REFinBlog

Editor: David Reiss
Brooklyn Law School

July 14, 2016

Deductible Up, Premium Down

By David Reiss

 

photo by Stewart Black

InsuranceQuotes.com quoted me in Homeowners Insurance: Higher Deductibles Lower Premiums, But Can You Afford to Take the Risk? It opens,

Raising the deductible on your home insurance policy is one proven way to save money on your premiums, but it’s not the best financial decision for every homeowner.

Before you reach for the phone to bump up your deductible there are two important factors to consider: Do you have enough money saved to cover higher out-of-pocket claim costs, and have you discussed potential savings and ramifications with an insurance agent?

“The bottom line is that you want to make sure you are comfortable with the deductible amount you’ve selected,” says Stacy Molinari, personal lines and claims manager of Insurance Marketing Agencies, Inc. “And that means you need to make sure you have enough of a financial cushion to cover the deductible. Otherwise it could cost you more in the long run.”

So, just how much savings are out there when switching to a higher deductible? Let’s break it down by looking at a report commissioned by insuranceQuotes.com.

The 2016 Quadrant Information Services study examined the average economic impact of increasing a home insurance deductible (i.e. how much you pay out of pocket for a claim before your insurance coverage kicks in). Using a hypothetical two-story, single-family home covered for $140,000, the study looked at how much an annual U.S. home insurance premium can decrease after increasing the deductible.

According to the National Association of Insurance Commissioners (NAIC), the average home insurance premiums is $1,034, and the study examined three different percentage increases and their respective premium savings:

  • Increase from $500 to $1,000: 7 percent savings.
  • Increase from $500 to $2,000: 16 percent savings.
  • Increase from $500 to $5,000: 28 percent savings.

What makes home insurance deductibles so significant?

In short, a home insurance deducible is one of many gauges an insurance company uses to determine how much risk the consumer is willing to accept. A higher deductible means more risk being taken on by the homeowner, and that additional risk makes it cheaper to insure the policyholder.

“A higher deductible is a signal to the insurance company that the homeowner is less likely to file claims because they are agreeing to a higher threshold for doing so,” says David Reiss, law professor and research director at Brooklyn Law School’s Center for Urban Business Entrepreneurship. “And the less likely you are to make a claim, the lower your premium is going to be.”

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July 14, 2016 | Permalink | No Comments

July 13, 2016

Caveat Rent-to-Own

By David Reiss

keys-1317391_1920WiseBread quoted me in 5 Things You Need to Know When Renting-to-Own a Home. It opens,

Your credit scores are too low. Or maybe you’ve run up too much credit card debt. Whatever the reason, you can’t qualify for the mortgage loan you need to buy a home. But there is hope: You can enter into a rent-to-own agreement and begin living in a home today — one that you might eventually be able to buy.

Just be careful: David Reiss, professor of law and research director for the Center for Urban Business at Brooklyn Law School, said that consumers need to be careful when entering rent-to-own arrangements. Often, these agreements end up with tenants losing money that they didn’t need to spend.

“Potential homebuyers should be very careful with rent-to-own opportunities,” Reiss said. “They have a long history of burning buyers. Does the law in your state provide any protection to a rent-to-own buyer who falls behind on payments? Could you end up losing everything that you had paid toward the purchase if you lose your job?”

These worries, and others, are why you need to do your research before signing a rent-to-own agreement. And it’s why you need to know these five key facts before agreeing to any rent-to-own contract.

1. How Do Monthly Rent and Final Selling Price Relate?

In a rent-to-own arrangement, you might pay a bit more in rent each month to the owner of a home. These extra dollars go toward reducing a final sales price for the home that you and the owner agree upon before you start renting.

Then, after a set number of years pass — usually anywhere from one to five — you’ll have the option to purchase the home, with the sales price lowered by however much extra money you paid along with your monthly rent checks. Not all companies that offer rent-to-own homes work this way. Some don’t ask for more money from tenants each month, and don’t apply any rental money toward lowering the eventual sales price of the home.

This latter option might be the better choice for you if you’re not certain that you’ll be able to qualify for a mortgage even after the rental period ends.

