Monday, March 31, 2008

Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending

Chapter 5 - The Pitch

The emotionally charged bombardment of easy dollars advertising campaigns utilized by the subprime lending industry did bring potential borrowers in the doors, or more accurately, caused subprime lenders’ phones to ring.  But, the emotions which ignited the ringing of the phones alone was not sufficient to seal a deal.  Subprime lenders needed an easy to hit, homerun pitch to win subprime borrowers’ confidence, and secure their signatures.

The subprime lending industry was exceptionally adept at making the refinance pitch to borrowers with credit problems.  Whether the borrower was hearing the pitch for the first time, the third time, or the fifth time, subprime lenders knew exactly what borrower buttons to push to induce borrowers to refinance, even if the benefits to the borrower of refinancing were few and lackluster.

All individuals, whether purchasing a car, a refrigerator, or, in our case, a mortgage, are susceptible to emotional cues, and the emotional cues, or buttons, for borrowers who only qualify for subprime financing are many.  Subprime lenders knew this, and they regularly plied these emotional buttons with virtuosity.

The majority of subprime lenders provided a sales script, what many of us would think of as a playbook, to their account executives.  These sales scripts, which have been psychologically refined for optimization of profitability, provided the subprime lender’s account executives with the exact sequencing of emotional buttons to push at specific points in their conversations with potential subprime borrowers.  In fact, the sales script were so well fine tuned that a subprime lender could take a reasonably intelligent and personable individual, with no mortgage experience what-so-ever, off of the street and have them signing up borrowers for subprime loans in five (5) weeks or less.  Which was quite important as the turnover rate of account executives within the subprime loan industry was quite high.

The primary emotional button for buyers; though as buyers we may not want to admit it; of any product or service, is enthusiasm.  This was especially true in subprime lending, and here is why.  Most individuals, who are experiencing credit problems which affect their ability to borrow, are embarrassed by this issue and are not necessarily willing to speak about the problem, whether to their family, their friends, or the unknown subprime lending account executive at the other end of a telephone line.

The most successful subprime lending account executives were those who took the provided sales script, memorized it frontward and backwards, and then enthusiastically delivered the scripted lines to the potential borrower beginning with the word hello.  The initial enthusiastic greeting and emotional cues, scripted by subprime lenders, and delivered word for word by the lender’s account executives, were designed to suck borrowers deeper into the sales script where the homerun pitch could be made.

After the initial greeting and introductions had been made, the sales scripts were designed for seamless gliding into the actual sales pitch.  One of the most effective initial sales pitches in the subprime lending industry ran along these lines, “Mr. Borrower, or may I call you Joe?  Okay Joe, we’ve just completed a review of your recent mortgage payment history, and based on your history it looks like we could very well put together a new mortgage for you and save you a bit of money every month, and put some cash in your pocket.  Do you have a few minutes to talk with me about this opportunity?”

Sounds promising, does it not?  Of course it does, and who wouldn’t have a few minutes to talk about a potential “opportunity” to save some money and obtain some cash at the same time?  The vast majority of subprime borrowers who heard the above words, especially the words “cash in your pocket,” delivered enthusiastically of course, breathlessly waited for the next line of the sales pitch.  Of course the borrowers may have been well aware that they had not been paying their mortgage payment, or other credit obligations, in a timely manner and had little chance to actually improve their current financial situation.  But why would a subprime lender contact them, state that they could save them some money, and possibly put some cash in their pocket, if what the subprime lender said was not true?  For one reason, and one reason only.  To profit from the borrowers’ beleaguered situation.

Another favored, and effective, sales pitch of the subprime lending industry was, “Mr. Borrower, your current mortgage loan is due to have an interest rate increase, and now would be a good time to beat that potential increase by refinancing while rates are still low.”  Whose ears would not perk up and pay attention if they were under the gun of a potential interest rate increase?

Less effective, but just as compelling to subprime borrowers, was the sales pitch of, “Mr. Borrower, I’ve recently refinanced quite a few people in your area,” (whether true or not) “and with interest rates about to increase,” (whether true or not) “now would be a good time to review your current mortgage to take advantage of existing rates, and possibly put some cash in your pocket.”

Of course not every sales call made necessarily followed the sales script.  The borrower may ask what interest rate is available right after the initial greeting.  Or, the borrower may offer up some other objection to continuing the call.  This did happen, and quite frequently, but the subprime lending sales script provided the answer to interest rate question, and every other offered objection to the call, in order to keep the prospect on the line and the account executive in charge of the pitch.

