Hearing on Bank Mergers and Subprime Mortgage Credit Problems
From Testimony of
Alex J. Pollock
Resident Fellow
American Enterprise Institute
To the Subcommittee on Domestic Policy Committee on Oversight and Government Reform
United States House of Representatives
Hearing on Bank Mergers and Subprime Mortgage Credit Problems
Cleveland, Ohio May 21, 2007
***
The One-Page Mortgage Disclosure Proposal
When considering borrowers in financial trouble, whether from unwise borrowing, not having understood the loan, or even induced into loans by misrepresentation, there is a natural political reaction to try to protect them through credit regulation.
I believe a superior strategy is to equip borrowers to protect themselves by requiring short, simple and clear disclosures of the key mortgage loan terms and their relation to household income. The borrowers can then “underwrite themselves.” They have the natural incentive to do so—we need to add intelligible, practical information.
To help address the shortcomings of the subprime market which have become evident, I believe a new, superior disclosure approach is needed, whether or not we do anything else. The key is to realize that complex, lengthy statements in regulatoryese and legalese do not achieve the goal. Moreover, the simple, clear disclosure should be focused on the financial impact on the borrower, not on the financial instruments.
Thus I propose there should be a required one-page form which gives the essentials of the loan and its monthly cost, which must be given to every mortgage borrower three days before closing. 2
A good mortgage lender wants a borrower who understands how the loan will work, including any possible future interest rate increases and prepayment penalties. The total monthly obligation needs to be put clearly in the context of the borrower’s income.
Current American mortgage loan documents certainly do not achieve this. Most of us have had the experience of being overwhelmed and befuddled by the huge stack of documents full of confusing language in small print presented to us for signature at a mortgage closing. The complexity results from legal and compliance requirements. Ironically, past regulatory attempts to insure full disclosure have made the problem worse. That is because they attempt full, rather than relevant, disclosure.
To achieve an informed borrower, the key information must be simply stated and clear, in regular-sized type: 90% of the relevant information which is clear and understandable is far better than 100% of the details which are complex and hard to read. Trying to describe the details in specific legal and bureaucratic terms results in essentially zero information transfer to the borrower.
The one-page form should include key underwriting concepts, including the borrower’s income and housing expense ratio, as well as principal loan terms. The “housing expense ratio” means the sum of the monthly interest payment, principal payment, property tax, and house insurance premium, expressed as a percent of the borrower’s monthly income. This should be shown for both the initial interest rate and the fully-indexed interest rate. In typical types of subprime loans, the fully-indexed expense ratio can be a remarkably larger burden than the initial or “teaser” rate suggests.
The proposed one-page “Basic Facts About Your Mortgage Loan” form, with accompanying common sense explanations and avuncular advice, is Attachment 1.
One of the deans of mortgage journalists has written of how the one-page proposal is distinct from previous regulations and simplification attempts. His article is also attached.
Whatever else is done or not done, I believe the one-page disclosure would be an important step forward for America’s and Ohio’s mortgage borrowers and housing finance system.