Home Mortgages: Provisions in a 2007 Mortgage Reform Bill (H.R. 3915) Would Strengthen Borrower Protections, but Views on Their Long-term Impact Differ
Published: 2009-07-31T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: H.R. 3915 (2007), a bill introduced, but not enacted by the 110th Congress, was intended to reform mortgage lending practices to prevent a recurrence of problems in the mortgage market, particularly in the nonprime market segment. The bill would have set minimum standards for all mortgages (e.g., reasonable ability to repay) and created a "safe harbor" for loans that met certain requirements. Securitizers of safe harbor loans would be exempt from liability provisions, while securitizers of non-safe harbor loans would be subject to limited liability for loans that violated the bill's minimum standards. In response to a congressional request, this report discusses (1) the proportions of recent nonprime loans that likely would have met and not met the bill's safe harbor requirements and factors influencing the performance of these loans, and (2) relevant research and the views of mortgage industry stakeholders concerning the potential impact of key provisions of the bill on the availability of mortgage credit. To do this work, GAO analyzed a proprietary database of securitized nonprime loans, reviewed studies of state and local anti-predatory lending laws, and met with financial regulatory agencies and key mortgage industry stakeholders.
section_title: What GAO Found
paragraphs: GAO estimates that almost 75 percent of securitized nonprime mortgages originated from 2000 through 2007 would not have met H.R. 3915's safe harbor requirements, which include, among other things, full documentation of borrower income and assets, and a prohibition on mortgages for which the loan principal can increase over time. The extent to which mortgages met specific safe harbor requirements varied by origination year. For example, the percentage of nonprime mortgages with less than full documentation rose from 27 percent in 2000 to almost 60 percent in 2007. Consistent with the consumer protection purpose of the bill, GAO found that certain variables associated with the safe harbor requirements influenced the probability of a loan entering default (i.e., 90 or more days delinquent or in foreclosure) within 24 months of origination. For example, on the basis of statistical analysis, GAO estimates that, all other things being equal, less than full documentation was associated with a 5 percentage point increase in the likelihood of default for the most common type of nonprime mortgage product. GAO also found that other variables--such as house price appreciation, borrowers' credit scores, and the ratio of the loan amount to the house value--were associated with default rates. Research on state and local anti-predatory lending laws and the perspectives of mortgage industry stakeholders do not provide a consensus view on the bill's potential effects on the availability of mortgage credit. Some research indicates that anti-predatory lending laws can have the intended result of reducing loans with problematic features without substantially affecting credit availability. However, it is difficult to generalize these findings to all anti-predatory lending laws or the potential effect of the bill, in part, because of differences in the design and coverage of these laws. Mortgage industry and consumer group representatives with whom GAO spoke disagreed on the bill's potential effect on credit availability and consumer protection. For example, mortgage industry officials generally said that the bill's safe harbor, securitizer liability, and other provisions would limit mortgage options and increase the cost of credit for nonprime borrowers. In contrast, consumer groups generally stated that these provisions needed to be strengthened to protect consumers from predatory loan products.

section_title: Letter
paragraphs: The U.S. housing and mortgage markets are experiencing severe stress,  with over 3.2 million home mortgages 90 or more days delinquent or in the  foreclosure process in the first quarter of 2009. The rise in delinquencies  and foreclosures has been particularly acute in the nonprime segment of  the mortgage market. Nonprime mortgages, which include subprime and  Alt-A loans, grew dramatically in terms of dollar volume and share of the  mortgage market from 2001 through 2006. In 2001, lenders originated   $215 billion in nonprime loans, but by 2006, had increased originations to  $1 trillion. Likewise, the share of the nonprime market as a percentage of  the total mortgage market increased from around 10 percent in 2001 to  almost 34 percent in 2006. Further, investment banks increased the volume  of nonprime loans they bundled into private label mortgage-backed  securities (MBS) over this period. In 2001, they bundled 46 percent of  nonprime loans into private label MBS, but by 2006, were bundling 81  percent of these loans. The market for nonprime mortgages contracted  sharply in mid-2007, as the nation entered a credit crisis and has not  rebounded.
As we reported in October 2007, an easing of underwriting standards for  nonprime mortgages and wider use of certain loan features associated  with poorer loan performance contributed to increases in mortgage  delinquencies and foreclosures. These features included mortgages with  higher loan-to-value ratios (the amount of the loan divided by the value of  the home), adjustable interest rates, limited or no documentation of  borrower income or assets, and deferred payment of principal or interest.  In some cases, lenders engaged in predatory practices that resulted in  loans with onerous terms and conditions. Often, borrowers could not  repay these loans and found themselves facing foreclosure or bankruptcy.  Some of these predatory practices included providing the borrower with  misleading information, manipulating the borrower through aggressive  sales tactics, or taking unfair advantage of the borrower’s lack of  information about the loan terms and their consequences.
To prevent a recurrence of problems in the mortgage market, the House of  Representatives passed the Mortgage Reform and Anti-Predatory Lending  Act of 2007 (bill) on November 15, 2007 (H.R. 3915). The Senate did not  pass companion legislation by the end of the 110th Congress, so the bill  did not become law. The bill, among other things, would have set  minimum standards for mortgages requiring that consumers had a  “reasonable ability to repay” at the time the loan was made and that they  received a “net tangible benefit” from mortgage refinancings. One of the  key provisions of H.R. 3915 would have been the creation of a “safe  harbor” from potential liability for assignees and securitizers of mortgages  (i.e., entities that purchase or hold mortgages in the secondary market),  provided that the loans met certain requirements. Assignees would have  been subject to limited liability if they securitized loans that fell outside  the bill’s safe harbor. Language in the bill and the accompanying House  report suggests that the safe harbor and other provisions were intended to  strengthen consumer protections for nonprime mortgage products  associated with higher levels of default and foreclosure. Additionally,  congressional hearings and debate about the bill highlighted, among other  things, the challenge of designing safe harbor requirements that protect  consumers from nonprime mortgage products that put them at high risk of  default and foreclosure, while maintaining broad access to mortgage  credit.
Given the serious problems facing the mortgage market, particularly those  associated with nonprime mortgages, and congressional interest in  protecting consumers and ensuring credit availability, you asked us to  assess the potential impact of the bill were it to become law. Accordingly,  this report (1) assesses the proportion of recent nonprime loans that  would likely have met and not met the bill’s safe harbor requirements, and  how variables associated with those requirements affect loan  performance, and (2) discusses relevant research and the views of  mortgage industry stakeholders concerning the potential impact of key  provisions of the bill on the mortgage market. The scope of our analysis  was limited to nonprime mortgages.
To assess the proportions of recent nonprime loans that would likely have  met and not met H.R. 3915’s safe harbor requirements, we analyzed a  proprietary database of securitized nonprime loans from  LoanPerformance (LP). This database covered about 87 percent of the  subprime and 98 percent of the Alt-A securitized mortgage originations  from January 2001 through July 2007. Nonprime mortgages that were not  securitized (i.e., mortgages that lenders held in portfolio) may have  different characteristics and performance histories than those that were  securitized. In this report, we define subprime loans as mortgages in  subprime securitization pools and Alt-A loans as mortgages in Alt-A  securitization pools. Specifically, we analyzed loans in the LP database  originated from 2000 through 2007. For each year, we estimated the  proportion of mortgages with terms and underwriting characteristics that  were consistent with the safe harbor requirements and those that were not  consistent with such requirements. When the data did not allow us to  duplicate a specific safe harbor requirement, we developed reasonable  proxies. Additionally, incorporating data from the Census Bureau, we  examined the proportions of safe harbor and non-safe harbor loans within  different census tract and borrower groupings. Finally, to examine factors  that could explain the performance of nonprime loans, we developed a  statistical model to estimate the relationship between variables associated  with the safe harbor requirements and other variables and the probability  of loan default within 24 months of origination.
We assessed the reliability of the data by interviewing LP representatives  about the methods they use to collect and ensure the integrity of the  information. We also reviewed supporting documentation about the  database, including LP’s estimates of the database’s market coverage. In  addition, we conducted reasonableness checks on the data to identify any  missing, erroneous, or outlying figures. We found the data elements we  used to be sufficiently reliable.
To describe relevant research on the bill’s potential effects on the  nonprime mortgage market, we identified and reviewed empirical studies  on the effects of state and local anti-predatory lending laws on key  nonprime mortgage indicators. The indicators used in these studies  included mortgage originations and the cost of credit. We reviewed the  studies’ overall conclusions concerning the impact of the laws and  identified any limitations in the researchers’ methodologies. We also  interviewed selected authors to ensure that we interpreted their results  correctly. To obtain the views of mortgage industry participants and  stakeholders, we interviewed officials from organizations representing  mortgage lenders, mortgage brokers, securitizers, and consumer interests.  We also interviewed officials from a large mortgage lender and a major  investment bank involved in the securitization of mortgages. Finally, we  interviewed officials from the federal banking regulators, Department of  Housing and Urban Development (HUD), Federal Trade Commission  (FTC), and Securities and Exchange Commission (SEC).
