'Vanilla' loans may benefit borrowers

WASHINGTON -- If President Obama gets his way, consumers who take out mortgages would automatically get a "plain vanilla" loan -- such as a traditional 30-year fixed-rate mortgage -- unless they opted for a riskier variety.

Obama's plan to revamp financial regulation aims to protect borrowers from the high-risk mortgages that fed delinquencies and foreclosures, led to the worst financial crisis in decades and thrust the nation into a recession.

Obama is expecting opposition to the plan. In his Internet and radio address Saturday, he said, "While I'm not spoiling for a fight, I'm ready for one."

Government officials want to make the process of getting a mortgage as simple and abuse-free as signing up for a retirement savings plan: A growing number of companies now automatically enroll new employees in 401(k) plans unless they opt out.

For mortgage brokers, though, the plan threatens to shrink the fee income some have received from encouraging the use of adjustable-rate, interest-only and other sometimes risky loans.

Obama's plan to overhaul financial regulation, unveiled last week, would create a Consumer Financial Protection Agency to monitor consumer financial products and revamp the home-loan process.

It's the administration's latest step to tackle the aftermath of the housing bust. The administration in March launched a $50 billion plan to give the lending industry financial incentives to modify mortgages to lower payments.

But that plan is off to a slow start. Many housing counselors say it hasn't made much of a difference nationwide because lenders have been slow or reluctant to cooperate. As of mid-June, about 50,000 borrowers were enrolled in three-month trial modifications under the plan, according to the Treasury Department.

Critics in the mortgage industry are denouncing Obama's plan for government-approved mortgages. Some call it a paternalistic intrusion that would restrict borrowers' options and make loans harder to get and potentially more expensive.

Guy Cecala, publisher of Inside Mortgage Finance, a trade publication, called the idea "un-American." He said it would make the U.S. mortgage market heavily regulated, like those of Germany or France, where consumers have fewer options.

"We're a free-enterprise country," Cecala said. "We encourage innovation. This is certainly not going to encourage innovation. It will stifle it."

But others in the industry are open to the idea. A good mortgage broker should always show a borrower plenty of options, including the traditional 30-year fixed-rate loan, and explain the risks clearly, said Kevin Iverson, a mortgage broker with Reed Mortgage Corp. in Denver.

During the lending boom, unscrupulous brokers "were selling bad products because it was one of the ways people made more money," Iverson said. They focused on closing deals fast, he said, rather than building customer relationships that would endure for years.

If the Obama plan for simplifying the mortgage process is approved, here's how it might work:

The government would give its seal of approval to a handful of mortgage types -- a standard 30-year fixed-rate mortgage and perhaps a few varieties of adjustable-rate loans. For a loan to get the "vanilla" label, the lender would have to verify borrowers' income and have them set aside money for property tax and insurance.

Borrowers would still be able to get mortgages that don't pass the government's vanilla test. But they would be warned about the risks.

The Obama administration faces a tough fight over its financial overhaul plan. Powerful trade groups like the American Bankers Association, for example, oppose creating a consumer financial protection agency. Even lobbying groups open to the idea of a consumer-products regulator question whether the government should suggest which mortgages are best for consumers.

"We don't want to stifle innovation, and we don't want to stifle competition," said John Courson, president of the Mortgage Bankers Association.

Traditional fixed-rate loans fell out of favor during the housing boom. They dropped from a 75 percent market share in 2002 and 2003 to around 50 percent in 2004 and 2005, according to Inside Mortgage Finance. But with the housing bubble burst and mortgage rates near historic lows, fixed-rate loans -- 30-year, 15-year and other types -- now account for about 95 percent of the market.

Previous efforts in Congress to crack down on mortgage abuses have fallen short. Even regulatory proposals on seemingly simple issues, like reducing the paperwork to get a loan, have devolved into battles among industry factions.

Supporters say a new consumer regulator is sorely needed. They point to academic research suggesting that consumers, faced with a difficult choice about their personal finances, tend to choose the path of least resistance. As a result, they often make poor decisions.

That's particularly true with mortgages, which require signing numerous complex documents. Many borrowers say they didn't understand the loans they signed up for during the housing boom. Some say they were surprised when their rates adjusted to much higher payments.

"These loans are so complicated that the consumers can't figure out what's going on," said Bill Apgar, senior adviser for mortgage finance at the Department of Housing and Urban Development.

The Obama plan includes other elements likely to produce drawn-out lobbying fights. For example, administration officials want to curb the fees that brokers and lenders receive tied to inflated mortgage rates.

Brokers argue such fees are a legitimate way for borrowers to afford a loan without having to come up with thousands of dollars in closing costs, because the fees can be spread over the life of a loan. They also intend to fight a plan to have their compensation linked to whether a borrower winds up defaulting.

"There's no reason that we should have to assume that risk," said Marc Savitt, president of the National Association of Mortgage Brokers. He argues that brokers merely submit loans to lenders and don't influence whether the loans are approved.

Brokers have already seen their market share dwindle, from more than 60 percent of new loans at the peak of the market to less than 20 percent now, said David Olson, president of Access Mortgage Research in Columbia, Md.

If mortgage broker fees were eliminated, "that would be the complete kiss of death" for mortgage brokers, Olson said. "That's really how they make their money."