Jack M. Guttentag The Mortgage Professor

Since its last effort to reform market practices was defeated by the industry in 2002, HUD (the Department of Housing and Urban Development) has been promising to come back with some less ambitious -- but hopefully more acceptable -- proposals. They finally did, in March of this year.

The proposals have three major thrusts: one is to convert the Good Faith Estimate of fees and charges (GFE) into a document that borrowers can use to shop alternative loan providers (LPs). That is the subject of this article. The second thrust is to protect borrowers against various types of opportunistic pricing that the current GFE facilitates. The third thrust is to make mortgage broker pricing transparent, which the current GFE does not.

The current GFE does not have the critical summary information on loan features that borrowers need to shop effectively. In addition, the fees and charges shown on the GFE are not totaled in meaningful ways and can change behind the borrower's back. Furthermore, even if the information were complete and dependable, the borrower doesn't get it until after submitting a loan application, which is too late to be useful in shopping.

For the GFE to become an effective shopping tool, it must 1) provide borrowers with critical information about the features and prices of the borrower's desired loan; 2) limit the right of LPs to change the fees and charges shown on the GFE; and 3) require LPs to view issuance of the GFE as a loan approval, subject only to verification of the information provided by the borrower. The proposed GFE does all this.

The information on the proposed GFE includes the interest rate, total lender charges, and total third-party charges, which are sufficient to shop effectively for fixed-rate mortgages. On adjustable-rate mortgages, HUD plans to require additional information on the factors that affect future rate adjustments, and is seeking comments on how to best do this.

The fees and charges contained in the proposed GFE no longer depend entirely on the "good faith" of the LP. Changes between the numbers shown on the GFE and those contained in the HUD1 final closing document will be limited, as discussed next week.

The new GFE is also a conditional loan approval (my term, not HUD's) based on six pieces of information provided by the borrower: name, social security number, property address, gross monthly income, loan amount, and house value. HUD envisages borrowers seeking GFEs from multiple LPs, making a selection from among them, and then submitting a loan application. The application provides the much more detailed information required by lenders, but it cannot be rejected unless the new information is materially different from that submitted in applying for the GFE. The burden of proof is on the LP.

One loose end I see in this procedure is verification of the borrower's income. If the borrower cannot verify the income stated on the GFE application, the lender must be allowed to reject the application without becoming vulnerable to legal challenge. The best way to deal with this is to add a seventh item to the list required for the GFE: "Will you verify income?" If the borrower says no, then the LP can set the higher price of a stated-income loan, and if the borrower says yes, it is clear that the burden of proof shifts to the borrower.

The proposed GFE does not protect the borrower against the practice of low-balling -- that is, offering a low quote to get the business, then raising it later when the borrower locks the price. The very first item on the new GFE reads, "The interest rate for this GFE is available until..." followed by a blank space where the LP will place a date. In practice, that date will always be the current day, since in a volatile market, no LP will ever commit to tomorrow's price.

HUD's aborted 2002 proposals included a rate-indexing provision for dealing with this problem, but this time they totally ignore it. While price volatility is not a problem that can be solved by regulation, borrowers should be placed on notice that the problem exists. HUD views the new GFE partly as an educational document, yet they leave the borrower wholly in the dark on this critical issue.

In addition to warning borrowers about this problem, HUD should encourage them to ask the LP how a new price will be determined after the borrower submits a loan application and looks to lock the price. When LPs realize that their answer to this question may well affect whether or not they get the loan, they will come up with their own solutions.

Next week: Protecting borrowers against opportunistic pricing.