The trend toward stated, no-doc and no-ratio loan
It was inevitable that the recent sub-prime collapse would trigger legislative hearings, investigations and the enactment of tighter consumer protection laws relating to mortgage loans. The mantra in the media has been that consumers were victimized by overzealous lenders, brokers and loan officers, and convinced to enter ill prepared into loan transactions.
There may be some merit in the argument that too many in our industry were focused on profits rather than serving the personal needs of borrowers. However, it is also true that borrowers were only too eager to snatch up the lowest payment, lowest rate products, regardless of repayment terms.
That is all in the past now. We can glimpse the future of our industry in the statutory regulations emerging nationwide that are requiring lenders, brokers and their employees to act more like financial advisors to their borrower clients.
At hearing after hearing around the country and in Washington, D.C., tragic stories were told of borrowers in dire financial straights after entering into low-rate, quick-adjustment products and "choose-your-payment" loans that suddenly saw greatly accelerated interest and principal payments far beyond the initial obligation.
On June 14, Minnesota Attorney General Lori Swanson testified before the Board of Governors of the Federal Reserve about a "stacked deck" and "lack of market discipline" as serious problems in the mortgage industry in need of greater legislative requirements for consumer protection. Recounting the recent boom mortgage years, the attorney general opined that the recent sub-prime blowup was an inevitable result of a lack of discipline by loan officers and brokers looking to make money regardless of the personal needs and financial situation of consumers. She also talked about the un-level playing field between mortgage lenders and borrowers when the consumers face incredibly complex financial transactions, usually for the first time in their lives, with very little guidance and understanding of the documents, the terms and all of the financial consequences beyond the closing.
Statewide legislative initiatives have been pushed to the front of the line by a shared understanding (articulated in media as diverse as The Wall Street Journal and consumer blogs on the Internet) that with many Americans living daily with bad credit and little savings, they are particularly susceptible to undisclosed and hidden fees and terms (such as pre-payment penalties), bait-and-switch rates and unfair manipulation by loan officers and brokers.
New consumer protection and predatory lending statutes are springing up, most recently in Nevada (NV Rev. Stat. § 598D.100; AB 440) and Minnesota (Minn. Stat. Ch. 58; SF 988; HF 2004), creating an affirmative obligation to anyone involved in originating a mortgage loan to first make a determination, using commercially reasonable means, that a borrower has the financial ability to repay his loan at the time of the closing. While there was talk of prohibiting stated loans, no-doc loans and no-ratio loans altogether, the actual legislation permits those products to be sold to borrowers as long as the borrower's financial ability to repay is still verified before closing.
The new restrictions, which I predict will be codified in most states by the end of 2008, will add new obligations on loan officers and brokers to stop and evaluate a consumer's ability to pay and properly document it before proceeding with a loan. One of the ambiguities with the legislation already in place lies in the interpretation of just what type of "commercially reasonable" action satisfies the statutory requirements. While some commentators suggest that accessing independent records sources, such as data found at Salary.com, is sufficient, others say that nothing short of viewing and verifying bank records, pay stubs and employment records will insulate a lender from possible liability for post-closing defaults.
In offering guidance, Nevada has gone so far as to propose a worksheet, certified by consumers and a lender representative, and verifying the ability to pay has been discussed, investigated and confirmed. The new document will be required to be maintained as a record of compliance upon an audit.
Massachusetts, Rhode Island, New York, California and several others states are considering similar amendments to existing predatory lending or consumer protection statutes to address a lender's obligation to verify the accuracy of a borrower's financial information and his ability to afford a mortgage. This trend suggests that stated-income, no-ratio and no-doc loan products may indeed be on the endangered list. It may not be very long before lenders, brokers and their employees evolve into the type of personal financial consultants to their borrower clients that one could find at the old Bailey Building and Loan, the fictional savings and loan in the film "It's a Wonderful Life."
To many lawmakers, that is the type of personal service mortgage professionals should have been performing for consumers all along.