Few borrowers read every line of the avalanche of paperwork that comes with a mortgage, and even the most well-intentioned consumer might have difficulty understanding all costs associated with their loan -- and how it compares with what other lenders are offering.
Now, well-intentioned lawmakers are looking to make the mortgage process easier to understand and fairer overall, through regulations that could come to fruition via the proposed Consumer Financial Protection Agency.
If the reforms materialize, "the days of fine print, amorphous language and an avalanche of papers . . . will come to an end," said John Taylor, president and CEO of the National Community Reinvestment Coalition, an association of community-based institutions that promotes access to banking services to create affordable housing and job development. "Transparency is the name of the game."
The goals of the reforms:
- Requiring transparency. Consumers would receive a simple, integrated federal mortgage disclosure that is "reasonable, clearly written and concise," and be adequately presented with the risks and benefits of a mortgage product.
- Promoting simplicity. Borrowers would first be offered "plain vanilla" mortgages with terms that are straightforward. They can obtain more complex mortgages, but those vanilla loans will be presented as a first choice.
- Demanding fairness. Mortgage brokers would be required to determine whether the mortgage they're selling to a borrower is affordable, and prepayment penalties would be banned or restricted. Hidden fees that compensate a broker for selling higher-cost loans would be banned.
Loan originators and the sponsors of securitizations could also be required to retain 5% of the credit risk of a mortgage, requiring them to have "skin in the game," or a stake in the outcome of the loan originated, said Shaun Donovan, secretary of the U.S. Department of Housing and Urban Development.
That requirement -- along with all of the reforms, really -- could cost consumers more for their mortgage, perhaps adding as much as a half a percentage point to their mortgage rates, said Cameron Findlay, chief economist for LendingTree.com. In addition, lenders who can't afford to make the procedural changes might be forced out of business, which could effectively decrease competition, he added.
"It's going to create a situation where banks and brokers alike are going to make sure that their costs are covered for any adjustment to their process," Findlay said.
But, Findlay said, any extra costs would be worth it to restore faith in the system and protection for consumers. Also, it's a drop in the bucket compared with what it's costing to clean up the havoc created in the mortgage market and the entire economy when mortgage money was easy to get.
"How can it possibly cost consumers more than what it has already cost this nation?" Taylor said.
Clear disclosure 'worth it'
"I would rather people have more difficulty getting the loan than getting a loan they can't afford to pay in three years," he said.
At their heart, the reforms intend to force clear disclosure in the mortgage market so consumers can compare mortgage products on an apples-to-apples basis -- with easy-to-discern costs so that lender-to-lender comparisons are more straightforward. The goal is for people to always pick a mortgage based on what is actually being offered, not how it is worded or what is presented -- like they'd buy any consumer good, based on the product inside and not the packaging in which it's wrapped, Taylor said.
"Do you offer the best widget or don't you? It shouldn't be the best slogan or the best box," Taylor said.
All of these reforms are still a way off: First, the CFPA must be created. And some in the mortgage industry spy flaws in the proposals, and they'll fight to make their case.
"Traditionally, the lending world has been able to water down positive reform efforts on the regulation side, so the result is not as good as it could have been," said Howard Banker, executive director for the Fair Mortgage Collaborative, a nonprofit organization that identifies and certifies lenders that adhere to standards of fairness. If points are debated for too long a time, "momentum is lost and what you end up with is a shadow of a proposed idea," he said.
If the proposals do, however, emerge from this process and go into effect, below are some changes a mortgage shopper might expect.
1. You could have less paper to wade through
Alex Pollock, in testimony to the House Financial Services Committee in June, said the one good idea that has emerged from the reform proposals has been the proposed requirement of clear and simple disclosures. Pollack is a resident fellow at the American Enterprise Institute for Public Policy Research.
"In congressional testimony in the spring of 2007, I proposed a one-page mortgage form so borrowers could easily focus on what they really need to know. The one-page-form idea was included in bills in both the House and Senate, but not enacted, unfortunately. It remains my opinion that something like it would be a huge improvement in the way the American mortgage system works," he said.
With better disclosures, borrowers can be better able to "underwrite themselves," he said, making sure they understand the debt commitments they are making.
2. Your first option might always be 'plain vanilla'
That doesn't mean you couldn't get a more complex product, just that you have to see more basic options first. To obtain a mortgage with more complicated terms, "people would have to opt into them and be warned that they would be doing something unusual," he said of the more complex mortgage products.
Thaler is co-author of the book "Nudge," which examines scenarios that "steer people in the direction that is likely to be helpful and warn them about things that are likely to be dangerous." A "plain vanilla" mortgage encourages borrowers to opt for a certain basic mortgage type without banning other choices, he said.
This system could help prevent consumers from agreeing to complex terms they don't understand, when they might otherwise have chosen a simple, basic product. Case in point: Sullivan recently was involved in a transaction with sellers who didn't realize they had an interest-only loan until five years later when they wanted to sell the property; without paying principal on a loan, they didn't build equity.
3. You could be spared certain fees
Because it's not easy to spot to begin with, one fee -- the yield spread premium -- could become extinct without consumers even noticing. Donovan called them "unfair practices," used by lenders to encourage brokers to sell riskier and higher-priced loans.
From the industry perspective, Savitt said the premiums are a way consumers can finance origination costs over time. He said costs built into the interest rate -- both from brokers and lenders -- should remain permissible, but that "it's important that everything be disclosed on both sides," meaning both brokers and lenders should disclose all fees embedded into the rate.