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Archive for the ‘Mortgage Brokers’ Category

Consumers are often confused as the various types of mortgage lenders available to them.   It is extremely important that you know who you are dealing with when it comes to your largest financial transaction.

Mortgage Brokers: Often confused with the other lenders, mortgage brokers do not actually lend their own money.  Mortgage brokers arrange financing from relationships with a number of a different banks.  The mortgage broker will provide counsel on the types of loans you will qualify for and will guide you through the loan process.  However, the mortgage broker does not actually approve the loan, nor do they actually fund the mortgage.

The advantage of a mortgage broker is that they have very low overhead and work with multiple lenders, so on average they will be cheaper to deal with.   Mortgage brokers obtain interest rates on a wholesale basis from mortgage banks.  In addition, some of the best mortgage originators tend to work for brokers.  However, the disadvantage of a mortgage broker is that there are a lot of bad ones. 

Most mortgage brokers tend to be small Mom & Pop type businesses.  Many may have very strong brand names in their local market, but rarely any kind of national brand recognition.  However, with the recent crisis in the financial markets, mortgage brokers are seeing their numbers dwindle dramatically as most are not large enough and financially stable enough to make it through these tough times.

Direct Lenders: A direct lender is a mortgage company that has the ability to underwrite and fund their own mortgages.  Typically, after the loan is funded, the lender then sells the loan to a larger mortgage bank or institution.   In fact, a large number of direct lenders still shop multiple banks like mortgage brokers, but they retain the ability to underwrite the loan and fund it so they don’t lose control of the transaction like a pure mortgage broker. 

The advantage of a direct lender is that they can be like a mortgage broker, but they tend to be larger more stable companies and have more control over the transaction.  The disadvantage is that some direct lenders can be bloated and may not pass savings on to consumers.   Many well known mortgage lenders such as Quicken Loans, E-Loan, etc are examples of large national direct lenders.  Perl Mortgage is a direct lender.  Direct lenders often times will refer to themselves as “mortgage banks” because they are actually writing the check for the mortgage, however, this can be a little misleading as they aren’t really banks.

Mortgage Banks: A true mortgage bank is also known as a depository institution.  In other words, these banks use the deposits from its customers to make other loans such as mortgages.  True mortgage banks are the large retail banks you find on your local corner – Wells Fargo, Bank of America, Citibank, etc.  

The advantage of these banks is that they have brand recognition.  Since Mortgage Banks are the source of funds, they also underwrite and fund the loans.  The disadvantage is that they are large institutions and they also only offer one mortgage product which may or may not be the best for you or the most competitive.  In addition, big banks are not known to have the most knowledgable loan officers and you may be dealing with a call center.

Regardless of which type of lender you use to get your mortgage, it is important that you spend a lot of time vetting the individual loan officer.  Mortgage may be a commodity, but the loan officer is not.  Ninety percent of your experience will be driven by the individual loan officer which can make all the difference in the world in this market.

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I was going to write something on how to read Good Faith Estimates (GFEs), but an article on CNNMoney.com caught my eye.  As you know, I have been pretty critical of the mainstream media in their reporting of mortgage issues.  Mainly because they don’t have a freaking clue.  This article is yet another piece that is so full of misinformation all I can do is just shake my head.  Journalist have really got to do a better job sourcing information and really understanding the issues they are writing about.  However, I guess this is what you get when you have english majors who have never done anything but journalism writing stories on business topics.

The CNN article is about Yield Spread Premiums (YSPs).  YSP is how mortgage brokers are compensated.  Basically, it is compensation paid by the mortgage lender to the mortgage broker for delivering a mortgage loan at a certain interest rate.  The best way to think about YSP is as a profit margin.  In short, the Wholesale Interest Rate plus the Yield Spread Premium paid to the Broker equals the Retail interest rate.  For those of you with low reading comprehension skills, put another way:

Wholesale Rate + YSP = Retail Rate.  Simple enough, right?

For the life of me, I cannot figure out why this concept is so hard to understand?  In predictable fashion, the article characterizes the YSP as some evil “kickback from lenders in return for steering consumers into more expensive loans – a problem that the Federal Reserve failed to address.”

