Mortgage offers keep coming – brokers want commissions
Ever since the real estate market boiled over, melting down the mortgage industry and its cheap-money feeding frenzy, I’ve been waiting for one happy outcome: an end to the roar of mortgage brokers at my various doors.
But no. Via e-mail, fax, phone and daily mail, mortgage solicitations have continued to pour into my life. Next thing you know, they’ll be hiring skywriters, smoke signalers and carrier pigeons or staging musical revues:
“No matter your desire,
no matter your need,
a college education,
a thoroughbred steed,
a neatly bundled debt,
a retirement RV,
it’s all for the taking
in your equity!”
In the past few weeks, the offers have formed a mountain on my desk, each promising a mortgageable moon, each aiming for a creative slant on the old chestnut “Here’s a deal you just can’t pass up.” Or as Lenox Financial, a controversial “no closing costs” (i.e. higher interest rates) lender, says in its radio ads: “It’s the biggest no-brainer in the history of mankind.”
Some offers focus on turning the idea of equity into a lifelong solution for any problem. A mailer from U.S. First Credit Union unfolds into a 16-by-25-inch blueprint of a fabulous house. On the house plans, various rooms are labeled according to what they can buy you: a new SUV, a college degree, bill consolidation, etc. All you need to do is take out a home equity line of credit at a 15-year fixed rate “as low as” 7.49 percent. And because they “want to wake you up to days full of excitement and possibilities” (hey, who wouldn’t want that?), the company is including a “FREE 3-day/2-night” getaway to one of 22 destinations.
Other companies focus less on the life of infinite possibilities and more on the world of insurmountable woes.
A notice “from the desk of Angie McGuirt” at Wachovia bank informed me that I was “preselected” (always good for your self-esteem) for an equity line of $250,000 with a variable rate of prime minus 0.5 percent – now amounting to about 7.75 percent. If this sounds like a so-so deal, Angie reminds me that it’s “far less than you’d pay for most credit cards or other personal loans.”
In other words, “You’re probably hemorrhaging money every month. Let us stanch the wound.” Um … yes, but you can’t lose your home using a credit card. I call Angie to learn more about the deal, but the broker informs me that no one will speak to me because I’m a journalist. “We refer all journalists to the Web site,” she says. What about Angie? “She doesn’t take incoming calls.”
Despite the mortgage morass, in which subprime and Alt-A loans are increasingly difficult to obtain, many companies are still attempting to lure us with too-good-to-be-true offers.
A mass-fax with no company name touting a “New Refinance Program” is offering a 1 percent, 30-year fixed loan. The lender didn’t care if I had bad credit, was going through bankruptcy or foreclosure. If I took out a $500,000 loan, my monthly payments would be a mere $1,608!
What exactly is going on here? I thought all the extravagant offers dried up along with the subprime loan companies. I thought the irrational exuberance had fizzled and mortgage companies were back to selling sober, rational products.
“It is a bit of a mystery,” agrees Robert Youngjohns, who recently turned off his fax machine to stem the tide of mortgage solicitations. As chief executive of Callidus Software, a company that sells programs that analyze the financial repercussions of clients’ incentive compensation plans, Youngjohns has become something of an expert in the ways commissions and other incentives influence employee behavior. “But when you understand how the mortgage brokers get paid, it also makes sense.”
There are primarily two ways brokers are paid. One is through points, in which a homeowner pays a percentage of the loan amount at the time the loan closes. A 1-point loan means a 1 percent fee.
Spread is commission
Another, more often misunderstood means of paying the brokers is yield-spread premium. In this scenario, the borrower pays a higher interest rate for the life of the loan in exchange for not paying points. The broker gets the spread – the difference between the wholesale rate from the lender and the rate that is passed to the consumer, which can add 0.5 percent to more than 1 percent to the interest rate.
In California, independent mortgage brokers are required to disclose the spread that their broker is taking, but retail brokers (employees of banks and other lending institutions that make loans directly to the public) are not. Despite such disclosure laws, many independent brokers don’t advertise their spread – instead, they may boast they have found you a no-points loan.
Borrowers need to do their own calculations to figure out whether points or spread are better for them, comparing the point loan to the spread loan based on the rates and the number of years they expect to keep the loan. A good explanation can be found at links.sfgate.com/ZBBR.
Either way, the broker gets paid – the points or the spread constitutes the broker’s commission.
Youngjohns believes that the very structure of the lending industry – specifically how the brokers are compensated – ensures that the three-ring circus of freaky mortgage offers will continue.
He also says badly designed compensation programs helped foster the mortgage implosion, by giving brokers incentives to peddle too many risky loans. Why? Because the boom minted thousands of new mortgage brokers, brokerage boiler rooms and lending departments, and the only way these people can feed their children is to close a deal. By brokers I mean not only independent mortgage brokers but retail brokers as well. And the only way to get new clients is to get folks in the door.
Youngblood contends that paying brokers through yield-spread premiums often keeps people in the dark about how the mortgage broker is being paid.
“Commissions are a fascinating topic,” says Youngjohns. “They often have exactly the opposite effect of what the company intends.”
He points to the practice of brokers receiving bonuses for originating lots of loans from a given lending institution. If a broker gets paid extra for every loan she originates, she may be tempted to do one loan after another for the same client with the same lender – a process known as churning or serial refinancing.
Excessive refinancing is illegal, because it can damage the borrower’s credit. It’s also verboten because investors in mortgage-backed securities think it hurts their investments. But for the broker motivated by a productivity bonus, churning may be very tempting. By fudging the details on refinance documents, she can make it look like John Smith is a different person than J. Smith, creating the impression she’s generating lots of new business.
Churning the loan
When he bought his house on the Peninsula, Youngjohns experienced churning firsthand. His broker redid his loan to the same lender three times in the first couple of years.
“I thought, what’s driving this? It must be the way the broker is getting a commission. Obviously, that’s not what the lender had in mind when they created their bonus system,” he says. “But that’s how it was working.”
In Youngjohns’ case, it had no deleterious effect, because it was lowering his payments slightly each time and they were no-fee refinances. But the effect on the overall system creates a lot of economic froth and an incentive to write exotic loans.
And sometimes such incentive packages do hurt the consumer. My mortgage broker told me some lenders are paid more for selling loans with three-year prepayment penalties – which hit the consumer with hefty fees should they refinance or sell within three years of closing the loan. “Lenders like them because they are easier to sell to the secondary market. But I don’t do them,” he told me. “I think they are wrong. But a lot of brokers do.”
Youngjohns suggests that complex commission structures often lead to what he calls “bad behavior.”
“I was raised Quaker, and so I was taught to see the good in everyone,” he says. “Until it comes to people’s commissions – then you have to assume they’re fundamentally evil.”