We conducted this performance audit from March 2008 to July 2009, in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives. Appendix I explains our objectives, scope,  and methodology in greater detail.
subsections: section_title: Background
paragraphs: The primary mortgage market features a variety of loan products and  relies, in part, on the process of securitization to provide funds for  mortgage lending. Over the years, a number of federal and state laws and  regulations were implemented to protect mortgage borrowers. In 2007, the  bill was introduced to strengthen consumer protections and included  provisions that would have created a safe harbor for loans that met certain  requirements.
subsections: section_title: Mortgage Markets and Securitization
paragraphs: The primary mortgage market has several segments and offers a range of  loan products:    The prime market serves borrowers with strong credit histories and  provides the most attractive interest rates and mortgage terms.
The Alt-A market generally serves borrowers whose credit histories are  close to prime, but the loans often have one or more higher-risk features,  such as limited documentation of income or assets.
The subprime market generally serves borrowers with blemished credit  and features higher interest rates and fees than the prime market.
Finally, the government-insured or -guaranteed market primarily serves  borrowers who may have difficulty qualifying for prime mortgages but  features interest rates competitive with prime loans in return for payment  of insurance premiums or guarantee fees. HUD’s Federal Housing  Administration (FHA) and the Department of Veterans Affairs (VA)  operate the two main federal programs that insure or guarantee  mortgages.
Across all of these market segments, two types of loans are common:  fixed-rate mortgages, which have interest rates that do not change over the  life of the loans and adjustable-rate mortgages (ARM), which have interest  rates that change periodically based on changes in a specified index. Other  more unique loan products, referred to as nontraditional mortgage  products, grew in popularity over the last decade (see table 1). Hybrid  ARMs—which are fixed for a given period and then reset to an adjustable  rate—also became popular in recent years, especially in the subprime  market. In particular, a significant portion of subprime loans originated  from 2003 through 2006 were 2/28 or 3/27 hybrid ARMs—that is, they were  fixed for the first 2 or 3 years before resetting to often much higher  interest rates and correspondingly higher mortgage payments. Other  nontraditional mortgage products included interest-only or payment- option loans, which allowed borrowers to defer repayment of principal  and possibly part of the interest for the first few years of the loan.
A number of loan features also became more common over the past  decade. While these features potentially expanded access to mortgage  credit, they are often associated with higher default rates. These features  included the following:    Low and no-documentation loans. Originally intended for borrowers who  had difficulty documenting income, such as the self-employed, these loans  were made with little or no verification of a borrower’s income or assets.
High loan-to-value (LTV) ratios. As homebuyers made smaller down  payments, the ratio of loan amount to home value increased.
Prepayment penalties. Some loans contained built-in penalties for  repaying part or all of a loan in advance of the regular schedule.
Many loans were originated with a number of these features, a practice  known as risk layering.
The secondary mortgage market and the process of securitization play  important roles in providing liquidity for mortgage lending. Mortgage  lenders originate and then sell their loans to third parties, freeing up funds  to originate more loans. Securitization, in this context, is the bundling of  mortgage loans into investment products called residential MBS that are  bought and sold by investors. The secondary market consists of (1) Ginnie  Mae-guaranteed MBS, which are backed by cash flows from federally- insured or -guaranteed mortgages; (2) government-sponsored enterprise  (GSE) MBS, which are backed by mortgages that meet the criteria for  purchase by Fannie Mae and Freddie Mac; and (3) private label MBS,  which are backed by mortgages that do not conform to GSE purchase  requirements because they are too large or do not meet GSE underwriting  criteria.  Investment banks have traditionally bundled most subprime and  Alt-A loans into private label MBS, although since 2007, the market has  slowed dramatically.
section_title: Federal Mortgage Lending Laws
paragraphs: The Truth in Lending Act (TILA), which was enacted in 1968, and the  Home Ownership and Equity Protection Act of 1994 (HOEPA), which  amended TILA in 1994, are among the primary federal laws governing  mortgage lending. TILA was designed to provide consumers with  accurate information about the cost of credit. Among other things, TILA  requires lenders to disclose information about the terms of loans— including the amount financed, the finance charge, and the annual  percentage rate (APR)—that can help borrowers understand the overall  costs of their loans. Congress enacted HOEPA to amend TILA, in response  to concerns about predatory lending. HOEPA regulates and restricts the  terms and characteristics of certain kinds of high-cost mortgage loans that  exceed certain thresholds in their APRs or fees (often referred to as “rate  and fee triggers”). The Board of Governors of the Federal Reserve System  (Federal Reserve) implements TILA and HOEPA through Regulation Z,  which was amended in 2001 and 2008 with respect to high-cost lending. As  a result of the most recent rulemaking in 2008, Regulation Z will restrict  mortgage lending in the following ways, as of October 1, 2009:    Higher-priced loans: First-lien loans with APRs that equal or exceed an  index of average prime offer rates by 1.5 percentage points above an index  of average prime offer rates—a category meant to include virtually all  loans in the subprime market, but generally exclude loans in the prime  market—are called “higher-priced mortgage loans.” Creditors are  prohibited from making these loans without regard to the borrower’s  ability to repay from income and assets other than the home’s value, and  creditors must verify the income and assets they rely upon to determine a  borrower’s repayment ability. Also, prepayment penalties are prohibited  for these loans if the payment can change in the first 4 years of the loan;  for loans where the payment is fixed for at least the first 4 years,  prepayment penalties are limited to 2 years. In addition, creditors must  establish escrow accounts for this category of loans for property taxes and  homeowners’ insurance.
High-cost HOEPA loans: First-lien loans with APRs that exceed the yield  on Treasury securities of comparable maturity by more than 8 percentage  points or with total points and fees that exceed the greater of 8 percent of  the loan amount or $583, are called “high-cost HOEPA loans.” For these  loans, the law restricts prepayment penalties, prohibits balloon payments  (i.e., a large balance due at maturity of the loan term) for loans with terms  of less than 5 years, prohibits negative amortization, and contains certain  other restrictions on loan terms or payments.
General provisions: For all loans, regardless of whether they fall into one  of the above categories, Regulation Z includes a number of basic  disclosure requirements and prohibits certain activities considered to be  unfair, deceptive, misleading, abusive, or otherwise problematic, such as  coercing a real estate appraiser to misstate a home’s value, and abusive  collection practices by loan servicers.
Each federal banking regulator is charged with enforcing TILA and  HOEPA with respect to the depository institutions it regulates, and the  FTC has responsibility for enforcing the statutes for mortgage brokers and  most financial entities other than banks, thrifts, and federal credit  unions. The Federal Reserve has concurrent authority to enforce T and HOEPA for non-bank subsidiaries of bank holding companie s.
In addition to TILA and HOEPA, some other federal laws govern aspects of  mortgage lending. For example, the Real Estate Settlement Procedures Act  (RESPA), passed in 1974, seeks to protect consumers from unnecessarily  high charges in the settlement of residential mortgages by requiring  lenders to disclose details of the costs of settling a loan and by prohibiting  kickbacks (payments made in exchange for referring a settlement service)  and other costs. HUD has primary rule-writing authority and is responsible  for enforcing RESPA. HUD coordinates on RESPA issues, as it deems  appropriate, with federal banking regulators and other federal agencies,  such as the FTC and the Department of Justice. In addition, the federal  banking agencies, under section 8 of the Federal Deposit Insurance Act,  examine for and enforce compliance with RESPA’s requirements with  respect to the institutions they supervise. Finally, the Federal Deposit  Insurance Act and Federal Credit Union Act allow federal banking  regulators to use their supervisory and enforcement authorities to ensure  that an institution’s conduct with respect to consumer protection laws  does not affect its safety and soundness or that of an affiliated institution.
section_title: Banking Regulator Guidance
paragraphs: In conjunction with enforcing federal statutes, federal banking regulators  have issued guidance to their institutions—including federally-regulated  banks, thrifts, credit unions, holding companies and their subsidiaries— about nontraditional and subprime lending.
In September 2006, banking regulators issued final guidance clarifying  how institutions can offer nontraditional mortgage products in a safe and  sound manner, and in a way that clearly discloses the risks that borrowers  may assume. The guidance provides specific steps institutions should take  to help ensure that loan terms and underwriting standards are consistent  with prudent lending practices, including considering a borrower’s  repayment capacity; ensuring strong risk management standards,  including capital levels; and ensuring that consumers have sufficient  information to clearly understand loan terms and associated risks.
In June 2007, banking regulators issued a final statement on subprime  lending, in response to concerns about certain types of loans that could  result in payment shock to borrowers. The statement warned institutions  about risks associated with subprime loans with adjustable rates with low  initial payments, based on fixed introductory rates that expire after a short  period, limited or no documentation of income, prepayment penalties that  were very high or that extended beyond the initial fixed rate period, and  other product features likely to result in frequent refinancing to maintain  an affordable monthly payment.
section_title: State Mortgage Lending Laws
paragraphs: In response to concerns about the growth of predatory lending over the  past decade, many states have enacted laws to restrict the terms or  provisions of certain types of mortgage loans. According to the  Congressional Research Service, at least 30 states and the District of  Columbia had enacted a wide array of such laws, as of November 2008.  Many of these state laws are similar to HOEPA in that they regulate and  restrict the terms and characteristics of certain kinds of high-cost  mortgages exceeding certain interest rate or fee thresholds that require  enhanced protections. Like HOEPA, these laws often restrict certain loan  features that can, in certain cases, be abusive—such as prepayment  penalties, balloon payments, negative amortization, and loan flipping—and  many laws also require enhanced disclosures and credit counseling. While  some laws are only minimally different than HOEPA, others are more  comprehensive.