Let’s address the kickback issue.  Why do lenders pay YSP to Brokers?

Lenders pay YSP to brokers because it is cheaper than paying their own workforce for the broker’s client.  The broker incurs the cost of advertising, marketing, and other business expenses to originate (obtain clients) a loan.   In other words, YSP is an incentive to the broker to use that bank’s products.  The bank has to compensate the broker for their work and YSP is how they do it. 

Doesn’t YSP raise my interest rate?

Yes and No.  Remember, banks offer mortgage brokers WHOLESALE interest rates.  The RETAIL interest rate is the rate that includes the YSP.  Put another way, Bank A may have 30 year fixed rate loans at 6% with no YSP.   This is known as the par rate.  However, if the broker sells the client the loan at 6.5%, the bank will then pay the broker say 1% of the loan amount as YSP.   At 6%, the broker is not being compensated, so they would have to charge the borrower “points”.  The borrower is either going to get 6% with 1% in total points or 6.5% with no points.  No borrower will ever get 6% with no points as that would put the broker out of business since there is no profit margin either in points or YSP. 

The most egregious error in the article though is that it fails to mention that if the broker is offering a borrower 6.5% with YSP baked in, that rate is still cheaper than if that borrower went to the bank directly. 

Does the Broker have an incentive to earn as high of a YSP possible by giving me a higher rate?

The last time I checked our economic system is solidly capitalist.  When I price a loan I want to make as much profit as possible while remaining competitive.  It is the American way.  However, at the end of the day, it is IMPOSSIBLE for a broker to gouge a consumer who aggressively shops for their mortgage.  If a broker is trying to raise the rate on a deal so they can make 2% in YSP on a deal that most other brokers might do for 1% YSP at 6.5%, it wouldn’t take but two or three phone calls to competiting brokers to uncover this as the inflated YSP is going to result in a higher rate being offered than other competitors.  It really is that simple.

Why did the Fed ignore the YSP issue in their ruling?

Because the Fed figured out that YSP doesn’t matter to consumers.  Let’s take a little test.  You are shopping for a mortgage.  Broker A quotes a rate of 6.5%.  Broker B is quoting 6.875%.  Banker C works for Kuntrywide and claims he doesn’t charge the ripoff YSP since he is a banker and his rate is 7%.  Broker A does a lot of loans and has a special deal where he gets incentive pricing and will earn a YSP of $8,000.  Broker B only gets a YSP of $4,000.  Banker C doesn’t disclose since banks are treated differently. 

Which is the better deal?  Broker A making $8k in YSP at 6.5%,  Broker B making $4k in YSP at 6.875% or Banker C with the “free” loan at 7%?

If you are smart enough to own a home, you are going to pick Broker A because it has the lowest rate of all the lending choices you had REGARDLESS OF HOW MUCH PROFIT IS MADE ON THE LOAN.  You could give a rats ass what he is making.   He gave you the best deal out of all the competitors you called.

Real life example.  I just closed a loan yesterday and had a YSP of $5200, no points.  The borrower asked me to lower the YSP after I disclosed it on the GFE.  I said no.  The rate was 5.250% on a 5/1 i/o ARM.  Why did I say no?  Regardless of my YSP, there was no way anyone was going to be able to match that rate.    The borrower soon figured it out and agreed.  End of discussion.  They got freaking good deal and at the end of the day, my YSP was irrelevant because the closest competitor had pricing of 5.75% on the same loan.

At the end of the day, it bothers me that such misinformation is spread around by news sources.  Some consumer is going to read this article and think their broker is ripping them off when it isn’t the case.

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I haven’t been shy about pointing out that the mainstream media seems determined to paint mortgage brokers as the bad guy.  While I am not a conspiracy theorist, I can’t help but wonder if mortgage banks are paying off the media big wigs or are journalist really just not qualified to discuss financial issues.

On Friday, CNN’s Gerri Willis will be doing a show on the Mortgage Meltdown.  While I expect the whole show will be devoid of facts and attempt to absolve the consumer of any responsibility for fiscal mismanagement, something caught my eye today that leads me to believe the media is really biased.