“A pitfall is if the tenant buyer signs into the program but will never be approved for financing, thus never purchases the house,” said John Matthews, president of operations of Chicago Lease to Own. “That is how the scammers out there have used rent-to-own to hurt people. They sell it to those who should never have been in the program and take their portion of the rent every month used ‘for the purchase of their home’ knowing that the tenant will never qualify to buy the home.”

Make sure you know — and are comfortable with — the home’s final sales price and monthly rent payments before you agree to a rent-to-own arrangement. And if you don’t want to pay extra in rent each month for a home that you might never end up buying? A rent-to-own agreement might not be for you.

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July 13, 2016 | Permalink | No Comments

July 12, 2016

Owning v. Renting Smackdown

By David Reiss

photo by Agardikevin00

Forbes quoted me in Are You Really Just Throwing Your Money Away When You Rent? It reads, in part,

There are a number of reasons for wanting to buy a home over renting and most are valid. Some people want to buy because their current rental unit may have restrictions on owning a pet, while home ownership would, in most cases, not have this limitation. Others want to diversify their assets beyond the stock market. Still others may be pressured by friends and family – loved ones may claim you are simply throwing your money away if you rent, but with owning, you could be building equity every month.

Is this really true?

You Are Building Equity As A Homeowner, But…

It is true that you are building equity each month as a homeowner. However, the amount of equity you’re building is equivalent to the portion of your monthly mortgage payment that goes toward paying down principal.

Because most mortgages are structured to have a uniform monthly payment for the life of the loan, in practice, this means that your early payments will consist of more interest than principal. So while you are paying down principal and building equity, you may not be building as much as you imagined.

For example, let’s say you had a 30-year fixed rate mortgage with an interest rate of 4% and a starting loan balance of $500,000. Your monthly payment would be $2,387, but just 30% of this payment or $720 would go toward “building equity” during the first month. Over the first five years, less than 35% of your total mortgage payments go toward paying down principal (i.e. about $48,000 out of $143,000 of total payments).

Scott Trench, director of operations at real estate investment social network BiggerPockets, added, “Yes, equity can make you feel good, but it’s not really money you can use freely until you’ve sold the property. And if you end up selling in a down market, you may not end up realizing as much equity as you expected.”

*     *     *

The Transaction Costs Are Large For Buying!

The costs of buying and selling real estate are significant, and those costs don’t go toward building equity either.

“Buying a house entails many transaction costs that add up to three, four, or five percent of the price of the home and sometimes even more,” said David Reiss, a professor who teaches residential real estate at Brooklyn Law School. “Many advise that homebuyers should have at least a five-year time horizon or they risk having those transaction costs eat into any gains they were hoping to get out of the sale of their home. Even worse, those costs can lead to a loss, if the local market is soft.”

 On a $500,000 home purchase, three to five percent of closing costs translates to $15,000 to $25,000 – not an immaterial amount of money. When you ultimately sell your home, you may have to pay another three to five percent in closing costs or more.

That’s why your expected time horizon in a home is one of the most important factors to consider when deciding whether it is the right time for you to buy. A longer time horizon gives your home a better opportunity to realize sufficient price appreciation, to offset those large transaction costs.

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July 12, 2016 | Permalink | No Comments

July 11, 2016

Does Housing Finance Reform Still Matter?

By David Reiss

Ed DeMarco and Michael Bright

Ed DeMarco and Michael Bright

The Milken Institute’s Michael Bright and Ed DeMarco have posted a white paper, Why Housing Reform Still Matters. Bright was the principal author of the Corker-Warner Fannie/Freddie reform bill and DeMarco is the former Acting Director of the Federal Housing Finance Agency. In short, they know housing finance. They write,

The 2008 financial crisis left a lot of challenges in its wake. The events of that year led to years of stagnant growth, a painful process of global deleveraging, and the emergence of new banking regulatory regimes across the globe.

But at the epicenter of the crisis was the American housing market. And while America’s housing finance system was fundamental to the financial crisis and the Great Recession, reform efforts have not altered America’s mortgage market structure or housing access paradigms in a material way.

This work must get done. Eventually, legislators will have to resolve their differences to chart a modernized course for housing in our country. Reflecting upon the progress made and the failures endured in this effort since 2008, we have set ourselves to the task of outlining a framework meant to advance the public debate and help lawmakers create an achievable plan. Through a series of upcoming papers, our goal will be to not just foster debate but to push that debate toward resolution.