For example, if a borrower interrupted the sales pitch with a question in regards to the interest rate charged, a typical scripted reply was, “Mr. Borrower, we have many interest rates to choose from, but the only way I can quote you an interest rate is by completely reviewing your credit and income information, which, by the way, is free of charge.  Are you interested in reviewing this information with me so that we can provide you with the best possible interest rate?”

Another effective and emotional sales pitch utilized in subprime lending preyed on subprime borrowers’ constant dealings with disgruntled creditors requesting payments owed.  Where these creditors may have been brusque with the borrowers, the subprime lender was soothing and full of optimism.  The subprime lender may have promised immediate relief from the constant creditor calls by consolidating all of the borrowers’ current outstanding debt into one, low, monthly payment.  Or, the lender may have informed the borrower that their connections to the credit monitoring agencies may assist the borrower in having negatively reporting credit lines cleaned up, which, in turn, may allow the borrower to qualify for a better interest rate.  Needless to say, both of the above mentioned offers, made by subprime lenders, offered an emotional, and actual, relief which subprime borrowers were quick to grasp.

What happens, though, after the sales pitch has been made to the borrower, and the loan terms offered to the borrower did not induce the borrower to proceed with the loan?  Did the subprime lender simply chalk it up to the vagaries of doing business and move on to the next potential borrower?  Not likely.  In many instances subprime lenders practiced a technique which is known in the industry as “second voicing.”

Second voicing was the practice of handing off an unsuccessfully sales pitched borrower to a more seasoned subprime lending account executive, or preferably the sales manager, within the same subprime lending branch.  What typically happened in a second voicing was the borrower was contacted once again, ostensibly as a simple courtesy call to check up on the performance of the account executive who originally made the sales pitch.  The second voicing individual usually said something along the lines of “Mr. Borrower, my name is Joe the manager, and I wanted to touch base with you today to evaluate Mike the account executive’s performance and ensure that Mike the account executive adequately answered all of your questions and addressed all of your lending needs.  I also want to ensure the Mike the account executive recommended the correct lending program for your financial needs.  Do you have a few minutes to talk with me about that?”

This second voicing approach, once again, appealed emotionally to subprime borrowers.  It provided borrowers with another opportunity to talk, to provide input, and possibly voice objections, which the second voicing individual would politely listen to and take notes on.  More importantly, it provided the subprime lender, under the guise of performance monitoring, via the individual performing the second voicing, an opportunity to pitch the subprime loan to the borrower once again.

Though second voicing may have only converted one (1) out of ten (10) potential borrowers who had refused the initial subprime loan pitch, that ten percent (10%) second voicing conversion rate brought in thousands of dollars in profit to the subprime lenders’ bottom lines.

But the pitch which produced the most homeruns in subprime lending was the monthly payment, cash in your pocket pitch.  If a borrower had allowed the account executive to gather all their pertinent financial and credit information, the account executive would take that data and massage the borrower’s current credit obligation numbers in an attempt to ascertain how to most effectively present a monthly payment to the borrower which was less than what the borrower was currently paying per month.

In most instances, if a monthly payment number could be presented to the borrower which saved them fifty dollars ($50.00) or more per month, as compared to what they were actually currently paying per month for all their monthly debts, and put cash in their pocket, like a trophy for a job well done, another subprime loan deal was inked.

Posted by John Venlet on 03/31 at 08:48 AM
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Sunday, March 30, 2008

Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending

Chapter 4 - Bombardment of Easy Dollars

At the height of the subprime lending boom, how often did you receive a phone call from a nationally known mortgage lender, or, for that matter, an unknown mortgage lender, soliciting you to refinance your home?  Two times per week?  Three times per week or more?  How many pieces of mail did you receive per week soliciting you to refinance your home?  Five pieces, six pieces, more?  How many television or radio spots did you view or listen to per week soliciting you to refinance your home?  Ten, a dozen or more?  And let’s not forget about the internet.  Were there any internet pages that did not display some mortgage lender’s solicitation to refinance your home, credit problems notwithstanding?