CNN is running a web piece called “The lies broker’s told.”    It then goes on to say, “An ex-Ameriquest mortgage broker reveals how he talked borrowers into loans then couldn’t afford.”  The piece shows Gerri Willis interviewing some guy as a former Ameriquest employee discussing how he duped consumers.

Here’s the problem.  Ameriquest, the poster child of predatory lending, is not a mortgage broker.  In fact, Ameriquest was a mortgage bank.  Ameriquest did not broker mortgage loans.  They were a retail sub-prime mortgage bank. 

Are there bad mortgage brokers?  Sure.  However, the media has done an effective job of placing the whole implosion of the mortgage market at the feet of the broker community.  I don’t think it is accurate and their lack of knowledge of the business shows in hit pieces like this…

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gas-stations.jpgThe other day, I showed you how the gas stations and mortgage brokerages have a lot in common.  You can read it here.  As promised, there is more to the story between Big Moe’s and BP. 

Recall that Big Moe’s is just across the street from BP.  Since Big Moe’s doesn’t have much overhead, he is buying gas from BP wholesale and selling it to consumers five cents cheaper than the BP located just across the street.  As the customer, you are happy because you get cheaper gas.  Big Moe’s is happy because they are a making a few cents profit.  BP is happy because even though they didn’t sell the gas to you directly, they indirectly made money through Big Moe’s selling it to you.

This goes one awhile and everyone seems content.   One day, a new gas station opens up on the same street as Big Moe’s and BP.  This new gas station is Citgo.  Citgo is just as big of a company as BP with fancy restrooms and kids play areas.  Both Citgo and BP are still five cents more expensive than Big Moe’s.

Citgo decides that they have refined too much gas and they too call up Big Moe’s and tell them that they can sell gas wholesale cheaper than BP.  Being an astute businessman, Big Moe’s takes Citgo up on their offer.  After all, his customers don’t care if it is BP or Citgo gas.  All they care about is getting gas five cents cheaper than going to BP or Citgo and Big Moe’s can make a little more money.   Everyone is happy.  Except BP that is…  Not only is Big Moe’s undercutting BP, but they also lost money to Citgo since Big Moe’s is no longer exclusively using BP for their wholesale gas.

BP starts noticing fewer and fewer cars showing up while Big Moe’s seems to be doing pretty well and Citgo is also making money.  BP decides that the only way they can compete is to undercut Citgo’s wholesale price.  BP drops their wholesale gas prices and approach Big Moe’s with their new wholesale price.  Of course, Big Moe’s agrees to the lower price and he is making more money and still selling gas cheaper than either BP or Citgo.  Now Citgo is pissed at Big Moe’s as he is getting even more business and has no loyalty to either BP or Citgo.  Citgo and BP are essentially fighting each other while Big Moe’s is laughing all the way to the bank.

One day, the CEO of BP calls for a meeting with the CEO of Citgo.  They discuss lowering their gas prices to compete with Big Moe’s, but it becomes apparent that they can’t afford to because they are also sponsoring the local NASCAR driver.   They also just bought a bunch of corporate jets, not to mention their big executive salaries.   Their cost are just too high.  They are really upset that they started wholesaling gas just to make a little extra money, but didn’t expect some rinky dink gas station like Big Moe’s to steal all their market share.  Big Moe’s started off with about 5% market share and quickly grew to almost 60% in no time.  This is unacceptable the CEOs thought.  Both CEOs then decide they have an idea.  They call up their friend who happens to be the Mayor of the town.  We will call him Barney Frank, I mean Fife.  They tell Barney that Big Moe’s is gouging customers and that theses small gas stations need to be licensed better.  They also donated a lot of money to his campaign, so Mayor Fife owes them one.

Being the great Mayor that he is, Mr. Fife imposes a law that says gas stations that don’t refine their own gas have to disclose their profit margins to their customers.  Since gas is so complicated, these profit margins are going to be called yield spread premiums (YSP).   The YSP must be disclosed on the pump of the gas station at Big Moe’s for all consumers to see.  Mayor Fife doesn’t believe REFINERS should have to disclose their profit margins.  Refiners call their profits service release premiums (SRP).  The logic is that it would be too cumbersome for a refiner to disclose since they aren’t sure what they are going to sell the gas for at the time of refinement.

