Now that the subprime woes are generating fat headlines across the land, a debate is roiling around what to do about it. One idea that has received a fair deal of attention is the loan suitability requirement. Which means that lenders can only put borrowers in loans that are suitable for them. That they are able to repay. Some consumer advocates also propose that the borrower should have the right to sue if there is any breach of this fiduciary duty. Hmmm.
Frankly, I do have deep reservations about a loan originator being called to make subjective judgments about which mortgage program best suits an applicant. That would translate into him taking the responsibility of making a financial decision for someone else. Just doesn't sound right. Would that potentially open the door to allegations of discrimination? Yes, indeed.
Let's go into it a little deeper. A professional loan officer normally strives to become a trusted adviser for the prospect. So, by looking at the credit report and the application he can form a decent picture where the customer is financially. This is pretty standard. Now the discussion is steered into the borrower's future plans regarding the house purchase or refinance and then, armed with a full package of information now in front him, he can suggest a couple of mortgage programs for consideration. He'd also take a moment to explain the various loan features and answer any questions. Isn't that his role?
If the loan officer follows the suitability doctrine, he would make that decision for the borrower based on what he knows and has been told. What if the borrower falls ill three years later, can't make the payments and defaults on the home loan? He could sue the lender for the breach of his fiduciary duty. What if there is a divorce and the same thing happens? Or the consumer just simply changes his future plans for the worse? The payments were made on time up until that point, the mortgage was deemed suitable, but all of sudden the loan is in dire peril and now the lender could be liable.
I can see the investors who are buying mortgage-backed securities reacting to any legislation like this with alarm. Liability could come knocking on their door, too. What would it do to the cost of mortgage funding? Increase it.