California's Sensible Mortgage Restraints

Earlier, I wrote about banks' absurd push to bring back interest-only mortgages. Subsequent to that, I read the delightful news that California is coming to its senses regarding mortgage origination. The Los Angeles Times reports that Gov. Schwarzenegger signed a number of new mortgage laws late last night. I'd like to highlight several of these new rules, which I think the entire nation should embrace.

AB 260 ... tightens restrictions on mortgage brokers so they cannot steer borrowers to riskier, higher-interest loans when they qualify for less-expensive ones.

... bans so-called negative-amortization loans, which offer the option of monthly payments so low that the loan amounts can actually grow over time.

... limits prepayment penalties to no more than 2% of the loan balance and allows state regulators to enforce federal lending laws.

I like all of these changes. First, mortgage brokers should be working in the borrowers' best interest. Clearly, they're out to make a profit, and that's fine. But that profit should be based on originating sound loans, not by tricking borrowers to take on risky mortgage products that ultimately fail.

As for those negative-amortization loans, they're perhaps the most dangerous kind of mortgage. I think one way to determine whether or not a new mortgage rule is a good idea is to try to figure out a reason why someone might legitimately object to it. I can't think of any reason why a responsible borrower would ever need a negative amortization mortgage. That just puts a homeowner in a precarious situation once the principal has to be paid.

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Finally, there are prepayment penalties. I think a 2% cap is a reasonable restraint. It doesn't eliminate them altogether, but limits them to very low levels. That way, borrowers are still discouraged from refinancing too hastily, but not to the extent where they feel trapped in a mortgage.

SB 36 ... sets licensing requirements for all residential loan originators.

This is also pretty hard to object to. Not just any random person should be able to set up shop as a mortgage originator. Some credentials should be necessary.

SB 239 ... makes it a felony to commit fraud on a mortgage loan application.

I like this rule because it addresses the other side of the coin: when the borrowers themselves acted improperly by committing fraud to obtain mortgages. The prospect of a felony might make potential fraudsters think twice about exaggerating their creditworthiness. Presumably it would also apply to mortgage brokers who alter loan applications.

AB 329 ... requires lenders to give more and clearer information to those interested in reverse mortgages, which let seniors borrow against their homes' equity.

I'm all for clarity. I think it's particularly prudent for seniors to be given greater disclosure for what they might be getting themselves into regarding reverse mortgages. I believe those who take advantage of the elderly are pure evil, so any measure to prevent that I'm on board with.

AB 1160 ... requires that mortgage loan documents be written in the same language the verbal negotiations were conducted in.

This is utterly obvious. Particularly in California, which has a very large Spanish-speaking population, I can imagine borrowers being made promises in Spanish, when their documents said something different in English.

I'm all for giving consumers and businesses the benefit of the doubt and having as few laws as possible. Yet, in the case of the mortgage industry -- particularly in California -- history has shown that the rules in place were inadequate. People were negligent, stupid, misinformed or evil. That led to the disaster that was the housing bubble. Thus, broad new laws like these that strategically attack the causes of the problem make sense. They say that everything starts out in California, and I hope these new mortgage rules follow that adage.