My daddy told me years ago, "Never put something down to malice when ignorance covers all the facts."
Seems to apply here. As a secondary note, greater efficiency is not always desirable. Just think of the politicians you despise...and picture THEM being more efficient.
Well I LIKE the first paragraph of the disclosure. It's clear and concise. I think that the "your interest rate may be different" paragaph should be clearer, at least because it is the early teaser rate feature that is MOST dangerous in these loans. I could wish that the examples paragraph included charts or graphs, partly because that's the way I think and partly because at that point we've reached the MEGLO point.
I thought both of these documents were clear and understandable, but I'm not an average reader. I note that FED had most of its loans tied to an index that changes monthly. Payments were capped by 7.5%, an they had a graduated payment program. In general, after 5 years the monthly payment was reamortized over the life of the loan--without regard to the cap. How many surprises do you think there will be? Remember when it was just the interest rate that was capped?.
What is missing, IMV, is a simple schedule that shows what happens if your interest is X, Y, Z over the life of your loan. Despite the clarity of the docs, nothing sings like the numbers. So nods of agreement in reading the language may very well be replaced with "What the !#$#?!!!!".
The opening paragraph still obfuscates the key attribute of the loan: the initial monthly payments are the lowest they will ever be over the duration of the loan, and the monthly payment WILL GO UP A LOT. People evaluate loans based on their monthly cash flow. This loan is not clearly presented in terms of impact on monthly cash flow.
Only at the end of doc (4. Maximum Rate and Payment Examples) do they actually include real numbers, and even there they do it in terms of a $10,000 principal balance. Unless this is a 2nd mortgage, why talk about payments per $10,000 prinicipal? That should be payment per $100,000, which is much easier mental arithmetic. This disclosure does not tell a buyer straight up that their initial monthly payment of $321 per $100,000 will jump to $1017 per month.
All in all it appears to be readable, but no real world examples.
It needs less accounting jargon and more examples. This is a computer age and we know the financials and we know the ball park mortgage amounts. We can show examples what happens with payment resets and principal increases using current interest rates and we can show what happens under a couple of simple situation.
I can see the desire to keep from the customer thinking those figures are a commitment, but they can sign off on that just as well as this.
In summary, pictures and actual information should be there, not theory.
My experience as a borrower is that the only thing a borrower really understands (and feels that he/she needs to know) is contained in par. 4. (Maximum Rate and Payment Examples). I agree with spcs, there are more straight forward ways to give the information that, in fact, is there.
six percent, most people never see a note until the day they're asked to sign it.
That's part of the reason why Reg Z demands that the disclosure be given no later than the time the application is made. (Actually, it says the disclosure must be given whenever a borrower inquires about an ARM loan, even if she hasn't officially applied yet. You're supposed to keep a stack in your desk drawer--or be able to pull them off the computer--for anyone who wanders in and says, "Do you have those ARM things?")
In the bad old days before Reg Z, the note was the only thing the borrower had to go on.
In the old days of round-robin sit-down loan closings where people brought their attorneys, it wasn't so bad. These days people do mail-in or escrow closings, skimp on the cost of legal representation, and often never even read the note--someone fans out a set of docs and the borrower just signs.
Notice that the Thornburg note doesn't have initial lines on the bottom of each page, just a signature line on the last page. I'm a real bitch about that: I have always insisted on having the borrower initial each page. It is not a legal requirement, but it's a good precaution, not just to encourage the borrower to look at each page. It also protects borrowers against having a crooked broker or lender slip in a page that doesn't match what got signed.
I would also add, in BIG BOLD FONT at the top of the note, a warning about signing anything with blanks that aren't filled in. Too many people get told that the blanks will get filled in later. THERE IS NO LATER WITH A PROMISSORY NOTE. It is the terms to which you are contractually bound. But people sign them all the time with blanks unfilled.
I have always found that our local parrochial banking system was not on par with its anglo-saxon counterparts.
Reading through your blog and others, I feel relieved my country has only recently indulged into "financial engineering". Limited damage has been done. Just because we were late not smart.
We have mostly fixed-rates rates, always capped in percentage and very few buzzwords in contracts.
I feel relieved. Not everyone is smart and educated. And even so!
Still feel an utterly proponent of "wild-free markets" for goods and services.
Depict me as the local Thatcherian bloke! However strong regulations are needed for quite a few human activities including medical services, banking to name a few...
The language in the disclosure document is very clear, but unless one is reasonably numerate, it is hard to imagine what can happen. I think the banks should put a simple interactive excel spreadsheet on their websites. Loan parameters could be entered by the user, and the amortization schedule would adjust accordingly. Then you could add some requirement about showing the borrower how it worked, and illustrating some specific scenarios.
Those docs should use real numbers and should also be written in plainer english. The only reason to use so many big words is to misdirect the reader. If the loan wasn't bad, the bank wouldn't go out of their way to obfuscate the terms. If my mom read this she wouldn't understand it completely. Maybe that should be the test -- would you let your mom or pop sign these docs as they're written?
Ooh, ooh, mandatory quiz! To test that the borrower actually understands the terms, quiz them afterwards. They don't get the loan until they understand it. Again, the problem with that is once they understand it, they may (understandably) no longer want it.
Hahah. Honestly, you are going to lose a lotof homebuyers at LIBOR. And imagine what a broker will say when a homebuyer says: "Um, I have a question about how my interest is calculated..."
I second Isabel -- the real information is contained in par. 4 - but it needs to be in chart form-not long sentences. And for God's sake, this is the age of the computer. What ought to be required is a statement in big bold type right under the chart: "To see how your own monthly loan payments may change when interest rates change, go to the online calculator at www.knowyourloan.gov." Just having a consumer fill out the terms of the loan in this type of calculator, be able to output payment skeds based on different rate-change scenarios, would be far more informative than a paper trying to explain the math in long, obfuscatory sentences.
Warning language at the tip-top of paperwork a great idea too!
OT PS: Tanta thanks for info on Countrywide, even tho I misspelled it. In good times, SL's seemed to rush to become commercial banks, now maybee this is start of reverse trend... Really irksome that that may mean they run from responsibility, too.
I agree with the other commenters on the need to include specifics, but also: in many lines of business, nobody writes anything longer than two pages without some sort of executive summary at the beginning that contains the facts of greatest importance to the reader. You also could approach this like a news story. The important stuff needs to be up front. In a document this important to the financial health of the borrower, a Surgeon General tone might be appropriate:
You are taking out a loan for $xxx,xxx. You will have a choice of payments. Your initial payment will be $x,xxx, if you pay the fully amortized rate. After x years, your balance would be xxx,xxx and the payment will adjust to a range between x,xxx and x,xxx. Here are the subsequent yearly adjustments...
The is a pay option loan, and you may choose to pay less than the amortizing rate. If you choose to pay the minimum required, you will pay x,xxx. After x years, your balance would be xxx,xxx and your new payment will adjust to a range between x,xxx and x,xxx. If your loan balance reaches xxx,xxx, your minimumn payment will be revised sharply upward, to the range $xxxx-xxxx.
Oral statements from any party, including mortgage broker, real estate agents, and your very smart Uncle Freddy as to the likely direction of interest rates over the term of this loan; the availablity of refinancing in the future; the appreciation of the property on which this loan is based should be disregarded, and course of actions based on such matters should be diregarded. Past market activities are no guarantee of future market opportunities.
I concur with those comments already written: I am a lawyer who drafted a lot of notes (although on the commercial side), and that disclosure is really well done, in that it accurately states what is going on in the note. However, having read your negative amortization for Ubernerds post with spreadsheets was a lot clearer.
Tanta - How did you get to the disclosure and note? I have been poking about Thornberg's website looking for the directory, but I can't find it.
I think there should be a standard form that's easily comparable between loans.
The actual maximum monthly payment at the start one year out, and also for years 2-5. If it's an option ARM, or there are teaser rates which don't cover the accruing interest, the stated payment amount would be the fully amortizing rate.
For option ARM, interest only, loans with a teaser rate discount or ARMs with large potential resets, there would be need to be a separate page in simple, prescribed, terms, nad in large type giving a clear warning that there was the potential payment shocks, and exactly what those would entail. Then these loans really would only be used by sophosticated borrowers who understood the risks.
payment cap is only good when the balance is less than 115% of orginal amount.
once neg amortizated over 115%, lender can do whatever they want. The only option out is to refinance, which is only available in environment RE price never goes up.
"Interest rate is at historical low" is good for fixed rate mortgage. ARM and others are never cheaper. However anyone who bought a house with that belief probably used ARM instead
Alo puts the hammer right over the nail and swings hard:
What ought to be required is a statement in big bold type right under the chart: "To see how your own monthly loan payments may change when interest rates change, go to the online calculator at www.knowyourloan.gov." Just having a consumer fill out the terms of the loan in this type of calculator, be able to output payment skeds based on different rate-change scenarios, would be far more informative than a paper trying to explain the math in long, obfuscatory sentences.
The problem with this wonderful idea is all the various parameters a borrower has to input in order to get the thing to work. You have to find the value of LIBOR. You have to know what the margin is. You have to express the loan term in years or months. You have to know date of first rate adjustment, of payment adjustment, what the cap is, etc. In other words, you have to understand how the loan works before you can use the calculator that shows you how the loan works.
Lawyer, I just Googled "ARM Loan Program Disclosure Option ARM" and got the Thornburg hit (among others). I was particularly looking for an OA disclosure.
I come at this not as the neophyte you seek (you have played a part in corrupting me) but as a person used to trying to parse technical documents for laymen. I was a reporter and newspaper editor.
In the interest of brevity, I will confine myself to the first page in this comment.
The first problem is words for which a typical consumer does not have definitions. Words like interbank, promissory, margin, and amortization are really the jargon of the lending industry and while there may be context clues and even outright definitions, there's a big difference between having a word defined for you and understanding that definition.
A word like margin has a generic meaning (available or empty space) that is widely understood, but the precise definition given doesn't automatically match up with that.
The legalese also is an issue. The whole bit about "If the Index is no longer available... " is extraneous ass-covering legalese from the perspective of the typical consumer; while the bank certainly needs to say it, does the consumer really need to know it?
Finally, there is the whole aspect of math word problems. Some people (cough, cough Tanta) may enjoy such puzzles, but a lot those kids in class who complained about "not getting them" were serious.
I guarantee the sentence that begins "The most recent Index figure available..." in the index definition will totally flummox a good portion of the population.
Whatizit about this RegZ special document to ensure that ARM borrower really understands what he is promising?
Should it be pulled out of a crimson envelope marked "DANGER"? Should the person on the delivery side be mandated to wear the costume of The Devil as he prepares to make his offering? How about the recipient donning the Sheep costume?...Ok, too kinky.
I notice one party has the document, prepares the document and the other party "puts his hand" to it. This transaction is pretty one-sided and allows for no input on the other side.
Like: here's the reason why I am opting for this ARM: you may think you are fleecing me at 8% but I already have this house sold in 6 months to a reliable guaranteed customer at a solid 10% over this current principal.
