Ten years ago, non-profit organizations the Greenlining Institute and Operation HOPE convened fifteen major banks—including Countrywide Financial and World Savings Bank—to urge restraints on irresponsible adjustable-rate mortgages and interest-only loans. Three months later, we met with former Federal Reserve Chairman Alan Greenspan to discuss the issue. Greenspan argued that ARMs were the best way to save money for homeowners—although he admitted that he personally preferred the comfort and predictability of a 30-year fixed-rate mortgage.
Today, many major financial institutions no longer exist as a result of their dangerous alternatives to 30-year fixed rates. Regulators at the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Consumer Financial Protection Bureau far more fully comprehend the sweeping negative consequences of reckless mortgage instruments thrust at unsuspecting low- and moderate-income homeowners. Yet it appears that a number of financial institutions are considering or have already introduced potentially dangerous ARMs, including interest-only mortgage products.
Thirty-year fixed-rate mortgages remain an important product for low- and moderate-income homeowners. However, many potential homeowners from Black, Latino and Southeast Asian communities are being shut out of the present market. With that in mind, we believe that reforming ARMs and creating a new kind of qualified mortgage product could benefit millions of low- and moderate-income homebuyers.
The biggest problem with ARMs a decade ago is that they were thrust upon inexperienced first-time homebuyers who sought the American dream. This often unrealistic goal, combined with a highly combustible free-market desire for quick profits, helped create the worst economic crisis since the Great Depression. Mandatory financial education as a prerequisite for a quality mortgage for low- and moderate-income families might do more to prevent a future crisis than any other change—particularly if certain highly volatile ARMs products are carefully scrutinized and viable alternative prime products are available.
Our simple suggestions for reforming ARMs are as follows:
First and foremost, no low- or moderate-income family should be offered any type of ARM or interest-only mortgage unless they are first enrolled in a mandatory financial education program. These programs should be administered by non-profit organizations that are church-based or approved by the U.S. Department of Housing and Urban Development. Further, we would suggest that any family with less than $5 million in net worth be offered a voluntary option of a financial education program.
Second, no ARM should be for a term less than the median time Americans own their primary residence—approximately seven to nine years.
Third, at this time, and until a compelling case be made, no institution should be permitted to offer interest-only mortgages to borrowers with less than $5 million in net worth.
Had these suggestions been adhered to a decade ago, they would have likely prevented the crisis that caused Black and Latino families to lose more than half of their net worth. It is a crisis that has caused millions of foreclosures and, at one time, had 20 million Americans underwater.
But restrictions alone are insufficient to promote the legitimate dream of responsible homeownership held by 95% of minorities and new immigrants. We also need to develop responsible instruments that will not exclude the vast majority of responsible low- and moderate-income families from securing financing from traditional, regulated and supervised financial institutions as opposed to being dependent upon predatory unregulated institutions.
Federal Housing Finance Agency director Mel Watt may be on the right track in proposing modifications of Fannie Mae and Freddie Mac requirements to purchase non-qualifying mortgages. Consistent with the new FHFA philosophy, we propose the following type of mortgage product:
- Fannie and Freddie should treat as a qualified mortgage any 30-year fixed-rate mortgage with a minimum 7% down payment (twice the FHA minimum) for homebuyers at or below median income who purchase a home that is no more than 90% of the median price in the region.
- To be eligible as a qualified mortgage, however, the mortgage must require a mandatory pre- and post-financing education and home counseling. It should also require a minimum credit score that is not unduly influenced by circumstances beyond the control of the homeowner. For example, the steep decline in home values in devastated areas such as Las Vegas is generally not the fault of any individual underwater homeowner who has been foreclosed upon.
- Unlike FHA requirements, no mortgage insurance would be necessary. However, to minimize risks, financial institutions shall be able to charge a premium of up to 50 points for the first five years of the mortgage, or beyond five years if payments within the first five years are not made in a timely fashion.
- Other clauses, which we will be discussing with financial institutions, should include the temporary waiver for up to six months of full payments should a homebuyer suffer a major medical emergency or temporary loss of job after five or more years of homeownership.
It is essential that the financial industry work together with regulators and community groups to learn from the mistakes of the past. We need mortgage instruments that are both profitable and safe—and we must promote responsible homeownership through truly effective financial education.
John Bryant is the founder and chair of Operation HOPE, has been an official advisor on financial inclusion to Presidents Clinton, Bush and Obama and is the author of a new book, How the Poor Can Save Capitalism.
Robert Gnaizda, former general counsel and a founder of Greenlining Institute, is general counsel for the National Asian American Coalition and a broad range of Black and Latino churches, including the National Hispanic Christian Leadership Conference and the Orange County Interdenominational Alliance.