Before setting forth solutions, however, it is important to frame the issues and state why we should do this in the first place. In light of the growing chorus urging surrender and going back to the failed model of the past, our objective in this paper is to remind policymakers why housing finance reform is needed and help distinguish aspects of the current system that are worth preserving from those that should be scrapped. (1)

I agree with a lot of what they have to say.  First, we should not go back to “the failed model of the past,” and it amazes me that that idea has any traction at all. I guess political memories are as short as people say they are.

Second, “until Congress acts, the FHFA is stuck in its role of regulator and conservator.” (3) They argue that it is wrong to allow one individual, the FHFA Director, to dramatically reform the housing finance system on his own. This is true, even if he is doing a pretty good job, as current Director Watt is.

Third, I agree that any reform plan must ensure that the mortgage-backed securities market remain liquid; credit remains available in all submarkets markets; competition is beneficial in the secondary mortgage market.

Finally, I agree with many of the goals of their reform agenda: reducing the likelihood of taxpayer bailouts of private actors; finding a consensus on access to credit; increasing the role of private capital in the mortgage market; increasing transparency in order to decrease rent-seeking behavior by market actors; and aligning incentives throughout the mortgage markets.

So where is my criticism? I think it is just that the paper is at such a high level of generality that it is hard to find much to disagree about.  Who wouldn’t want a consensus on housing affordability and access to credit? But isn’t it more likely that Democrats and Republicans will be very far apart on this issue no matter how long they discuss it?

The authors promise that a detailed proposal is forthcoming, so my criticism may soon be moot. But I fear that Congress is no closer to finding common ground on housing finance reform than they have been for the better part of the last decade. The authors’ optimism that consensus can be reached is not yet warranted, I think. Housing reform may not matter because the FHFA may just implement a new regime before Congress gets it act together.

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July 11, 2016 | Permalink | No Comments

July 8, 2016

Spreading Mortgage Credit Risk

By David Reiss

photo by A Syn

The Federal Housing Finance Agency has released the Single-Family Credit Risk Transfer Progress Report. Important aspects of Fannie and Freddie’s future are described in this report. It opens,

Since 2012, the Federal Housing Finance Agency (FHFA) has set as a strategic objective that Fannie Mae and Freddie Mac share credit risk with private investors. While the Enterprises have a longstanding practice of sharing credit risk on certain loans with primary mortgage insurers and other counterparties, the credit risk transfer transactions have taken further steps to share credit risk with private market participants. Since the Enterprises were placed in conservatorship in 2008, they have received financial support from the U.S. Department of the Treasury under the Senior Preferred Stock Purchase Agreements (PSPAs). The Enterprises’ credit risk transfer programs reduce the overall risk to taxpayers under these agreements.

These programs have made significant progress since they were launched in 2012 and credit risk transfer transactions are now a regular part of the Enterprises’ businesses. This progress is reflected in FHFA’s 2016 Scorecard for Fannie Mae, Freddie Mac, and Common Securitization Solutions (2016 Scorecard), which sets the expectation that the Enterprises will transfer risk on 90 percent of targeted single-family, 30-year, fixed-rate mortgages. FHFA works with the Enterprises to ensure that credit risk transfer transactions are conducted in an economically sensible way that effectively transfers risk to private investors.

This Progress Report provides an overview of how the Enterprises share credit risk with the private sector, including through primary mortgage insurance and the Enterprises’ credit risk transfer programs. The discussion includes year-end 2015 data, a discussion of which Enterprise loan acquisitions are targeted for the credit risk transfer programs, and an overview of investor participation information. (1, footnotes omitted)

This push to share credit risk with private investors is a significant departure from the old Fannie/Freddie business model and it should do just what it promises: reduce taxpayer exposure to credit risk for the trillions of dollars of mortgages the two companies guarantee through their mortgage-backed securities. That being said, this is a relatively new initiative and the two companies (and the FHFA, as their conservator and regulator) have to navigate a lot of operational issues to ensure that this transfer of credit risk is priced appropriately.