That is the wrong skit. You sign their paper. They don't sign whatever you are mumbling about or agree to whatever paper you might have.
Does the document, Reg Z, represent a transaction (ARM) that is inherently short-sighted, modestly if latently predatory (your cue is the max Interest Rate Cap of 9.95% rate) and trading on the borrower's marginal (not just financial but possibly ethical) capacity that has turned him away from those FRM?
Does the invention of this new financial instrument arise from the nature of the market: faster rising house prices than wages?
The Reg Z strikes me as an effort to legitimize a practice that is almost legitimate: flipping.
as someone who has had a customer ask about "one of them ARM things",and who has tried to explain it to them,i think charts and graphs would be helpful for some...on the other hand there are plenty of people whose eyes glaze over at any 3 syllable word,and say "just get me the lowest payment,like that guy on the radio".try to tell them it is too risky,and why,or not suitable for them,and they frequently yell at you,and walk out,which i am ok with.mencken was right when he said"no one has EVER gone broke by underestimating the intelligence,or good taste of the american people"sad.BTW have you considered selling "Tanta's Groupies" t-shirts? the Motto could be "A Thirst for Knowledge,And A Taste For Chocolate"If you are ever in the wine country drop me a line,i'll pour a gallon or two of the good stuff,and feed you my unforgettable tunafish-marshmallow casserole with the raspberry caper sauce.
I began reading the document but then struggled. I suppose if i was a motivated buyer i would have continued, taken some notes, and had some questions to help me figure it all out. Some people are even less verbal/analytical than i am. They are right brained rather than left brained and really they would need this to be done in pictures or something to grasp what the hell is going on.
The problem, of course, is that these documents must stand in court. Therefore the words must be chosen on the way the law defines them. "Normal language" documents suffer when they get into courts for this reason. Nonetheless, what I'd like to see is one more note - a "normal language translation" - that begins something like this:
This note lets the lender change what I pay each month. It might limit how much change can be made in my monthly payments. Because of the changes, the total amount I owe might also change. This note establishes the most that this total change can be.
And at the head - BEFORE the title which says "normal language translation of the note" - put a signature block under a clause that is clear and legal, saying something like:
The following is a normal language translation of the official note to help understand it. In the event that this goes to court, I understand and agree that the official note is what will be referenced.
my unforgettable tunafish-marshmallow casserole with the raspberry caper sauce.
Don't forget that I'm in the DC area, so if you ever end up facing a congressional subpoena--the House Committee on Unsafe and Unsound Recipes, perhaps?--you could stop by and admire my classic spreadsheet collection.
Give the forms to someone, then give them the inputs for a hypothetical situation, and ask them to determine their monthly payment. (They would be allowed use of a calculator, or any other aids they saw as helpful.)
If they came up with the right number, they could have the loan.
Now, what percentage of the people who took out option ARMs over the last tree years woiuld be able to do it?
I suspect that no matter how easily understandable the disclosure were made, it's effect would frequently be negated by the broker fast-talking the borrower with, "If your payments go up you can just refinance." Especially in cases where the borrower is getting a low teaser rate for the first few years, it would not be unnatural for them to think they could get the low teaser starting rate again. They don't understand how points and prepayment penalties affect the overall real interest rate; moreover, when the belief that real estate is sure to go up 15% a year and will never go down* has taken root, a prepayment penalty won't cause any fear -- just cash out a little equity and it's covered, right? If the borrower is not getting oral representations like that from the mortgage broker, they're probably getting them from the real estate agent, or they know someone who has done that -- or they've watched the homes in the neighborhood they're buying into go up from $300k to $600k in five years, and can easily figure it out for themselves.
A major underlying element of the problem is the widespread belief that bidding up the prices of assets produces wealth -- a belief fostered by numerous economists and economic commentators. We've had statements to that effect not only from Alan Greenspan, but also from numerous op-ed writers and pundits who claim that the nation's savings rate not only isn't negative, but is actually high, because asset prices have risen so much.
*There having been a steady stream of statements from numerous eminent economists to that effect.
**Despite the fact that salaries have been stagnant and numerous managers and professionals have lost their jobs to offshoring.
I have a Master's degree in mathematics. I have been an actuary for several years (a while ago). I've been reading CR for about two years, and I usually read many of the comments. I have bought and sold a house, and have had a simple fixed-rate 15yr mortgage.
While I understood the note, it required actual serious thought on my part, and I doubt that most people could understand it. When I bought my house, I trusted my lawyer, but I read all the documents and questions my lawyer on all the stuff that was a little unclear.
I agree with many of the commentators about the need for graphs and charts.
jm, this is the actual text (bold and caps in the original) from the very top of the Fannie Mae/Freddie Mac standard balloon note:
THIS LOAN IS PAYABLE IN FULL AT MATURITY. YOU MUST REPAY THE ENTIRE PRINCIPAL BALANCE OF THE LOAN AND UNPAID INTEREST THEN DUE. LENDER IS UNDER NO OBLIGATION TO REFINANCE THE LOAN AT THAT TIME. YOU WILL, THEREFORE, BE REQUIRED TO MAKE PAYMENT OUT OF OTHER ASSETS THAT YOU MAY OWN, OR YOU WILL HAVE TO FIND A LENDER, WHICH MAY BE THE LENDER YOU HAVE THIS LOAN WITH, WILLING TO LEND YOU THE MONEY. IF YOU REFINANCE THIS LOAN AT MATURITY, YOU MAY HAVE TO PAY SOME OR ALL OF THE CLOSING COSTS NORMALLY ASSOCIATED WITH A NEW LOAN EVEN IF YOU OBTAIN REFINANCING FROM THE SAME LENDER.
Perhaps we should add something like that to ARM notes/disclosures?
Thornburg Mortgage markets its products to sophisticated, relatively wealthy people. Broadly speaking, a Thornburg customer knows how to read a prospectus.
So I have a hunch that:
a) Most Thornburg borrowers understand the disclosures and note;
b) These borrowers would be turned off by unnecessarily obfuscatory language;
c) and therefore, Thornburg's disclosures are probably written more clearly than those from lenders who go after unsophisticated customers. You know, the kind of lender that is backed by a huge corporation, but advertises late at night with TV commercials with bad production values. Now, why would they do that, if they could afford better? Hmmm......
Tanta, I most definitely agree we should, except it shouldn't be in all caps, as it has been well known since the military studied instruction manual readability back in WWI days that all-caps text has very low readability.
Tanta, I think even if you are just offering ballparks you actually can get a consumer to understand their loans better on a calculator than in writing (and if you can't even then -what are we doing allowing loans like this to be made??)
However, figures like Libor and margin stuff, I think, could be made to be fed in automatically (after the fact you could even reqire the lender to notify the buyer with updated figures in a new calculator link each time they change rates) And you can make the lender disclose (in another pretty chart, as customized for the consumer as possible, all the other figures you'd need to plug into the calculator.
But at minimum, you can offer the consumer a brief definition of LIBOR and Margin on the calculator, autofeed the going figures (provided by the market or the lender), then give a chart history of how these figures change over time to let consumers try to ballpark. This would not be exact, of course, but again, would be a hell of a lot more informative than what you have shown us.
I bet consumers would take a much harder look at what they're doing after simply being allowed to play with some of these figures.
This calculator page also could include information on how to budget for a loan -- calculating real housing costs (taxes, maintenance etc) -data on how housing can by cyclical etc.
But even if the Fannie Mae verbiage were included in readable mixed case, we'd still have, "Lender is under no obligation to refinance ...", which the broker would negate by saying that's just legalese. And even though it says, "... you may have to pay some or all of the closing costs normally associated with a new loan even if you obtain refinancing from the same lender," well, it says "may", right? And we know that even if you have to pay closing costs, well, you'll still have enough after the cash-out refinance to buy an SUV and spend a few weeks in Cancun -- you'll just have to put off the vacation home purchase till the next refinance.
The real problem here is that economists refuse to treat asset price inflation as inflation. If wages had been rising at anything like the rate of housing prices (or dot-com era stocks), the Fed would have come down on them like a ton of bricks.
Slightly off-topic, I wonder how much the popularity of this blog is due not only to the excellence of its content but also the equal excellence of its typography and layout. The generous leading (spacing) between the lines (and use of a serif typeface in the main text) make it far more readable than most.
Reposted:
All the disclosure in the world means nothing if borrowers don't understand what they are signing. That's why this is the most chilling comment from yesterday's hearing:
"I don't think there is one borrower in a thousand that understands the papers that they sign." -- John Robbins, chairman, Mortgage Bankers Association (as reported by the WashPost)
I agree with Bob_in_MA. The maximum payments must be reported, along with the earliest date such payment could be required. That should put an end to it.
jm - I agree, there seem to be many who are under the illusion that rising asset prices are a good thing. To my mind asset prices are a zero sum game. For every dime that somebody makes because they sold their house or stock or beanie baby collection at a price greather than they paid, somebody else has paid an extra dime to secure the benefits of ownership. I tend to suspect that asset prices have become so high in proportion to yield that we will soon have a whiplash correction in which large amounts of M3 will evaporate. There are those who would do anything to avoid such a correction, without realizing that the only way to avoid it is not to have the runup in prices in the first place.
"Your interest rate may be different" = "The rate of interest quoted prominently by your broker in all marketing is meaningless and only affects your payments for 1 year."
(and if you can't even then -what are we doing allowing loans like this to be made??)
BINGO!
I suggested at one point in our prior neg am discussion that it's like Vicodin versus aspirin. If you have a headache that can't be relieved with an aspirin, you're free to see a doctor who can prescribe Vicodin. The solution to the problem is not taking opiates off the DEA schedule and putting them on the shelf next to the Tylenol for people who like to "self-diagnose."
And I really hope everyone remembers all this when next the "private accounts" in lieu of Social Security thing starts up again. My confidence in most people's ability to read prospectuses and ignore fast-talking sales pitches from "investment advisors" is even less than my confidence in people's ability to understand fancy mortgages. And anyone who can't see the "social cost" of uninformed or misinformed or just nutsy individual decisions has not been paying attention to the housing/mortgage implosion.
jm, I think the best thing about this blog is that I can get you people all fired up about shit like adjustable rate mortgage regulatory disclosures at 7:00 a.m. without paying you to do it.
Tanta, if you have the inclination, could you possibly drop me a line directly? I've got a Q or three that I'd like to pose privately not the least of which would be why is Tom under the impression that you prefer marshmallow with your tuna? I've always been partial to crushed oreos myself...
I found both documents extremely clear. While a some examples using real numbers could be helpful, they could also be dangerous because the borrower might assume that that the example is what their payments would actually be. Honestly, if you can't understand the loan contract then you really shouldn't sign it.
I deserve shaved bingo points for "doing allowing" -- ugh sorry- pick your word - 7 a.m. Indeed. Geek remorse.
