In the midst of a hailstorm of negative news about its accounting woes, Fannie Mae has quietly begun two significant consumer reforms.
In new guidance to lenders nationwide, Fannie Mae, the country's largest source of home mortgage money, delivered what could be a knockout punch to the mandatory arbitration clauses that sometimes are tucked into home mortgage documents.
Mandatory arbitration means that a home buyer or refinancer who gets into a dispute with a lender anytime after the loan closes must submit to binding arbitration. Consumer advocates charge that many borrowers are unaware of the clauses when they shop for or settle on their mortgages, and they end up trapped later when they discover they have no right to take their lender to court.
"Lenders try to tie the hands" of customers to minimize the likelihood of individual or class action lawsuits, said David Berenbaum, senior vice president for civil rights, policy and research at the National Community Reinvestment Coalition. While the arbitration process may be faster and less costly in some cases, consumer groups complain that too often arbitration proves to be just as expensive and protracted as the judicial route, but that it eliminates a consumer's rights to argue before a jury and obtain reasonable compensation.
In Fannie Mae's new instructions to lenders, delivered at the end of September, the company bans mandatory arbitration language in all mortgages it purchases or guarantees in mortgage-backed securities. The ban covers all loans closed on or after Oct. 31, and it is similar to a policy put into effect Aug. 1 by Freddie Mac, the other big government-chartered mortgage company. Both companies purchase billions of dollars worth of loans monthly and provide liquidity to the national mortgage marketplace.
Both companies' moves are targeted primarily at "subprime" loans extended to borrowers whose credit histories and scores render them ineligible for standard loan terms. Those borrowers in turn are the main victims of predatory lending schemes, where mortgage documents include combinations of toxic terms, such as single-premium credit life insurance on top of bogus fees and charges, balloon payments and heavy penalties for early payoffs. Mandatory arbitration clauses make it difficult or impossible for predatory lending victims to challenge such abusive combinations in court.
Though Fannie and Freddie primarily invest in standard loans made to home buyers with adequate credit, both companies in recent years have plunged into the subprime field. Subprime mortgages are especially attractive to lenders and investors because they carry high rates, offering the prospect of higher profit margins. Subprime lending is this year's boom segment of the home mortgage market.
In Fannie's new guidance, the company said that while it recognizes "that arbitration potentially represents a more efficient, streamlined, and less costly process . . . we also recognize, however, that borrowers who would prefer to present their grievances in court may unknowingly agree to mandatory arbitration at the time they sign their mortgage documents."
Though Fannie "does not believe arbitration provisions are inherently abusive," said the company, "we believe it can be used in an abusive fashion."
Allen Fishbein, the Consumer Federation of America's housing and credit policy director, said the joint bans by Fannie and Freddie "really send an important message to lenders. You can no longer take away people's rights without their knowing it" -- at least not if the lender expects to sell such loans to the two biggest investors.
"We see this as a critical piece in the battle against predatory lending," Fishbein said.
Fannie Mae also announced a second pro-consumer move in its latest guidance: a strong recommendation to lenders whose loans include prepayment penalties to waive some or all of those fees when a borrower prepays a Fannie Mae-owned loan because the house is being sold.
Prepayment penalties often require borrowers to fork over substantial sums of money -- sometimes six months of interest or more -- to the lender when they refinance or otherwise pay off the mortgage before a specified date. Sometimes the penalty is enforced only during the first couple of years, but occasionally it extends to three years or more.
Many lenders impose the penalties to discourage serial refinancings or short-term rate-hopping. When homeowners sell their house prior to the penalty date, it's usually because of an employment relocation or other important life change, not because they are looking for a better rate deal on their mortgage.
While Fannie does not ban loans with prepayment penalty clauses, it urged its lender partners to "follow our encouragement and offer a waiver of the prepayment [penalty] to borrowers at the time the house is sold."
Kenneth R. Harney's e-mail address is KenHarney@earthlink.net.