by Dan Krell © 2007
The Federal Reserve System (the Fed) has offered advice about mortgage lending for many years. Just last week, the Fed met to discuss ways to address abusive lending practices. The Fed wants to get busy and try to create restrictions to change the sub-prime industry through what one board member called its “rule making authority” under the Home Ownership and Equity Protection Act of 1994 (HOEPA).
The Fed’s most recent action was initiated to thwart poor lending practices that have created a crisis in the housing industry due to the unusually high foreclosure rate. Although the Fed is on the right track, their authority with the HOEPA may have limited impact on the current crisis because many current foreclosures are due to purchase money mortgages rather than refinancing.
HOEPA was enacted in 1994 to address unfair and deceptive practices in mortgage lending. According to the Federal Trade Commission (FTC.gov), HOEPA does not cover mortgages to purchase or build a home, reverse mortgages, or home equities line of credit that are revolving (not closed ended).
When HOEPA was enacted, the mortgage industry was being abused by unscrupulous characters that made their fortunes by equity stripping. By targeting homeowners who had considerable equity in their home, the equity strippers would give the homeowner the cash they needed for home improvements, debt consolidation, or anything else they needed. The money did not come cheap, however, as the mortgages were usually high cost with rates that adjusted in two or three years.
Not only did these loan officers charge heavily for their service; they would come back every month or so to refinance the homeowner to a better rate. This was done until there was no equity left in the home.
The recent abuses in the mortgage industry that the Fed is reacting to are again one of deception and fraud, not for refinancing but in purchasing a home. In the fast paced buy at any cost recent “sellers’ market,” many home buyers were put into precarious mortgage situations with assurances and promises of low interest refinancing and rapid equity.
A lesson learned from “hard money” lenders. Hard money loans are typically private loans that are made against the property’s value, and sometimes do not take account for the borrower’s credit or income. To limit their risk, hard money lenders usually charge very high interest rates and limit the loan to about 60% to 70% of the value of the home. Additionally, the terms are kept short and usually have a final balloon payment. Each loan is “underwritten” based on the merits of the deal; basically if it makes sense the loan is approved.
Hard money is commonly used in commercial transactions, but is also used in residential lending. Many home buyers use hard money loans when traditional lenders will not lend, such as in purchasing a unique home or if the home buyer has very poor credit.
The mortgage industry is under pressure to make rapid changes while licking its wounds from recent foreclosure losses. Change needs to take place where the abuse is occurring. Rather than shaping a loan package to have the appearance of fitting the underwriting guidelines, why not have the loan originators take more responsibility in determining if the loan makes sense in the first place.
This column is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of July 2, 2007. Copyright (c) 2007 Dan Krell.