There are also some important policy issues that have not been settled. The FHFA has asked for feedback on a series of issues in its Single-Family Credit Risk Transfer Request for Input, including,

  • how to “develop a deeper mortgage insurance structure” (RfI, 17)
  • how to develop credit risk transfer strategies that work for small lenders (RfI, 18)
  • how to price the fees that Fannie and Freddie charge to guarantee mortgage-backed securities (RfI, 19)

Congress has abdicated its responsibility to implement housing finance reform, so it is left up to the FHFA to make it happen. Indeed, the FHFA’s timeline has this process being finalized in 2018. The only way for the public to affect the course of reform is through the type of input the FHFA is now seeking:

FHFA invites interested parties to provide written input on the questions listed [within the Request for Input] 60 days of the publication of this document, no later than August 29, 2016. FHFA also invites additional input on the topics discussed in this document that are not directly responsive to these questions.

Input may be submitted electronically using this response form. You may also want to review the FHFA’s update on Implementation of the Single Security and the Common Securitization Platform and its credit risk transfer page as it has links to other relevant documents.

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July 8, 2016 | Permalink | No Comments

July 7, 2016

Plunging Minority Homeownership Rates

By David Reiss

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Construction Dive quoted me in Why Minority Homeownership Rates Plunged After the Housing Crash — and How to Reverse The Trend. It opens,

The recovery from the 2007 U.S. housing crash is still underway, with the ramifications of foreclosures and subprime mortgages still playing out for many current and potential American homeowners. Northeastern markets are still struggling to clear out crisis-era inventory, largely due to foreclosure laws, and members of Generation X — one of the hardest hit groups during the crash — are just now building up the required financial strength and confidence to claw their way back to homeownership.

While the Census Bureau Housing Vacancy Survey indicated that U.S. homeownership overall was 63.5% in the first quarter of 2016 — down significantly from a 25-year average of 66.2% — the groups encountering the most difficulties snapping back from the housing crisis are the black and Hispanic populations.

The Census Bureau found that 41.5% of black households and 45.3% of Hispanic households are currently homeowners, compared to 72.1% of white households. And last year, while the Urban Institute projected that Hispanic homeownership would rise over the next 15 years, it also predicted that black homeownership would drop to 40%.

The stagnant and declining minority homeownership numbers are clear, but experts have varying views regarding why this situation is occurring and what can be done to reverse the trend.

 *     *     *

In Newark, NJ, for example, entire minority neighborhoods were targeted with home renovation schemes, which ended in high-interest home equity loans for the consumer, according to David Reiss, professor of law and academic program director for urban business entrepreneurship at Brooklyn Law School. “You would see entire streets with home improvement projects through the same company,” he said.

A study by University of Buffalo professor Gregory Sharp and Cornell University professor Matthew Hall found that “race was the leading explanation for why people lost homes they owned and turned back to rentals.” Sharp and Hall said that minorities were “exploited” by the mortgage lending system, which led to blacks being 50% more likely than whites to lose their homes and enter the rental market.

After the housing market crash, there weren’t enough educational resources and financial literacy programs available to minority groups to help them navigate the “new normal” of adjustable-rate mortgages and increases to their monthly payments, according to Franky Bonilla, with Churchill Mortgage in Houston. “Without access to even the most basic information, such as how to save money or properly document income, many borrowers were unequipped to overcome (these problems), and, as a result, many owners walked away from their homes,” he said.

How to boost homeownership among minorities

So with minority homeownership rates lagging — and in some cases sinking — since the housing crisis, what’s the answer to reverse the trend?

Bonilla, who is also a member of the National Association of Hispanic Real Estate Professionals (NAHREP), said approximately 60% of his business comes from minority homeowners and that this group in particular could benefit from borrower education and outreach, such as bilingual employees, as well as workshops and seminars.

“Lenders with more cultural diversity have an advantage because they can relate and communicate more effectively with individuals who might otherwise feel disadvantaged or intimidated by the mortgage process,” Bonilla said. “In turn, this creates an opportunity to establish a relationship at a personal level and determine which mortgage options are the best fit for each borrower’s unique financial situation.”

Another possible solution to increasing minority homeownership rates, along with homeownership among those who don’t meet the credit requirements for prime loans, is an overhaul of lending criteria for mortgages.

Reiss said there has been a move by some housing advocates to have credit for mortgage purposes reflect factors more indicative of future success as a homeowner. One of the critical issues, however, is to try to determine exactly how much credit is the right amount of credit. “You want to make credit available to people without having excessive default rates,” Reiss said. “Clearly the amount of credit we had in the early 2000s was too much credit, and it ended poorly for many people.”

