I spent 45 minutes with their analyst trying to convince her that declining our application would be the single greatest mistake in the 35-year history of their company. It’s difficult to remember all the bullshit nonsense I slung during that phone call, but I’m fairly certain it included some delusional argument about Kellner and Countrywide working together to house America. I’m still not certain how it happened, whether it was great timing, sheer luck, or pure moxie, but they bought the argument and waived the requirement.
That’s when I started thinking, maybe there is a little gunslinger in me after all.
CHAPTER 3
The Underbelly: Mortgage Brokers
In mid-2007, I received an e-mail that summed up the insanity that had infiltrated mortgage finance. The message was simply a photo of a business sign hung in front of an office. It read:
Welcome to U S Center
Hair, Nails
Mortgages
Apparently the advertisers wanted to cash in on the housing boom along with everyone else. Comical as it was, the sign illustrated just how much the mortgage business had grown. If beauticians were offering mortgages, who might be next? During a plane flight in 2005, a former employee of mine sat next to a pilot traveling on vacation. He informed her he had just gotten a broker’s license and was planning to leave his job and work full-time as a loan officer.1 I hope he didn’t give up his day job.
By 2004, brokers were entering the business in droves. With so many new brokers wanting to get approval to do business with Kellner, we had to hire more employees to process the applications. According to Wholesale Access, a residential lending market researcher, the industry peaked at 53,000 mortgage broker companies in 2006, nearly a 50 percent increase from the 2001 figure of 37,000. By some estimates, the number of new loan originators working for mortgage brokers increased by 100,000 during this period.
Annie Nguyen was our first loan coordinator and eventually managed the entire department. As the go-between for the broker and the underwriter, she and her team of coordinators helped the mortgage brokers we worked with make sure all the loan conditions were met. This put her in close contact with our customers, the brokers. Here are her thoughts on the state of the business at that time.
After a while, things just got crazy. My employees told me stories of brokers who didn’t know anything about the business. We’d receive loan files where the loan applications were blank and the disclosures were incorrect or missing. For many loans we had to go hunting for the information.
I once had a loan officer ask me if we really needed to have an appraisal before closing. I thought he was joking. He didn’t understand why he couldn’t get it to us after the loan had funded. We spent so much time doing quality control we went from being loan coordinators to full-time fraud detectors.
Some loan officers really had the customer’s best interest at heart. Others were so green they couldn’t interpret a credit report or paycheck stub. Not only did we have to double- and triple-check the information provided to us, we had to help them understand the document they were submitting and whether it was acceptable to underwriting.
While Annie’s account paints an accurate picture, nothing describes the sheer lunacy better than my partner Ken’s trip to Houston in 2005. As you read this story, keep in mind that a loan officer in Texas must either work for a mortgage lender or have a sponsoring mortgage broker in order to operate legally. The law doesn’t require the broker and loan officer to work out of the same office as long as the loan officer’s license is displayed in the broker’s office.
Ken describes his Houston trip this way:
I’m traveling with a new wholesale rep trying to help him get some loans from his new broker accounts. Walking into the broker’s office made me realize just how screwed up this business had become.
The office is one tiny room, maybe 12 × 12. The place is a mess, unbelievably filthy and it smells of body odor. There’s no place to sit down and even if I could find a spot, I’m afraid to think what I might catch. The first things I notice are the loan officer’s licenses. Every square inch of his office walls is covered top to bottom, side to side, with licenses. I’m guessing there must be 250 licenses either stapled or taped to the walls.
The biggest problem was the broker’s recordkeeping or lack thereof. His loan files were stacked in piles around the room and he didn’t know where anything was. As we’re talking, he’s knocking files to the ground trying to locate deals for us to review. The place was utter chaos. I saw copies of borrowers’ tax returns lying on the floor. When I asked him which file they belonged to, he didn’t know.
This broker had no control over his company and it eventually cost him. The Texas Department of Savings and Mortgage Lending conducted an audit shortly after Ken’s visit—no, we didn’t call them, but it crossed our minds. They required him to pay some large penalties and take numerous steps to improve his operation.
Aside from not following the compliance requirements of the business, his decision to sponsor all these (mostly unqualified) loan officers was perfectly legal. The state allowed him to operate this way and he took advantage of it. The challenge for us came in supporting the loan officers since most were new and understood little about the business. Colleagues tell me he’s improved his operation, but the Texas Savings & Loan web site as of December 2007 still shows him sponsoring more than 335 loan officers.
The lack of oversight became more pronounced with the proliferation of “net branch” companies, the mortgage equivalent of franchising but without the large up-front fees. These companies handled the basic business functions (accounting, IT, licensing) so that brokers were freed up to generate more business.
