Borrowers Beware of New Rules on Lending

This article originally appeared in The Washington Times.

Within a matter of days the House of Representatives will vote on 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. House Majority Leader Dick Armey is heroically trying to fix things, but unless a sudden wave of common sense overtakes the House, this Naderite legislation will carry the day — and only later will the costs be apparent.

Just three weeks ago the House Banking Committee approved by a 36 – 1 vote a bill by requiring housing lenders to cancel mortgage insurance when a borrower’s equity in the home reaches 25 percent. (The lone dissenter was the heroic newcomer Ron Paul of Texas.) Advocates charge there is now “widespread overpayment” of mortgage insurance 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 home mortgage insurance policies once the borrower has reached 25 percent equity. TD This whole issue got started when Rep. James Hansen, Utah Republican, became frustrated in his inability to cancel the mortgage insurance on his Northern Virginia condo — as if the bank had stuck a gun to his head, forcing him into the contract in the first place. The Democrats rallied around the issue. Rep. Joseph Kennedy, Massachusetts Democrat, even attempted unsuccessfully to make the automatic cancellation policy retroactive, so as to nullify existing mortgage agreements. So much for the sanctity of contract.

Meanwhile, in the Senate, Banking Committee Chairman Al D’Amato is joining hands with Naderite Democrats to try to corral enough votes to approve a similar measure — but with a threshold level of 20 percent equity. That Mr. D’Amato is one of the primary instigators of this federal power grab should raise suspicions among his congressional colleagues. Mr. D’Amato, who is up for re‐​election in 1998, is prone to gratuitous business‐​bashing whenever he is in political trouble. Remember, not long ago Mr. D’Amato incited a panic in the banking industry by proposing a cap on interest rates that credit card companies could charge. Don’t be surprised if next month Mr. 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 these 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 private mortgage insurance protection some 20 million homeowners over the past 40 years may not have been able to obtain the financing to purchase their houses in the first place.

Mortgage insurance protects the lender against default on low down payment mortgages. The homebuyer pays a premium to the PMI for this protection. There’s no law that requires a prospective buyer to purchase mortgage insurance. And this 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 PMIs, not insurance provided directly by the federal government via the FHA.

OK, but doesn’t Mr. D’Amato have a point? Why would anyone need mortgage insurance after having paid more than 25 percent of the loan? At this point the risk of default is extremely low. In the first place, the vast majority of homeowners stop paying mortgage insurance at this point. The mortgage insurance industry calculates that out of 5 million homes today with private mortgage insurance, less than 250,000 or 5 percent, are still paying insurance costs after paying down 25 percent of the original house price. 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. This 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 a case, 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 this risk of a falling market.

If Congress prohibits lenders from that protection, they have two avenues of recourse: (1) deny the loan in the first place, or (2) require a heftier downpayment. So the paradox is that by meddling into the mortgage marketplace in the guise of “helping homeowners,” the net result of this intervention will be to make it harder and more expensive for many first‐​time buyers to purchase a home. 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 capital gains. This will lower interest rates and make housing more affordable to all of us.

Stephen Moore

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