AskRodd.com

Cleansing the industry

One of the more frustrating aspects of the mortgage industry was its low barrier to entry.  Just about anyone could become a mortgage broker or bank loan officer if they so desired.  Much like real estate sales, the mortgage industry attracted thousands of get-rich-quick types that wanted to capitalize on a hot market.  Sadly, this influx of unqualified people sullied the image of the mortgage professional and contributed to the mortgage meltdown.  If there was one positive outcome from the overhaul of the mortgage industry, it was the creation of the National Mortgage Licensing System & Registration (NMLS & R), which also mandated state compliance with a uniform set of standards.  Known as the SAFE Act (Secure and Fair Enforcement for Mortgage Licensing Act of 2008), it fully takes effect on August 1 of this year.  As a result, very few people are attempting to enter the mortgage marketplace, and many others are being forced out.

There are a number of criteria that both new and existing mortgage loan originators (MLOs) must meet.  Probably the most black-and-white of these is a criminal background check.  All originators, including those employed by federally insured depositories and credit unions, are now required to be fingerprinted for an FBI criminal history background check.  Regulators will be looking for any felonies that have occurred in the last 7 years, or if there are any felonies involving fraud, dishonesty, breach of trust, or money laundering in the applicant's past.  In addition, the bar is raised for any originator that is not employed by a federally insured depository or credit union.  For those individuals, they must also perform the following:

• Demonstrate financial responsibility and general fitness (through the examination of a personal credit report)
• Never have had a loan originator license revoked
• Score 75% or better on a national mortgage loan originator exam
• Score 75% or better on state-specific originator exams (for each state in which the originator wishes to be licensed)
• Complete 20 hours of pre-licensing education courses by an approved education provider
• Annually complete continuing education courses as prescribed by individual states (10 for Oregon; 9 for Washington)

As noted above, employees of federally insured depository banks and credit unions do not have to meet the bullet points listed above - only the criminal background check.  In states such as Oregon and Washington, which have had testing and education requirements for quite a while now (even before the SAFE act was passed), this has been sore subject for mortgage bankers and brokers as they have been held to a higher standard than the big banks.  While it's been a bit of an inconvenience (as well as a costly expense) to sit for the education classes, it has also turned out to be a competitive advantage as most bank loan officers lack the knowledge that has been accumulated by state-licensed originators.

Now that the SAFE Act is upon us, it's expected that a few more MLOs will be flushed out of the industry.  Combined with a slowdown in the volume of loan originations and an overall increase to the complexity of the mortgage process, the number of state-licensed MLOs in Oregon has already declined from over 14,000 at the peak of the market to around 4,000 today.  Granted, some have likely gone to work for the federally insured banks and avoided the stringent requirements of state licensing, but the message is clear: there are fewer MLOs in the marketplace, and the ones that remain are the strongest of the bunch.

Going forward, it's expected that small mortgage companies will be forced to either be absorbed by larger mortgage banking organizations or exit the industry.  The unfortunate reality is that is has become very expensive to remain a small, independent operator, and as a result we may see even more people leave the industry.  The impact to the consumer is somewhat mixed.  While some competition is being eliminated by the new regulations (as well as market forces), the companies and MLOs that remain will be the best and the brightest.  Survival of the fittest is certainly an apt phrase to explain what has been happening over the past few years in the mortgage industry. 

The Independent Mortgage Broker: Dying a Slow Death (part 2)

Continuing with my series, at this point I’ll start illustrating some of the restrictions that market forces are imposing on the mortgage brokers.  As noted in my first post on the subject, it used to be that mortgage brokers were able to access mortgage products and rates that most retail banks could not offer.  In the early 2000’s, real estate was a hot commodity, and mortgage loans were easy to come by if you were a buyer or investor.  Lending guidelines began to erode to the point that most anyone could finance a new home.  In situations where a home buyer found himself in financial distress, he simply put his home on the market, sold the property, and paid off the loan before going into default.  Another exit strategy was to refinance the original loan into a new one with better terms.  This worked splendidly for a number of years.  However, once the market peaked and home values began to fall, both of these strategies became obsolete in a hurry.

As losses began to mount with lenders, they began investigating the loans that were in their mortgage pools.  Their analysis concluded that loans originated by a third party (another way of saying loans acquired from mortgage brokers) performed worse than loans originated by a direct lender.  This caused some lenders to exit the TPO (third party origination) business altogether.  Some of the big names were the first to do it: Bank of America, Chase, and Citibank.  Further, the mortgage insurance industry took notice of these findings, and some decided that the risk of a TPO mortgage was too great.  As a result, some MI companies instituted policies that banned MI coverage for TPO mortgages.  Others took a different approach and began to track the performance of specific mortgage brokers.  Those that produced the lowest quality loans would not be eligible for mortgage insurance in the future.  This was a much fairer approach, since many mortgage brokers produce quality loans and should not be lumped in with the bad actors.  However, the message was clear: TPO loans present a higher risk to lenders, mortgage insurance, companies, and the end investor.

