National Association of Attorneys General

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The Housing Bust and Approaches to the Mortgage Foreclosure Crisis

Dennis Cuevas, Project Director and Chief Counsel, Consumer Protection and Telemarketing Fraud

For many homeowners, the unexpected housing boom that started in 2001 represented double digit gains in the value of their homes and newly found untapped equity. For buyers, the housing boom represented a frenzied period with increased competition for an ever-shrinking inventory of homes. Multiple offers and waived home inspections became the rule rather than the exception in some markets. Lenders began to hand out loans more freely. Potential homebuyers could obtain a mortgage loan easily, and even borrowers with questionable credit were hoping to obtain a mortgage loan.

The Evolution of Creative Financing

Over the next several years, lenders began offering new mortgage products that were very different than the mortgages of the past. When homeownership solidified in the United States in the 1950s, the mortgage of choice was the 30-year, fixed-rate mortgage with 20 percent down. But as home prices increased, lenders found it more difficult to qualify borrowers for loans using traditional underwriting standards, i.e., a monthly mortgage payment including taxes and insurance not exceeding 28 percent of a borrower’s gross monthly income. Interest-only loans, adjustable rate mortgages (ARMs), most notably the “2/28,” and no documentation loans became rampant. Subprime mortgages increased tremendously, as did the number of people using the “zero down” loans. According to Merrill Lynch, 28 percent of the people who bought a home in 2003 did so with no money down, and, in 2005, it was 43 percent.

Many borrowers were approved based on teaser rates and interest-only loan payments. Lenders gave out these loans knowing that once the interest rate adjusted and the payments reset, borrowers would not be able to afford these mortgages.

The Housing Boom Ends

Six years later, as houses remain on the market much longer and sellers begin lowering their prices, reports of today’s mortgage foreclosure crisis appear daily in news outlets across the country. The days of rising home values and increased home sales have given way to homeowners’ struggles with their mortgage payments and their inability to refinance due to the drop in home values.

According to the Mortgage Bankers Association, foreclosure activity in the past decade is running at a rate 10 percent higher than at any other time over the past 50 years. A recent study conducted by the Center for Responsible Lending (CRL) reveals that millions of Americans will lose their homes and as much as $164 billion due to foreclosures in the subprime mortgage market. CRL finds that despite low interest rates and a favorable economic environment during the past several years, the subprime market has experienced high foreclosure rates, and projects that one out of five (19.4 percent) subprime loans issued during 2005-2006 will fail.

Attorneys General Tackle the Mortgage Foreclosure Crisis

Although the mortgage foreclosure crisis threatens the national economy, the fact remains that mortgage foreclosures are local in nature. Too many foreclosures can devastate neighborhoods, and city, county and state governments bear significant costs. According to the CRL, a city can lose nearly $20,000 in lost property tax and other costs for every property foreclosed.

State Attorneys General, using a multi-pronged approach, have been in the forefront of addressing the mortgage foreclosure crisis issue through a number of initiatives.[1]

Attorneys General and banking regulators from 10 states have formed a task force aimed at persuading mortgage-servicing companies and investors to restructure troubled subprime loans and explore ways to find long-term solutions for borrowers facing foreclosure, such as lowering the borrower’s mortgage interest rate, rather than creating a repayment plan that only offers a quick fix.

In addition to working collaboratively, Attorneys General continue to address the mortgage foreclosure issue individually, through enforcement, legislative and consumer education initiatives. For example, Massachusetts Attorney General Martha Coakley filed suit against Fremont Investment and Loan, alleging it used predatory lending practices to sell loans to borrowers who eventually lost their homes. Fremont allegedly paid high commissions to independent mortgage brokers who sold risky mortgages with high payments that borrowers could not afford, a violation of the state's anti-predatory lending law.

The suit is one of a growing number of actions brought by Attorneys General in Connecticut, New York, Ohio and other states against subprime lenders to prevent them from selling new loans. Furthermore, Attorneys General in Florida, Illinois, Texas and other states have filed enforcement actions against mortgage foreclosure rescue scams.

