GAO-09-741 Home Mortgages: Provisions in a 2007 Mortgage

GAO

United States Government Accountabilit

Office

Report to Congressional Requesters

HOME MORTGAGES

Provisions in a 2007

Mortgage Reform Bill

(H.R. 3915) Would

Strengthen Borrower

Protections, but Views

on Their Long-term

Impact Differ

July 2009

GAO-09-741

What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

Jul

2009

HOME MORTGAGES

Provisions in a 2007 Mortgage Reform Bill (H.R. 3915)

Would Strengthen Borrower Protections, but Views

on Their Long-term Impact Differ

Highlights of GAO-09-741, a report to

congressional requesters

GAO estimates that almost 75 percent of securitized nonprime mortgages

originated from 2000 through 2007 would not have met H.R. 3915’s safe harbor

requirements, which include, among other things, full documentation of

borrower income and assets, and a prohibition on mortgages for which the

loan principal can increase over time. The extent to which mortgages met

specific safe harbor requirements varied by origination year. For example, the

percentage of nonprime mortgages with less than full documentation rose

from 27 percent in 2000 to almost 60 percent in 2007. Consistent with the

consumer protection purpose of the bill, GAO found that certain variables

associated with the safe harbor requirements influenced the probability of a

loan entering default (i.e., 90 or more da

s delinquent or in foreclosure) within

24 months of origination. For example, on the basis of statistical analysis,

GAO estimates that, all other things being equal, less than full documentation

was associated with a 5 percentage point increase in the likelihood of default

for the most common type of nonprime mortgage product. GAO also found

that other variables—such as house price appreciation, borrowers’ credit

scores, and the ratio of the loan amount to the house value—were associated

with default rates.

Research on state and local anti-predatory lending laws and the perspectives

of mortgage industry stakeholders do not provide a consensus view on the

bill’s potential effects on the availability of mortgage credit. Some research

indicates that anti-predatory lending laws can have the intended result of

reducing loans with problematic features without substantially affecting credit

availability. However, it is difficult to generalize these findings to all anti-

predatory lending laws or the potential effect of the bill, in part, because of

differences in the design and coverage of these laws. Mortgage industry and

consumer group representatives with whom GAO spoke disagreed on the bill’s

potential effect on credit availability and consumer protection. For example,

mortgage industry officials generally said that the bill’s safe harbor, securitizer

liability, and other provisions would limit mortgage options and increase the

cost of credit for nonprime borrowers. In contrast, consumer groups generally

stated that these provisions needed to be strengthened to protect consumers

from predatory loan products.

H.R. 3915 (2007), a bill introduced,

but not enacted by the 110th

Congress, was intended to reform

mortgage lending practices to

prevent a recurrence of problems in

the mortgage market, particularly in

the nonprime market segment. The

bill would have set minimum

standards for all mortgages (e.g.,

reasonable ability to repay) and

created a “safe harbor” for loans

that met certain requirements.

Securitizers of safe harbor loans

would be exempt from liability

provisions, while securitizers of

non-safe harbor loans would be

subject to limited liability for loans

that violated the bill’s minimum

standards. In response to a

congressional request, this report

discusses (1) the proportions of

recent nonprime loans that likely

would have met and not met the

bill’s safe harbor requirements and

factors influencing the performance

of these loans, and (2) relevant

research and the views of mortgage

industry stakeholders concerning

the potential impact of key

provisions of the bill on the

availability of mortgage credit. To

do this work, GAO analyzed a

proprietary database of securitized

nonprime loans, reviewed studies of

state and local anti-predatory

lending laws, and met with financial

regulatory agencies and key

mortgage industry stakeholders.

What GAO Recommends

GAO makes no recommendations

in this report.

View GAO-09-741 or key components.

For more information, contact William B.

Shear at (202) 512-8678 or [email protected].

Page i GAO-09-741

Contents

Letter 1

Background 5

Most Recent Nonprime Mortgages Would Not Have Been Safe

Harbor Loans and Certain Variables Associated with the Safe

Harbor Requirements and Other Factors Influenced Defaults 17

Relevant Research and Stakeholder Perspectives Do Not Provide a

Consensus View on the Bill’s Potential Impact 35

Agency Comments and Our Evaluation 43

Appendix I Objectives, Scope, and Methodology 45

Appendix II Description of the Econometric Analysis of

Safe Harbor Requirements 50

Appendix III Comments from the National Credit Union

Administration 62

Appendix IV GAO Contact and Staff Acknowledgments 63

Tables

Table 1: Nontraditional Mortgage Products 6

Table 2: Percentage of Nonprime Mortgages That Were Safe Harbor

and Non-safe Harbor Loans by Racial, Ethnic, and Income

Groupings, 2000-2007 25

Table 3: Percentage of Nonprime Mortgages That Were Safe Harbor

and Non-Safe Harbor Loans by Credit Score Groupings,

2000-2007 26

Table 4: Estimated Probability of Nonprime Purchase Mortgages

Defaulting within 24 months of Origination with and

without Full Documentation, 2000-2006 Loans 29

Table 5: Estimated Probability of Nonprime Purchase Mortgages

Defaulting within 24 months of Origination under Different

Assumptions for the Safe Harbor Spread Requirement,

2000-2006 Loans 30

Impact of Mortgage Reform

Table 6: Estimated Percentage of Nonagency Securitized Subprime

and Alt-A Loans in the LP Database, 2001-2007 46

Table 7: Safe Harbor Requirements and LP Variables Used to

Duplicate the Requirements or Develop Proxies 47

Table 8: Variables Used in the Model 51

Table 9: Mean Values for Short-term Hybrid ARMs with DTI

Information 54

Table 10: Mean Values for Fixed-rate mortgages with DTI

Information 54

Table 11: Mean Values for Longer-term ARMs with DTI information 55

Table 12: Mean Values for Payment-option ARMs with DTI

Information 56

Table 13: Estimation Results for Short-term Hybrid ARMs with DTI

Information 58

Table 14: Estimation Results for Fixed-rate Mortgages with DTI

Information 59

Table 15: Estimation Results for Longer-term ARMs with DTI

Information 60

Table 16: Estimation Results for Payment-option ARMs with DTI

Information 61

Figures

Figure 1: H.R. 3915 Loan Standards 16

Figure 2: Estimated Proportions of Nonprime Mortgages Meeting

and Not Meeting the Safe Harbor Requirements, 2000-2007 18

Figure 3: Estimated Proportions of Nonprime Mortgages Not

Meeting Documentation and Amortization Requirements,

2000-2007 20

Figure 4: Estimated Proportions of Nonprime Mortgages Not

Meeting Interest Rate and Debt Burden Requirements,

2000-2007 22

Figure 5: Estimated Proportions of Nonprime Mortgages Not

Meeting the Fully Indexed Rate Requirement, 2000-2007 24

Figure 6: Estimated Probability of Nonprime Purchase Mortgages

Defaulting within 24 Months under Different House Price

Appreciation, Credit Score, and LTV Ratio Assumptions,

2000-2006 Loans 34

Page ii GAO-09-741 Impact of Mortgage Reform

Abbreviations

APR annual percentage rate

ARM adjustable-rate mortgage

DTI debt-service-to-income

FHA Federal Housing Administration

FTC Federal Trade Commission

GSE government-sponsored enterprises

HMDA Home Mortgage Disclosure Act

HOEPA Home Ownership and Equity Protection Act

HPA house price appreciation

HUD Department of Housing and Urban Development

LIBOR London Interbank Offered Rate

LP LoanPerformance

LTV loan-to-value

MBS mortgage-backed securities

MSA metropolitan statistical area

NCUA National Credit Union Administration

OCC Office of the Comptroller of the Currency

OTS Office of Thrift Supervision

RESPA Real Estate Settlement Procedures Act

SEC Securities and Exchange Commission

TILA Truth in Lending Act

VA Department of Veterans Affairs

This is a work of the U.S. government and is not subject to copyright protection in the

United States. The published product may be reproduced and distributed in its entirety

without further permission from GAO. However, because this work may contain

copyrighted images or other material, permission from the copyright holder may be

necessary if you wish to reproduce this material separately.

Page iii GAO-09-741 Impact of Mortgage Reform

Page 1 GAO-09-741

United States Government Accountability Office

Washington, DC 20548

July 31, 2009

The Honorable Barney Frank

Chairman

Committee on Financial Services

House of Representatives

The Honorable Adam H. Putnam

House of Representatives

The U.S. housing and mortgage markets are experiencing severe stress,

with over 3.2 million home mortgages 90 or more days delinquent or in the

foreclosure process in the first quarter of 2009. The rise in delinquencies

and foreclosures has been particularly acute in the nonprime segment of

the mortgage market. Nonprime mortgages, which include subprime and

Alt-A loans, grew dramatically in terms of dollar volume and share of the

mortgage market from 2001 through 2006.

In 2001, lenders originated

$215 billion in nonprime loans, but by 2006, had increased originations to

$1 trillion. Likewise, the share of the nonprime market as a percentage of

the total mortgage market increased from around 10 percent in 2001 to

almost 34 percent in 2006. Further, investment banks increased the volume

of nonprime loans they bundled into private label mortgage-backed

securities (MBS) over this period.

In 2001, they bundled 46 percent of

nonprime loans into private label MBS, but by 2006, were bundling 81

percent of these loans. The market for nonprime mortgages contracted

sharply in mid-2007, as the nation entered a credit crisis and has not

rebounded.

The conventional mortgage market (i.e., mortgages not insured or guaranteed by the

federal government) comprises prime loans for the most creditworthy borrowers and

nonprime loans (i.e., subprime and Alt-A loans). The subprime market generally serves

borrowers with blemished credit and features higher interest rates and fees than the prime

market. The Alt-A market generally serves borrowers whose credit histories are close to

prime, but the loans often have one or more higher-risk features, such as limited

documentation of income or assets.

Securitization allows lenders to sell loans from their portfolios, transferring credit risk to

investors, and use the proceeds to make more loans. Private label MBS, which are bought

and sold on the secondary market, are backed by mortgages that do not conform to

government-sponsored enterprise (GSE) purchase requirements because they are too large

or do not meet GSE underwriting criteria.

Impact of Mortgage Reform

As we reported in October 2007, an easing of underwriting standards for

nonprime mortgages and wider use of certain loan features associated

with poorer loan performance contributed to increases in mortgage

delinquencies and foreclosures.

These features included mortgages with

higher loan-to-value ratios (the amount of the loan divided by the value of

the home), adjustable interest rates, limited or no documentation of

borrower income or assets, and deferred payment of principal or interest.

In some cases, lenders engaged in predatory practices that resulted in

loans with onerous terms and conditions.

Often, borrowers could not

repay these loans and found themselves facing foreclosure or bankruptcy.

Some of these predatory practices included providing the borrower with

misleading information, manipulating the borrower through aggressive

sales tactics, or taking unfair advantage of the borrower’s lack of

information about the loan terms and their consequences.

To prevent a recurrence of problems in the mortgage market, the House of

Representatives passed the Mortgage Reform and Anti-Predatory Lending

Act of 2007 (bill) on November 15, 2007 (H.R. 3915). The Senate did not

pass companion legislation by the end of the 110th Congress, so the bill

did not become law.

The bill, among other things, would have set

minimum standards for mortgages requiring that consumers had a

“reasonable ability to repay” at the time the loan was made and that they

received a “net tangible benefit” from mortgage refinancings. One of the

key provisions of H.R. 3915 would have been the creation of a “safe

harbor” from potential liability for assignees and securitizers of mortgages

(i.e., entities that purchase or hold mortgages in the secondary market),

provided that the loans met certain requirements.

Assignees would have

GAO, Information on Recent Default and Foreclosure Trends for Home Mortgages and

Associated Economic and Market Developments, GAO-08-78R (Washington, D.C.: Oct. 16,

2007).

While there is no uniformly accepted definition of predatory lending, a number of

practices are widely acknowledged to be predatory. These include, among other things,

charging excessive fees and interest rates, lending without regard to borrowers’ ability to

repay, refinancing borrowers’ loans repeatedly over a short period of time without any

economic gain for the borrower, and committing outright fraud or deception—for example,

falsifying documents or intentionally misinforming borrowers about the terms of a loan.

On May 7, 2009, the House of Representatives passed the Mortgage Reform and Anti-

Predatory Lending Act of 2009 (H.R. 1728, 111th Congress), which has a similar purpose to

H.R. 3915.

For ease of presentation, we use the term “assignee” to mean either an assignee or a

securitizer.

Page 2 GAO-09-741 Impact of Mortgage Reform

been subject to limited liability if they securitized loans that fell outside

the bill’s safe harbor. Language in the bill and the accompanying House

report suggests that the safe harbor and other provisions were intended to

strengthen consumer protections for nonprime mortgage products

associated with higher levels of default and foreclosure. Additionally,

congressional hearings and debate about the bill highlighted, among other

things, the challenge of designing safe harbor requirements that protect

consumers from nonprime mortgage products that put them at high risk of

default and foreclosure, while maintaining broad access to mortgage

credit.

Given the serious problems facing the mortgage market, particularly those

associated with nonprime mortgages, and congressional interest in

protecting consumers and ensuring credit availability, you asked us to

assess the potential impact of the bill were it to become law. Accordingly,

this report (1) assesses the proportion of recent nonprime loans that

would likely have met and not met the bill’s safe harbor requirements, and

how variables associated with those requirements affect loan

performance, and (2) discusses relevant research and the views of

mortgage industry stakeholders concerning the potential impact of key

provisions of the bill on the mortgage market. The scope of our analysis

was limited to nonprime mortgages.

To assess the proportions of recent nonprime loans that would likely have

met and not met H.R. 3915’s safe harbor requirements, we analyzed a

proprietary database of securitized nonprime loans from

LoanPerformance (LP).

This database covered about 87 percent of the

subprime and 98 percent of the Alt-A securitized mortgage originations

from January 2001 through July 2007. Nonprime mortgages that were not

securitized (i.e., mortgages that lenders held in portfolio) may have

different characteristics and performance histories than those that were

securitized. In this report, we define subprime loans as mortgages in

subprime securitization pools and Alt-A loans as mortgages in Alt-A

securitization pools. Specifically, we analyzed loans in the LP database

originated from 2000 through 2007. For each year, we estimated the

proportion of mortgages with terms and underwriting characteristics that

were consistent with the safe harbor requirements and those that were not

consistent with such requirements. When the data did not allow us to

duplicate a specific safe harbor requirement, we developed reasonable

LoanPerformance is a unit of First American CoreLogic, Inc.

Page 3 GAO-09-741 Impact of Mortgage Reform

proxies. Additionally, incorporating data from the Census Bureau, we

examined the proportions of safe harbor and non-safe harbor loans within

different census tract and borrower groupings. Finally, to examine factors

that could explain the performance of nonprime loans, we developed a

statistical model to estimate the relationship between variables associated

with the safe harbor requirements and other variables and the probability

of loan default within 24 months of origination.

We assessed the reliability of the data by interviewing LP representatives

about the methods they use to collect and ensure the integrity of the

information. We also reviewed supporting documentation about the

database, including LP’s estimates of the database’s market coverage. In

addition, we conducted reasonableness checks on the data to identify any

missing, erroneous, or outlying figures. We found the data elements we

used to be sufficiently reliable.

To describe relevant research on the bill’s potential effects on the

nonprime mortgage market, we identified and reviewed empirical studies

on the effects of state and local anti-predatory lending laws on key

nonprime mortgage indicators. The indicators used in these studies

included mortgage originations and the cost of credit. We reviewed the

studies’ overall conclusions concerning the impact of the laws and

identified any limitations in the researchers’ methodologies. We also

interviewed selected authors to ensure that we interpreted their results

correctly. To obtain the views of mortgage industry participants and

stakeholders, we interviewed officials from organizations representing

mortgage lenders, mortgage brokers, securitizers, and consumer interests.

We also interviewed officials from a large mortgage lender and a major

investment bank involved in the securitization of mortgages. Finally, we

interviewed officials from the federal banking regulators, Department of

Housing and Urban Development (HUD), Federal Trade Commission

(FTC), and Securities and Exchange Commission (SEC).

