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Editor: David Reiss
Cornell Law School

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February 8, 2018

Loan Mods Amidst Rising Interest Rates

By David Reiss

photo by Chris Butterworth

The Urban Institute’s Laurie Goodman et al. have posted Government Loan Modifications: What Happens When Interest Rates Rise?. This brief is another product of the newly formed Mortgage Servicing Collaborative. This brief

examines the current loan modification product suite for government loans insured or guaranteed by the Federal Housing Administration (FHA), US Department of Veterans Affairs (VA), or the US Department of Agriculture (USDA). When a delinquent borrower with a government loan obtains a modification, the mortgage rate is typically reset to the prevailing market rate, which can be higher or lower than the original note rate. When the market rate is below the original rate, providing payment reduction becomes inherently easier and less expensive for the investor. Conversely, when market rates are above the note rate, providing payment reduction becomes more expensive and challenging, making it more difficult to cure the delinquency. This can result in more redefaults and foreclosures, larger losses for government insurers, and greater distress for borrowers, communities, and neighborhoods. In addition, most government mortgage borrowers are first-time homebuyers and minorities, who tend to have limited incomes and savings, making loan modifications all the more important. (1)

Given the recent upward trend in interest rates, this is more than a theoretical exercise. And indeed, the brief “explains why FHA, VA, and USDA borrowers who fall behind on their payments are unlikely to receive adequate payment relief when the market interest rate is higher than the original note rate. ” (3)

The brief outlines some options that could increase payment relief for those borrowers, including deploying a 40-year extended term and principal forbearance to reduce the monthly mortgage payment. The brief acknowledges that there are barriers to implementing the options it has identified but it also proposes ways to overcome those barriers.

As I had stated previously, the Mortgage Servicing Collaborative is providing sorely needed guidance through some of the darker corners of the mortgage market. This brief sheds some welcome light on an obscured problem that may cause trouble in the years to come.

February 8, 2018 | Permalink | No Comments

February 7, 2018

The Fate of CFPB’s Civil Investigative Demands

By David Reiss

 

Mick Mulvaney’s Consumer Financial Protection Bureau issued a Request for Information Regarding Bureau Civil Investigative Demands and Associated Processes:

The Bureau is using this request for information to seek public input regarding the exercise of its authority to issue CIDs, including from entities who have received one or more CIDs from the Bureau, or members of the bar who represent these entities.

The issuance of CIDs is an essential tool for fulfilling the Bureau’s statutory mission of enforcing Federal consumer financial law. The Bureau issues CIDs in accordance with the law and in furtherance of its investigatory objectives. The Bureau understands, however, that responding to a CID can impose burdens on the recipients. Entities who have received one or more CIDs, members of the bar who represent these entities, and members of the public are likely to have useful information and perspectives on the benefits and burdens of the Bureau’s existing processes related to CIDs. The Bureau is especially interested in better understanding how its processes related to CIDs may be updated, streamlined, or revised to better achieve the Bureau’s statutory and regulatory objectives, while minimizing burdens, consistent with applicable law, and how to align the Bureau’s CID processes with those of other agencies with similar authorities. Interested parties may also be well-positioned to identify those parts of the Bureau’s processes related to CIDs that are most in need of improvement, and, thus, assist the Bureau in prioritizing and properly tailoring its review process. In short, engaging CID recipients, potential CID recipients, and the public in an open, transparent process will help inform the Bureau’s review of its processes related to CIDs. (83 F.R. 3686 (Jan. 26, 2018))

There is a lot of subtext in this request, of course, because Mulvaney is set on hamstringing the Bureau which he has described as a “sick, sad” joke. A review of CIDs is likely to lead to a decrease in enforcement activity for the financial services companies regulated by the CFPB.

Be that as it may, the Bureau is seeking comments on “Specific suggestions regarding any potential updates or modifications to the Bureau’s practices regarding the formulation, issuance, or modification of CIDs consistent with the Bureau’s regulatory and statutory objectives, including, in as much detail as possible, the potential update or modification, supporting data or other information such as cost information or information concerning alignment with the processes of other agencies with similar authorities . . .” (Id.)

Comments are due by March 27, 2018.

