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   ARTICLE   |   From Scotsman Guide Residential Edition   |   May 2007

Behind the Curtain

Think the back end of the mortgage process doesn’t affect brokers? Think again

Stated-income mortgages were popular in the past few years. Mortgage brokers and lenders offered these loans — which often were in the nonprime market — to help an increasing number of homeowners purchase or refinance their homes.

Many mortgage brokers and loan originators never checked the reality of the stated-income mortgages they originated, however. Too often, the idea was to get a loan closed, earn a commission and move on to the next one. Many people assumed that if the lender’s underwriter approves the loan, then the stated income listed on the 1003 residential loan application must be fine for the borrowers’ job title.

That pervasive sentiment now stands in the face of the mounting foreclosures associated with stated-income mortgages. Brokers and loan originators are increasingly being affected by the foreclosures of loans they originated. To understand why and how, you first must understand the mortgage-investment food chain.

Most loan originators understand the relationship between themselves, their mortgage brokerages and the lenders they use to approve loans. But often, they don’t know what happens after the loan closes because it does not impact their financial lives. That is changing, so it’s time to take notice of the back end of the mortgage process.

How it works

Few lenders service the loans they approve. This is especially true in the nonprime market, where stated-income-mortgage foreclosures are increasing. Most nonprime lenders sell their loans on the secondary market to large mortgage-investment firms or banks.

Consider the following sample scenario, in which “Bank A” is a nonprime lender and “Bank B” is a mortgage-investment firm that buys loans on the secondary market.

Bank A packages groups of its closed mortgages together to sell to Bank B for an upfront fee. Bank B uses the packages of mortgages as investment material for its clients. It also services the mortgages and collects interest in the long term. Bank A accepts an upfront fee versus collecting the mortgage interest in the next 10 to 30 years. It gets instant profit and avoids the overhead costs (e.g., employees and paperwork) associated with mortgage servicing.

Bank B, however, is increasingly concerned with the true salability of Bank A’s mortgages. It does not trust the lender and its underwriters. After all, the underwriters know the mortgages they approve will be sold within weeks of closing, and they are pressed to approve mortgages.

Bank B typically employs two safety measures to prevent getting stuck with many “near-future foreclosures.” First, it makes Bank A agree to buy back any mortgage that defaults or goes into foreclosure within a certain time period after the sale. This period rarely exceeds 12 months.

Second, Bank B uses a due-diligence underwriter. Also known as back-end underwriters, these contractors take another look at the mortgage, the borrowers’ credentials and the original underwriter’s decisions.

Essentially, due-diligence underwriters review closed mortgages and offer advice on their suitability as good, long-term investments. The due-diligence underwriters look at anything the investment bank tells them to, from basic compliance issues to complete re-underwriting of the closed mortgage.

As foreclosures mount, Bank B asks its due-diligence underwriters to look far more closely at Bank A’s mortgages. Specifically, due-diligence underwriters are performing the following activities: comparing stated income and job titles on 1003s to online salary databases; matching job titles on 1003s to employment-verification documents; performing fraud checks on borrowers’ employers, addresses, phone numbers and relationships with brokers and appraisers; reviewing credit reports for poor credit histories; and reviewing appraisals for poor comparables.

In addition, due-diligence underwriters have begun to report mortgage-broker and loan-officer information on a mortgage-by-mortgage basis to Bank B. As a result, it can now match good and bad mortgages with specific mortgage brokers and loan officers.

More due-diligence underwriters are “failing” closed mortgages based on stated incomes that are not logical for borrowers’ jobs. They give this information to Bank B and advise it not to purchase those mortgages. Bank B then tells Bank A why it won’t purchase certain mortgages.

As a result, Bank A must continue to fund the mortgages that it had planned to sell. Like most nonprime lenders, it uses a warehouse line of credit from a retail bank. These are meant to be short-term sources of funding to bridge the gap between closing mortgages and selling them to Bank B.

What it means

As more stated-income mortgages are refused on the secondary market or go into foreclosure, nonprime lenders often must buy the mortgages back. As such, they are losing a lot of money quickly — hence the rash of nonprime lenders that have filed for bankruptcy or gone out of business in the past few months.

It does not take long for the lenders to make the same connection their investment banks have made. As lenders look for a reason behind their losses, they focus on the mortgage-broker and loan-originator data their investors and due-diligence underwriters provide.

Further, the pressure on mortgage brokers and loan originators to take more responsibility for the information they submit to underwriters is not just coming from lenders and investment banks. House Financial Services Committee Chairman Barney Frank, D-Mass., has said he wants to pass legislation that places suitability standards on mortgage brokers and lenders by the end of this year.

The proposed legislation will, among other things, require mortgage brokers and loan originators to take more responsibility for putting borrowers in mortgages they cannot afford to pay. Federally and state-elected officials are supporting Rep. Frank’s agenda as more high-risk mortgages go into foreclosure, thus creating complications for borrowers and for mortgage lenders.

The bottom line is that mortgage brokers and loan originators are facing — or soon may face — a substantial piece of the financial consequences associated with the increasing defaults and foreclosures in the stated-income and nonprime mortgage market.


 


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