CHAPTER 5

Banks, Mortgage Banks, and Mortgage Brokers in the New Mortgage Market

THE HOME LOAN INDUSTRY is constantly evolving. Even though it may not seem that way on a day-to-day or even month-to-month basis, it’s changing. In the late 1800s and early part of the 1900s, private banks made most of the loans people used to buy their homes. Insurance companies also played a huge role in home loan lending.

In the 1970s, home loans began to be issued more by thrifts, or savings and loans (S&Ls) than retail banks. Credit unions also began to play a role in mortgage lending during this time. S&Ls thrived for decades until the late 1980s, when many S&Ls were shut down or otherwise went out of business. Mortgage banks began to fill the void left behind by the S&L collapse.

In this era, most home loans were conventional ones underwritten to Fannie Mae or Freddie Mac guidelines. Very soon thereafter, in the early 1990s, mortgage brokers began their ascent to the mortgage origination mountain, which by the early 2000s commanded nearly two-thirds of residential mortgage loan origination.

As that decade came to an end, the influence of the mortgage broker began to wane, as many major mortgage companies stopped using mortgage brokers to market their mortgage loans for them and instead used their own retail presence to market directly to the public.

At no time did these various institutions simply vanish, rather they increased or decreased their market share. This shifting of market share can be caused by a variety of factors—sometimes by economic forces, sometimes by marketing, or by a combination of the two. You can get your mortgage at a bank down the street. You can go to your credit union. Mortgage bankers offer mortgage loans, as do mortgage brokers. You can even go online to find a lender.

So if there are so many different players in the mortgage business, where is the best place to get a mortgage loan? The answer to that is to first understand how all these different sources for mortgage money operate and who they really are.

CHANGING PRESENCE OF BANKS IN THE MORTGAGE INDUSTRY

Banks are the easiest to spot and perhaps the oldest source of home loans. They’re easy to spot, they’re on street corners everywhere it seems, and they typically have the word “bank” somewhere on their storefront. Chase Bank. Bank of America. Compass Bank. Bank of New York. Pretty easy, no? But their presence in the mortgage industry has changed dramatically over the past century.

The biggest change regarding banks now and banks just a few short years ago is that there are fewer of them. Some of the biggest banks in the country were shut down by the Fed or acquired by another bank. Initially, in the late 1800s and into the mid-1900s, banks made home loans, but they did so primarily from the deposits in their vaults. Quite frankly, mostly rich people could get loans because they also had the money required for the sizable down payment.

As banks evolved, they drew money from their own credit lines and would decide to sell the loan to someone else to replenish their credit line and make more loans, or they could keep the loan and collect the monthly payments and make their profits from the interest the bank charged. Credit unions and S&Ls operate in much the same fashion; they can issue loans from their own funds or make a loan from a credit account previously set up.

Mortgage banks also make mortgage loans, but they’re distinguished from the previous three institutions in that the only thing mortgage banks do is make mortgage loans. They don’t offer credit cards or savings accounts; they just make mortgage loans. Mortgage banks are not as easy to identify just from their name. A mortgage banker might be called something like “Reed Mortgage” or “Reed Capital” or some such.

CHANGING ROLE OF MORTGAGE BROKERS

A mortgage broker is different than all other sources for mortgage money. Mortgage brokers don’t have credit lines to draw from nor do they have any money in their vaults to make a mortgage loan. A broker is someone who acts as an agent that brings lender and borrower together. Exactly which lenders does the broker use, and how does the broker find them?

Many mortgage companies have two types of operations, retail and wholesale. A retail mortgage operation is the business unit that works directly with the borrower. A wholesale mortgage company is a business that works with mortgage brokers, who then work directly with the borrower.

It’s a wholesale business unit because wholesale lenders in fact offer lower-than-market interest rates to mortgage brokers, who then mark up the mortgage loan program to a more competitive “street,” or retail, price level. Common markups from wholesale to retail are usually 0.25 percent. If a mortgage broker quotes 6.00 percent to a borrower, the mortgage broker obtained that mortgage at about 5.75 percent.

Wholesale mortgage lenders use mortgage brokers to market their mortgage products to consumers in lieu of retail loan officers. Mortgage brokers have their own overhead, such as offices, employees, insurance and benefits, supplies, telephone lines—the typical business requirements.

Wholesale lenders avoid these overhead charges needed to run a retail operation and recruit mortgage brokers who already have a business in place. Wholesale lenders employ account executives, or sales reps, who make sales calls on mortgage brokers to recruit mortgage brokerage operations and their bevy of loan officers.

Mortgage brokers came onto the scene in a big way in the late 1980s, primarily pioneered by such lending giants as Countrywide and Bank of America. The business plan of a mortgage brokerage operation made for a rapid expansion of mortgage lending, as mortgage companies didn’t have to spend the time and capital needed to open up new retail operations or bank branches. Instead, they found independent mortgage brokers to market for them.

Wholesale mortgage lenders could then distribute their mortgage products in a highly efficient manner, using a business entity already in place with a customer base already established.

Mortgage brokers were largely unregulated and certainly unlicensed. The mortgage broker would apply to market the mortgages for a wholesale lender and had to have good credit and a place of business, but mortgage brokers mostly policed themselves without any regulation from state or federal agencies.

