Sunday, April 09, 2006

Slower Home Loan Market Worsens Fraud

After years of red-hot housing sales and refinancings, a cooling market this year is likely to uncover some problems, like a rocky seabed revealed by the ebbing tide.

There is growing concern, in particular, that a glut of mortgage brokers chasing diminished business will pressure them to "look the other way" in generating leads and underwriting loans. Brokers now originate nearly two-thirds of all residential mortgages nationwide.

Originations are projected to be 20 percent lower this year, yet the past five high-production years have swelled the ranks of operating brokerages to more than 53,000, according to an industry firm that counts them. By next year, it estimates that number will be halved. Until then, though, mortgage business practitioners worry that competition for receding business is creating a natural pressure on brokers to relax due diligence.

"Brokers have more financial incentive not to examine deeply all of the applicants and deal characteristics that they probably should," says Mark Clifford, chief information officer of GE Home Finance.

That laxity could reverberate up the funding chain to financial institutions and then out into the secondary market where loans are purchased by investors.

That's where, Clifford notes, "any claim that the loan source (broker) is solely culpable will not hold up under legal scrutiny. The argument that the lender did not gather information directly from the customer and thus shouldn't have any liability in the transaction is viewed with increased skepticism by the courts," he reports.

A case in point is the recently suspended, new ordinance in Montgomery County, Md., which would hold liable investors and buyers of a mortgage loan on the secondary market and be subjected to substantial monetary fines for violations of the law's anti-discriminatory requirements. The Mortgage Bankers Association argues that "as a result of this potential substantial monetary liability for violations, lenders, investors and buyers would have a great reluctance to make, sell or buy loans made in Montgomery County."

Mix of challenges

As if the natural arc of business expansion and contraction were not challenge enough, loan originators also have to labor in a market overshadowed by the federal Do-Not-Call law, enacted three years ago and now blanketing more than 40 percent of all U.S. households. It is significantly limiting brokers' previously unfettered telephone access to prospective borrowers.

Regulatory and legal issues aside, it is economic issues – notably tighter margins – that fuel the diligence problem, according to Chris Stimac, credit risk manager, Oak Street Mortgage. "It is only natural," he holds, "that with shrinking profits, there is less incentive to drill down in those mortgage applications and fewer personnel to do it.

"Obviously you're not going to pay more people to take longer to look at loans," says Stimac, who suggests brokers and loan officers ought to turn to technology for the heavy lifting.

This is especially important for the small- to mid-size originator who could be hurt by a slew of buybacks, or literally put out of business by serious litigation like a class-action lawsuit.

One mortgage company executive, who preferred not to be named, says he believes better data and more reliance on technological protections would enable lenders to take a more proactive stance on due diligence and fraud problems that might ensue. He claims today's originators do not have the same level of expertise they had 20 years ago and that could silently contribute to more fraud.

What's more, he alleges that lenders "are embarrassed when they've been taken in fraud, so a lot of (that) information is shrouded in secrecy…which makes it more difficult on organizations trying to originate for their own portfolios."


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