We conducted this performance audit from March 2008 to July 2009, in

accordance with generally accepted government auditing standards. Those

standards require that we plan and perform the audit to obtain sufficient,

appropriate evidence to provide a reasonable basis for our findings and

conclusions based on our audit objectives. We believe that the evidence

obtained provides a reasonable basis for our findings and conclusions

based on our audit objectives. Appendix I explains our objectives, scope,

and methodology in greater detail.

Page 4 GAO-09-741 Impact of Mortgage Reform

Background

The primary mortgage market features a variety of loan products and

relies, in part, on the process of securitization to provide funds for

mortgage lending. Over the years, a number of federal and state laws and

regulations were implemented to protect mortgage borrowers. In 2007, the

bill was introduced to strengthen consumer protections and included

provisions that would have created a safe harbor for loans that met certain

requirements.

Mortgage Markets and

Securitization

The primary mortgage market has several segments and offers a range of

loan products:

• The prime market serves borrowers with strong credit histories and

provides the most attractive interest rates and mortgage terms.

• The Alt-A market generally serves borrowers whose credit histories are

close to prime, but the loans often have one or more higher-risk features,

such as limited documentation of income or assets.

• The subprime market generally serves borrowers with blemished credit

and features higher interest rates and fees than the prime market.

• Finally, the government-insured or -guaranteed market primarily serves

borrowers who may have difficulty qualifying for prime mortgages but

features interest rates competitive with prime loans in return for payment

of insurance premiums or guarantee fees. HUD’s Federal Housing

Administration (FHA) and the Department of Veterans Affairs (VA)

operate the two main federal programs that insure or guarantee

mortgages.

Across all of these market segments, two types of loans are common:

fixed-rate mortgages, which have interest rates that do not change over the

life of the loans and adjustable-rate mortgages (ARM), which have interest

rates that change periodically based on changes in a specified index. Other

more unique loan products, referred to as nontraditional mortgage

products, grew in popularity over the last decade (see table 1). Hybrid

ARMs—which are fixed for a given period and then reset to an adjustable

rate—also became popular in recent years, especially in the subprime

market. In particular, a significant portion of subprime loans originated

from 2003 through 2006 were 2/28 or 3/27 hybrid ARMs—that is, they were

fixed for the first 2 or 3 years before resetting to often much higher

interest rates and correspondingly higher mortgage payments. Other

nontraditional mortgage products included interest-only or payment-

Page 5 GAO-09-741 Impact of Mortgage Reform

option loans, which allowed borrowers to defer repayment of principal

and possibly part of the interest for the first few years of the loan.

Table 1: Nontraditional Mortgage Products

Adjustable rate loans Initial period Remaining loan period

Hybrid ARMs (2/28s, 3/27s) For an initial period of usually 2 or 3 years, loan is

fixed at an introductory rate.

After the initial fixed period, the rate will eventually

adjust to a “fully indexed” interest rate equal to a

floating index, such as the London Interbank

Offered Rate (LIBOR), plus a fixed margin.

Although reaching the fully indexed rate is often a

gradual process because incremental increases

are capped, even the first increases, which

average approximately 2 percent, can cause

payment shock.

Interest-only mortgages For an initial period, typically the first 3 to 10 years,

borrowers can defer principal payments.

After the initial period, the mortgage is “recast” to

require higher monthly payments that cover

principal as well as interest and to pay off

(amortize) the outstanding balance over the

remaining term of the loan.

Payment-option mortgages For an initial period of typically 5 years or when the

loan balance reaches a specified cap, borrowers

can make minimum payments that do not cover

principal or all accrued interest, thereby, in some

cases, resulting in increased loan balances over

time (negative amortization).

After the initial period, payments are recast to

include an amount that will fully amortize the

outstanding balance over the remaining years of

the loan.

Source: GAO.

A number of loan features also became more common over the past

decade. While these features potentially expanded access to mortgage

credit, they are often associated with higher default rates. These features

included the following:

• Low and no-documentation loans. Originally intended for borrowers who

had difficulty documenting income, such as the self-employed, these loans

were made with little or no verification of a borrower’s income or assets.

• High loan-to-value (LTV) ratios. As homebuyers made smaller down

payments, the ratio of loan amount to home value increased.

GAO, Alternative Mortgage Products: Impact on Defaults Remains Unclear, but

Disclosure of Risks to Borrowers Could Be Improved, GAO-06-1021 (Washington, D.C.:

Sept. 19, 2006).

Page 6 GAO-09-741 Impact of Mortgage Reform

• Prepayment penalties. Some loans contained built-in penalties for

repaying part or all of a loan in advance of the regular schedule.

Many loans were originated with a number of these features, a practice

known as risk layering.

The secondary mortgage market and the process of securitization play

important roles in providing liquidity for mortgage lending. Mortgage

lenders originate and then sell their loans to third parties, freeing up funds

to originate more loans. Securitization, in this context, is the bundling of

mortgage loans into investment products called residential MBS that are

bought and sold by investors. The secondary market consists of (1) Ginnie

Mae-guaranteed MBS, which are backed by cash flows from federally-

insured or -guaranteed mortgages; (2) government-sponsored enterprise

(GSE) MBS, which are backed by mortgages that meet the criteria for

purchase by Fannie Mae and Freddie Mac; and (3) private label MBS,

which are backed by mortgages that do not conform to GSE purchase

requirements because they are too large or do not meet GSE underwriting

criteria.

Investment banks have traditionally bundled most subprime and

Alt-A loans into private label MBS, although since 2007, the market has

slowed dramatically.

Federal Mortgage Lending

Laws

The Truth in Lending Act (TILA), which was enacted in 1968, and the

Home Ownership and Equity Protection Act of 1994 (HOEPA), which

amended TILA in 1994, are among the primary federal laws governing

mortgage lending.

TILA was designed to provide consumers with

accurate information about the cost of credit. Among other things, TILA

requires lenders to disclose information about the terms of loans—

including the amount financed, the finance charge, and the annual

percentage rate (APR)—that can help borrowers understand the overall

costs of their loans. Congress enacted HOEPA to amend TILA, in response

to concerns about predatory lending. HOEPA regulates and restricts the

terms and characteristics of certain kinds of high-cost mortgage loans that

The GSEs Fannie Mae and Freddie Mac are private, federally chartered companies created

by Congress to, among other things, provide liquidity to home mortgage markets by

purchasing mortgage loans, thus, enabling lenders to make additional loans. To be eligible

for purchase by the GSEs, loans (and borrowers receiving the loans) must meet specified

requirements. In September 2008, Fannie Mae and Freddie Mac were placed into federal

government conservatorship.

TILA, as amended, is codified at 15 U.S.C. §§ 1601 – 1666j.

Page 7 GAO-09-741 Impact of Mortgage Reform

exceed certain thresholds in their APRs or fees (often referred to as “rate

and fee triggers”). The Board of Governors of the Federal Reserve System

(Federal Reserve) implements TILA and HOEPA through Regulation Z,

which was amended in 2001 and 2008 with respect to high-cost lending. As

a result of the most recent rulemaking in 2008, Regulation Z will restrict

mortgage lending in the following ways, as of October 1, 2009:

• Higher-priced loans: First-lien loans with APRs that equal or exceed an

index of average prime offer rates by 1.5 percentage points above an index

of average prime offer rates—a category meant to include virtually all

loans in the subprime market, but generally exclude loans in the prime

market—are called “higher-priced mortgage loans.”

Creditors are

prohibited from making these loans without regard to the borrower’s

ability to repay from income and assets other than the home’s value, and

creditors must verify the income and assets they rely upon to determine a

borrower’s repayment ability. Also, prepayment penalties are prohibited

for these loans if the payment can change in the first 4 years of the loan;

for loans where the payment is fixed for at least the first 4 years,

prepayment penalties are limited to 2 years. In addition, creditors must

establish escrow accounts for this category of loans for property taxes and

homeowners’ insurance.

• High-cost HOEPA loans: First-lien loans with APRs that exceed the yield

on Treasury securities of comparable maturity by more than 8 percentage

points or with total points and fees that exceed the greater of 8 percent of

the loan amount or $583, are called “high-cost HOEPA loans.”

For these

HOEPA imposes substantive restrictions and special pre-closing disclosures on

particularly high-cost refinancings and home equity loans secured by the borrower’s

principal dwelling. These restrictions and disclosures have been in effect since 1995. When

Congress enacted HOEPA in 1994, it authorized the Federal Reserve to adopt new or

expanded restrictions, as needed, to protect consumers from unfairness, deception, or

evasion of HOEPA in connection with mortgage loans. The Federal Reserve is also

authorized to prohibit acts or practices in connection with refinancings that are associated

with abusive lending practices or are otherwise not in the interest of the borrower. In 2008,

the Federal Reserve used this authority to put in place special protections for certain

higher-priced loans secured by the borrower’s principal dwelling, including home purchase

loans, as well as refinancing and home equity loans.

Second lien loans are also subject to TILA and HOEPA restrictions, but have higher rate

triggers.

HOEPA requires the Board of Governors of the Federal Reserve System to adjust this

dollar figure, initially set at $400, every year according to changes in the Consumer Price

Index. For loans made in 2009, the adjusted dollar figure is $583. 73 F.R. 46190 (Aug. 8,

2008).

Page 8 GAO-09-741 Impact of Mortgage Reform

loans, the law restricts prepayment penalties, prohibits balloon payments

(i.e., a large balance due at maturity of the loan term) for loans with terms

of less than 5 years, prohibits negative amortization, and contains certain

other restrictions on loan terms or payments.

• General provisions: For all loans, regardless of whether they fall into one

of the above categories, Regulation Z includes a number of basic

disclosure requirements and prohibits certain activities considered to be

unfair, deceptive, misleading, abusive, or otherwise problematic, such as

coercing a real estate appraiser to misstate a home’s value, and abusive

collection practices by loan servicers.

Each federal banking regulator is charged with enforcing TILA and

HOEPA with respect to the depository institutions it regulates, and the

FTC has responsibility for enforcing the statutes for mortgage brokers and

most financial entities other than banks, thrifts, and federal credit

unions.

The Federal Reserve has concurrent authority to enforce T

and HOEPA for non-bank subsidiaries of bank holding companie

ILA

In addition to TILA and HOEPA, some other federal laws govern aspects of

mortgage lending. For example, the Real Estate Settlement Procedures Act

(RESPA), passed in 1974, seeks to protect consumers from unnecessarily

high charges in the settlement of residential mortgages by requiring

lenders to disclose details of the costs of settling a loan and by prohibiting

kickbacks (payments made in exchange for referring a settlement service)

and other costs. HUD has primary rule-writing authority and is responsible

Prepayment penalties are prohibited on high-cost HOEPA loans unless (a) the monthly

payment will not change during the first 4 years of the loan; (b) the consumer’s total

monthly debts with the mortgage do not exceed 50 percent of the consumer’s monthly

gross income, as verified by the consumer’s signed financial statement, a credit report, and

payment records for employment income; (c) the penalty is limited to 2 years; and (d) the

source of the prepayment funds is not a refinancing by the creditor or an affiliate of the

creditor. Negative amortization occurs when loan payment amounts do not cover the

interest accruing on a loan, resulting in an increasing outstanding principal balance over

time. See 15 U.S.C. § 1639(f).

In the context of this report, the term “federal banking regulators” refers to the Federal

Reserve, the federal supervisory agency for state-chartered banks that are members of the

Federal Reserve System; Office of the Comptroller of the Currency, which supervises

national banks and their subsidiaries; Federal Deposit Insurance Corporation, the federal

regulator responsible for insured state-chartered banks that are not members of the

Federal Reserve System; Office of Thrift Supervision, the primary federal supervisory

agency for federally insured thrifts and their subsidiaries; and National Credit Union

Administration (NCUA), which supervises federally insured credit unions.

Page 9 GAO-09-741 Impact of Mortgage Reform

for enforcing RESPA. HUD coordinates on RESPA issues, as it deems

appropriate, with federal banking regulators and other federal agencies,

such as the FTC and the Department of Justice. In addition, the federal

banking agencies, under section 8 of the Federal Deposit Insurance Act,

examine for and enforce compliance with RESPA’s requirements with

respect to the institutions they supervise.

Finally, the Federal Deposit

Insurance Act and Federal Credit Union Act allow federal banking

regulators to use their supervisory and enforcement authorities to ensure

that an institution’s conduct with respect to consumer protection laws

does not affect its safety and soundness or that of an affiliated institution.

Banking Regulator

Guidance

In conjunction with enforcing federal statutes, federal banking regulators

have issued guidance to their institutions—including federally-regulated

banks, thrifts, credit unions, holding companies and their subsidiaries—

about nontraditional and subprime lending.

• In September 2006, banking regulators issued final guidance clarifying

how institutions can offer nontraditional mortgage products in a safe and

sound manner, and in a way that clearly discloses the risks that borrowers

may assume. The guidance provides specific steps institutions should take

to help ensure that loan terms and underwriting standards are consistent

with prudent lending practices, including considering a borrower’s

repayment capacity; ensuring strong risk management standards,

including capital levels; and ensuring that consumers have sufficient

information to clearly understand loan terms and associated risks.

• In June 2007, banking regulators issued a final statement on subprime

lending, in response to concerns about certain types of loans that could

result in payment shock to borrowers. The statement warned institutions

about risks associated with subprime loans with adjustable rates with low

See 24 C.F.R. § 3500.19(a), “It is the policy of the [HUD] Secretary regarding RESPA

enforcement matters to cooperate with Federal, State, or local agencies having supervisory

powers over lenders or other persons with responsibilities under RESPA. Federal agencies

with supervisory powers over lenders may use their powers to require compliance with

RESPA.”

For more information on federal laws and statutes related to mortgage lending, see GAO,

Consumer Protection: Federal and State Agencies Face Challenges in Combating

Predatory Lending, GAO-04-280 (Washington, D.C.: Jan. 30, 2004).

71 Fed. Reg. 58609 “Interagency Guidance on Nontraditional Mortgage Product Risks,”

(Oct. 4, 2006).

Page 10 GAO-09-741 Impact of Mortgage Reform

initial payments, based on fixed introductory rates that expire after a short

period, limited or no documentation of income, prepayment penalties that

were very high or that extended beyond the initial fixed rate period, and

other product features likely to result in frequent refinancing to maintain

an affordable monthly payment.

State Mortgage Lending

Laws

In response to concerns about the growth of predatory lending over the

past decade, many states have enacted laws to restrict the terms or

provisions of certain types of mortgage loans. According to the

Congressional Research Service, at least 30 states and the District of

Columbia had enacted a wide array of such laws, as of November 2008.

Many of these state laws are similar to HOEPA in that they regulate and

restrict the terms and characteristics of certain kinds of high-cost

mortgages exceeding certain interest rate or fee thresholds that require

enhanced protections. Like HOEPA, these laws often restrict certain loan

features that can, in certain cases, be abusive—such as prepayment

penalties, balloon payments, negative amortization, and loan flipping—and

many laws also require enhanced disclosures and credit counseling. While

some laws are only minimally different than HOEPA, others are more

comprehensive.

Significant debate has taken place as to the advantages and disadvantages

of state predatory lending laws. In several cases, regulators of federally

supervised financial institutions have determined that federal laws

preempt state predatory lending laws for the institutions they regulate. In

making these determinations, two regulators—the Office of the

Comptroller of the Currency (OCC) and Office of Thrift Supervision

(OTS)—have cited federal law that provides for uniform regulation of

federally chartered institutions and have noted the potential harm that

state predatory lending laws can do to legitimate lending. Many state

officials and consumer advocates are opposed to federal preemption of

state predatory lending laws.

They maintain that federal laws related to

72 Fed. Reg. 37569 “Statement on Subprime Mortgage Lending,” (Jul. 10, 2007). Banking

regulators have issued other guidance on subprime lending, including Interagency

Guidance on Subprime Lending, Mar. 1, 1999; and Expanded Guidance for Subprime

Lending Programs, Jan. 31, 2001.

Congressional Research Service, A Predatory Lending Primer: The Homeownership and

Equity Protection Act (HOEPA), RL34259 (Washington, D.C.: Nov. 2008).

