With a new administration in Washington, the time is ripe to reconsider some fundamental features of our housing finance system. In recent articles, I focused on three weaknesses of the system, and on how to fix them.
- The rigidity of the mortgage payment obligation makes the standard mortgage very difficult to manage. The proposed remedy is to replace the minimum payment obligation with a maximum loan balance that declines over time. This would result in faster payoffs and fewer defaults.
- The second weakness of the standard mortgage is that house purchasers incur a risk of equity decline from sources outside of their control. The proposed remedy is to adjust the loan balance for changes in a broad house price index, but with upward balance adjustments limited to prior declines. This would prevent episodes where large numbers of homes fell underwater.
- The third weakness is lack of an effective private secondary market. The proposed remedy is to create a new industry of private mortgage banks similar to those in Denmark, while retaining Fannie Mae and Freddie Mac until that new industry matures. This would prevent the drastic decline in activity that would follow a rapid phase-out of the agencies.
The fourth weakness, discussed below, is a dysfunctional market structure in which borrowers often overpay, and may not get the type of mortgage that best meets their needs. The sources of dysfunction include the following:
Mortgages Are Complicated: Loan officers understand them because that is their day-to-day business, but most borrowers see them only a few times during their lives.
Borrowers May Have to Commit Before All the Information That Affects the Price Has Been Verified. Lenders can then use changes in price determinants as a screen that allows them to extract a higher price from the borrower. The most common abuse of this type involves property value, which usually requires an appraisal that takes days or weeks to complete.
Borrowers Cannot Depend on Mortgage Price Quotes: Lenders reset their prices every day, and sometimes more frequently. Until the price is locked, the prices quoted to a borrower are supposed to be those the lender would charge if the borrower had been cleared to lock, called the "posted price", but whether it is or not the borrower never knows. Low-balling, the practice of quoting a price well below the posted price, pervades the home mortgage market because lenders being compared to other lenders usually have no other way to distinguish themselves. Low-ballers have many ways to explain the higher price borrowers inevitably face after they are committed.
Borrowers Are Subject to Lock Abuse: Lock abuse is a lock price that is above the lender's posted price at that time. Probably the most pervasive lock abuse is ignoring a market price decrease that occurs between the last time a price was quoted to the borrower and the time the price is locked. In that case, borrowers receive the price of the earlier quote, which in most cases is the price they expected, rather than the lower posted price, which is the price they deserve.
Note that the mandatory disclosures now administered by the Consumer Financial Protection Bureau prevent none of these abuses.
The remedy for market dysfunction is the independent multi-lender web site that allows users to compare posted prices of multiple lenders, uniformly formatted, at one site. While there are no legal barriers to the creation of such facilities now, it is extremely difficult for such a site to distinguish itself from fake versions, and to counter the high-powered merchandising of lenders with name recognition. The need is for certification by a known trustworthy source that a site has the features necessary to provide borrowers with competitive prices and selection guidance. The features required for certification would include the following:
Prices Posted Directly to Site: Three or more lenders provide posted prices to the site directly from each lender's internal pricing system, without the intermediation of loan officers.
Complete Prices: Prices should cover all lender charges and all price-related features of adjustable rate mortgages.
Live Prices: Whenever a participating lender posts new prices on its own site or for its loan officers, prices on the multi-lender site change as well.
Fully-Adjusted Prices: The site should have the capacity to adjust prices from each lender for all the transaction characteristics that affect price, employing the adjustment rules specific to the lender.
Anonymity: Borrowers should be able to shop prices on the site without revealing contact information to lenders until a lender has been selected. In ot her words, lender contact is initiated only by borrowers.
Price Monitoring: Borrowers are able to monitor the posted prices of the lender they select until their price is locked.
Lender Selection: Borrowers select the lender, not the site.
Product Decision Support: Borrowers have access to guidance in making decisions about the type of mortgage, and the combination of upfront fees and interest rate that best meets their needs.
The list is designed to be illustrative. It would have to be fleshed out by the certifying agency, which might be HUD or CFPB. The burden on the agency that does it would be very small, however, while the potential benefits are enormous.