A large percentage of these solicitations, no matter what the advertising medium, begging for your business with promises of easy cash, no matter what your creditworthiness may be, were simply shotgun pellet scattered, in the hope that a new mark would be induced to call the offered 800 number for a “free” mortgage analysis.  There was no need for rifled advertising, as the subprime lending target was huge.

What about those individuals who were currently paying on a subprime loan?  How often were they bombarded with offers to refinance their home?  Current subprime borrowers were often solicited almost to the point of harassment.

Borrowers currently paying on subprime loans, in many instances, were solicited to refinance their homes on an almost daily basis.  In addition to the unsolicited shotgunned solicitations noted above, and the solicitations which arrived with each monthly mortgage payment coupon, current subprime borrowers typically received a minimum of one phone call per week, and possibly more, from the subprime mortgage lender to whom they were currently submitting their mortgage payment (the Servicer).  The call from the lender may have come into their home as simple “courtesy” call, or a “friendly reminder” to make your payment call, or simply a “mortgage checkup” call, but the end game of the subprime lender was to induce the homeowner to speak with an account executive in order to solicit (encourage) the homeowner to refinance once again.  And subprime lenders did do everything in their power to make it easy for you to refinance, again and again, even if you last refinanced less than six months ago, your credit was still sub-par, and you had little remaining equity in your home.

The impetus behind this advertising bombardment of “easy dollars” was the profitability of originating subprime loans on a volume basis.  And when you consider the net profit per subprime loan, which was anywhere between four percent (4%) and seven percent (7%), the dollars spent on subprime solicitation advertising were dollars well spent.

As noted in the previous chapter, the profits being made by mortgage brokers, in the subprime lending side of the mortgage business, did not miss the gaze of traditional “A” paper national mortgage lenders.  Like mortgage brokers, traditional “A” paper lenders were also feeling the pinch of declining profitability on the “A” paper side of the business in the early 1990s, due to mortgage brokering’s meteoric rise.  Once the profits being made by mortgage brokers in subprime lending were noted, these traditional “A” paper national lenders brought their formidable marketing machines to bear on the general public, trumpeting messages of “easy” mortgage money.  And once traditional “A” paper national lenders began advertising subprime loans nationally, the stigma previously attached to subprime lending faded into the past, and an aura of respectability took its place.

Where previously advertisements for subprime mortgage money had been buried in the classified ad section of newspapers, they now appeared right out in the open.  Subprime mortgage advertising began blaring from national television, radio, and internet advertising.  Like a new fad, subprime mortgage financing swept across the country, and began devouring the equity in high risk credit borrowers’ homes.

The advertisements played, and preyed, upon peoples’ emotions.  Are your creditors hassling you about past due payments?  Call 1-800-EZMONEY!  Has your car broke down and you cannot afford to repair it?  Call 1-800-EZMONEY!  Are your bills piling up and are you losing sleep at night?  Call 1-800-EZMONEY!  Have you been turned down for a home mortgage by a traditional, tight fisted mortgage lender?  Call 1-800-EZMONEY!  Do you have bad credit?  No problem, call 1-800-EZMONEY!

All of this advertising did drive a substantial amount of mortgage business, and profit, to subprime, and the traditional “A” paper lenders who tapped into this profitable lending vein.  But, the thirst for additional profits, at the expense of homeowners’ equity, created a need for even more effective advertising methods.  Aggressive telemarketing filled this need.

In addition to the shotgun marketing of subprime loans noted previously, many mortgage lenders also utilized “hired guns” to fill their subprime telemarketing needs.  Lenders would contract with seasoned telemarketing firms, provide a detailed script for the firm’s telemarketers, and then pursue the leads the telemarketers provided them.  And though this also did drive a lot of subprime business, there was still room for

The weakness lenders found in this “hired gun” telemarketing method was time lapse.  The more time that passed between the time of the telemarketers’ initial contact with a potential subprime borrower, to the follow-up call by the lender, after the lead had been received, the less likely it was that a borrower would be willing to apply for a subprime loan.  The lenders were not striking while the “iron was hot.”

Subprime lenders corrected this time lapse problem in a number of ways.  Some created their own telemarketing departments, which enabled the telemarketer’s call to be transferred immediately to a loan officer just waiting for the phone to ring.  Others fined tuned the telephone technology which would allow “hired gun” telemarketers’ calls to be transferred immediately to a loan officer, with the borrowers totally unaware that the telemarketer they were speaking with was not an employee of the lender. 

