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New York Commission of Investigation Presentation
February 2008
Good morning. I would like to thank the Commission of Investigation for inviting me to speak today on behalf of the Registered Mortgage Broker community. As we are all well aware, the mortgage market is in a crisis of unprecedented magnitude. As an industry, we’re suffering the aftermath of a perfect storm. Since the turn of the century the housing market has been dealt the perfect hand.
Inflation has been kept in check while at the same time; the value of homes has kept rising. The financial marketplace, believing that investing in mortgages was a safe investment, gave us historically low interest rates. In its drive to make every American a homeowner, the government encouraged the GSEs to develop programs to meet the needs of the first time homebuyer. The combination of low cost financing and inflated home values created a temptation that no red blooded American could resist, the opportunity to take equity out of their homes to feed their addiction to spending above their means.
The industry saw record profits and the consumer felt wealthier every time they saw a home sell in their neighborhood. Real estate investors couldn’t lose money no matter how poorly thought out the investment was. Ordinary people became real estate speculators over night. Blinded by all this, the industry became more aggressive in designing mortgage products and underwriting standards and consumers saw no downside to their actions.
Last year this perfect storm came to an abrupt end. Everyone from the average guy on the street, in all levels of government and every industry participant, is now asking, how could this have happened and who is to blame. Before we can begin to address the current crisis we need to agree that everyone from the government to the consumer shares the blame.
Meeting such as this are an opportunity for government to identify the issues in order to formulate a meaningful response to the problem. This is far better than writing legislation or regulation without taking the time to completely research the problem. Time invested here helps to reduce the impact of “The Law of Unexpected Consequences”.
There are 2 core issues that form the foundation of this mortgage crisis. Approaches that were taken with the best of intentions had a negative side to them. For example, writing more liberal underwriting standards designed to assist the first time homebuyer was a noble effort. However there are cases where people were put into houses that they truly couldn’t afford, the negative side.
The second issue can be summed up in one word, greed. Individuals putting their own personal gain above all else. Greed will encourage a banker to place borrowers into the highest profit program they have to offer, just as easily as it can force a borrower to misrepresent his financial position to a lender to get the most generous financing package he can.
A Mortgage Broker does not lend out its own money. Its services are advisory and administrative in nature. A broker is not authorized to make mortgage loans or commitments and cannot guarantee acceptance into any particular loan program or specific loan terms or conditions.
Entities that wish to operate as a mortgage broker in this State need to apply to be registered with The Banking Department. The entity can be either an individual or a business. This entity can then take on additional staff to work on originating mortgages. As of this year, all originators also need to apply for registration with the Banking Department and both the mortgage broker and the originator now need to meet continuing education requirements. The Mortgage Broker is responsible for all the actions of his originators; the originator is nothing more than an extension of the mortgage broker he is associated with.
The role of the Mortgage Broker is to assist the consumer in obtaining the right mortgage to fit his needs. In order to do this job, the broker must first be familiar with the available mortgage products and the underwriting guidelines associated with each product. He then needs, through the interview with the applicant, to develop a concise understanding of the applicant’s needs and goals. From here he gives his opinions to the applicant. After this discussion the applicant, armed with the information provided by the broker, decides which mortgage to apply for.
The broker will then collect all the data necessary to submit the application package to the lender. Should the underwriter have any questions or concerns regarding the package, he will contact the broker. The broker will answer any questions he can and go back to the applicant to address any issues that the broker needs clarity on. The broker is available throughout the process to answer all the applicant’s questions guiding the package through underwriting, commitment and finally to closing.
The applicant’s benefit of working with a Mortgage Broker is to have access to current information before applying for the mortgage and to have someone working in his best interests in acquiring financing. Under New York State law the applicant is hiring the broker and is paying the broker for this service. This implies an obligation of the broker to work in the best interests of his applicant.