A recent Supreme Court case (Cuomo v. The Clearing House Association) allows states to

bring lawsuits against national banks to enforce state fair lending and consumer protection

laws.

Page 11 GAO-09-741 Impact of Mortgage Reform

predatory lending are insufficient, and that preemption, therefore,

interferes with their ability to protect consumers in their states.

The first state predatory lending law, the North Carolina Anti-Predatory

Lending Law of 1999, has been the subject of particular attention by

researchers and policymakers. The law was more restrictive than HOEPA

was at the time. Among other things, it banned prepayment penalties on all

home loans with a principal amount of $150,000 or less, and prohibited

loan flipping (refinancings of consumer home loans that do not provide a

reasonable, net tangible benefit to the borrower). It included more

restrictions for a category of high-cost loans, which were defined to

include lower points and fee triggers than HOEPA, as well as a third

trigger that included any loan with a prepayment penalty that could be

collected more than 30 months after closing or that was greater than 2

percent of the amount paid.

H.R. 3915

The U.S. House of Representatives passed H.R. 3915—the Mortgage

Reform and Anti-Predatory Lending Act of 2007—on November 15, 2007,

in response to significant increases in mortgage defaults and foreclosures,

especially among subprime borrowers.

Although the bill was passed by

the U.S. House of Representatives, it was not enacted into law before the

end of the 110th Congress. The bill would have reformed mortgage lending

by, among other things, setting minimum standards for residential

mortgage loans (see fig. 1). The two standards included:

• Reasonable ability to repay. The bill would have created a “reasonable

ability to repay” standard by prohibiting a creditor from making a

residential mortgage loan without making a determination based on

verified and documented information that a consumer was likely to be

able to repay the loan, including all applicable taxes, insurance, and

assessments. Such a determination was to be based on the consumer’s

credit history, current and expected income, obligations, debt-service-to-

For more information about preemption, see GAO-04-280; GAO, OCC Preemption

Rulemaking: Opportunities Existed to Enhance the Consultative Efforts and Better

Document the Rulemaking Process, GAO-06-8 (Washington, D.C.: Oct. 17, 2005); and GAO,

OCC Preemption Rules: OCC Should Further Clarify the Applicability of State Consumer

Protection Laws to National Banks, GAO-06-387 (Washington, D.C.: Apr. 28, 2006).

H.R. 3915 was one of several bills introduced during the 110th Congress to address

concerns about rising foreclosures and abusive lending practices. See also S. 2452, 110th

Congress (2007), Home Ownership Preservation and Protection Act of 2007.

Page 12 GAO-09-741 Impact of Mortgage Reform

income (DTI) ratio, employment status, and financial resources other than

any equity in the real property securing the loan. Additionally, the bill

would have required lenders making ARMs to qualify borrowers at the

fully indexed rate. However, the actual standard was to be prescribed in

regulation by the federal banking agencies, in consultation with the FTC.

• Net tangible benefit. The bill would have created a “net tangible benefit”

standard by prohibiting a creditor from refinancing a loan without making

a reasonable good faith determination that the loan would provide a net

tangible benefit to the consumer. The bill stated that a loan would not

meet the standard if the loan’s costs exceeded the amount of newly

advanced principal, without any corresponding changes in the terms of the

refinanced loan that were advantageous to the consumer. However, the

term “net tangible benefit” was to be defined in regulation by the federal

banking agencies.

The specific responsibilities of lenders to meet the standards, and the

rights of consumers to take action against lenders to claim standards had

not been met, depended on the category of the loan. Under the bill, loans

are classified into three basic categories:

• Qualified mortgages would have had relatively low APRs, be insured by

FHA, or made or guaranteed by VA. This category was intended to include

most prime loans. Specifically, a loan would have been considered a

qualified loan if either the APR was less than 3 percent above the yield on

comparable Treasury securities, or less than 1.75 percent above the most

recent conventional mortgage rate (a term that would have been more

explicitly defined in regulation). For second-lien loans, the limits were 5

and 3.75 percent, respectively. Qualified mortgages would have been

presumed under the law to meet the “ability to repay” and “net tangible

benefit” standards, and for these loans, the creditor’s presumption could

not be rebutted by borrowers.

• Qualified safe harbor mortgages would have fallen outside of the

definition of qualified mortgages (i.e., would not have met this standard),

but would have met certain underwriting requirements. This category was

intended to include subprime loans that did not contain certain high-risk

features. Specifically, these mortgages were required to (1) have full

documentation, (2) be underwritten to the fully indexed rate, (3) not

negatively amortize, and (4) have a fixed rate for at least 5 years, have a

variable rate with an APR less than 3 percentage points over a generally

accepted interest rate index, or meet a DTI ratio to be established in

Page 13 GAO-09-741 Impact of Mortgage Reform

regulation.

Qualified safe harbor mortgages, like qualified mortgages,

would have been presumed under the law to meet the “ability to repay”

and “net tangible benefit” standards. Unlike borrowers with qualified

mortgages, however, borrowers with these mortgages would have had the

right to challenge a creditor’s presumption that these loans met the “ability

to repay” and “net tangible benefit” standards.

• Nonqualified mortgages would have fallen outside of the two definitions

above (i.e., would not have met either standard). This category was

intended to include subprime loans with high-risk features. For these

loans, the law would have required lenders to meet the reasonable ability

to repay and net tangible benefit standards, as well as provide borrowers

with the ability to challenge such determinations by creditors and

assignees.

As shown in figure 1, the bill would also have imposed restrictions on

specific loan terms, depending on the loan category. First, the bill would

have prohibited prepayment penalties for loans that were not qualified

mortgages and would have required the penalties on all qualified

mortgages with an adjustable interest rate to expire 3 months before the

initial interest rate adjustment. Second, negative amortization loans to

first-time borrowers would have been prohibited, unless the creditor made

certain disclosures to the consumer and the consumer had received

homeownership counseling from a HUD-certified organization or

counselor. Finally, single-premium credit insurance and mandatory

arbitration on mortgage loans would have been prohibited for all loans.

The bill would have established additional liability for creditors of

qualified safe harbor and nonqualified mortgages (see fig. 1).

In addition,

The bill provided the federal banking agencies the authority to jointly prescribe

regulations to revise, add to, or subtract from these safe harbor provisions to the extent

necessary and appropriate to meet the purposes intended in the law, to prevent

circumvention or evasion of the provisions, or to facilitate compliance with the provisions.

Credit insurance is a loan product that repays the lender should the borrower die or

become disabled. In the case of single-premium credit insurance, the full premium is paid

all at once—by being added to the amount financed in the loan—rather than on a monthly

basis. Because adding the full premium to the amount of the loan unnecessarily raises the

amount of interest borrowers pay, single-premium credit insurance is generally considered

inherently abusive.

Under the terms of the bill, the liability of rescission faced by creditors would have been

“[i]n addition to any other liability” under TILA for violating the minimum standards. H.R.

3915, § 204. Those additional liabilities include individual and class action damages. See 12

U.S.C. §1640.

Page 14 GAO-09-741 Impact of Mortgage Reform

it would have established limited liability for assignees of nonqualified

mortgages. Borrowers would have been able to bring civil actions against

creditors or assignees if loans violated the “reasonable ability to repay” or

“net tangible benefit” standards. Creditors would have been liable for the

rescission of a loan and the borrower’s cost associated with the rescission

unless they could make the loan conform to minimum standards within 90

days. In addition, assignees would have been liable for the rescission (i.e.,

cancellation) of a loan and for borrower costs associated with the

rescission unless the loan could be made to conform to the minimum

standards within 90 days, or unless the assignee (1) had a policy against

buying loans that were not qualified loans or qualified safe harbor loans,

(2) exercised reasonable due diligence, as defined in regulation by the

federal banking agencies and the SEC, and (3) had agreements with the

seller or assignees of loans requiring that certain standards be met and

certain steps be taken. The bill included additional provisions to resolve

situations in which the parties could not agree on loan changes and set

certain time frames for addressing challenges to these changes. Liability

would not have been extended to pools of loans, including the

securitization vehicles, or investors in pools of loans. According to the

House Committee Report on the bill, it was not intended to apply to

trustees or titleholders who held loans solely for the benefit of the

securitization vehicle.

Committee Report, 110th Congress, 1st Session, Report 110-441.

Page 15 GAO-09-741 Impact of Mortgage Reform

Figure 1: H.R. 3915 Loan Standards

APR requirements

and underwriting

standards

Qualified mortgages

Loan categories

Qualified safe harbor mortgages Nonqualified mortgages

Loan terms

and

standards

Liability for

creditors

Liability for

assignees and

securitizers

Presumed to meet minimum lending standards (i.e., “reasonable ability to repay” and “net tangible benefit”)

• APR less than three percent above yield on

comparable Treasury securities or less

than 1.75 percent above most recent

conventional mortgage rate (to be defined

in regulation)

• Second lien (subordinate loan): APR less

than 5 percent above yield on

comparable Treasury securities or 3.75

percent above most recent conventional

mortgage rate (to be defined in regulation)

• Loan is insured by FHA

• Loan is made or guaranteed by V

• Limits on prepayment penalities for first

3 years

• No prepayment penalties after initial fixed

term expires on hybrid-ARM

• No liability for creditors

• No liability for assignees and securitizers

• Potential liability for rescission or cure of

loans (presumption of having met minimum

lending standards is rebuttable if borro

wer

can prove a violation of the miniumum

lending criteria)

• Potential liability for rescission or cure of

loans if borrower can prove loan violation

of minimum lending standards

• Prohibits prepayment penalties

• Prohibits single premium credit insurance from being financed

• Prohibits requirement of arbitration

• Do not meet standards established for

qualified mortgages or qualified safe

harbor mortgages

Mortgages must meet all four underwriting

standards:

(1) Full documentation

(2) No negative amortization

(3) Underwritten to the fully indexed rate

(4) Have ONE of the following features:

fixed interest rate for at least 5 years, or

- variable rate mortgage where the

APR has a margin less than 3 percent

over a generally-accepted interest

rate index, or

- meet a DTI ratio to

be established in regulation

Source: GAO.

Liability of creditors for rescission would be in addition to other liabilities (e.g., damages) that

currently exist in TILA.

The bill would also have expanded the definition of “high-cost” loans

under HOEPA. Specifically, the bill would have included home purchase

loans in the definition, reduced the points and fees trigger from 8 to 5

percent—the APR trigger would stay at 8—and expanded the definition of

points and fees for high-cost mortgages. The bill would have also added a

third high-cost trigger for loans with prepayment penalties that applied for

more than 3 years or exceeded 2 percent of the prepaid amount. Further,

Page 16 GAO-09-741 Impact of Mortgage Reform

the bill would have enhanced existing HOEPA restrictions on lending

without repayment ability by presuming that creditors engaged in a

pattern or practice of making high-cost mortgages without verifying or

documenting consumers’ repayment ability were violating HOEPA.

Finally, the bill would have established a federal duty of care for mortgage

originators; prohibited steering of consumers eligible for qualified

mortgages to nonqualified mortgages; established a licensing and

registration regime for loan originators; established an Office of Housing

Counseling within HUD and imposed additional counseling requirements;

made changes to mortgage servicing and appraisal requirements; and

provided protections for renters in foreclosed properties.

We estimate that almost three-quarters of securitized nonprime mortgages

originated from 2000 through 2007 would not have been safe harbor loans.

The extent to which mortgages would have met the individual safe harbor

requirements varied substantially by origination year, reflecting changes in

market conditions and lending practices over the 8-year period. We also

found that the proportions of safe harbor and non-safe harbor loans varied

across different census tract and borrower groupings. Our statistical

analysis of loan data shows that certain variables associated with the safe

harbor requirements—documentation of borrower income and assets, in

particular—were associated with the probability of a loan default. We

found that other variables, such as house price appreciation and borrower

credit score, were also associated with default rates.

Most Recent

Nonprime Mortgages

Would Not Have Been

Safe Harbor Loans

and Certain Variables

Associated with the

Safe Harbor

Requirements and

Other Factors

Influenced Defaults

Most Recent Nonprime

Loans Would Not Have Met

the Bill’s Safe Harbor

Requirements

To illustrate the potential significance of the safe harbor requirements

under different lending environments and market conditions, we applied

those requirements to nonprime mortgages originated from 2000 through

2007 and calculated the proportions of loans that likely would and would

not have met the requirements. Because of data limitations and

uncertainty about how federal regulators would have interpreted some of

the safe harbor requirements, our analysis includes a number of

assumptions discussed in this section. (See appendix I for details about

our methodology.)

We estimate that almost 75 percent of nonprime mortgages originated

from 2000 through 2007 would not have met the bill’s safe harbor

requirements. More specifically, the estimated proportion of non-safe

harbor loans ranged from a low of 58 percent for 2001 to a high of 84

Page 17 GAO-09-741 Impact of Mortgage Reform

percent for 2006 (see fig. 2). The non-safe harbor loans were primarily

ARMs, while the safe harbor loans were largely fixed-rate mortgages. For

all 8 years combined, Alt-A mortgages represented about 37 percent of

non-safe harbor loans, or slightly more than the Alt-A share of the

nonprime market over this period (35 percent). Over this same period,

subprime mortgages comprised about 63 percent of non-safe harbor loans,

or slightly less that their 65 percent share of the nonprime market.

Figure 2: Estimated Proportions of Nonprime Mortgages Meeting and Not Meeting

the Safe Harbor Requirements, 2000-2007

100

20072006200520042003200220012000

Percentage

Year

Safe harbor loans

Non-safe harbor loans

Source: GAO analysis of LP data.

The significance of particular safe harbor requirements varied by

origination year. As previously noted, the safe harbor requirements include

the following:

• Documentation and amortization. The mortgage would have to be

underwritten based on full documentation of the borrower’s income and

assets and could not have a negative amortization feature.

• Interest rate and debt burden. The mortgage would be required to have

either (1) a fixed interest rate for at least 5 years, (2) a DTI ratio within a

Page 18 GAO-09-741 Impact of Mortgage Reform

level to be specified in regulation (we used the 41 percent ratio that serves

as a guideline in underwriting FHA-insured mortgages), or (3) an ARM

with an APR of less than 3 percentage points over a generally accepted

interest rate index.

Because the loan data we used did not include APRs,

we instead compared the initial interest rate on each loan to the relevant

interest rate index.

• Fully indexed rate. The mortgage would have to be underwritten to the

fully indexed interest rate (which the bill defines as the initial interest rate

index, plus the lender’s margin). We could not determine from the data we

used whether a mortgage was underwritten to the fully indexed rate. We

created a proxy by assuming that the mortgage satisfied this requirement if

the fully indexed rate was 1 percentage point or less over the initial

interest rate, indicating a reasonable likelihood that the borrower could

have qualified for a loan underwritten to the fully indexed rate.

As shown in figure 3, there was an increasing trend in the proportion of

nonprime loans originated from 2000 through 2007 that would not have

met the safe harbor documentation and amortization requirements. More

specifically, the estimated percentages of nonprime loans without full

documentation ranged from a low of 27 percent in 2000 to a high of almost

60 percent in 2007.

Also, from 2004 through 2007, the proportion of

nonprime loans with a negative amortization feature increased steadily.

The growth in these percentages reflects the increased use of low-

documentation mortgages in both the subprime and Alt-A markets and

We used the FHA guidelines because FHA primarily serves borrowers with credit

characteristics somewhat similar to those of nonprime borrowers.

Because the APR is generally higher than the initial interest rate, our results may

overestimate the number of loans that would meet this requirement. The bill did not specify

particular interest rate indexes, so we used the Treasury 2-year constant maturity rate for

short-term hybrid ARMs (e.g., 2/28 and 3/27 mortgages), the Treasury 5-year constant

maturity rate for longer-term ARMs, and the Treasury 10-year constant maturity rate for

fixed-rate mortgages.

One industry and one consumer group representative told us that nonprime lenders often

underwrote loans to less than the fully indexed rate. We based our assumption on the

policy of a major subprime lender, which underwrote its riskiest loans at one percentage

point below the fully indexed rate. To the extent that lenders underwrote loans to more

than one percentage point below that rate, our approach would tend to underestimate the

proportion of loans meeting the fully indexed rate requirement.