Early in the 1990s, however, that began to change. It became apparent that mortgage brokers were marketing products that should have commanded a bit more attention. If stockbrokers or life insurance agents had to be licensed and regulated, then why not monitor companies that were marketing another financial instrument— mortgages?

The advantage of a mortgage broker was primarily focused in two areas: shopping around for the best rate from various wholesale mortgage companies and passing the savings on to the consumer and finding a unique mortgage program not all lenders would offer.

Shopping for the Best Rate Is Not as Simple as Checking Percentages

Each day, both retail and wholesale mortgage lenders set their interest rates for that business day. We’ll discuss in detail how mortgage rates are set in the next chapter. As a wholesale mortgage lender issued its mortgage rates, it would distribute them to its mortgage broker network by fax, e-mail, or with special rate quotes designed around the loan level pricing adjustment (LLPA) explained in Chapter 2.

A wholesale rate sheet might look something like this:

30-Year Fixed Wholesale Rates

5.00 percent	2 points
5.125 percent	1.5 points
5.25 percent	1 point
5.375 percent	0.5 points
5.50 percent	0 points

The mortgage broker would review these rates, then add its profit to make the loan competitive with retail. A mortgage broker could take these rates, mark them up by 0.25 percent, or simply add its profit in the form of another point. The new broker retail rate sheet might then look like this:

30-Year Fixed Rates

5.00 percent	3 points
5.125 percent	2.5 points
5.25 percent	2 points
5.375 percent	1.5 points
5.50 percent	1 point

Or a broker could add instead an origination fee, or a mortgage broker fee, or really any fee a broker could think up as long as it remained competitive with the marketplace. A broker might add a 1 percent origination fee. An origination fee is expressed as a percentage of the amount being borrowed. On a $200,000 loan, one origination fee would equal $2,000. Much like a point. The brokers’ rate sheet would look like this:

30-Year Fixed Rates

5.00 percent	2 points +	1 origination fee
5.125 percent	1.5 points +	1 origination fee
5.25 percent	1 point +	1 origination fee
5.375 percent	0.5 points +	1 origination fee
5.50 percent	0 points +	1 origination fee

Or it could look like this:

5.00 percent	2 points +	1 percent broker fee
5.125 percent	1.5 points +	1 percent broker fee
5.25 percent	1 point +	1 percent broker fee
5.375 percent	0.5 points +	1 percent broker fee
5.50 percent	0 points +	1 percent broker fee

The result to the consumer was the same, regardless if the broker added one point, one origination fee, or 1 percent broker fee. But because the mortgage brokers got wholesale interest rates from multiple wholesale lenders, then the mortgage brokers could compare the various mortgage companies to find the best interest rate for their clients.

A mortgage broker can be signed up with as many wholesale mortgage companies as it sees fit. When shopping around for a mortgage broker, you’ll encounter advertising slogans that say something like, “We have over 100 lenders,” or, “Let our lenders compete for your business.”

In reality, a mortgage broker has no reason to do business with 100 lenders, and I’ll just bet that when push comes to shove, there aren’t even 100 wholesale lenders in the country. At the very least, a mortgage broker doesn’t have 100 lenders at its disposal that they’re approved with. But it makes for good marketing. I know, because when I started in this business as a mortgage broker, we touted our 50 lenders we worked with.

The daily routine works like this: As wholesale lenders distributed their mortgage rates to their brokers, the brokers would then scour those rate sheets to find the absolute best lender for that day.

I can recall when I first got into this business as a mortgage broker many years ago. Each morning, I would stand by the fax machine waiting for all of my mortgage lenders to fax their rates to me. I would pore through them, hoping I would find the one lender that would be better than any other lender, but it was to no avail. Mortgage companies essentially have the very same rates, and they’re all offered to mortgage brokers.

The fact of the matter is that lenders can’t be wildly apart from one another in interest rate because mortgage companies set their rates on the same index, as discussed in the next chapter.

Rate sheets from two different lenders might look like this:

30-Year Fixed Wholesale Rates

Lender A
5.00 percent	2.0 points
5.125 percent	1.5 points
5.25 percent	1.0 point
5.375 percent	0.5 points
5.50 percent	0 points

Lender B
5.00 percent	1.875 points
5.125 percent	1.375 points
5.25 percent	1.25 points
5.375 percent	1.00 point
5.50 percent	0.5 points

And that’s for just one loan program, a conventional 30-year fixedrate loan. Now add 25-year loans, 20-year, 15-year, and so on. Rate sheets can be four or five pages long!

The Right Mortgage Program Could Come from a Mortgage Broker—or Not

Perhaps the single biggest change in the mortgage brokerage industry is the fact brokers don’t have mortgage programs that other banks, credit unions, savings and loans, and mortgage banks don’t have. There is no benefit to using a broker.

Historically, besides trying to shop around for the best interest rate for their clients, brokers can also market hard-to-find mortgage programs. For instance, there might be a special loan program designed for condominiums that have yet to be completed, are primarily rental units, or aren’t approved by Fannie, Freddie, VA, or FHA as approved condominiums. Such condos are called “nonwarrantable” condos.

