There was a huge real estate market development recently that surprisingly has attracted little media or market attention. But it will. It?s going to have a huge impact on our New York City real estate market because it affects the basics of how real estate financing works and how existing mortgages are serviced. What?s more, many peoples? intuitive reaction about how this will affect the market will be wrong. Here?s a summary of what?s happening and my analysis as an attorney active in real estate law, and actively representing buyers, sellers, developers, owners, and condo and coop associations, about what the impact is likely to be.
And for the really good news: this time the glass is (more than) half full!
Two weeks ago the newly minted Consumer Financial Protection Bureau (CFPC) started down a road that will lead to fundamental real estate change and an incredible impact on the real estate market throughout America. The CFPB proposed, and will be proposing more, ?rules? for mortgage lenders to prevent future ?risky mortgage lending? of the kind that contributed so mightily to the 2008 housing market collapse and the recession that followed, which still impacts the housing market and America?s economy.
Before I get into the proposed ?rules? I should say that though this will have a market impact right now, it won?t actually go into effect until at least January of 2014. Even then, the best bet is that the rules will be phased in probably over a seven-year period. Nonetheless, I think the impact will be immediate and almost universal.
The proposals aren?t for hard and fast rules ? they really create a sort of ?safe harbor? provision for lenders, and aren?t actually prohibitions. But what bank or mortgage lender would dares to not follow these ?rules?? If they go into effect next year, and I think you can be pretty certain they will, complying with these provisions will mean the resulting loans will be ?qualified mortgages.? That means the bank, mortgage company or other mortgage lender who follows the rules for ?qualified mortgages? will gain legal protection against being successfully sued by borrowers or those who would buy mortgages from the original mortgage issuer. Put another way, failure to issue qualified mortgages will virtually assure law suits because the failure to comply with the ?qualified? standards will become the road map for asserting claims.
Failure to use the ?qualified? provisions would be like committing malpractice in the lending business. It will certainly become an industry standard.
You might think mortgage bankers or others involved in the business of real estate lending would oppose more regulation. But you?d be wrong. Actually, after billions-and-billions in legal settlements, litigation costs and loads of claims still pending or lurking in the future, lenders in the mortgage business and especially those involved in packaging and selling mortgage backed securities are eager for the bright line rules the CFPB rules could provide. The prospect of a safe harbor where they can do business with little or no exposure to legal claims will likely induce greater lending.
It?s a safe bet the rules for ?qualified mortgages? will quickly become minimum standards for virtually all government loans and related programs. How can the federal government support, insure or back mortgages based on practices the CFPB claims are misleading, unfair or predatory? How can state or local governments? How could regulators not require these standards as a minimum for bundling mortgages to create mortgaged backed securities; and even if the regulators somehow didn?t require it, mortgage security buyers in the marketplace surely would.
Failing to comply will be like flying a flag for state attorney generals, federal prosecutors and consumer protection agencies loudly proclaiming ?come investigate me?.? Different tax treatment for mortgages that do not comply with the CFPB standards won?t be far behind. And that?s not attractive to anyone.
Why wait? And few in the industry will wait. Failure to adopt these ?best practices? immediately would put a mortgage lender, and their shareholders, in peril. So it?ll be a dramatic, almost universal, market-place impact and an immediate one.
So what are the new ?rules??
The new standards will do away with ?interest only? loans, curtail large up-front fees, limit ?balloon payments? and set standards for income-to-loan ratios in an effort to prove potential buyers seeking financing can actually afford the mortgages they are getting. The proposed rules adopt a very top debt burden limit of not-more-than 43% of gross income. The requirements absolutely guarantee no more so-called ?no docs? loans (loans without supporting document, which believe it or not were widespread even in the subprime market back in pre-recession 2008) if the lender wants the qualified certification that provides the safe harbor litigation protection.
The rules may require that loans be amortized over not more than 30 years, and many who have been following the process think there will eventually be proposed rules setting specific percentage down payment requirements. They may prohibit ?seller financing? based on longer amortization periods but with pay offs required in 3 to 7 years, or with significantly higher than market interest rates ? though the standards won?t be directly applicable to individuals who finance only one or a few ?deals? a year (though as an attorney I?d advise my clients to be very careful, and protective of their own interests, if they aren?t in compliance with these rules if they become the industry standard as I believe they will). ?Negative amortization? loans, amortized with very low initial payments and structured so that the borrower actually loses equity in the home early in the transaction, will probably be prohibited for ?qualified mortgages?.
The CFPB says about 75% of mortgage loans issued in 2011 would already have met the new ?qualified? provisions, but that?s largely because credit markets have been very tight, and requirements very strict, since the 2008 meltdown. Far, far fewer than 75% of the mortgages issued in 2007 would have complied.
Most consumer advocates have long claimed the practices being targeted by the CFPB were unfair, disreputable or bad practices that never should have been allowed. Kathleen Day, of the Center for Responsible Lending, hailed the new proposals and particularly called interest only and balloon payment loans ?predatory practices.? Guy Cecela, publisher of Inside Mortgage Finance Borrower, an industry publication, said no-interest loans were ?a recipe for disaster? and predicted a ?huge number of these? existing interest-only and balloon payment ?loans are going to default.?
The CFPB also adopted rules for mortgage service companies requiring them to issue clear monthly billing statements that indicate how much of each payment goes to principal reduction, interest and fees and requirements to warn borrowers well in advance of any payment increase due to automatic adjustments or rising interest rates. Mortgage servicers will also be required to promptly credit loan payments and swiftly correct errors, and be prohibited from pursuing foreclosure at the same time they are discussing loan modification with a borrower. They?ll also be more closely regulated to prevent abuses of so-called ?force insurance? premiums, where mortgage servicers place a borrower in a high premium insurance policy if they ?believe? a borrower?s required insurance coverage may have lapsed. The rules on mortgage servicers are also set to go into effect next January 1st.
Rather than further slow a tight credit market, these bright line rules aiming to create an industry standard are likely to loosen credit and allow more potential buyers to obtain mortgages. It?s likely to create more mortgage money in what has been an artificially tight credit environment, which will serve to kick-start real estate sales. Predatory mortgage practices will be gone, and good riddance to them; but money will begin to flow again to credit-worthy buyers to finance proper deals on fair terms. That?s a win-win outcome for mortgagors, mortgagees, the real estate market and the economy.
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