Some subprime brokers/lenders simply handed out sheets torn from their local phone book and simply directed their account executives to dial, dial, dial, until they located a hot prospect.  And why wouldn’t they?  Even if it took thirty (30) or more phone calls to land one deal, the deal was going to profitable.

Another marketing method utilized in subprime lending was for lenders to comb through their own list of current borrowers (mortgagees), tallying up those who were behind on their current mortgage payment, and then handing out these borrowers names and phone numbers to their stable of account executives.  This particular marketing method, known as “churning,” was probably the most profitable for the subprime lending industry.  There were no “hired gun” telemarketing expenses, no lender staff telemarketing expenses, and most advantageous of all, the lender retained their current subprime borrower rather than potentially losing them to another subprime lender’s servicing portfolio who was telemarketing just as aggressively.

Like so much penny candy, thousands of these types of lead were handed out each week to subprime lenders’ account executives.  Though eighty percent (80%) or more of these leads were worthless, the profits which were garnered from the remaining twenty percent (20%) more than made up for the eighty percent (80%) of fruitless leads.

One reason eighty percent (80%) or more of these what I would call “captive” leads were worthless, was that the borrowers’ credit situation may have actually degraded since their last refinance, and the lender could not figure out a way to provide any “financial benefit” to the borrower while at the same time profiting from the loan.  And proof of so called “financial benefit” for the subprime borrower was considered as a gold star for the loan if regulatory agencies sniffed around, or disgruntled borrowers contacted a lawyer.

Another reason eighty percent (80%) of these leads were worthless was because many borrowers may have only had five percent (5%), or less, equity remaining in their home, due to previous refinances, and refinancing yet again would have actually increased the borrowers’ interest rate and mortgage payment, not to mention eaten up their remaining equity.  Much to the chagrin of the lender who had hoped to pluck additional profits from the borrower’s remaining five percent (5%) equity.  Even so, these worthless leads were recycled over and over and over to account executives, just in case a “deal” could be made and receive the “financial benefit” gold star.

One final reason to note for the eighty percent (80%) of these “captive” leads which were worthless is that some current subprime borrowers simply became sick and tired of being solicited to refinance.  Though even if this fact was noted in the lender’s database, the lead was often recycled through to an account executive once again.  Additionally, some borrowers finally figured out that even though the lender was still willing to refinance their mortgage once again, their financial situation was little improved each time the lender reached out their supposedly cash filled helping hand, and their credit worthiness had actually gotten worse.

There is only one true escape for subprime borrowers from this bombardment of easy dollars, and that is to bite the bullet in regards to misuse of credit and living beyond their financial means.  If individuals are unwilling to bite the bullet, they may soon find themselves with little or no remaining equity in their home, and quite possibly in real danger of losing their home through foreclosure proceedings.  Though in all likelihood, even in this direst of financial circumstances, they will still be receiving multiple offers to refinance their home, no matter what they credit situation may be.

Posted by John Venlet on 03/30 at 12:48 PM
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Saturday, March 29, 2008

Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending

Chapter 3 - Vanilla Ice Cream, or Big Chicken Dinner?

When I first began working in the mortgage industry, in 1987, I strictly worked with “A” (prime) borrowers who were looking to purchase a home.  This was also true for the majority of “A” paper mortgage lenders in 1987.  The borrowers we worked with on the “A” side of the mortgage business were borrowers with good credit, decent jobs, and in most instances, the borrowers also had at least ten percent (10%) of the value of the home in cash as a down payment.  The vast majority of mortgages written for these “A” borrowers were thirty (30) year, fixed rate mortgages, which were called “vanilla ice cream” mortgages.

This does not mean that there were not borrowers out there in 1987 that had bad credit.  Nor does this mean that there were not mortgage lenders out in the marketplace that wrote “B,” “C,” and “D” paper (subprime) mortgage loans at this time.  “B,” “C,” “D” paper borrowers, and lenders, were out there in the marketplace in 1987, though the subprime lenders willing to risk lending to subprime borrowers in 1987 were operating on the margins of the mortgage industry, and the number of subprime lenders doing business in 1987 was minimal.  “A” (prime) paper mortgage lenders just did not, or would not, work with these subprime lenders.  We called these “B,” “C,” “D” mortgages (subprime loans), and borrowers, “big chicken dinners,” for reasons which will soon be related.

