AS THE FALLOUT from the subprime mortgage crisis continues to grow, millions of borrowers are in danger of losing their homes. Predatory lenders are being blamed for encouraging borrowers to take on mortgages that they could not afford. Crackdowns on predatory lending are certainly appropriate. All borrowers, including subprime borrowers, should be protected from lending practices that reward mortgage originators for taking advantage of unsophisticated borrowers.
The danger, however, is in overreacting. In their zeal to protect borrowers from abusive lenders and to protect borrowers who may lose their homes, lawmakers could hurt all borrowers. Among the interventions being considered are steps to make it more difficult for lenders to foreclose on defaulting borrowers and to change bankruptcy laws. Both of these types of measures would have lasting consequences that will cause much more damage in the long term than they will prevent in the short term.
One of the most important features in the American housing market is the straightforward foreclosure process that enables lenders to get control of homes from defaulting borrowers and sell them quickly. This feature translates into lower interest rates for all borrowers, and is a primary factor in the availability of mortgages and ease of refinancing that American homeowners are accustomed to. Any changes that increase the time and difficulty of foreclosure will affect all borrowers in the future.
Perhaps the most dangerous part of a bill being considered by the US House Financial Services committee is a change in the bankruptcy laws that would repeal the provision prohibiting a bankruptcy court from modifying a home mortgage. American borrowers have benefited enormously from the securitization of mortgages that has brought vast amounts of funding into the mortgage market through Wall Street investors who buy pieces of mortgage pools. Loan modifications in bankruptcy will not only fuel the number of borrowers who attempt to use bankruptcy to stave off foreclosure but will treat investors who bought the riskiest portions of bonds more favorably than owners of safer slices (tranches) once a loan is modified.
Massachusetts has been among the nation's leaders in curbing practices that have contributed to the rise in foreclosures. Attorney General Martha Coakley has proposed regulations that prohibit lenders and brokers from putting borrowers into low teaser-rate loans where they know that the borrower is unable to afford the higher payments when the teaser-rate period expires.
A more worrisome part of the Massachusetts legislation is a 90-day grace period that borrowers receive if they fall behind on loan payments. If this is a one-time extension, the damage to long-term mortgage markets in Massachusetts will be small, but a permanent extension to the grace period that defaulting borrowers have before the lender can start foreclosure proceedings will have a negative impact on every future mortgage originated in Massachusetts.
On the positive side, legislation to increase funding available for subprime borrowers to refinance their mortgages into mortgage vehicles that they can afford is helpful. So is legislation to modernize the Federal Housing Administration, to increase the size of mortgages that FHA can insure, and to lower down payments. This would allow FHA, which insures mortgages for low- and middle-income borrowers, to back refinanced loans for borrowers who fall behind on their payments.
Regulations to set minimum state licensing standards for all bank loan officers and brokers will help drive out unqualified actors from the industry. Also, a ban on fees to brokers who increase the yield spread premium - additional payments that brokers receive for selling borrowers on, say, a 7 percent mortgage instead of a 6.5 percent rate - is appropriate. Mortgage lending practices that push borrowers to take low "teaser-rate" mortgages or promise them that they will be able to refinance their mortgages later to avoid a steep rise in interest rates should be stopped.
The Housing Office of the State of Massachusetts is doing many things right - it is providing assistance to borrowers who have a reasonable prospect of holding on to their homes in the form of refinancing alternatives and payment assistance. Lawmakers, however, should be cautious about making fundamental changes in foreclosure and bankruptcy laws. Such changes will raise the cost of borrowing for everyone, while making homeownership less affordable to the very people they are seeking to protect.
Richard Peiser is a professor of real estate development at the Harvard Graduate School of Design.
