May 19, 2024


Mad about real estate

Subprime Mortgage Lending – 2007 Statement on Subprime Mortgage Lending – Jane A. Smith

In June 2007, the United States Treasury Department, along with other federal financial regulatory agencies, issued the Statement on Subprime Mortgage Lending. This document incorporates the Statement on Working with Borrowers published by the agencies two months previously, and is intended to supplement the recent Interagency Guidance on Nontraditional Mortgage Products. The agencies specifically targeted lenders who use adjustable rate mortgages (ARMs), addressing the necessity for appropriate guidelines in this area. One main concern for financial institutions using ARMs is the offer of a “teaser rate”. This brings in a borrower at a very low rate of interest for a brief period; however, within a few months this adjusts up to a much higher rate, based on prime plus a formulary percentage. Thus an ARM is changed very quickly from an affordable product to one that subprime borrowers cannot carry without undue financial hardship. Here are some other concerns expressed by the agencies in their Statement.

A second practice of concern to agencies and addressed in the Statement on Subprime Mortgage Lending is failure to disclose fully to the borrower how these ARMs will affect future payments. In addition, so-called “liar loans” are being underwritten by some less scrupulous subprime lenders. These loans are more politely referred to as “statement of income” loans: a potential borrower simply states on an application form how much money he makes. No verification of this income is required, nor is any attempted by the lender. Such total lack of due diligence and documentation of the borrower’s repay ability means that the lender assumes greater risk of default, while the borrower is more likely to fail to meet the financial responsibility. “Statement of income” loans were originally intended for people who are self-employed, and would be unable to produce pay stubs or a W2 form to substantiate their income claims. Liar loans are a clear abuse of this intention.

A third concern described in the Statement on Subprime Mortgage Lending refers to penalties for early prepayment extending far into the term of the loan. Such penalties are usually quite substantial, and are not always fully explained in advance to the borrower. Moreover, subprime borrowers are not always informed about additional monthly payments, like insurance, taxes, and closing costs that accompany the purchase of property but are not part of the loan itself.

Three months before releasing the final Statement, the agencies released it for comment from the public, as well as from members of Congress and various financial institutions. It is interesting that the lending industry’s most repeated comments were in opposition to the requirement of full disclosure of rates and fees relating to ARMs. Such full disclosure was described as “information overload.” We find it difficult to understand how non-disclosure of all costs connected with a loan could be considered anything other than deceptive lending practices. It is only when subprime lenders offer full disclosure and open discussion to borrowers that they will be thought of as reputable entities. To fight mandatory disclosure of costs and fees seems to indicate that they have something to hide.

Most comments on the Statement also pointed out the need for a better, more inclusive definition of the term “subprime.” The final 2007 Statement references the Expanded Guidance (2001) for full criteria for considering a borrower “subprime”.

The 2007 Statement recommends that the borrower be given a full schedule for repayment of the loan, including an informed estimate of associated closing costs, insurance, and taxes. This should be provided by the lender at the time the loan originates. The document also recommends that these extra charges be calculated into the borrower’s debt-ratio status.

All in all, the 2007 Statement on Subprime Mortgage Lending provides excellent guidance for the many questionable practices that seem to have become intrinsic to subprime lending. It is inclusive of other earlier such statements, and refers the reader to the earlier 2001 Expanded Guidance document when necessary.