When a client wanted to buy a condo that wasn’t considered to be warrantable, the broker would contact a few of its “niche” lenders that would offer mortgage programs that could be found nowhere else. The niche lender would use mortgage brokers to advertise its products, and the brokers would then promote those special loan programs to their clients.

Or a client might have damaged credit and need a loan program that catered to those with bad credit. Or maybe a client had hardto-prove income. Whatever the issue, if a borrower couldn’t get a conventional or government loan, it could always turn to a mortgage broker who could find the special loan program.

No longer. Mortgage loans in the market today are either government-backed or conventional loans underwritten to Fannie or Freddie standards. Mortgage brokers no longer have mortgage programs that other lenders don’t have. I can recall in 2005 and 2006 that there was a huge influx of “alternative documentation” loan programs. These were the loans that were acceptable for nonwarrantable condos as previously described or that met other unique borrower requirements. My company only had government and conventional loan programs and simply couldn’t compete against brokers who offered such products. Yet that is no longer the case; mortgage brokers have the very same mortgage programs that banks do.

From your perspective, it doesn’t matter if you use a bank, mortgage bank, or a broker. A mortgage broker doesn’t approve the loan. The broker takes the loan application from the borrowers, pulls a credit report, and begins to document the file. The broker then submits the file electronically to the wholesale lender’s AUS for an approval, then proceeds to submit the loan application and supporting documentation in accordance with the loan approval issued by the lender.

Bankers do the same thing, but instead of sending the loan to another company to complete the process, banks keep the loan internally and close the loan themselves.

From a consumer’s standpoint, there really is little difference in the result of going to a broker versus a banker; the loan is still approved in much the same fashion. So the mechanics matter little with regard to the method of providing a mortgage to a consumer as long as the loan gets to the consumer in a competitive fashion.

I started my career in the mortgage industry some 20 years ago as a mortgage broker in San Diego. That’s how I learned the business. I would take the application, qualify the buyers, review the credit, then attempt to find the best deal possible for my clients.

When I found the best deal, I would send the loan via overnight delivery to the wholesale lender and wait for its approval to be issued. Typically, the wholesale lender would ask for some additional documentation, which I would provide, and then order closing papers that would be delivered to the escrow agent who would handle the closing.

When I moved to Texas in 1995, I began working with a mortgage banker. This company, Partners Mortgage Services, was a small, independent mortgage banker that had its own credit line with a local bank. Partners would document the file, approve the loan, print the closing papers, and deliver them to the settlement agent.

Partners was not a loan servicer; it didn’t make money on collecting monthly interest payments but instead sold the loan to other mortgage bankers, who would buy closed loans from other mortgage banks. Most every major national or regional lender had a division designed to buy mortgage loans from smaller mortgage bankers like Partners. Bank of America, Chase, Countrywide—all had departments that catered to mortgage bankers like Partners. This would appear to be exactly how mortgage brokers operate—find clients, then match them up with a lender. On the surface, it might appear that the function between a broker and a banker were the same, but there are some significant differences.

Shh: Small Mortgage Bankers Can Get Better Rates Than Brokers (and They Have More Control Over the Loan)

Primarily, the difference is that the mortgage banker provides the underwriting (approving) of the loan, prepares the loan documents, and delivers them to the settlement agent and prepares and packages the loan to sell to the mortgage bank agreeing to buy the loan. These activities represent a significant amount of overhead the buying mortgage bank doesn’t have to provide.

The selling bank warrants the fact that the loan meets government or conventional guidelines and the loan is then eligible for sale on the secondary market. In exchange for not only originating the loan from the borrower, underwriting, documenting, and delivering a closed loan, the originating bank would get better mortgage rates than a mortgage broker could get.

This is a little-known facet of the mortgage industry that smaller mortgage bankers can actually get better pricing than brokers can—plus, they have more control over the loan. How much better? Typically, it’s imperceptible, but sometimes banks can get 0.25 to 0.5 point better than brokers can get. Besides price—and, in my opinion, more importantly—bankers have control over the loan that mortgage brokers just don’t have. Once the broker sends the loan to a wholesale lender, the wholesale lender takes control of the loan, issues loan papers, and decides what additional documentation will be required: This, of course, assumes that the loan is in fact an approvable mortgage loan.

Mortgage bankers, by contrast, use all their employees in the loan process, not just the loan officer. When there is a problem with a brokered loan, the loan officer is ultimately contacted by the account executive and says, “Hey Dave, we’re going to have to decline this loan. The husband’s credit score is too low,” or some such.

The loan officer then tries to figure out how to get the loan approved and then has to resubmit the mortgage loan all over again. In this example, the loan officer took the husband off of the loan and qualified them with just the wife’s income. The loan is resubmitted under the new arrangement, and the process starts all over again.

Mortgage banks can decline the loan, but instead of the loan decision being made through an array of people, the underwriter can call the loan officer, and say, “Dave, we can’t do this loan with the husband on the loan. Do you want to take him off and just qualify using the wife’s income?”

“Sure.” And the loan continues to move forward. I learned this advantage first hand when one of my first loans as a mortgage banker had a problem just a day before the closing; I noticed the loan papers had the wrong interest rate—it was higher by an eighth of a percent. I was mortified. Here was one of my first loans in Texas, and it was going south. I would never get another referral from the Realtor involved in the deal again!

