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Prepared Statement of Senator Schumer Hearing on "Ending Mortgage Abuse: Safeguarding Homebuyers"

Subcommittee on Housing, Transportation and Community Development

I want to welcome everyone to this critical hearing on “Ending Mortgage Abuse: Safeguarding Homebuyers” and thank the witnesses who are appearing before the Subcommittee today.  Many of the members of this Committee, including myself, know first hand about the rising home foreclosures that are devastating communities in our home states.  The big question is why?  Is it really “the economy, stupid”?  Is it as simple as lack of borrower education?  Is it a sharp rise in family financial emergencies?  Or is it downright bad lending practices?


I hope we will get to the heart of this question today, so that we can figure out how best to solve it.


There are a lot of different interests represented in this room today to ensure we get all perspectives. 


But at least we can begin by all agreeing that sustainable home ownership is the key to having a strong financial future in this country.  Buying a home is the largest purchase most families will ever make and it is the path to wealth and asset accumulation for families and their future generations. It is also critical to building flourishing communities in which homeowners and small businesses are willing to invest in their local economies, create new jobs, and contribute to the country’s economic growth.


Yet, our mutual respect for this basic principal has not been enough to prevent a widespread effort to exploit the most vulnerable segments of our population by tricking them into signing on to loans they can ill-afford –  making it virtually impossible for many to truly achieve the American Dream.  


African-Americans, Hispanics, single mothers, and the elderly are targeted everyday in predatory lending schemes and deceptive loan practices – enticed into mortgages with low “teaser” rates that will only reset to future payments that the borrowers cannot mathematically afford.  For example, a study by HUD and the U.S. Treasury found that sub-prime loans were issued 5 times more frequently to black neighborhood households as they were to white neighborhood households. And 39 percent of homeowners living in upper-income black neighborhoods have sub-prime refinancing--twice the rate of homeowners living in lower-income white neighborhoods.


This sub-prime storm has left virtually no corner of this country untouched. You can’t go a day without reading or hearing about the families in New York, in Ohio, in Pennsylvania that are stuck in risky loans that they can’t afford, and desperate for a way out that allows them to preserve their home.  The problem is bad and getting worse. This map shows the areas of the country with the greatest increases in reported foreclosures over the past two years.


Depressed economic regions, like parts of the Midwest that have experienced significant job losses in recent years, have also been prime targets for deceptive lending practices.  And even in growing states like Colorado and Georgia, unsuitable loans abound. According to RealtyTrac, nearly 3,000 foreclosure actions were reported in my colleague and former Chairman of this Subcommittee Wayne Allard’s state of Colorado last month alone.


Before our eyes whole communities are being set up to fail when we should be arming them with tools to succeed. The risk of a foreclosure boom in these communities is real. In a widely publicized report, the Center for Responsible Lending estimated that 2.2 million sub-prime loans made in recent years have already failed or will end in foreclosure, costing homeowners as much as $164 billion, primarily in lost home equity. 


It is bad enough that these families that have to foreclose will lose their main source of financial stability, not to mention their credit-worthiness, but if these foreclosures are concentrated in a few communities, the effects will be devastating.  Studies have shown that even one foreclosure could lower the value of nearby homes by almost 1.5%.  That is about $3,000 in lost home value per neighbor, or $150,000 of lost neighborhood value for just one foreclosure.  If two million home foreclose nationwide, our communities would lose $300 billion in neighborhood wealth and $6 billion in local taxes that go to fund schools, roads, etc.


So…the question is why is this happening?    There is a lot of blame going around, but I think the fundamental reason is very simple. 


The catalyst behind this impending avalanche of foreclosures are risky subprime mortgage loans that thousands of middle and lower income Americans were tricked into borrowing, even though the loans themselves are designed to fail them.


These so-called “liar loans” are often wrapped in complex rate terms, high fees, and shocking rate increases that in the near-term leave the borrower unable to afford rising mortgage payments.


I ask all of you panelists why have these loans not been underwritten at the fully indexed rate?


Many in the industry participants argue that that these loans themselves are not to blame – it’s not the product, they say, it’s the economy…and that is why we are seeing record delinquencies and foreclosures. 


But one look at this payment chart for the most popular subprime loan in recent years – a “2/28 Adjustable Rate Mortgage” – and the answer is clear.  These loans are traps.