While our analysis examined the documentation requirement in the context of the bill’s

safe harbor provisions, the bill’s minimum lending standards include a similar requirement,

as discussed in the Background section of this report.

Page 19 GAO-09-741 Impact of Mortgage Reform

mortgages with negative amortization features (e.g., payment-option

ARMs) in the Alt-A market. In both cases, these products were originally

intended for a narrow population of borrowers but, ultimately, became

more widespread. For example, as we reported in 2006, payment-option

ARMs were once specialized products for financially sophisticated

borrowers who wanted to minimize mortgage payments to invest funds

elsewhere or borrowers with irregular earnings who could take advantage

of minimum monthly payments during periods of lower income and could

pay down principal when they received an increase in income.

However,

according to federal banking regulators and a range of industry

participants, as home prices increased rapidly in some areas of the

country, lenders began marketing payment-option ARMs as affordability

products and made them available to less creditworthy and lower income

borrowers. borrowers.

Figure 3: Estimated Proportions of Nonprime Mortgages Not Meeting Figure 3: Estimated Proportions of Nonprime Mortgages Not Meeting

Documentation and Amortization Requirements, 2000-2007

2007

2006200520042003200220012000

Percentage

Source: GAO analysis of LP data.

Year

Documentation requirement

Amortization requirement

GAO-06-1021.

Page 20 GAO-09-741 Impact of Mortgage Reform

Substantial proportions of the nonprime loans made over the 8-year period

we examined also did not meet the safe harbor interest rate and debt

burden requirements, although the proportions varied by year:

• The proportion of nonprime originations that did not have a fixed interest

rate for at least 5 years rose from 52 percent in 2000 to 64 percent in 2004

(see fig. 4). This increase can be attributed primarily to a shift in the Alt-A

market away from fixed-rate mortgage products to adjustable-rate

products. For example, in 2000 about 88 percent of Alt-A loans were fixed

rate, but by 2004 this figure had dropped to about 38 percent. Beginning in

2005, the percentage of nonprime originations with adjustable rates began

falling, reaching 37 percent in 2007. The decline was due in large part to a

trend in the Alt-A market toward fixed-rate mortgages.

• As figure 4 also shows, the proportion of nonprime originations that did

not have a DTI ratio under 41 percent grew over the 8-year period, rising

from 43 percent in 2000 to 51 percent in 2006, although it fell slightly in

2007. The generally increasing trend is partly a result of house prices

growing faster than borrowers’ incomes over the period and of lenders

allowing borrowers to take out larger mortgages relative to their incomes.

For example, from 2000 through 2006, average home prices grew by 38

percent nationally, while over the same period, average incomes grew by

just 23 percent.

• Finally, the proportion of nonprime ARM originations with initial interest

rates not less than 3 percentage points over a generally accepted interest

rate index (3 percent test) ranged from a high of 96 percent in 2002 to a

low of 48 percent in 2007 (see fig. 4). The changing proportions over time

were largely due to movements in the interest rate indexes used to set

ARM interest rates that affected the size of the gap between the initial

rates and the index values. For example, when the 2-year Treasury

constant maturity rate (a common interest rate index) dropped from 2000

through 2002, the proportion of nonprime ARMs that did not meet the 3

percent test rose. But when the 2-year Treasury rate rose from 2004

through 2006, the proportion declined sharply.

The bill’s interest rate and debt burden requirements for safe harbor

mortgages were structured so that a loan would only have to meet one of

the three requirements. As a result, some loans could have met one of the

requirements, but not one or both of the other requirements and still could

have qualified as safe harbor loans. To illustrate, of the safe harbor loans

that met the bill’s safe harbor requirements by having a fixed interest rate

for 5 or more years, almost one-half would not have met the DTI ratio

requirement, assuming the 41 percent ratio we used for our analysis. Some

Page 21 GAO-09-741 Impact of Mortgage Reform

of the banking regulators we interviewed said that the DTI ratio was an

important factor in assessing a borrower’s ability to repay a mortgage loan.

They said that all borrowers should be required to meet some DTI ratio in

order for their loans to be eligible for the bill’s safe harbor. Consistent

with this view, H.R. 1728, which was passed by the House earlier this year,

requires borrowers of safe harbor loans to meet a DTI ratio to be

established by regulation.

Figure 4: Estimated Proportions of Nonprime Mortgages Not Meeting Interest Rate

and Debt Burden Requirements, 2000-2007

Note: About 37 percent of the loans in the LP database did not have information on the DTI ratio. We

compared the credit score distribution for loans with DTI data to the distribution for loans without this

information, and found them to be very similar. As a result, we believe that the DTI data we present

are a reasonable reflection of trends in the nonprime market as a whole.

Over the 8-year period we examined, about 38 percent of the nonprime

loans originated would not have met the safe harbor fully indexed rate

100

2007

2006200520042003200220012000

Percentage

Source: GAO analysis of LP data.

Year

ARM interest rate requirement

Fixed interest rate requirement

DTI requirement

Page 22 GAO-09-741 Impact of Mortgage Reform

requirement, although the proportions varied by year (see fig. 5).

previously noted, we assumed that if the fully indexed rate—that is, the

index rate at origination plus the lender’s margin—was more than 1

percentage point above the initial interest rate, the mortgage did not meet

the requirement. The variation by year largely reflected changes in the

index used to determine the fully indexed rate. More specifically, during

years in which a commonly used index such as the 6-month LIBOR was

relatively high (e.g., 2000 and 2005 through 2006), a larger proportion of

the nonprime loans would not have met the requirement because the fully

indexed rate would have been well above the initial interest rate of the

loan. In contrast, during years in which the index was low (e.g., 2001

through 2004), a greater proportion of loans would have met the

requirement because the fully indexed rate would have been close to the

initial rate. For example, in 2000, when the average 6-month LIBOR was

6.7 percent, the proportion of nonprime loans that did not meet the fully

indexed rate requirement was 47 percent. In 2003, when the average 6-

month LIBOR was 1.2 percent, the proportion was 9 percent. A potential

shortcoming of this requirement is that many ARMs could meet this

requirement when interest rates were low, but the mortgages could

become unaffordable if interest rates were to rise and the borrower’s

payments adjusted upward to reflect the higher rates. However, it may be

difficult to design a more stringent fully indexed rate requirement to

provide protection during low interest rate environments without possibly

reducing the availability of ARMs during high interest rate environments.

While our analysis examined the fully indexed rate requirement in the context of the bill’s

safe harbor provisions, the bill’s minimum lending standards include a similar requirement,

as discussed in the Background section of this report.

Page 23 GAO-09-741 Impact of Mortgage Reform

Figure 5: Estimated Proportions of Nonprime Mortgages Not Meeting the Fully

Indexed Rate Requirement, 2000-2007

2007

2006200520042003200220012000

Percentage

Source: GAO analysis of LP data.

Year

The Proportions of Safe

Harbor and Non-Safe

Harbor Loans Differed

across Zip Code and

Borrower Groupings

Prior research has indicated that nonprime lending occurred

disproportionately in areas with higher proportions of minority, low-

income, and credit-impaired residents.

Therefore, in contemplating the

potential impact of the Bill, one consideration is the extent to which

nonprime mortgages made to these groups of borrowers would have fallen

inside or outside of the safe harbor. For groups with higher proportions of

non-safe harbor mortgages, the Bill’s impact on the availability of these

loans and consumer protections for them may be particularly important.

Accordingly, we examined the estimated proportions of safe harbor and

non-safe harbor loans within various zip code and borrower groupings.

GAO, Federal Housing Administration: Decline in the Agency’s Market Share Was

Associated with Product and Process Developments of Other Mortgage Market

Participants, GAO-07-645 (Washington, D.C.: June 29, 2007) and Mayer and Pence,

“Subprime Mortgages: What, Where, and to Whom?”, Finance and Economics Discussion

Series 2008-29, Federal Reserve Board (2008).

We did not examine the reasons for differences among the various groupings as part of

our analysis.

Page 24 GAO-09-741 Impact of Mortgage Reform

Specifically, we looked at zip codes grouped by race, ethnicity, and

income characteristics, as well as borrowers grouped by credit score.

Our analysis of safe harbor and non-safe harbor loans by race and

ethnicity groupings found that zip codes with higher percentages of

households that Census identified as black or African-American had lower

percentages of non-safe harbor loans than the nonprime borrower

population as a whole. For example, in zip codes where black or African-

American households made up 75 percent or more of the household

population, the proportion of non-safe harbor loans was 68 percent,

compared with 75 percent for all nonprime borrowers (see table 2). In

contrast, in zip codes with higher percentages of households that Census

identified as Hispanic or Latino, the percentages of non-safe harbor loans

were higher than for nonprime borrowers as a whole. For example, in zip

codes where Hispanic or Latino households comprised 75 percent or mor

of the household population, the percentage of non-safe harbor loans was

80 percent, or 5 percentage points higher than for all nonprime

borrowers.

e as

ime borrower population.

Our analysis by income groupings found that the proportio

of non-safe harbor loans for each grouping was essentially the sam

that for the entire nonpr

Table 2: Percentage of Nonprime Mortgages That Were Safe Harbor and Non-safe

Harbor Loans by Racial, Ethnic, and Income Groupings, 2000-2007

Zip code population

grouping

Percentage of safe

harbor loans

Percentage of non-safe

harbor loans

All nonprime borrowers 25 75

Black or African-American

Less than 5% 25 75

5% to 24% 26 74

25% to 74% 29 71

75% or greater 32 68

We used the Census 2000 data for our analysis.

Individuals who classify themselves as Hispanic or Latino include people of different

racial backgrounds.

We defined low-, moderate-, and upper-income census tracts as those with median

incomes that were less than 80 percent, at least 80 percent but less than 120 percent, and

120 percent and above, respectively, of the median income for the associated metropolitan

statistical area.

Page 25 GAO-09-741 Impact of Mortgage Reform

Zip code population

grouping

Percentage of safe

harbor loans

Percentage of non-safe

harbor loans

Hispanic or Latino

Less than 5% 31 69

5% to 24% 24 76

25% to 74% 20 80

75% or greater 20 80

Median income

Low income 26 74

Moderate income 25 75

Upper income 24 76

Source: GAO analysis of LP and Census data.

We also analyzed safe harbor and non-safe harbor loans by credit score

groupings. We used four groupings that ranged from the least creditworthy

borrowers (scores of 599 and less) to the most creditworthy borrowers

(scores of 720 and above). We found that borrowers with scores of 599

and less (the lowest category) had the smallest percentage of non-safe

harbor loans (69 percent), while borrowers with scores of 600 to 719 (the

second highest category) had the largest percentage of non-safe harbor

loans (see table 3).

Table 3: Percentage of Nonprime Mortgages That Were Safe Harbor and Non-Safe

Harbor Loans by Credit Score Groupings, 2000-2007

Credit score

grouping

Percentage of safe harbor

loans

Percentage of non-safe

harbor loans

599 and less 31 69

600-659 25 75

660-719 22 78

720 and above 26 74

Source: GAO analysis of LP and Census data.

Page 26 GAO-09-741 Impact of Mortgage Reform

Prior research has shown that a number of different loan, borrower, and

economic variables influence the performance of a loan. To see if the bill’s

provisions appear to fulfill their consumer protection purpose, we

developed a statistical model, based on the data available to us, to

examine the relationship between safe harbor requirements, as well as a

subset of other variables known to affect performance, and the probability

of a loan defaulting within the first 24 months of origination.

We defined

a loan as being in default if it was delinquent by at least 90 days, in the

foreclosure process (including loans identified as in real-estate-owned

status), paid off after being 90 days delinquent or in foreclosure, or had

already terminated with evidence of a loss.

Some of the Safe Harbor

Requirements and Other

Factors Were Associated

with the Likelihood of

Default

We focused on 24-month performance because a large proportion of

nonprime borrowers—particularly those with hybrid ARMs—prepaid their

loans (e.g., by refinancing) within 2 years. Using a 24-month time frame

allowed us to include these loans in our model. The variables we used in

the model included variables based on the individual safe harbor

requirements, house price appreciation, borrower credit scores, and LTV

ratios.

We developed the model using data on nonprime mortgages

originated from 2000 through 2006 (the latest year for which we could

examine 24-month performance). We produced separate estimates for four

types of loan products: (1) short-term hybrid ARMs (i.e., 2/28 or 3/27

mortgages), which accounted for 54 percent of the loans originated during

this period; (2) longer-term ARMs (i.e., ARMs with interest rates that were

fixed for 5, 7, or 10 years before adjusting), which accounted for 10

percent of originations; (3) payment-option ARMs, which represented 6

percent of originations and (4) fixed-rate mortgages, which represented 30

As previously discussed, data limitations prevented us from developing variables that

precisely replicated all of the safe harbor requirements. Had we been able to do so, the

results of our statistical analysis might have been different. Additionally, certain variables

associated with the risk of default (e.g., borrower income) were not contained in the data

set we used and, therefore, are not reflected in our model.

As an alternative specification for short-term hybrid ARMs, we included a variable

indicating whether each mortgage was a safe harbor or a non-safe harbor loan, in contrast

to including variables for separate safe harbor requirements. We found that this variable

had a small marginal effect, most likely because many non-safe harbor loans met some of

the safe harbor requirements. In particular, a substantial percentage of non-safe harbor

loans had full documentation of borrower income and assets but failed to meet other safe

harbor requirements.

Page 27 GAO-09-741 Impact of Mortgage Reform

percent of originations.

Appendix II provides additional information

about our model and estimation results.

Consistent with the consumer protection purpose of the bill’s provisions,

we found that two safe harbor variables were associated with the

probability of default. Across all product types, the safe harbor variable

with the largest estimated influence on default probability was

documentation of borrower income and assets. For example, less than full

documentation was associated with a 5.5 percentage point increase in the

estimated probability of default for short-term hybrid ARMs used for home

purchases, all other things being equal (see table 4). The corresponding

increases in estimated default probabilities for longer-term ARMs,

payment-option ARMs, and fixed-rate mortgages were 4.8 percent, 2.0

percent, and 4.6 percent, respectively. The higher default probabilities

associated with no- and low-documentation loans may reflect use of this

feature to overstate the financial resources of some borrowers and qualify

them for larger, potentially unaffordable loans. Our results are generally

consistent with prior research showing an association between a lack of

documentation and higher default probabilities.

For short-term hybrid ARMs, longer-term ARMs, and fixed-rate mortgages, we present

estimation results for purchase loans in the body of the report, and results for both

purchase and refinance loans in appendix II. In the body of the report and appendix II, the

estimation results we present for payment-option ARMs are for purchase and refinance

loans combined, and reflect mortgages originated from 2003 through 2006. We took this

approach for payment-option ARMs because the proportion of purchase loans was

relatively small and very few of these loans were made prior to 2003.

Pennington-Cross and Ho, “The Termination of Subprime Hybrid and Fixed Rate

Mortgages,” Federal Reserve Bank of St. Louis Working Paper Series (2006), Sherlund,

“The Past, Present, and Future of Subprime Mortgages,” Finance and Economic

Discussion Series 2008-63, Federal Reserve Board (2008), Demyanyk, “Quick Exits of

Subprime Mortgages,” Federal Reserve Bank of St. Louis Review, 91(2): (2009).

Page 28 GAO-09-741 Impact of Mortgage Reform

Table 4: Estimated Probability of Nonprime Purchase Mortgages Defaulting within

24 months of Origination with and without Full Documentation, 2000-2006 Loans

Estimated probability of default

Product type

Full documentation

Less than full

documentation

Short-term hybrid ARMs 14.0% 19.5%

Longer-term ARMs 3.5 8.3

Payment-option ARMs

2.1 4.1

Fixed-rate mortgages 4.7 9.3

Source: GAO analysis of LP data.

Note: The estimated default probabilities we present do not necessarily reflect the ultimate

performance of any product type. For example, many payment-option ARMs do not recast to higher,

fully amortized payments until 5 years after origination. Because we focused on 24-month

performance, our analysis does not capture defaults on payment-option ARMs that may occur due to

future increases in monthly payments.

Includes purchase and refinance loans.