So if that is the point, maybe we start by saying that any loan that consumers can't figure out with a neat little chart (or neater calculator --please let me keep my calculator dream) -- isn't worth making. More than fair enough and wise enough.
six percent solution - The reason $10,000 is used is because that is how Reg Z requires it be presented in 226.19. Also, there are model clauses, etc, in Reg Z which should be used to protect the lender from FTC claims. You see, if the lender uses those clauses, they have a legal protection that they do not have if they use plain language.
I do prefer and always use the chart format for the required example. However, there are also rules as to not including extras in this mandatory disclosure [see 226.17(a)]. The disclosures shall be grouped together, shall be segregated from everything else, and shall not contain any information not directly related 37 to the disclosures required under
Sec. 226.18.38
So if you expand the required disclosure to include things not mandated, you are opening yourself up to a legal claim.
The bottom line is that new law is needed and new regulations to protect borrowers getting these types of loans. The regulations were not written with them in mind.
The guidances issued (not absolutely binding and not binding on non-depositories) do suggest additional, separate examples and disclosures, and I strongly agree with that.
One change I would strongly suggest is that a fifteen year or term historical example be mandatory instead of an option in the regulation for any loan with a potential for negative amortization. This is my two cents. I wouldn't do business with an institution that offered such loans who didn't provide such examples in a separate disclosure given to the borrower at the time the completed application is submitted or before any fee is taken.
Congress needed to act long before this. Unified federal authority must be given to some regulator to make rules binding on all lenders, and the federal agencies have only the authority to regulate as given to them by Congress. The CHARM booklet doesn't contain anything really relevant to many of the newer loan products, for example. Consumers have been very badly served by Congressional inaction in this respect. TILA did not give federal regulatory agencies all the authority that they need in order to institute some changes in Reg Z (binding on all subject lenders) that are needed. For example, when FRB wanted to change the definition of "clear and conspicuous" in Reg Z, they were threatened with legal action which probably would have succeeded, and they backed off.
Tanta wrote, "Nerds. All of you. Geeks and nerds."
And you glory in it, Tanta. It's a nerd and geek party of unparalleled dimensions. A lot of good sense on this thread. You are our Nerd Princess, our Empress of Loan Geekdom.
Oh and speaking of dreams - Winston do you really think if that doc wasn't accompanied by a realtor/broker snow job that your average joe would agree to a loan like that? Would you agree to this loan now that you profess to understand it so well?
Let's try that sentence again-- If you can't make an understandable loan contract, don't make the damn loan.
What the disclosure statements really need to say is:
"Over the long term, home prices can't rise faster than incomes. So if prices have been going up faster, that'll soon stop. If they've been going up a lot faster, they'll fall.
"That means you must not plan to refinance with a bigger loan and get cash back. Prices can easily fall so much you won't be able to refinance at all -- even just to get a lower rate.
"Don't trust anyone, repeat anyone, telling you different, no matter who they are. Not even if you hear it on TV."
"Most bills still getting paid on time
American Bankers Association study shows payments on home equity loans going delinquent, but credit cards holding steady."
I think people forget how most Americans will look at a increase in payments and say "By that time we will be making a lot more income and the payments will be no problem"
think people forget how most Americans will look at a increase in payments and say "By that time we will be making a lot more income and the payments will be no problem"
Yeah, it's just that they've already justified lying about their "stated income" by telling themselves that soon they'll be making more income and can afford the starting payments.
Tanta, someone -- might have been the Mortgage Asset Research Institute -- scrutinized 100 state-income loans selected at random last year and looked at the borrowers' true incomes as stated in their IRS returns.
90 had exaggerated their incomes.
60 had exaggerated their incomes by at least 50 percent.
I suppose you could say that they told the truth to the lender and lied to the IRS. Either way, those lenders were lending to liars.
I think this discussion is pretty good evidence that there should be one type of mortgage for everyone: fixed interest rate, with variation only allowed as to the term (20 or 30 or x years...). But basically anything else is just too complicated and leads to the possibility of abuse. We don't let Mom and Pop invest in hedge funds, unless they have sufficient net worth; we shouldn't let Mom and Pop gamble on housing either. It's easy to comparison shop on fixed-rates loans, and I think it's really the lack of transparency, touted as financial innovation, which appeals to the financial industry.
zoiks,
All but 2 pages of the tax code are accomodations to special interest groups.
Without special interest groups, your tax return would look like this:
back when i worked for the government drafting regulations they sprung for a three day seminar by a famous writing instructor to teach us to write more gooder so people could understand what the heck we were saying.
first thing famous writing guru guy says is "you won't be allowed to use anything you learn during this seminar in your actual jobs."
The warning on the back of my box of Q-tips reads: "Do not insert swab into ear canal. Entering the ear canal could cause injury. If used to clean ears, stroke swab gently around the outer surface only."
I confess, I put Q-tips in my ears. My parents and grandparents do as well and no harm has ever come to them. So I figured it was harmless.
I'm sure most people would dismiss payment tables in the same manner. They would think, "In the past people who were approved for home loans could afford to make payments. I've been approved for a loan, therefore the person making the loan (who has a lot more experience than I do in these matters) must think I can afford it."
Even the most ominous plain language warnings would be dismissed as legal ass-covering.
I like the disclosure as is, which appears to put me in the minority.
For one thing, I know a lot of areas where a First Mortgage can be had for much less than $100K. $10K makes sense, and if you can't figure out how to convert "per $10K" to a $250K mortgage, you're not going to understand a spreadsheet.
Assuming I read the doc correctly, the point at which the loan reaches 115% of principal [110% in NY State] ($115K [$110K NYS] for an initially-$100K mortgage), the payment automatically goes to either (1) an amount that covers at least the full imputed interest, (2) an amount that allows paying of the loan in full over 15 years, or (3) an amount to cover the 9.95% maximum interest rate.
Point 4 makes it clear that the payment at that time would likely be more than three times the initial payment ($32.16 to $101.70), so the only thing not Really Obvious is that the new principal would make the required payment equivalent to $111.87 in NYS and $116.98 elsewhere.
It's a Very Clear Disclosure, which is one reason I suspect it's the exception, not the rule.
Assuming I read the doc correctly, the point at which the loan reaches 115% of principal [110% in NY State] ($115K [$110K NYS] for an initially-$100K mortgage), the payment automatically goes to either (1) an amount that covers at least the full imputed interest, (2) an amount that allows paying of the loan in full over 15 years, or (3) an amount to cover the 9.95% maximum interest rate.
Hate to have to say it, Ken, but that's not what it says. When you hit the balance cap, you go to a fully amortizing payment over the remaining term of the loan. You no longer have the "IO option."
9.95% is the maximum interest rate on the loan. It may or may not ever be achieved on an individual loan; that depends on the future value of the index. This disclosure does not give an actual margin--did anyone notice that?--but it uses an "example" margin of 2.00%. In order for the interest rate on the loan to get to 9.95%, that means LIBOR would have to get to 7.95%.
OT: (my head was hurting from all this mortgage finance stuff)
I was strolling through the back issues of CR and came across this from Jan '06:
30 year Pleasure Boat Loans
So I'm opening this to anyone with sad stories (anecdotal or otherwise) of boat owners owners gone bust, or bargains to be had from the boat-REO world (if such a beast exists).
thought you might find this interesting. It came from a Washington Mutual broker that I have never met or heard of:
While many non-prime companies are getting out of the market, WaMus adding more non-prime programs . . .
No need for perfect creditclients with FICO® scores as low as 500 can
qualify for financing (no scores required for co-borrowers!)
With expanded qualifying guidelines and debt ratios up to 55%, more
buyers can get into the house they want
Plus special programs for clients with past defaults, foreclosures or
bankruptcies
Cash reserves are not required
Loan amounts up to $1.3M
Sellers contribution allowed up to 6%
NOT high-cost loans
Faster processing with flexible documentation guidelines
Does this sound credible? Wouldn't the FDIC be very interested in what WaMu is doing if this is the case?
The language is about as straightforward as is possible given the context in which it is being delivered (companies, lawyers, lawsuits etc.).
Here is the problem with a "real world example." The unsophisticated are going to assume THAT will be what happens and beware if it doesn't. What is really needed is a table of possibilities. Yet even that is riskier than lawyers will ever allow a lender.
I think the bigger issue is timing and laziness. In the midst of a boring signing, folks are tired and just want to get it over with (at least I always am). They simply aren't going to choose AT THE END OF THE PROCESS not to buy a home. They just aren't. To be useful, this needs to be done at the beginning of the process and borrowers have to be willing to put in the time to actually read it.
I think it's time, as a matter or national policy, to assert that a person's principal place of residence is not going to be used as a source of leverage.
Once upon a time, for example, NO self-respecting bank would be involved in a second. Zero. None. You had to go to a "finance" company for that. It's time to put an end to this crap.
Banker: "Here is the problem with a "real world example." The unsophisticated are going to assume THAT will be what happens and beware if it doesn't."
That's the point! Out of one side of their mouths, lenders say these loans are used by sophisticated borrowers who understand the risks... out of the other, they tell us, "you'll really confuse the borrowers (by showing them what could happen), because they aren't sophisticated enough to understand these loan terms..."
Well, which is it?
That this is even being discussed after all the previous cases of exposed predatory lending is a great testament to how easily bought off our legislators are, at both the Federal and state levels. And the regulators too, perghaps. How many retire from "government service" to enrich themselves in the industry they once supervised?
Banker: "Here is the problem with a "real world example." The unsophisticated are going to assume THAT will be what happens and beware if it doesn't."
That's the point! Out of one side of their mouths, lenders say these loans are used by sophisticated borrowers who understand the risks... out of the other, they tell us, "you'll really confuse the borrowers (by showing them what could happen), because they aren't sophisticated enough to understand these loan terms..."
Well, which is it?
That this is even being discussed after all the previous cases of exposed predatory lending is a great testament to how easily bought off our legislators are, at both the Federal and state levels. And the regulators too, perghaps. How many retire from "government service" to enrich themselves in the industry they once supervised?
It certainly is not easy to determine whether a person understands something. This is traditionally done in schools by giving a test, and I've not heard of a shortcut. One approach then is to allow only a restricted set of loan products, and produce standard tests (like a driver's license) if the allowed products include arms, option arms, etc. But I'd rather have market forces strengthened so that the institution selling the loan does not have an incentive to sell bad loans, collect fees, and shutter their doors. Would it help if the loan issuer had to retain some 'reserve fraction' of all loans they write?
Reading graphs, let alone running spreadsheets, is not a skill an intelligent illiterate bricklayer should have to acquire in order to buy a house, IMO.
I think the basic ARM explanation is fine. Once it gets into the option parts, all understanding vanishes. This is not necessarily because it is badly worded; it might be that there is just too much stuff flying around for a person to clearly grasp.
My personal experience with an ARM is good: I bought a house in 1983 with an ARM (2 points over prime, adjusted annually) and kept it until 2006. There were a few years when it was steep, but, on average, I came out pretty good - some years I had a rate of about 3 percent. However: no options, no negative-am... and I had some savings reserves and my earnings grew over the years. Other circumstances would have come to a different ending.