Significant debate has taken place as to the advantages and disadvantages  of state predatory lending laws. In several cases, regulators of federally  supervised financial institutions have determined that federal laws  preempt state predatory lending laws for the institutions they regulate. In  making these determinations, two regulators—the Office of the  Comptroller of the Currency (OCC) and Office of Thrift Supervision  (OTS)—have cited federal law that provides for uniform regulation of  federally chartered institutions and have noted the potential harm that  state predatory lending laws can do to legitimate lending. Many state  officials and consumer advocates are opposed to federal preemption of  state predatory lending laws. They maintain that federal laws related to  predatory lending are insufficient, and that preemption, therefore,  interferes with their ability to protect consumers in their states.
The first state predatory lending law, the North Carolina Anti-Predatory  Lending Law of 1999, has been the subject of particular attention by  researchers and policymakers. The law was more restrictive than HOEPA  was at the time. Among other things, it banned prepayment penalties on all  home loans with a principal amount of $150,000 or less, and prohibited  loan flipping (refinancings of consumer home loans that do not provide a  reasonable, net tangible benefit to the borrower). It included more  restrictions for a category of high-cost loans, which were defined to  include lower points and fee triggers than HOEPA, as well as a third  trigger that included any loan with a prepayment penalty that could be  collected more than 30 months after closing or that was greater than 2  percent of the amount paid.
section_title: H.R. 3915
paragraphs: The U.S. House of Representatives passed H.R. 3915—the Mortgage  Reform and Anti-Predatory Lending Act of 2007—on November 15, 2007,  in response to significant increases in mortgage defaults and foreclosures,  especially among subprime borrowers. Although the bill was passed by  the U.S. House of Representatives, it was not enacted into law before the  end of the 110th Congress. The bill would have reformed mortgage lending  by, among other things, setting minimum standards for residential  mortgage loans (see fig. 1). The two standards included:    Reasonable ability to repay. The bill would have created a “reasonable  ability to repay” standard by prohibiting a creditor from making a  residential mortgage loan without making a determination based on  verified and documented information that a consumer was likely to be  able to repay the loan, including all applicable taxes, insurance, and  assessments. Such a determination was to be based on the consumer’s  credit history, current and expected income, obligations, debt-service-to- income (DTI) ratio, employment status, and financial resources other than  any equity in the real property securing the loan. Additionally, the bill  would have required lenders making ARMs to qualify borrowers at the  fully indexed rate. However, the actual standard was to be prescribed in  regulation by the federal banking agencies, in consultation with the FTC.
Net tangible benefit. The bill would have created a “net tangible benefit”  standard by prohibiting a creditor from refinancing a loan without making  a reasonable good faith determination that the loan would provide a net  tangible benefit to the consumer. The bill stated that a loan would not  meet the standard if the loan’s costs exceeded the amount of newly  advanced principal, without any corresponding changes in the terms of the  refinanced loan that were advantageous to the consumer. However, the  term “net tangible benefit” was to be defined in regulation by the federal  banking agencies.
The specific responsibilities of lenders to meet the standards, and the  rights of consumers to take action against lenders to claim standards had  not been met, depended on the category of the loan. Under the bill, loans  are classified into three basic categories:    Qualified mortgages would have had relatively low APRs, be insured by  FHA, or made or guaranteed by VA. This category was intended to include  most prime loans. Specifically, a loan would have been considered a  qualified loan if either the APR was less than 3 percent above the yield on  comparable Treasury securities, or less than 1.75 percent above the most  recent conventional mortgage rate (a term that would have been more  explicitly defined in regulation). For second-lien loans, the limits were 5  and 3.75 percent, respectively. Qualified mortgages would have been  presumed under the law to meet the “ability to repay” and “net tangible  benefit” standards, and for these loans, the creditor’s presumption could  not be rebutted by borrowers.
Qualified safe harbor mortgages would have fallen outside of the  definition of qualified mortgages (i.e., would not have met this standard),  but would have met certain underwriting requirements. This category was  intended to include subprime loans that did not contain certain high-risk  features. Specifically, these mortgages were required to (1) have full  documentation, (2) be underwritten to the fully indexed rate, (3) not  negatively amortize, and (4) have a fixed rate for at least 5 years, have a  variable rate with an APR less than 3 percentage points over a generally  accepted interest rate index, or meet a DTI ratio to be established in  regulation. Qualified safe harbor mortgages, like qualified mortgages,  would have been presumed under the law to meet the “ability to repay”  and “net tangible benefit” standards. Unlike borrowers with qualified  mortgages, however, borrowers with these mortgages would have had the  right to challenge a creditor’s presumption that these loans met the “ability  to repay” and “net tangible benefit” standards.
Nonqualified mortgages would have fallen outside of the two definitions  above (i.e., would not have met either standard). This category was  intended to include subprime loans with high-risk features. For these  loans, the law would have required lenders to meet the reasonable ability  to repay and net tangible benefit standards, as well as provide borrowers  with the ability to challenge such determinations by creditors and  assignees.
As shown in figure 1, the bill would also have imposed restrictions on  specific loan terms, depending on the loan category. First, the bill would  have prohibited prepayment penalties for loans that were not qualified  mortgages and would have required the penalties on all qualified  mortgages with an adjustable interest rate to expire 3 months before the  initial interest rate adjustment. Second, negative amortization loans to  first-time borrowers would have been prohibited, unless the creditor made  certain disclosures to the consumer and the consumer had received  homeownership counseling from a HUD-certified organization or  counselor. Finally, single-premium credit insurance and mandatory  arbitration on mortgage loans would have been prohibited for all loans.
The bill would have established additional liability for creditors of  qualified safe harbor and nonqualified mortgages (see fig. 1). In addition,  it would have established limited liability for assignees of nonqualified  mortgages. Borrowers would have been able to bring civil actions against  creditors or assignees if loans violated the “reasonable ability to repay” or  “net tangible benefit” standards. Creditors would have been liable for the  rescission of a loan and the borrower’s cost associated with the rescission  unless they could make the loan conform to minimum standards within 90  days. In addition, assignees would have been liable for the rescission (i.e.,  cancellation) of a loan and for borrower costs associated with the  rescission unless the loan could be made to conform to the minimum  standards within 90 days, or unless the assignee (1) had a policy against  buying loans that were not qualified loans or qualified safe harbor loans,  (2) exercised reasonable due diligence, as defined in regulation by the  federal banking agencies and the SEC, and (3) had agreements with the  seller or assignees of loans requiring that certain standards be met and  certain steps be taken. The bill included additional provisions to resolve  situations in which the parties could not agree on loan changes and set  certain time frames for addressing challenges to these changes. Liability  would not have been extended to pools of loans, including the  securitization vehicles, or investors in pools of loans. According to the  House Committee Report on the bill, it was not intended to apply to  trustees or titleholders who held loans solely for the benefit of the  securitization vehicle.
The bill would also have expanded the definition of “high-cost” loans  under HOEPA. Specifically, the bill would have included home purchase  loans in the definition, reduced the points and fees trigger from 8 to 5  percent—the APR trigger would stay at 8—and expanded the definition of  points and fees for high-cost mortgages. The bill would have also added a  third high-cost trigger for loans with prepayment penalties that applied for  more than 3 years or exceeded 2 percent of the prepaid amount. Further,  the bill would have enhanced existing HOEPA restrictions on lending  without repayment ability by presuming that creditors engaged in a  pattern or practice of making high-cost mortgages without verifying or  documenting consumers’ repayment ability were violating HOEPA.  Finally, the bill would have established a federal duty of care for mortgage  originators; prohibited steering of consumers eligible for qualified  mortgages to nonqualified mortgages; established a licensing and  registration regime for loan originators; established an Office of Housing  Counseling within HUD and imposed additional counseling requirements;  made changes to mortgage servicing and appraisal requirements; and  provided protections for renters in foreclosed properties.
section_title: Most Recent Nonprime Mortgages Would Not Have Been Safe Harbor Loans and Certain Variables Associated with the Safe Harbor Requirements and Other Factors Influenced Defaults
paragraphs: We estimate that almost three-quarters of securitized nonprime mortgages  originated from 2000 through 2007 would not have been safe harbor loans.  The extent to which mortgages would have met the individual safe harbor  requirements varied substantially by origination year, reflecting changes in  market conditions and lending practices over the 8-year period. We also  found that the proportions of safe harbor and non-safe harbor loans varied  across different census tract and borrower groupings. Our statistical  analysis of loan data shows that certain variables associated with the safe  harbor requirements—documentation of borrower income and assets, in  particular—were associated with the probability of a loan default. We  found that other variables, such as house price appreciation and borrower  credit score, were also associated with default rates.
subsections: section_title: Most Recent Nonprime Loans Would Not Have Met the Bill’s Safe Harbor Requirements
paragraphs: To illustrate the potential significance of the safe harbor requirements  under different lending environments and market conditions, we applied  those requirements to nonprime mortgages originated from 2000 through  2007 and calculated the proportions of loans that likely would and would  not have met the requirements. Because of data limitations and  uncertainty about how federal regulators would have interpreted some of  the safe harbor requirements, our analysis includes a number of  assumptions discussed in this section. (See appendix I for details about  our methodology.)
