MPR on Predatory Lending Law Headaches

by Alex Stenback on November 26, 2007

From MPR:

Minnesota’s predatory lending law went into effect on Aug. 1 with a goal of reducing the number of foreclosures in the state. But some e say the new law is making it more difficult for them to get a loan, even though they haven’t done anything wrong.

In a piece that sets out to describe some of the unintended consequences of Minnesota’s freshly minted anti-predatory lending laws, the MPR perpetuates a bit of mythology that we want to debunk here and now.

Minnesota’s predatory lending law eliminated a large number of high-risk loans. The law was designed to stop mortgage brokers from making loans that require little or no documentation of a home buyer’s income and assets.

The law did not eliminate these high risk loans – it simply restricted lwhich lenders had access to them. Under the new law, stated income loans remained alive and well – just not through a broker. You had to get it through a bank. Or at least that was the plan.

But a funny thing happened on the way to legislative bliss.  [read the rest after the jump]

Before the ink was dry on the new law, the secondary market for these types of loans imploded – nobody was buying them anymore. Now, to the extent that banks offer them at all, they are very restricted, and must be of sufficient quality that they can be kept on balance sheet.

So it wasn’t the law that eliminated a large number of high-risk mortgages, it was the market itself.

But back to the story.  The article pivots around the plight of one couple seeking to move up to a higher priced home, who are having trouble with financing:

Holmgren and Schaffer have dreams of building a home with an extra bedroom, plus an office for Schaffer’s growing accounting and tax practice. But there’s just one problem. They can’t get a loan because Schaffer is self-employed.

"I don’t get a paycheck that is same amount every two weeks," Schaffer said. "So it’s hard for them to verify the amount of money that I make every year."

This idea – that self employed income is so endlesslesly complicated lenders simply can’t understand it and just throw up their hands – is another bit of myth making.  Lets be perfectly clear here.  It is not "hard" to verify the amount of money a self-employed borrower makes, nor do lenders much care whether or not your pay is the same every two weeks.  Self employed income is readily verified through tax returns, usually averaged over a year or two – It is mind numbingly simple. 

Lenders have been lending to the self-employed in this way since dirt, and it does not require any sort of special creativity – the income is either there, or it isn’t, and all that is required is some reasonable track record. 

But also since dirt, the self-employed have used that status to bury income, (usually by washing as much of their personal expenses as possible through the business,) to avoid paying taxes.  Some call this creative accounting, others call it tax cheating – we’ll leave that judgement to the reader.

Anyway, therein lies the vacuum – self employed borrowers who under-report income, but also want to buy a home – that was filled by "stated income" loans, which in addition to enabling the self-employed to enjoy a little have-your-cake-and-eat-it-too party, invited so much fraud and other bad lending and borrowing behaviors that the entire mortgage market is now going through the most severe credit crunch in modern history.

This is the new reality: Underwriting standards are simply getting tougher, for all borrowers, not just the self-employed.

Which is of little comfort to Mr Schaffer:

Schaffer said they’re frustrated by their lack of options.

"Everybody says ‘we love small business’ and ‘small business is what drives America,’" Schaffer said. "They can’t say that in one breath, and in the other breath cut off your access to credit."

Actually "they" can, because it is "their" money they should. At least until someone can advance an argument that someone deserves special consideration simply by virtue of being self employed, and "what drives America." and all that.

The real issue here, we suspect, is that Mr. Self Employed’s accounting and tax practice does not show sufficient income to cover his desired mortgage.  Who knows why (maybe his practice is too new, maybe he has had a tough year,) but whatever the reason, one does not need a degree in credit analysis to understand why they don’t have lenders knocking down their door, and its certainly not because of some fancy new law that nobody seems to understand. 

This is not meant to beat up on Mr. Schaffer – I am sure he is a solid guy who runs a good business and is simply finding out what many others are going to in the coming months – getting a mortgage will be more difficult, and maybe impossible if you can’t show income.

Point being, if we are going to engage in meaningful reportage and conversation about the mortgage and real estate market, lets try to get the causes straight.
Predatory Lending Law Causes Headaches for Some Homebuyers [MPR]

{ 1 comment… read it below or add one }

ranty December 20, 2007 at 10:55 pm

*applause!*

Yours is by far the most succinct commentary I’ve read yet on this subject.

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