Policy

Reforms to federal and state law and policy are needed to reduce the damage the current foreclosure crisis is inflicting upon homeowners, neighborhoods and local governments, and to address the causative factors of this crisis. Foreclosures are not new to lenders, homeowners or local governments. What is so different about this crisis is: the unprecedented scale of foreclosed properties, the fact that lax underwriting standards forced borrowers into default even while their income remained stable, and the disproportionate negative impact it has had on low-income communities of color. Advocates across the country are proffering specific changes to law and policy at the federal and state levels to assist with neighborhood stabilization. Some key proposed policy changes include the following.

Improve regulation of the mortgage brokerage industry. Federally regulated financial institutions such as commercial banks provided just a fraction of the mortgages now in default. Non-bank lenders and mortgage brokers originated more than 50 percent of all mortgage and refinance loans, yet they are, for the most part, unregulated by the federal government. As a result, it is critical that new regulation be promulgated to restrict the conduct of brokers and non-bank lenders. Alan Mallach, Director of Policy for the National Housing Institute, proposes that all individuals and institutions that provide mortgage loans should be licensed and should be required to adopt an explicit fiduciary duty to act in the borrowers’ interest and provide the “best available product” to meet the needs of the borrower.

Reform the appraisal process to ensure appraisals are accurate. In February, 2007, an independent study conducted by the October Research Corporation found that 90 percent of appraisers were pressured by mortgage brokers, realty agents and others to raise property valuations to enable deals to go through, nearly double the findings of a similar study three years ago. Moreover, the survey found that 75 percent of appraisers reported “negative ramifications” if they did not cooperate, alter their appraisal, and provide a higher valuation. The appraiser should be a vital independent service provider in any mortgage transaction. Yet appraisers have been used by loan sellers to support larger loans for which they will receive a larger fee. Regulation to ensure appraisers are providing their best, independent estimate of value is critical.

Lenders and servicers should be required under state or federal regulation to assume property maintenance obligations for homes they assert control over. To hold lenders and servicers accountable, cities and states should amend property maintenance and nuisance abatement laws to expand the definition of owner to include mortgage holders who have issued a notice of default or foreclosure. The law should specify that it applies only to vacant properties where the title holder is no longer occupying the premises. The lender or servicer is responsible for keeping the property up to code and must provide a local agent who can be contacted regarding any violations. Fines for failure to comply should be substantial.

Adopt well-reasoned, sustainable practices to provide lower-income households with housing choices For a short time, the subprime market was revered as a hero for extending credit to lower-income households and offering them homeownership. Soon, however, it became clear that offering credit with little concern for the borrower’s ability to pay it back, and offering products that look attractive but put the borrowers at risk of losing their homes, are not appropriate methods for extending homeownership. National rhetoric talks about homeownership as a key part of the American dream, and the federal government facilitates homeownership with tax deductions, low interest rates and other incentives. Even in the face of a $700 billion drop in the value of households’ real estate holdings from mid-2007 to the present, home equity still accounted for the largest element of household wealth in the second quarter of 2008. However, this foreclosure crisis has made very clear that for some households, preserving and expanding affordable rental options is critical. The affordable rental sector provides housing for the majority of lower-income households. Homeownership may be the American dream for some, but as this crisis illustrates, it is a nightmare for others. Rental housing plays an important role in sheltering Americans and should be strongly supported by state and federal governments.

Prohibit loan prepayment penalties. According to the Center for Responsible Lending, two-thirds of subprime loans charge prepayment penalties, compared to only 2 percent of conventional loans. Lenders assert that such penalties are necessary because the lender is selling that cash flow to someone and depends on the loan being outstanding for a set period of time. These penalties are harmful because they stop borrowers from getting out of loans once their credit or income improves. The borrower is prevented from refinancing to a lower-cost conventional loan or refinancing to a loan that will not endanger their homeownership. Prepayment penalties should be eliminated.

Create statewide databases of foreclosure information. Local governments are struggling to collect data and map it so that they can define foreclosure concentrations and appropriate actions in response. State governments should create statewide databases of foreclosed properties by requiring each foreclosure to be registered with the state and include the identity of the lender and the contact information for a disposition manager.