In 1987, the overwhelming perception of “B,” “C,” “D” (subprime) mortgage lenders, held by “A” paper lenders, was that subprime lenders were “sharks,” preying on the financially unfortunate. There was a distinct, slimy stigma associated with subprime lenders, and most “A” paper lenders wanted nothing to do with these subprime lenders, or the borrowers they tended to feed on.  And why would they?  The “A” paper side of the mortgage business was more than profitable, with gross margins per loan averaging around three and one-half percent (3.5%).

In 1987, subprime lenders were averaging gross margins any where between ten percent (10%) and twelve percent (12%) per loan, at the expense of borrowers’ equity, and they were gloating about this.  In fact, the few “B,” “C,” “D” mortgage lender representatives who were calling on “A” paper mortgage lenders in search of subprime business in 1987, proclaimed these gross profit numbers with pride, wondering aloud why any lender would work with “A” borrowers when so much money could be made off of borrowers who have no other recourse for mortgage financing due to their poor credit.  Why settle for vanilla ice cream, when you can have a big chicken dinner?

“A” paper lenders continued to perceive subprime lenders as “sharks” into the early 1990s.  But, this perception began to give way to a perception of envy of subprime lenders, as profit margins for “A” paper lenders gradually began to erode.  What was the impetus for the erosion of “A” paper lender profits?  The phenomenal growth of the mortgage broker business.

Though mortgage brokering had been around for many years on a small scale, it really began to take off in the late 1980s after the deregulation of the mortgage industry as a whole.  This rapid expansion of mortgage brokering brought so many players into the “A” paper mortgage loan origination market profits could do nothing but be squeezed.  “A” paper lenders saw their gross margins drop from three and one-half percent (3.5%) per loan, to three percent (3.0%), then to two and one-half percent (2.5%), then to two percent (2.0%), and even lower.  In 1992 there were even small one and two man mortgage broker shops who would work for a one percent (1.0%) gross margin per loan, operating as if they were in the grocery business.

Though this rapid growth of mortgage brokering was good for “A” borrowers, in the form of more competitive interest rates and lower fees, and fewer overrides for the lender, it also spurred the growth of subprime lending.  But this growth spurt in the subprime lending industry was not so much a benefit for subprime borrowers, as it was for the “A” paper lenders who were looking for ways to stem the loss of their profitability, which brought a new found legitimacy to subprime lending which previously it had lacked.

Unfortunately, it was a shady legitimacy.  As more and more “A” paper lenders, who previously had shunned subprime lending, began pursuing subprime borrowers, the excesses which had been whispered about the subprime lending industry, became mainstream.  No longer would subprime lending’s notorious profit making, at the expense of marginal borrowers’ home equity, be operated on the margins of the mortgage industry.  In fact, subprime lending would become the fastest growing segment of the mortgage industry.

Initially, many “A” paper lenders only would do three or four subprime mortgages per month.  Just enough subprime loans to pad the bottom line, but this would not last long.  As the easy profits which had been intimated to “A” paper lenders by subprime lenders began to roll in, many “A” paper lenders jumped feet first into the “easy” money mode of subprime lending and simply let their “A” paper business languish.

Other “A” paper lenders setup subprime lending DBA’s (doing business as) entities, not wishing to tarnish their “A” paper lender reputations with subprime lending’s previously noted stigma.  But, as larger and larger nationwide mortgage lending corporations jumped into this very profitable segment of the mortgage business, the stigma previously associated with subprime lending soon received wholesale legitimization.

Though the “A” paper side of the mortgage industry continued to grow; just look at the stock performance of the Federal National Mortgage Association (Fannie Mae) over the years; in comparison, the growth of the subprime loan industry rocketed into the stratosphere.  Subprime lenders became more and more visible, and rapacious, across the nation.  This is turn led to “A” paper lenders; who previously would not have considered advertising the fact that they participated in lending to subprime borrowers; to begin saturating the market with myriads of advertisements targetted specifically to subprime borrowers spouting “easy” mortgage money availability, no matter what borrowers personal credit circumstances may be.

Though the phenomenal growth of the mortgage broker business was initially the main catalyst for the rapid growth of the subprime lending industry, the national mortgage lenders soon became the major players, and legitimizers, of the subprime lending industry nationwide.  These national mortgage lenders brought a whole new meaning to the term “easy” money.