In addition, the Mayor also says that places like Big Moe’s must have their bathroom’s cleaned.  However, this portion of the law only applies to places like Big Moe’s that don’t refine their own gas.  Refiners aren’t required to follow city cleanliness laws because it would interfere with commerce of large refining gas stations.

Naturally, Big Moe’s isn’t too happy about these new laws, especially since they only apply to him and not the other gas stations on the street.  However, he didn’t have the extra money to contribute to the Mayor’s campaign, so he just chalks it up as being “politics”.  It doesn’t matter to Big Moe’s though.  He knows most of his customers are smart enough to figure out that the only thing that matters is the price of his gas, not how much profit he is making on it.  He lost a few customers when they saw he was making 1-2% profit on a gallon of gas.  Not enough to lose sleep though.

Even after all these challenges were thrown in front of Big Moe’s, his volume of gas continued to grow.  In fact, he now had a nice gas station and more amenities than both BP and Citgo.  His share of the market place grew from 10% to about 60% in no time.  He also never told BP or Citgo that he started buying gas from another refiner who was even cheaper called Shell.

To Be Continued…

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bpgas1.jpgThe easiest way to explain how mortgage brokerages work is by using an unrelated industry.  Mortgages are not something people deal with frequently and because it is financial product, I can understand the confusion.  However, everyone can relate to buying gas.

Let’s imagine you are taking a road trip to visit your family this Thanksgiving.  About 300 miles in you look at your dashboard and the gas needle is at less than a 1/4 tank.  You need to fill up so you pull off the highway to find a gas station.  On the left side of the road is BP and on the right side of the road is Big Moe’s Gas Station.  The BP gas station is brand new with balloons, a kid’s play area, bright and shiny signage, etc.  Big Moe’s on the other hand is pretty rinky dink next to the BP by comparison.

You are there to get some gas, so all you are thinking about is the price of a gallon of gas.  BP has regular gas advertised for $3.00 per gallon and Big Moe’s has gas for $2.95 per gallon.  A large number of consumers are going to go to Big Moe’s to save money and some are just going to go to BP because they are familiar with BP and never heard of Big Moe. 

Most people wonder how Big Moe’s is able to undercut BP.  It is simple.  Big Moe doesn’t have the same overhead as BP.  Big Moe isn’t offering a kid’s play area.  Nor is he too particular about keeping the bathrooms clean.  He is only there for one purpose and that is to offer you gas cheaply.  Since you really don’t care about all the other extra’s BP is offering, you go get gas from Big Moe’s to save a few cents.

Most people would think that BP would be upset about losing business to Big Moe since he is undercutting them.  However, BP is smiling all the way to the bank.  See, Big Moe is actually getting his gas from BP wholesale.  Big Moe is actually selling you BP gas five cents cheaper than the BP gas station across the street.  BP produces too much gas for them to sell only through their company owned gas stations, so they sell extra gas on a wholesale market to privately owned gas stations.   The wholesale gas is cheap enough from BP wholesale so that Big Moe can buy it, add a few pennies to the price so he can make a profit and still offer the gas cheaper than BP does through it’s own retail gas stations.  

Everyone is happy.  You got cheaper gas.  Big Moe’s made a few cents profit.  BP made money selling gas to Big Moe’s.

This folks is EXACTLY how the mortgage brokerage business works.  Mortgage brokerages are just like Big Moe’s and large retail mortgage banks are BP. 

There’s more to this story though… check back tomorrow.

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Show Me The MoneyLoan Originator compensation is one of the world’s last big mysteries.  Fortunately for you, I am here to provide the answers.   When I say Loan Originator, I am referring to mortgage brokers and loan officers at banks.  The term is being used generically.

For the most part, all Loan Originators work on 100% commission basis and wouldn’t have it any other way.   Salaries are a for wimps.  They are only paid when your loan actually closes.   The LOs compensation is derived from the fees paid on a loan and can be structured in any number of ways.  Regardless if you see it or not, LOs are going to get paid as no LO is going to do a deal for free on purpose.

