Foreclosures and Residential Real Estate and Mortgage Fraud and Mortgages and Real Estate & Retail

Regulators seek mortgage reforms

December 3, 2007

State regulators want more firepower to fight mortgage crimes. But a month before the General Assembly convenes, real estate interests are uneasy, fearing lawmakers may go overboard.

The Securities Division of the Indiana Secretary of State's Office made headway against fraud during the last legislative session, winning approval for tighter controls on the industry--including new requirements that mortgage brokers take licensing exams and endure background checks.

Chris Naylor, who became Indiana's securities commissioner in October, says it's time to go further. Naylor wants 10-year background checks to be handled by the FBI, rather than the state police, with results fed into a national electronic registry. He also hopes to beef up criminal penalties for mortgage fraud and to standardize disposal procedures for sensitive documents.

"We all saw a need to raise the level of expertise and professionalism within the industry," Naylor said. "Frankly, there were people who were less than qualified to be participating in these very important investment decisions on the purchase of homes."

The push comes amid wrenching turmoil in the national housing industry that has caused prices to fall in many areas and foreclosures to spike. Indiana is second only to Ohio in foreclosures, a sign that many Hoosiers bought homes they could not afford, or agreed to mortgage features, such as adjustable interest rates, they didn't fully understand.

Naylor's office oversees 1,200 mortgage-brokerage firms in Indiana. The firms employ nearly 3,500 brokers who originate loans and place them with various lenders.

Until the Legislature tightened standards last spring, regulation was lax. By paying a $200 registration fee and providing a $50,000 surety bond, any company could become a mortgage brokerage--without employees' having to endure a professional test or criminal background check.

The tests and background checks should have been mandated years ago, said Gary Avery, vice president of First Republic Mortgage and co-chairman of the Indiana Mortgage Fraud and Foreclosure Prevention Task Force.

"We require them for masseuses and hair designers. Yet here we are, one of the largest transactions many people do in their lives, and people involved [weren't] going through any kind of background check," he said.

In October, the Secretary of State's Office introduced the first mortgage broker exams. It also has rolled out higher licensing fees. Company registrations now cost $400, plus another $100 for each loan originator.

In addition, every loan origination office must now employ a "principal manager" who has to pass a more stringent test and pay a $200 registration fee.

The real estate industry so far has been happy to embrace these kinds of reforms. But its support is shakier for other ideas legislators are discussing that would go further to prevent and prosecute fraud.

"There's kind of a fine line," said Karl Berron, CEO of the Indiana Association of Realtors. "States that monkey around with this stuff can cause more harm than good. I guess that's the Hippocratic Oath of regulation: 'First, do no harm.'"

The Legislature this spring appointed the Interim Study Committee on Mortgage Lending Practices and Home Loan Foreclosures to broadly consider how to reform the home purchase process.

Chaired by State Sen. Connie Lawson, R-Danville, the committee heard expert testimony from every significant real estate sector, from builders and real estate agents to title companies and bankers.

At issue was Indiana's extraordinarily high home foreclosure rate. According to the Indiana Mortgage Bankers Association, 2.98 percent of all home loans in the state are now in foreclosure--more than double the national average of 1.28 percent.

The 12-member committee of lawmakers quickly learned that foreclosures have many causes--from macro factors like the economy and home-appreciation rates to broad lending practices that have spawned a boom in lending to subprime borrowers, those with checkered credit. Personal issues, such as divorce or health crises, also frequently play a role.

The Indiana Attorney General's Office testified that somewhere between 5 percent and 13 percent of Indiana foreclosures involve mortgage fraud, such as inflated appraisals and document-falsification schemes.

"We learned in our committee there are several problems that have contributed to the high rate of home loan foreclosure in Indiana, and one of them is fraud and abuse," Lawson said. "Even though it's not [responsible for] a huge amount of the foreclosures in Indiana, it does exist."

The committee's final report recommended all the reforms Naylor wants. It also suggested that legislators consider increasing the $50,000 bond brokerages must maintain.

The committee advocates broader changes, too. It wants mortgage-closing documents to include a one-page summary that includes sales price; information on property tax exemptions; and the names, signatures and registration numbers of all parties involved in the transaction.

Naylor's office is additionally working on clarifying the rules for a "suitability standard" mortgage brokers would have to apply to loan approvals, considering borrower's income, assets, liabilities and credit history.

"The [mortgage broker] industry has become complex, because there are a variety of products available. But not each product is appropriate for each investor," Naylor said. "There should be some accountability for loan brokers to examine the borrower and say, 'Is this suitable or not?'"

Real estate professionals are on board with reforms that augment licensing standards. But they're not so sure about the rest, fearing new rules and paperwork could bog down the mortgage process, expanding the time between a mortgage application and closing.

Further, they say that requiring signatures from every party involved in a real estate transaction could open unexpected liability issues for builders, title companies, real estate agents and others.

Berron said real estate officials want to get bad apples out of the barrel. But imposing too-restrictive regulations ultimately could reduce the availability of loans to people who have the ability to pay them back.

"Folks are pretty nervous about [fraud and other excesses in the mortgage market] and they should be. There's clearly been some stuff going on that shouldn't have been going on," Berron said. "But many issues are largely being dealt with by the market," he said, noting that the credit crunch that started over the summer already has reduced the availability of mortgages.

Legislators say they, too, want to strike a balance.

"The purpose was not to be onerous," Lawson said. "But obviously education is a key, making sure that we can prevent fraud is a key, and then also making legitimate loans is a key."

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