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California Legislature Passes Mortgage Reform Bill

Removal of key elements weakens protection for consumers

August 28, 2008

"The California Legislature has approved a bill with important, though limited, reforms this year," said Paul Leonard, director of the California office of the Center for Responsible Lending. "While it doesn't do everything needed to protect consumers going forward, it represents a positive step to help California borrowers and mortgage markets. Now the ball is in Gov. Schwarzenegger's court."

Leonard called the measure "the most important mortgage market reform bill the Legislature has sent to the governor," adding, "his signature on this modest bill should be a slam dunk."

The governor's efforts to date have focused on helping borrowers and communities avoid the negative consequences of foreclosure rather than tightening lending regulations. Schwarzenegger announced an agreement with loan servicers last November which has had limited success in stemming the rising tide of foreclosures.

Schwarzenegger also announced a new program in July to help first-time homebuyers purchase foreclosed properties with favorable terms. These initiatives, however, address only the consequences of excessively risky lending, but do nothing to fix regulatory framework of the mortgage marketplace.

The bill, AB 1830, includes key reforms, such as establishing that for all home loans, brokers have a fiduciary duty to their clients and must put the borrower's economic interests ahead of their own. Brokers are prohibited from steering borrowers to loans that are more costly than what the borrower would qualify for.

AB 1830 also adds to recent federal regulations by capping the size of prepayment penalties, the expensive exit fee that traps borrowers in subprime loans.

"The new broker duties should help ensure that California mortgage brokers are looking out for the best loans for borrowers, not with fattening their wallets," Leonard added.

The version of AB 1830 approved by the Senate takes California a step in the right direction, according to the center. But it pales in comparison to the earlier reform package passed by the Assembly in May, and to state mortgage reforms in less heavily impacted states like New York, Connecticut, North Carolina and Minnesota, officials said.

The bill was significantly weakened through the legislative process, removing a number of features designed to correct market failures and protect consumers. Key elements like codifying basic underwriting standards for non- traditional (Alt-A) loans, banning the use of abusive yield-spread premiums and prepayment penalties; requiring translation of key mortgage terms for non- English speakers; instituting bonding requirements for mortgage brokers and recognizing greater accountability for secondary market purchasers fell off of the legislative radar.

While critical, the measures in AB 1830 do not go far as far as some activists would like to correct the systemic problems of the mortgage market that have brought California and the nation unprecedented foreclosures.

"We hope the Legislature and governor will move next year to finish the job of making the subprime and nontraditional mortgage markets safe for borrowers," said Leonard.

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