LO compensation can range from as little as .5% to 4% on a deal with typical fees ranging from 1 to 2% of the final loan amount.  So if a LO is making 1.5% on $400,000 transaction, the compensation amounts to $6,000.   While this is a lot of money, keep in mind that it is also usually split with the LO’s employer.  For simplicity, let’s assume 50/50.  So the LO gets $3,000 for the transaction and their employer keeps $3,000.  While that seems like a lot of money for one transaction, most LOs don’t do a substantial amount of business so that might be their only closing that month.  In addition, LOs spend an inordinate amount of time working on deals that die on the vine so they are not compensated adequately.  Obviously, if the LO is a top producer closing dozens of transactions each month, you can see that the sky is the limit in regards to income which is why the field is so popular.

LO Compensation is paid in one of three ways: 1) Buyer 2) Lender 3) Combination of Buyer & Lender

Buyer Pays: When the buyer is paying the LO, it is usually in the form of points or an origination fee.  The loan officer tacks on his 1.5% or the agreed upon amount as part of the closing costs.  Typically, this will allow the borrower to get a lower interest rate.    Even though you may get a lower rate, this may not be the best approach unless you plan on staying in your home for a long time.  It may takes three or four years to breakeven from paying points.

Lender Pays: When the lender pays, it is known as Yield Spread Premium (YSP) in the case of brokers or Service Release Premium for mortgage bankers.  Instead of offering you 6% with 1.5% in points, the LO may offer 6.5% with no points.  The 1.5% that the LO desires for compensation is instead paid by the lender for giving you the 6.5% rate instead of 6% rate.  By doing it this way, you don’t have to come up with thousands of dollars in additional closing costs.    The higher the rate, the larger the YSP/SRP paid to the LO.

It is important to note that if a loan has no points/origination fee then there is ALWAYS a YSP/SRP being paid to the LO.   By law, mortgage brokers must disclose the YSP they plan to earn on the Good Faith Estimate and any YSP will always be shown on the final settlement statement.  Mortgage banks are not required to disclose their SRP. 

Specifically, YSP has come under fire because many consumer groups believe that since the final rate increases as YSP increases that the LO has an incentive to upsell rates as much as possible.  While this is true to some degree as it is with any business that wants to make a profit, it is impossible for a LO to gouge a consumer who is proactively shopping for a mortgage.   If you have a standard mortgage and an LO is trying to make 3% on it when most LOs would probably do it for 1-1.5%, a few phone calls will quickly result in the gouging LO to be undercut by the competition as their final rate will be significantly higher than everyone else.

With few exceptions, most lenders offer rates within a very narrow range.  As such, most good LOs know when a borrower is being bait and switched because the YSP will not be available to realistically offer the rate to the borrower profitably.

Buyer & Lender Pays:  Sometimes the LO may structure the deal so some portion of the compensation comes from the borrower and some from the lender.  For instance, say the LO needs to make a total of 2% on the deal to feel adequately compensated.  The LO may charge 1% origination and receive 1% YSP/SRP from the lender.

Alternative Approach – Upfront Mortgage Brokers/Lenders

In order to prevent any inpropriety on the part of the LO, many have been operating in an upfront manner by agreeing to a set fee upfront with the borrower.  For example, a borrower agrees to hire an LO as an agent and pay the LO 1.5% (or whatever is negotiated) of the final loan amount for securing their financing.  In turn, the LO agrees to share their wholesale interest rates from their approved lenders with the borrower.  With this approach, the goal is transparency from both parties.  The LO can focus on the consumers needs knowing ahead of time that the borrower is not rate shopping them and the consumer can trust that the LO is working on their behalf in a transparent manner.

Many LOs have been doing this for years, myself included, but the practice was branded by Wharton Business School Professor, Jack Guttentag aka The Mortgage Professor.  He calls this approach Upfront Mortgage Brokers/Bankers or UMB.

While the transparency of UMB has some advantages, it really only works when you are dealing with mature consumers who understand money, service, and value.  Most consumers prefer to just call around and see who gives them the lowest rate quote ignoring all the risk inherent with that approach. 

