September 6, 2007 10:03

What Chris Dodd and Barney Frank want to do about mortgage lending

From an article in this morning's NYT about proposed legislation on the way from the chairmen of the House and Senate banking committees:

The Democratic proposals would attack several practices that advocacy groups for low-income homeowners have singled out. The first is prepayment penalties, which are rare for borrowers with good credit but common among subprime borrowers. The penalties make it very expensive for a person to refinance a subprime mortgage in less than two years, and sometimes in less than three years.

Defenders of prepayment penalties say they reduce the risks for investors who buy mortgages and thus help provide capital for low-income home buyers. Defenders also note that such penalties allow a lender to offer the low initial teaser rates, which were highly popular with many borrowers.

Okay, so it's not just David Laibson who wants to get rid of prepayment penalties. I find it interesting that some people defend them because they allow mortgage lenders to offer "low initial teaser rates," when I thought that was the problem. The argument about prepayment penalties making the loans more attractive to investors is legit, though. There's a natural tradeoff between prepayment penalties and interest rates.

Some other proposals:

The Democratic measures would also restrict if not prohibit so-called yield spread premiums, which are sales commissions to mortgage brokers that are largely invisible to home buyers because they are paid through a higher loan rate rather than through an upfront payment. Critics argue that yield spread premiums are deceptive, but defenders say they benefit many borrowers who have little cash to pay the upfront closing costs on a loan.

The Democratic bills would also prohibit mortgage brokers from “steering” customers into taking a subprime loan even if they qualify for conventional mortgages. Some analysts have estimated that 20 percent to 40 percent of people who now have subprime loans could qualify for cheaper fixed rates.

I get the reasoning behind these, but I do start to wonder how deep Congress really ought to get into the mechanics of mortgage lending. Richard Boltuck, a commenter to one of my earlier posts on this subject, thinks lawmakers should restrict themselves to encouraging more "transparency and simplicity" in the lending business:

The requirement that interest rates charged be presented on a standardized basis, comparable across product offerings, as an annual percentage rate (APR) is an example. The premise is that complexity and deception cause confusion among non-expert consumers ...