Friday, June 15, 2007

I Rest My Case on Disclosures

The FTC recently completed a study concerning disclosures for home purchases and found them to be lacking (LA Times via Tim Iacono's blog). This goes back to my earlier post on the “Knowledge Gap” between borrowers and lenders in the mortgage industry and how this gap can be closed. Based on this study more disclosures are not the answer. Basically the borrower does not usually understand the disclosure statements, much less what they are actually mean.

The question continues to be how do you close the “Knowledge Gap”. Personally, I am coming down on the side of eliminating certain types of loans. Specifically, stated income and min doc, the so-called “liar” loans. For both of these loan types the criteria used in decision making (stated income and min doc) are risk related issues that should be eliminated. What “real” banker would make a loan without verifying income or assets? This goes against all the training I ever had.

With regard to ARMs, neg-am, and interest only loans the perspective should be different. For commercial loans a “real” bankers analyze a loan from a cash flow perspective to make certain that there is sufficient cash flow to make the required loan payments. This is the major difference between commercial loans which are made based on cash flow analysis and consumer loans which are based on credit analysis. Credit analysis is based on the applicants previous credit history the chance of the customer repaying the loan based on that history (basis of the FICO score). ARMs, neg-am, and interest only loans should be underwritten using cash flow analysis along with using credit history criteria.

If mortgage lenders were required to complete a cash flow analysis on certain types of mortgage loan products, ARMs, neg-am, interest only, both the lender and borrower would be required to be more knowledgeable about the products and the ramifications of choosing one of the products. Not to mention the fact that a lender could be held liable for cramming a borrower into a product they had no business being in.

These are my thoughts, what do you think?

A study released Wednesday by the Federal Trade Commission found that the required disclosures were ineffective at explaining the costs and risks of home loans. . . . .This has been especially true with increasingly popular but complicated products such as "option ARMs" — adjustable-rate mortgages that let borrowers choose their payment amount each month and can even increase the total amount they owe on their loan.

The FTC doesn't have jurisdiction over loan disclosures, but it decided to examine them after many borrowers complained to it of deceptive tactics used to sell them home loans.The agencies that do oversee mortgage disclosures are the Federal Reserve and the Department of Housing and Urban Development, which respectively monitor the nation's truth-in-lending law and the law governing real estate settlement procedures. Both agencies agreed that home loan disclosures were too complex and said they were working on solutions.

In the FTC study, more than 800 recent mortgage customers were each given disclosure forms for a hypothetical loan. About half got forms of the type currently used. The rest got prototype forms designed by the study authors to be understandable.The study found that when given the disclosures now used:

• Half the borrowers couldn't correctly identify the loan amount.
• Nine in 10 couldn't figure out the total upfront cost of the loan.• Two-thirds did not recognize that they would have to pay a penalty if they paid off the mortgage within two years. And 95% didn't know how much that penalty would be.
• Three-quarters did not know when substantial charges for credit insurance had been included in the loan.
• One in five couldn't correctly identify the annual percentage rate, the amount of cash due at closing or the monthly payment — or whether that payment included charges for property taxes and insurance.

The study's authors said they chose the best disclosures they could find. In other words, many forms used by lenders were less readable than the ones used in the study. Also, the study looked only at fixed-rate loans. Disclosures for adjustable mortgages might be even more confusing.The FTC found that the disclosures it designed improved understanding of 17 of 21 key loan terms.

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