January 23, 2017
With a new administration in Washington, the time is ripe to
reconsider some fundamental features of our housing finance
system. In recent articles, I focused on three weaknesses of
the system, and on how to fix them.
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The rigidity of the mortgage payment obligation makes the standard mortgage very difficult to manage. The proposed remedy is to replace the minimum payment obligation with a maximum loan balance that declines over time. This would result in faster payoffs and fewer defaults.
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The second weakness of the standard mortgage is that house purchasers incur a risk of equity decline from sources outside of their control. The proposed remedy is to adjust the loan balance for changes in a broad house price index, but with upward balance adjustments limited to prior declines. This would prevent episodes where large numbers of homes fell underwater.
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The third weakness is lack of an effective private secondary market. The proposed remedy is to create a new industry of private mortgage banks similar to those in Denmark, while retaining Fannie Mae and Freddie Mac until that new industry matures. This would prevent the drastic decline in activity that would follow a rapid phase-out of the agencies.
The fourth weakness, discussed below, is a dysfunctional
market structure in which borrowers often overpay, and may
not get the type of mortgage that best meets their needs.
The sources of dysfunction include the following:
Mortgages Are Complicated:
Loan officers understand them
because that is their day-to-day business, but most
borrowers see them only a few times during their lives.
Borrowers May Have to Commit
Before All the Information That Affects the Price Has Been
Verified. Lenders can then
use changes in price determinants as a screen that allows
them to extract a higher price from the borrower. The most
common abuse of this type involves property value, which
usually requires an appraisal that takes days or weeks to
complete.
Borrowers Cannot Depend on Mortgage Price Quotes:
Lenders reset their prices every
day, and sometimes more frequently. Until the price is
locked, the prices quoted to a borrower are supposed to be
those the lender would charge if the borrower had been
cleared to lock, called the “posted price”, but whether it
is or not the borrower never knows. Low-balling,
the practice
of quoting a price well below the posted price,
pervades the home mortgage market because lenders being
compared to other lenders usually have
no other way to distinguish themselves. Low-ballers have
many ways to explain the higher price borrowers inevitably
face after they are committed.
Borrowers Are
Subject to Lock Abuse: Lock
abuse is a lock price that is above
the lender’s posted price at that time.
Probably the most pervasive lock abuse is ignoring a market
price decrease that occurs between the last time a price was
quoted to the borrower and the time the price is locked. In
that case, borrowers receive the price of the earlier quote,
which in most cases is the price they expected, rather than
the lower posted price, which is the price they deserve.
Note that the mandatory disclosures now administered by the
Consumer Financial Protection Bureau prevent none of these
abuses.
The remedy for market dysfunction is the independent
multi-lender web site that allows users to compare posted
prices of multiple lenders, uniformly formatted, at one
site. While there are no legal barriers to the creation of
such facilities now, it is extremely difficult for such a
site to distinguish itself from fake versions, and to
counter the high-powered merchandising of lenders with name
recognition. The need is for certification by a known
trustworthy source that a site has the features necessary to
provide borrowers with competitive prices and selection
guidance. The features required for certification would
include the following:
Prices Posted Directly to Site:
Three or more lenders provide posted prices to the site
directly from each lender’s internal pricing system, without
the intermediation of loan officers.
Complete Prices:
Prices should cover all lender charges and all price-related
features of adjustable rate mortgages.
Live Prices:
Whenever a participating lender posts new prices on its own
site or for its loan officers, prices on the multi-lender
site change as well.
Fully-Adjusted Prices:
The site should have the capacity to adjust prices from each
lender for all the transaction characteristics that affect
price, employing the adjustment rules specific to the
lender.
Anonymity:
Borrowers should be able to shop
prices on the site
without revealing contact
information to lenders until a lender has been selected.
Price Monitoring: Borrowers
are able to monitor the posted prices of the lender they
select until their price is locked.
Lender Selection:
Borrowers select the lender, not
the site.
Product Decision Support: Borrowers
have access to guidance in making decisions about the type
of mortgage, and the combination of upfront fees and
interest rate that best meets their needs.
The list is designed to be illustrative. It would have to be
fleshed out by the certifying agency, which might be HUD or
CFPB. The burden on the agency that does it would be very
small, however, while the potential benefits are enormous.
