Adjustable-rate mortgage (ARM): With ARMs, the interest rate shifts based on a corresponding financial index tied to the loan. These mortgages often begin with a low-fixed rate but adjust to match the national interest rate after a set initial period ends. Their payment schedules, initial periods, benchmark indices, and other terms may vary. These loans benefit borrowers by allowing them to take on larger loans, but can also create financial difficulties if rates and thus required payments rise. During the 2008 financial crisis, many buyers who had taken out cheap ARMs without fully understanding the terms of their loans saw their monthly payments skyrocket, which caused many to default.
Amortization: The process by which a borrower repays principal over the course of a long-term loan. Typically, at the beginning of a mortgage loan, most of the money will be paid toward interest, and at the end, a majority will go toward paying off the principal.
Balloon mortgages: The opposite of a full amortization loan, balloon mortgages have a large amount of principal due at the very end of the loan term (the amount owed “balloons”). The most common form of real estate mortgage prior to the 1920s, balloon mortgages have smaller initial payments but can hurt borrowers when home properties fall or they lose their source of income, as happened to many homeowners during the financial crisis.
Bank Holding Company Act: This 1956 Congressional Act regulated bank holding companies and defined them as any company with a stake in at least a quarter of the shares of at least two banks. See Chouliara memo.
Board of the Federal Reserve System: The Federal Reserve System is the central banking system of the United States; it sets interest rates for major banks and financial institutions and has significant regulatory authority over the largest banks, including the responsibility to. enforce HOEPA, which seeks to prevent predatory lending practices in the home mortgage market. See Karstens memo.
“Cash for trash”: Phrase denoting the purchase of worthless or toxic securities; can also specifically refer to US Treasury Secretary Henry Paulson’s bank bailout plan proposed in fall of 2008 (formally the Emergency Economic Stabilization Act.) The Paulson proposal bought (provided cash) many mortgage-backed securities (“trash” because of the many low-quality mortgages in the securities) through the Troubled Asset Relief Program. The bank bailout was unpopular among many politicians and with the general public. See Edward Pinto interview.
Collateralized debt obligations (CDO): A type of financial product sold to investors that is backed by cash flow-generating assets, such as mortgages. CDOs have “tranches” (levels) based on risk. Subprime (or risky) mortgage backed CDOs exploded in popularity during the housing boom of the early 2000s and contributed heavily to the 2008 financial crash. A lack of transparency about the quality of assets contained in CDOs masked their riskiness, and eventual defaults led to huge losses for banks, a financial crisis and the ensuing economic recession. CDOs are similar to MBS, but have a more complicated structure, involving the combination of parts of large numbers of loans, such as principal payments, or interest payments.
Consolidated Supervised Entities (CSE) program: A Securities and Exchange Commission program created in 2004 and terminated in 2008 that provided light-touch oversight of self-regulatory risk assessment and risk management practices at the five largest investment bank conglomerates (Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley). This program eventually attracted strong criticism for encouraging the unsustainable risk-taking of Wall Street during the 2000s.
Consumer Financial Protection Bureau (CFPB): A U.S. government agency that Congress established in the Dodd-Frank Act as one key response to the 2008 financial crisis. The CFPB has the responsibility to ensure that financial institutions such as banks and lenders treat consumers fairly, and to protects consumers from deceptive and abusive acts through regulatory rulemaking and enforcement, as well as monitoring market conditions and providing consumer education.
Correspondent lender: A key type of American mortgage originators during the late twentieth and early twenty-first centuries. Unlike mortgage brokers, who helps customer obtain financing and find wholesale lenders to approve and close the loan, a correspondent lender processes, underwrites, closes, and takes responsibility for the loan in their own name, while selling the servicing of that loan to a larger organization. Prior to the housing boom of the 2000s, Union Home Mortgage, with about 100 employees, was a typical correspondent lender. Now, Union Home has 1600 employees and not only originates, processes, underwrites, and approves loans, but it holds onto the servicing of the loan, which makes it a full-service mortgage banker. See Bill Cosgrove interview.
