Most economists view mandatory disclosure as a reasonable way of making a market
work better if the market is one in which one party to the transaction knows much
less than the other. This is the rationale for the extensive disclosure requirements
imposed on mortgage lenders. Lenders are obliged to incur heavy costs to provide
borrowers with information the Federal Government believes borrowers need to protect
themselves.
Unfortunately, the implementation of Federal mandatory disclosure rules has
been so poor that it is not even clear that the disclosures do borrowers more
good than harm. Borrowers are overwhelmed with information they often don't
understand, and critically important information that they would understand
is nowhere to be found.
As a particularly glaring example, there is no requirement to disclose the
total upfront credit charge -- the total amount the borrower must pay the lender
and mortgage broker for the loan. Aside from the interest rate, this is the
single most important piece of information a borrower can have, yet it is not
shown in either the Truth in Lending Statement (TIL) required by the Federal
Reserve nor the Good Faith Estimate of Settlement (GFE) required by HUD.
Recently, my mailbox has alerted me to another glaring shortcoming in disclosure
requirements. This one applies to second mortgages, a rapidly growing segment
of the market.:
"I obtained an FHA adjustable rate loan 1 1/2 years ago, and later
took out a second mortgage. When FHA came out with a program providing for a
streamlined refinance into a fixed-rated loan, I applied for one and was approved.
To my surprise, however, I found that the second mortgage lender must agree
to be subordinated to a new first mortgage, and my second mortgage lender categorically
refuses. I have written the president of the bank and gotten no response…It
never occurred to me to ask about this when I took out the second mortgage,
and the lender's policy of refusing to subordinate was nowhere disclosed…"
What shook me up about this letter is that it could have happened to me. I
was aware that the second mortgage lender had to agree to be subordinated to
a new first mortgage, but I was not aware that there were lenders who categorically
refuse to do it.
Such stubbornness makes no business sense. So long as the borrower is not increasing
the balance of the first mortgage, which was the case for the letter-writer,
the position of the second mortgage lender is not affected by the replacement
of one first mortgage with another. Indeed, since the interest rate will be
lower, which reduces the payment burden on the borrower, the position of the
second mortgage lender is if anything strengthened. OK, it takes a little clerical
time to fill out the necessary forms, so charge the borrower a reasonable amount
for your trouble. But refusing to be bothered? That's treating your customers
with contempt!
Second mortgage lenders should be required to disclose their subordination
policy in their Truth in Lending statement. A suggested sample disclosure is
contained below. If they want to limit subordination to cases where the balance
of the first mortgage is not increased, fine. If they want to be pig-headed
and refuse to allow it under any circumstances, that's fine too, so long as
consumers are forewarned about this when they take out their loan.
But consumers should not hold their breath waiting for the regulations to be
changed. Mortgage disclosure is a politically super-charged area that moves
at a glacial pace when it moves at all. You must protect yourself, and the way
to do it is to ask about subordination policy at the first contact with a lender.
If the lender doesn't allow subordination, march out the door. There's
another second mortgage lender down the street. If they say they do allow it,
ask about conditions if any, if there is a fee and how long it will take. If
the answers are satisfactory, get it in writing and make sure it is incorporated
in the loan documents so that if the loan is sold the new lender will be bound
by it.
Suggested Disclosure on Subordination
| New First Mortgage |
Yes |
No |
Conditional |
Period Fee |
| No Change in Balance |
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| Balance Includes Refi Costs |
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| Cash-out |
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| Note: If conditional, explain the condition |
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May 24, 1999