A second safe harbor variable that had a significant influence on default

probability was the variable representing the difference between the loan’s

initial interest rate and the relevant interest rate index (the spread). As

previously noted, ARMs with a difference of 3 percentage points or more

over a generally accepted interest rate index would not meet one of the

bill’s safe harbor interest rate and debt burden requirements. To examine

the effect of this variable for each product type, we estimated the default

probability assuming the spread was near the 25th percentile (base

assumption) for that product and compared this with the estimated default

probability assuming the spread was near the 75th percentile (alternative

assumption) for that product. We estimated that for short-term hybrid

ARMs used for home purchases, moving from the lower spread to the

higher one was associated with a 4.0 percentage point increase in default

probability, all other things remaining equal (see table 5). The

corresponding increases in estimated default probabilities for longer-term

ARMs and fixed-rate mortgages were 1.8 percent and 2.6 percent,

respectively. These results were generally consistent with other economic

research showing a positive relationship between higher interest rates and

default probabilities for nonprime mortgages.

This relationship may

Demyanyk, “Quick Exits of Subprime Mortgages.”

Page 29 GAO-09-741 Impact of Mortgage Reform

reflect the higher monthly payments associated with higher interest rates

and difficulties borrowers may face in making these payments, particularly

during times of economic hardship.

Table 5: Estimated Probability of Nonprime Purchase Mortgages Defaulting within

24 months of Origination under Different Assumptions for the Safe Harbor Spread

Requirement, 2000-2006 Loans

Variable

(base assumption)

Estimated

probability of

default

Variable

(alternative

assumption)

Estimated

probability of

default

Short-term hybrid ARMs

Spread of 3 percent 14.1% Spread of 5 percent 18.1%

Longer-term ARMs

Spread of 1.75 percent 5.2% Spread of 2.5 percent 7.0%

Fixed-rate mortgages

Spread of 2 percent 4.8% Spread of 3.75

percent

7.4%

Source: GAO analysis of LP data.

Note: As indicated earlier, the relevant interest rate index we used for short-term hybrid ARMs was

the Treasury 2-year constant maturity rate. For longer-term ARMs we used the Treasury 5-year

constant maturity rate, and for fixed-rate mortgages we used the Treasury 10-year constant maturity

rate.

We also estimated the effect of the DTI ratio at origination and found that

for all product types, this variable did not have a strong influence on the

probability of default within 24 months. This relatively weak association

may be due, in part, to changes in borrower income or indebtedness after

loan origination. For example, a mortgage that is affordable to the

borrower at origination may become less so if the borrower experiences a

decline in income or takes on additional nonmortgage debt.

Finally, we estimated the effect of the proxy variable we developed for the

safe harbor requirement that loans be underwritten to the fully indexed

For a further discussion of this hypothesis, see Foote and others, Reducing Foreclosures,

Federal Reserve Bank of Boston Public Policy Discussion Paper 09-2, (Apr. 2009).

Page 30 GAO-09-741 Impact of Mortgage Reform

rate.

As previously noted, if the fully indexed rate was 1 percentage point

or less over the initial interest rate, we assumed the loan met this

requirement. For all product types, we found that this variable did not

have a strong influence on the probability of default within 24 months (see

app. II). It is possible that other model specifications—such as examining

default probabilities beyond 24 months—would have yielded different

results. For example, the difference between the initial interest rate and

the fully indexed rate might have been more significant using such an

alternative specification because the initial interest rates for many short-

term hybrid ARMs begin adjusting upward after 24 months.

In examining the influence of safe harbor variables on the probability of

default within 24 months, we controlled for other variables not associated

with the safe harbor requirements, such as house price appreciation,

borrower credit score, and the LTV ratio. Because these variables have

been shown to influence default probabilities, it was important to control

for their effects in order to properly analyze the implications of the safe

harbor provisions. Consistent with other economic research, we found

that house price appreciation, borrower credit score, and the LTV ratio

were strongly associated with default probabilities.

The estimated

influence of these variables on default probabilities for each product type

were as follows:

We did not estimate the effect of the safe harbor variable representing whether a loan was

fixed for at least 5 years because this feature is only associated with certain mortgage

products. We only estimated the effect of the safe harbor variable representing whether a

loan had a negative amortization feature for longer-term ARMs. We did not include it in the

models for the other mortgage types because the negative amortization feature was,

essentially, never present (in the case of fixed-rate mortgages and short-term hybrid ARMs)

or was, essentially, always present (in the case of payment-option ARMs). The lack of

variation within these mortgage types made estimating the marginal effects of the negative

amortization variable problematic.

Danis and Pennington-Cross, “The Delinquency of Subprime Mortgages,” Federal Reserve

Bank of St. Louis Working Paper 05-022A (2005), and Sherlund, “The Past, Present, and

Future of Subprime Mortgages.”

Page 31 GAO-09-741 Impact of Mortgage Reform

• House price appreciation.

We found that lower rates of house price

appreciation were associated with a higher likelihood of default. For each

product type, we estimated the default probability assuming house price

appreciation near the 75th percentile for that product (base assumption)

and compared this with the estimated default probability assuming house

price appreciation near the 25th percentile for that product (alternative

assumption). For short-term hybrid ARMs used for home purchases,

moving from the higher rate of appreciation to the lower rate was

associated with a 13.5 percentage point increase in estimated default

probability (see fig. 6). The corresponding figures for longer-term ARMs,

payment-option ARMs, and fixed-rate mortgages were 3.7 percent, 1.3

percent, and 3.5 percent, respectively.

• Borrower credit score. We found that lower credit scores were associated

with a higher likelihood of default. For each product type, we estimated

the default probability assuming a borrower credit score close to the 75th

percentile for that product (base assumption) and compared this with the

estimated default probability assuming a borrower credit score close to

the 25th percentile for that product (alternative assumption). For short-

term hybrid ARMs used for home purchases, moving from the higher

credit score to the lower one was associated with a 7.3 percentage point

increase in the estimated default probability (see fig. 6). For longer-term

ARMs, payment-option ARMs, and fixed-rate mortgages, the

corresponding figures were 3.3 percent, 2.1 percent, and 5.5 percent,

respectively.

• LTV ratio. We found that higher LTV ratios were associated with higher

probabilities of default. For each product type, we estimated the default

probability assuming a LTV ratio close to the 25th percentile for that

product (base assumption) and compared this with the estimated default

probability assuming a LTV ratio close to the 75th percentile for that

product (alternative assumption). For short-term hybrid ARMs used for

home purchases, moving from the lower ratio to the higher ratio was

associated with a 4.4 percentage point increase in the estimated default

We used the Federal Housing Finance Agency (FHFA) house index (HPI), which is a

broad measure of the movement of single-family house prices. The HPI is a measure

designed to capture changes in the value of single-family homes in the U.S. as a whole, in

various regions of the country, and in the individual states and the District of Columbia.

The HPI is published by FHFA using data provided by Fannie Mae and Freddie Mac. The

Office of Federal Housing Enterprise Oversight (OFHEO), one of FHFA’s predecessor

agencies, began publishing the HPI in the fourth quarter of 1995.

Page 32 GAO-09-741 Impact of Mortgage Reform

probability (see fig. 6). The corresponding figures for longer-term ARMs,

payment-option ARMs, and fixed-rate mortgages were 4.7 percent, 6.3

percent, and 3.7 percent, respectively.

Page 33 GAO-09-741 Impact of Mortgage Reform

Figure 6: Estimated Probability of Nonprime Purchase Mortgages Defaulting within

24 Months under Different House Price Appreciation, Credit Score, and LTV Ratio

Assumptions, 2000-2006 Loans

Source: GAO analysis of LP data.

Short-term

hybrid ARMs

Longer-term

ARMs

Payment -

option

ARMs

Fixed-rate

mortgages

Base estimated probability of default

Alternative estimated probability of default

Variable

Base

Assumption:

Alternative

Estimated probability of default

House price apprecia-

tion 24 months after

origination:

Borrower credit score:

LTV ratio:

House price apprecia-

tion 24 months after

origination:

Borrower credit score:

LTV ratio:

House price apprecia-

tion 24 months after

origination:

Borrower credit score:

LTV ratio:

House price apprecia-

tion 24 months after

origination:

Borrower credit score:

LTV ratio:

600

100%

-10%

675

100%

-10%

675

90%

625

100%

25%

675

80%

20%

750

90%

15%

750

75%

25%

725

80%

24.2

20.6

18.0

7.0

7.8

8.1

3.6

4.6

9.0

7.9

9.6

8.4

10.7

13.3

13.6

3.3

4.5

3.4

2.3

2.5

2.7

4.4

4.1

4.7

Includes purchase and refinance loans.

Page 34 GAO-09-741 Impact of Mortgage Reform

While some research indicates that anti-predatory lending laws can reduce

originations of problematic loans without overly restricting credit,

research on state and local anti-predatory lending laws and the views of

mortgage industry stakeholders do not provide a consensus view on the

potential effects of the bill. The state and local anti-predatory lending laws

we reviewed are, in some ways, similar to the bill, but the results of the

research on these laws may have limited applicability to the bill for a

number of reasons. Mortgage industry and consumer group

representatives we interviewed disagreed on the bill’s potential effect on

credit availability and consumer protections. For example, mortgage

industry representatives said that the safe harbor and assignee liability

provisions were too stringent and would restrict and raise the cost of

mortgage credit. In contrast, consumer group representatives indicated

that the provisions were not strong enough to prevent predatory lending

and, thereby, protect borrowers.

Relevant Research

and Stakeholder

Perspectives Do Not

Provide a Consensus

View on the Bill’s

Potential Impact

Research Shows That State

and Local Laws Can Affect

Mortgage Lending, but the

Findings Are Difficult to

Apply to the Bill

Several studies have examined the impact of state and local anti-predatory

lending laws on subprime mortgage markets. Our review of eight such

studies found evidence that anti-predatory lending laws can have the

intended effect of reducing loans with problematic features without

substantially affecting credit availability, but also that it is difficult to

generalize these findings to all anti-predatory lending laws or to the

potential effect of the bill.

The studies we reviewed fell into two broad

categories: those that focused solely on the North Carolina law and those

that examined laws in multiple states and localities. In general, the

researchers measured the effect of the laws in terms of the volume of

subprime originations, the probability of originating a subprime loan, or

the probability of originating a loan with predatory characteristics.

The three studies on the North Carolina law (which was implemented in

phases beginning in October 1999 and ending in July 2000) concluded that

the law had a dampening effect on subprime originations in that state, but

one found that the drop occurred primarily in the types of loans targeted

by the law. For example, using data from nine subprime lenders and

controlling for a number of demographic and housing market variables,

We identified a number of studies examining the impact of state and local anti-predatory

lending laws on subprime mortgage lending. We narrowed our scope to eight studies that

used control groups (e.g., comparison states without anti-predatory lending laws) or

statistical techniques that controlled for factors other than the laws that could affect

lending patterns.

Page 35 GAO-09-741 Impact of Mortgage Reform

Elliehausen and Staten estimated that subprime originations fell by 14

percent after the law was first implemented.

A second study by Quercia,

Stegman, and Davis that used an LP data set with broader coverage and

used neighboring states as a control group, found that subprime

originations declined 3 percent after the law was fully implemented and

that subprime originations in four neighboring states without similar laws

rose over the same period.

Importantly, the authors also determined that

90 percent of the decline in subprime originations resulted from a

decrease in refinance loans with one or more “predatory” characteristics,

such as prepayment penalties lasting 3 years or more, balloon payments,

or LTV ratios over 110 percent. Finally, a study by Burnett, Finkel and

Kaul, which used Home Mortgage Disclosure Act (HMDA) data and also

used neighboring states as a control group, found a 0.2 percent increase in

subprime originations in North Carolina after implementation of the law.

Like the Quercia study, the study by Burnett and others concluded that

subprime refinance loans fell sharply in North Carolina over the period

examined and that states neighboring North Carolina experienced higher

percentage increases in total subprime originations.

Additionally, the

study noted that the volume of subprime originations in North Carolina fell

in census tracts that were more than 50 percent minority but rose in other

areas.

The five studies that examined multiple state and local anti-predatory

lending laws found mixed results but provide insights into the importance

of the specific attributes of the laws. For example, using HMDA data, Ho

and Pennington-Cross calculated the percentage change in subprime

originations in 10 states with anti-predatory lending laws over periods that

captured each state’s experience before and after the laws were passed.

Elliehausen and Staten, “Regulation of Subprime Mortgage Products: An Analysis of North

Carolina’s Predatory Lending Law,” Journal of Real Estate Finance and Economics 29:

(2004). The study used data covering the period from January 1997 through March 2000.

Quercia, Stegman, and Davis, “Assessing the Impact of North Carolina’s Predatory

Lending Law,” Housing Policy Debate 15: (2004). The study compared the volume of

subprime originations in the seven quarters prior to the initial implementation of the law to

the seven quarters after the law’s full implementation.

Burnett, Finkel, and Kaul, “Mortgage Lending in North Carolina After the Anti-Predatory

Lending Law,” A Report from Abt Associates to the Mortgage Bankers Association of

America, (Cambridge, MA: 2004). The study used data covering 1997 through 1998 and 2000

through 2002.

Ho and Pennington-Cross, “The Varying Effects of Predatory Lending Laws on High-Cost

Mortgage Applications,” Federal Reserve Bank of St. Louis Review 89: (2007). The study

used data covering 1999 through 2004.

Page 36 GAO-09-741 Impact of Mortgage Reform

They compared the changes they found with the corresponding changes

during the same periods in a control group of neighboring states without

such laws. They found that in 5 of the 10 states (including North Carolina)

with anti-predatory lending laws, subprime originations increased less

than in the control group, but that in the other 5 states, subprime

originations increased more. In another study, Ho and Pennington-Cross

developed a legal index to measure the coverage and restrictions of anti-

predatory lending laws, and examined how laws in 25 states and 3

localities affected the probability of originating a subprime loan.

They

found that, controlling for other factors, anti-predatory lending laws can

increase, decrease, or have no effect on the flow of mortgage credit.

Specifically, they found that:

• laws with broader coverage (i.e., those affecting a larger portion of the

market) increased the estimated likelihood of subprime originations;

• those with greater restrictions (i.e., those with stricter limits on high-risk

loan features) decreased the estimated likelihood of subprime

originations; and

• in some instances, these two effects appeared to cancel each other out.

As a result, they noted that the design of the law can have an important

impact on the availability of credit in the subprime market. For example,

the authors hypothesized that the effect of broader coverage may result

from borrowers being more comfortable applying for a mortgage where

there is a law to protect them from predatory loans.

A study by Bostic and others built on this research by refining the legal

index previously discussed, adding an enforcement dimension to the

index, and examining a larger set of laws.

The study confirmed the earlier

findings regarding the impact of the coverage and restriction provisions of

anti-predatory lending laws on the subprime market. Additionally, this

study found that the strength of a law’s enforcement provisions (e.g., the

Ho and Pennington-Cross, “The impact of local predatory lending laws on the flow of

subprime credit,” Journal of Urban Economics 60: (2006).

Bostic and others, “State and Local Anti-Predatory Lending Laws: The Effect of Legal

Enforcement Mechanisms,” Journal of Economics and Business 60: (2007). The study

examined 44 states with either anti-predatory lending laws or other laws or regulations

regulating prepayment penalties, balloon clauses, or mandatory arbitration clauses in

residential mortgages as of January 1, 2007.

Page 37 GAO-09-741 Impact of Mortgage Reform

extent of potential liability for assignees) was not associated with changes

in the estimated likelihood of subprime originations.

Li and Ernst examined anti-predatory lending laws in 33 states and used

LP data on subprime mortgages made from January 1998 through March

2005 to examine the impact of these laws on the origination of loans with

predatory features and the cost of subprime credit.

They concluded that

state anti-predatory lending laws that provided greater consumer

protections than HOEPA had the intended effect of reducing subprime

mortgages with predatory features. They also concluded that such laws

did not lead to any systematic increase in costs to consumers. Pennington-

Cross and Ho also examined the impact of predatory lending laws on the

cost of subprime credit by reviewing anti-predatory lending laws in 24

states and analyzing HMDA and LP data from 1998 through 2005.