“Credit box”: A term used by lenders to describe rules of thumb about acceptable credit risk one takes on. In the leadup to the financial crisis, mortgage lenders bought exorbitant amounts of loans from borrowers with low credit scores because lenders believed they had new advanced modeling that could offset much of this credit risk through alternate pathways, such as credit insurance and over-collateralization). However, this approach turned out to be a dramatic expansion of the “credit box.”. See Frank Nothaft interview.
Credit enhancement: A strategy to offset risk, such as through insurance mechanisms, provision of additional collateral, improves its credit structuring so that it can receive more favorable terms of payment for mortgages. During the early 2000s, ratings agencies pointed to credit enhancements as a key reason for providing high ratings to CDOs and other mortgage-related securitized assets. See Saul Sanders interview.
Credit risk: The risk that a borrower fails to meet the terms of a financial contract, for example, failing to pay required amounts on loans. A main role of banks is to access and distribute risks from its lending and trading businesses.
Credit Service Organization (CSO): Also commonly known as credit repair agencies, these entities claim to be able to consumers who are in need of credit – an increase to their credit standing or score, an extension of credit, or help preventing bankruptcy. See Richard Swerbinsky interview.
Back-end ratio: Also known as debt-to-income (DTI) ratio, this term refers to the percentage of income that goes towards paying debts. More conservative lenders view a DTI ratio under 36% as a good credit risk. Leading up to the 2008 financial crisis, many lenders relaxed their standards for DTI, so as to increase the number of loans that they could provide to securitizers.
Delinquent mortgages: Loans for which borrowers have failed to make a required payment, often triggering additional costs to borrowers, through both fees and interest rate resets. Multiple missed payments on a property greatly increase the likelihood of default and foreclosure. During the mortgage crisis, delinquency rates were nearly 11 percent, as compared to around 2 percent between 1980 to 2005.
Derivatives: a financial contract between two or more parties whose value derives from the value of some agreed-upon underlying financial asset (e.g. security) or set of assets. The housing boom of the early 2000s depended on a dramatic expansion in the demand for mortgage-related derivatives, fueled in part by low interest rates.
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank): A multi-faceted and extremely complex piece of legislation enacted in 2010 to respond to the many regulatory shortcomings highlighted by the Financial Crisis of 2008.
Equity stripping: The process of reducing the equity value of a real estate asset by using it as collateral for new debt. In some cases, equity stripping may be employed by firms as an asset-protection strategy meant to make a property relatively valueless to creditors. However, in the context of predatory lending, equity stripping often refers to the stripping of borrowers’ assets’ equity by lenders through practices like excessive upfront fees, abusive interest rates, and prepayment penalties on subprime loans.
“Fallout” rate: The percentage of initially accepted loans within a mortgage originator’s pipeline that do not successfully close. The fallout rate increased during the housing crisis, since many borrowers requested mortgages contingent on their selling of a current asset (often a home), but as they failed to sell, they could not attain or cover the mortgage. Higher fallout rates are also correlated with rising interest rates, which dampen housing prices. See Greg Sayegh interview.
Fannie Mae, or Federal National Mortgage Association (FNMA): A stockholder-owned, publicly traded government-sponsored enterprise (GSE) established in 1938 as part of the New Deal. Like the newer Freddie Mac, Fannie Mae operated in the secondary market, buying and guaranteeing loans from lenders on the basis of clearly articulated underwriting standards, in order to help support moderate to low-income borrowers by increasing liquidity for lenders making these loans. Prior to the2008 crisis, it had its annual affordable housing goals set by the HUD and reported its outcomes to Congress. It was also beholden to its stockholders as a company. Fannie Mae entered government conservatorship alongside Freddie Mac after 2008 and is now overseen by Federal Housing Finance Administration. Fannie Mac tends to buy loans from larger commercial banks, while Freddie Mac buys loans from small to medium-sized banks.