The Lenders have solid business reasons to work with a broker. The mortgage process is very manpower intense, with the majority of the hours being dedicated to customer service. The volume of mortgage applications taken by a Lender varies greatly from year to year. This makes it difficult for Lenders to hire and keep good people since the number of employees that are required will be different from year to year.
Getting past the customer service component and looking at the actual underwriting process we find the next benefit. A Lender is forced to take an application from a consumer in any condition the consumer decides to present it. The application may not be filled out completely, it may not be signed, the supporting documentation may not be there or what’s there isn’t complete. This results with more man-hours being spent on the file.
When a Lender conducts business with a broker, it is a business-to-business relationship. The Lender can dictate to the broker what condition a package needs to be in before it gets to underwriting, require the broker to confirm the package meets certain guidelines before submission, demand a minimum closure rate on packages that are submitted, etc. The Lender can pick and choose which brokers it wants to work with and can stop dealing with a broker for any reason.
This cost saving is substantial to a Lender. In order to encourage brokers to deal with them and to prove to the broker community that they are committed to the industry, a Lender will offer better pricing to the broker channel than is offered to the general public. This pricing is called the Wholesale price. Many brokers, myself included, price their services in such a way that the applicant’s net cost for financing is the same regardless of the path chosen.
The comparison I like to use when explaining how the mortgage broker gets compensated is with the travel agency model. Think back, before the Internet. If you needed to purchase an airline ticket you could contact an airline directly or a travel agent. The ticket cost the same in both cases. You knew the airline was compensating the agent but your net cost was no different. You chose to deal with the travel agent for 2 reasons. The agent had access to multiple airline schedules and prices and the agent had knowledge of the industry that you could access. An applicant chooses to deal with a mortgage broker for the same reasons.
The Community of Mortgage Brokers, just as any profession, is made up of people with different levels of knowledge, experience and integrity. It’s impossible to calculate how many “bad apples” are in the bunch; after all you can’t conduct a survey to find out. For the purpose of this discussion I’m going to say that 50% of the mortgage brokers aren’t up to professional standards. In order to address the contribution that the Mortgage Brokers made to this mortgage crisis we need to focus on these sub par individuals.
It wasn’t until December 2006 that New York State recognized a weakness in the requirements of becoming a Registered Mortgage Broker. There was no minimum or continuing education requirement attached to being a Mortgage Broker. After a 20 year fight spearheaded by the New York Association of Mortgage Brokers, the governor signed into Law a Bill that requires continuing education for all mortgage brokers as well as originators. It also expanded the requirement of a criminal background to include all originators not just the Mortgage Brokers or Mortgage Bankers they worked for.
This is a good first step in addressing the lack of knowledge of the sub par individuals. The Law requires 18 hours of education every 2 years. The Banking Department hasn’t issued any standards for these courses as of yet so I can’t comment on the quality of the courses being offered. What I can do is pose 3 questions. Is 18 hours every 2 years adequate? Should there be a testing requirement added? And finally, should the requirement be the same for originators as for brokers?
The correct number of classroom hours will be dependant on the quality of the courses being presented. Until we see what is offered we will need to reserve comment. The Banking Department has taken the position that a testing requirement doesn’t add anything. “Anyone can pass a test simply by cramming the night before” is what I’m told. I feel that a test given at the conclusion of the course is an incentive to the student to pay attention during class. With no testing requirement, you are inviting people to book hours and nothing else. This is a potential area of improvement.
A Mortgage Broker is responsible for the actions of all his staff of originators. Shouldn’t the broker be held to a more rigorous standard of education? This is another area of the regulation that we may consider revisiting.
Every mortgage originator associated with a State regulated mortgage banker or broker will be given a unique identification number as part of this new law. Originators working for State regulated entities will now be accountable for their actions. This creates an environment that is difficult for a thief to work in. Unfortunately this law doesn’t cover federally chartered institutions. Hopefully the Federal government will follow suit and require all originators throughout the country to meet similar standards as to those that New York State is requiring.
