Monday, October 8, 2007

Shock of the Day -- Mortgage Brokers are Just in it for the Money!

I want to begin today's post with a sad story -- just to get you into the "mortgage people suck" spirit, and then I'll explain why Loan Officers deserve to be paid for a day's work just like regular, nice, good people do.

There's a heartbreaking video attached to this article about a man who purchased a tri-plex for $2,600 per month when his take-home pay is only $1,500 per month. He expected to have tenants making most of the mortgage payment, but alas, he learned that being a landlord is not so easy (or predictable). And now he's going to lose his home (which he never should have qualified for to begin with). Along the same lines, someone in my office was telling me today that a woman who earned $1,900 per month ended up with a $7,000 per month mortgage payment.

Now in both of these stories there's probably both a realtor and a Loan Officer who offered bad advice, but at the end of the day, no matter how poor you are, you really should know that you don't have $7,000 per month to spend on a mortgage -- and you really shouldn't buy something you know you can't afford -- certainly not to that outrageous of a degree. That said, it doesn't seem possible for the woman I described to have landed in that position without someone committing some sort of fraud. I'll reserve judgment as to whether or not she was complicit.

One of the ways people have been trying to make sense of this mortgage fallout and prevent it in the future is by trying to blame, not lack of character (because how are we going to fix that?), but the manner in which mortgage brokers make money. It's reasoned that if Loan Officers were not paid on commission, then there would be less motivation for them to seek out loans at every turn. (Which is likely what their employers think and probably why they're paid on commission to begin with!) It seems to really upset people that Loan Officers actually get paid for the services they provide. Here's a stunning quote:

"I was raised Quaker, and so I was taught to see the good in everyone," he says. "Until it comes to people's commissions - then you have to assume they're fundamentally evil."

I wonder if that makes the shoe salespeople at Macy's fundamentally evil? The purpose of commission-based pay is to give people an incentive to produce. On the flip side, Loan Officers who don't produce don't make any money. At all. And here is where the real problem comes in. It's not commission that causes the problem. The problem is that when rates are low and there's a real estate boom, everyone with at least one pair of shiny shoes and a solid handshake gets into the business and tries to make as much money as they can. And then when the party's over, they go back to the used car lot.

Or as Angelo Mozilo recently put it: "When you're born in a boom, you die in a bust."

One more thing I want to clear up from Carol's article is this statement about prepayment penalties:

"Lenders like them because they are easier to sell to the secondary market. "

Actually lenders like them because it deters the borrower from refinancing before they have a chance to make any money off of them, and they are high risk (and therefore expensive) loans. The Loan Officer putting them together can make an obscene amount of money per transaction.

This is how it works - Mortgage Broker gives loan scenario to the lender and Lender says "the rate is (fill in the blank) with a 3 year prepay and that pays you 2.625%." Which on a $250,000 loan is $6,562 (generally about half goes to the Loan Officer and half to his employer).

But some people never want a prepayment penalty (because any Loan Officer who's here for the long haul hopes that in two years the borrower will have ironed out his credit problems and be ready to refinance into a better loan), and so they ask what it will cost to buy it out. The standard answer to this is your borrower will get maybe a quarter to a half of a percent better interest rate and you'll get nothing.

So it's true that subprime lenders issue pricing that encourages pre-payment penalties. And it's also true that the vacuum cleaner salesman who put on a mortgage tie to make some easy money this year, isn't thinking about his relationship to this borrower down the road.

Your stock broker and insurance salesman all get paid on commission too -- nobody ever complains about that. The problem in the mortgage industry (that is actually being addressed now -- about several booms too late) is that it's too easy to get in and out. Many states (Oregon included) are starting to require licensing and continuing education classes for loan originators, and that is definitely a step in the right direction.

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Anjali said...

Our first mortgage had a prepayment penalty, and we had no idea until we refinanced a few years later. My current real estate agent watches out for us so much, she would have never let us do a mortgage with a prepayment penalty.

Our previous agent, I guess, just stayed out of our mortgage business all together -- and unfortunately we paid the price.

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