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Posts Tagged ‘Mortgage Brokers’

The New York Times has an interesting graphic showing the areas of the country where home owners owe more than their home is worth.  In other words, Joe Homeowner has a $300,000 mortgage on a home that is now just worth $250,000.  This is called being underwater by about $50,000. 

Being underwater is not a good thing.  Ever.   One of the reasons there are so many foreclosures is that many home owners who are in trouble financially are unable to sell their homes at prices that would pay off their current mortgage and they are also unable to refinance because no lender is going to grant a new mortgage on a property that is worth less than the loan amount since it is the home that is securing the loan.

What is interesting is that Illinois has a fairly sizable bubble indicating a decent number of homes underwater.  My guess is that the much of that bubble is driven by the far flung suburbs.  Like many areas in the country, Illinois had unchecked development out in the middle of the sticks as homeowners moved further out into the exburbs due to cheaper prices.  However, as gas prices surpassed $4.00/gallon, living in a bland McMansion in a former cornfield didn’t seem so appealing when you have to drive 30 miles each way to work everyday in a SUV.

Most my clients that live in the city haven’t had any problems getting the needed appraised value on refinances.  Typically, we have been assuming that the home is worth what the borrower paid for it if bought within the last two years.  Generally, this hasn’t been an issue.  So while the Chicago market certainly isn’t booming anymore, it also isn’t totally cratering either.

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Online lender E-Loan recently announced that they will be shutting down their mortgage operations after the first of the year.  Most people will chalk this up as another lender cratering due to the credit crisis.  I chalk it up as just a failure of the online business model for mortgages.  Ever since the internet all but destroyed travel agents, every one has been predicting the same would happen to mortgage brokers.  The failure of E-Loan puts the nail in the coffin of that theory.  The credit crisis merely exposed the flaw in the business model.

The Role of the Loan Officer

The reason E-Loan failed is because they did not understand the role of the loan officer.  The simplistic way of thinking is that you can eliminate the highly paid workforce of loan officers and pass the savings on to the consumer by opening up huge call centers staffed with hourly workers.  The problem with this approach is that it ignores the central role of the loan officer at a bank or brokerage which is to GENERATE BUSINESS (bring in mortgage loans). 

The Flawed Model

The theory behind businesses such as E-Loan is that they would be able to lower costs and pass it on to consumers.  This almost never happened.  Business models like E-Loan instead chose to spend a ton of money on advertising to bring in business and minimize the role of the loan officer as the rain maker.  There are two obvious problems with this approach.  First, it ignores the inherent cost of large scale advertising.  Second, it costs a ton of money to staff up a call center with non-productive loan officers.  As a result, E-Loan could not pass on the cost savings to consumers OR its shareholders because while the loan officers compensation may have been lower, the other expenses with running the business were a lot higher than your typical mortgage brokerage that employs loan officers that bring in business with minimal advertising.  In other words, E-Loan was simply not efficient at originating mortgage loans. 

To make matters worse, the business model only really works in booming refinance markets when mortgage loans are falling off the trees.  However, in a down market, it actually takes skill and relationships to bring in mortgage loans.  This is why many mortgage companies who employ top producers are still doing well.  There are several loan officers at Perl who will still close in excess of $75 million in loans this year in a market in which many loan officers can barely close one loan a month!

The mortgage business is very complex and is a lot more involved than simply pushing paper around.  As any great mortgage company will tell you, it is the loan officers that seperate the one company from the next.  When companies devalue their loan officers, it is almost like they are choosing to sell an inferior product.  The results are evident.

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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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Yeah, that is a bold headline, but it seems like there are a large number of consumers in the market right now who don’t have a freaking clue about how hard it is to get a mortgage right now. I don’t care how great your credit is or how much money you make, it is tough. Underwriting guidelines are changing week to week, if not day to day. Even the most experienced mortgage brokers and loan officers find it challenging to stay abreast of the market changes.  I was recently interviewed by nationally syndicated news show First Business X on tightening guidelines.

If you are serious about a home purchase, it is more important than ever to engage a qualified mortgage professional to ensure you have a clear picture of your financing options and if you truly can get a mortgage BEFORE you even think about looking for homes.

I am getting at least two or three calls per week from borrowers who have entered into contracts on properties and are having problems getting a mortgage. Many are well beyond their mortgage commitment dates and may wind up losing their earnest money.

Get Yourself Pre-Approved, not Pre-Qualified

The first step in buying a house is getting yourself pre-approved. I mean really pre-approved. A pre-approval is when you sit down and have a lender formally underwrite the mortgage. A pre-approval means the lender has completed all of the due diligence by evaluating your credit, income, and assets. The goal is to get a formal loan commitment from the lender in writing.

If you haven’t submitted w-2’s, paystubs, and bank statements YOU HAVE NOT BEEN PRE-APPROVED.  Pre-approvals take days, not minutes!  No bank is going to commit to lend hundreds of thousands of dollars and they haven’t seen a paystub! If your lender is saying you have been pre-approved, demand to see a formal loan commitment outlining the loan “conditions” and signed by the underwriter.

A prequalification is just the mortgage broker or loan officers opinion.  All it means is the loan officer feels you have a reasonably good chance of getting a mortgage.  However, until the underwriter actually approves the loan, they really don’t know.  The problem with pre-qualifications is that they are only as good as the person giving it.  Many inexperienced or shady mortgage brokers and loan officers will tell ANYONE they are pre-qualified or pre-approved just to increase their chances of getting your business.  Often times, you won’t know until it it too late or you have to take a worse loan program.

Don’t Let Your Greed Bite You

One of the biggest problems consumers face is that they want the “best deal” and there is nothing wrong with ensuring you are getting competitive terms on your mortgage. However, the problem is that consumers often times forget the other side of the equation which is expertise, service, and professionalism.

What consumers often fail to understand is that rate quotes ARE NOT A COMMITMENT TO LEND. Any mortgage broker or loan officer can tell you they have a super low rate or can still do 100% financing. However, the issue is if the loan can actually close? As a consumer, you won’t know this until it closes. You have to put your faith in what the mortgage broker or loan officer is telling you. This is why it is important that you look beyond the interest rate and ensure the person you are dealing with is reputable and can actually deliver what is being promised.

Too many consumers are not balancing the desire to get that best deal with ensuring they can actually get a mortgage.  In other words, everyone is shopping on price and not results which is a dangerous position to put yourself in as a consumer when you have thousands of dollars on the line in your largest financial transaction.  Buying a home is not the kind of transaction where you need to worry about saving $50 bucks.  It is kind of like shopping for attorney based on their hourly rate without consideration to their win/loss record in court.  Saving money is important, but sometimes you have to focus on the overall big picture.

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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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Yeah, I know I haven’t been a good blogger.  The reality is that I took a little vacation from blogging to focus on my clients.  Despite all of the negative press that you have been hearing about mortgage companies going out of business, there are many of us in the business who actually are having a very good year!  In fact, 2008 is on pace for a record year in volume for me.  However, the mortgage market has been more challenging requiring more work than expected on many deals which has sucked up a lot of my time that I used for blogging in the past.  The formula is simple – increased business with increased amount of time required on deals means less time for blogging.

Nevertheless, I am back with a vengenance.

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Final Four

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