With all the talk about the sub-prime mortgage mess, the Fed is considering new regulations on the loan industry.  Among other things, pre-payment penalties and no-doc loans are on the Fed’s chopping block. I always go back and forth with these sorts of efforts. The Ron Paul in me says, “Stay out of the free market and my personal business. Let people make and reap the consequences of their own decisions,” but the Hillary Clinton in me says, “Somebody please help those poor saps who are being preyed on by unscrupulous lenders.”

Well, I think the reality of the matter falls somewhere in between my inner Ron and Hillary. We obviously need to do something to fix this lending mess; however it likely does not need to be as complicated as we think. Well here is my single proposal for making this mess better - Make people read their closing documents. So, I know what your thinking, “Trevor this is an overly simpleton, Jed Clampett solution for a very serious problem. Please don’t patronize us.” However, before you write this idea off, take a moment to think about it:

Although many people who took sub-prime loans would go into foreclosure no matter what was disclosed to them (because some people are just irresponsible and there is nothing you can do about it), I believe many people are in financial trouble today because they did not truly understand the implications of their loan. For instance, how many sub-prime borrowers do you think could answer these questions: What is a pre-payment penalty? What is an ARM? What is the difference between a 2/1 ARM and a 5/1 ARM? What is a Balloon Payment? My guess is that if you did a survey of people in foreclosure, less than 10% could answer all of these questions correctly. The sad thing is that many of them would actually have some or all of these terms in their own loan.  So what would things look like if people did actually understand the terms of their loan prior to closing? Let’s look at the problem and a possible solution:

• I practice real estate in Washington State. Here, most borrowers do not see their closing papers until they are signing them at the escrow company.
• Most closers allott anywhere between 45 minutes and 1 1/2 hours to sign buyers. They typically rush buyer’s through the process using very generalized terms to describe what the paperwork means.
• If it became law that all buyer’s take a 72 hour review period to look over their loan docs, the now 1% of people who read their loan documents might jump to 40, 50, or 60%.
• Now, what if you added a law which stated that every lender is required to review the loan documents with their borrower, and sign off that they did so? Perhaps the actual number of people who understand their loan would jump to 70%
• Now what if you added as part of this review period a spreadsheet of possible scenarios. For instance, If you choose to sell your house prior to your prepayment penalty, here is how much you would have to sell it for in order to break even. Another example would be: After your fixed rate term ends here is what your monthly payment might look like at different interest rates.  How do you think this might affect things?

OK, so maybe I am exaggerating a bit when I say that this could fix all the problems with the sub-prime debacle; however I believe if you truly make people understand their loan prior to the pressure of sitting at the closing table with a pen in their hand, many would realize that they could not afford their home.  Those who choose to move forward would be doing so at their own risk (well really the bank’s own risk) and/or their own stupidity.

America is about choice and a free market economy. Many hard working, upstanding people could not have bought a home without a sub-prime mortgage. However, America is also about honesty, and people need to know what they’re signing before they have all their belongings in a moving van ready to move into their brand new foreclosure….uh…. I mean home.