Point of View: Lending Abuses Threaten To Spark More Defaults
Mr. Eakes is the CEO of the Center for Responsible Lending, a consumer advocacy organization that has called for a "suitability standard" in mortgage lending. While many in the industry disagree with the Center's policy proposals, we thought Mr. Eakes' recent testimony before the Sen. Banking committee might provide some insight into the concerns that are circulating about subprime mortgage performance. The following is an excerpt from his written testimony.
I testify as CEO of Self-Help (www.self-help.org), which consists of a credit union and a non-profit loan fund. For the past 26 years, Self-Help has focused on creating ownership opportunities for low-wealth families, primarily through financing home loans. Self-Help has provided over $4.5 billion of financing to over 50,000 low-wealth families, small businesses and nonprofit organizations in North Carolina and across the country, with an annual loan loss rate of under one percent.
We are a subprime lender. In fact, we began making loans to people with less-than-perfect credit in 1985, when that was unusual in the industry. We believe that homeownership represents the best possible opportunity for families to build wealth and economic security, taking their first steps into the middle class.
I emphasize this point because expanding access to homeownership has been central to Self Help's mission and it would be counter to everything I believe to recommend any policies that would diminish beneficial credit to families seeking a better future.
I am also CEO of the Center for Responsible Lending (CRL) (www.responsiblelending.org), a not-for-profit, non-partisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices.
The subprime mortgage market today is a quiet but devastating disaster. The ultimate effects are very much like Hurricane Katrina, as millions of citizens lose their homes and the fabric of entire communities is threatened. The difference is that this disaster in the subprime market is occurring every single day across the country, house by house and neighborhood by neighborhood.
Our analysis of subprime mortgages made in recent years shows that 2.2 million families will lose their home to foreclosure-foreclosures that were, for the most part, predictable and entirely avoidable through more responsible lending practices. As housing appreciation slows down in many areas of the country, it is clear that the problem will only grow worse. All indications are that subprime mortgage loans are headed toward the worst rate of foreclosures in modern mortgage market history.
Why does a foreclosure epidemic in the subprime mortgage market matter?
First, subprime mortgages are no longer a niche market; they have become a significant share of all new mortgages made in America, now making up well over 20 percent of all home loans originated and currently representing $1.2 trillion of mortgages currently outstanding. Second, homeownership is the best and most accessible way most families have to acquire wealth and economic security. If home loans are actually setting citizens back rather than helping them build for the future, there are serious ramifications for local economies and the nation as a whole.
The problem is particularly serious for communities of color, since more than half of African-American and 40 percent of Latino families who get home loans receive them in the subprime market. If current trends continue, it is quite possible that subprime mortgages could cause the largest loss of African-American wealth in American history.
Under typical circumstances, foreclosures occur because a family experiences a job loss, divorce, illness or death. However, the epidemic of home losses in today's subprime market is well beyond the norm. Subprime lenders have virtually guaranteed rampant foreclosures by approving risky loans for families while knowing that these families will not be able to pay the loans back. There are several factors driving massive home losses:
* Risky products. Subprime lenders have flooded the market with high-risk loans, making them appealing to borrowers by marketing low monthly payments based on low introductory teaser rates. The biggest problem today is the proliferation of hybrid adjustable-rate mortgages ("ARMs," called 2/28s or 3/27s), which begin with a fixed interest rate for a short period, then convert to a much higher interest rate and continue to adjust every six months, quickly jumping to an unaffordable level.
* Loose underwriting. It is widely recognized today, even within the mortgage industry, that lenders have become too lax in qualifying applicants for subprime loans. Especially troubling is the practice of qualifying borrowers without any verification of income, not escrowing for property taxes and hazard insurance, and failing to account for how borrowers will be able to pay their loan once the payment adjusts after the teaser period expires.
* Broker abuses. Today's market includes perverse incentives for mortgage brokers to make high-risk loans to vulnerable borrowers. Brokers often claim that borrowers engage them for their knowledge and generally believe that brokers are looking for the best loan terms available. Yet brokers also claim they do not need to serve the borrower's best interests.
* Investor support. Much of the growth in subprime lending has been spurred by investors' appetite for high-risk mortgages that provide a high yield. The problem is that the investor market reaction occurs only after foreclosures are already rampant and families have lost their homes.
* Federal neglect. Policymakers have long recognized that federal law-the Home Ownership and Equity Protection Act of 1994 (HOEPA)-governing predatory lending is inadequate and outdated. Although the Federal Reserve Board (hereinafter, the "Board") has the authority to step in and strengthen relevant rules, they have steadfastly refused to act in spite of years of large-scale abuses in the market. For the majority of subprime mortgage providers, there are no consequences for making abusive or reckless home loans.
In the United States, the proportion of mortgages entering foreclosure has climbed steadily since 1980, with 847,000 new foreclosures filed in 2005. In 2006, lenders reported 318,000 new foreclosure filings for the third quarter alone, 43 percent higher than the third quarter of 2005. In the past 18 months, there have been frequent stories in the media about risky lending practices and surges in loan defaults, especially in the subprime market.
Foreclosure filings on subprime mortgages now account for over 60 percent of new conventional foreclosure filings reported in the MBA National
Delinquency Survey. This fact is striking given that only 23 percent of current originations are subprime, and subprime mortgages account for only 13 percent of all outstanding mortgages.
For most families, foreclosure is a last resort, often coming in the wake of unemployment, illness, divorce, or some other personal event that causes a drop in income. However, in recent years there has been a surge in subprime foreclosures that cannot be explained by a change in employment levels or other factors that typically drive foreclosures. Instead, as widely discussed in the press during recent months, the consequences of loose underwriting practices in the subprime market are now exacerbated by a general slow-down in housing appreciation. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com