The Dodd-Frank Wall Street Reform and Consumer Protection Act contains some significant provisions that will dramatically affect the way mortgage originators can be paid in the future. The new law also requires all originators going forward to verify a borrower's ability to repay the loan based on a formal assessment of his or her income and assets, not including the home's value.
These sweeping changes are partly based on an amendment passed in the Senate and included in the Senate's version of the financial regulatory reform legislation. The amendment was sponsored by Senators Jeff Merkley (D-Oregon) and Amy Klobuchar (D-Minnesota). The Senate amendment was also co-sponsored by Senators Chuck Schumer (D-New York), Olympia Snowe (R-Maine), Scott Brown (R-Massachusetts), Mark Begich (D-Alaska), Barbara Boxer (D-California), Chris Dodd (D-Connecticut), Al Franken (D-Minnesota), John Kerry (D-Massachusetts) and Carl Levin (D-Michigan).
The Merkley/Klobuchar amendment contained two primary features--one prohibiting what was referred to as "secret steering payments" in a two-page description of the amendment. The description says the amendment would "ban mortgage lenders and loan originators from receiving payments based on the terms of the loans." The other component of the amendment is the one that will require all loan originators to ensure the borrower's ability to repay his or her loan.
The description of the senators' amendment states, "Documenting ability to repay would end the practice of 'no-doc' or 'liar' loans, which were an important element of the housing bubble." The provision requires lenders to assess the repayment ability based on the maximum interest rate allowed in the first five years of the loan.
Mortgage Banking caught up with Sen. Merkley in Washington, D.C., in late July after the historic reform legislation had been signed into law by the president. We asked him about the provisions he was instrumental in getting included in the Senate's bill. Sen. Merkley serves on the Senate Banking, Housing and Urban Affairs Committee.
Q: Thank you, senator, for taking time to do this.
A: You bet. I'm delighted to chew on mortgage issues.
Q: What of all the measures in the new law do you think will make the mortgage market less risky for borrowers?
A: Well, I think there are three significant factors. And those are prepayment penalties, steering payments and liar loans. And let me touch on each of those.
I'll just give you my version of history here. In 2003, we had a new form of subprime, [and many of the subprime mortgages that were getting approved] essentially [had] a two-year teaser rate, [After the two-year period, the rate] then went up to a much higher interest rate.
And several things combined to drive that subprime market. One was the appeal of the teaser rate. A second is that folks assumed that they could refinance after two years. A third was people generally were not familiar with the prepayment penalty that occurred when they attempted to refinance. A fourth was that you have a situation where if a mortgage originator was receiving a big bonus to advocate for that type of mortgage, ... [there] certainly was a sales incentive tied into that type of loan.
And ... that teaser rate became a two-year fuse. And it came into use on securities that incorporated many of these loans, [and] the securities blew up.
So having a steady interest rate in most cases, fully amortizing loans, 30-year fixed-rate mortgages, has so much less risk. And [by eliminating sales incentives to originate higher-risk loans] there's not a temptation for [originators] to sign up to do teaser-rate structures. There's much more stability for the economy as a whole having securities that do not have mortgages with that two-year [teaser rate]. It's also beneficial. So those three changes really addressed [the problems in the mortgage market]. …