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Mortgage Consumer Protection in Action

Since the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) authorized the Consumer Financial Protection Bureau (CFPB) to regulate lending practices in the credit market, the CFPB has addressed the mortgage market with several amendments to existing mortgage regulations under the Truth in Lending Act (TILA) and the Homeowner Equity Protection Act (HOEPA).

The TILA and the HOEPA provide a safety net for mortgage consumer protection. First enacted in 1968 and implemented by Regulation Z, the TILA initially stipulated certain information disclosure standards for all kinds of credit including open-end credit such as credit card loans and closed-end credit such as home-purchase mortgage loans. The purpose was to mandate proper disclosures of the costs and charges associated with the credit transactions to the consumers. The HOEPA of 1994, an amendment to the TILA, on the other hand, only regulated non-purchasing home equity loans and refinanced mortgage loans. It imposed additional lending restrictions on so called “high-cost” mortgage loans. The regulation was written in two parts – the first part defined the scope of regulated loans, i.e., the “high-cost” loans, based on the points and fees charged by the lender, and the second part specified restrictions and prohibitions on the regulated loans. Lending practices banned by the HOEPA included negative amortization, advance payment, increased interest rates after default, etc.

As the mortgage market developed, mortgage products became increasingly complex, and those regulations had become insufficient to protect consumers. In particular, the HOEPA left a large segment of the mortgage market unregulated due to its limited coverage of mortgage types and high points and fees triggers. State lawmakers had taken the initiative to fill the loopholes by extending the scope of the HOEPA to cover a wider spectrum of mortgage products and imposing more stringent restrictions than the HOEPA. Typical extensions of the HOEPA at the state level involved extended coverage of home purchasing mortgages and lower trigger points for the points and fees. Additional restrictions may include bans on prepayment penalties, arbitrage, loan flipping, financing home-improvement projects, lending without due regards.  North Carolina was the first state to pass a state mini-HOEPA anti-predatory lending law in 1999; by 2005, most states and some cities had passed mini-HOEPA laws.

By amending the HOEPA in 2013, the CFPB established a uniform mortgage regulation nationwide, incorporating the HOEPA extensions that have been proven effective at the state level – extending the scope of regulation to home-purchasing loans and adding restrictions and prohibitions on balloon payments, prepayment penalties, and due-on-demand features.  Ho and Pennington-Cross (2006) and Bostic et al. (2008) pioneered studies evaluating the effects of mini-HOEPA laws. Their studies show some evidence that mortgage regulations curbed subprime credit flow, as measured by applications to subprime lenders identified by the Department of Housing and Urban Development (HUD) and loans originated by these lenders. However, according to HUD’s definition, not all loans originated by those lenders were necessarily high-cost or high-risk; hence these studies had only limited insight on the quality effect of the mini-HOEPA laws. My study filled in the gap to evaluate the quality effect as measured by the change of the probability of “early foreclosure”, i.e. foreclosures that occurred within the first 24 months after the origination. I investigated a state Supreme Court-mandated repeal of a local mini-HOEPA law in Cleveland, Ohio. On November 20, 2006, the Ohio Supreme Court concluded a four-year lawsuit between the American Financial Services Association (AFSA) and the city of Cleveland, overturning the Cleveland mini-HOEPA ordinance of 2002. The ruling removed lending restrictions imposed by the city ordinance on all home mortgage loans with APRs between 4.5 and 8 percentage points above the comparable Treasury rates. Following the repeal, lenders were free to charge an APR spread larger than 4.5 percentage points and may include mortgage terms such as loan flipping, prepayment penalties, balloon payments, advance payments, negative amortization, an increased interest rate on default, financing of credit insurance, lending without counseling, lending without due regard to prepayment – all of which were prohibited for home purchasing mortgages by the city ordinance but not by the Ohio statute. By comparing home-purchasing mortgages originated in Cleveland six months after the repeal to those originated six months before the repeal, in reference to those originated in the suburban municipalities where no institutional change occurred in the period, I found that invalidating the mini-HOEPA ordinance substantially increased the APRs and the foreclosure rate – mortgages were 20 percent more likely to exceed the removed regulatory threshold and the foreclosure rate increased by 6 percentage points to 20 percent. The empirical evidence suggests that the Cleveland mini-HOEPA law, when in effect, fostered mortgage loans that survived longer without foreclosures. The findings provide the rationale for the CFPB’s efforts to incorporate state and local HOEPA extensions to build a uniform, strengthened mortgage regulation at the federal level.

Besides outlawing additional predatory lending practices by amending the HOEPA, the CPFB will also implement new standards of disclosure to ease the comprehension of the mortgage terms and costs.  The integration of the TILA (Regulation Z) and the Real Estate Settlement Procedures Act (RESPA, implemented by Regulation X), to be effective on August 1, 2015, takes several measures to reduce consumer confusion about mortgage contracts. For instance, the new rules require the interest rate, monthly payments, and the total closing costs to be clearly presented on the first page of a mortgage contract. The rules also mandate the timing of information disclosure – the loan estimates to be given three business data after loan application, and the closing disclosures to be given three business days before closing – allowing consumers more time to compare costs across loan applications and between estimated costs and actual costs.

With those CFPB consumer financial protections measures in place, I am optimistic that mortgage contracts will become more transparent and less predatory. However, consumer protection is only part of the solution to prevent massive mortgage defaults and foreclosures, as witnessed by the Great Recession – there still exist unexplained individual differences in mortgage payment behaviors. For example, Gerardi et al. found that consumers with low numerical abilities were more likely to default on their mortgage loans; however, the differences in default rates could not be attributed to different choices of mortgage contract. This study suggests that non-cognitive differences among consumers are likely to contribute to more frequent mortgage defaults among certain population.

In a project collaborated with U of I psychology professor Brent Roberts and finance professor Jeffrey Brown, we will investigate the genetic, behavior, and environmental factors contributing to individual differences in financial management behaviors. Our central hypothesis is that personality traits are non-cognitive factors in explaining individual differences in financial behaviors, and the linkage between traits and behaviors is mediated by gene and environment to different degrees. We will apply a behavior genetic method to a sample of twins to differentiate the genetic and environmental pathways linking personality traits and financial behaviors. The discovery of genetic and environment pathways will provide additional insights on designing effective consumer interventions to foster, modify, and influence personal financial management behaviors.

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