There’s a new game of musical chairs going on in the home financing industry and increasingly it’s mortgage brokers who have no place to sit.
Mortgage brokers describe themselves as real estate financing professionals who act as independent contractors. “There are circumstances,” says National Association of Mortgage Brokers, “when brokers may act as bankers, funding their loans. However, the majority perform origination services up to the point of funding.”
Mortgage brokers typically sell mortgages to homeowners; however, they do not determine whether a loan application is accepted or declined nor are they obligated under federal rules to get the best possible rates and terms for a borrower.
Marc Savitt, president of the NAMB, explains that “mortgage brokers do not create loan products, do not determine the automated underwriting systems used to qualify borrowers, do not underwrite the loans, and do not approve borrowers for those loans — Wall Street investment banks ‘who are now out of business’ did that.”
Harry Dinham, a past president of the NAMB, told Congress in 2007 that “some have proposed that a fiduciary duty standard should be implemented and mortgage originators and their loan officers should act in the ‘best interests’ of the consumer. NAMB remains opposed to any proposed law, regulation or other measure that attempts to impose a fiduciary duty, in any fashion, upon a mortgage broker or any other originator.
“Simply put,” said Dinham, “a mortgage broker should not, and cannot, owe a fiduciary duty to a borrower. The consumer is the decision maker, not the mortgage broker.”
How The System Works
In real life, mortgage brokers try to sell mortgages to borrowers who want to buy or refinance homes. Since the mortgage brokers typically don’t have the money available to fund the loan themselves, what they actually do is sell loans from those who do have money — banks for example.
A mortgage broker likely has relationships with numerous lenders and in theory can shop around for the best price and terms on behalf of the borrower. The mortgage broker essentially locates a loan at a wholesale price from a lender and sells the loan to a borrower at retail.
The idea that a borrower is the “decision maker” in the lending process does not say that the borrower can make good decisions or that the mortgage broker is offering any help. The borrower depends on the mortgage broker for information, programs, rates and terms. Asking another lender which loan is best simply means a new dependency. The real conflicts in this arrangement are both overwhelming and obvious.
For instance, one loan may be quoted with a 6 percent interest rate without points — that’s the “par” price. But how do you know that 6 percent was the best available rate? Suppose the mortgage broker could have gotten 5 percent for you with no points — doesn’t sound like a lot, but if you accept a loan at 6 percent the broker’s commission can increase by thousands of dollars. How? A process called “overage.”
“Overages associated primarily with rebate loans are an equal opportunity abuse, practiced by lenders and mortgage brokers alike,” says Jack Guttentag, a Wharton professor of finance. “The only difference is that mortgage brokers who retain rebates from lenders leave a trail in the Good Faith Estimate of disclosure, where it can be discovered by the borrower, although usually too late to do anything about it. Rebates retained as overages by loan officer employees of lenders disappear without a trace.”
A mortgage broker can get paid on the front end with points, fees and charges from the borrower and on the back end by selling the loan at a premium if a borrower can be induced into accepting a higher rate or more points. Since the borrower typically has no idea how the system works or how a given loan is priced, up-selling mortgage loans to under-informed borrowers is hardly difficult.
Not only are borrowers subject to the good graces of the mortgage broker, so are lenders. The lender underwrites the loan but the mortgage broker pulls together the application. Knowing how the underwriting system works, and knowing that underwriters have often been pressured to approve dicey loans, it’s sometimes possible to slip in loans which are of marginal quality, or maybe no quality.
As a result of the mortgage meltdown a number of lenders have closed and with them funding sources for mortgage brokers. Perhaps more importantly, a number of major lenders that remain in business have simply closed their wholesale operations, meaning no loans for mortgage brokers to re-sell.
The argument of the big lenders is that they can get better quality loans and have lower costs if they handle loan originations in-house. At the same time, by squeezing out mortgage brokers banks can also capture greater market share and increase margins, points not to be missed.
Mr. Dimon Speaks
Mortgage brokers have good reason to feel nervous, a sense not helped by Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co. Speaking in March before the 3rd Annual Capital Markets Summit, Dimon reviewed the current mortgage crisis and said several things that stand out, according to a transcript provided to me by JPMorgan Chase.
“Banks,” said Dimon to the Chamber of Commerce group, “have to do safe and sound lending, ’cause one o’ the big problems in this whole crisis was bad lending. Banks have to say no to clients. All the time I am given an example of we said ‘no’ to a client, like that was the wrong thing, very often, that was the right thing for, not just for us, but for them.”
This, of course, is exactly right. To be solvent lenders have to say “no” in situations which represent excess risk.
“Option ARMs were the worst of all,” said Dimon, looking at recent financial history. “We didn’t do it, but we obviously bought some when we bought WaMu (Washington Mutual). Eighty — now we all remember why we were 80 percent loan-to-value. There was a reason, and bad losses of 90 percent and a 100 percent loan-to-value were, were hidden by the fact that home prices (had) been goin’ up for so long. Mortgage securitization had flaws. There’s a legitimate complaint that, from the originator, to packager, to seller, no one was really responsible for the underwriting, from beginning to end; a legitimate complaint, helped fuel some o’ this problem.”
Translation: It used to be that you could buy real estate with 20 percent down and 80 percent could then be financed by a lender. If you didn’t have 20 percent down you could buy with less cash up front if you could get the FHA, VA or a private mortgage insurance company to guarantee the loan. With the introduction of so-called “affordability” loan products, down-payment requirements melted away, stated-income loan applications became common and risk soared. Figures from the National Association of Realtors show that in 2007 the typical first-time buyer purchased with just 2 percent down while 29 percent of all buyers bought without any down payment.
Dimon also said this: “If I had to point out my biggest mistake, probably of my whole career, (it) was not closing down our mortgage broker business sooner. Okay? It, a mortgage broker product, that was not our own salesperson from the client, has two or three times the loss rates of all our product(s). There was excessive leverage everywhere, everywhere in the system.”
Mortgage brokers think Dimon is off base, far off base.
“I understand the need to blame someone outside the financial institutions for the failures of leadership and accountability to their respective Boards of Directors” said NAMB’s Savitt, “but Mr. Dimon should admit to the world that they created mortgage products and sold them through all origination channels — banks, lenders, credit unions, homebuilders, mortgage brokers — based on Wall Street’s determination that they could be securitized and sold to investors across the globe. Most Wall Street investment banks owned the largest of the subprime lenders, a fact Mr. Dimon failed to disclose in his remarks”
JPMorgan Chase has the final word, of course. In January it closed its wholesale mortgage business.
As bad as it may be for mortgage brokers that Chase and other big lenders are shuttering their wholesale operations, there’s another problem which is emerging: Washington has begun to talk about limiting overage and otherwise reforming the mortgage brokerage business.
The New York Post reports that Rep. Barney Frank, D-Mass., chairman of the House Financial Services committee, will “introduce, by March 30, a bill, which will make loan originators — and not investors in the collateralized paper — pay for the first losses on subprime loans.”
The paper notes that the legislation is designed to “keep mortgage brokers from pocketing additional commissions for steering customers into riskier but higher fee-generating mortgages.”
“The mortgage lending system is now being restructured,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the leading online marketplace for foreclosure properties. “Lenders simply cannot avoid the marketplace realities that have threatened the entire financial system and driven millions of people into foreclosure and bankruptcy. No less important, if reform is not made within the industry then the federal government is likely to create new rules and standards to protect both borrowers and the financial system. Fair or not, mortgage brokers and all loan officers are likely to face major changes in the way they do business.”
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.