Because I was used to the fact that brokered loans would have to sometimes start all the way back at square one, I was facing the prospect that my loan papers wouldn’t make it to closing on time. This was something that I was used to expecting would add days to the loan process.

I told my boss what happened, and he told me to call the underwriter and explain what happened.

“The rate says 8.125 percent but should be 8.00 percent. What do I do?”

“Nothing,” she said. “I’ll make the change.”

She did make the change in a matter of minutes. My loan papers were corrected, and I closed my first loan as a banker. Bankers and brokers will always be competitive on price, but bankers have a superior advantage over brokers in controlling the loan process.

Finally, mortgage brokers can no longer order appraisals. This also widens the control gap. When a borrower applies for a mortgage from either a broker or banker, the loan officer will eventually order an appraisal. This doesn’t sound like that big of a deal, but it is.

The state of New York took a lender to court regarding some loan shenanigans. The lender was nationally known, and the suit was aimed at the wholesale division. Among other things, the state of New York alleged corruption between a loan officer and the appraiser. Loan officers were pressuring appraisers to come in at a required value. If the appraiser said he didn’t think the value would be what was needed, the loan officer would threaten to take his business elsewhere.

HOME VALUATION CODE OF CONDUCT

As previously discussed, appraisals are an integral part of the loan approval process. Lenders use appraisals not just to determine the value of the property in question but also to set the maximum loan amount a lender can lend. Yet appraisals can be manipulated. An appraisal will have a minimum of three closed sales within a local area but the underwriter won’t have additional data at their disposal that might dispute the appraisal.

If a loan officer, who might be paid 100 percent on commission, had a refinance loan of, say, $300,000, yet the values of local sales showed the value to be only $295,000, there would be no loan issued. That means no commission check. For a $300,000 conventional refinance, typically there needs to be a minimum value of $333,000.

So what if there were other sales, perhaps a bit further out than the comps closer to the subject? What if the appraiser used bad comps to support a $333,000 value and not the comps listed on the very same street as the subject property?

If the appraiser used the bad comps, the underwriter might not ever know. The underwriter may not have closed sale data on the neighborhood where the subject property is located. As long as the bad comps were within 12 months old and followed typical appraisal guidelines, then the loan could go ahead and be approved.

Now the loan officer closes the mortgage, makes a commission, and the appraiser makes money from the appraisal. The next time the loan officer needs an appraisal, he’ll call up his appraiser buddy and go through the whole routine all over again.

The loan officer and appraiser have a special relationship, and like other business relationships, if not held in moral check can be abused. Think of someone selling stock based on insider information. The stockholder found out from her friend at corporate that the quarterly earnings report was going to be dismal, so the stockholder sold all her shares before the bad news was released, profiting from the insider dealings. This is insider trading, and it is illegal.

Loan officers and appraisers have been working hand in hand for decades with no problems. But just like any other business, there are bad guys who manipulate the system.

When it was discovered that appraisals in some instances were being manipulated by loan officers, appraisers, and even real estate agents, the end result was, partially, the Home Valuation Code of Conduct, or HVCC.

The HVCC, which took effect in 2009, addresses several lenderappraiser issues but mainly attempts to halt a loan officer from coercing an appraiser into coming in with a particular value.

The HVCC identifies as illegal actions coercion, inducement, extortion, instruction, collusion, intimidation, compensation, and bribery. All such actions to get to a particular value would violate the HVCC.

A loan officer might sit at her desk and, seeing that she might have some value issues with a potential deal (read: commission check), she could start making phone calls to different appraisers and saying things like this:

“If you don’t make value, then I’ll never use you again.”

“If you can make value, then I’ll throw in another $500.”

“Make sure the value comes in at $300,000.”

“If this appraisal doesn’t come in at what we need, I’ll blackball you from our database.”

The HVCC addresses all these statements and attempts to eliminate them. The truth is that bad people will be bad people regardless of what the law says, so the HVCC tries to eliminate the temptation altogether by removing the mortgage broker from ordering the appraisal directly from the appraiser altogether.

Now mortgage brokers can’t coerce, induce, extort, instruct, collude, intimidate, compensate, or bribe an appraiser. This itself is monitored by the wholesale lender, who makes certain the appraisal meets HVCC standards.

But mortgage banks aren’t off the hook entirely, either. Though a mortgage banker or bank isn’t prohibited from ordering an appraisal directly, the HVCC does prohibit anyone that works for the mortgage bank that would profit directly from the loan closing.

This was initially meant to encompass loan officers or production supervisors who might get a commission check when the deal closed, cutting off the temptation of trying to influence a value in order to make money.

Unfortunately, the wording of the code is unclear. Does a loan processor profit when a loan closes? Can she order the appraisal? After all, she’s not getting paid solely on whether the deal closes. She gets her regular paycheck, regardless of any particular deal closing or not closing. But does she not also profit if a loan closes? In fact, doesn’t the entire company profit when the processor does what the business is designed to do: close loans? Of course. While it’s clear a loan officer of a mortgage bank can’t order an appraisal directly from the appraiser, the company can, as long as no one who orders the appraisal profits directly from the closing of the loan.

Appraisals Are Now More Money

Mortgage banks addressed the HVCC guidelines in two ways: a rotating wheel and an appraisal management firm.

