the real-estate agent on the sale, and told him repeatedly that he couldn't spend more than $1,800 a month on mortgage payments. Given Mr. Duluna's annual income of $27,000, and his family's combined income of about $72,000, "these folks have no ability to actually afford this loan," says Mr. Duluna's attorney Pamela Simmons, with Simmons & Purdy.
In weighing whether a loan is suitable, lenders might need to consider the borrower's financial circumstances, ability to repay the loan and their objectives, consumer groups say. "It's not enough to say somebody is qualified for a loan...if they are left with $200, or a small amount, after the mortgage is paid," says Allen Fishbein, director of housing and credit policy for the Consumer Federation of America.
Whether a loan is suitable depends on a variety of factors, including a borrower's current situation and future plans, experts say. An adjustable-rate mortgage could be a smart choice for borrowers who expect to move in a few years or believe their salaries will rise to accommodate higher monthly payments. But the same loan could be dangerous for someone on a fixed income.
Another factor to consider is how much of a borrower's income will be devoted to housing. Some lenders will allow homeowners to spend as much as 50% of their gross income on mortgage payments, taxes and insurance, but that doesn't leave enough of a cushion for most people, says Mitch Ohlbaum, a mortgage broker in Los Angeles. Even in a high-cost market such as California, "for a regular guy in a regular job, 45% is the most they should be looking at."
Mr. Miller, the Iowa attorney general, advises borrowers to be wary of loans with low "teaser rates" and loans with prepayment penalties that can make selling a home or refinancing costly. Rather than focusing on the initial payment, borrowers should consider their ability to pay "not just the first payment or payments for the first couple of years, but the first five years or even longer" if they plan to stay put, he says.
Another consideration is what will happen if things don't work out as planned. Many borrowers took out adjustable-rate mortgages and exotic loans, figuring they would refinance in a few years. "One of the things that is driving the increased default rate is people who thought they could solve their problems by refinancing," says Kurt Eggert, a professor at Chapman University School of Law in Orange, Calif. Tighter lending standards, a soft housing market and, in some cases, their own credit problems are making refinancing less of an option for some borrowers.
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-- March 09, 2007