We estimate that almost 75 percent of nonprime mortgages originated  from 2000 through 2007 would not have met the bill’s safe harbor  requirements. More specifically, the estimated proportion of non-safe  harbor loans ranged from a low of 58 percent for 2001 to a high of 84  percent for 2006 (see fig. 2). The non-safe harbor loans were primarily  ARMs, while the safe harbor loans were largely fixed-rate mortgages. For  all 8 years combined, Alt-A mortgages represented about 37 percent of  non-safe harbor loans, or slightly more than the Alt-A share of the  nonprime market over this period (35 percent). Over this same period,  subprime mortgages comprised about 63 percent of non-safe harbor loans,  or slightly less that their 65 percent share of the nonprime market.
The significance of particular safe harbor requirements varied by  origination year. As previously noted, the safe harbor requirements include  the following:    Documentation and amortization. The mortgage would have to be  underwritten based on full documentation of the borrower’s income and  assets and could not have a negative amortization feature.
Interest rate and debt burden. The mortgage would be required to have  either (1) a fixed interest rate for at least 5 years, (2) a DTI ratio within a  level to be specified in regulation (we used the 41 percent ratio that serves  as a guideline in underwriting FHA-insured mortgages), or (3) an ARM  with an APR of less than 3 percentage points over a generally accepted  interest rate index. Because the loan data we used did not include APRs,  we instead compared the initial interest rate on each loan to the relevant  interest rate index.
Fully indexed rate. The mortgage would have to be underwritten to the  fully indexed interest rate (which the bill defines as the initial interest rate  index, plus the lender’s margin). We could not determine from the data we  used whether a mortgage was underwritten to the fully indexed rate. We  created a proxy by assuming that the mortgage satisfied this requirement if  the fully indexed rate was 1 percentage point or less over the initial  interest rate, indicating a reasonable likelihood that the borrower could  have qualified for a loan underwritten to the fully indexed rate.
As shown in figure 3, there was an increasing trend in the proportion of  nonprime loans originated from 2000 through 2007 that would not have  met the safe harbor documentation and amortization requirements. More  specifically, the estimated percentages of nonprime loans without full  documentation ranged from a low of 27 percent in 2000 to a high of almost  60 percent in 2007. Also, from 2004 through 2007, the proportion of  nonprime loans with a negative amortization feature increased steadily.  The growth in these percentages reflects the increased use of low- documentation mortgages in both the subprime and Alt-A markets and  mortgages with negative amortization features (e.g., payment-option  ARMs) in the Alt-A market. In both cases, these products were originally  intended for a narrow population of borrowers but, ultimately, became  more widespread. For example, as we reported in 2006, payment-option  ARMs were once specialized products for financially sophisticated  borrowers who wanted to minimize mortgage payments to invest funds  elsewhere or borrowers with irregular earnings who could take advantage  of minimum monthly payments during periods of lower income and could  pay down principal when they received an increase in income. However,  according to federal banking regulators and a range of industry  participants, as home prices increased rapidly in some areas of the  country, lenders began marketing payment-option ARMs as affordability  products and made them available to less creditworthy and lower income  borrowers.  borrowers.
Substantial proportions of the nonprime loans made over the 8-year period  we examined also did not meet the safe harbor interest rate and debt  burden requirements, although the proportions varied by year:    The proportion of nonprime originations that did not have a fixed interest  rate for at least 5 years rose from 52 percent in 2000 to 64 percent in 2004  (see fig. 4). This increase can be attributed primarily to a shift in the Alt-A  market away from fixed-rate mortgage products to adjustable-rate  products. For example, in 2000 about 88 percent of Alt-A loans were fixed  rate, but by 2004 this figure had dropped to about 38 percent. Beginning in  2005, the percentage of nonprime originations with adjustable rates began  falling, reaching 37 percent in 2007. The decline was due in large part to a  trend in the Alt-A market toward fixed-rate mortgages.
As figure 4 also shows, the proportion of nonprime originations that did  not have a DTI ratio under 41 percent grew over the 8-year period, rising  from 43 percent in 2000 to 51 percent in 2006, although it fell slightly in  2007. The generally increasing trend is partly a result of house prices  growing faster than borrowers’ incomes over the period and of lenders  allowing borrowers to take out larger mortgages relative to their incomes.  For example, from 2000 through 2006, average home prices grew by 38  percent nationally, while over the same period, average incomes grew by  just 23 percent.
Finally, the proportion of nonprime ARM originations with initial interest  rates not less than 3 percentage points over a generally accepted interest  rate index (3 percent test) ranged from a high of 96 percent in 2002 to a  low of 48 percent in 2007 (see fig. 4). The changing proportions over time  were largely due to movements in the interest rate indexes used to set  ARM interest rates that affected the size of the gap between the initial  rates and the index values. For example, when the 2-year Treasury  constant maturity rate (a common interest rate index) dropped from 2000  through 2002, the proportion of nonprime ARMs that did not meet the 3  percent test rose. But when the 2-year Treasury rate rose from 2004  through 2006, the proportion declined sharply.
The bill’s interest rate and debt burden requirements for safe harbor  mortgages were structured so that a loan would only have to meet one of  the three requirements. As a result, some loans could have met one of the  requirements, but not one or both of the other requirements and still could  have qualified as safe harbor loans. To illustrate, of the safe harbor loans  that met the bill’s safe harbor requirements by having a fixed interest rate  for 5 or more years, almost one-half would not have met the DTI ratio  requirement, assuming the 41 percent ratio we used for our analysis. Some  of the banking regulators we interviewed said that the DTI ratio was an  important factor in assessing a borrower’s ability to repay a mortgage loan.  They said that all borrowers should be required to meet some DTI ratio in  order for their loans to be eligible for the bill’s safe harbor. Consistent  with this view, H.R. 1728, which was passed by the House earlier this year,  requires borrowers of safe harbor loans to meet a DTI ratio to be  established by regulation.
Over the 8-year period we examined, about 38 percent of the nonprime  loans originated would not have met the safe harbor fully indexed rate  requirement, although the proportions varied by year (see fig. 5). As  previously noted, we assumed that if the fully indexed rate—that is, the  index rate at origination plus the lender’s margin—was more than 1  percentage point above the initial interest rate, the mortgage did not meet  the requirement. The variation by year largely reflected changes in the  index used to determine the fully indexed rate. More specifically, during  years in which a commonly used index such as the 6-month LIBOR was  relatively high (e.g., 2000 and 2005 through 2006), a larger proportion of  the nonprime loans would not have met the requirement because the fully  indexed rate would have been well above the initial interest rate of the  loan. In contrast, during years in which the index was low (e.g., 2001  through 2004), a greater proportion of loans would have met the  requirement because the fully indexed rate would have been close to the  initial rate. For example, in 2000, when the average 6-month LIBOR was  6.7 percent, the proportion of nonprime loans that did not meet the fully  indexed rate requirement was 47 percent. In 2003, when the average 6- month LIBOR was 1.2 percent, the proportion was 9 percent. A potential  shortcoming of this requirement is that many ARMs could meet this  requirement when interest rates were low, but the mortgages could  become unaffordable if interest rates were to rise and the borrower’s  payments adjusted upward to reflect the higher rates. However, it may be  difficult to design a more stringent fully indexed rate requirement to  provide protection during low interest rate environments without possibly  reducing the availability of ARMs during high interest rate environments.
section_title: The Proportions of Safe Harbor and Non-Safe Harbor Loans Differed across Zip Code and Borrower Groupings
paragraphs: Prior research has indicated that nonprime lending occurred  disproportionately in areas with higher proportions of minority, low- income, and credit-impaired residents. Therefore, in contemplating the  potential impact of the Bill, one consideration is the extent to which  nonprime mortgages made to these groups of borrowers would have fallen  inside or outside of the safe harbor. For groups with higher proportions of  non-safe harbor mortgages, the Bill’s impact on the availability of these  loans and consumer protections for them may be particularly important.
Accordingly, we examined the estimated proportions of safe harbor and  non-safe harbor loans within various zip code and borrower groupings.
Specifically, we looked at zip codes grouped by race, ethnicity, and  income characteristics, as well as borrowers grouped by credit score.  Our analysis of safe harbor and non-safe harbor loans by race and  ethnicity groupings found that zip codes with higher percentages of  households that Census identified as black or African-American had lower percentages of non-safe harbor loans than the nonprime borrower  population as a whole. For example, in zip codes where black or African- American households made up 75 percent or more of the household  population, the proportion of non-safe harbor loans was 68 percent,  compared with 75 percent for all nonprime borrowers (see table 2). In  contrast, in zip codes with higher percentages of households that Censusidentified as Hispanic or Latino, the percentages of non-safe harbor loanswere higher than for nonprime borrowers as a whole. For example, in zip  codes where Hispanic or Latino households comprised 75 percent or mor of the household population, the percentage of non-safe harbor loans was 80 percent, or 5 percentage points higher than for all nonprime  borrowers. of non-safe harbor loans for each grouping was essentially the sam that for the entire nonprime borrower population.
section_title: Some of the Safe Harbor Requirements and Other Factors Were Associated with the Likelihood of Default
paragraphs: Prior research has shown that a number of different loan, borrower, and  economic variables influence the performance of a loan. To see if the bill’s  provisions appear to fulfill their consumer protection purpose, we  developed a statistical model, based on the data available to us, to  examine the relationship between safe harbor requirements, as well as a  subset of other variables known to affect performance, and the probability  of a loan defaulting within the first 24 months of origination. We defined  a loan as being in default if it was delinquent by at least 90 days, in the  foreclosure process (including loans identified as in real-estate-owned  status), paid off after being 90 days delinquent or in foreclosure, or had  already terminated with evidence of a loss.
