Recent news reports indicate that over 8,000 homes are being foreclosed on in the United States every day. For many Americans, the American dream of home ownership has turned into a financial nightmare. The purpose of this article is to discuss the causes and risks of the subprime mortgage crisis and provide an overview of applicable consumer protection laws. If you are facing foreclosure, you have rights and possible remedies. We hope that you find this article to be both interesting and informative, and we invite you to contact us for further information.

The mortgage industry has evolved over the years.  Initially, Banks would generally lend money only to people who were well off. As the saying goes, the only people who qualified for a loan were the people who didn’t need a loan. During the turn of the century, (1900), entrepreneurs saw an opportunity arranged mortgages by matching people turned down by the banks with wealthy individuals with money to invest. As these private mortgages became more popular, these entrepreneurs became established as the first mortgage brokers. Overall, however, home loans were still very hard to get.  

The New Deal of the 1930s led to several federal statutes that changed real estate financing and national housing policy in the United States. These statutes were an attempt to broaden qualifications for home mortgages and increase home ownership. The statutes and programs included:

These federal programs created another player in the mortgage industry; the mortgage banker. Mortgage bankers were similar to mortgage brokers in that they arranged mortgages for people who could not qualify for a traditional bank loans. The big difference was that mortgage brokers arranged loans financed by wealthy individuals, whereas loans arranged by mortgage bankers were financed through government agencies.

 

By the 1980s, the mortgage industry had stabilized with well defined roles. Savings and Loans (S&Ls) handled conventional home mortgages; Banks handled commercial loans; mortgage bankers dealt with government agencies; and mortgage brokers dealt with everything else. During this period, there were no national home loan lenders; federal regulations required lenders to be domiciled in the same state as the borrower. Other regulations regulated the interest rate at which banks and S&Ls make loans and pay their depositors. Other general characteristics of personal home financing included:

The 1980s also brought inflation and extremely high interest rates. In October of 1980, the prime rate hit 21.5%. The government passed laws that deregulated the industry, hoping they would lower interest rates and make loans more available through lender competition. New legislation allowed banking subsidiaries to cross state lines.

By the end of the 1980s, deregulation had changed the face of the mortgage industry.  S&Ls tried to adapt by offering products in addition to conventional loans, and mortgage brokers took advantage of the new free-market climate by adding many innovative products, using the Savings and Loans as a source of financing. The mortgage industry had become a competitive market place.

The 1990s saw the collapse of the local Savings and Loan model and a move toward nationally regulated lending entities. The collapse left mortgage brokers without a source of financing.  In this new, deregulated, economy, mortgage brokers were getting financing for many of their loans through the S&Ls. Mortgage bankers saw a business opportunity. They started funding conventional loans for the mortgage brokers. They then sold these loans to Freddie Mac and Fannie Mae. These two government-sponsored-enterprises (GSE) became primary players in the secondary mortgage market. Still, Freddie Mac and Fannie Mae would only buy fully documented, prime loans.

With Freddie Mac and Fannie Mae loans the standards were very strict. They required verified income, verified bank account deposits, credit reports with all derogatory entries satisfactorily explained, and proper appraisal reports. Furthermore the borrower’s income to housing expense ratio generally had to be 25% or less; the income to all debt ratio could not usually exceed 33%.

Wall Street also saw an opportunity in the S&L collapse. Investor groups were formed by investment bankers to buy the assets and loan portfolios of the failed Savings and Loans. These investment bankers, with the backing of Wall Street, would now offer non-conventional and jumbo loans to borrowers.

Appraisers are an integral part of the underwriting process. The primary lender does not want a mortgage secured by a house that is worth less than the loan. However, with the industry becoming increasingly broker driven, this is exactly what is happening. The broker wants the loan to close and many times views a rigorous appraisal as an obstacle to closing. To close the loan, the broker or lender will sometimes put pressure on the appraiser to attach a particular value to the property. 

 

Brokers are not the only people who might put pressure on the appraiser. Secondary market lenders may also pressure the appraiser, knowing that the loan will soon be sold to someone else. In this case, the lender has little risk if the property eventually goes into foreclosure, since the mortgage has already been sold. 

