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regrettable.

The project firmly supports a critical

consideration of regulatory and/or incentive approaches to the reinvolvement of depositories. However, such approaches must be carefully designed to avoid the pitfalls of previous programs.

Depositories should meet the FHA/VA needs of the communities in which they are chartered. Incentives should be developed to encourage local depositories to provide a mix of conventional and federally insured loans for older urban neighborhoods. At the same time, policymakers must be careful not to allow certain depositories to become FHA/VA specialists. Past experience shows that depositories originating a large volume of FHA/VA mortgages have abused and exploited the program just like the most irresponsible mortgage companies.

To avoid abuse, incentives might have some kind of limit for instance, a special incentive might cover only the first two or three percent of FHA/VA mortgages originated annually. Further, incentives should not encourage institutions to substitute a government-insured loan when a borrower qualifies for a conventional loan.

In the context of promoting depository reinvestment in local communities, congressional hearings should critically examine: coinsurance proposals, the FHA/VA conventional turndown concept,87/ suggested increased in origination fees for depository FHA/VA lenders, obligations relating to the credit needs of low and moderate income communities in the Community Reinvestment Act of 1977, and ways of lessening FHA redtape.

FHA/VA COMMUNICATION

The Project recommends that FHA and VA enter into

immediate discussions about the necessity of increasing communications and the desirability of having common

regulatory standards and procedures.

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In many cities, mortgage bankers work interchangeably with FHA and VA mortgages. When FHA standards are toughened, the mortgagees quickly substitute VA insured loans, as is now happening in Chicago, Los Angeles and Cleveland. A systematic series of reforms in FHA might thus lead to a major shift to VA, and a dramatic increase in abuses in that program. It is therefore vital that VA introduce reforms which parallel those recommended at FHA, and that the two agencies actively collaborate as they find abuses and fashion appropriate sanctions.

• FOOTNOTES

1

H.R. Rep. No. 15, Defaults on FHA-Insured Home Mortgages-Detroit, Michigan, 92nd Cong., 2d sess., June 20, 1972, p. 5.

2

Comptroller General of the U.S., "Report to the Subcommittee on Antitrust and Monopoly Committee on the Judiciary, U.S. Senate: Processes for Approving and Monitoring Nonsupervised Mortgagees, B-114860, Department of Housing and Urban Development, Nov. 8, 1973, p. 49.

3

H. R. Rep. No. 23, Alarming Deterioration of Reserves of FHA Mortgage Insurance Funds, 93d Cong., 2d sess., Dec. 18, 1974, p. 25.

4 H.R. Rep. No. 20, Reducing Losses through Improved Mortgage Servicing, 94th Cong., 2d sess., March 29, 1976, p. 7.

5

Special HUD Investigative Task Force. Criticisms and Recommendations for Punitive Actions on Mortgage Lenders. Released by Metropolitan Area Housing Alliance, Chicago, Illinois, July 1975.

6

Dr. Oliver H. Jones, "Members Urged to Participate Fully in MBA Affairs", The Mortgage Banker, January 1977, p. 26.

7

Saul B. Klaman, The Postwar Rise of Mortgage Companies, National Bureau of Economic Research, Occasional Paper no. 60 (New York: National Bureau of Economic Research, Inc., 1959) P. VII.

10 Mortgage Bankers Association of America (MBA),

Mortgage Banking 1975: Loans Closed and Servicing Volume, Economic and Research Committee Trends Report no. 19 (Washington, D.C.: MBA, 1976) p. 9.

11

Phillip Edwin Kidd, Mortgage Banking 1963 to 1972: A Financial Intermediary in Transition (Ph.D. dissertation, American University, 1976) p. 166.

12 Interview with William Cumberland, Mortgage Bankers Association of America, Washington, D. C., March 17,

13

MBA, Mortgage Banking 1975: Loans Closed and Servicing Volume, p. 10.

14

1977.

Dr. Oliver H. Jones, "Across My Desk", The Mortgage Banker, May 1977, p. 8.

15

The key aspect of the rationale for discount points is that the ceiling interest rate set by FHA and VA is usually below the competitive market rate for conventional mortgages. Therefore, some procedure is

necessary to increase the real rate of return on the mortgage for the secondary market investor. The mortgage banker, whose goal is to sell the mortgage note, does this by selling it at a cost less than its real value. For every one hundred dollars of face value on a mortgage note, the mortgage company charges the secondary market purchaser only ninetysix dollars. Therefore, the investor purchases the FHA or VA mortgage at a discount, paying only 96 percent of its face value even though s/he receives interest and payment on the full face value. Thus, the rate of return to the lender is actually higher than the FHA or VA ceiling rate.

This procedure is called the discount system and a simple mathematical example can illustrate how it functions. Assume a seller wants $20,000 for his/her home. If the homebuyer uses an FHA loan with a 5 percent downpayment, the seller receives $1000.00 in cash, The face value of the mortgage would be $19,000. But to make up for having to sell it at a discounted price, the mortgage company charges the seller some extra points (federal law prohibits charging the buyer more than a one percent origination fee on FHA/VA). Assume the mortgage company charges a sales commission to the seller equal to seven points (7 percent). Seven percent of $19,000 is $1,330 which the seller would have to pay the mortgage company. Thus the seller ends up with $18,670 for his home ($1,000 downpayment + $17,670 from the mortgage company i.e. 19,000

1,330 = $17,670).

99-247 - 78 - 22

The price the mortgage company can obtain for selling the note will determine whether the firm profits or loses from the sale. For instance, the mortgage company paid $17,670 for a $19,000 mortgage note. If the firm finds a secondary market investor willing to purchase the note at a 96 percent discount, the firm has earned $570.00 on the transaction (i.e., 96 percent of 19,000 $18,240; mortgage company paid $17,670; 18,240 $570.00). Conversely, the firm could lose on the sale if secondary market purchasers were only willing to pay 91 percent of the face value.

16

p. 89.

=

17,670 =

Phillip Edwin Kidd, "Mortgage Banking 1963 to 1972,"

17 St. Ambrose Housing Aid Center, "Foreclosures in Baltimore City in 1974," Part I, Baltimore, Md., 1975 (mimeographed) p. 18.

18 William DeHuszar, CMB, "Anatomy of Management Failure," The Mortgage Banker, February 1977, p. 52.

19 Dr. Oliver H. Jones, "Members Urged to Participate Fully in MBA Affairs," p. 26.

20

Jerome L. Howard, "MBA to Implement Internal Control Standards," The Mortgage Banker, May 1976, p. 6.

21

John J. McConnell, "Profit/Loss Evaluation Model Has Varied Applications," The Mortgage Banker, May 1975, p. 14.

22

Oakley Hunter, "On Importance of Servicing," Seller/Servicer, January, 1966, p. 1.

23 "Mortgage Company Ripoff?"

March 1977, p. 8.

24

Jeff-Vander-Lou News,

Mortgage Bankers Association of America (MBA), Mortgage Banking 1975: Financial Statements and Operating Ratios, Economic and Research Committee Trends Report

no. 18 (Washington, D.C.: MBA, 1976) p. 4.