We focused on 24-month performance because a large proportion of  nonprime borrowers—particularly those with hybrid ARMs—prepaid their  loans (e.g., by refinancing) within 2 years. Using a 24-month time frame  allowed us to include these loans in our model. The variables we used in  the model included variables based on the individual safe harbor  requirements, house price appreciation, borrower credit scores, and LTV  ratios. We developed the model using data on nonprime mortgages  originated from 2000 through 2006 (the latest year for which we could  examine 24-month performance). We produced separate estimates for four  types of loan products: (1) short-term hybrid ARMs (i.e., 2/28 or 3/27  mortgages), which accounted for 54 percent of the loans originated during  this period; (2) longer-term ARMs (i.e., ARMs with interest rates that were  fixed for 5, 7, or 10 years before adjusting), which accounted for 10  percent of originations; (3) payment-option ARMs, which represented 6  percent of originations and (4) fixed-rate mortgages, which represented 30  percent of originations. Appendix II provides additional information  about our model and estimation results.
Consistent with the consumer protection purpose of the bill’s provisions,  we found that two safe harbor variables were associated with the  probability of default. Across all product types, the safe harbor variable  with the largest estimated influence on default probability was  documentation of borrower income and assets. For example, less than full  documentation was associated with a 5.5 percentage point increase in the  estimated probability of default for short-term hybrid ARMs used for home  purchases, all other things being equal (see table 4). The corresponding  increases in estimated default probabilities for longer-term ARMs,  payment-option ARMs, and fixed-rate mortgages were 4.8 percent, 2.0  percent, and 4.6 percent, respectively. The higher default probabilities  associated with no- and low-documentation loans may reflect use of this  feature to overstate the financial resources of some borrowers and qualify  them for larger, potentially unaffordable loans. Our results are generally  consistent with prior research showing an association between a lack of  documentation and higher default probabilities.
A second safe harbor variable that had a significant influence on default  probability was the variable representing the difference between the loan’s  initial interest rate and the relevant interest rate index (the spread). As  previously noted, ARMs with a difference of 3 percentage points or more  over a generally accepted interest rate index would not meet one of the  bill’s safe harbor interest rate and debt burden requirements. To examine  the effect of this variable for each product type, we estimated the default  probability assuming the spread was near the 25th percentile (base  assumption) for that product and compared this with the estimated default  probability assuming the spread was near the 75th percentile (alternative  assumption) for that product. We estimated that for short-term hybrid  ARMs used for home purchases, moving from the lower spread to the  higher one was associated with a 4.0 percentage point increase in default  probability, all other things remaining equal (see table 5). The  corresponding increases in estimated default probabilities for longer-term  ARMs and fixed-rate mortgages were 1.8 percent and 2.6 percent,  respectively. These results were generally consistent with other economic  research showing a positive relationship between higher interest rates and  default probabilities for nonprime mortgages. This relationship may   reflect the higher monthly payments associated with higher interest rates  and difficulties borrowers may face in making these payments, particularly  during times of economic hardship.
We also estimated the effect of the DTI ratio at origination and found that  for all product types, this variable did not have a strong influence on the  probability of default within 24 months. This relatively weak association  may be due, in part, to changes in borrower income or indebtedness after  loan origination. For example, a mortgage that is affordable to the  borrower at origination may become less so if the borrower experiences a  decline in income or takes on additional nonmortgage debt.
Finally, we estimated the effect of the proxy variable we developed for the  safe harbor requirement that loans be underwritten to the fully indexed  rate. As previously noted, if the fully indexed rate was 1 percentage point  or less over the initial interest rate, we assumed the loan met this  requirement. For all product types, we found that this variable did not  have a strong influence on the probability of default within 24 months (see  app. II). It is possible that other model specifications—such as examining  default probabilities beyond 24 months—would have yielded different  results. For example, the difference between the initial interest rate and  the fully indexed rate might have been more significant using such an  alternative specification because the initial interest rates for many short- term hybrid ARMs begin adjusting upward after 24 months.
In examining the influence of safe harbor variables on the probability of  default within 24 months, we controlled for other variables not associated  with the safe harbor requirements, such as house price appreciation,  borrower credit score, and the LTV ratio. Because these variables have  been shown to influence default probabilities, it was important to control  for their effects in order to properly analyze the implications of the safe  harbor provisions. Consistent with other economic research, we found  that house price appreciation, borrower credit score, and the LTV ratio  were strongly associated with default probabilities. The estimated  influence of these variables on default probabilities for each product type  were as follows:    House price appreciation. We found that lower rates of house price  appreciation were associated with a higher likelihood of default. For each  product type, we estimated the default probability assuming house price  appreciation near the 75th percentile for that product (base assumption)  and compared this with the estimated default probability assuming house  price appreciation near the 25th percentile for that product (alternative  assumption). For short-term hybrid ARMs used for home purchases,  moving from the higher rate of appreciation to the lower rate was  associated with a 13.5 percentage point increase in estimated default  probability (see fig. 6). The corresponding figures for longer-term ARMs,  payment-option ARMs, and fixed-rate mortgages were 3.7 percent, 1.3  percent, and 3.5 percent, respectively.
Borrower credit score. We found that lower credit scores were associated  with a higher likelihood of default. For each product type, we estimated  the default probability assuming a borrower credit score close to the 75th  percentile for that product (base assumption) and compared this with the  estimated default probability assuming a borrower credit score close to  the 25th percentile for that product (alternative assumption). For short- term hybrid ARMs used for home purchases, moving from the higher  credit score to the lower one was associated with a 7.3 percentage point  increase in the estimated default probability (see fig. 6). For longer-term  ARMs, payment-option ARMs, and fixed-rate mortgages, the  corresponding figures were 3.3 percent, 2.1 percent, and 5.5 percent,  respectively.
LTV ratio. We found that higher LTV ratios were associated with higher  probabilities of default. For each product type, we estimated the default  probability assuming a LTV ratio close to the 25th percentile for that  product (base assumption) and compared this with the estimated default  probability assuming a LTV ratio close to the 75th percentile for that  product (alternative assumption). For short-term hybrid ARMs used for  home purchases, moving from the lower ratio to the higher ratio was  associated with a 4.4 percentage point increase in the estimated default   probability (see fig. 6). The corresponding figures for longer-term ARMs,  payment-option ARMs, and fixed-rate mortgages were 4.7 percent, 6.3  percent, and 3.7 percent, respectively.
section_title: Relevant Research and Stakeholder Perspectives Do Not Provide a Consensus View on the Bill’s Potential Impact
paragraphs: While some research indicates that anti-predatory lending laws can reduce  originations of problematic loans without overly restricting credit,  research on state and local anti-predatory lending laws and the views of  mortgage industry stakeholders do not provide a consensus view on the  potential effects of the bill. The state and local anti-predatory lending laws  we reviewed are, in some ways, similar to the bill, but the results of the  research on these laws may have limited applicability to the bill for a  number of reasons. Mortgage industry and consumer group  representatives we interviewed disagreed on the bill’s potential effect on  credit availability and consumer protections. For example, mortgage  industry representatives said that the safe harbor and assignee liability  provisions were too stringent and would restrict and raise the cost of  mortgage credit. In contrast, consumer group representatives indicated  that the provisions were not strong enough to prevent predatory lending  and, thereby, protect borrowers.
subsections: section_title: Research Shows That State and Local Laws Can Affect Mortgage Lending, but the Findings Are Difficult to Apply to the Bill
paragraphs: Several studies have examined the impact of state and local anti-predatory  lending laws on subprime mortgage markets. Our review of eight such  studies found evidence that anti-predatory lending laws can have the  intended effect of reducing loans with problematic features without  substantially affecting credit availability, but also that it is difficult to  generalize these findings to all anti-predatory lending laws or to the  potential effect of the bill. The studies we reviewed fell into two broad  categories: those that focused solely on the North Carolina law and those  that examined laws in multiple states and localities. In general, the  researchers measured the effect of the laws in terms of the volume of  subprime originations, the probability of originating a subprime loan, or  the probability of originating a loan with predatory characteristics.
The three studies on the North Carolina law (which was implemented in  phases beginning in October 1999 and ending in July 2000) concluded that  the law had a dampening effect on subprime originations in that state, but  one found that the drop occurred primarily in the types of loans targeted  by the law. For example, using data from nine subprime lenders and  controlling for a number of demographic and housing market variables,  Elliehausen and Staten estimated that subprime originations fell by 14  percent after the law was first implemented. A second study by Quercia,  Stegman, and Davis that used an LP data set with broader coverage and  used neighboring states as a control group, found that subprime  originations declined 3 percent after the law was fully implemented and  that subprime originations in four neighboring states without similar laws  rose over the same period. Importantly, the authors also determined that  90 percent of the decline in subprime originations resulted from a  decrease in refinance loans with one or more “predatory” characteristics,  such as prepayment penalties lasting 3 years or more, balloon payments,  or LTV ratios over 110 percent. Finally, a study by Burnett, Finkel and  Kaul, which used Home Mortgage Disclosure Act (HMDA) data and also  used neighboring states as a control group, found a 0.2 percent increase in  subprime originations in North Carolina after implementation of the law.  Like the Quercia study, the study by Burnett and others concluded that  subprime refinance loans fell sharply in North Carolina over the period  examined and that states neighboring North Carolina experienced higher  percentage increases in total subprime originations. Additionally, the  study noted that the volume of subprime originations in North Carolina fell  in census tracts that were more than 50 percent minority but rose in other  areas.