While some firms like Allied Home Mortgage Capital Corporation had stringent experience requirements and zero tolerance for fraudulent behavior, others provided new loan officers with easy entry to the business. Many of them allowed the loan originators to work from home. Although the practice wasn’t illegal or improper, we experienced more problems working with these types of loan officers. There was a collective feeling within our company that inexperienced originators who worked from home were less competent since they seldom received proper training and support.
Rob Legg was our lead salesperson for Carteret Mortgage, a large net branch company. Here’s a summary of his four-year experience calling on this customer:
Aside from a handful of top-notch loan officers, most of their originators really struggled with the business. I had so many loan officers calling me that didn’t know a tax return from a credit report, I eventually stopped returning their messages. It amazed me that some of them could earn a paycheck.
When I left Kellner in late 2005, incidents of fraud had already hit record levels. Amazingly, it got even worse. The figures released by the MIDEX (Mortgage Industry Date Exchange) database show that mortgage fraud incident submissions were 30 percent greater in 2006 than in 2005.
Eventually more than 70 percent of all brokered loan applications submitted to us at Kellner were somehow deceptive, so everything a broker said or did needed to be double-checked and reverified. I’ve had several colleagues who owned subprime mortgage companies tell me this estimate is conservative compared to their own experience, especially during the last few years before the industry imploded.
I can’t think of another industry where the vendor-client relationship has such a high degree of distrust. If almost three-fourths of all potential transactions are somehow fraudulent, unreliable, or misleading, it means the business model is fundamentally flawed.
While there are no statistics to support the following claim, it’s highly probable that a direct correlation exists between the increased levels of fraud and the influx of new loan originators.
What Brokers Do, and What They’re Supposed to Do
In theory, brokers are the best option when shopping for a mortgage loan. With access to dozens of lenders and hundreds of programs, brokers offer a one-stop alternative to app
lying with multiple lenders. The credit-challenged borrower has even more to gain from using a broker. The rates and fees for subprime mortgages can vary widely, and good brokers can locate the best product and price to meet the borrower’s needs.
There are some disadvantages as well. Brokers have little control over the loan process, as it is the lender who must underwrite and fund the mortgage. In addition, using brokers adds one more step to the mortgage food chain, which can result in higher, not lower, costs for the borrower. Finally, since brokers are largely unregulated, it’s often difficult for consumers to differentiate between the honest and the unethical loan officer until the transaction is nearly complete.
There’s also a direct correlation between the type of mortgage a borrower obtains and the amount of influence a broker has over the borrower. Conforming or conventional mortgages that conform to national lending standards such as Fannie Mae’s are considered plain vanilla products. Since borrowers need reasonably good credit and income to qualify, these loans are easier to transact and require less work on the part of the broker. Borrowers who present a good credit risk have options. If they feel a broker is acting inappropriately or charging excessive fees, they can easily move their loan to another mortgage company.
The subprime borrower, however, typically undergoes a different experience. The loan process can be difficult and arduous, like trying to fit a square peg into a round hole. Borrowers want a good deal, but their main concern is getting approved. Since credit scores are a major issue, most brokers will counsel their borrowers on how to act between application and closing—no major purchases, no new credit, and no credit inquiries. Any of these activities can cause the score to drop and jeopardize the loan. In addition, brokers advise their borrowers not to talk to competing brokers, since the competing broker will also pull the borrower’s credit report—which can lower the borrowers credit score. This advice has merit but it also limits the subprime borrower’s options. In addition, since the approval process can be a difficult and emotionally draining experience, many subprime borrowers prefer to use one loan officer to find the best deal.
The problem comes when a broker presents an offer, and the borrower has no competing offers. When there’s no basis for comparison, the borrower has to trust that it’s a reasonable offer. That’s a lot of faith to put in a broker who has no financial liability, little regulatory oversight, and no clear fiduciary duty. When a vulnerable borrower puts a mortgage in the hands of an unscrupulous broker, the mix can be toxic.
To complicate matters, brokers became a driving force for subprime loans. By 2003, they originated only 25 percent of all prime loans but over 50 percent of all subprime mortgages. There are three reasons for this disparity. First, since conforming mortgages are a commodity, direct lenders would usually win a price war unless the broker was willing to drastically reduce his income. Second, with more than 100 wholesale subprime lenders in the market by 2003, borrowers with damaged credit had access to far more loan options through a broker than a single lender. Third, the greater income potential from subprime mortgages meant brokers had a motive to steer marginal borrowers toward this product even if they qualified for a more competitive loan with better rates and lower fees.
When salespeople in any business are left to their own devices, they’ll work the system to their benefit. As the next chapter shows, this is also true of the lender’s account executives. With few rules and minimal consumer protections, abusive behavior flourished. The harsh reality of brokering subprime mortgages is that many loan officers are more concerned with their own paycheck than with the best interests of the borrower.
In this chapter, I expose the world of mortgage brokers by examining their practices through the eyes of a subprime lender. You’ll learn about the business of brokering mortgages, the impact of fraud on the industry, and the tactics used by brokers to secure loan approvals, which fall into three categories: honest, dysfunctional, and corrupt.
