Mortgages Under Financial Reform: 5 Ways the Market Will Change

The financial reform law includes tough new mortgage regulations, to stop the deceptions (and self-deceptions) that have driven millions of homeowners into foreclosure. Here’s how the market will change in 12 to 18 months, when the new rules start to take effect:

1. The fees you can be charged at closing will be capped at 3 percent. That’s not as money-saving as it sounds. Many fees aren’t counted toward the cap, including such things as FHA insurance premiums, up to two of the points you pay in order to get a lower interest rate, and third-party charges such as appraisal and legal fees. But it does cover fees paid to mortgage brokers. Some lenders already limit fees to 3 percent. High-fee brokers will be squeezed.

2. You’re less likely to be steered unfairly into a loan with high fees and interest rates. Today, lenders offer incentive payments, to encourage brokers and loan officers to recommend mortgages that cost you more. You might not realize that you qualify for a better deal. The law makes these payments illegal.

Also, brokers won’t be able to collect a fee from you and from the bank as well. That gives you two choices: Pay the closing costs directly, in cash or by rolling them into the loan. Or accept a higher interest rate and let the broker collect his or her fee from the lender. You can’t split the difference by paying part out-of-pocket and part in the form of a higher interest rate.

Roy DeLoach, head of the National Association of Mortgage Brokers, says these rules are anti-consumer because they deprive you of choice. But does that choice matter? Either way, you pay. The point of the law is to save you from greedy brokers who put you into higher-rate loans, collect a fee from the lender, and charge you the full fee, too.

Since January, brokers have been required to disclose these extra fees on the “good faith estimate” of costs that you get before the closing. But that doesn’t mean that borrowers understand what was done to them. Brokers who treat their customers fairly should welcome this change, which drives out bait-and-switch practices that taint their industry’s reputation.

3. Marginal borrowers will continue to find it hard to get a mortgage, even when the job and housing markets recover. The law has created a new “affordability” rule. To get a loan, you’ll have to be able to document your ability to repay. This cuts out people who took “no-doc” and “stated-income” loans, also known as “liars loans,” which hid the fact that they earned too little to qualify. And it stops the lenders and brokers who encouraged or deceived them.

Unfortunately, it also cuts out some potentially good borrowers. One example might be the self-employed  who report low taxable incomes but might have considerable cash flow (say, because of large business-related depreciation deductions).

The law exempts certain refinancings from the affordability rule, provided that you refinance only the amount that’s currently outstanding.

4. Easy-to-get conventional loans, which have all but vanished from the market, won’t come back. These include interest-only loans, no-downpayment loans, 40-year loans, no-doc loans, and option ARMs (loans that let you pay less than the interest due and tack the unpaid amounts onto the loan principal). The law classes them as “non-qualified mortgages.” Lenders will have to keep 5 percent of their value in their own loan portfolios rather than selling the whole amount to mortgage investors. Where available, these loans will cost you more. In practice, the majority of lenders probably won’t offer them at all.

People with minimal down payments will be able to get mortgages through the Federal Housing Administration or Veterans Administration. But you’ll still have to pass the affordability test.

5. Adjustable-rate mortgages will carry more conservative terms. If you want an ARM, lenders will have to document that you can afford to make monthly payments at the highest interest rate the loan could charge over the first five years. This puts a stake in the heart of the pernicious “2/28s,” which carried low, “affordable” rates for the first two years and killed you with higher rates in year three. In the new ARM market, you’ll see more loans with rates fixed for the first five years before they start to float. If rates are fixed for shorter terms, future increases, within the the five-year window, won’t be large.

Mortgage expert Jack Guttentag hinks the rules have gone too far — “It’s a knee-jerk reaction, from Lady Bountiful to Mr. Scrooge,” he says. For example, you might not get a loan, even with a 60 percent down payment, if your income falls short. He’s hoping for more flexibility in the affordability regulations.

But where is the line? “Flexibility should be limited by commonsense rules that prevent lenders from putting people into bad loans,” says Julia Gordon, senior policy analyst at the Center for Responsible Lending. Dangerous lending will return if it gets the chance.

The mortgage brokers’ association hasn’t given up the fight.  DeLoach hopes to nudge the the regulations in ways that raise origination fees “without hurting consumers,” he says. On this point, at least, I hope that the regulators hold tight.

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