Page 25 - Impact: Collected Essays on the Threat of Economic Inequality

the extended loan period and minimal principal repayment in early loan years . Moreover, some lenders introduced the interest-only home loan, whose loan payments encompassed only accrued interest and no repayment of principal during the life of the loan, resulting in a balloon payment at loan maturity of the entire original loan balance . Presumably the borrower would have to refinance the debt or sell her home to surmount that balloon payment obligation .
Best showcasing the affordability problems of subprime mortgage loans was the introduction of so-called pay-option or flex-payment mortgage loans . Mortgage lenders took the concept from credit card issuers who offered some card holders the discretion to occasionally skip a month’s payment, or to pay a lesser amount, as determined by the borrower, than the regular monthly payment . In the mortgage loan context, mortgage brokers or loan officers might appease a worried borrower, having stretched her budget to make the loan payments and concerned about the lack of a rainy day fund for emergencies or of the stability of her income, by pointing to the flex feature that allows the strapped borrower periodically to skip a payment or reduce the full payment to a more desirable amount . To the extent the borrower’s skipped or reduced payment does not fully satisfy the accrued interest since the prior monthly payment, that unpaid interest is added to the principal balance, potentially resulting (particularly for an otherwise interest-only payment loan) in a new principal balance that exceeds the original loan balance .
Even with these techniques to lower the borrower’s monthly payment, oftentimes the high loan fees and interest rate bumped up against the traditional standards for a prudent debt-to-income ratio, particularly as wages remained stagnant and house prices rose dramatically as more money entered the mortgage market . Addressing this disconnect was the no-doc or stated-income loan, a mainstay of home mortgage financing in the subprime era . Rather than verifying income with the borrower’s employer, or relying on a steady history of past self-employment income, lenders offered a loan program whereby the borrower might supply any salary or income figure (typically an amount necessary to comfortably satisfy the lender’s debt-income ratio) and not face its verification by the lender with her employer or other income records, such as bank statements, paychecks, and tax returns . The derogatory moniker of liar loans, suggesting borrower fraud, was a misnomer in many instances, as oftentimes the borrower had no idea of the actual income amount filled in the loan application by the mortgage broker or loan officer . Even when approached more overtly, the conversation with the no-doc borrower addressing income might begin along the lines, as it did once for me with a mortgage broker, of “How much do you think you could earn next year if you had to do whatever it took to earn as much money as possible from any source?” Of course, as an alternative to the hijinks of stated income loans, lenders might maintain their rigor of income verification, but simply relax their income qualification standards, as many did . One mortgage broker suggested to me that for clients with high credit scores, a lender might be willing to allow a total debt-to-income ratio exceeding 50 percent .18
Even if the borrower earns enough income to meet required debt-to-income ratios, the applicant may run afoul of the lender’s loan-to-value requirement . Customarily, home buyers were required to make a down payment of at least 20 percent of the purchase price . The Garn .- St . Germain Depository Institutions Act of 198219 prohibited home lenders from refusing consent to subsequent home equity loans obtained by the borrower . It became commonplace
18 It makes sense to allow more leeway in the debt ratio for higher incomes, as some expenses, such as gasoline, utilities, and food, might be similar for differently situated income-earners, therefore allowing the higher earner more leftover income to devote to housing and other recurring credit expenses.
19 Garn-St. Germain Depository Institutions Act of 1982, Pub. L. No. 97-320, 96 Stat. 1469.
Housing and Community
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