Anatomy of a Bad Loan

The other day one of the loan officers in my office came in to show me a good faith estimate for one of her clients. The borrower didn’t use her for a mortgage, but instead used a company that called her off a trigger list. The borrower called my co-worker back after the closing realizing that she had probably been taken advantage of. Needless to say when we looked at the settlement statement we almost choked.

I have posted the borrowers final good faith estimate here and the names of the company and borrower have been removed to protect the guilty and innocent. This is also an example of the sub-prime excess and quick buck mentality that is plaguing the industry right now.

One of the problems with the mortgage business is that is too easy to hide the true cost of the mortgage. Most borrowers have absolutely no clue how to read a settlement statement and really compare mortgage loans. The end result is situations like this. In addition, too many borrowers do not take a step back and focus on the big picture of this being the largest financial transaction of their lives, but instead spend too much time rate shopping and nick picking over $50.00 or they allow themselves to be sold by some sheister.

To summarize, this was a self-employed borrower who was going through some tough times and wanted to get some cash out of their home until things turned around. In short, they got cash out alright. They paid a whopping $22,169 in fees in order to get $27,750.17 in cash. Yes, you read that right. I don’t even think it is worth calculating the interest. Not only that, this boiler room loan officer also put the borrower into a 2/28 with a three year hard prepayment penalty of six months interest. Remember, the point of the transaction was to be a temporary fix which means refinancing as soon as possible. The prepayment penalty will also cost the borrower another $21,454 if the loan is paid off in three years. Talk about usury, this borrower would have been better off just running up their credit cards.

So how do you read the good faith estimate above?

Lines 800: These are the fees the mortgage broker and end lender charged the borrower. This section includes items such as the appraisal, underwriting, processing, and all the miscellaneous fees incurred when purchasing or refinancing. The one that sticks out is line 801 which is a $14,000 origination fee which comes out to 2.2% of the loan amount. Folks, this is pure profit for the broker. Now I don’t believe we should be working for free, but to “earn” $14k worth of fees for a few hours of work? Making you rethink medical school, huh?

The other item that sticks out is the loan discount fee of $3155 on line 802. A discount fee is where the borrower buys the rate down below par. In other words, the actual rate of the loan should have been higher, but by paying the discount fees you can get a lower rate. This is a favorite tactic of lenders when they low ball rate quotes. For instance, Quicken loans is running radio ads right now all over Chicago saying “Refinance to get a rate around 5.5%.” What they fail to tell you is that the 5.5% rate is going to cost you several thousands dollars or more in discount points. What you don’t see on here is the original good faith estimate initial disclosed which showed the broker making $18,000. My guess is what happened was the interest rates moved up, so the broker had to use the some of the origination fee to pay the discount point to keep the rate as originally promised. All of the other fees in this section are typical, albeit on the high side.

Lines 1100: These are the charges associated with the title company. There is definitely something funky going on here. Typical title fees at reputable title companies in Chicago run about $1500-$2000 on purchases. On most refinances, title charges are $500-$750. This transaction is a refinance. The total charges for title fees are $3150! More than $2500 higher than market rates. My guess is that the title company is somehow related to the lender through an affiliated business arrangement. Nevertheless, this is absolute robbery.

Lines 900: This is just prepaid interest. It is basically the first mortgage payment prorated from the day of the closing till the end of the month. Nothing out of the ordinary.

Total Estimated Funds Needed to Close: This section is detailing the crime and where all the money went in the transaction. The borrowers original mortgage was $579,293. The loan officer gave the borrower a new loan of $631,000, so the borrower had access to $51,707. However, the closing costs were $22,169 and the prepaid interest was another $1787.83 for a total of $23,956.83. So the borrower walked away from the closing with just $27,750.17. Nearly half of the cash was to pay for the closing costs, the bulk of which is broker compensation. Unbelievable. Given that there is a prepayment penalty of $21,454, the borrower AT BEST actually got $6,296.17. Of course, I didn’t even factor into this the actual cost of financing all of these closing costs into the loan which would make it even less.

What most reputable loan officers/brokers would have done is maybe charge one point origination point and dropped the discount point or just took a small yield spread premium. Since this is a short term transaction, we would have looked to minimize the total closing costs to the borrower even at the expense of a higher rate. In addition, because this is a short-term transaction, the broker would have been more than compensated by getting paid the second time around on the refinance out of this loan. Second, a prepayment penalty should have been an absolute no no in this situation.

Keep your guard up.