Commentary

Congress’s New Mortgage Regs Imperil Home Ownership

By Stephen Moore
April 24, 1997

On April 16th the House of Representatives approved housing legislation that the Washington Post recently described as “one of the hottest consumer issues of 1997.” In this case, as with most so-called consumer issues, that spells trouble for businesses and taxpayers. Unless a sudden wave of common sense overtakes the Senate, this Naderite legislation will carry the day — and only later will the costs become apparent.

The bill would require housing lenders to cancel private mortgage insurance (PMI) when a borrower’s equity in the home reached 25 percent. Advocates charge that there is now “widespread overpayment” of PMI premiums by “unsuspecting” homeowners. So who better to protect them than Uncle Sam? The legislation would empower a new federal regulator — the Department of Housing and Development — to automatically cancel PMI policies once the borrower had reached 25 percent equity.

The whole issue got started when Rep. James Hansen (R, Utah) became frustrated by his inability to cancel the PMI on his Northern Virginia condo — as if the bank had stuck a gun to his head to force him into the contract in the first place.

Meanwhile, in the Senate, Banking Committee chairman Al D’Amato has joined hands with liberal Democrats to try to corral enough votes to approve a similar measure. His bill is even worse. It would require a threshold level of only 20 percent equity, and it would be applied retroactively — thus nullifying existing mortgage agreements. So much for the sanctity of contract.

That D’Amato is one of the primary instigators of this federal power grab should raise suspicions among his congressional colleagues. D’Amato, who is up for reelection in 1998, is prone to gratuitous business bashing whenever he is in political trouble. Remember, in 1991 he incited a panic in the banking industry by proposing a cap on interest rates that credit card companies could charge. Last year he went after banks for charging an Automatic Teller Machine fee to customers of other banks. Don’t be surprised if next month D’Amato suggests a price ceiling on Nike Air Jordans and Whopper hamburgers.

There is no more depressing example of the GOP’s ideological drift than this. It used to be that Republicans proved their pro-consumer inclinations by promising to cut taxes and cost-ineffective regulations. Now they propose new ones and justify their actions by resorting to Naderite rhetoric about price gouging and consumer protection.

The House Banking Committee estimates — with great exaggeration — that the new mortgage insurance requirements will save some homeowners $300 to $900 a year (a gross exaggeration) in premiums. The underlying premise here is that mortgage insurance is simply a frivolous extra cost of a home loan. The truth is that without PMI protection some 20 million homeowners over the past 40 years might not have been able to obtain financing to purchase their houses in the first place.

Mortgage insurance protects the lender against default on low-downpayment mortgages. The homebuyer pays a premium for that protection. There’s no law that requires a prospective buyer to purchase mortgage insurance. And mortgage lending is a highly competitive industry. Consumers are free to shop around for the best credit terms from hundreds of mortgage banks and for insurance from eight private mortgage insurers, who compete against each other and the Federal Housing Administration (FHA) for business. For some unexplained reason, the new mortgage insurance statutes would only apply to PMI, not insurance provided directly by the federal government via the FHA.

Okay, but doesn’t D’Amato have a point? Why would anyone need mortgage insurance once he had paid more than 25 percent of the loan? At that point the risk of default is extremely low, and the vast majority of homeowners does stop paying mortgage insurance. The mortgage insurance industry calculates that of the 5 million homeowners covered today by PMI, fewer than 250,000, or 5 percent, are still paying insurance costs after paying down 25 percent of the original house loan. For a $100,000 home, the premium payments after 25 percent of the loan has been paid off are typically about $17 a month — not the $25 to $70 advertised by the Banking Committee.

There’s a perfectly rational explanation for why some homeowners still require insurance after paying down 25 percent of their loan. Housing markets fluctuate. Home prices sometimes depreciate in value by more than 25 percent. That was the case, for example, in the Houston housing market during the oil slump in the late 1980s and in the New England states during the real estate and banking crisis of the early 1990s. In such cases, the owner may still have a financial incentive to walk away from the home rather than pay off the balance of the mortgage. A prudent lender requires protection against the risk of a falling market. If Congress denies lenders that protection, they have two avenues of recourse: (1) deny the loan in the first place, or (2) require a heftier down payment. So the paradox is that by meddling in the mortgage marketplace in the guise of “helping homeowners,” Congress will make it harder and more expensive for many first-time buyers to purchase homes. Explain again how this helps consumers?

The House bill and the D’Amato measure won’t help financially strapped home purchasers. But here is what will: Get back to the business of cutting government spending and anti-investment tax provisions, such as the capital gains tax. That will lower interest rates and make housing more affordable for all of us.

Stephen Moore is director of fiscal policy studies at the Cato Institute.