The U.S. Senate voted Wednesday to ban certain bonus payments to mortgage brokers and loan officers, cutting off what experts have called one of the key causes of the nation's mortgage meltdown.
The little-known bonuses were paid for home loans that could be sold at higher prices because they carried higher interest rates and other more onerous terms than those for which the borrowers were qualified.
Amending financial reform legislation as it makes its way through Congress, the Senate also voted to outlaw stated-income mortgages — loans made without using tax documents, pay stubs or bank records to verify that borrowers actually earn as much as they say they do.
These so-called liar loans and the bonus payments are widely regarded as key factors leading to the subprime lending debacle that snowballed into the deep recession. Critics described the bonuses as thinly disguised kickbacks for steering borrowers into burdensome mortgages.
"Deceptive mortgage practices like hidden steering payments directly led to the Wall Street meltdown and resulted in millions of families losing their homes," said Sen. Jeff Merkley (D-Ore.), who sponsored the ban on broker bonuses for higher-interest loans.
The vote to ban the practices was 63 to 36.
Most subprime loans, along with other mortgages based on loose standards during the housing boom, were sold into the secondary market, then pooled and packaged to back mortgage bonds.
The securities became known as toxic when mounting losses on them threatened to poison the entire financial system.
Mortgage brokers opposed the legislation. They argued that it was flawed because although the measure restricts bonuses at the front end, it would still permit Wall Street firms and other loan investors to pay more for bundled mortgages with higher interest rates.
The broker bonuses, known in the industry as yield spread premiums, reflect the fact that the value of mortgages is based on the terms of the loans.
Yield spread premiums essentially are bonuses or rebates that lenders give to mortgage brokers for getting borrowers to agree to higher interest rates or other terms favorable to lenders, such as adjustable interest rates or prepayment penalties.
In theory, loan originators can use the yield spread premiums to benefit borrowers, for example by using the rebated money to pay for appraisals, the recording of documents and other costs of obtaining the loan.
But critics said the rebates often went straight into the pockets of brokers without borrowers realizing what was happening. One major academic study found that nearly all the brokers surveyed were putting their clients into more expensive loans so they could get bounties averaging nearly $2,000.
"The bipartisan vote to eliminate the pernicious effect of yield spread premiums significantly strengthens the financial legislation," said Paul Leonard, California director for the advocacy group Center for Responsible Lending.
"These incentives were a major factor in so many borrowers being put into subprime loans that they could not afford," he said.
In a related action, the Senate defeated a proposal by Sen. Bob Corker (R-Tenn.) that would have required most borrowers to make a down payment of at least 5% in order to purchase a home. Real estate sales groups and home builders opposed the measure.
Corker's measure would have allowed for a waiver of the 5% down payment requirement for military veterans and groups such as Habitat for Humanity. In an interview, he said it addressed another of the root causes of the mortgage meltdown — allowing borrowers to purchase homes without putting their own funds at risk.
The Corker proposal also would have stripped out from the financial reform legislation a provision requiring lenders to retain a 5% interest in securities backed by their loans.
He said he would support other measures to ensure the lenders have "skin in the game," but believed the law as currently drafted would risk shutting down the mortgage securities market entirely, which would drastically restrict the funds available for home loans.
He said he would resubmit his proposal so it has only the provision for a 5% down payment, though he added that it would be tough getting that approved given the lobbying clout of the industries aligned against it.