Tanta, correct me if I'm wrong, but it wasn't all that long ago when a borrower on a first had to agree that a property would not be encumbered by a second. If it was, the first went into default.
I suspect that no matter how easily understandable the disclosure were made, it's effect would frequently be negated by the broker fast-talking the borrower with, "If your payments go up you can just refinance."
jm is exactly right. No amount of disclosure would overcome this.
What better disclosures can do is to make people accountable. It wont stop the speculation, but speculators will be made aware and acknowledge that they are speculating, and buyers who dont want to speculate wont end up unknowingly doing so because the lender took them for a ride. (speculating -> on house prices, interest rates, future income, whatever)
Why cant negative-amortization be disclosed for what it is?
"If you cannot pay the amortizing payment, you can borrow an extra amount to make the payment for that month.
If you borrow an extra amount for your monthly payments, the etxra amount will be added to your loan balance. Your loan balance will increase everytime you do this. When your loan balance reach Xxx,xxx dollars, you will have to make the full payments." and so on.
Really I would like to see,
-An actual amortization table for the loan at prevailing interest rates. If its LIBOR+margin, then use current LIBOR+margin.
-An actual amortization table at the interest rate cap, if the loan is an ARM
Additionally, if its an option loan,
-An example payment using the actual terms and amounts of the loan which makes it clear the maximum negative amortization that can get tacked on in one month, and how it gets added to the original loan as an extra loan.
-An example of the maximum possible monthly payment that will be needed when the loan recasts.
Did you ever see one of the many silent movies with the evil landlord, dressed in black with a handlebar moustache, demanding favors from poor little Mary because she couldn't pay the rent on time? Widespread home ownership in this great nation of ours is a relatively recent phenomenon, brought about because FDR made it a matter of national policy.
Not all that long ago, thanks largely to Reagan and his trickle-down geniuses, who set into motion this movement to de-regulate damned near everything, we've got this mess.
I think it's time for everyone to stop nibbling around the margins of the problem and start pushing the need to get back to basics. A HOME should not be allowed to become an instrument of financial leverage. Period. Get back to a twenty- or thiry-year fixed and be done with it. Even Joe Sixpack can, with a reasonable amount of voltage, be made to understand how a thirty-year fixed works.
Screwing around with home ownership not only has enormous financial implications, as we've come to know, but enormous social implications as well. Unfortunately, we have yet to learn what the social problems will be.
Seriously, on what basis do you make such an argument? If I buy a home and later my financial prospects improve, why souldn't I be able to borrow against any increased equity I may have? Are you going to make me move to a bigger home so I can stay as leveraged as I am comfortable with? Are you going to force me to keep all my accumulated equity in real estate?
Bottom line, all of this financial snow drove house prices into outer space.
It's ironic. FDR, that left-leaning pinko, made it possible for the little guys and gals to play the "home ownership" game. Reagan, and his fellow travellers, "real" conservatives all, made it possible for the little guy and gals to become serfs again.
Banker, it's not real estate, it's not a house, it's your HOME. Think HOME. If you're a German, think HEIMAT. Pride of place. Social anchor. Community.
If you want investment try the market, or buy an investment HOUSE. No one is forcing you to keep your accumulated equity in your HOME. If you want your equity, sell your HOME. People should have to decide what is more important to them, their accumulated equity or their HOME.
Why should the have to decide? Their existing home probably has enormous sentimental value, raised their kids there etc. You are going to FORCE them to sell to make alternative enivestment decisions? Let's see, time for the kids to go to college. I'm not allowed a home equity line, gotta move, sell the home we all grew together as a family in or the kids don't get to go to college.
Banker, I don't think you see how inflationary all of this is. All of this leverage has driven house prices skyward, making it damned near impossible for first-time buyers to enter the market, thus destroying FDR's dream of universal HOME ownership.
As to Mom and Dad selling the house to pay for college, guess what, they're going to have to sell it anyway because they piled on the leverage at the very peak of their economic lives to pay that tuition.
You know the saying, "You can't have your cake and eat it too." Well, that's what this country is doing. It is devouring itself. You can't have your home and, as CR says, have a "thirty-year hamburger" too.
I have always thought that option ARMs were the worst loans ever invented. California has a lot to answer for, in my opinion.
I have and will do standard ARMs, usually 5/1 or 10/1, for strong and financially sophisticated borrowers. Since nobody reads the disclosures I go over how the whole thing works to make sure that they understand it before they sign up for it. With I/O loans, I would put four figures on the yellow legal pad on the desk- the I/O payment, the 30 year amortized payment if they pick that option, the amortizing payment in five years at current rates (then about 5.5%), and the fully amortizizng payments at market plus 2% (say, 7.5% then), which seemed a reasonable worst case. Then I would say "If you can look at that payment and tell me 'Yes, I can make that payment', then you can get this loan." This to a borrower at 80 LTV or less with great reserves.
The way the mortgage brokers sell these deceptive option ARMS is nothing short of criminal.
I vote for a simple chart showing maximum monthly payment year by year for the term of the loan assuming either chart a) 5% fed funds/libor and chart b) 10% fed funds/libor. This would be one page and scare many borrowers straight.
Even the 5% chart should show some numbers to scare many borrowers and, with the 10% thrown in, lenders will be forced to explain why such interest rates are a longshot.
Of course, lenders will complain that they might easily/accidentally screw these numbers up due to the complicated calculations, but this is exactly the point, if the banks can't do the math, neither can the borrower.
I found the Note to be a little clearer than the Disclosure. I think that the Disclosure would benefit from an initial discussion of just what an option ARM is in general terms (without trying to get into the payment caps, index, etc.) and some charts at the end (including what the payment would be once the 115% limit is hit).
One question I had about the Note, though. At the end of Section 5 it states: "My partial prepayment may reduce the amount of my monthly payments after the first Interest Rate Change Date following my partial Prepayment. However, any reduction due to my partial Prepayment may be offset by an interest rate increase." Wouldn't a prepayment only (potentially) reduce the payments after a Payment Change Date (not the Interest Rate Change Date)? I understand that the principal is reduced by the prepayment, but assuming that the 115% max hasn't been reached, then the borrower's payments won't change until the annual payment change date, even if the interest accruing is reduced because of the prepayment. Or, are they trying to say that the total number of monthly payments (as opposed to the amount of each monthly payment) is being reduced? But, that wouldn't make sense either because the recalculated payment would still be based on the original 30 year loan term. I don't know if I'm missing something here or just being a little too nitpicky.
WaitinginOC, it would be clearer to you if this note were filled out with all of the relevant dates.
On this loan, the Payment Change Date would be the first day of the month following the Rate Change Date. (Mortgage interest is paid in arrears, so each payment is for the last 30 days of interest.) So if the rate changed on 3/1, the payment would change on 4/1, and would reflect the interest at the new rate for the balance outstanding on 3/1.
So if your rate changed on 3/1, your payment is calculated on the 3/1 balance. If you made a partial prepayment on 3/15, after the rate change date but before the payment change date, it wouldn't affect the payment calculation (it's too late for that). All ARMs work this way, not just neg am.
Let me clarify again. The prepayment made on 3/15 wouldn't affect your payment calculation until the next rate change date.
So if you have an ARM and you make partial prepayments and you want them to reduce your required monthly payment, you should always make them before the next rate change date.
I have read with interest the comments, most of which make valid points about using visual aids and technical improvements to the disclosure (the Note doesn't matter; the borrower is mentally committed (no pun intended) before they see the Note). But, none of this addresses the key point that is absent from the disclosure:
The initial monthly payment will certainly (probability > 99%) go up, by a lot (eg. more than 50 percent), and it will do so at a time that housing prices are flat due to everyone else's increased mortgage rates simultaneously reducing their purchasing power. So the odds of you being able to refinance when you need to are poor.
One odd thought: who buys these loans? I've read the past posts about CDOs--is the tranching all it took to disguise the crap nature of these loans? I mean, who bought the CDOs on subprimes intending to hold until maturity?
I understand your comment, and it matches with the language from Section 5. But, according to Section 4(D) of the Note, the payment only changes once per year (unless the exceptions in Section 4( or 4(I) apply), although the interest rate changes monthly under Section 4(A). Specifically, Section 4(D) states: "My monthly payment may change as required by Section 4(E) below beginning on the _____ day of ________________, and on that day every 12th month thereafter. Each of these dates is called a 'Payment Change Date.' So, I don't see how the Payment Change Date would occur one month after an Interest Rate Change Date, which appears to occur every month under Section 4(A). Thus, I'm still confused as to how a prepayment could change a monthly payment (which appears to be fixed until the next Payment Change Date) at the next Interest Rate Change Date.
Basically, as I read the Note, I thought that Section 4(D) said that payments were fixed for one year (until the Payment Change Date), then would adjust and remain fixed again for the next year (until the next Payment Change Date), and that this would go on until either the Maximum Limit was reached or the Borrower hit a fixed time (blank in 4(I)), at which the Full Payment would kick in. And that Section 4(A) stated that the Interest Rate Change Date would be once per month.
I know this isn't your loan document, but I'm just trying (and having a hard time) to reconcile what I see as an inconsistency. To me, the prepayment would only change the payment on the Payment Change Date, not on the next Interest Rate Change Date (unless these dates happened to coincide). I recognize that the amount of interest that would accrue would be affected by a prepayment, but I just don't see how a prepayment leads to a change in monthly payments until the next scheduled Payment Change Date. Thanks.
One month LIBOR today was 5.32%. My bank, today, was offering 30 year fixed for 6% (or 5.75 with .75 points). Thornburgh must be charging some margin over LIBOR, so there's essentially no savings. Is the teaser rate for the short period it'll be in effect worth the later, surely higher rates (one month LIBOR is up 44 bp over a year ago already)? Is the possibility of capped payments for the first five years (or whenever) worth the increased payments later when the increased balance will have to be amortized?
I can see adjustable rates when there's a real difference between the initial rate and the 30 year fixed rate and the initial rate stays for a while. But I don't see this.
Oh, and the note is a lot clearer than the disclosure.
My daddy told me years ago, "Never put something down to malice when ignorance covers all the facts."
Seems to apply here. As a secondary note, greater efficiency is not always desirable. Just think of the politicians you despise...and picture THEM being more efficient.
Well I LIKE the first paragraph of the disclosure. It's clear and concise. I think that the "your interest rate may be different" paragaph should be clearer, at least because it is the early teaser rate feature that is MOST dangerous in these loans. I could wish that the examples paragraph included charts or graphs, partly because that's the way I think and partly because at that point we've reached the MEGLO point.
I thought both of these documents were clear and understandable, but I'm not an average reader. I note that FED had most of its loans tied to an index that changes monthly. Payments were capped by 7.5%, an they had a graduated payment program. In general, after 5 years the monthly payment was reamortized over the life of the loan--without regard to the cap. How many surprises do you think there will be? Remember when it was just the interest rate that was capped?.
