September 4, 2007 - When it comes to risky mortgages, the writing has been on the wall for some time now. ACCESS has been warning about the economic consequences of these loans since the middle of 2006. No degree in rocket science was needed to figure out that many borrowers who took out these mortgages would wind up losing their homes. Both federal and state regulators failed to act.  But now that the bottom is falling out of mortgage markets, legislators are trying to enact new legislation to protect homeowners. Unfortunately, they may actually make matters much worse for many of the people that they are trying to help.

When legislators write new laws to regulate the economy it can be a tricky business. Regulate too little and you accomplish nothing. Regulate too much and you may bring certain markets to a halt. The key to getting it right is to have an understanding of what new regulations will do to the economy. This is almost impossible when new regulations are enacted in a knee-jerk reaction to current market conditions. This is exactly the situation that the mortgage industry and investors are facing right now.

The first state to react to problems in the mortgage industry was Minnesota. The state enacted a knee-jerk law that went into effect last month which makes it illegal for lenders to offer loans with negative amortization or prepayment penalties. While these regulations would have been good a few years ago, their effect in the current market is to eliminate a number of options that borrowers may have used to save their homes from foreclosure.

It is quite likely that the law will result in an increased number of foreclosures in Minnesota. It is equally likely that the new law will reduce home prices within the state; reducing the amount of equity that those not facing foreclosure have in their homes. On the other hand, if the law had been setup to slowly change state regulation of lenders, it could very well have had a positive effect.

Minnesota is not alone in its quest to deal with foreclosure problems related to risky mortgages. Nor is it alone in coming up with some very bad legislative ideas filled with good intent.

One of the effects of the current home mortgage crises is that it has brought out the snake oil salesmen who promise to save your home from foreclosure. These mortgage rescue schemes target those facing foreclosure and get them to sign over their homes, along with any equity they have. There is no doubt that their activities are illegal and that they should be prosecuted and thrown in jail.

The states already have laws that classify this kind of activity as fraud. No additional laws are needed. Instead, the states need to enforce the laws already on their books. But some state legislators don't see it that way and they are determined to pass new ill-conceived laws. Both Maryland, Illinois seem to be leading this charge.

The Maryland state assembly passed bill 761 which requires investors to pay a homeowner in foreclosure 82% of the net proceeds from the resale of their property. Here is an example of how this law will work if Maryland's governor signs it into law.

Let's say you own a home that is in foreclosure and an investor is willing to purchase it from you for $100,000. When the purchase is made your bank loan is paid off and you avoid having a foreclosure placed on your credit record. Now let's say that the investor holds onto the house for a few months and then manages to sell it for $200,000. Under Maryland's proposed law, the investor would have to pay the original owners of the house an additional $82,000.

While this may sound great on paper, the reality of the situation is that most investors will take their money elsewhere. The average cost of purchasing a foreclosure, holding it for a period of time and then selling it are 15%. That would leave 3% profit for the investor. Bank interest rates are higher than tat and there are plenty of states that don't interfere in free enterprise this way. Given this, why would anyone want to purchase a home in foreclosure in Maryland?

Illinois' proposed law is just as bad. I would require investors to pay 82% of the appraised value of a home, as determined by an independent appraiser, when a home is purchased from someone who is already in foreclosure proceedings. The law also has some other properties that simply prove that the legislators debating it never took Economics 101.

For instance, the law would force all liens on a property to be paid off when purchased. This would mean that mortgages could not be assumed by the investor, and that a purchase subject to liens would be impossible. Another provision within the law would prevent an investor from discounting a property purchased in foreclosure in order to attract buyers in a down market.

The road to perdition may be paved with good intent, but the road to foreclosure shouldn't be. Passing laws like the ones mentioned here may make for great sound bites on the evening news, but they will almost certainly have the opposite effect that their authors claim they will have.

As terrible as foreclosure is, chasing investors out of certain markets will only make matters worse. These types of regulations will leave many homeowners without an alternative to seeing their properties auctioned off on the courthouse steps. And when that happens, the person losing his or her home is almost always worse off. They lose their home, any equity in it, and ruin their credit all at the same time.

by Jim Malmberg

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