Posted by John Venlet on 03/29 at 08:29 AM
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Friday, March 28, 2008

Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending

Chapter 2 - Make a Pile of Cash

Two years after I purchased and financed my first home, I was presented with an opportunity to be employed in the mortgage industry.  I was presented with the opportunity by the very same individual who assisted me through my first mortgage application.  Because my knowledge of mortgage lending had not greatly increased since I purchased my home, I was a bit hesitant to explore the opportunity.  But, since I was offered a free dinner, and whispered promises of earning two to three times what I was currently earning, I went and listened attentively to the opportunity mortgage lending had in store for me.

The dinner I had that evening was excellent, but I was somewhat surprised that the entire conversation regarding the opportunity to pursue employment in the mortgage industry seemed to be dominated by how much money I could make, rather than the mechanics of how the business worked.  Each answer I received to my questions about the mechanics of the industry seemed to rotate around the money to be made, rather than the service to be provided.  There was no conversation regarding the “American Dream” of homeownership, or the mortgage industry’s role in fulfilling the dream.  There was no conversation regarding how one develops the necessary contacts to become successful in the mortgage industry.  There was no conversation about how to deal with borrowers, or their apprehensions, when in need of financing for a home purchase or refinance.  The entire conversation was dominated by the money to be made.

Do not get me wrong.  Making money at your job is a good thing.  The income we earn allows us to purchase the necessities we require, and the luxuries we desire, in life.  More importantly, it can allow us to take that step of fulfilling the “American Dream” of homeownership.  And, isn’t earning good money also a large part of the “American Dream?”

Earning good money is, without a doubt, part and parcel of the “American Dream,” and I also desired to realize this part of the dream.  Little did I realize, at that time, how easy it would become to focus only on the money to be made, rather than the service I was providing, to those in need of mortgage financing.

About two weeks after the above mentioned dinner, I accepted a position as a loan originator with the mortgage banker who had arranged my first home mortgage.  I approached this new opportunity with zeal, and naïveté.  Even though the carrot held before me was the money to be made in the mortgage industry, at the time I first began working in the industry, I was more inclined to think of the position I accepted as a chance to help people realize their dream, the homeownership dream, rather than simply a chance to make a pile of cash.

One of my first tasks upon starting this new job was to read everything I could that was available on mortgages.  I read underwriting regulations, loan program guidelines, mortgage sales technique manuals, and anything thing else I could get my hands on that had to do with mortgages.  I wanted to be the most knowledgeable, and informative, mortgage loan originator in the market.

After thirty days of intensive reading, and a few sales calls with an experienced loan originator, I hit the streets on my own.  The only problem was, I still didn’t fully understand how I was to be paid for the work I was performing.  Sure, I knew I was going to be paid a commission on each loan I was able to put together for a borrower, but the numbers based on the commissions to be paid per loan did not seem to add up to the dollars I could earn that had been whispered in my ear.

In nineteen eighty-seven (1987), the standard commission rate per loan was one-half (1/2) of one percent (1%) of the mortgage amount.  Thus, if I put together a one hundred thousand dollar ($100,000.00) mortgage, I would earn five hundred dollars ($500.00).  Not a bad commission rate.  As I mentioned though, that commission rate did not seem to add up to the dollars whispered in my ear which I could potentially earn.  You see I had been told that the top loan originators in the market I was working were putting together almost one hundred fifty (150) mortgages each year.  If the average mortgage loan balance was one hundred thousand dollars ($100,000.00), and the commission on that mortgage was five hundred dollars ($500.00), and the top originators, on average, put together one hundred fifty (150) mortgage loans per year,  my earnings would be approximately seventy-five thousand dollars ($75,000.00).  The earnings that had been whispered in my ear, for a top originator, were one hundred thousand dollars ($100,000.00) a year.  Where was the missing twenty-five thousand dollars ($25,000.00) going to come from?

It did not take me long to find out where the additional twenty-five thousand dollars ($25,000.00) was going to come from.  It was coming from the borrower.

How is that, you ask?  It was relatively simple.  When an individual applies for a mortgage loan, they are typically quoted an interest rate, and a certain number of points (points being that fancy mortgage term for one percent (1%) of the mortgage amount).  For example, if I quote you an interest rate of six percent (6.0%) with one (1) point, the cost of your interest rate would be one percent (1%) of the mortgage amount.  If the mortgage amount is one hundred thousand dollars ($100,000.00), the cost of the one (1) point would equal one thousand dollars ($1,000.00).