Federal Housing Administration (FHA): Created in 1934 as part of the New Deal, the FHA is currently part of the Department of Housing and Urban Development. The agency provides mortgage insurance on loans that meet underwriting standards from FHA-approved lenders throughout the United States and its territories. The aim of the FHA is to expand access to mortgages by decreasing the risk to lenders. From 2008 to 2013, FHA helped ease economic hardship during the financial crisis by extending credit to borrowers when private financing was generally highly risk-averse.
Federal Reserve Economic Data (FRED): a public database from the Federal Reserve Bank of St. Louis. The FRED website (https://fred.stlouisfed.org/) provides historical data on important indicators like GDP, inflation, and unemployment among others.
FICO Score: A quantitative credit score generated by the Fair Isaac Corporation (FICO). Lenders assess credit risk based in part on their FICO scores. If a lender extends credit to someone with a low FICO score, the loan is subprime. The emergence of FICO scores facilitated the increased automation of mortgage decisions, removing subjectivity from the process, but also reducing the number of inputs into credit decisions. See Todd Baker interview.
Financial Crisis Inquiry Commission: A ten-member bipartisan commission charged by leaders of the US Congress assigned to investigate the causes of the 2008 Financial Crisis. See Karstens memo.
Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley Act or GLBA): Signed by President Bill Clinton in 1999, this statute repealed the Glass-Steagall Act’s separation of commercial and investment banking, facilitated the creation of financial holding companies, and accelerated the deregulation of the financial industry. See Chouliara memo.
Foreclosure: The legal proceedings that allow a creditor to take ownership of mortgaged property and sell it in the event of borrower default. The specific process depends on each state’s laws. Foreclosure heavily affects borrowers’ credit scores and generally impedes them from obtaining major future loans.
Freddie Mac, or Federal Home Loan Mortgage Corp (FHLMC): A stockholder-owned, publicly traded government-sponsored enterprise (GSE) chartered by Congress in 1970. Like Fannie Mae, Freddie Mac buys loans from lenders and securitized mortgages into mortgage-backed securities. By increasing liquidity for lenders making these loans, Freddie Mac supports homeownership and rental housing for middle-income Americans. Simultaneously, it was also beholden to its stockholders as a company. Today, Freddie Mac is instead regulated by the Federal Housing Finance Agency (FHFA). After the crisis, Freddie Mac was placed under government conservatorship. The major difference between Fannie Mae and Freddie Mac is that Fannie Mac tends to buy loans from larger commercial banks, while Freddie Mac buys loans from small to medium-sized banks.
Front-end ratio (Mortgage-to-income ratio): Advisable fraction of spending on a mortgage for a given level of income. Generally, financial advisors suggest that no more than 28% of monthly income go toward housing expenses. See Edward Pinto interview.
Glass-Steagall Act: A cornerstone of the New Deal, this 1933 legislation separated investment and commercial banking, while also creating the Federal Deposit Insurance Corporation. See Chouliara memo.
Home equity: The portion of a home’s current value held by the homeowner – the difference between the home’s value and the owner’s mortgage balance. The amount of home equity can change over time depending on prices in the housing market, payments made on the mortgage, and any new loans.
Home Mortgage Disclosure Act (HMDA): A 1974 statute that requires certain mortgage lenders to disclose information about mortgages they make. HMDA mandates that mortgage lenders report information about both successful and unsuccessful mortgage applications but does not mandate any sort of behavior.
Home Ownership and Equity Protection Act (HOEPA): Added as an amendment to the Truth in Lending Act in 1994, this act aimed to discourage abusive practices in the home loan industry. It helped provide protection for borrowers so that if a loan met a certain high-cost coverage test, the lender had to provide additional disclosures on the ultimate cost of the loan and consequences for defaulting. See Karstens memo.
Key performance indicators (KPI): Statistical measures adopted by many financial firms, which can incentivize aggressive actions by managers, especially if they linked to managerial compensation. See Fay Chapman interview.
Least-cost test: A provision mandated by the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) that required the Federal Deposit Insurance Corporation (FDIC) to resolve issues with banks in the manner that is least costly to the deposit insurance fund. See Mike Krimminger interview.
