I started talking about predatory lending and improper homebuying practices over 19 years ago. I received a lot of hate mail and even anonymous threats from mortgage “professionals” (aka Mob Bosses) who didn’t want their secrets revealed. Today, lenders are required to be more transparent in their pricing and loan programs. Unfortunately, the policies designed to protect consumers are inadequate, and the majority of loan officers are undertrained order takers rather than educated financial advisers. Due to the economic downturn, lenders are more desperate for business than ever and even highly educated consumers are exceedingly easy to manipulate.
We spend a lot of time educating our buyers before we ever really talk seriously about buying. Education is vital if we are going to eliminate predatory lending practices.
Mortgage brokers hire loan officers to sell loans to consumers. Mortgage brokers have accounts with wholesale lenders, who are the actual source of funds. Each day, the wholesale lenders will provide the mortgage brokers (and all their loan officers) with wholesale rate sheets. The mortgage broker decides how much profit he/she wants to make on each loan and creates a retail rate sheet. The loan officers sell from the retail rate sheet. The difference between the wholesale rate and the retail rate AND closing fees make up the lender’s profit margin.
How Lenders Make Money
Mortgage brokers make money several different ways. They can manipulate these potential profit avenues all day long to come up with their desired profit.
- Closing costs – This includes fees for applications, credit reports, appraisals, processing, underwriting, document preparation, etc. These fees are sometimes referred to as “junk fees.”
- Origination fees – Origination fees are usually 1% of the loan amount. This is simply a fee the broker charges for writing the loan.
- Discount Points – Points are prepaid interest. They are usually only charged when you want an interest rate that is below market rates. Discount points are expressed as a percentage of the loan amount – 1 point is equal to 1% of the loan amount, 3 points is equal to 3% of the loan amount, etc. Example: If you are quoted an interest rate of 7.25% with 0 points, but you have your heart set on an interest rate of 7%, you could pay 1 point and buy the interest rate down to this amount.
- Yield Spread Premiums – YSPs are rebates paid by wholesale lenders to mortgage brokers for writing loans that are above “par” or market interest rates. If the “par” rate is 8%, but your mortgage broker can get you to pay 8.5%, the wholesale lender will pay your broker an extra commission called a YSP. YSPs can help consumers who are short on cash; they can pay a higher interest rate and have their mortgage broker pay some of their closing costs. But mortgage brokers make a LOT of money with YSPs without the consumer’s knowledge (until the day of closing) or consent. More on this later.
How Buyers Can Get Ripped Off
Now let’s talk about how you can get ripped off. It is tragically simple to rip off an uneducated consumer.
- Closing costs – Some closing costs are legitimate fees for services performed by a third party. Your credit report and appraisal are examples of legitimate fees – some of these fees are collected up front. Some legitimate fees, like fees for processing, are collected at closing. Are all other fees junk fees? It is impossible to say. There are an endless number of ways that predatory lenders can manipulate closing costs. They can waive most of your closing costs and charge you a higher interest rate (you still pay, of course, just not up front). They can charge you for services that are never performed. They can charge you $400 for an appraisal that costs $250.This includes fees for applications, credit reports, appraisals, processing, underwriting, document preparation, etc. These fees are sometimes referred to as “junk fees.”
- Origination fees – There are legitimate costs associated with loan origination and your lender is entitled to make a fair profit. To charge a 1% origination is fine, BUT to charge a 1% origination fee in conjunction with inflated or fabricated closing costs and premium interest rates could be considered excessive.
- Discount Points – Points paid for their stated purpose – to reduce the consumer’s interest rate – are fine. BUT, a dishonest lender can quote you a certain rate at the time of loan application and produce something quite different at the closing table. For example, you may be told that because of a past credit problem you don’t qualify for the best rate. You are “forced” to either buy down the interest rate by paying additional discount points, or you agree to a higher rate, in which case the broker receives a rebate in the form of a Yield Spread Premium.
- Yield Spread Premiums – If your loan officer can get you to pay a higher than market interest rate, they get a “rebate” called a Yield Spread Premium. Here’s what happens. You agree to a 30-year loan at 6.5%. Since interest rates change daily, your loan officer won’t lock in your interest rate right away. They will “float” your loan until there is a little dip in rates and then they will lock in your loan – let’s say at 6.25%. Since your loan officer has you committed to pay 6.5%, he/she will get an extra commission for selling you a loan at a higher than market interest rate. These commissions are often in the multiple thousands! An upfront and ethical loan officer would have rebated YOU the YSP or given you the 6.25% interest rate. Since the lender is not required to disclose this extra profit to you until closing, you are none the wiser until it is too late to do anything about it. YSPs provide a useful option to some borrowers. For those with little cash, YSPs make no-cost mortgages possible, one where settlement costs are paid by the lender. For those who expect to be in their house only a few years, YSPs permit a favorable exchange of higher rate for lower fees. BUT, in the hands of unscrupulous lenders, they can cost the borrower thousands and thousands of dollars.
How Can All This Happen?
Easily, unfortunately. Mortgage brokers are regulated by RESPA and the Texas Savings and Loan Department, but it’s tough to enforce the rules, and even educated consumers are very easy to manipulate. The system is broken and there is no easy fix. The best thing you can do is to educate yourself and hire an Exclusive Buyer Agent who will recognize fraud when they see it; chances are you won’t.