As most people know by now, the massive losses generated by non-performing loans triggered a tsunami of failures up and down Wall Street.  Some of the biggest names disappeared, and others were swallowed up by healthier competitors.  What resulted was an exodus from the once-prized market of collateralized debt obligations, or CDO’s, which were the vehicles used to sell the toxic mortgage products to investors.  Even quicker than the proliferation of these high-risk loans was their rapid exit from the marketplace.  What was left was a very vanilla landscape of mortgage programs.  Essentially, borrowers could obtain a fixed rate loan (30 or 15 years) or 1, 3, 5, 7, or 10-year ARM – and all of them required full documentation of assets and income.  There also were fewer outlets to broker these loans.  Where there was once over 200 wholesale lenders across the country, there was now roughly 30 wholesale lenders.  Subprime?  Gone.  Stated income or no doc loans?  History.  What about negative amortization loans?  No longer.  Since Wall Street had turned its back on anything except for Fannie Mae, Freddie Mac, FHA, and VA loans, there wasn’t a market to sell these high risk loans any longer.  Niche products were gone, and conservative government-backed mortgages were the new reality.

So, brokers began to feel the squeeze of market forces.  They no longer had access to unique mortgage products, and in fact they lost access to some programs because they could not secure mortgage insurance coverage for some of their low-down-payment loans.  This was a big blow to the mortgage broker industry, as part of their differentiation from retail banks was now gone.

With the reduction in the number of wholesale lenders still willing to accept loan applications from mortgage brokers, another shift has occurred.  The ability to offer lower rates is no longer a given.  Partly the result of the increased risk associated with TPO loans, wholesale lenders’ rates are not as aggressive as they once were.  This marks the second competitive advantage to disappear for the mortgage broker.   First it was the ability to offer a wider variety of loan programs, and now it’s the ability to offer more competitive rates.  In my next installment, I’ll illustrate how government regulations have removed the third competitive advantage from the broker: the ability to process loans more quickly than retail banks.

The Independent Mortgage Broker: Dying a Slow Death (part 1)

This is the first in a series of comments that I will post on the impending demise of the independent mortgage broker.  Having been in the mortgage business for over 13 years, it’s disappointing to see this occurring, especially since I feel that I’m a mortgage broker at heart.  I came into the business as an independent mortgage broker in February of 1996, and I found my role to be quite noble.  My mission was to seek out competitive loan terms based upon the needs of my clients and to successfully close the transactions on or before the schedule closing date.  If I did this well, then I’d be rewarded by receiving referrals from happy clients and real estate agents.  If I wasn’t providing competitive rates and fees, or if the process was cumbersome or slow, then my clients and real estate partners would not promote my services to others, and my business would begin to shrink.

 

At that time, mortgage brokers were providing a much-needed service, as traditional banks were not able to provide the breadth of products or competitive rates that brokers could access.  Consequently, mortgage brokers became the dominant provider of home loans, securing financing for over 60% of all mortgage transactions at the peak of their success.  The company that I was working for at the time had ascended to the top position in terms of local market share, and it began to evolve into a mortgage banking operation (meaning that it could originate and fund loans in its own name as opposed to brokering the transaction to a wholesale lender).  The broker/banker duality provided a competitive advantage, and this is the operating model that most successful mortgage companies utilize today.

 

In the early 2000’s, the secondary market for mortgage products began to expand, and it introduced new programs and more liberal underwriting guidelines.  Both mortgage brokers and retail mortgage companies began offering these new products to consumers.  Many were well-designed programs intended to be used as financial tools.  However, too often the loan officer (either a mortgage broker or a retail bank officer) misapplied the loan program, which contributed to the mortgage meltdown that eventually morphed into a global financial crisis.

 

I provide all of this background to set the stage for what has happened as a result.  In typical fashion, some elected officials at the state level began looking for someone to blame, and the mortgage brokerage industry was an easy target.  Because they are largely independent companies with weak state (and national) lobbying efforts, there was little push-back to legislation that was introduced to curb what was hailed as the predatory practices of the mortgage broker.  Never mind that two of the biggest providers of toxic mortgages – Countrywide and Washington Mutual – were exempt from these state legislative efforts.  Thus, the landscape began to change with respect to the rules that brokers were required to follow.

 

What has followed has been a series of changes – some by market forces, others by regulatory actions – that is putting the mortgage broker at a competitive disadvantage.  In my next post, I’ll begin to list the myriad issues that face the broker world today, and why it’s apparent to me that the mortgage broker is an endangered species that is facing extinction unless some things change soon.