Liquidity: The degree to which an asset can be converted into cash. Since equities of public companies and governments have robust markets, they are easily bought and sold, and so have high liquidity. Meanwhile, assets like homes are harder to sell immediately and turn into cash.
Lis pendens: A formal, written notice that a lawsuit has been filed involving the ownership of a property. See Kris Slayden interview.
Loan to value (LTV) ratios: The mortgage value divided by the property value, used by financial institutions and lenders to determine the riskiness of approving a mortgage. During the lead-up to the housing crisis, banks held LTV standards constant even as housing prices continued to soar, increasing their vulnerability to a break in home prices.
Mortgage-backed security: A type of asset-backed security (ABS) made up of an aggregation of various home loans., sold by a lender or wholesaler to a financial institution either an investment bank or a government agency, which can sell this collection of mortgages to investors. During the 2008 financial crisis, investment banks issued many subprime mortgage-backed securities, and when individuals defaulted on their mortgages, these subprime securities collapsed.
Mortgage Lender Implode-O-Meter: A website that, beginning in 2006, tallied all of the lenders that as a result of either of direct losses from borrowers’ defaults or indirect financial losses suffered bankruptcy. See Sherry Gallitz interview.
Negative equity: The outcome of having an outstanding mortgage balance that exceeds the prevailing value of the property. Also referred to as being “upside-down,” this situation became common masse during the height of the 2008 crisis, making it difficult for people to move to find new employment elsewhere. With negative equity, many homeowners simply left their properties.
NINAs (No Income/No Asset Mortgage): A mortgage granted without verifying or requiring the disclosure of the borrower’s income or assets. They are also known as SISA (Stated Income/Stated Asset) loans, liar loans, or low-doc/no-doc loans. NINA originated as a means to provide credit to self-employed borrowers who had hard-to-verify incomes, like independent contractors. However, NINAs played a major role in the run-up to the 2008 financial crisis, as they greatly facilitated purchases by financially unqualified consumers to buy houses, fueling the latter stages of the housing bubble. In the wake of the 2008 financial crisis, NINA loans have become rare. A subcategory of this loan is a NINJA mortgage, approved without the buyer demonstrating proof of employment. See David Andrukonis interview.
Paper loan: prime loan, available to borrowers with a credit score of 680 or higher. See Anthony Polidori interview.
Pass-through securities: Formed when a group of mortgage holders such as Freddie Mac bundle mortgages and sell shares of them to investors. This practice served as a core basis of the secondary market, and allowed intermediaries to purchase more mortgages because they did not intend to truly “own” them, and could quickly convert them to cash. The ease with which banks could offload mortgage-related securities encouraged a decline in underwriting standards. See David Andrukonis interview.
Pick-a-pay loan: A type of adjustable-rate mortgages that allow homeowners to select among a set of payment options, sometimes including the ability to pay, for a time, less than the full amount of interest owed. These “teaser rates”, along with a lack of information provided to many homeowners who were taking out loans, greatly expanded the pool of prospective homeowners, and exacerbated the housing bubble. See Lawrence Baxter interview.
Piggyback loan: A mechanism to allow homeowners to take out a second mortgage along with a first mortgage on a home. This option allowed some borrowers to avoid the higher interest rates of “jumbo loans,” as well as the costs of private mortgage insurance. Like teaser rates, the ability to deploy piggyback loans supported demand for real estate and helped to accelerate prices in the latter stages of their purchase of inflated assets, which further exacerbated the housing bubble. See Sherry Gallitz interview.
Prepayment: the early repayment of a loan by a borrower, in part or in full, to take advantage of lower interest rates. often accompanies refinance. To constrain the uncertainty associated with prepayment risk, some lenders have tried to incorporate prepayment penalty clauses in subprime loan contracts. Such clauses became a target of anti-predatory lending reformers.
Promissory estoppel: a rule in English and American law that makes a promise legally enforceable if the person who receives the promise relies on it and suffers damages as a result; the rule prevents promisers from going back on their word without legal accountability. See Mark Lawson interview.
