Residential mortgage production is down, which isn’t surprising given that interest rates have risen, as have home prices.
But, somewhat surprisingly, mortgage fraud has spiked as well.
Hmm. Some experts attribute this to home prices outstripping borrower income, thus motivating borrowers to stretch the envelope in qualifying. It certainly could be a factor.
But it’s likely that there’s another element, one that’s endemic to residential loan origination, and one that raises its ugly head when things get a bit tight.
The people on the point who originate the loan at application, and shepherd it through the qualifying process to closing, are called mortgage loan originators (MLOs). If they work for a mortgage brokerage company, they get paid only if a loan closes and is funded. In other words, they eat what they kill.
As for banks, thrifts (savings and loans) and credit unions, most MLOs are on salaries, often with some type of bonus for each funded deal. If a loan doesn’t fund, they don’t miss a paycheck, but it’s not unusual for banks to put a lot of pressure on loan originators, especially in the case of the bigger institutions. Nonproducers don’t stick around long. Wells Fargo just announced that it’ll be reducing its work force by 10 percent over the next three years. Who do you think will get the ax? People deemed “nonessential” and, of course, nonproducers.
The Dodd-Frank Act, passed in 2009, addressed perceived abuses in the loan origination process, and the compensation of MLOs. It changed who paid the commission, and capped the amount that could be paid, but not how brokers were paid.
Prior to Dodd-Frank, secondary market loan purchasers, i.e. wholesalers, paid a yield spread premium (YSP) to the originator of the loan. The amount of this premium was determined by the loan’s interest rate. The higher the rate that a borrower accepted, the more money the originator made. Can you believe that MLOs busted their chops to induce borrowers to take a higher interest rate? We’re shocked … shocked.
The wholesalers still pay a YSP, but now it goes to the borrower, not the producer of the deal. This YSP goes to reduce the borrower’s closing costs. If a lower loan interest rate is desired, the borrower takes a smaller YSP. If, however, more cash to cover costs is in order, then the borrower can opt for a higher interest rate.
The MLOs are now paid by the wholesalers in the form of lender paid compensation (LPC). It’s a set amount, generally around 1.5 to 1.75 percent of the loan amount. But the deal has to close for the broker to get paid.
So what could go wrong, right? Yup, that’s right, fewer loans, fewer paydays, and the incentive to get a loan funded increases dramatically.
So, is it surprising that some MLOs might have some chalk on their shoes? A borrower wanting to qualify for a new home, and a mortgage broker that’s scrambling for a payday, could be a combination that might promote a bit of tinkering.
Mortgage fraud was rampant leading up to the 2008 financial crisis. As much of it was perpetrated by borrowers as by professionals in the lending industry, if not more. But, in the case of mortgage brokers, the simple reality that everybody performs in line with how they’re compensated was ignored. Of course, if a broker gets paid more for a loan with a higher interest rate, then that broker will strive to produce that kind of loan. Nobody’s yet been able to obviate basic human nature.
For quite a few years, I’ve advocated a profit-center concept for production-oriented banking activities, such as residential loan production. The concept is simple: At the end of a given period, be it quarterly, semi-annually or at year end, the staff of the profit center are bonused based on the division’s net profit. That puts everybody in an entrepreneurial mode, working for the health of the corporate parent, while hustling to enhance their personal incomes.
(Required disclosure: So far I’ve not sold a single client on this idea, which shows what a great salesman I am.)
Pat Dalrymple is a western Colorado native and has spent more than 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
October 7, 2018
Article shared from Glenwood Springs Post Independent.