In this example, the borrower starts off paying $1300 a month, which is 44% of his monthly paycheck of $3,000.  And because subprime borrowers don’t have to escrow– this payment doesn’t even include the estimated $200 monthly payment for taxes and insurance.


After just 30 months, the initial teaser fixed rate expires, and the borrower’s monthly payment jumps over $400. 


Then, at 36 months, it resets again, to nearly 50% higher than her initial monthly payment.  In 42 months, assuming the underlying interest rate rises 1.5 percentage points, the borrower is paying $2200 a month – or 72% of their income – to service this mortgage.


In order to prevent payment shocks and stave off foreclosure, this borrower needs to get a 63% pay raise before his mortgage starts resetting -- or win the lottery.  And the worst part about it, is that the broker knows this from DAY ONE.


They know full well that the likelihood of the homeowner defaulting on their loan is high, but they don’t care because they’ve already made their money.


I know a man from my hometown by the name of Frank Ruggiero, who was talked into signing on to such a loan.  Unfortunately due to his weekly dialysis treatments he could not be here today to share his story first hand. 


In Mr. Ruggiero’s case, he was recently tricked by an aggressive broker who told him to refinance his mortgage of $368,000 with a new mortgage of $416,000. Of the $48,000 additional debt on Mr. Ruggiero's home, he received only $5,728, and the balance went to closing costs. Out of this deal, the broker alone received $9,300 from the proceeds and received an additional fee of $11,900 from the lender as "yield spread premium" because he duped Mr. Ruggiero with such a profitable loan.


Mr. Ruggiero is one of millions of borrowers that are getting duped into loans that are designed to fail the borrower and benefit the broker.


The economy is not the problem here.  It’s the product, stupid.  No one should be tricked into signing onto a loan that is purposely designed to fail them.  The very existence of these loans is not a sign of the market working.  The fact that these loans are underwritten almost exclusively to borrowers that can’t afford them is a market failure. By some estimates, 80% of subprime loans are these “exploding” ARMS..


And what I want to examine today is why this product even came to be, and in such volume.  Why are nearly three-quarters of subprime loans are being originated by independent brokers or non-bank affiliates with no federal supervision, or finance companies with only indirect federal supervision?    


And why are these bad loans being sold primarily to families that already own a home?  According to the chief national bank examiner for the Office of Comptroller of the Currency, only 11percent of subprime loans went to first-time buyers last year. The vast majority were refinancings that caused borrowers to owe more on their homes under the guise that they were saving money.


The bottom line is that it should be illegal for lenders to qualify a borrower for a loan for anything less than its fully indexed rate.  The industry must determine a borrower’s ability to pay.


       Subprime borrowers should also be required to escrow for taxes and insurance, like virtually all prime loan borrowers.  Including the taxes and insurance would make it impossible for most to get approved for these high rate mortgages, thus the reason the industry excludes them.  Lack of escrows will only result in borrowers returning to lenders in serious trouble or default when tax and insurance payments are due. 


We must put an end to these practices and now.


I have heard one horror story after another where brokers go into communities attend church services and not only offer to provide the loan, not only guarantee loans, but also offer to find the realtor and the appraiser.  There is an unregulated world that is on the loose with out adequate supervision – and we need to change that.


One of the things I have focused on - with my colleagues Senators Brown and Casey – is creating a national regulatory structure for mortgage brokers and other originators in addition to pushing the regulators to conduct more oversight using HOEPA and other relevant laws.


In April, we introduced a strong bill, S.1299, to offer a fix to make it harder for irresponsible brokers and non-bank lenders to sell mortgages that are designed to fail the homeowner and result in foreclosure. 


My goal is to strengthen standards for subprime mortgages by regulating mortgage brokers and all originators under the Truth in Lending Act (TILA) by establishing on behalf of consumers a fiduciary duty and other standards of care.  In addition, the bill outlines standards for brokers and originators to assess a borrower’s ability to repay a mortgage, requires taxes and insurance to be escrowed on all subprime loans and holds lenders accountable for brokers and appraisers. 


The bill will also focus on appraisers a group that has been talked about less.  The bill would protect appraisers who have often been pressured into becoming the silent partners in many predatory lending scams, providing inflated appraisals at the originators’ behest.


It is clear that the subprime mortgage market has been the Wild West of the mortgage industry for far too long.  We need a sheriff in town.  Thank you, I look forward to hearing your testimonies.


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