The five studies that examined multiple state and local anti-predatory  lending laws found mixed results but provide insights into the importance  of the specific attributes of the laws. For example, using HMDA data, Ho  and Pennington-Cross calculated the percentage change in subprime  originations in 10 states with anti-predatory lending laws over periods that  captured each state’s experience before and after the laws were passed.
They compared the changes they found with the corresponding changes  during the same periods in a control group of neighboring states without  such laws. They found that in 5 of the 10 states (including North Carolina)  with anti-predatory lending laws, subprime originations increased less  than in the control group, but that in the other 5 states, subprime  originations increased more. In another study, Ho and Pennington-Cross  developed a legal index to measure the coverage and restrictions of anti- predatory lending laws, and examined how laws in 25 states and 3  localities affected the probability of originating a subprime loan. They  found that, controlling for other factors, anti-predatory lending laws can  increase, decrease, or have no effect on the flow of mortgage credit.  Specifically, they found that:  laws with broader coverage (i.e., those affecting a larger portion of the  market) increased the estimated likelihood of subprime originations; those with greater restrictions (i.e., those with stricter limits on high-risk  loan features) decreased the estimated likelihood of subprime  originations; and in some instances, these two effects appeared to cancel each other out.
As a result, they noted that the design of the law can have an important  impact on the availability of credit in the subprime market. For example,  the authors hypothesized that the effect of broader coverage may result  from borrowers being more comfortable applying for a mortgage where  there is a law to protect them from predatory loans.
A study by Bostic and others built on this research by refining the legal  index previously discussed, adding an enforcement dimension to the  index, and examining a larger set of laws. The study confirmed the earlier  findings regarding the impact of the coverage and restriction provisions of  anti-predatory lending laws on the subprime market. Additionally, this  study found that the strength of a law’s enforcement provisions (e.g., the  extent of potential liability for assignees) was not associated with changes  in the estimated likelihood of subprime originations.
Li and Ernst examined anti-predatory lending laws in 33 states and used  LP data on subprime mortgages made from January 1998 through March  2005 to examine the impact of these laws on the origination of loans with  predatory features and the cost of subprime credit. They concluded that  state anti-predatory lending laws that provided greater consumer  protections than HOEPA had the intended effect of reducing subprime  mortgages with predatory features. They also concluded that such laws  did not lead to any systematic increase in costs to consumers. Pennington- Cross and Ho also examined the impact of predatory lending laws on the  cost of subprime credit by reviewing anti-predatory lending laws in 24  states and analyzing HMDA and LP data from 1998 through 2005. They  concluded that these laws resulted in, at most, a modest increase to  consumers’ cost of borrowing.
Although the bill is, in some ways, similar to the state and local laws  analyzed in these studies, the results of these studies may have limited  applicability to it, for a number of reasons. First, the legal indexes used by  some researchers to assess the impact of state and local laws are based on  an older set of laws that are similar to HOEPA. According to one of these  researchers, the indexes do not take into account a newer generation of  laws that, like the bill, have different thresholds and restrictions and cover  products that were previously not common in the marketplace (e.g., low-  and no-documentation loans). As a result, evaluating the bill, using these  analytical tools, could be problematic. Additionally, the impact of a federal  law could be different than the effects of state and local laws. For  example, lenders or assignees may choose to exit a state or local market  rather than comply with that jurisdiction’s anti-predatory lending law but  still conduct business in other markets. However, under a federal law,  these entities would not have that option. Finally, prior studies examined  the impact of laws during a relatively active period in the subprime lending  market. If a law similar to the bill were to be passed in the near future, it  would be implemented in the wake of a major contraction in the mortgage  market that would likely affect the response of both the mortgage industry  and consumers to new lending standards.
section_title: Views Differed Regarding the Bill’s Long-Term Effect on the Mortgage Market
paragraphs: Mortgage industry representatives and consumer groups we interviewed  generally agreed that the bill would have little short-term impact on the  mortgage market because of existing market conditions. However, they  held different views on the long-term impact that key provisions in the bill  would have on consumer access to affordable credit and protection from  predatory lending practices.
subsections: section_title: Recent Market Conditions and Regulatory Initiatives
paragraphs: Representatives from both groups generally agreed that the bill would  have very little impact on mortgage originations in the current financial  environment because the overall primary market was highly constrained,  with lenders tightening qualifications for all borrowers and the market for  private label MBS virtually nonexistent. In addition, representatives from  mortgage industry groups expected that the Federal Reserve’s revisions to  Regulation Z could lessen the impact of the bill. Specifically, the groups  stated that the revisions to Regulation Z would place lender requirements  on nonprime loans that were similar to the bill’s safe harbor requirements.  For example, both the Regulation Z revisions and the bill’s safe harbor  require that borrowers obtaining loans with APRs over certain thresholds  provide full documentation of income and assets and qualify for ARMs  based on a monthly payment that takes into account scheduled interest  rate increases.
section_title: Safe Harbor Requirements
paragraphs: Mortgage industry representatives we interviewed generally viewed the  bill’s safe harbor requirements as overly restrictive and said that these  requirements would reduce mortgage options and increase the cost of  credit for certain borrowers. Some of these representatives said that  lenders would be unwilling to make loans that did not meet the safe  harbor requirements. They cited the experience with HOEPA as an  example of what might take place if the safe harbor requirements were put  in place. Specifically, they noted that since the implementation of HOEPA,  very few lenders have been willing to make mortgages considered “high  cost” loans under HOEPA’s provisions because they cannot sell them to  the secondary market. For example, in 2006, less than 1 percent of  mortgages were high cost loans, as defined by HOEPA regulations.
The industry representatives also said that specific safe harbor  requirements would reduce access to credit for certain types of borrowers.  For example, they said that the safe harbor requirement that would  prohibit loans with less than full documentation of income and assets  could restrict access to credit for borrowers with irregular income  streams, such as some small business owners. Some industry  representatives acknowledged that many low- and no-documentation  mortgages should not have been made, but said that some flexibility  should be allowed under this requirement to account for borrowers with  nontraditional sources of income.
In addition, industry representatives said that borrowers who had  responsibly used negative amortization loans in the past could face limited  mortgage options under the bill, as the safe harbor requirement would  prohibit these loans. Some industry representatives acknowledged that  negative amortization products had been used inappropriately in recent  years to allow some borrowers to buy homes that they might not have  been able to afford, but added that prohibiting this feature would  adversely impact borrowers who had used this product responsibly. For  example, some borrowers with irregular income have taken out negative  amortization loans in order to pay minimum amounts when their income  was low and higher amounts when their income increased. One mortgage  industry participant suggested that one way to address concerns that these  loans subject borrowers to payment shock would be to limit the amount  by which the mortgage payments could reset.
In contrast, representatives from consumer groups that we interviewed  generally indicated that the safe harbor requirements would need to be  strengthened and applied to a broader range of loans in order to prevent  predatory lending practices to protect borrowers. For example, some  representatives supported adding more consumer protection features to  the bill, such as prohibiting prepayment penalties, balloon payments, and  yield spread premiums. They also said that the bill’s safe harbor  requirements should be applied to all mortgages, including FHA-insured  mortgages and loans with relatively low APRs, because these loans could  also contain predatory features.
Most of the consumer group representatives said that strengthening safe  harbor requirements and applying them more broadly would not  significantly affect the cost or availability of credit. For example, in  response to industry concerns that requiring full documentation would  restrict some borrowers’ access to credit, consumer group representatives  noted that full documentation had already become a marketplace  standard. They generally believed that the majority of borrowers, including  self-employed consumers, could provide sufficient documentation using  their income tax records, but some groups supported limited flexibility in  the types of documents that would be accepted. In addition, while industry  groups were concerned that prohibiting loans with a negative amortization  feature under the bill’s safe harbor provisions could restrict credit to some  borrowers, consumer groups supported prohibiting this feature in order to  protect consumers from potential payment shock. Some of these  representatives acknowledged that negative amortization loans could be  suitable for certain borrowers, but they viewed these cases as exceptional  and did not think the potential benefits to a small segment outweighed the  potential costs to the larger portion of the market.
section_title: Assignee Liability Provisions
paragraphs: Mortgage industry representatives we interviewed generally said that the  bill’s assignee liability provisions would increase the cost of credit for  borrowers and deter secondary market participants from reentering the  nonprime market. Specifically, these representatives said that the cost of  complying with the bill’s assignee liability provisions, including secondary  market participants’ cost of due diligence procedures, would increase the  cost of credit and cause some secondary market participants to stop  securitizing loans. Some industry representatives stated that mortgage  originators were better positioned to conduct due diligence to ensure that  loans were responsibly underwritten and argued that mortgage reform  legislation should focus on enhancing the primary market’s underwriting  standards.