Reiss added that home lending has always involved a careful balance between underwriting and available credit. “I think everyone would agree that the ‘Wild West’ days of lending were not good for American households in general,” he said.

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July 7, 2016 | Permalink | No Comments

July 6, 2016

Violations of Law and Consumer Harm

By David Reiss

ffiec_logo (1)

The Federal Financial Institutions Examination Council (FFIEC) issued a notice and request for comment regarding the Uniform Interagency Consumer Compliance Rating System (CC Rating System). My comment letter reads as follows:

The Federal Financial Institutions Examination Council (FFIEC) issued a notice and request for comment regarding the Uniform Interagency Consumer Compliance Rating System (CC Rating System). The FFIEC is seeking to revise the CC Rating System “to reflect the regulatory, examination (supervisory), technological, and market changes that have occurred in the years since the current rating system was established.”  81 F.R. 26553.  It is a positive development that the federal government is seeking to implement a consistent approach to consumer protection across a broad swath of the financial services industry.  Nonetheless, the proposed CC Ratings System can be refined to further improve consumer protection in the financial services industry.

One of the CC Rating System’s categories is Violations of Law and Consumer Harm.  The request for comment notes that over the last few decades, the financial services industry has become more complex, and the broad array of risks in the market that can cause consumer harm has become increasingly clear.  Violations of various laws – including the Fair Housing Act and other fair lending laws, for example – may cause significant consumer harm that should raise supervisory concerns.  Recognizing this broad array of risks, the proposed revisions directs examiners to consider all violations of consumer laws based on the root cause, severity, duration, and pervasiveness.  This approach emphasizes the importance of various consumer protection laws, and is intended to reflect the broader array of risks and potential harm caused by consumer protection violations.  81 F.R. 26556.

This is all to the good.  Prior to the Subprime Crisis, a big part of the problem was that financial services companies used regulatory arbitrage to avoid scrutiny.  Lots of mortgage lending migrated to nonbanks that did not need to worry about unwanted attention from the regulators that scrutinized banks and other heavily regulated mortgage lenders.  (To be clear, Alan Greenspan and other federal regulators did not do a good job of scrutinizing the banks. But let’s leave that for another day.)  With the CFPB now regulating many nonbanks and with an updated CC Rating System in place, we should expect that regulatory arbitrage will decrease in the face of this coordinated regulatory action.

I would note, however, an ambiguity in the “Violations of Law and Consumer Harm” category, an ambiguity that should be cleared up in favor of additional consumer protections.  The category title, “Violations of Law and Consumer Harm,” implies that there are some types of consumer harm that are distinct from violations of law and that is obviously true. The discussion of the category emphasizes this by stating that it encompasses “the broad range of violations of consumer protection laws and evidence of consumer harm.” 81 F.R. 26556 (emphasis added).  And the text of the guidance itself states this as well, indicating that the category’s assessment factors “evaluate the dimensions of any identified violation or consumer harm.”  81 F.R. 26558 (emphasis added).

But the remainder of the discussion of this category only focuses on violations of law and pays little attention to “the broad array of risks in the market that can cause consumer harm” that are not also violations of law.  81 F.R. 26556.  Indeed, the four assessment factors for this category are all premises on causes of identified “violations of law.”  This is a significant failing for the CC Rating System because of the many types of consumer harm that are not clear violations of law.  As proposed, the “Violations of Law and Consumer Harm” category appears to be as much about protecting the bank from legal liability from lawsuits brought on behalf of consumers as it is about addressing the legitimate interests of the consumers of financial services.

As we sort out the after-effects of the Subprime Crisis, we have seen many situations where there was no clear violation of law but homeowners suffered from outrageous industry practices.  For instance, many borrowers are suffering needlessly at the hands of their mortgage servicers.  Some servicers are under-resourced, intentionally or not, and continue to treat their borrowers with a maddening disregard.  In some cases, this outrageous behavior does not amount to a clear violation of law, but is behavior that reflects most badly on the parties engaged in it.  The CC Rating System should both acknowledge this type of harm and address it to maximize the benefits that can flow from this forthcoming revision to it.

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July 6, 2016 | Permalink | No Comments