The $8k First Time Home Buyer Tax Credit -- Some Final Thoughts

There was a lot of commentary by various housing-related groups when HUD announced that the $8,000 first-time home buyer tax credit could be used as the buyer’s down payment.  This was hailed as a sure-fire method of stimulating the housing market by providing thousands of otherwise-qualified buyers with the down payment money they lacked.  The fire was stoked when HUD made a formal announcement about this at the end of May.  Upon further review, however, all of the talk was misguided.  Let’s try to address this one last time.

In summary, nothing has really changed.  The announcement by HUD was essentially a public relations move after HUD Secretary Donovan jumped the gun (or “put his foot in his mouth,” to be more specific) at the NAR Real Estate Summit on May 12^th.  Unfortunately, Mr. Donovan wasn’t aware that using the funds in the manner that he described actually violated two rules – one an IRS guideline, and the other an FHA underwriting guideline.  The recent announcement on May 29^th (see Mortgagee Letter 2009-15) proclaimed two things. The first was that the tax credit can be used in connection with secondary financing from HUD-approved lending sources, but this provision has been available for years.  The second point was that the tax credit can be sold for cash.  However, the status of the purchaser of the credit will determine whether or not the funds can be used for the down payment.  If the purchaser is an FHA-approved non-profit organization or a federal, state, or local government agency, the proceeds of the sale can be used for the down payment.  However, if the tax credit is sold to the lender, the seller, or any other entity that has a financial interest in the transaction, then the proceeds can only be used to increase the down payment (after the buyer has already come up with their own 3.5% down payment), or the buyer can use the money to pay closing costs or reduce the interest rate.

In reality, the restrictions that HUD has placed on the selling of the tax credit make it such that no private party will entertain this notion as there is a fee limit to the purchaser of the credit (no more than 2.5%).  In addition, to my knowledge there aren’t any government agencies equipped to make such purchases at this time.  Since the $8k credit expires December 1, the window is closing quickly, and it’s not likely that we’ll see any agency come up with the funding to make such purchases within that time frame.  Furthermore, if buyers were enabled to purchase a home without any of their own money invested in the process, we’ll likely see FHA’s default rates climb higher since loan performance statistics clearly show that those loans fare far worse than loans with down payments from the buyer’s own funds.

In summary, the first-time home buyer credit is a nice reward to buyers that managed to come up with the down payment on their own.  While technically they could sell the tax credit to create the funds for the down payment, the reality is the marketplace won’t be able to accommodate this, and in the end that’s a good thing.

The Side Effects of a Declining Market

With the decline in home prices that we are all experiencing (some markets more so than others), we are beginning to see the effects that this trend is having on our clients’ ability to obtain financing.  Specifically, this is impacting those buyers that wish to make down payment of less than 10%.

The two most common loan programs for buyers with less than 10% down are FHA (which only requires 3.5% down) and conventional financing (which requires 5% down).  With FHA financing, the federal government provides mortgage insurance protection to the lender since the buyer is putting down less than 20%.  However, on conventional loans, mortgage insurance is obtained from private companies (hence the term PMI, or private mortgage insurance).  The challenge that we’re facing now is that private mortgage insurance companies are restricting the amount of coverage that they will provide based upon comments contained in the home appraisal.  If the appraiser states that the home resides in a declining market, then the MI companies are cutting their coverage by 5%.  This means that they will only insure loans with a 10% down payment, not 5%.

This scenario now causes buyers to make a decision: do they revert to an FHA loan or do they try to put another 5% down?  More often than not, the only option is to use FHA financing.

Until home values begin to stabilize, we’ll continue to see appraisals containing the term “declining market.” This means that FHA will be insuring more loans, and taxpayers will be on the hook for any foreclosures that occur.

Have we hit the bottom of the housing market?

A frequently asked question by potential homebuyers is the following: Has the housing market hit bottom yet?  The answer to that question depends upon what you define as the bottom of the market.  By one definition, the bottom may have been reached on May 26th, 2009.

When people speak of the bottom of the market, they are usually referring to the point in time that home prices hit their lowest point before turning upward again.  However, what they really want to know is the answer to this question: when can I purchase the most house for my money?  Unless you are a cash buyer, this doesn’t occur when home prices reach the bottom of the curve.  For the vast majority of buyers, this occurs when the carrying costs of a home are at their lowest point.  While price is a component of this measurement, the prevailing interest rate has a significant impact on the carrying cost of owning the home.  For example, you can finance $250k at 4.75% for 30 year for $1,304/mo.  However, at 5.50%, you can only finance $229,700k at that monthly payment.  This is why May 26th is such a critical date, for the following business day mortgage rates jumped by a full 1/2 percent.  They continued to increase over the following week, and we are now seeing the 30-year fixed rate around 5.5%.  Home prices will need to fall another 8-10% to make up for recent increase in rates.

Have we reached the bottom of the housing market?  It’s hard to say for certain.  However, the rapid rise in interest rates on May 27th may provide the evidence that May 26th was actually the bottom of the market based upon home affordability.  Only time will tell for certain.