Practices of home-lending industry draw scrutiny
As homeowners confront penalties, Legislature might re-examine issue

STEVE LAW
Statesman Journal

October 1, 2007

The next time that Staci Brigham signs loan papers for her home, she plans to consult a lawyer.

Two years ago, Brigham and her husband wanted out of their adjustable-rate mortgage and sought to replace it with an interest-only loan. They hoped to keep payments down and planned to sell their Woodburn home once she finished veterinary school at Oregon State University.

Brigham said instructions to their loan officer were clear: they didn't want another adjustable-interest mortgage; they didn't want a penalty for paying the loan off early; and they didn't want a "negative-amortization" loan, which allows people to add onto the principal each month.

They were shocked later to find the new loan included all three features.

"When we called to confront (the loan officer), he hung up on us," Brigham said. "I was pregnant with our second child when we figured everything out."

Monthly payments have since jumped more than $300, and the couple is locked into the loan one more year because of a $9,000 prepayment penalty.

Brigham's husband is an engineer, and the couple has healthy equity in a home near Woodburn's Tukwila Golf Course. Theirs is not one of the "subprime" loans, which are high-fee loans granted to those with weak or so-called "subprime" credit and are causing a flood of foreclosures.

But Brigham's experience raises similar questions about aggressive lending practices that backfired and are sending shock waves through the economy. It also shows how even relatively sophisticated, college-educated people can be victims of lax standards and practices in the home-lending industry.

Legislative debate

The 2007 Legislature debated Senate Bill 965, which addressed questionable lending practices, prepayment penalties, and interest-only and negative-amortization loans, along with subprime loans.

"There's obviously a problem out there," said Rep. Paul Holvey, D-Eugene, who was disappointed when the bill died in the face of industry opposition. Those issues are "definitely going to be on the table" in the coming months, Holvey said.

Holvey, the chairman of the House Consumer Protection Committee, sits on a new mortgage-lending task force appointed by Gov. Ted Kulongoski. The task force, along with Holvey's committee and a Senate counterpart led by Sen. Ben Westlund, D-Tumalo, are working on possible bills to present at next February's special legislative session, and the full session of 2009.

Tied to Oregon home prices

Subprime loans typically are used by buyers who couldn't otherwise buy or refinance homes because of bad credit.

Interest-only and negative-amortization loans typically are issued to a different segment of borrowers, who try to cut monthly costs by not paying down the principal each month, as in traditional mortgages. Use of both types of loans is rapidly rising.

"It's an affordability issue," said Bob Visini, the vice president of marketing for First American LoanPerformance in San Francicso.

Oregon's relatively high real-estate prices, combined with its modest incomes, help explain why the state has the ninth-highest use of interest-only mortgages in the country, and the seventh-highest use of negative-amortization loans, according to First American data.

In contrast, the company ranks Oregon as tied for 35th-highest in the use of subprime loans among the states.

First American's database includes roughly half the mortgages sold in the United States. The database doesn't include traditional loans resold to the federally sponsored Freddie Mac and Fannie Mae, so it may overstate the use of interest-only and negative-amortization loans, Visini said.

Of the loans tracked by the database, one-fourth of all home loans in Marion and Polk counties were interest-only loans as of May, five times the number in 2003. One in eight Salem-area loans was a negative-amortization loan, six times the number in 2004.

Consumer advocates warn that interest-only and negative-amortization loans, especially when combined with prepayment penalties, can cost homeowners thousands of dollars. Such borrowers are counting on increasing their home equity via rising property values, not by paying down the loans.

Loans risky

David Tatman, the state's chief banking regulator, said interest-only loans are "facilitating the American dream of being able to buy your own home."

However, "they have to be used judiciously," said Tatman, administrator of the state Division of Finance and Corporate Securities.

Negative-amortization or payment-option loans are a different animal. They allow the borrower a monthly choice of paying only the interest, paying the interest and some of the principal, or tacking on more money to the principal.

"For the general owner-occupied house, there would be few-and-far-between instances where I would think that would be a good thing," Tatman said. "All you're doing is falling further and further behind."

Visini said some of the fears about interest-only loans are misguided. There are fewer problems with delinquent mortgage payments on interest-only loans than with traditional loans, he said, in part because the payments are typically lower.

But Visini said there are more potential pitfalls with negative-amortization loans, because some borrowers don't understand them or use them improperly.

Staci Brigham said she and her husband have never exercised the option to add onto their principal with their negative-amortization loan. But one study showed that as many as two-thirds of the borrowers across the country are making the choice to add to their principal, Visini said.

Consumer advocates, led by the group Our Oregon, are pushing the Legislature to place more restrictions on negative-amortization loans and prepayment fees.

Prepayment fees are like an "exit tax" that locks people into an unaffordable loan, said Angela Martin, who works on predatory loan issues for Our Oregon.

Our Oregon proposes banning prepayment penalties for subprime loans, but is willing to negotiate a one-year limit on prepayment penalties for other loans, Martin said.

Rather than ban negative-amortization loans, as many states have done, Martin wants to target lending practices that improperly put people into such loans.

"I think that it makes more sense to say a loan must be suitable for the borrower, and a lender must be able to assess that the borrower is able to pay the loan," Martin said.

Industry perspective

Oregon mortgage-industry leaders say the market and "guidance" from federal regulators already have corrected most of the improper practices with subprime, negative-amortization and interest-only loans.

"I think the federal guidance has eliminated the misuse and misapplication of those types of loans," said Eric Wiley, co-owner of Pacific Residential Mortgage, which has an operation in Salem.

John McCulley, lobbyist for the Oregon Association of Mortgage Professionals, likened prepayment penalties to a certificate of deposit, which pays greater interest because banks know they can use the money for a set period of time. Prohibiting prepayment penalties makes it harder for consumers to find lower-cost mortgages, McCulley said.

Wiley, who is on the governor's task force, will argue that requiring licensing of loan originators will weed out the part-time and other unprofessional players who have soiled the industry's reputation. License fees will allow state regulators to expand their staff who monitor lending companies, Wiley said.

Martin said federal guidance isn't enough, because the state is the chief regulator of the majority of companies that issued subprime and other risky loans. That dispute may be the central issue in the talks leading up to the 2008 and 2009 legislative sessions.

HELP FOR DISTRESSED BORROWERS

National Foundation for Credit Counseling: Call (866) 557-2227 to connect with a certified housing counselor or visit www.nfcc.org.

HOPE hotline: (888) 995-HOPE, a toll-free foreclosure-prevention service established by the Homeownership Preservation Foundation.