What is missing, IMV, is a simple schedule that shows what happens if your interest is X, Y, Z over the life of your loan. Despite the clarity of the docs, nothing sings like the numbers. So nods of agreement in reading the language may very well be replaced with "What the !#$#?!!!!".
The opening paragraph still obfuscates the key attribute of the loan: the initial monthly payments are the lowest they will ever be over the duration of the loan, and the monthly payment WILL GO UP A LOT. People evaluate loans based on their monthly cash flow. This loan is not clearly presented in terms of impact on monthly cash flow.
Only at the end of doc (4. Maximum Rate and Payment Examples) do they actually include real numbers, and even there they do it in terms of a $10,000 principal balance. Unless this is a 2nd mortgage, why talk about payments per $10,000 prinicipal? That should be payment per $100,000, which is much easier mental arithmetic. This disclosure does not tell a buyer straight up that their initial monthly payment of $321 per $100,000 will jump to $1017 per month.
All in all it appears to be readable, but no real world examples.
It needs less accounting jargon and more examples. This is a computer age and we know the financials and we know the ball park mortgage amounts. We can show examples what happens with payment resets and principal increases using current interest rates and we can show what happens under a couple of simple situation.
I can see the desire to keep from the customer thinking those figures are a commitment, but they can sign off on that just as well as this.
In summary, pictures and actual information should be there, not theory.
my comment above refers to the Disclosure. At what point in the process is the Note supplied the borrower?
My experience as a borrower is that the only thing a borrower really understands (and feels that he/she needs to know) is contained in par. 4. (Maximum Rate and Payment Examples). I agree with spcs, there are more straight forward ways to give the information that, in fact, is there.
six percent, most people never see a note until the day they're asked to sign it.
That's part of the reason why Reg Z demands that the disclosure be given no later than the time the application is made. (Actually, it says the disclosure must be given whenever a borrower inquires about an ARM loan, even if she hasn't officially applied yet. You're supposed to keep a stack in your desk drawer--or be able to pull them off the computer--for anyone who wanders in and says, "Do you have those ARM things?")
In the bad old days before Reg Z, the note was the only thing the borrower had to go on.
In the old days of round-robin sit-down loan closings where people brought their attorneys, it wasn't so bad. These days people do mail-in or escrow closings, skimp on the cost of legal representation, and often never even read the note--someone fans out a set of docs and the borrower just signs.
Notice that the Thornburg note doesn't have initial lines on the bottom of each page, just a signature line on the last page. I'm a real bitch about that: I have always insisted on having the borrower initial each page. It is not a legal requirement, but it's a good precaution, not just to encourage the borrower to look at each page. It also protects borrowers against having a crooked broker or lender slip in a page that doesn't match what got signed.
I would also add, in BIG BOLD FONT at the top of the note, a warning about signing anything with blanks that aren't filled in. Too many people get told that the blanks will get filled in later. THERE IS NO LATER WITH A PROMISSORY NOTE. It is the terms to which you are contractually bound. But people sign them all the time with blanks unfilled.
Explanations only work when they are framed to the receptive abilities of the intended audience.
I have always found that our local parrochial banking system was not on par with its anglo-saxon counterparts.
Reading through your blog and others, I feel relieved my country has only recently indulged into "financial engineering". Limited damage has been done. Just because we were late not smart.
We have mostly fixed-rates rates, always capped in percentage and very few buzzwords in contracts.
I feel relieved. Not everyone is smart and educated. And even so!
Still feel an utterly proponent of "wild-free markets" for goods and services.
Depict me as the local Thatcherian bloke! However strong regulations are needed for quite a few human activities including medical services, banking to name a few...
The language in the disclosure document is very clear, but unless one is reasonably numerate, it is hard to imagine what can happen. I think the banks should put a simple interactive excel spreadsheet on their websites. Loan parameters could be entered by the user, and the amortization schedule would adjust accordingly. Then you could add some requirement about showing the borrower how it worked, and illustrating some specific scenarios.
Those docs should use real numbers and should also be written in plainer english. The only reason to use so many big words is to misdirect the reader. If the loan wasn't bad, the bank wouldn't go out of their way to obfuscate the terms. If my mom read this she wouldn't understand it completely. Maybe that should be the test -- would you let your mom or pop sign these docs as they're written?
Ooh, ooh, mandatory quiz! To test that the borrower actually understands the terms, quiz them afterwards. They don't get the loan until they understand it. Again, the problem with that is once they understand it, they may (understandably) no longer want it.
Hahah. Honestly, you are going to lose a lotof homebuyers at LIBOR. And imagine what a broker will say when a homebuyer says: "Um, I have a question about how my interest is calculated..."
I second Isabel -- the real information is contained in par. 4 - but it needs to be in chart form-not long sentences. And for God's sake, this is the age of the computer. What ought to be required is a statement in big bold type right under the chart: "To see how your own monthly loan payments may change when interest rates change, go to the online calculator at www.knowyourloan.gov." Just having a consumer fill out the terms of the loan in this type of calculator, be able to output payment skeds based on different rate-change scenarios, would be far more informative than a paper trying to explain the math in long, obfuscatory sentences.
Warning language at the tip-top of paperwork a great idea too!
OT PS: Tanta thanks for info on Countrywide, even tho I misspelled it. In good times, SL's seemed to rush to become commercial banks, now maybee this is start of reverse trend... Really irksome that that may mean they run from responsibility, too.
I agree with the other commenters on the need to include specifics, but also: in many lines of business, nobody writes anything longer than two pages without some sort of executive summary at the beginning that contains the facts of greatest importance to the reader. You also could approach this like a news story. The important stuff needs to be up front. In a document this important to the financial health of the borrower, a Surgeon General tone might be appropriate:
You are taking out a loan for $xxx,xxx. You will have a choice of payments. Your initial payment will be $x,xxx, if you pay the fully amortized rate. After x years, your balance would be xxx,xxx and the payment will adjust to a range between x,xxx and x,xxx. Here are the subsequent yearly adjustments...
The is a pay option loan, and you may choose to pay less than the amortizing rate. If you choose to pay the minimum required, you will pay x,xxx. After x years, your balance would be xxx,xxx and your new payment will adjust to a range between x,xxx and x,xxx. If your loan balance reaches xxx,xxx, your minimumn payment will be revised sharply upward, to the range $xxxx-xxxx.
[Escrow payment disclosure. Prepayment penalty disclosure. Foreclosure disclosure.]
Oral statements from any party, including mortgage broker, real estate agents, and your very smart Uncle Freddy as to the likely direction of interest rates over the term of this loan; the availablity of refinancing in the future; the appreciation of the property on which this loan is based should be disregarded, and course of actions based on such matters should be diregarded. Past market activities are no guarantee of future market opportunities.
I concur with those comments already written: I am a lawyer who drafted a lot of notes (although on the commercial side), and that disclosure is really well done, in that it accurately states what is going on in the note. However, having read your negative amortization for Ubernerds post with spreadsheets was a lot clearer.
Tanta - How did you get to the disclosure and note? I have been poking about Thornberg's website looking for the directory, but I can't find it.
I think there should be a standard form that's easily comparable between loans.
The actual maximum monthly payment at the start one year out, and also for years 2-5. If it's an option ARM, or there are teaser rates which don't cover the accruing interest, the stated payment amount would be the fully amortizing rate.
For option ARM, interest only, loans with a teaser rate discount or ARMs with large potential resets, there would be need to be a separate page in simple, prescribed, terms, nad in large type giving a clear warning that there was the potential payment shocks, and exactly what those would entail. Then these loans really would only be used by sophosticated borrowers who understood the risks.
Prepayment penalties should be completely barred.
2 points after reading an actually disclosure.
Alo puts the hammer right over the nail and swings hard:
What ought to be required is a statement in big bold type right under the chart: "To see how your own monthly loan payments may change when interest rates change, go to the online calculator at www.knowyourloan.gov." Just having a consumer fill out the terms of the loan in this type of calculator, be able to output payment skeds based on different rate-change scenarios, would be far more informative than a paper trying to explain the math in long, obfuscatory sentences.
The problem with this wonderful idea is all the various parameters a borrower has to input in order to get the thing to work. You have to find the value of LIBOR. You have to know what the margin is. You have to express the loan term in years or months. You have to know date of first rate adjustment, of payment adjustment, what the cap is, etc. In other words, you have to understand how the loan works before you can use the calculator that shows you how the loan works.
Lawyer, I just Googled "ARM Loan Program Disclosure Option ARM" and got the Thornburg hit (among others). I was particularly looking for an OA disclosure.
I come at this not as the neophyte you seek (you have played a part in corrupting me) but as a person used to trying to parse technical documents for laymen. I was a reporter and newspaper editor.
In the interest of brevity, I will confine myself to the first page in this comment.
The first problem is words for which a typical consumer does not have definitions. Words like interbank, promissory, margin, and amortization are really the jargon of the lending industry and while there may be context clues and even outright definitions, there's a big difference between having a word defined for you and understanding that definition.
A word like margin has a generic meaning (available or empty space) that is widely understood, but the precise definition given doesn't automatically match up with that.
The legalese also is an issue. The whole bit about "If the Index is no longer available... " is extraneous ass-covering legalese from the perspective of the typical consumer; while the bank certainly needs to say it, does the consumer really need to know it?
Finally, there is the whole aspect of math word problems. Some people (cough, cough Tanta) may enjoy such puzzles, but a lot those kids in class who complained about "not getting them" were serious.
I guarantee the sentence that begins "The most recent Index figure available..." in the index definition will totally flummox a good portion of the population.
Oh yeah,
As CR's example amply demonstrates, a couple of charts and tables with an example would be very helpful for many people.
Whatizit about this RegZ special document to ensure that ARM borrower really understands what he is promising?
Should it be pulled out of a crimson envelope marked "DANGER"? Should the person on the delivery side be mandated to wear the costume of The Devil as he prepares to make his offering? How about the recipient donning the Sheep costume?...Ok, too kinky.
I notice one party has the document, prepares the document and the other party "puts his hand" to it. This transaction is pretty one-sided and allows for no input on the other side.
Like: here's the reason why I am opting for this ARM: you may think you are fleecing me at 8% but I already have this house sold in 6 months to a reliable guaranteed customer at a solid 10% over this current principal.
That is the wrong skit. You sign their paper. They don't sign whatever you are mumbling about or agree to whatever paper you might have.
Does the document, Reg Z, represent a transaction (ARM) that is inherently short-sighted, modestly if latently predatory (your cue is the max Interest Rate Cap of 9.95% rate) and trading on the borrower's marginal (not just financial but possibly ethical) capacity that has turned him away from those FRM?
Does the invention of this new financial instrument arise from the nature of the market: faster rising house prices than wages?