February 7, 2018 | Permalink | No Comments

February 6, 2018

Investing in Small Commercial Real Estate

By David Reiss

photo by Nick

US News & World Report quoted me in How to Invest in Small Business Strength. It reads, in part,

Many indicators show the economy is strong, which in turn means small businesses are following suit.

Small business financials were at the strongest point in 2017 since data collection started in 2007, according to BizBuySell’s Q4 2017 Insights data. The median revenue of sold businesses grew more than 5 percent this year. There’s also a trend of home-based businesses moving to brick-and-mortar locations, says Danny Mulcahy, director of equity for Northstar Commercial Partners in Denver.

This bodes well for the landlords of the small office and retail commercial spaces they occupy, which have the potential to ride their success in the form of potential above-average returns.

But before investing in small commercial office, retail and industrial properties, which are fiercely different products than residential investment properties, it’s important to exercise adequate due diligence and heed the following advice, experts say.

Hire a good team of advisors. “Deciding to invest in commercial real estate is a large decision typically,” says Michael Marsh with real estate brokerage Lee & Associates in Phoenix. “There are many factors to potentially consider such as legal structures, financial evaluations, liability, loans, tax implications, and property management.”

A sales specialist in the type of commercial real estate you’re interested in will have the best available information for you to consider, he says.

“A commercial broker will be able to quickly work through a large set of properties as well as present off-market opportunities,” he says.

An investor should also have an idea of financing options from a competent commercial real estate banker. An experienced property attorney can help with setting up an adequate structure for holding the real estate and put bulletproof leases in place, Marsh adds.

Avoid empty buildings, at least to start. “The main criteria when selecting such a [commercial] property is to look for ones that have cash flow,” says Spencer Chambers, a general contractor and Realtor with The Chambers Organization in Newport Beach, California. “That is the reason you make any real estate investment. Avoid ones that don’t make money.” Properties with cash flow are more proven and it is easier to get financing to purchase them.

*     *     *

Do your research. Small commercial real estate is a trickier investment than residential. Before you buy, ask, “What are rents for comparable properties? How quickly are vacancies filled in the area? How much should you expect to spend on maintenance and repairs?” says David Reiss, a real estate professor at Brooklyn Law School. “You want to be able to predict the likely income and expenses the building will have.”

Evaluate any current tenants and their leases carefully as well: “There is a big difference between buying a building that is fully rented up with tenants who are paying their rent regularly and have a lot of time left on their lease and a building [that] has tenants with month-to-month leases who are behind on their rent,” he says.

That’s because the greatest costs for the landlord are vacancy and management. These aren’t often efficient with a limited economy of scale compared to larger landlords and real estate investment trusts, says Walt Batansky, chief financial officer of Avocat Group, a corporate real estate firm in Tampa, Florida.

Look at the capitalization rate. The building’s capitalization rate, based on its net operating income, is used to evaluate a commercial property. To arrive at the cap rate, the net operating income (or annual rental income minus expenses but before any mortgage payments are factored in) is divided by the average rate of return for similar properties in the area.

“You should go as big as your purchasing power allows, meaning whatever you’re able to get a loan for,” Chambers says. “As long as you’re buying a cash flow property from day one. You want to buy something with over 8 percent capitalization rate.”

February 6, 2018 | Permalink | No Comments

February 5, 2018

Trump Wins Another Round in CFPB Fight

By David Reiss

OMB Director Mick Mulvaney

Judge Gardephe (SDNY) ruled against the Lower East Side People’s Federal Credit Union in their suit against President Trump and Mick Mulvaney over the control of the Consumer Financial Protection Bureau. (Case 1:17-cv-09536-PGG, filed February 1, 2018) Trump has sought to install Mulvaney, his OMB Director, as the Acting Director of the CFPB. I submitted an amicus brief on behalf of the Credit Union along with a number of other academics who write about the consumer financial services sector but the judge did not reach the merits of the case. Rather, the judge found that the Credit Union did not have standing to bring the lawsuit. Standing, for you non-lawyers out there, refers to a showing by the plaintiff that it has enough of a connection to, as well as harm from, an action that the plaintiff is challenging to be the basis for the lawsuit.

