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Congress makes major changes to mortgages

Sweeping changes to the way home mortgages are structured and approved have been passed by Congress and signed into law by President Obama. The changes are included in the recent financial regulatory reform law. Although the main goal of the law is to change the way Wall Street banks are regulated, a large section of it is aimed at mortgage reform.

Here’s a brief summary of the most important changes:

  • One of the key goals is to reduce the number of “risky” mortgages that led to the recent housing bubble, such as mortgages that don’t require full documentation of the borrower’s income, mortgages that have “balloon” payments (large one-time payments at some point in the future), and “option ARM” mortgages that keep initial costs low by allowing borrowers to defer payments of principal and interest.

During the recent housing run-up, many banks made these loans without much regard for the potential consequences to borrowers, because they could bundle them and then sell them to investors.

Under the new law, lenders are discouraged from making such risky loans because if they do bundle them and sell them, they must keep a substantial stake themselves – thus giving them an incentive to make sure the loans they make are likely to be repaid.

  • The law requires lenders to make a good faith effort to ensure that borrowers have the ability to repay a loan. In many cases, borrowers who are given a loan they can’t afford will have the ability to sue the lender and to use this fact as a defense against foreclosure proceedings.
  • The law also regulates the way that mortgage brokers and loan officers are paid. In the past, these employees were sometimes given extra compensation if they “steered” borrowers into riskier loans, such as option ARMs or subprime loans. Under the new law, they cannot be paid extra based on getting a borrower to agree to a particular type of loan.

The law also bans “yield spread premiums,” in which a lender compensates a broker for persuading a borrower to accept a higher interest rate.

  • Prepayment penalties – fees that a lender charges if a borrower pays off a mortgage early – will be limited under the law. They will be prohibited for adjustable-rate mortgages and riskier types of mortgages, and phased out over time for standard fixed-rate mortgages.
  • Mortgage agreements can no longer require that the parties go to arbitration rather than to court if there’s a dispute. (However, once a dispute arises, the parties can agree to submit it to arbitration if they want.)
  • Lenders who offer hybrid adjustable-rate mortgages must notify the borrower six months before the loan resets or adjusts to a variable rate, providing an estimate of the new rate and the new monthly payment and suggesting options for avoiding the change, such as refinancing.
  • Generally, loan servicers must credit payments to the borrower’s account as of the date of receipt. They cannot “sit on” a payment for several days and then use the delay to impose a fee or report negative information to a credit bureau.
  • “Negative amortization” loans (in which the payments are so low that the total amount the borrower owes actually increases over time) are prohibited unless the lender makes certain disclosures. A first-time homebuyer can’t obtain such a loan unless he or she first visits a government-approved loan counselor.
  • A number of provisions concern appraisals, including mandating fair compensation of appraisers (in order to ensure quality work) and regulating lenders who invest in appraisal companies so they can get a cut of the fee. The law does not allow borrowers who switch lenders to force the new lender to accept their prior appraisal rather than paying for a new one, but it does allow regulators to adopt such a rule, and it may well be adopted over the next year or so.

Overall, the goal of the new law is to prevent another housing bubble and resulting financial crisis. This is obviously a good idea. However, there’s no question the law will make it somewhat harder for at least some borrowers to obtain a mortgage. “Standard” fixed- and adjustable-rate mortgages will remain available, but loans with more flexible terms will be harder to find.

Another issue is that the stricter standards for documentation of income and verification of a borrower’s ability to pay will make it harder for people to qualify for a mortgage if they don’t have a steady stream of income such as a salary. For instance, owners of small businesses, people who rely heavily on seasonal income, and salespeople who work on commission could find it harder to qualify for a mortgage.

It’s also possible that the fees and rates for obtaining a mortgage could go up as banks pass along the costs of complying with the law, although that remains to be seen.

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