The federal government’s consumer watchdog will introduce new mortgage rules today. They are designed to protect homebuyers from big bad banks. But they are also about protecting consumers from themselves, which is a slippery slope.
Post-financial crisis, it’s deemed too much to expect individuals to read and understand a mortgage document. Dozens of studies suggest we are a financially illiterate society; attempts to teach people about all manner of credit and personal financial matters have largely failed. For our own good, then, the government must mandate “plain vanilla” products that a child could understand.
So the Consumer Financial Protection Bureau is set to unveil standards for something called a “qualified mortgage.” If lenders meet certain criteria for simplicity and transparency, borrowers will have limited ability to sue for damages should things not work out. Basically, banks are being required to dumb down the process and make sure their clients can afford the loan.
Presumably, the new standards will take aim at things like verified income and a borrower’s debt ratio. The housing bubble was in part a product of banks’ willingness to lend without proof of income or with little concern for overall indebtedness. One likely result: To be a qualified mortgage, a borrower’s total monthly debt service could not exceed 43% of pre-tax income, reports the Wall Street Journal. And in most cases mortgage originators will be restricted from charging excessive upfront points and fees and offering loans that require balloon payments, reports the New York Times.
The upshot is that the mortgage business is being funneled down a more conservative path, which is great for folks who can’t or don’t want to do their homework. That’s a lot of people, by the way. The CFPB, acting as directed by the Dodd-Frank financial-regulator overhaul of 2010, is doing these folks a genuine service.
Yet this service has costs. It may smother innovative mortgages, like those that for a period charge interest-only or allow the principal balance to increase. Yes, such products were abused in the bubble years. But non-traditional mortgages still make sense for a homebuyer who, say, has relatively little income but will collect a windfall in a few years. One size does not fit all. Exotic mortgages have their place, small though it may be.
Meanwhile, the new rules may tighten credit for those who need it most and require a bigger down payment, locking some out of the housing market and undermining the recovery. All this is debatable. But clearly the new rules signal an approach to consumer protection that is about oversight—not education.
Maybe that’s just what we need. Maybe, as some scholars have argued, the vast majority of the population will never get it financially speaking. Better to spend our resources on watchdogs that will bite the big bad banks when they get too creative. I can’t dismiss the value of protecting those who cannot protect themselves.
Still, an educated borrower would not need so much protection. She could self regulate any financial institution that failed to point out her interest rate will double after an initial teaser period. We wouldn’t need so much oversight, which reinforces our worst instincts to want to be taken care of. That’s the slippery slope of dependency.
Our pension system is broken, the government is deeply in debt, and the growth we need for a solid fix is unlikely anytime soon. Folks need to know how to make smart money decisions in all parts of their life—from student loans through retirement saving.
(MORE: Arms Race)
We need to start with financial education in every classroom and extend it to the workplace. We need to train teachers to teach kids about money and make financial education programs part of every 401(k) plan. In the meantime, yes, we need plenty of oversight. But that’s not the best long-term solution.