It is important to note that dealing with a UMB DOES NOT assure you get the lowest rates.  It only guarantees the loan officer’s compensation and that they will be working on your behalf.  While there is a linkage between LO compensation and rates, it is not linear and varies greatly depending on what lenders a loan officer has access to in regards to rates and programs.  In other words, it is entirely possible for an UMB who agrees to 1% compensation to offer higher rates than a broker who is making 2% in compensation.  However, it should not be the rate or the LO’s compensation that is driving the consumer to the UMB, but being able to work with someone who is transparent, trustworthy, and who will not surprise you at the closing table.

The bottom line for consumers is that you should never be afraid to ask how the person representing you in your largest financial transaction is compensated.

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I haven’t posted much over the past few days because I have been bombarded with fire drills to help save loans for borrowers whose lenders either went belly up or because the lender is no longer offering certain loan programs.  The mortgage market is in a tough time right now as Wall Street has cut off funding for many mortgage lenders and mortgage investors are demanding higher quality loans.  Unfortunately, until they get their heads around the problem (or out of their asses) they are also throwing out the baby with the bath water. 

Even the most credit worthy borrowers can find themselves without money the day of closing.  The bottomline is consumers need to take a step back and reassess their choice of lenders and focus on reliability, expertise, and access to funds instead of blindly rate shopping at this point in the game.  It is now more important than ever to shop for a reliable mortgage broker, not simply a mortgage.

Fortunately, most of the emergency loans that have come into my office I can do with very little increase in promised rates and in some cases even better which illustrates why it is important you understand how to pick lenders who have options in case something does not go as planned.

In order to navigate this market, consumers need to:

Choose Mortgage Brokers, Not Mortgage Banks:  Most retail mortgage banks only offer their specific loan products.  If their access to funding dries up or underwriting guidelines change, you may be left without financing options.  Good mortgage brokers have access to dozens if not hundreds of lenders.  If one bank can’t do it, we can find another who will.   You need to ask your lender about how many end lenders or investors they work with.  More specifically, ask if they have a back up lender in place if the original investor can’t do the loan.

Correspondent Lenders are Better:  Correspondent mortgage lenders are basically mortgage brokers on steriods.   A correspondent lender can underwrite and fund their own mortgages through their credit lines and sell them off to investors after closing.  The reason it is important to work with a correspondent is because if there are problems, we can usually just change who we are going to sell the loan to after closing.  This means we can continue to meet established timelines in most cases.  Traditional brokers are at the mercy of the turn times of the actual lender, so if you only have two or three days to fix a problem, a regular mortgage broker may not have enough time to get the loan resubmitted to a new lender in order to meet the closing date. 

Grill Your Loan Officer:  Make sure you are dealing with an established professional who understands underwriting guidelines and what can get done in this market.  An established professional means they were referred to you by a trusted co-worker, Realtor or family member who has dealt with the lender previously.  It also means they can demonstrate a signifcant book of referral based business (closing at least $10 million/year in deals).  You do not want to be dealing with newbies and “call center order takers” in this market who are learning the ropes on your largest financial purchase when you could have tens of thousands of dollars at risk.  Make sure your loan officer has at least three years in the business doing purchase loan transactions and “A paper” lending. 

Pre-Approvals are a Must:  Financing comes first, not house hunting.  Absolutely do not make offers and submit earnest money on properties without a solid pre-approval from the mortgage broker you have chosen.  Pre-approval means you have submitted credit, income, and asset documentation to the lender and the loan has been formally underwritten.  Demand to see the conditional loan approval signed by the underwriter verifying the loan is approved at the terms promised.  Finally, under no circumstances should you waive your right to a mortgage contingency in your contract.  The mortgage contingency gives you an out and protects your earnest money if for some reason you can’t get financing.

It is Not About Rate:  Getting a good deal is important.  However, attempting to save .125% and $50 bucks only to have the deal blow up in your face at the closing is not worth it.  Being able to sleep at night knowing your deal is secure is a lot more valuable.  Reliability and the ability to get it done on time as promised is what is important right now.  Rate shoppers beware.  

 If you are unsure about your financing options or just want a second opinion, do not hesitate to give me a call.

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