Mortgage industry representatives also said that lack of certainty in what  assignees could be held liable for under the bill would deter participants  from reentering the secondary market. For example, some representatives  noted that the bill did not clearly define the standards that assignees  would be held to, such as “ability to repay” and “net tangible benefit.” They  cited Georgia’s 2002 anti-predatory lending law as an example of how the  lack of clarity concerning assignee liability could adversely impact the  market. As we have reported, because of the uncertainty surrounding  potential liability under the Georgia law, secondary market participants  withdrew from the mortgage market in Georgia until the provisions were  repealed.
In contrast, consumer group representatives generally believed that  enhanced regulation and accountability in the secondary market would  provide consumers with greater protections against predatory lending  practices. These representatives generally supported strengthening the  bill’s assignee liability provisions. For example, some consumer group  representatives said that the bill’s assignee liability provisions should not  allow for any exemptions from liability, such as allowing assignees to cure  a loan (i.e., modify or refinance the loan so that it meets the bill’s  minimum lending standards) to avoid liability. They noted that some  assignees might choose to cure the relatively few loans that violate the  bill’s minimum lending standards, rather than invest the resources in due  diligence policies and procedures that would help prevent predatory  lending practices.
Further, consumer groups said that the bill should not preempt state  assignee liability laws because these laws could potentially provide  consumers with an ability to seek redress if they obtain a predatory loan.  Finally, representatives of consumer groups also said that applying the  assignee liability provisions more broadly, beyond the bill’s nonqualified  mortgages, could also help prevent predatory lending on a wider variety of  mortgages. They contended that stronger and broader assignee liability  provisions would not significantly impact the cost of or access to credit  and would set a standard to which secondary market participants would  eventually adapt.
section_title: Federal Preemption of State Anti-Predatory Lending Laws
paragraphs: Mortgage industry representatives preferred that any federal legislation on  mortgage lending preempt all state anti-predatory lending laws, not just  assignee liability laws, in order to reduce the cost of and increase the  availability of credit. They stated that a uniform set of mortgage standards  for lenders would significantly reduce the cost of doing business and that  these savings could be passed on to consumers. According to one  mortgage industry participant, under the current legal and regulatory  environment, lenders’ costs are higher because lenders are required to  develop systems to track laws and regulations in up to 50 states, monitor  these laws and regulations, and ensure they are in compliance with them.  Some industry representatives stated that federal preemption could also  lower consumer costs by applying uniform standards and supporting  competition between state- and federally licensed mortgage originators.  Mortgage industry representatives also said that full federal preemption  would provide a uniform set of standards that would renew activity in the  secondary market, thereby, allowing lenders to make more credit available  to consumers.
In contrast, consumer group representatives generally believed that  federal legislation should not preempt state laws, because consumers  benefited from states’ abilities to enact stronger consumer protection  laws. For example, some consumer groups said that in the past, states had  responded faster to predatory lending abuses than federal regulators in  enacting anti-predatory lending laws, and expected this to continue if a  federal bill did not preempt state laws. Further, some of these  representatives said that state and federal regulations existed in a  complementary framework in other areas, such as civil rights and the  environment, and generally did not think that compliance costs would be  significant in light of the benefits to consumers and the long-term  sustainability of the mortgage market. They viewed states’  experimentation with mortgage reform as an important source of useful  information on changes in market conditions and industry responses to  different approaches.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Board of Governors of the Federal  Reserve System, Federal Deposit Insurance Corporation, Office of the  Comptroller of the Currency, Office of Thrift Supervision, National Credit  Union Administration, Department of Housing and Urban Development,  Federal Trade Commission, and Securities and Exchange Commission. We  received written comments from NCUA, which are summarized below.  Appendix III contains a reprint of NCUA’s letter. The Federal Reserve,  FDIC, OCC, HUD, and FTC provided technical comments, which we  incorporated into this report, where appropriate.
In its written comments, NCUA reiterated several of our findings and  noted that the findings supported its view that ensuring borrowers have a  reasonable ability to repay is in the best interest of credit unions and their  members.
We are sending copies of this report to the Ranking Member, House  Financial Services Committee and other interested parties. We will also  send copies to the Federal Reserve, FDIC, OCC, OTS, NCUA, HUD, FTC,  and SEC. The report also will be available at no charge on the GAO Web  site at http://www.gao.gov.
If you or your staff have questions about this report, please contact me at  (202) 512-8678 or shearw@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs are on the last page of this  report. GAO staff who made major contributions to this report are listed in  appendix IV.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives were to (1) assess the proportion of recent nonprime loans  that would likely have met and not met the Mortgage Reform and Anti- Predatory Lending Act of 2007’s (bill) safe harbor requirements, and how  variables associated with those requirements affect loan performance; and  (2) discuss relevant research and the views of mortgage industry  stakeholders concerning the potential impact of key provisions of the bill  on the mortgage market. The scope of our analysis was limited to the  nonprime mortgages.
subsections: section_title: Nonprime Loans and the Safe Harbor Requirements
paragraphs: To assess the proportions of nonprime loans originated from 2000 through  2007 that would likely have met and not met the bill’s safe harbor  requirements, we analyzed data on subprime and Alt-A (nonprime)  mortgages from that period. Specifically, we analyzed information from  LoanPerformance’s (LP) Asset-backed Securities database, which contains  loan-level data on nonagency securitized mortgages in subprime and Alt-A  pools. About three-quarters of subprime mortgages were securitized in  recent years. For purposes of this report, we defined subprime loans as  mortgages in subprime pools and Alt-A loans as mortgages in Alt-A pools.  The LP database covers the vast majority of mortgages in nonagency  subprime and Alt-A securitizations. For example, for the period 2001  through July 2007, the LP database contains information covering (in  dollar terms) an estimated 87 percent of securitized subprime loans and 98  percent of securitized Alt-A loans (see table 6). Nonprime mortgages that  were not securitized (i.e., mortgages that lenders held in portfolio) may  have different characteristics and performance histories than those that  were securitized.
For our analysis, we used a random 2 percent sample of the database that  amounted to almost 300,000 loans for the 2000 through 2007 period. Our  sample included purchase and refinance mortgages and loans to owner- occupants and investors, and excluded second-lien mortgages.
We assessed the reliability of the data by interviewing LP representatives  about the methods they use to collect and ensure the integrity of the  information. We also reviewed supporting documentation about the  database, including LP’s estimates of the database’s market coverage. In  addition, we conducted reasonableness checks on the data to identify any  missing, erroneous, or outlying figures. We found the data elements we  used to be sufficiently reliable.
To estimate the proportion of loans that likely would have met and not  met the safe harbor requirements, we used variables in the LP database  that directly corresponded with the requirements and developed proxies  when the database did not contain such variables (see table 7).
To compare the demographic characteristics (e.g., race, ethnicity, and  income level) of safe harbor and nonsafe harbor loans, we incorporated  data from the Census Bureau. More specifically, whenever possible, we  linked the zip code for each loan reported in the LP data to an associated  census tract in a metropolitan statistical area (MSA). We grouped the zip  codes according to the percentage of households that Census identified as  black or African-American and Hispanic or Latino. The groupings in our  analysis were: (1) less than 5 percent, (2) 5 to 24 percent, (3) 25 to 74  percent, and (4) 75 percent or greater of household populations. We also  grouped zip codes according to the median income of the MSA of a given  zip code. The specific groupings in our analysis were low-, moderate-, and  upper-income zip codes, defined as those with median incomes that were  less than 80 percent, at least 80 percent but less than 120 percent, and 120  percent and above, respectively, of the median income for the associated  MSA.
To analyze nonsafe harbor loans by borrower credit score, we used the  FICO scores in the LP database. FICO scores, generally based on software  developed Fair, Isaac and Company, are a numerical indicator of a  borrower’s creditworthiness. The scores range from 300 to 850, with  higher scores indicating a better credit history. For our analysis, we used 4  ranges of scores: 599 and below, 600 to 659, 660 to 719, and 720 and above.
To examine factors affecting the performance of nonprime loans, we  developed an econometric model to estimate the relationship between  variables associated with the safe harbor requirements, as well as other  variables, and the probability of a loan defaulting within 24 months of  origination. We developed the model using data on mortgages originated  from 2000 through 2006 (the latest year for which we could examine 24- month performance). Detailed information about our model and our  estimation results are presented in appendix II.
section_title: Research on State and Local Anti-Predatory Lending Laws and Views of Mortgage Industry Stakeholders
paragraphs: To describe relevant research on the bill’s potential effect on the mortgage  market, we identified and reviewed empirical studies on the impact of  state and local anti-predatory lending laws on key nonprime mortgage  indicators, such as subprime mortgage originations and the cost of credit.  While we identified a number of such studies, we narrowed our scope to  eight studies that used control groups (e.g., comparison states without  anti-predatory lending laws) or statistical techniques that controlled for  factors other than the laws that could affect lending patterns. The studies  we reviewed fell into two broad categories: three studies that focused  solely on North Carolina’s 1999 anti-predatory lending law and five that  examined laws in multiple states and localities. In general, the researchers  measured the effects of the laws in terms of the volume of subprime  originations, the probability of originating a subprime loan, or the  probability of originating a loan with predatory characteristics. Our review  of these eight studies included an examination of the methodologies used,  the data and time periods used, the limitations of the studies, and the  conclusions. We also interviewed selected authors to ensure that we  interpreted their results correctly and to obtain their views on whether the  results from their studies might apply to the potential impact of the bill on  the mortgage market.
