The legislative solution proposed here is simple, yet far-reaching. It comes in two parts, the first is to limit the amount that lenders can lend to borrowers with a rather unique enforcement mechanism, and the second is to increase the penalties for borrowers who commit mortgage fraud. The following is not in legal law, but it does contain the conceptual framework for potential legislation that could be enacted at the state and / or federal level. A detailed discussion of the text follows:
Loans for the purchase or refinancing of real estate secured by a mortgage and registered in the public record are limited by the following parameters based on the borrower's documented income and general debt and the assessed value of the property at the time of sale or refinancing:
1. All payments must be calculated on the basis of a 30-year fixed-rate, traditionally amortizing mortgage, regardless of the loan program used. Negative depreciation is not allowed.
2. The total debt-to-income ratio for the payment of mortgages, taxes and insurance may not exceed 28% of a borrower's gross income.
The total debt for income of all debt obligations may not exceed 36% of a borrower's gross income.
The total debt for senior debt may not exceed 90% of the assessed value of the property or the purchase price, whichever is less, except in specially sanctioned public programs.
Amounts borrowed in excess of these parameters shall not be repaid by the borrower and no contractual provision is permitted which may be construed as limiting the borrower's right to exercise this right, revoke the loan or otherwise shorten the priority agreement.
This last statement is the most critical. This is how the enforcement problem can be overcome. Regulators are pressured not to enforce laws when times are good, and they are declared unresponsive when times are bad. If the oversight function becomes a potential civil affair, which the borrowers themselves control, lenders know exactly what their risks and potential damages are. Any lender who is foolish enough to provide a loan outside the parameters does not have to fear the anger of the regulators, they will have to fear the civil lawsuits brought by borrowers who are eager to get out of their contractual obligations. If any borrower could get debt forgiveness by simply proving that their lender exceeded these guidelines based on the loan documents, no lenders would do this and regulatory oversight would be virtually unnecessary.
One key to making this work is to prohibit lenders from introducing a "poison pill" into the loan documents that would make borrowers reluctant to sue, otherwise lenders would enforce their loans in the event of a legal challenge that forces the borrower to to refinance or sell the property. Basically, if the borrower brought suits and won, they would see a major reduction corresponding to the deviation from the standards. If they brought suits and lost, they would have no punishment. Most of these cases will be settled by a summary judgment based on a review of the loan documents and thus minimize the legal costs.
The result of these restrictions will be that all homeowners will have at least 10% equity in their properties unless they have borrowed from a government program such as the FHA, where the total loan to value may exceed the limits. This stock pillow would buffer lenders from predatory loans and a huge increase in foreclosures should prices fall. Housing capital in the United States has been declining since the mid-1980s, and in fact it was falling while prices rose during the big housing bubble due to the violent capital outflow. The lack of an equity cushion exacerbated the foreclosure problem, as many homeowners who owed more on their mortgage than the my next project were worth simply stopped making payments and let the house fall into foreclosure.
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