The Reg Z strikes me as an effort to legitimize a practice that is almost legitimate: flipping.
as someone who has had a customer ask about "one of them ARM things",and who has tried to explain it to them,i think charts and graphs would be helpful for some...on the other hand there are plenty of people whose eyes glaze over at any 3 syllable word,and say "just get me the lowest payment,like that guy on the radio".try to tell them it is too risky,and why,or not suitable for them,and they frequently yell at you,and walk out,which i am ok with.mencken was right when he said"no one has EVER gone broke by underestimating the intelligence,or good taste of the american people"sad.BTW have you considered selling "Tanta's Groupies" t-shirts? the Motto could be "A Thirst for Knowledge,And A Taste For Chocolate"If you are ever in the wine country drop me a line,i'll pour a gallon or two of the good stuff,and feed you my unforgettable tunafish-marshmallow casserole with the raspberry caper sauce.
I began reading the document but then struggled. I suppose if i was a motivated buyer i would have continued, taken some notes, and had some questions to help me figure it all out. Some people are even less verbal/analytical than i am. They are right brained rather than left brained and really they would need this to be done in pictures or something to grasp what the hell is going on.
The problem, of course, is that these documents must stand in court. Therefore the words must be chosen on the way the law defines them. "Normal language" documents suffer when they get into courts for this reason. Nonetheless, what I'd like to see is one more note - a "normal language translation" - that begins something like this:
And at the head - BEFORE the title which says "normal language translation of the note" - put a signature block under a clause that is clear and legal, saying something like:
my unforgettable tunafish-marshmallow casserole with the raspberry caper sauce.
Don't forget that I'm in the DC area, so if you ever end up facing a congressional subpoena--the House Committee on Unsafe and Unsound Recipes, perhaps?--you could stop by and admire my classic spreadsheet collection.
Tanta,
Here would be the test of the Thornburg's forms:
Give the forms to someone, then give them the inputs for a hypothetical situation, and ask them to determine their monthly payment. (They would be allowed use of a calculator, or any other aids they saw as helpful.)
If they came up with the right number, they could have the loan.
Now, what percentage of the people who took out option ARMs over the last tree years woiuld be able to do it?
My guess is less than 5%.
The maximum payments need to be given. Period.
I suspect that no matter how easily understandable the disclosure were made, it's effect would frequently be negated by the broker fast-talking the borrower with, "If your payments go up you can just refinance." Especially in cases where the borrower is getting a low teaser rate for the first few years, it would not be unnatural for them to think they could get the low teaser starting rate again. They don't understand how points and prepayment penalties affect the overall real interest rate; moreover, when the belief that real estate is sure to go up 15% a year and will never go down* has taken root, a prepayment penalty won't cause any fear -- just cash out a little equity and it's covered, right? If the borrower is not getting oral representations like that from the mortgage broker, they're probably getting them from the real estate agent, or they know someone who has done that -- or they've watched the homes in the neighborhood they're buying into go up from $300k to $600k in five years, and can easily figure it out for themselves.
A major underlying element of the problem is the widespread belief that bidding up the prices of assets produces wealth -- a belief fostered by numerous economists and economic commentators. We've had statements to that effect not only from Alan Greenspan, but also from numerous op-ed writers and pundits who claim that the nation's savings rate not only isn't negative, but is actually high, because asset prices have risen so much.
*There having been a steady stream of statements from numerous eminent economists to that effect.
**Despite the fact that salaries have been stagnant and numerous managers and professionals have lost their jobs to offshoring.
I have a Master's degree in mathematics. I have been an actuary for several years (a while ago). I've been reading CR for about two years, and I usually read many of the comments. I have bought and sold a house, and have had a simple fixed-rate 15yr mortgage.
While I understood the note, it required actual serious thought on my part, and I doubt that most people could understand it. When I bought my house, I trusted my lawyer, but I read all the documents and questions my lawyer on all the stuff that was a little unclear.
I agree with many of the commentators about the need for graphs and charts.
10:01 comment
questions should be questioned
jm, this is the actual text (bold and caps in the original) from the very top of the Fannie Mae/Freddie Mac standard balloon note:
THIS LOAN IS PAYABLE IN FULL AT MATURITY. YOU MUST REPAY THE ENTIRE PRINCIPAL BALANCE OF THE LOAN AND UNPAID INTEREST THEN DUE. LENDER IS UNDER NO OBLIGATION TO REFINANCE THE LOAN AT THAT TIME. YOU WILL, THEREFORE, BE REQUIRED TO MAKE PAYMENT OUT OF OTHER ASSETS THAT YOU MAY OWN, OR YOU WILL HAVE TO FIND A LENDER, WHICH MAY BE THE LENDER YOU HAVE THIS LOAN WITH, WILLING TO LEND YOU THE MONEY. IF YOU REFINANCE THIS LOAN AT MATURITY, YOU MAY HAVE TO PAY SOME OR ALL OF THE CLOSING COSTS NORMALLY ASSOCIATED WITH A NEW LOAN EVEN IF YOU OBTAIN REFINANCING FROM THE SAME LENDER.
Perhaps we should add something like that to ARM notes/disclosures?
https://www.efanniemae.com/sf/formsdocs/documents/notes/doc/3260w.doc
Here's another thing to ponder:
Thornburg Mortgage markets its products to sophisticated, relatively wealthy people. Broadly speaking, a Thornburg customer knows how to read a prospectus.
So I have a hunch that:
a) Most Thornburg borrowers understand the disclosures and note;
b) These borrowers would be turned off by unnecessarily obfuscatory language;
c) and therefore, Thornburg's disclosures are probably written more clearly than those from lenders who go after unsophisticated customers. You know, the kind of lender that is backed by a huge corporation, but advertises late at night with TV commercials with bad production values. Now, why would they do that, if they could afford better? Hmmm......
Tanta, I most definitely agree we should, except it shouldn't be in all caps, as it has been well known since the military studied instruction manual readability back in WWI days that all-caps text has very low readability.
oops, WWII days.
WHAT?? I CAN'T HEAR YOU! SPEAK UP, SONNY!
I dislike shouting at my customers, even if it is motivated by an attempt to look out for their best interests.
Tanta, I think even if you are just offering ballparks you actually can get a consumer to understand their loans better on a calculator than in writing (and if you can't even then -what are we doing allowing loans like this to be made??)
However, figures like Libor and margin stuff, I think, could be made to be fed in automatically (after the fact you could even reqire the lender to notify the buyer with updated figures in a new calculator link each time they change rates) And you can make the lender disclose (in another pretty chart, as customized for the consumer as possible, all the other figures you'd need to plug into the calculator.
But at minimum, you can offer the consumer a brief definition of LIBOR and Margin on the calculator, autofeed the going figures (provided by the market or the lender), then give a chart history of how these figures change over time to let consumers try to ballpark. This would not be exact, of course, but again, would be a hell of a lot more informative than what you have shown us.
I bet consumers would take a much harder look at what they're doing after simply being allowed to play with some of these figures.
This calculator page also could include information on how to budget for a loan -- calculating real housing costs (taxes, maintenance etc) -data on how housing can by cyclical etc.
You may say I'm a dreamer...
But even if the Fannie Mae verbiage were included in readable mixed case, we'd still have, "Lender is under no obligation to refinance ...", which the broker would negate by saying that's just legalese. And even though it says, "... you may have to pay some or all of the closing costs normally associated with a new loan even if you obtain refinancing from the same lender," well, it says "may", right? And we know that even if you have to pay closing costs, well, you'll still have enough after the cash-out refinance to buy an SUV and spend a few weeks in Cancun -- you'll just have to put off the vacation home purchase till the next refinance.
The real problem here is that economists refuse to treat asset price inflation as inflation. If wages had been rising at anything like the rate of housing prices (or dot-com era stocks), the Fed would have come down on them like a ton of bricks.
Slightly off-topic, I wonder how much the popularity of this blog is due not only to the excellence of its content but also the equal excellence of its typography and layout. The generous leading (spacing) between the lines (and use of a serif typeface in the main text) make it far more readable than most.
Reposted:
All the disclosure in the world means nothing if borrowers don't understand what they are signing. That's why this is the most chilling comment from yesterday's hearing:
"I don't think there is one borrower in a thousand that understands the papers that they sign." -- John Robbins, chairman, Mortgage Bankers Association (as reported by the WashPost)
I agree with Bob_in_MA. The maximum payments must be reported, along with the earliest date such payment could be required. That should put an end to it.
jm - I agree, there seem to be many who are under the illusion that rising asset prices are a good thing. To my mind asset prices are a zero sum game. For every dime that somebody makes because they sold their house or stock or beanie baby collection at a price greather than they paid, somebody else has paid an extra dime to secure the benefits of ownership. I tend to suspect that asset prices have become so high in proportion to yield that we will soon have a whiplash correction in which large amounts of M3 will evaporate. There are those who would do anything to avoid such a correction, without realizing that the only way to avoid it is not to have the runup in prices in the first place.
"Your interest rate may be different" = "The rate of interest quoted prominently by your broker in all marketing is meaningless and only affects your payments for 1 year."
(and if you can't even then -what are we doing allowing loans like this to be made??)
BINGO!
I suggested at one point in our prior neg am discussion that it's like Vicodin versus aspirin. If you have a headache that can't be relieved with an aspirin, you're free to see a doctor who can prescribe Vicodin. The solution to the problem is not taking opiates off the DEA schedule and putting them on the shelf next to the Tylenol for people who like to "self-diagnose."
And I really hope everyone remembers all this when next the "private accounts" in lieu of Social Security thing starts up again. My confidence in most people's ability to read prospectuses and ignore fast-talking sales pitches from "investment advisors" is even less than my confidence in people's ability to understand fancy mortgages. And anyone who can't see the "social cost" of uninformed or misinformed or just nutsy individual decisions has not been paying attention to the housing/mortgage implosion.
jm, I think the best thing about this blog is that I can get you people all fired up about shit like adjustable rate mortgage regulatory disclosures at 7:00 a.m. without paying you to do it.
Nerds. All of you. Geeks and nerds.
Tanta, if you have the inclination, could you possibly drop me a line directly? I've got a Q or three that I'd like to pose privately not the least of which would be why is Tom under the impression that you prefer marshmallow with your tuna? I've always been partial to crushed oreos myself...
I found both documents extremely clear. While a some examples using real numbers could be helpful, they could also be dangerous because the borrower might assume that that the example is what their payments would actually be. Honestly, if you can't understand the loan contract then you really shouldn't sign it.
"the folks who loaned her nearly $1.5 million in four months remain mum. Countrywide and National City declined comment. Indy/Bank didn't call back."
Shabby home more proof of loan fiasco - The Denver Post
I deserve shaved bingo points for "doing allowing" -- ugh sorry- pick your word - 7 a.m. Indeed. Geek remorse.
So if that is the point, maybe we start by saying that any loan that consumers can't figure out with a neat little chart (or neater calculator --please let me keep my calculator dream) -- isn't worth making. More than fair enough and wise enough.
six percent solution - The reason $10,000 is used is because that is how Reg Z requires it be presented in 226.19. Also, there are model clauses, etc, in Reg Z which should be used to protect the lender from FTC claims. You see, if the lender uses those clauses, they have a legal protection that they do not have if they use plain language.