The current requirement to qualify to be a registered mortgage broker includes either being a Licensed Real Estate Broker in good standing with the Department of State or show evidence of a minimum 2 years work experience in some finance related field. Of course Licensed Attorneys enjoy their usual exception here.
In 1986 when the Law governing mortgage brokerage was enacted, there was a need to offer this free pass to real estate brokers. Prior to 1986 real estate brokers were permitted to earn a fee when originating mortgages. The Law changed the regulatory authority of Mortgage Brokers from the Department of State to the Banking Department. Now, over 20 years later we are still permitting real estate brokers to use their existing license in lieu of the 2 years experience requirement to become Mortgage Brokers. We are permitting individuals who may never have even seen a mortgage application advise a citizen on the largest purchase of their life. There is no question that this section of the regulation needs to be revised!
The mortgage industry has been very effective over the years in developing programs that can address the needs of nearly all applicants. Unfortunately these programs can also be used to defraud individuals and destroy communities. In order to prevent this from occurring we can either eliminate the programs or remove those individuals from the industry that are abusing the programs.
It would be a mistake to restrict the industry’s ability to create programs to meet the changing needs of the consumer. The needs of the public evolve over time; the industry needs the flexibility to accommodate that evolution. Will mistakes be made? Sure, it’s impossible to try new ideas in any field without having some failures.
Never in the history of underwriting have there been more tools available to confirm the integrity of an application package. What we need to do is to utilize these tools more consistently. There are computer programs available to confirm property values. There are databases available that show income ranges for various professions in every city and region of the country. The IRS can validate income tax returns within hours of a request. The across the board use of these tools will make it more difficult for thieves to operate in the mortgage market. It’s only in response to today’s mortgage crisis that there has been a renewed interest in the quality of a credit package.
The wealth of the typical middle class family is in the equity of their home. The more restrictions that are imposed on the mortgage industry the harder it will be for people to buy their first home or tap into the equity of their home. This is a result that no one wants.
We need to focus on removing the unethical and the criminal participants from the industry, not restrict the availability of credit. Now that the State can identify every individual originating mortgages under its jurisdiction and is holding them to a minimum standard of education it can move to the next step. That is, elevating the implied agency relationship between the Mortgage Broker and the applicant to a mandated one.
By requiring the broker to put the interests of his clients above that of his own we will be enhancing the delivery system of mortgages to the public. Mortgage brokers are typically small businesses located right in the communities they’re serving and they don’t work banker’s hours. This allows for convenient access for the members of the community to the mortgage market. The Mortgage Broker is the most efficient delivery system of mortgage money into communities throughout the State. It’s important that we don’t lose sight of that when drafting new regulations.
One of the most important tools that the broker has at his disposal is yield spread premium (YSP). It’s through the use of YSP that a broker can offer a consumer a 0 point mortgage earning his fee through the interest rate. The YSP has also been a tool abused by the broker to increase his compensation without the borrower being aware of it.
The abuse can be prevented without banning YSP. Under current regulation the broker must have a fee agreement signed by the applicant at first contact. This agreement, among other things, specifics the exact fee that the applicant agrees to pay the broker directly and the maximum fee that the broker can earn from the lender.
The problem here is obvious. The applicant is hiring the broker to supply a service and doesn’t know what the total cost for that service is going to be. The regulation was written in this way because a broker cannot commit a lender to a borrower and therefore cannot commit the lender to a price. The Banking Department recognized that the broker couldn’t predict what the YSP is going to be at this initial meeting with the applicant. The decision was made to do the next best thing, require the broker to disclose a maximum compensation.
One solution to this would be to require the broker to identify his total compensation, from all sources on the fee agreement. This way the applicant knows exactly what the broker is earning. If the YSP turns out to be greater than the agreed upon fee, then the broker would be required to credit that excess to the borrower’s remaining closing costs. If the YSP is less than the agreed upon fee, then the borrower would have to pay the shortfall as part of his direct out-of-pocket closing costs.