A rotating wheel is nothing more than ordering an appraisal simply based on “whose turn is it next?” without regards to any particular value or appraiser. If a lender has 10 appraisers in its database then appraisals will be ordered consecutively, with each appraiser waiting in line.

The next approach is to have an appraisal management company order the appraisals. These firms are independent third parties who manage the appraisal process by ordering the appraisals on behalf of the loan officer or lender, receive them, and then forward them to the lender.

On the surface, the HVCC appears to eliminate the coercion and extortion that can exist between a loan officer and an appraiser. But as with many government-induced programs, it has its drawbacks. It raised the cost of appraisals. Appraisal management companies find appraisers to join their network. Appraisal management companies then solicit lenders to use their services. How do appraisal management companies get paid? Primarily from reducing the appraisers fees. If an appraiser normally charges $400 for an appraisal, by signing on with an appraisal management company the appraiser may have to agree to charge less, say $200. The appraisal management company would then keep the difference.

Okay, so what? If the cost to the consumer doesn’t change, who cares who gets the money? Appraisers do, and if they make half of what they used to make, what would they ultimately do? Charge more for the appraisal itself, or quit the industry?

The Relationship with Appraisers Has Changed

Since the loan officer can’t communicate directly with the appraiser, what would happen if the consumer chose to go to a different lender? If you change lenders you might have to pay for an appraisal twice. Historically, the loan officer would order a “retype,” which would remove the old lenders name and put the new name in its place.

That would work if the new lender was a member of the appraisal management company. The lender would order a retype, but it’s likely that a whole new appraisal would have to be ordered if the appraiser is not a member of the appraisal management company. That means the consumer pays $800 for appraisals, not $400.

Before the HVCC, a loan officer would call the appraiser and ask for an approximate value for a refinance. Now, however, the loan officer can’t do that. That makes it important to talk to your loan officer when filling out your initial loan application.

There is a section on page 1 of the application that asks for the “estimated value.” Most often, this field is left blank and only completed after the loan is approved. Instead, consult with your loan officer to find out what the value might come in at and shoot for the high side. Enter that amount in the field when completing the application. This way, the value will be communicated to the appraisal management company, who is able to communicate the value to the appraiser.

Although eliminating a working relationship between a loan officer and an appraiser sounds like a good idea, in fact it throws the baby out with the bath water. The appraiser/loan officer relationship was important to me, and ultimately important to the consumer.

If there were an issue with a possible valuation problem, I could call up the appraiser I’ve used for the past 10 years and say, “Hey, here’s a potential problem. Can you look up 123 Main Street and see if we might get a value of $200,000 or so?”

The appraiser would run some numbers and check recent sales and call me back with a “Yes, it looks like that value will come in,” or, “Not sure until we look at the property,” or, “No way.” With that information, I could talk to the consumer and say yes, maybe, or no. The consumer would then decide whether to move forward and spend money for a new appraisal. With the HVCC, that option has vanished.

NATIONAL REGISTRY FOR LICENSED MORTGAGE LOAN OFFICERS

New regulations aren’t just limited to appraisals and loan programs; they also now apply to loan officers, specifically as it applies to licensing. Recall that wholesale mortgage lenders find mortgage brokers to market their products, but how does the wholesale lender know where to find these brokers in the first place? They first start with the governing board in the broker’s state that regulates and licenses mortgage brokers.

In the past, mortgage brokers were regulated and licensed by their individual state. Oklahoma has different licensing laws than Texas. In California, when I first became a mortgage broker, I was licensed and monitored by the California Department of Real Estate.

Mortgage bankers and employees of banks are typically regulated separately than brokers. When I was with a major bank, as loan officers we were not individually licensed. Banks come under some severe scrutiny as it is, with their own host of compliance and regulatory issues they must face. Brokers have complained for years that mortgage bankers and banks don’t fall under the same scrutiny as mortgage brokers do. And they’re right; they come under more regulation.

Banks are regulated by the Fed, the FDIC, the Office of Currency Comptroller, the Department of Housing and Urban Development, and FHA. In the case of mortgage banks, they too must meet minimum standards both in terms of net worth, loan quality, and liquidity. It’s no easy task to obtain a credit line and be approved by HUD, Fannie, or Freddie to underwrite and sell mortgage loans.

Although brokers have complained that they’re being licensed more than mortgage bankers, that fact is just the opposite. Mortgage brokers may have had more individual loan officer licenses simply because there were more of them, and in certain states individual mortgage bankers didn’t have to license their individual loan officers as long as the mortgage bank was qualified to sell loans to Fannie, Freddie, or FHA.

Still, mortgage banks are regulated in most every state. Often not in the same fashion as mortgage brokers, but regulated nonetheless. In California, for instance, mortgage bankers are regulated by the State Department of Corporations, while brokers are regulated by the Department of Real Estate.

Now, however, every single loan officer not employed by a bank is licensed and registered with the federal government. Broker or banker, both must not only be licensed in accordance with their state laws but also registered and assigned a unique identifier that stays with that loan officer for the remainder of his career regardless of where he ends up working.

