If the Obama administration has its way, your next mortgage is likely to be "plain vanilla."
Mortgage lenders will be required to offer "'plain vanilla' products that are simpler and have straightforward pricing," according to a proposal circulated by the White House. A new regulatory agency would "require all providers and intermediaries to offer these products prominently, alongside whatever other lawful products they choose to offer."
To extend the administration's metaphor, next year's mortgage marketplace might resemble an ice cream shop in which the salesperson's first words to you are, "Would you like a single dip of low-fat, plain-vanilla ice cream?" If you want a double dip, or desire a flavor that's more fattening, you have to sign a form opting in to less-healthy ice cream, then read a warning label about the perils of rocky road.
In short, the administration proposes a reform of banking regulations that would nudge consumers into taking fewer risks when they borrow. The new regulations would require financial disclosure documents to be easier to understand. Rules would push mortgage companies into competing on rate and price rather than competing by developing newfangled loan types.
The Obama administration wants to reform a lot more than mortgages. It's asking Congress to make a multitude of changes affecting the entire financial system to prevent another meltdown. The proposal addresses everything from credit cards to hedge funds. It blames much of the financial crisis on the deterioration in lending standards for mortgages, so mortgage regulatory reform takes a prominent place in the 85-page proposal.
All in oneThe administration proposes creating a Consumer Financial Protection Agency, or CFPA. Right now, a constellation of agencies regulates mortgages, depending on who originates them. States regulate mortgage brokers. Savings and loans are regulated by one agency and national banks are regulated by others. The Federal Reserve oversees one set of disclosures you get when you apply for a mortgage, and the Department of Housing and Urban Development oversees another batch of disclosures. The CFPA would gather all of these oversight activities under its umbrella.
The new agency would define the plain-vanilla home loans, including adjustable-rate mortgages. Lenders that offer these loans would have to get full income documentation, collect escrow for taxes and insurance, make monthly payments predictable, and could not charge prepayment penalties. Mortgage lenders would have to offer these simple mortgages. They would be allowed to offer more complex loans, too -- but consumers would have to jump through some hoops to get them.
"The CFPA should be authorized to use a variety of measures to help ensure alternative mortgages were obtained only by consumers who understood the risks and could manage them," the proposal says. The agency "could impose a strong warning label on all alternative products; require providers to have applicants fill out financial experience questionnaires; or require providers to obtain the applicant's written 'opt-in' to such products."
The proposal says disclosure forms should be "clear, simple, and concise," and that they should be tested regularly. This is the third presidential administration in a row that has tried to make mortgage disclosures clear, simple and concise. The problem is that different stakeholders have different definitions of those terms. Furthermore, it's hard to make a clear document concise, and a concise document clear. And if a loan isn't simple, the explanation can't be simple, either.
Starting Jan. 1, 2010, mortgage lenders will be required to provide loan applicants with a simplified, three-page good-faith estimate of closing costs. It is supposed to be easier for consumers to understand. The simpler disclosure is a product of revamped regulations under a law called the Real Estate Settlement Procedures Act, or RESPA. The Obama administration is asking Congress to let RESPA reform proceed on schedule.
Another facet of RESPA reform is a rule that would make it harder for lenders to surprise borrowers at the closing table with higher-than-expected fees.
Real innovations?At the height of the mortgage boom, 2005 to early 2007, lenders got carried away with what they called innovation. But their innovations were in marketing, not product development. Lenders didn't develop anything new: Stated-income and negative-amortization mortgages had existed for years, mostly for sophisticated borrowers. The innovation lay in marketing these riskier loans to borrowers who, in earlier years, would have been given plain-vanilla loans -- or no loans at all.
These innovations in marketing brought big profits for a while, before they led to Titanic losses. Despite the mortgage bust, the industry holds innovations dear. "We want to ensure that the new structure does not stifle innovation or increase costs for consumers," says John Courson, president of the Mortgage Bankers Association.
President Barack Obama, in announcing the proposed regulatory changes, spoke of innovation, too. He promised that lenders will be able to "offer innovative products that consumers actually want and actually understand."
Proving that "innovation" has multiple definitions, even a consumer advocate endorsed it. "We need a watchdog to restore consumer confidence and increase the availability of innovative financial products to promote wealth building and access to capital for all communities," said Linda Sherry of Consumer Action.
On the other hand, you had Lauren K. Sanders, managing attorney for the National Consumer Law Center, who said: "We need to get back to old-fashioned values like safe, affordable products that the good old Main Street banker used to offer. Consumers should not have to fear that the fine print of their mortgage or credit card is loaded with hidden tricks and traps that will explode on them."
It will be a rocky road to plain-vanilla mortgages.