But that does not answer where the additional money comes from, you say, and you would be correct.  So where does the money come from then?  The money comes from what is termed, in the mortgage industry, as overrides, of which the borrower is typically unaware.

In the example, above, I noted the interest rate of six percent (6.0%), with a charge of one (1) point quoted to the borrower, which seems pretty straightforward, and it is.  But, is this the best interest rate and points available to the borrower?  Not necessarily, though the document the borrower signs to lock in the quoted interest rate will lead the borrower to believe that it is the best interest rate and points currently available.

But here is what actually happens.  The borrower’s interest rate is indeed guaranteed to be six percent (6.0%) with one (1) point.  The lender, though, unbeknownst to the borrower, actually has the mortgage money available at an interest rate of six percent (6.0%) and one-half (1/2) point because of market improvements.  So the lender, in this example, gains another one-half (1/2) of one percent (1%) in income on the loan, or five hundred dollars ($500.00), which the lender then splits with the individual who originated the loan.

So without the borrower being aware of it, the originator of the loan, and the lender, both gain two hundred and fifty dollars ($250.00) in income because of their inside knowledge of the mortgage market.  The borrower has received a good interest rate, and though the lender was making a good profit margin on the loan at six percent (6.0%) interest and a charge of one (1) point, the lender has additionally profited from the borrower’s ignorance regarding the points associated with the guaranteed interest rate.

Initially, I was hesitant to employ this inside knowledge for my personal profit, but I was soon beyond this hesitation and actively pursuing every override I could.  There were times, when the market was especially working in my favor, that I was able to make one (1) to two (2) percent overrides.  This increased my commission per loan from one-half percent (1/2%) up to one and one-half percent (1 ½%) of the mortgage amount.  The earning potential whispers in my ear had been correct.

Today, individuals who are interviewing for loan originator positions in the mortgage industry still hear the same whispers in their ears regarding how much money can be made in the business.  The money is the primary recruiting tool.  One major difference should be noted though.  In nineteen eighty-seven (1987), when I first got into the mortgage business, the majority of the mortgages being written were “A” paper (prime) mortgages.  Subprime mortgage lending was barely a blip in the industry, and a certain stigma was associated with lenders who actually wrote subprime loans.  Today, a large percentage of mortgages being written are “B,” “C,” and “D” paper (subprime/non-conforming) mortgages, and the amount of profit to be garnered from originating these type of loans can be two (2) to three (3) times, or more, than the profits earned on the “A” (prime) mortgages.

Posted by John Venlet on 03/28 at 07:50 AM
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Thursday, March 27, 2008

Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending

Chapter 1 - Purveyors of the “American Dream”

For many years, now, the pinnacle of the “American Dream” has traditionally been sold to individuals as owning their own home.  Today, if you type “homeownership+American Dream” into the Google search engine, you will receive over one million possible results to review which offer various interpretations on this dream.  Most mortgage lenders, whether prime lenders or subprime lenders, also actively advertise this dream on their corporate websites, with promises that they can easily help you live the dream.

The dream of homeownership is a good dream, though the dream is not necessarily without its frightening moments.  Especially for those individuals who are purchasing their first home and applying for a home mortgage for the first time.  A fact I can attest to myself.

When I took the step of fulfilling the “American Dream” for myself, back in 1985, when purchasing my first home, my rudimentary knowledge of financing a home purchase was glaringly revealed.  Even though I was working with an individual I knew personally and trusted, and who was a certified mortgage banker, I still walked away from the mortgage application process in a somewhat dazed and confused manner.  Today, many first time homebuyers still can attest to this.

When a first time homebuyer sits down with a mortgage lender, they will be bombarded with questions,  unknown lending terms, and stacks of official documents requiring their signature.  The questions required to be answered delve into the individual’s work history, education, savings history, and credit use.  Highly personal questions, to most individuals, which are rarely discussed with even their closest personal friends.

Terms like amortization, points, buydown, ARM (adjustable rate mortgage), Balloon, escrows, to name but a few, come at the first time homebuyer in rapid-fire succession typically with only the most rudimentary of explanations, or, the terms are glossed over by the mortgage lender as being of little relative importance.  Unfortunately, many first time homebuyers will simply accept these most basic of explanations, or glossed over lender interpretations, rather than exhibiting to the lender their inexperience with the mortgage process.