Over-appraising one home can affect the values of the other homes in the neighborhood as well. For example, if one home is over-appraised by 10%, then that home can be used as a “comparable” in appraising the next home, which will then also be overvalued. This practice has lead to people refinancing their home for more than the real value of the property. This in turn results in investors holding mortgages that are backed by real estate that is worth less than they think.

The broker-driven, “close-at-all-costs” business model combined with an appraiser’s willingness to overvalue homes and the secondary lender’s willingness to sell off potentially bad loans placed the mortgage industry in a precarious position. Borrowers who were not in a strong financial condition were able to buy houses they could not afford with a loan they could not pay back. To make matters worse, this dangerous situation was obscured by investment bankers who used mark-to-market accounting, which they thought would turn these high-risk mortgages into safe, diversified securities.

 

Mark-to-market accounting allows the owner of the securities to assign a value to the security that is based on a market formula. This is not necessarily a real-world value. A problem occurs if an asset is overvalued and market value adjusts to reflect the real value. If the holder of an overvalued mortgage portfolio has used the portfolio as security to buy more assets on margin, there may be a margin call if the value of the portfolio drops. If the value goes down so much that the mortgage holder cannot pay back the margin loan, the mortgage holder loses everything.  This is what happened to Bear Stearns.

 

 

Many factors and people are to blame for the current mortgage crisis and it is impossible to place all the blame on one person or group of people. The mortgage meltdown is truly a “perfect storm.” Borrowers wanted the American Dream—to own a home. Some borrowers would lie about their income on income stated loans. Some brokers would change the income declaration on the applications before submission. Many brokers pressured appraisers to overvalue properties and many appraisers went along with this practice. Some lenders would overlook the fact that they were handling mortgages secured by overvalued property because they were planning to sell the mortgages to other lenders -- thus passing the risk on to another entity. In general, the safeguards previously in place, such as requiring a substantial down payment and full financial disclosures, were abandoned over time. “Teaser” loans and a variety of adjustable rate mortgages encouraged Americans to purchase a house with loans they might not really be able to afford when the interest rates went up. Everyone acted as if the believed that property values could only go up and interest rates would always be low!

 

 

Some new home developers have contributed to the crisis by using deceptive practices. If a developer had an inventory of houses to sell in a deteriorating market, it may offer to “buy down” the initial interest rate or arrange for other types of below market rate loans in order to induce customers to purchase a home. When those properties continue to go down in value, and when the loans re-set at new interest rates, the owner may be unable to either pay the new payment or refinance. This can lead to a foreclosure.

 

The U.S. Department of Housing and Urban Development (HUD) warns potential borrowers against predatory lenders. HUD’s list of what to look out for includes the following:

 

What are Some of the Tactics Used By Predatory Lenders? 

 

HUD also warns consumers to be on the lookout for the following tactics frequently used by predatory lenders:

If you have experienced any of the above practices, you should call an experienced consumer rights attorney who can protect your rights.

 

 

What is the Federal Truth in Lending Act? Does it Offer Consumer any Protection from Predatory Lenders? 

 

The Federal Truth in Lending Act (TILA) requires lenders to disclose certain provisions of their mortgages. These disclosures must be made in a clear and conspicuous manner. The provisions of the mortgage requiring disclosure include:

Many lenders and brokers failed to comply with TILA. Lenders especially failed to comply with the required disclosures of actual interest amounts and payments when selling adjustable rate mortgages (ARMs) to borrowers. To view the Federal Truth in Lending Act, click on the following link: http://www.fdic.gov/regulations/laws/rules/6500-200.html

 

Some consumers who have been hit by the subprime meltdown and are being buried by skyrocketing ARM payments may be able to sue these non-complying lenders over inaccurate TILA disclosures. In some instances, it may be possible to invalidate the loan in its entirety, a type of relief know as “rescission.” If the lender is found to have violated certain aspects of TILA, the borrower can have the mortgage contract rescinded.

 

 

Borrowers may also be protected by consumer protection acts enacted in their state of residence.

 

If you or a friend or family member is being victimized by a lender, broker, or developer who may not have complied with either federal or state laws you should contact an experienced attorney to protect your rights.