There would be no economic incentive for a broker to increase the interest rate on a mortgage in order to increase his profit on that mortgage. The broker would still be able to offer the applicant a 0 point mortgage as well as giving the applicant the option to reduce his out of pocket closing costs by accepting a higher interest rate on the mortgage. New York State has the highest closing costs in the country. The biggest hurdle for the first time homebuyer today is saving enough cash to purchase a home. The proper use of YSP can help out this buyer.
Another approach is to follow the example of Massachusetts. They just recently enacted a requirement that the maximum YSP that a broker can earn from a lender is 1.5 points. Any additional money automatically becomes a credit to the borrower.
As the agent of the applicant, the broker will be expected to prove that the product he is placing his client into is the right mortgage for that client. Developing formal guidelines for mortgage suitability is not necessary. It can be addressed under the regulations pertaining to Unfair and Deceptive Acts and Practices (UDAP). There will be many of you that disagree with this but if you stop to think about how varied the financial situation is from family to family you will find that writing a universal set of suitability guidelines is not realistic.
A consumer purchasing or refinancing a home in this State deals with several professionals, each one with his own specialty. The attorney hired to represent the purchaser is protecting the interests of his client. The real estate agent is trying to get the best price he can for his client. The Mortgage Broker is hired to arrange the most favorable financing for the applicant. The consumer depends on all these independent viewpoints in making decisions.
What happens when these professionals are not independent? What happens when the real estate broker is also the mortgage broker or the attorney is part of the real estate broker’s office? Our consumer no longer has independent advisors and can easily be mislead.
I’ve had clients tell me that their real estate agent wouldn’t present an offer to the seller unless they agreed to arrange the financing through the real estate broker. Why wouldn’t the client just refuse? He wants the property and feels threatened that the agent will simply sell it to a buyer that is more cooperative. Yes, this practice is currently illegal but it continues to go on because buyers are more concerned with making the buy than they are in reporting the agent to the regulators. If operating as a dual agent wasn’t permitted, the real estate broker would have no reason to be a Mortgage Broker.
I met with a woman late last year that had just closed on two 2-family homes in Brooklyn and couldn’t afford to carry them any more. She was advised to purchase these homes by a paid real estate investment advisor. The real estate broker signed all documents on the sale with a Power of Attorney from the seller’s development corporation. She was told she couldn’t use her own attorney and had to use one recommended by the real estate office. Financing was arranged through their in-house mortgage broker who arranged for 2 mortgages on each home through 4 different lenders.
After closing she discovered that she could only rent the apartments for 50% of what the broker represented the market rent at. Her total carry on these properties is over $10,000 per month and she was just informed by the city that one of the properties has a Certificate of Occupancy for a one family, not a two family and she needs to correct this before moving tenants in.
This woman is a nurse earning $40,000 per year and she is currently loosing over $5,000 a month on these investments. She paid $585,000 for each property and financed 100% of both properties. In reviewing her HUD-1s, I discovered she paid a total of $43,180 in points for financing.
Do you think she would have got involved in these transactions if she choose her own attorney or mortgage broker? Situations such as this one are more common than you think and we’ll be seeing more examples of it in the media throughout the year.
We must no longer permit the real estate broker representing the seller be involved as the mortgage broker representing the buyer. The Mortgage Broker and real estate broker must have no business relationship between each other. Both companies can’t be own by the same people and they can’t be involved in any form of a joint venture.
There is no doubt that the mortgage market is in crisis and the Mortgage Broker community shares in the blame. The Laws and regulations governing Mortgage Brokers in this State can be revised to protect the consumer and at the same time enable mortgage brokers to do their job. Mortgage Brokers represent the most cost efficient delivery mechanism of mortgages to the community. It would not be in the State’s best interest to legislate them out of existence.
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