Support the development and dissemination of community land trusts and other shared equity homeownership models. A national Shared Equity Coalition has proposed a national demonstration project to raise the visibility of shared equity homeownership and address challenges involved in taking this model to scale. The project would provide 8 to 10 state, regional and local jurisdictions with funding to test different approaches for taking
shared equity homeownership to scale.

 

Reform Low Income Housing Tax Credits (LIHTC) policies to encourage investment. LIHTCs finance the rehabilitation and construction of rental housing affordable for households at 120 percent of median income and below. Now that most companies have few if any profits to shelter, however, the once-valuable credits are going begging, leaving many pipeline properties with an allocation of credits but no equity investor. Making matters worse, the biggest buyers of the credits – mortgage giants Fannie Mae and Freddie Mac – started pulling out in 2007, leaving a huge void. New York Governor David Paterson, in a letter to President-Elect Barack Obama, asks for federal help in making the LIHTC program more attractive to investors. He suggests that federal reforms include:

  • Reducing the tax credit program from 10 years to five years on a temporary basis in order to attract corporations that are willing to invest over a shorter period instead of making a 10-year commitment.
  • Expanding Community Reinvestment Act areas by 25 percent for two to three years to encourage financial institutions (typically the largest LIHC purchasers) to invest over a larger area
  • Extending the time housing financing agencies have to allocate credits by an additional year before the agency must return unused credits to the national pool. According to the Affordable Housing Institute, historically it took six to nine months for a corporation to make a decision to make an LIHTC equity investment and that time interval is much longer in today’s financial climate.

    • Preparing for the loss of equity due to LIHTC price decline by providing more credits, soft loans and grants to fill the financing gap. A December 2008 report commissioned by the Massachusetts Housing Partnership found that LIHTCs that were valued at above $1 per dollar of LIHTC in 2006 are now valued at below 80 cents. The report predicts that Massachusetts’ allotment of credits will only go 77 percent as far as it did last year.

Allow bankruptcy court to modify foreclosure loans. Bankruptcy judges can modify most loans other than loans for primary residences. This means a bankruptcy judge can modify a loan for a yacht or a vacation home to prevent the household from losing those assets, but cannot modify a loan for a primary home. Allowing judges to modify principal amounts of mortgages on primary residences in Chapter 13 bankruptcy cases filed by debtors would allow many to avoid the worst impacts of a bad loan. Instead of using a standard formula, judges would be able to look at each situation and resolve it on its own merits. As proposed in existing legislation (HR 3609/S2136), this option would apply only to families on the verge of losing their home. Current proposals to permit such restructuring have built-in protections for lenders: only families who fail a means test and therefore face foreclosure would be eligible; interest rates would be set at commercially reasonable, market-based rates; the loan term would not be able to exceed 40 years; and the principal balance would not be able to be reduced below the fair market value of the property. One negative impact of this course of action may be to induce many more homeowners to file for bankruptcy.

Require lenders to work with homeowners before foreclosing. The Center for Responsible Lending supports legislation entitled the Foreclosure Prevention and Sound Mortgage Servicing Act of 2008 (HR 5679) that amends the Real Estate Settlement Procedures Act of 1974 to require loan servicers to engage in reasonable loss mitigation activities before foreclosing. If passed, this could help reduce foreclosures and increase constructive efforts to work with struggling homeowners.

Provide additional funding for neighborhood foreclosure recovery. The Neighborhood Stabilization Program was Congress’ initial response to the foreclosure crisis, yet the money will allow cities to restore only a small percentage of foreclosed properties to productive use. Many more resources will be necessary before the negative impact on neighborhoods can be healed.

Provide incentives to lenders/brokers who donate foreclosed properties to nonprofits and local governments. By offering lenders tax incentives and credit under the Community Reinvestment Act for donations of foreclosed properties in bulk to local governments, a major impediment to quickly getting property into a new responsible owner’s hands will be eliminated.

Enact municipal measures that discourage speculative flipping of foreclosed properties. Cities must take action to ensure that properties are transferred to responsible owners rather than speculators leave properties vacant, in disrepair, or only superficially rehabbed – further destabilizing neighborhoods. They can: 1) regulate vacant properties and require strict property maintenance standards to ensure the properties purchased by speculators are kept up; 2) encourage homeowner buyers and trusted builders to rehabilitate the property for their own or other homebuyers’ use; and 3) gain control of the property through purchase and once it is within the government’s or a nonprofit’s control, sell it to homeowner buyers.