This national registry performs a background check on each individual loan officer and keeps tabs on the loan officers, as long as they’re working in the mortgage field. This is probably long overdue, in my opinion. While I’m not a big fan of government regulations, the fact remained that the entry level for being a loan officer was next to nothing. Employees of pawn shops and so-called payday lenders endured more scrutiny. Frankly, due to the potential for fraud, anyone with an ounce of intentions to cheat as a loan officer picked the wrong industry. Imagine being a crook, taking a loan application, and then having at your disposal the names, social security numbers, and bank account information of all your “clients.” Think there might be a bit of temptation there? Apparently, there was plenty of it in the 2000s, and we’re still paying the price today.

NEW LICENSING RULES

Loan officers are at least registered with a single government entity, but that doesn’t really level the license playing field. Depository institutions, or institutions that take consumers’ deposits in the form of savings or checking accounts, are not required to have their individual loan officers licensed. Again, simply being a bank places more regulations than any individual loan officer could imagine.

Mortgage banks do have to be registered, as do their loan officers in a similar fashion as brokers do with one major exception: yield spread premiums.

There Are New Disclosure Requirements for Yield Spread Premiums

Yield spread premiums, or YSPs, is the latest moniker given to an amount of income a broker receives from the wholesale lender. Yes, that’s right. A wholesale lender can pay a mortgage broker on your mortgage loan. Is that a form of bribery? It might appear that way, but in reality it’s not, and here’s how YSPs come into play.

Recall that the lower the rate, the more points you’d pay? Here’s the chart we reviewed earlier:

30-Year Fixed Rates

5.00 percent	3.0 points
5.125 percent	2.5 points
5.25 percent	2.0 points
5.375 percent	1.5 points
5.50 percent	1.0 point

Now add some rates with a YSP.

5.625 percent	0.5 points
5.75 percent	0 points
5.875 percent	−0.50 points
6.00 percent	−1.00 points

Using this example, if you wanted a 5.00 percent rate, you’d have to pay three points. Or pay one point to get the higher 5.50 percent rate. By increasing the rate even higher, soon the “points” become negative. “Negative” points mean the rate is so much higher than for ones with points that there are points left over—to the loan officer or to the consumer in the form of yield spread premium.

For instance, this chart would have a 6.00 percent rate at –1.00 points. On a $200,000 loan, that would mean there is $2,000 available from the lender in exchange for a higher interest rate. Lenders quite frankly don’t care if someone pays points or not. A lender will issue a lower rate for more points and charge no points for a higher rate. The end result is typically the same for the lender. But not for the mortgage broker, who has to disclose the additional income that a lender is offering. This is called the “disclosure” rule and was implemented early on in my career as a mortgage broker in California.

A mortgage broker is supposed to declare any and all compensation in mortgage transaction. Brokers thought this was unfair, but in reality, every other business entity also has to disclose what they’re making. The real estate agents disclose their commissions, appraisers disclose how much their appraisals cost, and title insurance shows what the charges are.

Changes in RESPA Help Consumers

This is all required due to the Real Estate Settlement Procedures Act, or RESPA. All financial transactions must be disclosed to the borrowers. RESPA was designed to thwart back-door referral fees from one party to the next. Say a real estate agent referred the name of an insurance agent to provide a policy. Although it’s not illegal to refer an insurance agent, it’s illegal to refer an insurance agent and get a referral fee for doing so.

RESPA forced all parties to disclose who charged what and who paid for it. That’s when the YSP began to come into play.

Back in the late 1980s and early 1990s, disclosure of a YSP wasn’t a requirement. Back then, it wasn’t called a YSP but a “rebate.” As interest rate choices to the consumer rose, rebates would be provided to the broker, who would then pass along that rebate to the consumer or keep the rebate themselves as additional profit on the loan. It wasn’t a requirement to disclose to the borrower that there was a rebate involved.

But as there are so many rate and point combinations, it soon became evident that to comply with RESPA any rebate had to be disclosed to the borrower—after all, it was income paid by one party to another in the course of a real estate transaction.

In 1991, rebates were for the first time required to be disclosed by mortgage brokers to their clients. Personally, I never had an issue with disclosing when I was a broker. I always touted our “no point, no fee” mortgage loan program and actually showed my wholesale lenders rate sheet that I received to the client, which explained the process.

“In exchange for a slightly higher rate, we can cover your closing costs for you while at the same time having the lender pay our fee,” was a typical presentation.

Disclosing rebates has been a sore spot for mortgage brokers for years, claiming that it’s unfair to disclose all their income, including YSPs, when mortgage bankers aren’t required to disclose YSP.

A mortgage broker might have a YSP that is disclosed to the borrower when a mortgage banker, offering the very same rate, might have some similar amount built into the loan as well but the borrowers are not told about it—unless they ask.

The brokers have a good point. It doesn’t seem fair. All parties are supposed to disclose who is making how much off of the real estate transaction. But for a mortgage banker, the final profit may not be known on a particular loan for several days after the loan has closed. Or longer. Yes, the rate might be 6.00 percent at the closing table, but if the lender decides to keep that loan and not sell it, the profit to the banker would be much more than just the 6.00 percent rate at the closing table. It would be thousands upon thousands of dollars collected in long-term interest.