To obtain the views of mortgage industry stakeholders, we reviewed  written statements and congressional testimony about the bill by officials  from the federal banking regulatory agencies and organizations  representing mortgage lenders, mortgage brokers, securitizers, and  consumer interests. We also interviewed officials from a number of these  organizations, including the Mortgage Bankers Association, American  Securitization Forum, American Financial Services Association, American  Bankers Association, Independent Community Bankers of America,  National Association of Mortgage Brokers, Center for Responsible  Lending, National Community Reinvestment Coalition, National Consumer  Law Center, Neighborhood Association of Consumer Advocates, and  Consumer Federation of America. In addition, we interviewed officials  from a large mortgage lender and a major investment bank involved in the  securitization of mortgages. Finally, we interviewed officials from the  federal banking regulatory agencies, the Department of Housing and  Urban Development (HUD), the Federal Trade Commission (FTC), and the  Securities and Exchange Commission (SEC).
We conducted this performance audit from March 2008 to July 2009, in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
section_title: Appendix II: Description of the Econometric Analysis of Safe Harbor Requirements
paragraphs: This appendix describes the econometric model we developed to examine  the relationship between variables associated with the bill’s safe harbor  requirements, as well as other variables, and the probability of a loan  entering default. Safe harbor requirements include features related to  documentation of borrower income and assets, limits on debt-service-to– income (DTI) ratios, the duration before which any interest rate  adjustments may occur, limits on the relationship between a loan’s annual  percentage rate and other prevailing interest rates at origination, and  prohibitions on mortgages that allow negative amortization. The safe  harbor requirements limit features that may increase the risk of default,  but they may also restrict the number and types of mortgages lenders are  willing to originate. Since the requirements were not in effect during the  recent past, we do not know in what ways lenders and securitizers may  have responded to their introduction. Therefore, we characterize our  evaluation as an assessment of whether mortgages with safe harbor  characteristics performed better than those without them, as opposed to  an assessment of the effects of the introduction of a safe harbor. Our  investigation focused on a recent set of nonprime mortgages and  controlled for a variety of loan, borrower, and housing market conditions  that are likely to affect mortgage performance.
To do this work, we analyzed a 2 percent random sample of securitized  nonprime loans originated from 2000 through 2006 from  LoanPerformance’s (LP) Asset-backed Securities database. Our sample  was comprised of the approximately 92 percent of loans for which the  associated property was located in an area covered by the Federal  Housing Finance Agency’s house price indexes for metropolitan areas. The  LP database has been used extensively by regulators and others to  examine the characteristics and performance of nonprime loans. The  database provides information on loan characteristics, from which we  developed variables that indicated or measured relevant safe harbor  requirements. We determined the status of each loan 24 months after the  month of first payment. We used loan performance history through the  end of December 2008. We defined a loan as being in default if it was  delinquent by at least 90 days, in the foreclosure process (including loans  identified as in real-estate-owned status), paid off after being 90-days  delinquent or in foreclosure, or had already terminated with evidence of a  loss.
We categorized loans as follows: short-term hybrid adjustable rate  mortgages (ARM) (essentially 2/28 and 3/27 mortgages), fixed-rate  mortgages, payment-option ARMs, and other longer-term ARMs (i.e.,  ARMs with 5-, 7-, and 10-year fixed-rate periods). We included only first- lien loans for which the borrower is identified as an owner-occupant, and  we estimated default probabilities for purchase money loans separately  from loans for refinancing except for payment-option ARMs, for which we  examined purchase and refinancing loans together. Our primary reason for  examining performance by mortgage type is that borrower incentives and  motivations may vary for loans with different characteristics. For example,  short-term hybrid ARMs provide a strong incentive for a borrower to exit  from a mortgage by the time the interest rate begins to reset.
We estimated separate default models for each mortgage type, although  the general underlying structure of the models was similar. We used a  logistic regression model to explain the probability of loan default, based  on the observed pattern of actual defaults and the values of safe harbor  variables and a subset of other variables known to be associated with loan  performance (see table 8). Many loan and borrower characteristics are  likely to influence the status of a mortgage over time. Some factors  describe conditions at the time of mortgage origination, such as the loan- to-value (LTV) ratio and the borrower’s credit score. Other important  factors may change over time, sometimes dramatically, without being  observed by a lender, loan servicer, or researcher. For instance, an  individual household’s income may change due to job loss, increasing the  probability of default. Other conditions vary over time in ways that can be  observed, or at least approximated. For example, greater house price  appreciation (HPA) contributes to greater housing equity, thus reducing  the probability that a borrower, if facing financial distress, views  defaulting on a loan as a better option than prepaying. We focused on  whether a loan defaulted within 24 months as our measure of performance  because a large proportion of nonprime borrowers had hybrid ARMs and  prepaid their loans (e.g., by refinancing) within 2 years. Using a 24-month  time frame allowed us to include these loans in our model, as well as loans  originated in 2006, a year in which many nonprime loans were originated.
For reasons described below, some of the variables associated with the  safe harbor requirements are included in all four models, while others are  only included in certain models:    Full documentation of borrower income and assets: This variable is in all  four models.
Negative amortization feature: This variable is only in the model for  longer-term ARMs. We did not include it in the models for the other  mortgage types because the negative amortization feature was essentially  never present (in the case of fixed-rate mortgages and short-term hybrid  ARMs) or was essentially always present (in the case of payment-option  ARMs). The lack of variation within these mortgage types made estimating  the marginal effects of the negative amortization variable problematic.
Fully indexed proxy: This variable is in three of the models, but we do not  include it in the model for fixed-rate mortgages because it is only relevant  to loans with adjustable interest rates.
DTI ratio: In the context of the bill’s safe harbor requirements, this  variable would only apply to short-term hybrid ARMs and payment-option  ARMs. However, we include it in all four models because the DTI ratio is  an important measure of the borrower’s ability to repay.
Spread over relevant interest rate index: In the context of the bill’s safe  harbor requirements, this variable would only apply to short-term hybrid  ARMs. However, we include it in all four models because loans with  higher interest rates may be at greater risk of default due to their higher  monthly payments.
Tables 9 through 12 provide information on the number of loans and mean  values for each of the mortgage types for which we estimated default  probabilities. Short-term hybrid ARMs were the most prevalent type of  mortgage, and refinance loans were more prevalent than purchase loans.  In addition, more loans were originated in the later portion of the time  period we examined than the earlier portion. Default rates were highest  for short-term hybrid ARMs, lower for loans originated in the middle years  of the time period and higher for purchase loans than for refinance loans.
The results of our analysis are presented in tables 13 through 16. We ran  seven regressions: separate purchase loan and refinance loan regressions  for three of the product types (short-term hybrid ARMs, fixed-rate  mortgages, and longer-term ARMs) and a single regression combining  purchase and refinance loans for payment-option ARMs.  For this set of  regressions, we only included the 63 percent of loans for which DTI  information was available. We also ran a second set of regressions that  used all of the loans for each mortgage type and binary variables  indicating DTI ranges, including categories for missing information. We  found that the results were very similar to those for the first set of  regressions. We presented coefficient estimates, as well as a  transformation of the coefficients into a form that can be interpreted as  the marginal effect of each variable on the estimated probability of default.  This marginal effect is the calculation of the change in the estimated  probability of default that would result if a variable’s standard deviation  were added to that variable’s mean value, while all other variables are held  at their mean values. This permits a comparison of the impact of different  variables within and across mortgage types. In general, combined LTV  ratio, HPA, and FICO score had substantial marginal effects across  different mortgage types and loan purposes. Specifically, higher LTV  ratios, lower HPA, and lower FICO scores were associated with higher  likelihoods of default. The observed effects for DTI ratio were relatively  small. Among safe harbor characteristics, documentation of borrower  income and assets and a loan’s spread over the applicable Treasury rate  had substantial marginal effects. Less than full documentation and higher  spreads were associated with higher default probabilities.
Our results for full documentation of borrower income and assets were  not sensitive to alternative specifications. Including the loan amount as an  additional variable, adding or substituting different interest rates, and  changing the form in which house price appreciation or FICO scores  entered the model all had no effect on our general conclusion that the  presence of full documentation was strongly associated with lowering the  probability of default. Our conclusion concerning high cost loans—that  larger spreads over specified Treasury rates at the time of origination are  associated with increased default probability—is somewhat more  nuanced. In some respects, the spread variable is capturing something  about the effect of higher interest rates generally. For example, alternative  specifications which substituted the initial interest rate or the Treasury  rate for the spread variable yielded similar results. However, when the  Treasury rate and the spread variables are included in the model, both  variables are significant and have large marginal effects.
As an alternative specification for short-term hybrid ARMs, we included a  variable indicating whether each mortgage was a safe harbor or a non-safe  harbor loan, in contrast to including variables for separate safe harbor  requirements. We found that this variable had a small marginal effect,  most likely because many non-safe harbor loans met some of the safe  harbor requirements. In particular, a substantial percentage of non-safe  harbor loans had full documentation of borrower income and assets but  failed to meet other safe harbor requirements.
section_title: Appendix III: Comments from the National Credit Union Administration
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Steve Westley, Assistant  Director; Bill Bates; Stephen Brown; Emily Chalmers; Rudy Chatlos;  Randy Fasnacht; Tom McCool; John McGrail; Mark Metcalfe; Rachel  Munn; Susan Offutt; Jasminee Persaud; José R. Peña; Scott Purdy; and Jim  Vitarello made key contributions to this report.