Foreclosure risks may be identifiable and preventable in advance. Governments can counter risks through targeted outreach, regulations to prohibit the riskiest loans and enhanced consumer awareness to help families make better mortgage decisions.
Strengthen predatory lending laws and guidelines
The increase in foreclosures during the foreclosure crisis has been linked to the prevalence of subprime mortgages, especially loans with high-risk terms and a lack of transparency. The riskiest and highest-cost mortgages, which also tend to be subprime, are often referred to as predatory loans.
According to the Center for Responsible Lending, typical characteristics of predatory loans are excessive fees, extreme penalties for prepayment, excessive kickbacks to brokers, unbeneficial refinancing (also known as “loan flipping”), unnecessary add-on products, binding mandatory arbitration clauses and aggressive sales tactics and fraud.
Many subprime loans are originated by non-deposit institutions, which the states regulate so they have the power to restrict these high-risk loans. In their role as regulator, states can protect consumers from the riskiest mortgages and direct them instead to more sustainable forms of homeownership. Anti-predatory lending measures can limit excessively high fees and interest rates for homeowners, as well as other clearly unbeneficial mortgage terms, while allowing responsible uses of subprime lending to continue. For example, a key provision to prevent abusive lending practices was adopted in August 2007, requiring lenders to verify that their customers have the ability to repay the loans they are offered.
Many states have already taken action against these high-risk loans. A study of state anti-predatory lending laws by the Center for Responsible Lending reports that 23 states have anti-predatory lending laws stronger than the federal law (Home Ownership and Equity Protection Act of 1994). The study finds that borrowers in the states with strong protections against anti-predatory lending have abundant access to responsible subprime credit. In addition, they pay about the same or less for subprime mortgages as do borrowers in states without such laws and are able to get loans with fewer abusive terms.
Increase oversight of mortgage brokers and originators
As the regulators of the majority of mortgage brokers and lenders, states can help to create a lending environment that is clear, fair and consistent. In addition to restricting risky or predatory loans, states can strengthen their oversight of mortgage brokers and lenders and coordinate with other states to track enforcement actions taken across the country.
In January 2008, a national coalition of state regulators released the Nationwide Mortgage Licensing System (NMLS), an online system for coordinating states’ mortgage regulations and oversight. The NMLS allows licensing applications to be completed and processed online, facilitates coordination of state licensing and regulations and enables states to track license and enforcement activity from all participating state regulators.
Currently, NMLS is the sole system of licensure for mortgage companies for 58 state agencies and the sole system of licensure for mortgage loan originators for 59 state and territorial agencies. Over half the states also currently manage additional license types through the system in the money services business, debt and consumer finance industries.
Expand pre-purchase homeownership education and counseling
While government action could help make the homeownership process easier to navigate, there will always be a need to strengthen the understanding of that process by individual homeowners. States and localities can help by reforming the school curriculum to teach children more thoroughly about financial literacy and the home-buying process and by augmenting funding for pre-purchase homeownership education and counseling that helps to prepare families to make sound decisions regarding homeownership.