Relying on false wealth usually has its moment of truth. That moment's here for many US homeowners who hear a leak in a housing bubble. And as prices cool, those who took out high-risk loans – helping create the bubble – now need special help.
Federal and state regulators have been slow off the mark to control an expanding slice of the mortgage business that lures many borrowers into thinking they can afford a home when they can't. After many warnings from Alan Greenspan and others that so-called "exotic" mortgages may be a threat to the housing market – and the economy – the first set of new rules for this type of dangerous debt finally came down Friday.
Aimed first at banks (the more high-flying mortgage brokers will get their regs later), the federal rules aim to rein in abuses in types of mortgages that have loose standards or are simply too complex for an average person to understand. Such loans go way beyond the usual fixed-rate or traditional adjustable-rate mortgages in their level of riskiness or detail. A Government Accountability Office study released last month found most lenders "did not fully or clearly discuss the risks and the terms of these products."
More than 30 percent of loans are now exotic, up from 10 percent in 2000. They include "interest only and no down payment" loans or "payment option" mortgages that come with teasing low-interest rates but can later expand into loan obligations greater than the worth of a home.
While these exotics have helped create near-record homeownership (68.7 percent), the recent weakening of the housing market has led to a rapid rise in foreclosures and delinquencies in payments, mainly among those with such risky mortgages.
State and federal regulators have been scrambling to come up with better requirements on what a lender must disclose. "Marketing materials for these loans often emphasize their benefits and downplay or omit the risks," Sandra Thompson, director of supervision and consumer protection at the Federal Deposit Insurance Corporation, told Congress last month.
A controversial aspect of the new rules – some expected in a few weeks – would require banks and the more than 90,000 mortgage companies to make a credible analysis of a borrower's capacity to repay a loan. In the fierce competition of this industry, many lenders of exotics do not do that scrutiny very well. But the mortgage-broker industry rejects the idea that it can determine if a borrower will falter on payments over the life of a loan.
Nonetheless, the level of fraud among mortgage brokers doubled last year, with a $1 billion cost to the economy. Many brokers, if caught by state regulators, simply flee to another state. (An interstate remedy for that is in the works.) The industry needs a shake-up and better licensing to improve its professionalism. Being forced to delve deeper into a client's finances should not be considered a burden but a necessary duty.
The regs coming down may help save future borrowers by putting a brake on the riskiest loans. Acting as a red flag, the rules should also serve as a warning to consumers to make sure they understand the fine print on a mortgage. Owning a home should not be a false dream.