The stacks of documents, requiring a homebuyer’s signature when applying for home financing, can also be intimidating.  The documents are full of fine print and cautions of prosecution for falsification, which are rarely read by the homebuyer, and the documents are typically paraphrased by the lender’s sales staff, to facilitate fast, question-less signatures.  Is it any wonder, then, that purchasing a home for the first time is a bit frightening?  Additionally, all the parties involved in the transaction; seller, Realtors, and lenders; seem to desire that the transaction be completed at the fastest possible speed.  Rush, rush, rush and get this deal done before the buyer gets too nervous to proceed.

Though applying for a mortgage for the very first time can indeed be a bit frightening, it does not need to be intimidating, or completely nerve wracking.  Though it can be difficult to remember, as an individual financing a home purchase for the first time, you are actually in control.  The processes which must be completed, as they say in the mortgage business “to close the deal,” cannot, and more importantly should not, be completed until you, the borrower, are fully informed and satisfied with your understanding of what is actually taking place in the transaction.  This is also true if you are simply refinancing a mortgage on a home you already own.

If, as a borrower, you have any questions regarding the mortgage loan, ask them!  If you do not understand what points are; a point is simply a fancy mortgage term for one (1) percent – one (1) point equals one (1) percent; ask for a thorough explanation from the lender.  If you do not understand what escrows are; escrows are monies you pay ahead of time in your monthly mortgage payment to cover yearly property tax bills or homeowner’s insurance bills as they come due; ask for a thorough explanation from the lender.  A good mortgage lender will ensure you receive a complete, and thorough, answer.

I know that when I went through the mortgage application process for the first time, I made my share of the mistakes mentioned above.  I did not want to exhibit my lack of knowledge about the mortgage process, so I accepted less than thorough answers.  I nodded my head in agreement, when I should have been shaking my head no and asking more questions.  I signed documents with only a cursory review, or a glossy lender explanation, instead of reading the fine print.  I looked at the list of fees charged by the lender, and simply swallowed hard, rather than inquiring into whether the costs could possibly be less.  In other words, I acted like I was a fully informed individual, when in reality I was bluffing both the mortgage lender, and myself, in regards to my grasp of the mechanics of mortgage lending and the effects such a commitment had on my daily life.

As the primary purveyors of the “American Dream;” mortgage lenders have the money you need to purchase the home you want; and they should be working diligently to make the mortgage loan process clearly understood.  Especially for first time homebuyers.  First time homebuyers, though, also have a responsibility.  Their responsibility as homebuyers, whether first time purchasers or sixth time, is to not let embarrassment at their lack of knowledge regarding the mortgage process get in the way of learning the process and understanding it.

Owning a home is a large responsibility, a long term financial commitment, and at times a financial challenge, not simply a warm and fuzzy dream.  After you sign on the proverbial dotted line, you will no longer be dreaming, you will be living the reality of owning a home and having to pay off a mortgage.  The reality of the dream of homeownership does not always mesh well with the “American Dream” as it is sold, or your current financial situation.

Posted by John Venlet on 03/27 at 01:40 PM
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Disillusioned by the Delusioned, Etcetera

Since August 2007, I have not posted much here, or anywhere else for that matter, mainly because I have become more and more disillusioned by the delusioned masses who believe, rather than think, that the solutions to all their needs will be met, or somehow achieved, by the machinations of the state.

Much has gone on, think fifteen minutes of fame on a grand scale, since August 2007, and has been well documented and commented on within the blogosphere.

In my life also, much has occurred, both positive and negative, since August 2007, which I will not bore you with.

What I will share with you is some writing I have done, and possibly naively thought would be of interest to a wider audience, and hoped to have published, regarding the mortgage industry, my experiences in said industry, with an emphasis on the debacle of subprime lending.  Alas, my attempts at bringing this writing to the market have failed.  Maybe it’s my writing, I don’t know.

Be that as it may, I will, over the next four weeks or so, be posting that writing here.  The title I christened this writing with is Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending.  Which may be a bit too much of a mouthful for a book title.

Anyway, I shall begin posting this immediately after this short explanatory post.  If you care to comment on it, please do so, whether your comments are constructive, negative, or positive.

Posted by John Venlet on 03/27 at 01:15 PM
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