The dispute over the leadership of the CFPB is still ongoing as Leandra English, the Deputy Director appointed by former Director Cordray, is still pressing the suit that she filed in the District Court for the District of Columbia. In that suit, English claims that she is the rightful Acting Director of the CFPB. While she lost in the District Court, she has filed an appeal to the Court of Appeals for the District of Columbia. That case turns on the complex interaction between the Dodd-Frank Act and the Federal Vacancies Reform Act, so it is hard to predict what the Court of Appeals will end up doing in that case.

In the short term, it means that the CFPB is somewhat rudderless as two people claim to lead the agency. This condition will likely prevail until President Trump gets a permanent Director confirmed by the Senate.

February 5, 2018 | Permalink | No Comments

February 2, 2018

Tax Reform and Home Equity Loans

By David Reiss

photo by Kalmia

MortgageLoan.com quoted me in Tax Reform Just Made Home Equity Loans A Lot Less Attractive. It reads, in part,

Home equity loans have long been attractive ways for homeowners to borrow money to pay for everything from major home improvements to a child’s college education. But these loans just lost a major benefit: When filing their income taxes, homeowners can no longer deduct the interest they pay on home equity loans each year.

This might make these loans less popular. The loss of the interest deduction might persuade homeowners to look for other ways to tap the money in their homes.

“From what I see, there are very limited times that home equity loans would still come in as a benefit,” said Tristan Ahumada, a real estate agent with Keller Williams Realty in Westlake Village, California.

A rush to pay off home equity loans?

And she’s not alone. Donald Daly, managing partner of REIS Group LLC in New York City and a licensed real estate appraiser, said that since January 1 he has seen a higher level of requests for appraisals from homeowners seeking to refinance their existing mortgage loans. Many of these owners are doing this as a way of paying off their Home Equity Lines of Credit, a form of home equity loan.

The reason? These lines of credit, better known as HELOCs, are not nearly as attractive to homeowners when they don’t come with the bonus of a tax deduction.

“We fully expect this trend to grow over the next weeks and months as more and more homeowners learn of the effect these changes will have on their personal finances,” Daly said.

Goodbye, deduction

In the past, homeowners who took out home equity loans or HELOCs could deduct the interest they paid on up to $100,000 of these loans. If you took out a home equity loan for $50,000, then, you could deduct all the interest you paid during the year on that loan. If you took out a home equity loan for $150,000, you could deduct the interest you paid on the first $100,000 of that loan.

When Congress in December of last year signed the Tax Cuts and Jobs Act into law, this all changed. The big tax reform legislation eliminates the home equity loan deduction starting in 2018. You can still claim your tax deduction when you file your income taxes in April of this year. That’s because you’re paying taxes from 2017.

But you won’t be able to claim the home equity loan deduction when you file on your 2018 taxes and beyond. Most of the tax cuts impacting taxpayers, including the home equity deduction rules, are scheduled to expire after 2025. No one knows, though, whether Congress will vote to continue them past that date once that year rolls around.

Existing loans aren’t grandfathered in, either. If you took out a home equity loan in 2016 and you’re still paying it off this year, you won’t be able to deduct any interest you pay on it in 2018, even if you’ve already deducted interest payments in the past.

*     *      *

Home equity loans can still work, though

Just because the tax benefits of home equity loans are disappearing, though, doesn’t mean that these loans are no longer a viable option for all homeowners.

The deduction was a benefit, but the biggest advantage of home equity loans is that they are a relatively cheap way to borrow money. The mortgage rates attached to home equity loans tend to be low. That isn’t changing.

So if you do have equity in your home and you want money to help pay, say, for your children’s college tuition, a home equity loan or HELOC might still be a smart move.

“While tax deductions are important, they are not the only reason we take out home equity loans,” said David Reiss, professor law at Brooklyn Law School in Brooklyn, New York.

Reiss said that when considering whether a home equity loan or HELOC is right for them, homeowners need to ask several important questions.

First, why do they want to take out the loan? If it’s for home improvements or to reduce high-interest-rate debt, the loan might still be worthwhile, even with the tax changes.

Next, homeowners need to look at their monthly budgets to determine if they can afford the payments that come with these loans. Finally, homeowners should consider whether they can borrow money cheaper somewhere else, taking the loss of the deduction into consideration.

