Thursday, February 9, 2006

Second of three parts

The promise of easy money comes in an official-looking envelope marked, “Important Financial Information Enclosed.” Need $2.5 million at 1 percent to 2 percent to buy or refinance a home? No problem.

Borrowers put no money down and pay just interest. A good credit rating is not a requirement. Bankruptcy judgments, debt charge-offs or tax liens don’t matter, and “all difficult credit scenarios are okay,” the lender says.

The home-financing offers come from an army of mortgage brokers estimated at 250,000 nationwide, many operating outside the reach of banking regulators. They have become the principal source of home financing in the United States.

In years past, banks and savings and loans provided most mortgages, but their share of the $2.8 trillion market dwindled to less than half in recent years, according to Harvard University’s Joint Center for Housing Studies.

As the role of banks has declined, the share of unconventional mortgages with easy and risky lending terms has exploded — and now account for more than $650 billion last year, up from $56 billion in 2001, according to the Federal Reserve. Most of that growth occurred since 2003, when the total was $118 billion.

“The mortgage industry of today bears little relationship to the mortgage industry of even the 1990s,” said William C. Apgar of the Harvard center.

The number of unscrupulous brokers offering “junk mortgages” has multiplied with the housing boom and advent of Internet financing in the past five years, said David Levine of Mortgage Loan Request, a mortgage information service.

Their advertisements “are designed to hit consumers where they are most susceptible, their wallet.”

They are often successful, because many consumers never see or understand the fine print — often on the back of the flier — that explains what a bad deal the mortgages can be, he said.

“The sleight of hand is that the low rate advertised is actually adjustable, and it can increase in as little as 30 days’ time. You may be paying less every month, but your interest is not being paid up and your loan balance continues to accumulate at an alarming rate,” he said.

“Homeowners who think that they may be saving $200 to $300 a month on their payments are actually falling behind by that very same amount” because payment of full principal and interest is being postponed to a later day of reckoning, he said.

No-risk sales

The brokers who offer such mortgages often have no licenses or formal training and may have just recently graduated from high school or college. They are essentially salespeople for whom there is no downside to the risky debt propositions they peddle.

The riskier the mortgages, the bigger their commissions, so they often try to get homeowners to take on the largest mortgage possible with low initial payments and interest rates that can explode in later years.

Some of the loans have abusive terms, such as no annual caps on rate increases and clauses that permit the lender to increase the required monthly mortgage payment at any time.

“Only a limited number of states have laws and regulations in effect to protect borrowers,” Mr. Levine said.

Maryland licenses brokers and requires 40 hours of training and a criminal background check, but no training is required in the District or Virginia.

For many buyers trying to stretch their resources to purchase increasingly expensive homes in Washington and other major cities, the risky loans may be the only way they can qualify.

But millions of others take out what seem like easy-money loans so they can splurge on gifts and other lavish purchases.

Brokers encourage frequent refinancing or “churning” of mortgages because that increases their commissions and ensures a stream of future business. That also is why they promote interest-only loans and adjustable-rate mortgages that almost certainly will have to be refinanced in a few years if the borrowers are to avoid punishing increases in their monthly mortgage payments.

Once the brokers close on the loans, they sell them to “wholesalers” who repackage them into pools of mortgages and sell them to private investors, including hedge funds, insurance companies and brokerage houses.

The extraordinarily easy terms on the loans are dictated by the investors, not federal or state regulators who set lending standards for banks, and reflect the seemingly insatiable appetite for the risky but high-yielding debt paper.

Investors step in

All this was made possible by an evolution of the mortgage market away from banks and thrifts, which in years past had to follow conservative credit guidelines laid down by regulators.

The mortgage companies have been able to bypass the regulated banking industry by tapping into a plentiful source of funding for the loans — private and international investors.

Although the unconventional mortgage securities have not been tested in a financial crisis, many investors still view them as among the safest investments because mortgages are secured by property liens and most borrowers are unwilling to forfeit their homes by going into default.

Brokers and investors argue that they are doing a major service for borrowers by providing them with options they never had before to hold down their monthly payments and buy homes without having to save for a down payment.

As the booming housing market has seemed to ratify the wisdom of lenders and borrowers alike, mortgage “wholesalers” have increasingly loosened their lending terms to take in more marginal borrowers and housing transactions.

It is now routine to approve loans that cover 100 percent or more of a home’s value and require up to 60 percent of a borrower’s income to make debt payments. Recently, several wholesale lenders announced that they would offer 100 percent loans to people who just emerged from bankruptcy.

Without such easy lending terms, economists say many borrowers with marginal credit could never have purchased homes, and many young, first-time home buyers would not have been able to get into the market.

The mortgage industry has changed because of the growing role played by nonbank mortgage brokers and investors, said Mr. Apgar of the Harvard center.

“The declining importance of bank deposits as a funding source for mortgages has largely driven the structural shift,” he said.

In 1990, fewer than half of all mortgages were secured and sold to investors; today, nearly 70 percent of mortgages are funded in the secondary market.

Rather than applying credit standards designed to maintain the soundness of the banking system, today’s mortgage brokers have eliminated the old rules and are largely in the business of matching borrowers and investors who are willing to take increasing risks.

The brokers now have inherent conflicts of interest because they maximize their commissions by processing as many loans as possible and have no long-term interest in the performance of loans sold to investors, Mr. Apgar said.

Brokers and real estate agents intent on clinching a home sale and mortgage financing have been known, among other things, to pressure home appraisers to ratify inflated prices on homes in overpriced markets, according to the Chicago-based Appraisal Institute.

“Brokers are immune from the potential adverse consequences of both failing to match the borrower with the best available mortgage and failing to provide accurate data to underwrite the loan,” Mr. Apgar said. “Both affect the odds that the loan will default, which can have devastating consequences for the borrower.”

Part I: American dream putting homeowners in deep debt

Part III: Federal directive targets risky mortgage

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