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 04:50 AM
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