They

concluded that these laws resulted in, at most, a modest increase to

consumers’ cost of borrowing.

Although the bill is, in some ways, similar to the state and local laws

analyzed in these studies, the results of these studies may have limited

applicability to it, for a number of reasons. First, the legal indexes used by

some researchers to assess the impact of state and local laws are based on

an older set of laws that are similar to HOEPA. According to one of these

researchers, the indexes do not take into account a newer generation of

laws that, like the bill, have different thresholds and restrictions and cover

products that were previously not common in the marketplace (e.g., low-

and no-documentation loans). As a result, evaluating the bill, using these

analytical tools, could be problematic. Additionally, the impact of a federal

law could be different than the effects of state and local laws. For

example, lenders or assignees may choose to exit a state or local market

rather than comply with that jurisdiction’s anti-predatory lending law but

still conduct business in other markets. However, under a federal law,

these entities would not have that option. Finally, prior studies examined

the impact of laws during a relatively active period in the subprime lending

market. If a law similar to the bill were to be passed in the near future, it

would be implemented in the wake of a major contraction in the mortgage

Li and Ernst, “Do State Predatory Lending Laws Work? A Panel Analysis of Market

Reforms,” Housing Policy Debate 18: (2007).

Pennington-Cross and Ho, “Predatory Lending Laws and the Cost of Credit,” Real Estate

Economics, 36: (2008).

Page 38 GAO-09-741 Impact of Mortgage Reform

market that would likely affect the response of both the mortgage industry

and consumers to new lending standards.

Views Differed Regarding

the Bill’s Long-Term Effect

on the Mortgage Market

Mortgage industry representatives and consumer groups we interviewed

generally agreed that the bill would have little short-term impact on the

mortgage market because of existing market conditions. However, they

held different views on the long-term impact that key provisions in the bill

would have on consumer access to affordable credit and protection from

predatory lending practices.

Representatives from both groups generally agreed that the bill would

have very little impact on mortgage originations in the current financial

environment because the overall primary market was highly constrained,

with lenders tightening qualifications for all borrowers and the market for

private label MBS virtually nonexistent. In addition, representatives from

mortgage industry groups expected that the Federal Reserve’s revisions to

Regulation Z could lessen the impact of the bill.

Specifically, the groups

stated that the revisions to Regulation Z would place lender requirements

on nonprime loans that were similar to the bill’s safe harbor requirements.

For example, both the Regulation Z revisions and the bill’s safe harbor

require that borrowers obtaining loans with APRs over certain thresholds

provide full documentation of income and assets and qualify for ARMs

based on a monthly payment that takes into account scheduled interest

rate increases.

Recent Market Conditions and

Regulatory Initiatives

Mortgage industry representatives we interviewed generally viewed the

bill’s safe harbor requirements as overly restrictive and said that these

requirements would reduce mortgage options and increase the cost of

credit for certain borrowers. Some of these representatives said that

lenders would be unwilling to make loans that did not meet the safe

harbor requirements. They cited the experience with HOEPA as an

example of what might take place if the safe harbor requirements were put

in place. Specifically, they noted that since the implementation of HOEPA,

Safe Harbor Requirements

The Federal Reserve Board made revisions in 2008 to Regulation Z, which implement the

Truth in Lending Act and HOEPA.

The bill’s safe harbor requires lenders to qualify borrowers at the fully indexed rate,

which is defined as the index rate at the time of origination plus the lender’s margin.

Regulation Z requires lenders to qualify borrowers at the highest possible payment in the

first 7 years of the loan for both higher-priced and high-cost HOEPA loans. In addition, both

the Act and Regulation Z limit, or in certain cases prohibit, prepayment penalties.

Page 39 GAO-09-741 Impact of Mortgage Reform

very few lenders have been willing to make mortgages considered “high

cost” loans under HOEPA’s provisions because they cannot sell them to

the secondary market. For example, in 2006, less than 1 percent of

mortgages were high cost loans, as defined by HOEPA regulations.

The industry representatives also said that specific safe harbor

requirements would reduce access to credit for certain types of borrowers.

For example, they said that the safe harbor requirement that would

prohibit loans with less than full documentation of income and assets

could restrict access to credit for borrowers with irregular income

streams, such as some small business owners. Some industry

representatives acknowledged that many low- and no-documentation

mortgages should not have been made, but said that some flexibility

should be allowed under this requirement to account for borrowers with

nontraditional sources of income.

In addition, industry representatives said that borrowers who had

responsibly used negative amortization loans in the past could face limited

mortgage options under the bill, as the safe harbor requirement would

prohibit these loans. Some industry representatives acknowledged that

negative amortization products had been used inappropriately in recent

years to allow some borrowers to buy homes that they might not have

been able to afford, but added that prohibiting this feature would

adversely impact borrowers who had used this product responsibly. For

example, some borrowers with irregular income have taken out negative

amortization loans in order to pay minimum amounts when their income

was low and higher amounts when their income increased. One mortgage

industry participant suggested that one way to address concerns that these

loans subject borrowers to payment shock would be to limit the amount

by which the mortgage payments could reset.

In contrast, representatives from consumer groups that we interviewed

generally indicated that the safe harbor requirements would need to be

strengthened and applied to a broader range of loans in order to prevent

predatory lending practices to protect borrowers. For example, some

representatives supported adding more consumer protection features to

the bill, such as prohibiting prepayment penalties, balloon payments, and

Page 40 GAO-09-741 Impact of Mortgage Reform

yield spread premiums.

They also said that the bill’s safe harbor

requirements should be applied to all mortgages, including FHA-insured

mortgages and loans with relatively low APRs, because these loans could

also contain predatory features.

Most of the consumer group representatives said that strengthening safe

harbor requirements and applying them more broadly would not

significantly affect the cost or availability of credit. For example, in

response to industry concerns that requiring full documentation would

restrict some borrowers’ access to credit, consumer group representatives

noted that full documentation had already become a marketplace

standard. They generally believed that the majority of borrowers, including

self-employed consumers, could provide sufficient documentation using

their income tax records, but some groups supported limited flexibility in

the types of documents that would be accepted. In addition, while industry

groups were concerned that prohibiting loans with a negative amortization

feature under the bill’s safe harbor provisions could restrict credit to some

borrowers, consumer groups supported prohibiting this feature in order to

protect consumers from potential payment shock. Some of these

representatives acknowledged that negative amortization loans could be

suitable for certain borrowers, but they viewed these cases as exceptional

and did not think the potential benefits to a small segment outweighed the

potential costs to the larger portion of the market.

Mortgage industry representatives we interviewed generally said that the

bill’s assignee liability provisions would increase the cost of credit for

borrowers and deter secondary market participants from reentering the

nonprime market. Specifically, these representatives said that the cost of

complying with the bill’s assignee liability provisions, including secondary

market participants’ cost of due diligence procedures, would increase the

cost of credit and cause some secondary market participants to stop

securitizing loans. Some industry representatives stated that mortgage

originators were better positioned to conduct due diligence to ensure that

loans were responsibly underwritten and argued that mortgage reform

legislation should focus on enhancing the primary market’s underwriting

standards.

ssignee Liability Provisions

A more recent bill with similar purposes, the Mortgage Reform and Anti-Predatory

Lending Act of 2009 (H.R. 1728) bans yield spread premiums for all mortgages. A “yield

spread premium” is a payment a mortgage broker receives from a lender based on the

difference between the actual interest rate on the loan and the rate the lender would have

accepted on the loan given the risks and costs involved.

Page 41 GAO-09-741 Impact of Mortgage Reform

Mortgage industry representatives also said that lack of certainty in what

assignees could be held liable for under the bill would deter participants

from reentering the secondary market. For example, some representatives

noted that the bill did not clearly define the standards that assignees

would be held to, such as “ability to repay” and “net tangible benefit.” They

cited Georgia’s 2002 anti-predatory lending law as an example of how the

lack of clarity concerning assignee liability could adversely impact the

market. As we have reported, because of the uncertainty surrounding

potential liability under the Georgia law, secondary market participants

withdrew from the mortgage market in Georgia until the provisions were

repealed.

In contrast, consumer group representatives generally believed that

enhanced regulation and accountability in the secondary market would

provide consumers with greater protections against predatory lending

practices. These representatives generally supported strengthening the

bill’s assignee liability provisions. For example, some consumer group

representatives said that the bill’s assignee liability provisions should not

allow for any exemptions from liability, such as allowing assignees to cure

a loan (i.e., modify or refinance the loan so that it meets the bill’s

minimum lending standards) to avoid liability. They noted that some

assignees might choose to cure the relatively few loans that violate the

bill’s minimum lending standards, rather than invest the resources in due

diligence policies and procedures that would help prevent predatory

lending practices.

Further, consumer groups said that the bill should not preempt state

assignee liability laws because these laws could potentially provide

consumers with an ability to seek redress if they obtain a predatory loan.

Finally, representatives of consumer groups also said that applying the

assignee liability provisions more broadly, beyond the bill’s nonqualified

mortgages, could also help prevent predatory lending on a wider variety of

mortgages. They contended that stronger and broader assignee liability

provisions would not significantly impact the cost of or access to credit

and would set a standard to which secondary market participants would

eventually adapt.

Mortgage industry representatives preferred that any federal legislation on

mortgage lending preempt all state anti-predatory lending laws, not just

Federal Preemption of State

Anti-Predatory Lending Laws

GAO-04-280.

Page 42 GAO-09-741 Impact of Mortgage Reform

assignee liability laws, in order to reduce the cost of and increase the

availability of credit. They stated that a uniform set of mortgage standards

for lenders would significantly reduce the cost of doing business and that

these savings could be passed on to consumers. According to one

mortgage industry participant, under the current legal and regulatory

environment, lenders’ costs are higher because lenders are required to

develop systems to track laws and regulations in up to 50 states, monitor

these laws and regulations, and ensure they are in compliance with them.

Some industry representatives stated that federal preemption could also

lower consumer costs by applying uniform standards and supporting

competition between state- and federally licensed mortgage originators.

Mortgage industry representatives also said that full federal preemption

would provide a uniform set of standards that would renew activity in the

secondary market, thereby, allowing lenders to make more credit available

to consumers.

In contrast, consumer group representatives generally believed that

federal legislation should not preempt state laws, because consumers

benefited from states’ abilities to enact stronger consumer protection

laws. For example, some consumer groups said that in the past, states had

responded faster to predatory lending abuses than federal regulators in

enacting anti-predatory lending laws, and expected this to continue if a

federal bill did not preempt state laws. Further, some of these

representatives said that state and federal regulations existed in a

complementary framework in other areas, such as civil rights and the

environment, and generally did not think that compliance costs would be

significant in light of the benefits to consumers and the long-term

sustainability of the mortgage market. They viewed states’

experimentation with mortgage reform as an important source of useful

information on changes in market conditions and industry responses to

different approaches.

We provided a draft of this report to the Board of Governors of the Federal

Reserve System, Federal Deposit Insurance Corporation, Office of the

Comptroller of the Currency, Office of Thrift Supervision, National Credit

Union Administration, Department of Housing and Urban Development,

Federal Trade Commission, and Securities and Exchange Commission. We

received written comments from NCUA, which are summarized below.

Appendix III contains a reprint of NCUA’s letter. The Federal Reserve,

FDIC, OCC, HUD, and FTC provided technical comments, which we

incorporated into this report, where appropriate.

Agency Comments

and Our Evaluation

Page 43 GAO-09-741 Impact of Mortgage Reform

In its written comments, NCUA reiterated several of our findings and

noted that the findings supported its view that ensuring borrowers have a

reasonable ability to repay is in the best interest of credit unions and their

members.

We are sending copies of this report to the Ranking Member, House

Financial Services Committee and other interested parties. We will also

send copies to the Federal Reserve, FDIC, OCC, OTS, NCUA, HUD, FTC,

and SEC. The report also will be available at no charge on the GAO Web

site at http://www.gao.gov.

If you or your staff have questions about this report, please contact me at

(202) 512-8678 or [email protected]. Contact points for our Offices of

Congressional Relations and Public Affairs are on the last page of this

report. GAO staff who made major contributions to this report are listed in

appendix IV.

Director, Financial Markets

y Investment

William B. Shear

and Communit

Page 44 GAO-09-741 Impact of Mortgage Reform

Appendix I:

Methodology

Objectives, Scope, and

Page 45 GAO-09-741

Appendix I: Objectives, Scope, and

Methodology

Our objectives were to (1) assess the proportion of recent nonprime loans

that would likely have met and not met the Mortgage Reform and Anti-

Predatory Lending Act of 2007’s (bill) safe harbor requirements, and how

variables associated with those requirements affect loan performance; and

(2) discuss relevant research and the views of mortgage industry

stakeholders concerning the potential impact of key provisions of the bill

on the mortgage market. The scope of our analysis was limited to the

nonprime mortgages.

Nonprime Loans and the

Safe Harbor Requirements

To assess the proportions of nonprime loans originated from 2000 through

2007 that would likely have met and not met the bill’s safe harbor

requirements, we analyzed data on subprime and Alt-A (nonprime)

mortgages from that period. Specifically, we analyzed information from

LoanPerformance’s (LP) Asset-backed Securities database, which contains

loan-level data on nonagency securitized mortgages in subprime and Alt-A

pools.

About three-quarters of subprime mortgages were securitized in

recent years. For purposes of this report, we defined subprime loans as

mortgages in subprime pools and Alt-A loans as mortgages in Alt-A pools.

The LP database covers the vast majority of mortgages in nonagency

subprime and Alt-A securitizations. For example, for the period 2001

through July 2007, the LP database contains information covering (in

dollar terms) an estimated 87 percent of securitized subprime loans and 98

percent of securitized Alt-A loans (see table 6). Nonprime mortgages that

were not securitized (i.e., mortgages that lenders held in portfolio) may

have different characteristics and performance histories than those that

were securitized.

Nonagency mortgage-backed securities (MBS), also known as private-label MBS, are

backed by nonconforming mortgages securitized primarily by investment banks.

We used this approach because the field in the LP database indicating whether a mortgage

was subprime or Alt-A was not well-populated. According to mortgage researchers, some

of the loans in subprime pools may not be subprime loans, and some of the loans in Alt-A

pools may not be Alt-A loans.

Impact of Mortgage Reform

Appendix I: Objectives, Scope, and

Methodology

Table 6: Estimated Percentage of Nonagency Securitized Subprime and Alt-A Loans in the LP Database, 2001-2007

Year

2001 2002 2003 2004 2005 2006 2007

Subprime 83% 77% 87% 87% 88% 91% 85%

Alt-A 97 99 99 97 98 98 96

Source: LP.

Note: Percentages are in terms of dollar volume.

Percentages reflect loans securitized as of the end of July 2007.

For our analysis, we used a random 2 percent sample of the database that

amounted to almost 300,000 loans for the 2000 through 2007 period. Our

sample included purchase and refinance mortgages and loans to owner-

occupants and investors, and excluded second-lien mortgages.

We assessed the reliability of the data by interviewing LP representatives

about the methods they use to collect and ensure the integrity of the

information. We also reviewed supporting documentation about the

database, including LP’s estimates of the database’s market coverage. In

addition, we conducted reasonableness checks on the data to identify any

missing, erroneous, or outlying figures. We found the data elements we

used to be sufficiently reliable.

To estimate the proportion of loans that likely would have met and not

met the safe harbor requirements, we used variables in the LP database

that directly corresponded with the requirements and developed proxies

when the database did not contain such variables (see table 7).

Page 46 GAO-09-741 Impact of Mortgage Reform

Appendix I: Objectives, Scope, and

Methodology

Table 7: Safe Harbor Requirements and LP Variables Used to Duplicate the Requirements or Develop Proxies

Safe harbor requirement LP variable used Comments

Loan must have full documentation of

income and financial resources of

borrower.

DOCUMENT: Specifies whether the loan

has full, low, or no documentation.

Loans with full documentation met the

requirement. Loans with low or no

documentation did not meet the requirement.

Loan must be underwritten to the fully

indexed rate. (This requirement only

applies to adjustable rate mortgages

(ARM)).

INDEX_ID: Specifies the type of interest

rate index to which an ARM is tied (e.g.,

London Interbank Offered Rate (LIBOR))

MARGIN: Specifies the margin for ARMs.