If the mortgage bank does in fact decide to sell the loan, at what rate and at what fee does the banker sell it for? Loans can be sold at a profit or at a potential loss, depending on market conditions. For instance, a mortgage bank has several loans it closed at 6.00 percent, and the mortgage bank wants to sell them to raise money. But the rates had moved down since the original close dates to 5.00 percent. Instead of those loans being worth 6.00 percent, they sell them closer to market conditions and, in effect, take a loss on those loans.

That’s why disclosing by direct lenders of all the profit on a mortgage loan at closing can’t be determined. Any YSP by a banker may not be the profit on the loan; there are too many other potential costs involved to make that determination. Brokers make their money at the settlement table and move on. Bankers hold onto that asset and value it differently as markets change.

Brokers had in the past disclosed YSP as a “range” of potential rebate, and this disclosure comes in the form of the good faith estimate, or GFE, that must be provided to the borrowers at the initial meeting between the loan officer and the borrowers or within three days if the application was received via mail, fax, or online. The GFE highlights all the potential charges a borrower might incur while obtaining a mortgage.

The broker would disclose to the borrower something like, “Your rate, if you locked in today, would be 6.00 percent, I would charge a 1 percent origination fee, and there might be some yield spread premium. This yield spread premium is paid directly to me by the lender and could be anywhere from 0 to 3 percent of the loan amount.” On a $200,000 loan, that range could be anywhere from zero to $6,000. That’s hardly an accurate disclosure, but the brokers used that method for years.

Until now. Brokers must disclose to the borrower any YSP not to exceed a certain amount of money. If the broker initially disclosed to the borrower that the broker would be making 1 percent in YSP on a $200,000 loan, or $2,000, and the actually YSP came in at 1.25 percent in YSP, then the broker would either have to give the additional 0.25 percent to the borrower in the form of a credit or disclose once again to the borrower the higher YSP.

Why don’t brokers know how much YSP they will be getting at the initial application? Because interest rates change over time, and unless the loan is “locked in,” that rate as well as the YSP will float along with the market. We’ll discuss rates and locks in detail in Chapter 6.

If the YSP is higher upon locking than originally disclosed, the wholesale lender will not release the loan until the new disclosure forms are signed.

Direct Lenders Have the Upper Hand

So which is better, a broker or a banker? For definition purposes, a banker means a retail bank, savings and loan, credit union, or mortgage bank—anyone who approves and provides the funds for a mortgage.

Since interest rates can’t be that much different from one lender to the next, be it comparing a broker to a banker, it may not matter all that much where the mortgage loan comes from. Personally, I think it’s best to go with a mortgage banker as long as the rates are as competitive as can be found from a mortgage broker. Mortgage brokers certainly have access to multiple wholesale lenders, and on any given day one or two lenders might be 0.25 of a point better than the rest of the market.

Note that this is a quarter of a point, not 0.25 percent in interest rate. If you’re being quoted 6.00 percent at 1.00 point and the broker can get 0.25 in YSP, it’s not very likely you’ll get that 0.25 point for you to apply to your closing costs. It’s possible, just not likely. Mortgage brokers will shop around to different lenders—not necessarily to get you a better rate but a competitive one, while finding a little bit extra for themselves.

If you found a mortgage broker who could find a 5.75 percent rate while everyone else was at 6.00 percent for the same amount of money, then certainly use the mortgage broker. But unless the broker is doing the loan for free, you can’t expect that much disparity in rate.

What if you do get a quote at 6.00 percent for 1.00 point and the broker discloses to you that there’s another 0.50 point available in the form of YSP? Why not ask for it? That’s right, tell the broker that you see there’s an additional 0.50 point from the lender and can she apply that 0.50 point toward your closing costs.

YSPs Are Negotiable

Consumers aren’t typically aware that the YSP is negotiable and figure that it’s simply something the wholesale lender is paying the broker for sending a loan to them. It’s not; the YSP is nothing more than a by-product of the interest rate selected by the consumer or the broker. So go ahead and ask for it. It doesn’t hurt to do so, and you’ll probably get some of it.

ADVANTAGES OF MORTGAGE BANKERS

If brokers can’t be hands down the best all the time, then I suggest using a banker due to the control of the loan the banker has. But not just any old banker. National banks with a presence seemingly everywhere, or older, established institutions have an inherent advantage when it comes to their interest rates; they don’t have to be the lowest in order to get a consumer’s business.

The big lenders have a loyal following and can offer more than just a mortgage by issuing credit cards or keeping someone’s checking or savings account. That loyalty factor will result in slightly higher rates than what can be found through a mortgage broker or smaller mortgage bank.

In fact, the best choice might be a pure-play mortgage bank. These business types offer nothing but mortgages and have to be competitive in the marketplace to compete with brokers. In addition to always being competitive, the mortgage bank has complete control of the loan file from start to finish.

Mortgage banks view loan files a bit differently than a mortgage broker might. Mortgage bankers have a sense of ownership on the loan file that brokers may not have. This is different than committing to excellent customer service or keeping in contact with old clients.

Mortgage bankers originate, process, underwrite, fund, and sell or service your loan. If the loan is sold and for some reason it goes bad, the loan gets sent back to the original lender. Mortgage bankers have to be certain their loan is a good loan, or else they’ll have a loan on their hands they don’t want or can’t afford.