“If you are comfortable with your answers, there is no reason not to consider a home equity loan as a financing option,” Reiss said.

February 2, 2018 | Permalink | No Comments

February 1, 2018

An Independent CFPB

By David Reiss

Baron de Montesquieu, a proponent of the tripartite system of government

The United States Court of Appeals for the District of Columbia, sitting en banc, upheld the constitutionality of the structure of the Consumer Financial Protection Bureau in PHH Corporation v. CFPB, No. 15-1177 (Jan. 31, 2018). There has been a lot reporting around this lengthy decision (there are 7 opinions, totaling 250 pages). And certainly, its fate in the Supreme Court is still up for grabs. Personally, I found the following passage from the majority opinion interesting:

There is nothing constitutionally suspect about the CFPB’s leadership structure. … there is no reason to assume an agency headed by an individual will be less responsive to presidential supervision than one headed by a group. It is surely more difficult to fire and replace several people than one. And, if anything, the Bureau’s consolidation of regulatory authority that had been shared among many separate independent agencies allows the President more efficiently to oversee the faithful execution of consumer protection laws. Decisional responsibility is clear now that there is one, publicly identifiable face of the CFPB who stands to account—to the President, the Congress, and the people— for all its consumer protection actions. The fact that the Director stands alone atop the agency means he cannot avoid scrutiny through finger-pointing, buck-passing, or sheer anonymity. What is more, in choosing a replacement, the President is unhampered by partisan balance or ex-officio requirements; the successor replaces the agency’s leadership wholesale. Nothing about the CFPB stands out to give us pause that it—distinct from other financial regulators or independent agencies more generally—is constitutionally defective. (35)

While this is of great consequence for the CFPB and its role in the regulation of the financial sector, it also has great consequence as a matter of separation of powers doctrine. The DC Circuit is giving Congress a lot of discretion in organizing the modern Administrative State. It is up to Congress to exercise that discretion responsibly.

 

 

February 1, 2018 | Permalink | No Comments

January 31, 2018

What Housing Finance Reform May Look Like

By David Reiss

 

A class photo of the 111th United States Senate

Senate Staff Discussion Draft #29 of the much discussed housing finance reform bill has just seen light of day. The purpose clause of the draft gives an overview of what the drafters are trying to accomplish:

  1. to offer a guarantee backed by the full faith and credit of the Federal Government of the timely payment of principal and interest on eligible mortgage-backed securities in order to foster a liquid housing finance market across the United States and during changing economic conditions and to promote the continued availability of an affordable, fixed rate, pre-payable long-term mortgage loan, such as the 30-year fixed rate mortgage loan;
  2. to protect taxpayers against losses that might arise out of that guarantee by arranging for private sector entities to assume the risk of loss on guarantee mortgage-backed securities and to capitalize a mortgage insurance fund;
  3. to protect taxpayers against bailouts of any of those entities by ensuring that none becomes “too big to fail”;
  4. to foster a competitive secondary mortgage market;
  5. to promote access to affordable mortgage credit and affordable housing across the United States, including to underserved borrowers;
  6. to ensure that mortgage lenders of all sizes, charter types, and locations have equitable access to the secondary mortgage market; and
  7. to provide for a gradual and smooth transition to the housing finance system contemplated by this Act. (Sec. 2)

There are no real surprise here, but there are a couple of things worth emphasizing. The draft proposes a framework where the Common Securitization Platform currently being built to support a Single Security would be used by a half dozen or more mortgage guarantors. This would be a significant move away from the Fannie/Freddie duopoly we now have. The draft even goes so far as to forbid the use of the names Fannie and Freddie by any of the mortgage guarantors. The draft also appears to contemplate a strong affordable housing role for the actors in this new system, with its emphasis on “underserved borrowers.”

As with all important bills, though, the devil is in the details. We’ll have to wait and see how those details start to fill out before we have a real sense who the real winners and losers will be in this new system. That being said, it is great to see that Congress is making some bipartisan progress in addressing the last unresolved issue from the financial crisis — defining the scope of the government’s appropriate role in the housing finance system.

January 31, 2018 | Permalink | No Comments

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