INIT_RATE: Specifies the initial interest

rate as of the loan’s first payment.

The LP data set did not have information on

this safe harbor requirement. As a result, we

developed a proxy by assuming that the

mortgage met the requirement if the fully

indexed rate (the index plus the margin) was 1

percentage point or less over the initial interest

rate, indicating a reasonable likelihood that the

borrower could have qualified at the fully

indexed rate.

Loan must not negatively amortize. NEGAM: Specifies whether the loan had a

negative amortization feature.

Loans with a negative amortization feature did

not meet the requirement. Loans without this

feature met the requirement.

Loans must meet one of the following three requirements

Loan must have a fixed interest rate for

at least 5 years.

PROD_TYPE: Contains an indicator for

fixed-rate mortgages.

FIRST_RATE: Indicates the length of the

initial fixed-rate period (in months) for

ARMs.

For ARMs, if the length of the initial fixed-rate

period was shorter than 60 months, the loan

did not meet the requirement. All other ARMs

and fixed-rate mortgages met the requirement.

Loan meets a debt-service-to-income

(DTI) ratio to be established in

regulation.

UNDER_RAT 1: Represents the borrower’s

total monthly debt service payments

divided by monthly gross income.

For purposes of our analysis, we assumed that

if the DTI ratio was 41 percent or less, the loan

met the requirement. The 41 percent ratio

serves as a guideline in underwriting

mortgages insured by the Federal Housing

Administration (FHA).

Our analysis of this requirement only included

loans for which DTI information was available.

About 37 percent of the loans in the LP data

did not have information on the DTI ratio.

Variable rate loans must have an

Annual Percentage Rate (APR) less

than 3 percentage points over a

generally accepted interest rate index.

INIT_RATE: Initial or original interest rate

as of the loan’s first payment date.

The LP data did not include APRs, so we

developed a proxy that compared the initial

interest rate on the loan to the relevant interest

rate index. For short-term hybrid ARMs (e.g.,

2/28 and 3/27 mortgages), we used the

Treasury 2-year constant maturity rate. For

longer-term ARMs, we used the Treasury 5-

year constant maturity rate.

When the difference between the initial interest

rate and the relevant interest rate index was

less than 3 percentage points, we assumed

that the loan met the requirement.

Source: GAO.

To compare the demographic characteristics (e.g., race, ethnicity, and

income level) of safe harbor and nonsafe harbor loans, we incorporated

Page 47 GAO-09-741 Impact of Mortgage Reform

Appendix I: Objectives, Scope, and

Methodology

data from the Census Bureau. More specifically, whenever possible, we

linked the zip code for each loan reported in the LP data to an associated

census tract in a metropolitan statistical area (MSA).

We grouped the zip

codes according to the percentage of households that Census identified as

black or African-American and Hispanic or Latino. The groupings in our

analysis were: (1) less than 5 percent, (2) 5 to 24 percent, (3) 25 to 74

percent, and (4) 75 percent or greater of household populations. We also

grouped zip codes according to the median income of the MSA of a given

zip code. The specific groupings in our analysis were low-, moderate-, and

upper-income zip codes, defined as those with median incomes that were

less than 80 percent, at least 80 percent but less than 120 percent, and 120

percent and above, respectively, of the median income for the associated

MSA.

To analyze nonsafe harbor loans by borrower credit score, we used the

FICO scores in the LP database. FICO scores, generally based on software

developed Fair, Isaac and Company, are a numerical indicator of a

borrower’s creditworthiness. The scores range from 300 to 850, with

higher scores indicating a better credit history. For our analysis, we used 4

ranges of scores: 599 and below, 600 to 659, 660 to 719, and 720 and above.

To examine factors affecting the performance of nonprime loans, we

developed an econometric model to estimate the relationship between

variables associated with the safe harbor requirements, as well as other

variables, and the probability of a loan defaulting within 24 months of

origination. We developed the model using data on mortgages originated

from 2000 through 2006 (the latest year for which we could examine 24-

month performance). Detailed information about our model and our

estimation results are presented in appendix II.

Research on State and

Local Anti-Predatory

Lending Laws and Views of

Mortgage Industry

Stakeholders

To describe relevant research on the bill’s potential effect on the mortgage

market, we identified and reviewed empirical studies on the impact of

state and local anti-predatory lending laws on key nonprime mortgage

indicators, such as subprime mortgage originations and the cost of credit.

While we identified a number of such studies, we narrowed our scope to

eight studies that used control groups (e.g., comparison states without

We used the Census 2000 data for our analysis. We were able to link race and ethnicity

information for about 98 percent of the loans and income information for about 89 percent

of the loans.

Page 48 GAO-09-741 Impact of Mortgage Reform

Appendix I: Objectives, Scope, and

Methodology

anti-predatory lending laws) or statistical techniques that controlled for

factors other than the laws that could affect lending patterns. The studies

we reviewed fell into two broad categories: three studies that focused

solely on North Carolina’s 1999 anti-predatory lending law and five that

examined laws in multiple states and localities. In general, the researchers

measured the effects of the laws in terms of the volume of subprime

originations, the probability of originating a subprime loan, or the

probability of originating a loan with predatory characteristics. Our review

of these eight studies included an examination of the methodologies used,

the data and time periods used, the limitations of the studies, and the

conclusions. We also interviewed selected authors to ensure that we

interpreted their results correctly and to obtain their views on whether the

results from their studies might apply to the potential impact of the bill on

the mortgage market.

To obtain the views of mortgage industry stakeholders, we reviewed

written statements and congressional testimony about the bill by officials

from the federal banking regulatory agencies and organizations

representing mortgage lenders, mortgage brokers, securitizers, and

consumer interests. We also interviewed officials from a number of these

organizations, including the Mortgage Bankers Association, American

Securitization Forum, American Financial Services Association, American

Bankers Association, Independent Community Bankers of America,

National Association of Mortgage Brokers, Center for Responsible

Lending, National Community Reinvestment Coalition, National Consumer

Law Center, Neighborhood Association of Consumer Advocates, and

Consumer Federation of America. In addition, we interviewed officials

from a large mortgage lender and a major investment bank involved in the

securitization of mortgages. Finally, we interviewed officials from the

federal banking regulatory agencies, the Department of Housing and

Urban Development (HUD), the Federal Trade Commission (FTC), and the

Securities and Exchange Commission (SEC).

We conducted this performance audit from March 2008 to July 2009, in

accordance with generally accepted government auditing standards. Those

standards require that we plan and perform the audit to obtain sufficient,

appropriate evidence to provide a reasonable basis for our findings and

conclusions based on our audit objectives. We believe that the evidence

obtained provides a reasonable basis for our findings and conclusions

based on our audit objectives.

Page 49 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

This appendix describes the econometric model we developed to examine

the relationship between variables associated with the bill’s safe harbor

requirements, as well as other variables, and the probability of a loan

entering default. Safe harbor requirements include features related to

documentation of borrower income and assets, limits on debt-service-to–

income (DTI) ratios, the duration before which any interest rate

adjustments may occur, limits on the relationship between a loan’s annual

percentage rate and other prevailing interest rates at origination, and

prohibitions on mortgages that allow negative amortization. The safe

harbor requirements limit features that may increase the risk of default,

but they may also restrict the number and types of mortgages lenders are

willing to originate. Since the requirements were not in effect during the

recent past, we do not know in what ways lenders and securitizers may

have responded to their introduction. Therefore, we characterize our

evaluation as an assessment of whether mortgages with safe harbor

characteristics performed better than those without them, as opposed to

an assessment of the effects of the introduction of a safe harbor. Our

investigation focused on a recent set of nonprime mortgages and

controlled for a variety of loan, borrower, and housing market conditions

that are likely to affect mortgage performance.

To do this work, we analyzed a 2 percent random sample of securitized

nonprime loans originated from 2000 through 2006 from

LoanPerformance’s (LP) Asset-backed Securities database. Our sample

was comprised of the approximately 92 percent of loans for which the

associated property was located in an area covered by the Federal

Housing Finance Agency’s house price indexes for metropolitan areas. The

LP database has been used extensively by regulators and others to

examine the characteristics and performance of nonprime loans. The

database provides information on loan characteristics, from which we

developed variables that indicated or measured relevant safe harbor

requirements. We determined the status of each loan 24 months after the

month of first payment. We used loan performance history through the

end of December 2008. We defined a loan as being in default if it was

delinquent by at least 90 days, in the foreclosure process (including loans

identified as in real-estate-owned status), paid off after being 90-days

delinquent or in foreclosure, or had already terminated with evidence of a

loss.

We categorized loans as follows: short-term hybrid adjustable rate

mortgages (ARM) (essentially 2/28 and 3/27 mortgages), fixed-rate

mortgages, payment-option ARMs, and other longer-term ARMs (i.e.,

ARMs with 5-, 7-, and 10-year fixed-rate periods). We included only first-

Page 50 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

lien loans for which the borrower is identified as an owner-occupant, and

we estimated default probabilities for purchase money loans separately

from loans for refinancing except for payment-option ARMs, for which we

examined purchase and refinancing loans together. Our primary reason for

examining performance by mortgage type is that borrower incentives and

motivations may vary for loans with different characteristics. For example,

short-term hybrid ARMs provide a strong incentive for a borrower to exit

from a mortgage by the time the interest rate begins to reset.

We estimated separate default models for each mortgage type, although

the general underlying structure of the models was similar. We used a

logistic regression model to explain the probability of loan default, based

on the observed pattern of actual defaults and the values of safe harbor

variables and a subset of other variables known to be associated with loan

performance (see table 8). Many loan and borrower characteristics are

likely to influence the status of a mortgage over time. Some factors

describe conditions at the time of mortgage origination, such as the loan-

to-value (LTV) ratio and the borrower’s credit score. Other important

factors may change over time, sometimes dramatically, without being

observed by a lender, loan servicer, or researcher. For instance, an

individual household’s income may change due to job loss, increasing the

probability of default. Other conditions vary over time in ways that can be

observed, or at least approximated. For example, greater house price

appreciation (HPA) contributes to greater housing equity, thus reducing

the probability that a borrower, if facing financial distress, views

defaulting on a loan as a better option than prepaying. We focused on

whether a loan defaulted within 24 months as our measure of performance

because a large proportion of nonprime borrowers had hybrid ARMs and

prepaid their loans (e.g., by refinancing) within 2 years. Using a 24-month

time frame allowed us to include these loans in our model, as well as loans

originated in 2006, a year in which many nonprime loans were originated.

Table 8: Variables Used in the Model

Variable Variable description

Mortgage default

(dependent variable)

1 if the mortgage was in default by 24 months, 0 otherwise. We defined a loan as in default if it was

delinquent by at least 90 days, in the foreclosure process (including loans identified as in real-estate-

owned status), paid off after being 90-days delinquent or in foreclosure, or had already terminated with

evidence of a loss.

Origination year indicator 1 if the mortgage was originated in 2000, 0 otherwise

1 if the mortgage was originated in 2001, 0 otherwise

1 if the mortgage was originated in 2002, 0 otherwise

Page 51 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

Variable Variable description

1 if the mortgage was originated in 2003, 0 otherwise

1 if the mortgage was originated in 2005, 0 otherwise

1 if the mortgage was originated in 2006, 0 otherwise

Combined LTV ratio Defined as a continuous variable. Represents the amount of the mortgage and any associated second

lien divided by the house value. The LP data do not capture all second liens. As a result, the combined

LTV ratios are likely understated for some loans.

FICO score Defined as a continuous variable for payment-option ARMs.

For other mortgage types, defined as a set of continuous variables split into low, middle, and high ranges.

Specifically, for short-term hybrid ARMs and fixed-rate mortgages, the low FICO range was either 600 or

the FICO score itself if the FICO score was below 600; the middle range varied between 0 and 60, with a

minimum of 0 if the FICO score was below 600, a maximum of 60 if the FICO score was above 660, and

between 0 and 60 if the FICO was between 600 and 660; and the high range was 0 for FICO scores

below 660 and the difference between the FICO score and 660 for FICO scores above 660. Because Alt-

A borrowers generally had higher credit scores, the range boundaries for longer-term ARMs were 660 and

720, rather than 600 and 660.

House price appreciation Defined using the Federal Housing Finance Agency’s metropolitan house price indexes and split into two

time periods: one measuring appreciation during the first four quarters after origination and the second

measuring appreciation during the second four quarters after origination. We assigned each loan to a

metropolitan area using the property zip code information in the LP database and data that relates zip

codes to Core-based Statistical Areas.

Full documentation of

borrower income and

assets

1 if full documentation, 0 otherwise

Negative amortization

feature

1 if allows negative amortization, 0 otherwise

Meets fully indexed proxy 1 if the fully indexed rate is 1 percentage point or less over the initial rate, 0 otherwise. Only used for

ARMs.

DTI ratio Defined as a continuous variable. Represented the borrower’s total monthly debt service payments

divided by monthly gross income.

Spread over relevant

interest rate index

Defined as a continuous variable. Represented the difference between a loan’s initial interest rate and the

relevant Treasury rate at the time of origination. For short-term hybrid ARMs, we used the 2-year

Treasury constant maturity rate, for fixed-rate mortgages we used the 10-year Treasury constant maturity

rate, and for payment-option and longer-term ARMs, we used the 5-year Treasury constant maturity rate.

Interest-only loan 1 if loan type indicated interest-only feature, 0 otherwise

Source: GAO.

Note: In the case of longer-term ARMs and fixed-rate mortgages, we also included indicator variables

for whether the loan was securitized in a subprime or Alt-A pool because these mortgage types

appear in substantial numbers in both types of pools. In contrast, payment-option ARMs were almost

entirely found in Alt-A pools, and short-term hybrid ARMs were substantially found in subprime pools.

In the case of longer-term ARMs, we included indicator variables for loans with 7- and 10-year fixed-

rate periods. In the case of payment-option ARMs, we included an indicator variable for whether the

loan was a purchase or refinance loan.

For reasons described below, some of the variables associated with the

safe harbor requirements are included in all four models, while others are

only included in certain models:

Page 52 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

• Full documentation of borrower income and assets: This variable is in all

four models.

• Negative amortization feature: This variable is only in the model for

longer-term ARMs. We did not include it in the models for the other

mortgage types because the negative amortization feature was essentially

never present (in the case of fixed-rate mortgages and short-term hybrid

ARMs) or was essentially always present (in the case of payment-option

ARMs). The lack of variation within these mortgage types made estimating

the marginal effects of the negative amortization variable problematic.

• Fully indexed proxy: This variable is in three of the models, but we do not

include it in the model for fixed-rate mortgages because it is only relevant

to loans with adjustable interest rates.

• DTI ratio: In the context of the bill’s safe harbor requirements, this

variable would only apply to short-term hybrid ARMs and payment-option

ARMs. However, we include it in all four models because the DTI ratio is

an important measure of the borrower’s ability to repay.

• Spread over relevant interest rate index: In the context of the bill’s safe

harbor requirements, this variable would only apply to short-term hybrid

ARMs.

However, we include it in all four models because loans with

higher interest rates may be at greater risk of default due to their higher

monthly payments.

Tables 9 through 12 provide information on the number of loans and mean

values for each of the mortgage types for which we estimated default

probabilities. Short-term hybrid ARMs were the most prevalent type of

mortgage, and refinance loans were more prevalent than purchase loans.

In addition, more loans were originated in the later portion of the time

period we examined than the earlier portion. Default rates were highest

for short-term hybrid ARMs, lower for loans originated in the middle years

of the time period and higher for purchase loans than for refinance loans.

As discussed earlier, this variable is one of three requirements in the bill’s interest rate and

debt burden requirements. Under the bill, safe harbor mortgages would only have to meet

one of the three requirements. As a result, the “spread” requirement would not apply to

fixed-rate mortgages and longer-term ARMs because they would meet the requirement that

a loan have a fixed interest rate for at least 5 years. The spread requirement would also not

apply to payment-option ARMs because they typically fail to meet the safe harbor

requirement that loans not contain a negative amortization feature.

