Mortgage bankers and mortgage brokers, along with financial institutions, have long functioned in a free market premised on the notion that a borrower should have the right to choose his own loan product from those made available by originators. These are the products offered by a mortgage brokerage that has the loan types that are available from the investors it does business with, or, the products offered by a mortgage banking firm from the products it has available and will close in its own name.
The borrower, on the other hand, has the ability to seek out his originator of choice through the Internet, newspaper ads, direct mailings or other media. Once having selected a particular originator, the borrower should be supplied with a clear and understandable explanation, as well as written disclosures, about those loan products being offered that appear to suit the borrower's repayment ability. The products can vary from fixed-rate, fixed-term loans to pay option adjustable-rate mortgages (ARMs), interest-only products and others. The borrower should then be free to make the choice as to which of the loans will best suit his needs. The responsibility and rewards for this decision belong to the borrower and not the mortgage banker or broker!
This is essentially the system in place today that has brought homeownership at an affordable cost to so many in the United States. It is the system that brought us record low interest rates and a variety of prime, alt-A and sub-prime products that resulted in the highest homeownership rate in our history. In fact, the mortgage delivery system also was the primary factor in maintaining the strength of our economy for a long period of time. Should a system that has resulted in the prosperity of so many - by providing them with the kind of substantial net worth through home equity that they might never had achievedotherwise be altered to remove the very choice that it was premised on? The answer should be a resounding "no!"
What is threatening this freedom of borrower choice? Many regulators and others are beginning to look seriously at what is commonly known as "loan suitability," which is akin to the concept of fiduciary duty in the law. Suitability refers to the notion that the lender or broker should determine whether a particular loan product is suitable for a borrower, i.e., whether it meets that borrower's needs. This connotes both an economic evaluation as well as non-economic, for if it was simply economic, it would fall within the category of "ability to repay." Suitability goes beyond this evaluation to see whether, even with the ability to repay, there was a better loan product to be selected. That inevitably requires consideration of all of the borrower's circumstances - at least those that can be gleaned from the individual, who may not be willing to divulge everything at that time for a variety of reasons.
What if a borrower would rather pay less with an interest-only loan or an ARM because he wants to use the difference in monthly payment for some other purchase, but an originator, in his infinite wisdom, finds a 15-year fixed loan more suitable because it builds equity more quickly? If the borrower's choice of an ARM is selected, what happens when the same borrower loses his job and goes into foreclosure but then alleges that he did not get a suitable loan? Who will prevail? It is very likely that, given the sympathy for a borrower who is about to lose his home, a court or jury might very well find that the lender or broker had a duty to have the borrower close the loan that, in his view, was more suitable, thereby ignoring the borrower's own preference. Once a finding is made of lack of suitability, the foreclosure could be dismissed and the lender or broker held liable, depending on the wording of the particular legal requirement. The likely expansion of litigation that suitability requirements would trigger would also increase costs for the industry that would necessarily be passed on to borrowers, thereby increasing the cost of credit to consumers.
The issue is the point at which the buyer's right to choose ends and the allegedly superior judgment of a mortgage lender or broker takes precedence. It is inevitable that the subjective judgment as to whether a loan product is suitable for a borrower will be tested by the regulators during examinations, as well as the plaintiffs' bar. The uncertainty that results from the potential for fines, license suspension or revocation proceedings, and legal liability would prevent many lenders and brokers from offering loans to prospective borrowers when suitability is not clear to them from the outset (if it ever can be, given its inherent subjectivity and ambiguity). Therefore, many will go without loans that otherwise would have closed. Suitability requirements can therefore result in the loss of a borrower's ability to choose a mortgage loan he would prefer or even preclude him from obtaining any loan at all, depending upon his circumstances.
Therefore, what appears on the surface to be a fairly reasonable approach to mortgage lending - namely, a suitable loan requirement - is, when analyzed properly, a major step toward undermining the very foundation of the mortgage delivery system in place today. It can be an extremely negative formula for the consumers who most need affordable mortgage financing.
Our industry must begin to focus on the positive aspects of consumer choice and why it is an integral and important part of our economic system today. We all buy products every day, mortgage loans included, and we choose them based upon the information available. In some cases, we make mistakes. That is a right we have in this country, and simply because mistakes occur from time to time, we don't change the way the free marketplace functions.
E. Robert Levy Esq. of Woodbridge, N.J.-based law firm Levy & Watkinson PC is executive director and counsel of the Mortgage Bankers Association of New Jersey and the New Jersey Association of Mortgage Brokers. He may be reached at (732) 404-1128.