Rate locks: Provisions on mortgages that keep interest rates fixed for a given period of time for a prospective loan. While beneficial in markets in which interest rates are rising, they can be detrimental to a customer should interest rates fall afterwards or should a borrower no longer be able to meet the terms of their loan. See Richard Swerbinsky interview.
Real Estate Settlement Procedures Act (RESPA): A 1974 statute created to protect consumers in the real estate process. Under this act, lenders and mortgage brokers must provide borrowers with disclosures regarding real estate settlement and the costs and conditions involved. The shortcomings of both RESPA and the Truth in Lending Act became clear in the aftermath of the 2008 Financial Crisis; critiques of these statutes shaped many provisions of Dodd-Frank in 2010.
Refinance: Replacing an existing debt obligation (mortgage loan) with another debt obligation (mortgage loan) under different terms. Generally, refinancing occurs during periods with declining interest rates, which allows borrowers to receive more favorable mortgage terms. Prior to 2008, homeowners capitalized on low interest rates to refinance their homes. However, many refinanced into riskier loans with more opaque terms, often because of predatory marketing practices.
Reverse redlining: The practice of targeting neighborhoods, most of which are non-white, for the purpose of marketing abusive or predatory mortgages, especially to existing homeowners. See Karstens memo.
Safeguards rule: Enacted in 2002 in accordance with the Gramm-Leach-Bliley Act, this rule required that financial institutions use secure programs to protect the data of their consumers. See Chouliara memo.
Second line function: One of three functions designed to protect against credit risk in many large financial institutions, which identifies current and future risks within the daily operations of the company. See Ron Cathcart interview: Part 1
Service Release Premium (SRP) schedule: The compensation for lenders who sell mortgage loans to secondary mortgage market players (i.e. Fannie Mae and Freddie Mac) in the creation of mortgage-backed securities. The Service Release Premium pricing schedule represents the SRP percentage for the Servicing Rights. See Kevin Peranio interview.
Spiffs: Favors that the government gave to mortgage services in the form of programs, with the intention of incentivizing deals. They allowed mortgagers to give homeowners reduced interest rates and longer terms in mortgage deals, and represented one tactic for boosting the housing market after the 2008 crash. See Geoffrey Giles interview.
Subordination: The preferential ordering of financial obligations owed by a given debtor, in the event of default. Higher subordinations give more security to those respective lenders. See Laurie Goodman interview.
Troubled Asset Relief Program (TARP): A temporary economic program that ran from 2008 to 2013, authorized through the Emergency Economic Stabilization Act of 2008. Its aim was to restore economic growth and mitigate foreclosures in the wake of the 2008 financial crisis. TARP allowed the government to buy massive amounts of mortgage-backed securities and equity in many major financial institutions. TARP also placed some limits on company freedom of action, constraining managerial bonuses, but did not impose requirements to replace management.
Truth in Lending Act (TILA): Passed in 1968, TILA sought to protect consumers from predatory lending practices through disclosure mandates. The act requires lenders to disclose specific terms, conditions, and costs associated with their loans.
Underwriting: The due diligence that financial firms are supposed to undertake in assessing risks before extending credit or selling initial public offerings of securities. The nature of underwriting changed significantly with the emergence of FICO scores, better communication, networks, and more sophisticated economic modeling. The quality of underwriting also declined substantially during the housing boom, in part because of unrealistic forecasting about housing values.
Waterfall of payments: The ongoing flow of mortgage payments through different tranches of CDOs. With a strong housing market, that waterfall sustained tranche value. Once the housing market turned, the flow stopped, leading to collapsing values for mortgage-related securities. See Ron Cathcart Interview, Part 2.
Yield spread premium (YSP): compensation for a mortgage broker for selling a mortgage at an interest rate higher than the rate for which the borrower qualifies (usually to make up for lower origination fees). This form of compensation encouraged predatory mortgage marketing. See Brad Miller interview.