The Leadership Conference on Civil and Human Rights

The Nation's Premier Civil and Human Rights Coalition

The Leadership Conference on Civil and Human Rights  & The Leadership Conference Education Fund
The Nation's Premier Civil and Human Rights Coalition
Civil Rights Monitor - Volume 17, No. 1 - Winter 2007

Congress Begins Addressing Subprime Mortgage Fallout

By Rob Randhava

An estimated 2.4 million subprime borrowers across the country will likely lose their homes to foreclosure in the next several years. In addition, a growing number of economists -- pointing to volatile stock markets and a weakening dollar -- believe that the foreclosure crisis could drastically weaken what has appeared on the surface to be a strong economy. For most Americans, whose biggest investment is their home, this news is coming as a shock.

The Modern Subprime Mortgage Industry: Causes of the Foreclosure Epidemic

Subprime mortgages are generally defined as higher-cost home loans made to borrowers with less-than-ideal credit. Responsible subprime lending has long been recognized as an important tool for giving opportunities to people who for various reasons might otherwise never be able to own a home. In recent years, however, the "responsible" part of "responsible subprime lending" has been rendered meaningless.

Much of what went wrong in the subprime lending industry lies in the widespread abuse of what were long considered to be sound subprime lending practices. For example, many Americans were given home loans without being required to prove that they had enough income to pay them back. Many other borrowers were only required to show they had enough income to pay low "teaser" rates for the first two or three years of hybrid adjustable rate mortgage (ARM) loans. To make mortgages look cheaper and more appealing to borrowers, many lenders did not factor in critical expenses, such as property taxes and insurance, into the cost of home loans.

At the same time, other aspects of the subprime mortgage lending system reflected not just carelessness and a lack of accountability, but outright greed. For example, many mortgage brokers were given bonuses, or "yield spread premiums," for steering unwitting borrowers into higher-rate subprime mortgages than their incomes or credit scores would otherwise dictate.

Assessing the Fallout

The Center for Responsible Lending estimates that as many as 2.4 million subprime mortgages are likely to fail in the next several years as a result of such practices. The situation is especially troubling to communities represented by LCCR member organizations.

According to Home Mortgage Disclosure Act data, in 2005, over half of the loans to African Americans were higher-rate subprime loans, including 54.7 percent of purchase loans and 49.3 percent of refinance loans. For Latino borrowers, these figures were 46.1 percent and 33.8 percent, respectively.

That same year, African Americans were 3.2, and Latinos 2.7, times more likely to receive a higher-rate home purchase loan than white non-Latino borrowers. And for refinances, African Americans were 2.3, and Latinos 1.6, times more likely to receive a higher-rate loan than non-Latino whites, according to Federal Reserve data.

According to research by the Center for Responsible Lending, these racial and ethnic disparities exist even after controlling for borrower traits such as credit scores, equity, and other risk factors.

As a result, as foreclosures continue to increase nationwide, minority communities are likely to be hit especially hard.

Responding to the Foreclosure Crisis

Many stakeholders, as well as federal and state regulators, are acknowledging the extent of the problems in the subprime market, and are taking a variety of steps to reduce the prevalence of irresponsible loans in the future. But to date, these efforts have amounted to a piecemeal approach that will not adequately protect borrowers.

Many lenders, often in cooperation with local and national community development organizations, have expanded the use of voluntary programs to avert foreclosures, including mortgage "rescue" programs, debt counseling and financial literacy campaigns.

Reformers also say that Congress and other policymakers must ensure that lenders and organizations delivering the counseling or other assistance are soundly equipped, knowledgeable, and genuinely working with the interests of the borrower in mind. Moreover, they urge Congress to ensure that there is an adequate system in place to provide pre-closing loan counseling to borrowers, so that borrowers are made aware of the full terms and conditions of their loans before arriving at the closing table.

Earlier this year, the Federal Reserve (the "Fed") and other federal regulators issued a Proposed Statement on Subprime Mortgage Lending, which also acknowledges the growing concerns with the current state of the subprime lending industry. It, however, falls short in several important respects in that it does not require: (1) documentation of income; (2) a meaningful evaluation of the long-term affordability of monthly payments to adjustable rate mortgages; or (3) truly helpful disclosures to borrowers -- which would, at the very least, include a disclosure of the maximum possible monthly payments on adjustable rate mortgages. In addition, the Statement would only apply to subprime loans originated by federal depositories or their affiliates, and does not address unsound or predatory loans originated by state-chartered lenders. While some states have enacted strong anti-predatory lending protections, many have not.

Under the Home Ownership and Equity Protection Act of 1994 (HOEPA), the Fed has not only the statutory authority, but the obligation, to take much stronger action that would apply to all mortgage lenders. HOEPA states that the Federal Reserve "shall prohibit" mortgage loans that are "unfair, deceptive or designed to evade the provisions" of HOEPA, or that are associated with abusive lending practices, or that are otherwise not in the interest of the borrower.

To date, the Fed has failed to use its sweeping authority under HOEPA to curtail abusive subprime mortgage lending practices. In an effort to push the Fed to take stronger action, the Leadership Conference on Civil Rights (LCCR) urged the Senate Banking Committee in July to delay confirmation of several new appointees to the Fed's Board of Governors until the nominees promised to use their authority. The response, from both the Banking Committee and the nominees, was encouraging.

LCCR believes that Congress must step in to enact strong protections for subprime borrowers. A sensible legislative response would:

  • Establish a fiduciary duty for mortgage brokers and other non-bank mortgage originators;
  • Create a "good faith and fair dealing" standard for all originators;
  • Require originators to underwrite loans at the maximum possible payment for the first seven years of the mortgage;
  • Require mortgage originators to create escrow accounts to set aside anticipated property taxes and hazard insurance;
  • Prohibit the "steering" of borrowers into more expensive loans than their credit scores or other factors would warrant;
  • Hold lenders responsible for policing their associated appraisers and brokers; and
  • Prohibit originators from influencing the appraisal process.

Some of these measures were included in The Mortgage Reform and Anti-Predatory Lending Act of 2007 (H.R. 3915), a bill recently passed by the House. Because the bill did not contain adequate enforcement mechanisms, LCCR was unable to support it in its entirety, but it is possible that the Senate will enact a more effective bill.

Congress is also considering allowing troubled borrowers to restructure their debts in Chapter 13 bankruptcy proceedings. Currently, most other debts -- including second homes -- can be reworked in bankruptcy, but primary home mortgages cannot be included in this process. Changing the law would potentially allow hundreds of thousands of borrowers to keep their homes, benefiting borrowers and lenders alike. The lending industry, however, has strongly opposed such measures.

Congress, as well as President Bush, has also discussed increasing the number and size of mortgage loans that can be guaranteed by the Federal Housing Administration, or purchased by federally-backed corporations such as Fannie Mae and Freddie Mac. Congress has yet to take any action in this direction, however; and because any such remedy could be branded as a "bailout" by opponents, it may be reluctant to do so in the future.

The prospects for any legislation are uncertain at this point, but next year, according to several studies of the housing market, an even greater number of subprime mortgages are scheduled to reset at higher interest rates, possibly leading to an even greater number of foreclosures. This could increase the pressure on Congress and other policymakers to take more definitive action.

The Civil Rights Monitor is an annual publication that reports on civil rights issues pending before the three branches of government. The Monitor also provides a historical context within which to assess current civil rights issues. Previous issues of the Monitor are available online. Browse or search the archives

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