Single-Family Mortgage Pricing and Primary Market Policy Issues

A mortgage is a loan secured by the underlying real estate collateral being financed by the loan. Specifically, a single-family mortgage is a loan secured by a residential property dwelling having at least one and no more than four separate units. A single-family mortgage borrower is typically the homeowner using the loan to purchase the residence. Over the life of the loan, the borrower typically makes installment payments to repay the loan’s outstanding principal balance and interest costs. The mortgage price consists of two components—the monthly coupon (i.e., interest rate) and the upfront costs. For the conventional 30-year fixed rate mortgage, the monthly coupon component typically begins with a baseline U.S. Treasury interest rate followed by adjustments for additional financial risks and fees. The monthly ongoing (i.e., paid over the life of the loan) coupon begins with a baseline interest rate—a rate equivalent to that of the 10-year Treasury bond, which has a maturity that better aligns with the lifespan of a 30-year mortgage. The borrower’s prepayment risk—the risk that the loan is paid ahead of schedule—and default risk—the risk that loan payments are late or not repaid at all—are subsequently added to the baseline interest rate. Next, loan servicing fees are added to the monthly coupon. The upfront mortgage component consists of various fees—some that are related to the housing purchase transaction and some linked to obtaining the mortgage that were not incorporated into the interest rate. These charges may include loan origination fees (e.g., costs to purchase credit reporting data and verify borrowers’ identities, incomes, and employment), appraisal fees, and settlement service fees (e.g., title insurance, recording fees). The total mortgage price, referred to as the annual percentage rate (APR), is the sum of the monthly coupon and various upfront costs and is usually expressed as a percentage. For any given APR, a borrower can choose whether to pay either higher upfront costs to lower the coupon rate or lower upfront fees and a higher coupon rate. Congressional interest in mortgage pricing stems from concerns about consumers obtaining high-cost residential mortgages. Some borrowers with impaired or nonexistent credit histories pose greater default risks to lenders and, consequently, pay higher borrowing costs relative to creditworthy borrowers. Borrowers, particularly first-time homebuyers, may lack sufficient understanding of key mortgage pricing disclosures. They may have little or no familiarity with the various charges and fees associated with obtaining a mortgage. They may be unaware of the option to pay either a higher monthly coupon payment or higher costs upfront to reduce their monthly payment. Consequently, these borrowers may be less effective at shopping for improved mortgage pricing. Another possibility is that borrowers may obtain high-cost mortgages due to predatory or discriminatory pricing practices. Furthermore, APRs exhibit much variability even for borrowers with similar financial risk characteristics due to variation in borrowers’ down payment sizes, regional variation in appraisal and settlement costs, and variation in seller-paid settlement costs. In other words, even with mortgage APR pricing disclosures, convergence to a representative market APR that can be used as a benchmark for comparison is challenging. Regulations focusing on particular aspects of APR pricing, therefore, are aimed to account for or minimize unexplained price variation. Congress has passed consumer protection legislation to reduce the proliferation of high-cost loan offerings in the primary mortgage market. For example, the Truth in Lending Act (P.L. 90-301), which applies to all forms of consumer credit, requires covered lenders to disclose APR offerings to prospective borrowers. The Real Estate Settlement Procedures Act (P.L. 93-533) requires disclosure of various settlement fees to borrowers. The Home Mortgage Disclosure Act (P.L. 94-200) requires the reporting of mortgage pricing information to regulators. These disclosure requirements may promote greater transparency and competitive pricing in the primary mortgage market. The Home Ownership Equity Protection Act (P.L. 103-325) and certain provisions from the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) impose higher costs and legal risks on lenders if they make higher-priced or less affordable loans that could exacerbate housing cost burdens for borrowers. Although these legislative actions may discourage excessive charges, they may also limit mortgage credit access to low- and moderate-income borrowers if lenders are reluctant to incur higher regulatory costs.