The Business of Brokering Mortgages
If there’s a demand for a product or service, someone is brokering it. Whether it’s real estate, technology, or sex, brokers are paid to connect people who want something with those who supply it. The service that mortgage brokers provide, however, is unique in two ways.
First, they sell a high-ticket item—mortgage debt. With a home still being the largest financial investment most people make, getting a bad deal on a loan can be an expensive mistake. Second, with over 60 percent of households owning a home, mortgage origination is a widely used service. When factored together, there is no other brokered product or service that has as large a financial impact on the majority of consumers.
By 2000, more than 250,000 mortgage brokers operated in the United States. Few states had licensing requirements, which meant the barriers to entry were minimal. Even when states started requiring licenses, the typical prerequisites were disproportionately easy to meet, such as passing a multiple-choice test and not having any felony convictions.
The income potential made brokering mortgages an attractive business. In the same way investors pay lenders a premium to buy mortgages, lenders pay brokers a yield-spread premium (YSP) to sell a higher interest rate. This applies to all mortgages, not just subprime. For example, if the market or par rate on a subprime loan is 9 percent, brokers earn 1 point in YSP by selling 9.5 percent, and 2 points for selling 10.25 percent.
So how much do brokers make per loan? It depends on how much they can charge the borrower in fees and the interest rate they can sell. The competitive nature of conforming mortgages usually limits brokers to making no more than 2 points. In a slower market, most of them struggle to make between 1 and 1.5 points. Since subprime borrowers are primarily concerned about getting approved, they aren’t as rate sensitive as prime borrowers, enabling brokers to charge them higher rates and fees.
Despite the disclosures the industry has created, there is still much confusion. Until a final settlement statement (the HUD-1) is ready for review, borrowers don’t know how much the broker will make on the loan. While consumers should receive a Good Faith Estimate (GFE) of costs within three days of application, each state treats the disclosure of YSP differently. In Texas and some other states, brokers are allowed to indicate they’ll make a range between “0 to 3%,” which is nonsensical. Why have a disclosure when it doesn’t tell the consumer anything?
To make matters worse, the broker is not obligated to honor the rates and fees on the disclosure. Of course, this applies to the lender as well, but abuse is more common at the broker level. As long as the borrower signs a corrected GFE that corresponds with the final HUD-1, a broker can change the deal at any time. For borrowers who are more vulnerable, the system has few protections.
How Brokers Operate
Once the borrower’s application is taken and a credit report has been ordered, most loans follow a similar path. There is no standard process, but unless the deal is identified early on as a government loan—either through the Federal Housing Authority (FHA) or Veterans Administration (VA)—brokers usually follow these steps:• The loan is run through Desktop Underwriter, Fannie Mae’s automated underwriting (AU) system, or through Loan Prospector, Freddie Mac’s AU system. An approval through either program classifies the loan as a conforming or conventional mortgage, which means the deal meets the guidelines established by these agencies.
• If neither system provides an approval, the broker can still seek FHA approval if he’s approved by the Department of Housing and Urban Development (HUD) and the loan meets the requirements. Before subprime became popular, FHA was the best alternative for credit-challenged borrowers.
• The broker can send the loan to a subprime or Alt-A lender or use the lender’s AU system to approve the loan. Lenders like Countrywide and RFC developed proprietary systems to underwrite their nonagency loans.
When we opened in 2000, AU systems were almost nonexistent for subprime mortgages. To get a loan prequalified, brokers relied on the lender’s acc
ount executive to review the borrower’s application and credit report. Handling difficult transactions through a manual process meant underwriting was a hit or miss experience. There are no official statistics, but it’s widely believed the loan fallout rate (the percentage of brokered loans submitted to subprime lenders for underwriting that did not fund) averaged 50 percent.
The high fallout rate meant subprime became synonymous with poor service. With many account executives lacking the expertise to handle complex transactions, brokers searched for reps who understood the business. The inefficiencies led some brokers to send loans through multiple lenders at the same time. This “throw it against the wall and see if it sticks” mentality also contributed to the high fallout rate.
Over the next five years, technology would become an integral part of the business. By 2005, most subprime lenders had developed their own proprietary AU systems. Even smaller companies like mine who couldn’t afford to build their own systems found alternative solutions. RFC allowed us to customize the look of their AU system, Assetwise, to match our branding campaign. When brokers used the system on our web site, it looked like we spent millions developing the technology.
While many brokers welcomed the use of technology for underwriting subprime loans, the systems took a while to catch on since every lender had its own version (which required training) and brokers used multiple lenders. For conforming loans, brokers had little choice—there were only two AU systems and loans had to be approved through one of them. Since AU systems were new to subprime, few lenders made their use mandatory when they first came out. Even when they did, brokers relied on their reps to help get loans approved.
Confessions of a Subprime Lender Page 5