The Volokh Conspiracy - Congress Is Making It Harder to Obtain or Refinance a Mortgage.--

For years, Congress had been pushing lenders to lend vigorously in poor neighborhoods and to avoid redlining. This effort worked--only too well.

Now Congress has discovered "predatory lending."

Jack Guttenberg (on Yahoo and in the Washington Post) has been criticizing Congress's efforts (H.R. 3915 the Mortgage Reform and Anti-Predatory Lending Act of 2007) to impose new requirements on lenders and brokers who repackage loans:

The tangible net benefit rule applied to loans being refinanced would make lenders responsible for something over which they have little or no control.

Virtually all refinanced mortgages provide tangible benefits — otherwise borrowers wouldn't do them. . . .

The problem is that, in exchange for the benefit, the predator extracts a pound of flesh. That's why the proposed legislation requires a "net" benefit, meaning that the benefit outweighs the cost. Unfortunately, there is no way that a lender can determine this. Whether or not the benefit outweighs the cost in any particular case depends heavily on what is in the borrower's head.

This will become clear from looking at the four main reasons that borrowers refinance: to reduce costs, raise cash, reduce monthly payments, and reduce interest-rate risk.

The Tangible Net Benefit in a Cost-Reduction Refinance

A cost-reduction refinance is one in which the new interest rate or mortgage insurance premium is lower than the existing one. In most cases, however, the borrower incurs costs upfront. If there is to be a net benefit, therefore, the future savings must outweigh the upfront costs.

But future savings depend, among other things, on how long the borrower expects to have the mortgage. This critical piece of information, if it is anywhere, is in the borrower's head.

The Tangible Net Benefit in a Cash-Out Refinance

Some of the worst market abuses arise on "cash-out" refinances, where the motive is to raise cash. Suppose that in raising $5,000 this way, John Doe has to accept a 7 percent loan as replacement for his current 6 percent loan, and $5,000 in refinance costs that are tacked on to his loan balance. The tangible benefit of $5,000 in cash is clear, but is it a net benefit?

There is no objective way for the lender to answer the question. The price seems high, but maybe the borrower needs the $5,000 to pay for life-saving medicine for his children? Again, the answer is in the head of the borrower.

It could be argued that whether or not there is a net benefit also should depend on the borrower's options. If the borrower could raise the $5,000 elsewhere at a much lower cost, the finding should be that there is no net benefit. It is neither feasible nor fair, however, to make lenders responsible for assessing their customers' options.

The Tangible Net Benefit in a Payment-Reduction Refinance

Some borrowers are willing to pay a stiff price, in the form of wealth reduction in the future, in order to reduce their monthly payments now. Frequently this involves converting a fixed-rate loan into an adjustable loan carrying a lower rate, often with an interest-only option, for a limited period. Costs are usually tacked on to the balance.

Whether there is a net benefit depends in good part on how critical it is to the borrower to lower the payment. Perhaps the alternative to a payment reduction is default. Only the borrower knows.

The Tangible Net Benefit in a Risk-Reduction Refinance

When interest rates are expected to rise, as was the case during much of 2005, many holders of adjustable-rate mortgages consider converting them to fixed-rate mortgages. The borrowers making the switch are willing to pay a higher rate now in exchange for future rate certainty. On this issue, lenders are in no position to substitute their judgment for the borrower's.

In sum, regardless of why borrowers refinance, the question of whether they receive a net benefit from it is for borrowers alone to answer. Lenders do not have the information needed to second-guess them.

This act would create new opportunities for lawyers to sue lenders and mortgage brokers for making or repackaging loans. This should raise the cost of borrowing and further restrict lending by banks and brokers. With a drop in housing prices and the need of many borrowers to refinance, substantially raising the cost of money may well make things worse rather than better.

	[Jim Lindgren, December 12, 2007 at 8:45pm] Trackbacks Congress Is Making It Harder to Obtain or Refinance a Mortgage.-- For years, Congress had been pushing lenders to lend vigorously in poor neighborhoods and to avoid redlining. This effort worked--only too well. Now Congress has discovered "predatory lending." Jack Guttenberg (on Yahoo and in the Washington Post) has been criticizing Congress's efforts (H.R. 3915 the Mortgage Reform and Anti-Predatory Lending Act of 2007) to impose new requirements on lenders and brokers who repackage loans: The tangible net benefit rule applied to loans being refinanced would make lenders responsible for something over which they have little or no control. Virtually all refinanced mortgages provide tangible benefits — otherwise borrowers wouldn't do them. . . . The problem is that, in exchange for the benefit, the predator extracts a pound of flesh. That's why the proposed legislation requires a "net" benefit, meaning that the benefit outweighs the cost. Unfortunately, there is no way that a lender can determine this. Whether or not the benefit outweighs the cost in any particular case depends heavily on what is in the borrower's head. This will become clear from looking at the four main reasons that borrowers refinance: to reduce costs, raise cash, reduce monthly payments, and reduce interest-rate risk. The Tangible Net Benefit in a Cost-Reduction Refinance A cost-reduction refinance is one in which the new interest rate or mortgage insurance premium is lower than the existing one. In most cases, however, the borrower incurs costs upfront. If there is to be a net benefit, therefore, the future savings must outweigh the upfront costs. But future savings depend, among other things, on how long the borrower expects to have the mortgage. This critical piece of information, if it is anywhere, is in the borrower's head. The Tangible Net Benefit in a Cash-Out Refinance Some of the worst market abuses arise on "cash-out" refinances, where the motive is to raise cash. Suppose that in raising $5,000 this way, John Doe has to accept a 7 percent loan as replacement for his current 6 percent loan, and $5,000 in refinance costs that are tacked on to his loan balance. The tangible benefit of $5,000 in cash is clear, but is it a net benefit? There is no objective way for the lender to answer the question. The price seems high, but maybe the borrower needs the $5,000 to pay for life-saving medicine for his children? Again, the answer is in the head of the borrower. It could be argued that whether or not there is a net benefit also should depend on the borrower's options. If the borrower could raise the $5,000 elsewhere at a much lower cost, the finding should be that there is no net benefit. It is neither feasible nor fair, however, to make lenders responsible for assessing their customers' options. The Tangible Net Benefit in a Payment-Reduction Refinance Some borrowers are willing to pay a stiff price, in the form of wealth reduction in the future, in order to reduce their monthly payments now. Frequently this involves converting a fixed-rate loan into an adjustable loan carrying a lower rate, often with an interest-only option, for a limited period. Costs are usually tacked on to the balance. Whether there is a net benefit depends in good part on how critical it is to the borrower to lower the payment. Perhaps the alternative to a payment reduction is default. Only the borrower knows. The Tangible Net Benefit in a Risk-Reduction Refinance When interest rates are expected to rise, as was the case during much of 2005, many holders of adjustable-rate mortgages consider converting them to fixed-rate mortgages. The borrowers making the switch are willing to pay a higher rate now in exchange for future rate certainty. On this issue, lenders are in no position to substitute their judgment for the borrower's. In sum, regardless of why borrowers refinance, the question of whether they receive a net benefit from it is for borrowers alone to answer. Lenders do not have the information needed to second-guess them. This act would create new opportunities for lawyers to sue lenders and mortgage brokers for making or repackaging loans. This should raise the cost of borrowing and further restrict lending by banks and brokers. With a drop in housing prices and the need of many borrowers to refinance, substantially raising the cost of money may well make things worse rather than better.