Compliance Article

03/26/2008

The headlines are everywhere, “Subprime Mortgage Crisis,” “Highest Foreclosure Rate in Years,” and “New Regulations for Mortgage Lending.” It’s hard to listen to the news or read a newspaper without seeing some negative remark about the mortgage industry. While we all recognize the problem, the question is what happened in the industry that got us to this point? And more importantly, where does the industry go from here?

History

Let’s go back a few years to when the mortgage industry was booming. It wasn’t that long ago that we were hearing about interest rates at 40-year lows, borrowers were encouraged to refinance their mortgages, and new construction sites were popping up everywhere. Many questioned where all these people were coming from that were moving into all these new homes. The typical response was that the “loosened” underwriting standards were allowing more individuals to obtain mortgage loan financing they would not qualify for in a “traditional” environment. This increase of borrowers flooding the market supported the basic economic theory of supply and demand. Unfortunately, many first-time homebuyers purchased more than they could afford, passing on the “starter” homes for larger, more expensive homes. This cause and effect allowed many current homeowners to sell and move into larger homes themselves. Because there were more buyers than product this created the “sellers” market, allowing the current homeowner to obtain the listing price or more. Buyers were willing to pay more than the listing price which created comparables appraisers could use to create double digit property value increases. Homes were appraising at all time highs, interest rates were at all time lows, and the homeowners that weren’t selling were standing in line to refinance the sudden equity they had in their homes.

Mortgage Slowdown

In mid-2006 the mortgage industry started seeing a slowdown in mortgage originations and new construction, and a jump in subprime delinquencies. In early 2007 the industry was feeling the growing pains of the previous years as many borrowers faced resetting interest rates. With principal and interest (P&I) doubling, many borrowers struggled with the funds needed for the payment of property taxes and homeowners insurance. Homeowners became hard pressed to keep up with the “newly” adjusted payment. This would continue throughout 2007.

A recent seminar, hosted by LexisNexis®, noted some startling statistics – 20% of mortgage loans originated in 2005 and 2006 were subprime loans. In 2006 alone, 26% of subprime loans were interest-only or payment-option Adjustable Rate Mortgages (ARMs). It is estimated that 374,000 mortgage loans with a value of $170 billion is scheduled to reset in each quarter of 2008. With the increase of these subprime mortgage loans resetting interest rates, the likelihood of default is greater. It is estimated that approximately 13% of subprime mortgage loans were seriously delinquent as of October 2007. You can bet this number will increase as additional ARMs reset.

According to the Mortgage Bankers Association there is a distinct difference with the performance of adjustable rate loans against the traditional fixed rate loan. The delinquency rate for seriously delinquent (90 days and over) fixed rate loans went unchanged comparing the first and second quarters of 2007. However, the delinquency rate of subprime ARM loans increased 227 basis points during the same time period.

Mortgage Fraud

To make matters worse, it appears mortgage fraud is also playing a role in all of this. As mortgage loans went into default many lenders discovered transactions that were closed in the previous years were actually fraudulent. According to William Matthews, co-author of a recent report on mortgage fraud by the Mortgage Asset Research Institute, “Criminals are opportunists. If you’ve got a booming market they’re going to get away with more fraud.” While it is unknown how many fraudulent transactions take place in the mortgage market, the institute found that 26 states had serious mortgage fraud problems. Matthews estimates fraud costs the industry at least tens of millions of dollars a year.

The Federal Bureau of Investigations (FBI) investigates Mortgage Fraud in two areas:  Fraud for Profit and Fraud for Housing. Generally speaking, Fraud for Profit is typically known as “Industry Insider Fraud” with the intention of revolving equity, erroneously inflating property values, or providing loans on fictitious properties. Fraud for Housing is typically illegal actions by individuals obtaining properties under false pretenses.

The defrauding of mortgage lenders should not be compared to predatory lending practices which primarily affect borrowers. Predatory lending often impacts senior citizens, low income borrowers, and borrowers with bruised credit. Predatory lending forces borrowers to pay high loan origination/settlement fees, subprime or higher interest rates, and even unreasonable service fees. These practices often result in the borrower defaulting on his/her mortgage payments undergoing foreclosure or forced refinancing.

Governmental Relief

It does appear that the increase in foreclosures may be a direct result of the subprime crisis, and this increase has definitely gotten the attention of the government. Regulators have been working diligently on different proposals to assist homeowners in keeping their home. President Bush signed into law H.R. 3648, the Mortgage Forgiveness Debt Relief Act. This Act provides a temporary tax relief to homeowners that have negotiated a modification with their lender or who have/might lose their home to foreclosure.

It is important to recognize that there are alternatives to foreclosure. Borrowers must be encouraged to talk to you early and attempt to work out a payment plan or a loan modification. Also, be informed there are many consumer handbooks and web sites that offer great information on what steps your borrowers can take to avoid foreclosure.

This too shall pass, but in the meantime working together is key.