The Cost of Reform

CNN Money posted a story today entitled, "How financial reform will really work." While the story breaks down the reform bill into different parts dealing with new regulation, mortgages, credit cards, etc., its basic theme is found in paragraph 3, "Borrowers and investors are likely to benefit from a higher level of regulation, but at the end of the day we could all be paying more for credit," according to Suffolk University Professor Kathleen Engel.

In fact, according to a Fox News story this morning, we are already paying more for credit. The average credit card interest rate is higher this year than last year at this time--not because of defaults but because credit card companies are raising the rates to offset their losses due to new restrictions limiting over the limit fees and late fees on credit cards. Since the cards are not allowed to raise interest rates without warning, they compensate by raising everybody's rate upfront.

The CNN money story states that we can expect more cost increases for credit items such as mortgages. The article quotes Keith Gumblinger, who is a mortgage analyst, as saying that lenders are going to pass on the higher costs of doing business due to financial reform on to the consumers. "We are not seeing it yet, because interest rates are so low and the mortgage market is still so weak."

Actually, we are seeing it now; we are just going to see it more later as the rates rise. An article published August 17 in Housingwire cites Bankrate's newest fee survey. According to the survey, mortgage origination and third party fees (appraisals, credit reports, surveys, etc.) have increased an average of 36.6% since last year. Loan origination fees have increased an average of 22.8% in 2010 and fees paid for services have increased an average of 47.2%. A 36-47% increase in fees in one year is huge. The culprits for the increased costs, according to Housingwire--the new good faith estimate and the higher costs of doing business because of increased regulation.

Since January 2010, the good faith estimate is a binding contract on the part of the lender, and if your loan originator underquotes, he or she has to pay the difference out of pocket. As a result, originators have to quote high. But as soon as the consumer has received and approved the higher estimate, there is no reason to ever reduce those fees.

Although Bankrate does not say so, I believe that another related reason that fees are increasing dramatically is that the new good faith estimate makes it almost impossible for a borrower to understand what he is paying and to whom he is paying it. The three page form is so confusing that it is easy to hide charges since it is illegal to break out the charges separately for the borrower. All fees are just lumped together into one block of charges. The problem is so serious that the title companies have to call after the closing to ask "How much is your check supposed to be?" before they send over the commission for the closing. Before the new good faith estimate, borrowers could negotiate with their loan originator because they could see the fees as separate items on the estimate, but now they have no idea how much of the money is going to the originator or to the lender, or to the attorneys who prepare the documents they sign.

According to Housingwire, the other reason that fees are increasing is that tight underwriting guidelines are so labor intensive that lenders and originators are having to increase their costs in order to cover expenses. And that also is true. As soon as the new good faith estimate was introduced, the title companies immediately raised their fees per transaction because the closings were about to become a lot more labor intensive. More time spent on each file equals fewer files that I can close, which equals less income, unless, of course, I raise the fees I charge per file and then I have fewer files and more income.

Still another reason that costs are going up, in my opinion, is the death of competition. Four years ago, when the mortgage industry was thriving, borrowers had a lot of choices. They could easily move a loan to a new bank or new loan originator to save some money. The borrower could normally transfer his appraisal as long as he had paid for it, so if he chose to move his file, he did not have to start over with a new appraisal. Today, with long underwriting turn times--sometimes as long as 20 to 30 days, and very few originators to choose from, borrowers feel trapped. And they feel that way because they are. A borrower who is buying a house may not be able to get a contract extension if he decides to change lenders after a long tedious underwriting process. Once a borrower has paid for an appraisal, which he almost certainly cannot transfer to a new lender, he has spent money which he is not going to recoup. Further, in an era of appraisal management companies, many appraisals do not come in for value. So a borrower who is lucky enough to have a good appraisal that his lender will approve is jeopardizing his entire transaction if he leaves his lender and starts over with a new lender and a new appraisal.

All of this means that in the new world of reform, you've got little choice but to go home with the one that brung ya', even if half way through the evening you discover that he is an obnoxious, two-timing jerk.

The supreme irony of all of this is that all of the reform we have seen in the past 12 months was supposed to make everything cheaper for borrowers. Last year, HUD repeatedly projected that the new good faith estimate would save borrowers approximately $700 per transaction. The new forms were supposed to improve competition by encouraging borrowers to shop for their mortgage loans, and increased disclosure was supposed to help them better understand the entire process. Instead, just the opposite has happened; according to the Bankrate survey last year the average cost of origination and third party fees for a $200,000 mortgage was $2739.00. This year the average cost of origination and third party fees for a $200,000 mortgage is $3741.00. Regulations that were supposed to save borrowers $700.00 per transaction are instead costing them approximately $1000 per transaction.

And if CNN Money's experts are to be believed, we are just getting started. After all, the costs associated with the newly passed financial reform bill have not even come into play yet.