Three mortgage industry veterans published a paper in February contending the U.S. system of refinance often works against borrowers and should be standardized and reformed.

The paper, published on the Urban Institute website, was authored by Edward Golding, the former head of the Federal Housing Administration, former Ginnie Mae President Ted Tozer and the Urban Institute’s Laurie Goodman.

Golding, now on the faculty at the Massachusetts Institute of Technology, spoke with Scotsman Guide last week about the group’s ideas.

Could you start by talking about why the U.S. system of refinance should be standardized and reformed?

Let me say, the main purpose of writing the paper is to get the discussion going. While we have recommendations and a proposal, what we’re trying to do is engage people who are active in this market, including your readers, in discussing it. It’s not that we have all the answers, but what we do is describe is a system that’s not working well.

The unconstrained and informed benefit from the refis and others are sort of locked out of the market. So, we think we’d be lowering cost, making a more efficient market, and that was the goal of this.

In what ways are people being locked out of refinances that they could benefit from?

Well, the principal area is in the conventional (government-sponsored enterprises) space for a rate-term refi. They have to underwrite the mortgage. There’s the expense of underwriting, verifying employment, verifying asset value and the like.

Today, there’s a lot of market uncertainty for consumers, uncertainty for originators, poolers. There’s a lot of transaction costs and unnecessary costs involved in it and, in addition, some people are benefiting from refis and others don’t.

And people get turned down because circumstances for some have deteriorated since they first got the mortgage. They actually will be lowering their risk if they refinanced, because if there’s lower payments, the risk of default is lower. So, a streamline refinance (offered by the GSEs would be) one of the biggest benefits, although not the only one.

You have proposed a net standard benefit that could curtail some refinancing activity. Could you talk about that?  

How it’s calibrated is up for discussion, but the idea is you want that benefit test because you know what you don’t want are refis that lower the payments by extending the term. One of the purposes of that benefit test is to protect the consumer from refis that are not in their best interest even though they have slightly lower payments. The (borrower) might be paying for another three to five years depending on the age of the first mortgage.

So, it’s important to have a net benefit test. It’s also important to calibrate it. And this is where there’s a lot of uncertainty. We don’t want to speed up the prepayments in the market because mortgage-backed security holders will just want a significantly higher yield.

We thought it would be (a requirement that a refinance must lower the fixed rate by) around 50 basis points. A minority of folks might be slightly impeded, but it makes sure that it’s in the interest of the borrower and it also is calibrated. We have to make sure that the mortgage-backed security holder is not overly worried about prepayments. We need an active, investor base to invest in mortgage-backed security. But if that’s set too high or too low, it will affect the market.

The paper makes the point that minorities and lower-income borrowers are less likely to refinance. Could you talk about that?

Well, I used the word ‘constrained’ versus minorities. It’s not just minorities. It’s people who originally were just on the edge of getting approved. They have a slightly lower credit score. Their loan-to-value ratios are up against constraints.

There’s a disproportionate share of African American families, Latino families that will fall into this constrained bucket.

Among your proposals, what would help them the most?

It’s having the GSEs adopt a streamline program for rate-and-term refi. The FHA and VA already have them. That would be the biggest help in the conventional space.

Are these new ideas or a compilation of proposals that have been around?

Well, nothing’s new in the mortgage space. These issues and the speed bumps and the like have been out there for a long time. We just say there is a lot of complexity across the different programs and a lot of uncertainty for the individual mortgage banker. And so, we’re trying to make it a better system.