A housing crunch resulting from a flood of foreclosures has cast the spotlight on the deceptive practices that cause borrowers-particularly those with weak credit-to unknowingly pay more than necessary for a mortgage.
The Federal Reserve earlier this month unanimously approved new lending rules in an attempt to tighten standards and prevent another such crisis. The changes will apply to all mortgage lenders and take effect Oct. 1, 2009.
In the subprime category, a lender will have to assess a borrower's ability to repay the loan and verify income sources, and will be barred from penalizing prepayments except in certain circumstances.
For all home mortgage loans, the rules prohibit practices such as pyramiding late fees, coercing a real-estate appraiser to misstate a home's value, and providing deceptively low cost estimates for a loan.
The Fed, however, withdrew a proposal relating to a controversial payment mortgage brokers receive from lenders for steering borrowers into higher-priced loans. Known as a "yield-spread premium," the bonus typically amounts to a few thousand dollars and is common in the subprime market.
Mortgage brokers currently are required to disclose YSPs on two mortgage forms. After testing consumers, the government agency found that any additional disclosure likely would be too confusing, but said it would continue reviewing the issue.
Though legal, yield-spread premiums are said by consumer groups to be destructive because they steer borrowers into loans they can't afford and, ultimately, boost foreclosures.
Mark Kuchik, president of the Indianapolis chapter of the Indiana Association of Mortgage Brokers, acknowledged their usage. He owns MAK Mortgage Consultants Inc. and has been in the busi- ness 19 years.
"Not being naive, I know what happens," Kuchik said. "There are unscrupulous loan originators out there; they're not just tied to mortgage brokers."
Subprime market mushrooms
Subprime, or high-interest, loans became more prevalent as housing values escalated, making it easier for borrowers to refinance or sell their homes. From 1996 to 2006, the size of the subprime mortgage market grew from $97 billion to $640 billion, increasing its share of total loans from 12 percent to 21 percent, according to Inside B&C Lending, a Maryland-based trade publication.
Many lenders pay a yield-spread premium to brokers, but only when the loan has a prepayment penalty that keeps the borrower in the higher-cost loan long enough for the lender to recoup the cost of the payment to the broker.
Subprime loans typically are shortterm Band-Aids meant to help consumers buy a home, rebuild their credit, and refinance into a lower-interest loan later, Kuchik said.
But prepayment penalties that can extend as long as five years keep consumers in the higher-interest loans, ensuring the lender recoups the cost of the payment to the broker.
"It's just not a good idea," Kuchik said. "The consumer should have the choice to refinance to improve their situation."
Mortgage brokers originate roughly two-thirds of all home loans. The Center for Responsible Lending in Washington, D.C., a not-for-profit dedicated to eliminating abusive financial practices, estimates that nearly 90 percent of all brokered subprime mortgages include yield-spread premiums.
On a $200,000 loan, a broker could earn an extra $4,000, or a 2-percent YSP, for steering a borrower into a higher-interest loan than what they qualified for.
The new Federal Reserve rules ban certain prepayments, however, which indirectly could cut the usage of YSPs. Prepayment penalties will be restricted on loans if the monthly payment can rise during the initial four years. For other higherpriced loans, the period for pre-payment penalties cannot last more than two years.
The Center for Responsible Lending wants to go a step further and bar YSPs. Yet, center spokeswoman Kathleen Day half-heartedly complimented the Fed for taking the action.
"The rules they implemented are terrific, but way too late," she said. "It's too bad people in Washington have to be stepping over dead bodies to do the right thing."
Local resident Jim Bruggenschmidt thinks he is among the casualties. With cash from a divorce settlement but no steady job, he obtained two loans, one with an interest rate of 11.3 percent, to purchase a $120,000 home in Wanamaker on the south-east side of Indianapolis.
Intending to flip, or resell, the property after renovating it, Bruggenschmidt wasn't concerned about the high interest rate of the loan. But after the property remained on the market for a year, and he flirted with bankruptcy, he ultimately sold the property back to the broker/real estate agent.
It wasn't until months after signing off on the loan that Bruggenschmidt noticed the $1,440 YSP among the costs. He cautioned anyone who has a subprime loan, or may be contemplating one, to read the fine print.
"If you see the yield-spread premium on your settlement statement," he said, "it should be an immediate red flag."
Bruggenschmidt, who is convinced some brokers aren't representing the best interests of their clients, has compiled mounds of research on the topic and expressed his concerns to various real estate organizations and governmental agencies.
Stricter state standards
The Indiana General Assembly has not tackled YSPs specifically, but has passed legislation meant to curb mortgage fraud and predatory lending practices.
A bill approved by lawmakers this spring required the homeowner protection unit within the Indiana Attorney General's Office to establish a toll-free number in which suspected mortgage fraud can be reported.
And legislation supported by leaders of the state's mortgage brokers requires managers to pass a state exam by July 1. But after the deadline passed, 70 percent of the 950 brokerages in the state had failed to have a manager take the competency exam.
The companies received an additional 30 days to respond and will be shut down if they do not comply by Aug. 5. State Securities Commissioner Chris Naylor said several brokers have surrendered their licenses voluntarily, likely in response to the shrinking market for subprime loans and the questionable tactics they may have been using.
"Most people would agree that most of the abuse occurred in the subprime market," he said, "and that market is virtually nil now."
Still, Day at the Center for Responsible Lending insisted additional safeguards need to be taken.
"Unless you ban the practices that got us here in the first place, it'll happen again," she said. "People forget."