This past summer, Illinois Attorney General Lisa Madigan convened the Illinois Homeownership Preservation Summit, bringing together lenders, servicers, regulators, housing counselors, lawyers and consumer advocates to lay the groundwork for a comprehensive strategy to assist homeowners who are currently facing foreclosure. Attorney General Madigan’s office will convene on-going working groups to coordinate with housing counselors and community advocates to ensure that lenders and servicers are following through on their commitments to offer assistance to borrowers in trouble.

Maryland, Massachusetts, New Jersey, New York, Ohio and Pennsylvania have rolled out mortgage programs intended to refinance loans by homeowners at risk, using proceeds from state bond issues and money from federal lending agencies.

On the legislative front, North Carolina passed legislation that limits the ability of mortgage brokers to charge customers above-market rates and prepayment penalties and protects subprime borrowers from high risk adjustable-rate mortgages. Colorado passed legislation that creates a duty of good faith and fair dealing for mortgage brokers in their communications and transactions with borrowers, including the duty not to recommend or induce the borrower to enter into a transaction that does not have a reasonable, tangible net benefit to the borrower. Illinois passed legislation that requires brokers and lenders to assess a borrower’s ability to repay a loan, including the borrower’s ability to repay both the initial monthly payment and the higher monthly payment when adjustable loans reset. Licensees also must act in good faith toward borrowers and offer them the best loan options available. Furthermore, lawmakers in several states have passed measures to tighten restrictions on subprime lending.

Massachusetts issued a regulation that prohibits a specific type of rescue plan in which a business or individual claims to offer assistance to distressed homeowners facing foreclosure if the homeowner gives over ownership of the property. The ban does not apply to rescue plans offered by members of the homeowner's family or by nonprofit or housing organizations that are attempting to help the troubled borrower. The regulation also will not apply to short sales, in which a homeowner sells the house for less than the outstanding balance and gets the lender to agree to accept a smaller settlement.

On the consumer education side, Iowa initiated a Mortgage Hotline that will enable borrowers to reach the Iowa Mediation Service for assistance. Massachusetts, in partnership with several bar associations, legal services organizations and advocacy groups, also announced the establishment of a Pro Bono Foreclosure Assistance Hotline, where legal advocacy and resource center staff could determine how to best assist the caller and provide general advice. Ohio and the District of Columbia have held town hall meetings on the issue of predatory lending and mortgage foreclosures.

Federal Responses

Barney Frank (D-MA), chairman of the House Financial Services Committee, unveiled legislation aimed at curbing abusive lending practices. The bill, H.R. 3915: The Mortgage Reform and Anti-Predatory Lending Act of 2007, allows homeowners to sue lenders for relief from mortgages that the borrowers never had a realistic chance of repaying, and would require any mortgage lender to verify that the borrower has a “reasonable ability to repay” based on documented income, credit history and debt level. Under the new bill, states would be required to set standards for mortgage brokers and lending. States that do not develop a standard would be subject to relatively strict federal standards, to be developed by the U.S. Department of Housing and Urban Development, which would require mortgage brokers to act “solely in the best interest” of the consumer.

In October, a House Judiciary subcommittee narrowly approved a measure that would allow bankruptcy courts to change the terms of home mortgages in order to prevent foreclosures. The bill would repeal a provision in current law that prohibits bankruptcy courts from modifying a primary home mortgage.

The White House recently announced initiatives at the federal level to help homeowners in need of assistance to avoid foreclosure. President Bush announced “HOPE NOW,” a new mortgage industry coalition that would help coordinate efforts by financial companies to help an estimated two million homeowners whose introductory mortgages with low rates are now resetting at much higher rates. Eleven of the largest mortgage service companies, representing 60 percent of all mortgages in the country, agreed to join the new coalition. In August of this year, the White House also made changes in the Federal Home Loan Administration (FHA) insured-loan program so that more people could qualify for FHA-insured loans.

Cooperative Solutions

The mortgage foreclosure crisis is a complex issue that “mushroomed” into a problem, seemingly all at once. While there are numerous discussions about possible solutions to the crisis, what has become apparent is that regulators, legislators, industry representatives, investors, and consumer advocates must all work together to ensure that the economy remains strong, and that, more importantly, homeowners keep their homes.

[1] It would be nearly impossible to capture every state Attorney General’s initiative. The purpose of this article is to provide you with a sampling of state’s initiatives. It is neither exhaustive nor inclusive of all state initiatives.

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