| Abusive
Lending Practices
In
a recent article I discussed one of the ways our
industry finances upfront closing costs at an interest
rate equivalent to 25%. I’d like to give you a
little more background on this as it is one of the
ways our industry has of to get more dollars out
of borrowers’ wallets without them realizing the
true costs. I’ll then show you how to protect yourself.
In
the old days prior to 1990, almost everyone paid
one or one and one-half points as an upfront Loan
Origination Fee. But in the early 1990’s, Fannie
Mae, FreddieMac, and the Wall Street sources that
buy fixed rate loans from banks and other mortgage
originators announced that they would pay higher
prices for loans that had higher yields. This
opened the door to zero-point loans, as we discussed
recently. The originator would add .25% to the loan
rate and the buyer would pay no points. Let’s
work through an example.
The
Smith family wants to borrow $100,000 and they don’t
want to pay points. So the bank lends them the money
at, say, 6.25 percent instead of at 6 percent and
one point, $1,00 in this case. The bank absorbs
the loan origination cost of $1,000. A week or
so later, the bank sells the loan to FNMA. Remember
that FNMA will pay more money for this loan. In
this case, they pay the bank $101,000 for this $100,000
loan. The bank has now gotten back the $1,000 it
absorbed while originating the loan.
Now
if this makes perfectly good sense to you, it does
not to lots of borrowers. There are literally
millions of people who think that there are some
banks that charge points and others that don’t.
Like the old carnival shell game, the people watched
the wrong shell and got stuck paying the extra .25
percent for as long as they had the loan. In this
case, .25 percent is $250 per year, a lot of money
over time.
There
is a funny thing that happens in the minds of consumers
that I don’t understand, but I swell understood
by the people on Madison Avenue who put together
advertising. There are certain buzzwords that appeal
to American consumers, much more so that consumers
in Europe, for example. When they hear words like
“Free,” or “Everything Must Go” or “Liquidation
sale,” or “Savings up to 40% and More!” many American
consumers seem to turn off their brains.
This
is exactly what seems to happen when they ask, “How
much is this going to cost?” and someone says back,
“Nothing. It’s free.” They turn off their sense
of caution and begin signing documents. The regulatory
authorities in my state have correctly warned consumers
that nothing is free, and that they are paying for
it in one way or another. They even prohibit advertising
that suggests that people can get loans for free,
although frankly, I still see a lot of ads that
are clearly deceptive, once you know what is really
going on.
But
here is the more insidious aspect to this practice.
The bank in our example above got back the $1,000
that they paid for originating the loan. There are
many mortgage origination sources that would not
be satisfied with just getting back the $1,000.
They might want $2,000, and FNMA will pay them
$102,000 for a $100,000 loan that carries and interest
rate of 6.5 percent. In this case, the borrowers
is paying $500 per year, and all they saved was
$1,000 upfront. Does that sound like a good deal
to you?
I
have dealt with over 2,500 borrowers in my career
and we treat them honestly, charging the same regardless
of what pricing they choose. But let me assure you
that on the times we do no-point deals, and there
are some specific reasons why they make sense sometimes,
my belief is that my clients stop thinking about
what I am making on the transaction, just what it
costs them upfront. There are many, many people
in the mortgage business who are not constrained
by ethics or even truth, and the borrowers who deal
with them are in for a ride. But because their
sense of caution has been turned off, they just
don’t ask the questions they should.
Is
this widespread? I study I heard about (but have
not read) suggests that in about 80 percent of loan
transactions the originator is actually making money
at the disadvantage of their clients, and that most
of the time, the clients are totally unaware.
So
what can you do to protect yourself? For openers,
choose a lender on the basis of recommendation and
referral. Get references and check them out. If
you are dealing with a mortgage broker, and there
are many advantages in doing so, enter into a contract
with them the sets a specific fee for their services.
Then when you sign loan documents, have the closing
agent show you what the broker is receiving in Loan
Origination Fee and any rebate they are getting
in any item labeled P.O.C, which stands for Paid
Outside of Closing. The sum of those two items should
add up to what you have agreed to in your contract.
If they add up to more, don’t sign the documents
and ask them to be re-drawn.
Be
careful out there!
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