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Government regulation’s role in the mortgage market

 
Think Tank
Mark A. Lane,
 Ph.D.
Associate Professor of Real Estate and Finance at Old Dominion University
Areas of research expertise in behavioral real estate, residential, and commercial.

Fannie, Freddie, FHA, VA, HAMP and HARP are just a few examples of the government’s influence on the current mortgage market. Add in the Federal Reserve’s efforts to keep mortgage rates low and you have a mortgage market that is currently dominated by government influence.

But is the U.S. mortgage market over-regulated or even perhaps under-regulated, and how do these regulations affect the cost and availability of mortgage loans? Does government influence make mortgages more expensive or harder for consumers to get?

To find out, we asked Mark A. Lane, Ph.D., associate professor of real estate and finance at Old Dominion University, to offer his thoughts on the role of government regulation in the residential mortgage market.

Q: Is the mortgage market is over-regulated or is it under-regulated? How do these regulations affect the cost and availability of mortgage loans?

A: First, let me say that some level of regulation in the housing market is useful. However, it is important to strike a balance so that the amount of regulation doesn’t place an unnecessary burden on the industry or distort market prices.

A consistent challenge here is that lenders are typically much more financially sophisticated than borrowers. For most people, purchasing a single-family home is one of the largest purchases they will make during their lifetimes and, because they do it very infrequently, they are unlikely to become experts in this area.

Why government regulation is necessary

Since the average consumer is not as financially sophisticated as their lender, they will have a harder time understanding everything in the very large stack of documents that accompanies the typical mortgage. So this opens borrowers up to the possibility of being taken advantage of in a transaction.

A lender taking advantage of a borrower is often referred to as “predatory lending.” The situation was so bad in the past that Congress enacted the “Home Ownership and Equity Protection Act (HOEPA)” in 1994 to combat some of the worst abuses.

Financing excessive fees into the loan amount, charging higher interest rates than warranted, excessive prepayment penalties, negative amortization and aggressive and deceptive marketing were just a few of the abuses HOEPA was designed to address.

So we have a situation where a lot of money is at stake and one of the parties is much more sophisticated than the other. I think most reasonable people would agree that some regulation is useful in such a situation, particularly if regulation is designed to protect the borrower.

Praise for government regulation

The government is directly tied to the residential housing market through the FHA, VA and other government-sponsored housing programs. These government-guaranteed mortgages have had both positive and negative effects on the residential real estate market. Here are a few of the items for which we can thank the FHA and VA for:

  • No prepayment penalties: FHA and VA loans do not include prepayment penalties. It is a definite win for consumers not to have to pay the lender a fee in order to pay off their loan early.
  • Assumable loans: FHA and VA loans are typically assumable, which means that when it comes time to sell, buyers can take over sellers' existing loans instead of taking out new mortgages at current mortgage rates as long as they can qualify for the loan. This helps with the marketability of the property, particularly if interest rates have increased since the loan was obtained.
  • Prohibition of kickbacks: Lenders and providers of services related to the loan closing are prohibited from paying kickbacks or referral fees.

The negative implications of government regulation

Since the FHA is fully backed by the U.S. government, they are used to try and achieve policy objectives where a normal lender would not.

For example, the average FHA loan amount on new loans has been very stable over the past decade at 94 percent. This means that someone can purchase a home with only a 6 percent down payment ($12,000 on a $200,000 home). The minimum down payment required on an FHA loan is 3.5 percent.

This sounds great until you realize that a low down payment increases the odds that a small decrease in the home price could result in you being “underwater,” owing the bank more than the house is worth. Our research has shown that being underwater greatly increases the odds that a borrower will default on the mortgage loan.

According to a recent report by Freddie Mac, 19.92 percent of the subprime mortgages are currently seriously delinquent and face possible foreclosure. People should understand that the more foreclosed homes in their neighborhood the lower their property values will be.

In addition, the government has basically taken over most of the market, especially in the last few years. According to a Freddie Mac report, Fannie Mae, Freddie Mac and Ginnie Mae issued 98 percent of the mortgage-backed securities in 2013 versus just 45 percent in 2005.

Finally, the Federal Reserve has severely distorted the market by forcing interest rates to very low levels and keeping them low for several years.

Extra regulations mean higher costs for consumers

Extra regulations undoubtedly increase the cost of lending, and those costs are passed to borrowers in the form of higher fees and/or higher interest rates.

For instance, review the amount of fees that are assessed on a conventional loan versus the fees charged for an FHA loan. As of May 2014, the fees on a $300,000 conventional loan ranged from $1,000 to $1,500 and the fees on an FHA loan ranged from $5,000 to $6,000.

Is easier access to credit a good thing?

As to the availability of credit, one of the objectives of these regulations is to make credit more available to lower income borrowers on lower value properties (typically $417,000 or below). However, I don’t believe that allowing people to borrow more than they can truly afford is good for society.

The government-insured loan programs typically allow borrowers to pay lower down payments and borrow more money for a given amount of income than traditional lenders. In exchange, the borrower pays higher fees and interest rates.

You have to ask yourself, is a person better off borrowing too much money if it means they ultimately lose their home to foreclosure?