Page 53 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

Table 9: Mean Values for Short-term Hybrid ARMs with DTI Information

Purchase

loans

Refinance

loans

Number of observations 33,985 45,622

Mortgage in default by 24 months 0.208 0.146

Mortgage originated in 2000 0.027 0.029

Mortgage originated in 2001 0.034 0.049

Mortgage originated in 2002 0.051 0.081

Mortgage originated in 2003 0.100 0.142

Mortgage originated in 2005 0.303 0.256

Mortgage originated in 2006 0.257 0.205

Combined LTV ratio 93.008 80.292

DTI ratio 41.358 40.104

FICO score

Low range 592.302 573.569

Middle range 33.245 15.665

High range 13.821 3.654

HPA: First four quarters after origination 1.095 1.098

HPA: Second four quarters after origination 1.033 1.044

Full documentation 0.545 0.658

Meets fully indexed proxy 0.374 0.446

Spread over 2-year Treasury constant maturity rate 4.174 4.663

Interest-only loan 0.254 0.118

Source: GAO analysis of LP data.

Table 10: Mean Values for Fixed-rate mortgages with DTI Information

Purchase

loans

Refinance

loans

Number of observations 7,566 23,858

Mortgage in default by 24 months 0.104 0.074

Mortgage originated in 2000 0.053 0.042

Mortgage originated in 2001 0.069 0.065

Mortgage originated in 2002 0.077 0.092

Mortgage originated in 2003 0.128 0.194

Mortgage originated in 2005 0.221 0.196

Page 54 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

Purchase

loans

Refinance

loans

Mortgage originated in 2006 0.278 0.202

Mortgage in subprime pool 0.547 0.854

Combined LTV ratio 90.427 75.599

DTI ratio 38.691 38.550

FICO score

Low range 595.235 587.043

Middle range 43.275 30.122

High range 32.693 14.220

HPA: First four quarters after origination 1.085 1.098

HPA: Second four quarters after origination 1.049 1.059

Full documentation 0.567 0.701

Spread over 10-year Treasury constant maturity rate 3.121 3.234

Interest-only loan 0.135 0.045

Source: GAO analysis of LP data.

Table 11: Mean Values for Longer-term ARMs with DTI Information

Purchase

loans

Refinance

loans

Number of observations 5,764 4,211

Mortgage in default by 24 months 0.129 0.082

Mortgage originated in 2000 0.005 0.005

Mortgage originated in 2001 0.005 0.013

Mortgage originated in 2002 0.018 0.035

Mortgage originated in 2003 0.053 0.084

Mortgage originated in 2005 0.317 0.278

Mortgage originated in 2006 0.433 0.427

Mortgage in a subprime pool 0.118 0.256

Initial rate fixed for 7 years 0.090 0.080

Initial rate fixed for 10 years 0.105 0.112

Combined LTV ratio 93.174 78.229

DTI ratio 38.549 37.527

FICO score

Low range 656.300 647.370

Middle range 38.551 28.142

High range 15.246 9.465

HPA: First four quarters after origination 1.074 1.067

Page 55 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

Purchase

loans

Refinance

loans

HPA: Second four quarters after origination 0.980 0.984

Full documentation 0.371 0.437

Meets fully indexed proxy 0.726 0.615

Spread over 5-year Treasury constant maturity rate 2.131 2.183

Negative amortization feature 0.027 0.059

Interest-only loan 0.797 0.669

Source: GAO analysis of LP data.

Table 12: Mean Values for Payment-option ARMs with DTI Information

Number of observations 6,623

Mortgage in default by 24 months 0.100

Mortgage originated in 2003 0.018

Mortgage originated in 2005 0.368

Mortgage originated in 2006 0.474

Purchase loan 0.262

Combined LTV ratio 78.716

DTI ratio 34.771

FICO score 702.505

HPA: First four quarters after origination 1.062

HPA: Second four quarters after origination 0.941

Full documentation 0.160

Meets fully indexed proxy 0.045

Spread over 5-year Treasury constant maturity rate 2.193

Source: GAO analysis of LP data.

The results of our analysis are presented in tables 13 through 16. We ran

seven regressions: separate purchase loan and refinance loan regressions

for three of the product types (short-term hybrid ARMs, fixed-rate

mortgages, and longer-term ARMs) and a single regression combining

purchase and refinance loans for payment-option ARMs.

For this set of

regressions, we only included the 63 percent of loans for which DTI

For our analysis of payment-option ARMs, we combined purchase and refinance loans and

limited our analysis to mortgages originated from 2003 through 2006 because the

proportion of purchase loans was relatively small and very few payment-option ARMs were

made prior to 2003.

Page 56 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

information was available. We also ran a second set of regressions that

used all of the loans for each mortgage type and binary variables

indicating DTI ranges, including categories for missing information. We

found that the results were very similar to those for the first set of

regressions. We presented coefficient estimates, as well as a

transformation of the coefficients into a form that can be interpreted as

the marginal effect of each variable on the estimated probability of default.

This marginal effect is the calculation of the change in the estimated

probability of default that would result if a variable’s standard deviation

were added to that variable’s mean value, while all other variables are held

at their mean values. This permits a comparison of the impact of different

variables within and across mortgage types. In general, combined LTV

ratio, HPA, and FICO score had substantial marginal effects across

different mortgage types and loan purposes. Specifically, higher LTV

ratios, lower HPA, and lower FICO scores were associated with higher

likelihoods of default. The observed effects for DTI ratio were relatively

small. Among safe harbor characteristics, documentation of borrower

income and assets and a loan’s spread over the applicable Treasury rate

had substantial marginal effects. Less than full documentation and higher

spreads were associated with higher default probabilities.

Our results for full documentation of borrower income and assets were

not sensitive to alternative specifications. Including the loan amount as an

additional variable, adding or substituting different interest rates, and

changing the form in which house price appreciation or FICO scores

entered the model all had no effect on our general conclusion that the

presence of full documentation was strongly associated with lowering the

probability of default. Our conclusion concerning high cost loans—that

larger spreads over specified Treasury rates at the time of origination are

associated with increased default probability—is somewhat more

nuanced. In some respects, the spread variable is capturing something

about the effect of higher interest rates generally. For example, alternative

specifications which substituted the initial interest rate or the Treasury

rate for the spread variable yielded similar results. However, when the

Treasury rate and the spread variables are included in the model, both

variables are significant and have large marginal effects.

As an alternative specification for short-term hybrid ARMs, we included a

variable indicating whether each mortgage was a safe harbor or a non-safe

harbor loan, in contrast to including variables for separate safe harbor

requirements. We found that this variable had a small marginal effect,

most likely because many non-safe harbor loans met some of the safe

harbor requirements. In particular, a substantial percentage of non-safe

Page 57 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

harbor loans had full documentation of borrower income and assets but

failed to meet other safe harbor requirements.

Table 13: Estimation Results for Short-term Hybrid ARMs with DTI Information

Purchase loans Refinance loans

Number of observations 39,985 45,622

Coefficient Significance

Marginal

effect Coefficient Significance

Marginal

effect

Intercept 7.74 *** 3.83 ***

Mortgage originated in

2000 0.57 *** 1.32 1.10 *** 2.00

2001 0.27 *** 0.67 0.50 *** 1.11

2002 -0.05 -0.16 -0.01 -0.03

2003 0.18 * 0.75 -0.08 -0.29

2005 0.27 *** 1.75 0.25 *** 1.12

2006 0.75 *** 4.96 0.81 *** 3.71

Combined LTV 0.02 *** 2.27 0.03 *** 4.24

FICO Low range -0.01 *** -1.21 -0.01 *** -1.18

FICO Middle range -0.01 *** -2.37 -0.01 *** -0.83

FICO High range -0.01 *** -2.00 -0.01 *** -0.90

HPA: First four quarters -3.54 *** -4.06 -3.89 *** -3.10

HPA: Second four quarters -4.74 *** -6.05 -3.02 *** -2.92

DTI ratio 0.01 *** 0.94 0.01 *** 1.22

Full documentation -0.39 *** -2.50 -0.44 *** -1.94

Meets fully indexed proxy -0.08 * -0.54 0.01 0.03

Spread over 2-year Treasury

constant maturity rate

0.15 *** 3.09 0.24 *** 4.36

Interest-only loan 0.04 0.24 0.07 0.23

Source: GAO analysis of LP data.

Note: *, **, and *** indicate statistical significance at the 10 percent, 5 percent, and 1 percent levels,

respectively.

This alternative specification was not well suited for other mortgage types. For payment-

option ARMs, almost no loans were safe harbor loans because of the prevalence of the

negative amortization feature. For fixed-rate mortgages, a safe harbor loan was identical to

a loan that met the full documentation requirement because the fully indexed rate

condition did not apply and these loans were fixed for an initial term of at least 5 years.

Similarly, for longer-term ARMs, initial terms were fixed for at least 5 years, and, as a

practical matter, about two-thirds of these loans met our fully indexed rate proxy, thus,

making a single safe harbor test similar to a full documentation test.

Page 58 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

Table 14: Estimation Results for Fixed-rate Mortgages with DTI Information

Purchase loans Refinance loans

Number of observations 7,566 23,858

Coefficient Significance

Marginal

effect Coefficient Significance

Marginal

effect

Intercept 3.84 ** 4.57 ***

Mortgage originated in

2000 0.28 0.38 0.77 *** 0.76

2001 0.35 0.54 0.41 *** 0.48

2002 0.22 0.36 0.20 0.27

2003 0.23 0.47 -0.15 -0.27

2005 -0.02 -0.04 0.03 0.05

2006 0.44 *** 1.27 0.35 *** 0.69

Combined LTV 0.03 *** 0.97 -0.04 -0.07

FICO Low range 0.00 * -0.39 -0.01 *** -0.59

FICO Middle range -0.01 *** -1.42 -0.01 *** -0.65

FICO High range -0.01 *** -1.67 -0.01 *** -0.72

HPA: First four quarters -1.88 * -0.87 -3.82 *** -1.33

HPA: Second four quarters -4.92 *** -2.47 -2.55 *** -1.12

DTI ratio 0.01 ** 0.57 0.01 *** 0.61

Full documentation -0.73 *** -1.85 -0.37 *** -0.71

Spread over 10-year

Treasury constant maturity

rate

0.26 *** 2.40 0.25 *** 1.82

Interest-only loan 0.26 ** 0.56 0.27 ** 0.26

Source: GAO analysis of LP data.

Note: *, **, and *** indicate statistical significance at the 10 percent, 5 percent, and 1 percent levels,

respectively.

Page 59 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

Table 15: Estimation Results for Longer-term ARMs with DTI Information

Purchase loans Refinance loans

Number of observations 5,764 4,211

Coefficient Significance

Marginal

effect Coefficient Significance

Marginal

effect

Intercept 1.74 4.51 **

Mortgage originated in

2000 0.97 0.38 1.92 *** 0.48

2001 2.01 *** 0.84 0.79 0.31

2002 -0.63 -0.46 0.22 0.14

2003 1.54 *** 2.28 0.77 * 0.79

2005 0.46 1.32 0.06 0.08

2006 1.23 *** 4.54 0.98 *** 2.02

Mortgage in subprime pool -0.10 -0.18 -0.03 -0.44

Initial rate fixed for 7 years -0.15 -0.24 -0.02 -0.02

Initial rate fixed for 10 years -0.29 * -0.48 -0.46 * -0.45

Combined LTV 0.05 *** 3.31 0.06 *** 4.12

FICO Low range 0.00 -0.34 -0.01 *** -0.75

FICO Middle range 0.00 -0.38 -0.01 *** -0.70

FICO High range -0.01 *** -1.69 -0.01 -0.32

HPA: First four quarters -2.29 ** -1.21 -3.78 ** -1.08

HPA: Second four quarters -4.94 *** -2.69 -3.10 *** -1.13

DTI ratio 0.02 *** 1.10 0.01 0.30

Full documentation -0.92 *** -2.08 -0.86 *** -1.16

Meets fully indexed proxy 0.05 0.13 -0.11 -0.17

Negative amortization feature 0.77 *** 0.74 0.40 * 0.32

Spread over 5-year Treasury

constant maturity rate

0.42 *** 2.28 0.19 *** 0.84

Interest-only loan -0.21 * -0.46 0.15 0.24

Source: GAO analysis of LP data.

Note: *, **, and *** indicate statistical significance at the 10 percent, 5 percent, and 1 percent levels,

respectively.

Page 60 GAO-09-741 Impact of Mortgage Reform

Appendix II: Description of the Econometric

Analysis of Safe Harbor Requirements

Table 16: Estimation Results for Payment-option ARMs with DTI Information

All loans

Number of observations 6,623

Coefficient Significance Marginal effect

Intercept 0.96

Mortgage originated in

2003 1.25 0.64

2005 0.35 0.64

2006 0.86 * 1.87

Purchase loan -0.11 -0.16

Combined LTV 0.08 *** 6.33

FICO score -0.01 *** -1.20

HPA: First four quarters -2.75 ** -0.89

HPA: Second four quarters -3.58 *** -1.22

DTI ratio 0.00 0.05

Full documentation -0.70 *** -0.81

Meets fully indexed proxy -0.06 -0.05

Spread over 5-year Treasury constant maturity rate 0.48 *** 1.97

Source: GAO analysis of LP data.

Note: *, **, and *** indicate statistical significance at the 10 percent, 5 percent, and 1 percent levels,

respectively.

Page 61 GAO-09-741 Impact of Mortgage Reform

Appendix III: Comments from the National

Credit Union Administration

Appendix III: Comments from the National

Credit Union Administration

Page 62 GAO-09-741 Impact of Mortgage Reform

Appendix IV: GAO Contact and Staff

Acknowledgments

Appendix IV: GAO Contact and Staff

Acknowledgments

William B. Shear, (202) 512-8678, [email protected]

In addition to the individual named above, Steve Westley, Assistant

Director; Bill Bates; Stephen Brown; Emily Chalmers; Rudy Chatlos;

Randy Fasnacht; Tom McCool; John McGrail; Mark Metcalfe; Rachel

Munn; Susan Offutt; Jasminee Persaud; José R. Peña; Scott Purdy; and Jim

Vitarello made key contributions to this report.

Page 63 GAO-09-741 Impact of Mortgage Reform

GAO Contact

Staff

Acknowledgments

(250399)

GAO’s Mission

The Government Accountability Office, the audit, evaluation, and

investigative arm of Congress, exists to support Congress in meeting its

constitutional responsibilities and to help improve the performance and

accountability of the federal government for the American people. GAO

examines the use of public funds; evaluates federal programs and policies;

and provides analyses, recommendations, and other assistance to help

Congress make informed oversight, policy, and funding decisions. GAO’s

commitment to good government is reflected in its core values of

accountability, integrity, and reliability.

The fastest and easiest way to obtain copies of GAO documents at no cost

is through GAO’s Web site (www.gao.gov). Each weekday afternoon, GAO

posts on its Web site newly released reports, testimony, and

correspondence. To have GAO e-mail you a list of newly posted products,

go to www.gao.gov and select “E-mail Updates.”

Obtaining Copies of

GAO Reports and

Testimony

Order by Phone

The price of each GAO publication reflects GAO’s actual cost of

production and distribution and depends on the number of pages in the

publication and whether the publication is printed in color or black and

white. Pricing and ordering information is posted on GAO’s Web site,

http://www.gao.gov/ordering.htm.

Place orders by calling (202) 512-6000, toll free (866) 801-7077, or

TDD (202) 512-2537.

Orders may be paid for using American Express, Discover Card,

MasterCard, Visa, check, or money order. Call for additional information.

Contact:

Web site: www.gao.gov/fraudnet/fraudnet.htm

E-mail: [email protected]

Automated answering system: (800) 424-5454 or (202) 512-7470

Ralph Dawn, Managing Director, [email protected], (202) 512-4400

U.S. Government Accountability Office, 441 G Street NW, Room 7125

Washington, DC 20548

To Report Fraud,

Waste, and Abuse in

Federal Programs

Congressional

Relations

Chuck Young, Managing Director, youngc1@gao.gov, (202) 512-4800

U.S. Government Accountability Office, 441 G Street NW, Room 7149

Washington, DC 20548

Public Affairs

Please Print on Recycled Paper