Most mortgages are supervised and regulated by the government. The term unregulated mortgage refers to the few that are exempt from federal and state regulation. In the early years of the 21st century, unregulated mortgage lenders originated a variety of creative mortgage packages that allowed homeowners who fell short of the banks' strict lending criteria to borrow money against their homes. Usually associated with the sub-prime market, unregulated mortgages are widely blamed for the 2008 housing market collapse.
Operating Without Rules
Banks and other "prime" mortgage lenders have always been restricted by national and local underwriting regulations. Any business that loans money outside the parameters of such regulations offers an unregulated mortgage. The category includes independent mortgage firms, private mortgages, such as the effective loan given by a seller to a buyer under a land contract installment agreement, and hard money lending -- the finance industry term for loans funded by private parties. More than 84 percent of the sub-prime mortgages issued in 2006 were unregulated mortgages.
Operating for Short Term Profit
Pre-crash, the business model of most, though not all, unregulated mortgage providers was short-term gain. Private mortgage lenders held mortgages for as short a period as possible before selling off bundles of paper loans at a profit - this is known as securitization. Because they did not administer the loans they issued, unregulated lenders had little regard for the borrower's ability to repay the debt. Unsurprisingly, when the crash came, these mortgages defaulted at much higher rates compared to traditional, bank-issued 30-year loans.
According to Forbes, private lenders made nearly 83 percent of the sub-prime loans in 2006, the vast majority to low-to-moderate income borrowers. While banks were forced by law to issue loans in accordance with strict underwriting criteria, such as low debt-to-income and loan-to-value ratios, unregulated lenders were free to create innovative mortgages that targeted a broader class of borrower. They offered loans with below-market rates that quickly shot up, interest-only loans and high-risk negative amortization loans that racked up as the months went on, as the borrower paid less each month than the amount of interest due.
Operating Post Reform
In response to the mortgage crisis, the federal government created new standards for mortgage lending. Most residential mortgages are now within the supervisory reach of the Consumer Financial Protection Bureau as part of the Dodd-Frank Wall Street Reform Act. The CFPB is mandated to punish unfair, deceptive and abusive lending practices. It has authority over independent mortgage lenders, payday lenders and debt collectors, as well as traditional banks and credit unions. Under new CFPB rules, lenders must take into account the borrower's ability to repay the loan and give federal disclosures about the mortgage's terms.
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