I do prefer and always use the chart format for the required example. However, there are also rules as to not including extras in this mandatory disclosure [see 226.17(a)].
The disclosures shall be grouped together, shall be segregated from everything else, and shall not contain any information not directly related 37 to the disclosures required under
Sec. 226.18.38
So if you expand the required disclosure to include things not mandated, you are opening yourself up to a legal claim.
The bottom line is that new law is needed and new regulations to protect borrowers getting these types of loans. The regulations were not written with them in mind.
The guidances issued (not absolutely binding and not binding on non-depositories) do suggest additional, separate examples and disclosures, and I strongly agree with that.
(continued below)
(continued)
One change I would strongly suggest is that a fifteen year or term historical example be mandatory instead of an option in the regulation for any loan with a potential for negative amortization. This is my two cents. I wouldn't do business with an institution that offered such loans who didn't provide such examples in a separate disclosure given to the borrower at the time the completed application is submitted or before any fee is taken.
Congress needed to act long before this. Unified federal authority must be given to some regulator to make rules binding on all lenders, and the federal agencies have only the authority to regulate as given to them by Congress. The CHARM booklet doesn't contain anything really relevant to many of the newer loan products, for example. Consumers have been very badly served by Congressional inaction in this respect. TILA did not give federal regulatory agencies all the authority that they need in order to institute some changes in Reg Z (binding on all subject lenders) that are needed. For example, when FRB wanted to change the definition of "clear and conspicuous" in Reg Z, they were threatened with legal action which probably would have succeeded, and they backed off.
Tanta wrote, "Nerds. All of you. Geeks and nerds."
And you glory in it, Tanta. It's a nerd and geek party of unparalleled dimensions. A lot of good sense on this thread. You are our Nerd Princess, our Empress of Loan Geekdom.
Oh and speaking of dreams - Winston do you really think if that doc wasn't accompanied by a realtor/broker snow job that your average joe would agree to a loan like that? Would you agree to this loan now that you profess to understand it so well?
Let's try that sentence again-- If you can't make an understandable loan contract, don't make the damn loan.
What the disclosure statements really need to say is:
"Over the long term, home prices can't rise faster than incomes. So if prices have been going up faster, that'll soon stop. If they've been going up a lot faster, they'll fall.
"That means you must not plan to refinance with a bigger loan and get cash back. Prices can easily fall so much you won't be able to refinance at all -- even just to get a lower rate.
"Don't trust anyone, repeat anyone, telling you different, no matter who they are. Not even if you hear it on TV."
People still using HELOC money to pay credit cards. This makes sense (interst on credirt card is very high)
so how does CNN describe it:
CNNMoney.com: 404 Page Not Found
"Most bills still getting paid on time
American Bankers Association study shows payments on home equity loans going delinquent, but credit cards holding steady."
Tanta, just read your post on SS privatization. Absolutely could not agree more passionately.
I think people forget how most Americans will look at a increase in payments and say "By that time we will be making a lot more income and the payments will be no problem"
think people forget how most Americans will look at a increase in payments and say "By that time we will be making a lot more income and the payments will be no problem"
Yeah, it's just that they've already justified lying about their "stated income" by telling themselves that soon they'll be making more income and can afford the starting payments.
Stated income + Neg Am = Delusion Squared
Hey, that disclosure is a lot clearer than our friggin' tax code! Miles clearer. Why doesn't that get more attention?
Tanta, someone -- might have been the Mortgage Asset Research Institute -- scrutinized 100 state-income loans selected at random last year and looked at the borrowers' true incomes as stated in their IRS returns.
90 had exaggerated their incomes.
60 had exaggerated their incomes by at least 50 percent.
I suppose you could say that they told the truth to the lender and lied to the IRS. Either way, those lenders were lending to liars.
I think this discussion is pretty good evidence that there should be one type of mortgage for everyone: fixed interest rate, with variation only allowed as to the term (20 or 30 or x years...). But basically anything else is just too complicated and leads to the possibility of abuse. We don't let Mom and Pop invest in hedge funds, unless they have sufficient net worth; we shouldn't let Mom and Pop gamble on housing either. It's easy to comparison shop on fixed-rates loans, and I think it's really the lack of transparency, touted as financial innovation, which appeals to the financial industry.
zoiks,
All but 2 pages of the tax code are accomodations to special interest groups.
Without special interest groups, your tax return would look like this:
back when i worked for the government drafting regulations they sprung for a three day seminar by a famous writing instructor to teach us to write more gooder so people could understand what the heck we were saying.
first thing famous writing guru guy says is "you won't be allowed to use anything you learn during this seminar in your actual jobs."
Would charts or payment tables help?
The warning on the back of my box of Q-tips reads: "Do not insert swab into ear canal. Entering the ear canal could cause injury. If used to clean ears, stroke swab gently around the outer surface only."
I confess, I put Q-tips in my ears. My parents and grandparents do as well and no harm has ever come to them. So I figured it was harmless.
I'm sure most people would dismiss payment tables in the same manner. They would think, "In the past people who were approved for home loans could afford to make payments. I've been approved for a loan, therefore the person making the loan (who has a lot more experience than I do in these matters) must think I can afford it."
Even the most ominous plain language warnings would be dismissed as legal ass-covering.
I like the disclosure as is, which appears to put me in the minority.
For one thing, I know a lot of areas where a First Mortgage can be had for much less than $100K. $10K makes sense, and if you can't figure out how to convert "per $10K" to a $250K mortgage, you're not going to understand a spreadsheet.
Assuming I read the doc correctly, the point at which the loan reaches 115% of principal [110% in NY State] ($115K [$110K NYS] for an initially-$100K mortgage), the payment automatically goes to either (1) an amount that covers at least the full imputed interest, (2) an amount that allows paying of the loan in full over 15 years, or (3) an amount to cover the 9.95% maximum interest rate.
Point 4 makes it clear that the payment at that time would likely be more than three times the initial payment ($32.16 to $101.70), so the only thing not Really Obvious is that the new principal would make the required payment equivalent to $111.87 in NYS and $116.98 elsewhere.
It's a Very Clear Disclosure, which is one reason I suspect it's the exception, not the rule.
Assuming I read the doc correctly, the point at which the loan reaches 115% of principal [110% in NY State] ($115K [$110K NYS] for an initially-$100K mortgage), the payment automatically goes to either (1) an amount that covers at least the full imputed interest, (2) an amount that allows paying of the loan in full over 15 years, or (3) an amount to cover the 9.95% maximum interest rate.
Hate to have to say it, Ken, but that's not what it says. When you hit the balance cap, you go to a fully amortizing payment over the remaining term of the loan. You no longer have the "IO option."
9.95% is the maximum interest rate on the loan. It may or may not ever be achieved on an individual loan; that depends on the future value of the index. This disclosure does not give an actual margin--did anyone notice that?--but it uses an "example" margin of 2.00%. In order for the interest rate on the loan to get to 9.95%, that means LIBOR would have to get to 7.95%.
OT: (my head was hurting from all this mortgage finance stuff)
I was strolling through the back issues of CR and came across this from Jan '06:
30 year Pleasure Boat Loans
So I'm opening this to anyone with sad stories (anecdotal or otherwise) of boat owners owners gone bust, or bargains to be had from the boat-REO world (if such a beast exists).
I found this on another blog:
thought you might find this interesting. It came from a Washington Mutual broker that I have never met or heard of:
While many non-prime companies are getting out of the market, WaMus adding more non-prime programs . . .
No need for perfect creditclients with FICO® scores as low as 500 can
qualify for financing (no scores required for co-borrowers!)
With expanded qualifying guidelines and debt ratios up to 55%, more
buyers can get into the house they want
Plus special programs for clients with past defaults, foreclosures or
bankruptcies
Cash reserves are not required
Loan amounts up to $1.3M
Sellers contribution allowed up to 6%
NOT high-cost loans
Faster processing with flexible documentation guidelines
Does this sound credible? Wouldn't the FDIC be very interested in what WaMu is doing if this is the case?
lama- "Without special interest groups, your tax return would look like this:"
In 1938, that's how the tax form DID look.
Anonymous | 03.29.07 - 12:44 pm | #
It's been ages since I got Haloed that bad. Above comment was mine.
François,
Ah, then you can answer several questions.
I take it that the Hexagon has not been invaded by ARM's yet, or at least not the neg-am, 100% LTV type?
That was my impression.
You seem a lot more "ultra-liberal" than I am. I would vote for Bayrou for example...but not in a million years Sarkrazy.
But we part ways I guess on free markets. Any citoyen who buys a Japanese car should have an appt. with the guillotine IMHO.
Bienvenue!
The language is about as straightforward as is possible given the context in which it is being delivered (companies, lawyers, lawsuits etc.).
Here is the problem with a "real world example." The unsophisticated are going to assume THAT will be what happens and beware if it doesn't. What is really needed is a table of possibilities. Yet even that is riskier than lawyers will ever allow a lender.
I think the bigger issue is timing and laziness. In the midst of a boring signing, folks are tired and just want to get it over with (at least I always am). They simply aren't going to choose AT THE END OF THE PROCESS not to buy a home. They just aren't. To be useful, this needs to be done at the beginning of the process and borrowers have to be willing to put in the time to actually read it.
Not going to happen.
Banker is right.
I think it's time, as a matter or national policy, to assert that a person's principal place of residence is not going to be used as a source of leverage.
Once upon a time, for example, NO self-respecting bank would be involved in a second. Zero. None. You had to go to a "finance" company for that. It's time to put an end to this crap.
Banker: "Here is the problem with a "real world example." The unsophisticated are going to assume THAT will be what happens and beware if it doesn't."
That's the point! Out of one side of their mouths, lenders say these loans are used by sophisticated borrowers who understand the risks... out of the other, they tell us, "you'll really confuse the borrowers (by showing them what could happen), because they aren't sophisticated enough to understand these loan terms..."
Well, which is it?
That this is even being discussed after all the previous cases of exposed predatory lending is a great testament to how easily bought off our legislators are, at both the Federal and state levels. And the regulators too, perghaps. How many retire from "government service" to enrich themselves in the industry they once supervised?
Banker: "Here is the problem with a "real world example." The unsophisticated are going to assume THAT will be what happens and beware if it doesn't."
That's the point! Out of one side of their mouths, lenders say these loans are used by sophisticated borrowers who understand the risks... out of the other, they tell us, "you'll really confuse the borrowers (by showing them what could happen), because they aren't sophisticated enough to understand these loan terms..."
Well, which is it?
That this is even being discussed after all the previous cases of exposed predatory lending is a great testament to how easily bought off our legislators are, at both the Federal and state levels. And the regulators too, perghaps. How many retire from "government service" to enrich themselves in the industry they once supervised?
It certainly is not easy to determine whether a person understands something. This is traditionally done in schools by giving a test, and I've not heard of a shortcut. One approach then is to allow only a restricted set of loan products, and produce standard tests (like a driver's license) if the allowed products include arms, option arms, etc. But I'd rather have market forces strengthened so that the institution selling the loan does not have an incentive to sell bad loans, collect fees, and shutter their doors. Would it help if the loan issuer had to retain some 'reserve fraction' of all loans they write?
Reading graphs, let alone running spreadsheets, is not a skill an intelligent illiterate bricklayer should have to acquire in order to buy a house, IMO.
I think the basic ARM explanation is fine. Once it gets into the option parts, all understanding vanishes. This is not necessarily because it is badly worded; it might be that there is just too much stuff flying around for a person to clearly grasp.
My personal experience with an ARM is good: I bought a house in 1983 with an ARM (2 points over prime, adjusted annually) and kept it until 2006. There were a few years when it was steep, but, on average, I came out pretty good - some years I had a rate of about 3 percent. However: no options, no negative-am... and I had some savings reserves and my earnings grew over the years. Other circumstances would have come to a different ending.
Tanta, correct me if I'm wrong, but it wasn't all that long ago when a borrower on a first had to agree that a property would not be encumbered by a second. If it was, the first went into default.
I suspect that no matter how easily understandable the disclosure were made, it's effect would frequently be negated by the broker fast-talking the borrower with, "If your payments go up you can just refinance."
jm is exactly right. No amount of disclosure would overcome this.
What better disclosures can do is to make people accountable. It wont stop the speculation, but speculators will be made aware and acknowledge that they are speculating, and buyers who dont want to speculate wont end up unknowingly doing so because the lender took them for a ride. (speculating -> on house prices, interest rates, future income, whatever)
Why cant negative-amortization be disclosed for what it is?
"If you cannot pay the amortizing payment, you can borrow an extra amount to make the payment for that month.
If you borrow an extra amount for your monthly payments, the etxra amount will be added to your loan balance. Your loan balance will increase everytime you do this. When your loan balance reach Xxx,xxx dollars, you will have to make the full payments." and so on.
Really I would like to see,
-An actual amortization table for the loan at prevailing interest rates. If its LIBOR+margin, then use current LIBOR+margin.
-An actual amortization table at the interest rate cap, if the loan is an ARM
Additionally, if its an option loan,
-An example payment using the actual terms and amounts of the loan which makes it clear the maximum negative amortization that can get tacked on in one month, and how it gets added to the original loan as an extra loan.
-An example of the maximum possible monthly payment that will be needed when the loan recasts.
Did you ever see one of the many silent movies with the evil landlord, dressed in black with a handlebar moustache, demanding favors from poor little Mary because she couldn't pay the rent on time? Widespread home ownership in this great nation of ours is a relatively recent phenomenon, brought about because FDR made it a matter of national policy.
Not all that long ago, thanks largely to Reagan and his trickle-down geniuses, who set into motion this movement to de-regulate damned near everything, we've got this mess.
I think it's time for everyone to stop nibbling around the margins of the problem and start pushing the need to get back to basics. A HOME should not be allowed to become an instrument of financial leverage. Period. Get back to a twenty- or thiry-year fixed and be done with it. Even Joe Sixpack can, with a reasonable amount of voltage, be made to understand how a thirty-year fixed works.
Screwing around with home ownership not only has enormous financial implications, as we've come to know, but enormous social implications as well. Unfortunately, we have yet to learn what the social problems will be.
MP,
Yup. Dammitt, let's keep the poor renting!
Seriously, on what basis do you make such an argument? If I buy a home and later my financial prospects improve, why souldn't I be able to borrow against any increased equity I may have? Are you going to make me move to a bigger home so I can stay as leveraged as I am comfortable with? Are you going to force me to keep all my accumulated equity in real estate?
Bottom line, all of this financial snow drove house prices into outer space.
It's ironic. FDR, that left-leaning pinko, made it possible for the little guys and gals to play the "home ownership" game. Reagan, and his fellow travellers, "real" conservatives all, made it possible for the little guy and gals to become serfs again.
Rant done. Sorry. My bad.
Banker, it's not real estate, it's not a house, it's your HOME. Think HOME. If you're a German, think HEIMAT. Pride of place. Social anchor. Community.
If you want investment try the market, or buy an investment HOUSE. No one is forcing you to keep your accumulated equity in your HOME. If you want your equity, sell your HOME. People should have to decide what is more important to them, their accumulated equity or their HOME.
Mp,
Why should the have to decide? Their existing home probably has enormous sentimental value, raised their kids there etc. You are going to FORCE them to sell to make alternative enivestment decisions? Let's see, time for the kids to go to college. I'm not allowed a home equity line, gotta move, sell the home we all grew together as a family in or the kids don't get to go to college.
WOW, just WOW!
Banker, I don't think you see how inflationary all of this is. All of this leverage has driven house prices skyward, making it damned near impossible for first-time buyers to enter the market, thus destroying FDR's dream of universal HOME ownership.
As to Mom and Dad selling the house to pay for college, guess what, they're going to have to sell it anyway because they piled on the leverage at the very peak of their economic lives to pay that tuition.
You know the saying, "You can't have your cake and eat it too." Well, that's what this country is doing. It is devouring itself. You can't have your home and, as CR says, have a "thirty-year hamburger" too.
I have always thought that option ARMs were the worst loans ever invented. California has a lot to answer for, in my opinion.
I have and will do standard ARMs, usually 5/1 or 10/1, for strong and financially sophisticated borrowers. Since nobody reads the disclosures I go over how the whole thing works to make sure that they understand it before they sign up for it. With I/O loans, I would put four figures on the yellow legal pad on the desk- the I/O payment, the 30 year amortized payment if they pick that option, the amortizing payment in five years at current rates (then about 5.5%), and the fully amortizizng payments at market plus 2% (say, 7.5% then), which seemed a reasonable worst case. Then I would say "If you can look at that payment and tell me 'Yes, I can make that payment', then you can get this loan." This to a borrower at 80 LTV or less with great reserves.
The way the mortgage brokers sell these deceptive option ARMS is nothing short of criminal.
I vote for a simple chart showing maximum monthly payment year by year for the term of the loan assuming either chart a) 5% fed funds/libor and chart b) 10% fed funds/libor. This would be one page and scare many borrowers straight.
Even the 5% chart should show some numbers to scare many borrowers and, with the 10% thrown in, lenders will be forced to explain why such interest rates are a longshot.
Of course, lenders will complain that they might easily/accidentally screw these numbers up due to the complicated calculations, but this is exactly the point, if the banks can't do the math, neither can the borrower.
I found the Note to be a little clearer than the Disclosure. I think that the Disclosure would benefit from an initial discussion of just what an option ARM is in general terms (without trying to get into the payment caps, index, etc.) and some charts at the end (including what the payment would be once the 115% limit is hit).
One question I had about the Note, though. At the end of Section 5 it states: "My partial prepayment may reduce the amount of my monthly payments after the first Interest Rate Change Date following my partial Prepayment. However, any reduction due to my partial Prepayment may be offset by an interest rate increase." Wouldn't a prepayment only (potentially) reduce the payments after a Payment Change Date (not the Interest Rate Change Date)? I understand that the principal is reduced by the prepayment, but assuming that the 115% max hasn't been reached, then the borrower's payments won't change until the annual payment change date, even if the interest accruing is reduced because of the prepayment. Or, are they trying to say that the total number of monthly payments (as opposed to the amount of each monthly payment) is being reduced? But, that wouldn't make sense either because the recalculated payment would still be based on the original 30 year loan term. I don't know if I'm missing something here or just being a little too nitpicky.
WaitinginOC, it would be clearer to you if this note were filled out with all of the relevant dates.
On this loan, the Payment Change Date would be the first day of the month following the Rate Change Date. (Mortgage interest is paid in arrears, so each payment is for the last 30 days of interest.) So if the rate changed on 3/1, the payment would change on 4/1, and would reflect the interest at the new rate for the balance outstanding on 3/1.
So if your rate changed on 3/1, your payment is calculated on the 3/1 balance. If you made a partial prepayment on 3/15, after the rate change date but before the payment change date, it wouldn't affect the payment calculation (it's too late for that). All ARMs work this way, not just neg am.
Let me clarify again. The prepayment made on 3/15 wouldn't affect your payment calculation until the next rate change date.
So if you have an ARM and you make partial prepayments and you want them to reduce your required monthly payment, you should always make them before the next rate change date.
I have read with interest the comments, most of which make valid points about using visual aids and technical improvements to the disclosure (the Note doesn't matter; the borrower is mentally committed (no pun intended) before they see the Note). But, none of this addresses the key point that is absent from the disclosure:
The initial monthly payment will certainly (probability > 99%) go up, by a lot (eg. more than 50 percent), and it will do so at a time that housing prices are flat due to everyone else's increased mortgage rates simultaneously reducing their purchasing power. So the odds of you being able to refinance when you need to are poor.
One odd thought: who buys these loans? I've read the past posts about CDOs--is the tranching all it took to disguise the crap nature of these loans? I mean, who bought the CDOs on subprimes intending to hold until maturity?
Tanta:
I understand your comment, and it matches with the language from Section 5. But, according to Section 4(D) of the Note, the payment only changes once per year (unless the exceptions in Section 4(
or 4(I) apply), although the interest rate changes monthly under Section 4(A). Specifically, Section 4(D) states: "My monthly payment may change as required by Section 4(E) below beginning on the _____ day of ________________, and on that day every 12th month thereafter. Each of these dates is called a 'Payment Change Date.' So, I don't see how the Payment Change Date would occur one month after an Interest Rate Change Date, which appears to occur every month under Section 4(A). Thus, I'm still confused as to how a prepayment could change a monthly payment (which appears to be fixed until the next Payment Change Date) at the next Interest Rate Change Date.
Basically, as I read the Note, I thought that Section 4(D) said that payments were fixed for one year (until the Payment Change Date), then would adjust and remain fixed again for the next year (until the next Payment Change Date), and that this would go on until either the Maximum Limit was reached or the Borrower hit a fixed time (blank in 4(I)), at which the Full Payment would kick in. And that Section 4(A) stated that the Interest Rate Change Date would be once per month.
I know this isn't your loan document, but I'm just trying (and having a hard time) to reconcile what I see as an inconsistency. To me, the prepayment would only change the payment on the Payment Change Date, not on the next Interest Rate Change Date (unless these dates happened to coincide). I recognize that the amount of interest that would accrue would be affected by a prepayment, but I just don't see how a prepayment leads to a change in monthly payments until the next scheduled Payment Change Date. Thanks.
One month LIBOR today was 5.32%. My bank, today, was offering 30 year fixed for 6% (or 5.75 with .75 points). Thornburgh must be charging some margin over LIBOR, so there's essentially no savings. Is the teaser rate for the short period it'll be in effect worth the later, surely higher rates (one month LIBOR is up 44 bp over a year ago already)? Is the possibility of capped payments for the first five years (or whenever) worth the increased payments later when the increased balance will have to be amortized?
I can see adjustable rates when there's a real difference between the initial rate and the 30 year fixed rate and the initial rate stays for a while. But I don't see this.
Oh, and the note is a lot clearer than the disclosure.