Mortgage bankers work as a team. If someone in the underwriting department has a question on a loan application, the underwriter will simply call or e-mail the loan processor or loan officer. “Are the borrowers married? They have different last names.” Or, “Who is the person giving the financial gift to the buyers? What relation are they?”

It may sound simplistic, but lenders who view loans as their own “baby” and watch it grow up can move loans more efficiently than a broker can. Ownership goes far beyond the loan closing. A mortgage broker originates the loan, documents it, and then submits it to the wholesale lender. The wholesale lender completes the loan process and pays the broker at the closing table. The broker moves on to the next loan.

Additionally, some of the largest banks in the country that used the mortgage broker channel have closed their wholesale operations altogether and no longer use brokers. Many lenders who used brokers, sometimes exclusively, are no longer in business, and there are fewer mortgage brokers today than there were just a few short years ago.

It’s hard sometimes to determine if you’re talking to a broker or a banker simply based on the name. You might find companies that have “mortgage bankers” in their name so that would be a start, but you may have to do a little research. One way to tell is to visit their websites and review the “About Us” section. Or at the bottom of the main page, it should say something to the effect of “Licensed as a Mortgage Broker” or “Licensed as a Mortgage Banker.”

Disclaimer: My primary experience has been a pure play mortgage bank and that’s what I do now, so maybe I’m biased. But I have worked with a mortgage brokerage operation, a pure-play mortgage bank, and at the time the nineteenth largest retail bank in the country in my 20 years in the business. I’ve worked all three options.

You won’t find a mortgage banker with the name of something like “ABC Mortgage Bank We Don’t Do Anything Else But Mortgages,” but instead something that sounds like any other mortgage company: “XYZ Capital” or “Super Mortgage.”

Does all that mean you should only contact mortgage bankers to find the best loan officer? Of course not. There are some very good loan officers that work at mortgage brokerage firms. There are some very good loan officers that work in retail banks and credit unions and savings and loan companies. It’s just that the business model of a mortgage banker is more in tune with consumers’ requirements in light of today’s market.

When there was a plethora of subprime loans, alternative loans, and “no document” loans, then brokers had a distinct advantage over their peers. Now that almost everyone has the same loan choices and rates are competitive, the utility of a broker has weakened.

FINDING A GOOD LOAN OFFICER

How do you identify a good loan officer? The best loan officers have been around for a while. They’ve gained experience in the lending industry. This isn’t uncommon for any business—those who have been in the business longer than others are either lucky or very good at what they do. But in the lending business there’s an additional reason why years in the business is critical: automated underwriting.

AUS applications introduced in the late 1990s marked a brand new way of approving loans. It streamlined the process, while at the same time cutting out certain efficiencies in the mortgage industry. It made my life and my loan processors’ lives a whole lot easier (see Chapter 4 for more details).

With an AUS, a loan officer simply “plugs in” the loan application data, hits the “send” button and within a few seconds the loan approval is issued along with a list of required information to close the loan.

AUS applications really made it big in the early 2000s, right about the same time as rates hit then-record lows and so many people were refinancing their home loan. Over the next few years, the nation enjoyed a substantial housing boom with home sales all across the country setting new records. With this new influx of both purchase and refinance business, lots of people quit what they were doing and went to work as loan officers. There wasn’t really a whole lot to learn, just open the door and let some new business walk in. The new loan officer didn’t need to know how loans were approved just how to enter the loan information into the AUS and wait for the approval.

Loan guidelines became more and more relaxed, which resulted in even more loans. New loan officers thought themselves fairly smart when they were “approving” all those new loans. Soon, of course, the housing bubble burst, and lots of loan officers went out of business and went back to what they were doing before.

But if loan officers never understand how loans are approved in the first place by reviewing credit histories, calculating debt ratios, and putting people in the correct loan program, then they won’t know what to do when a loan gets turned down.

“Sorry,” the loan officer says. “But your loan has been turned down.”

“Why?” you say.

“Not sure exactly. This is all I can do.”

Automated underwriting systems were designed to streamline the process, not make up for lack of mortgage skills. Loan officers who have been around pre-1997, before the AUS applications came into full force, know how to manually approve a loan. They know how much someone can afford before the loan is submitted to the AUS. They know how to fit monthly payments in order to meet debt ratio requirements. They know the nuances of the various loan programs and which ones will work and which ones will not.

I recall a client who worked in the marketing department for the corporate offices of one of the world’s largest real estate companies. She had been shopping for her first home, and obviously working for a large real estate organization allowed her to choose almost any real estate agent she wanted to. She had read one of my books and decided to give me a call.

“David, I’m having trouble getting qualified. I found a house and made an offer, but I’m getting declined and my mortgage broker says I have to wait to save up some more money,” she said. In fact, the mortgage broker she was working with was referred to her by her own real estate agent. She told me her situation, and after a few minutes, I said, “Stop right there. You’re on the wrong loan program. I can fix this.”

Sure enough, she had beaten her head against the wall while her mortgage broker was submitting her loan to this lender and that lender trying to get an approval, but she kept getting turned down time after time—for the very same reason. The broker kept thinking that maybe if she submitted the loan enough times, then certainly some lender would finally approve her.

She had great credit, good income, and a down payment. So what was the problem?

She was putting 10 percent down, and her down payment money was coming from a gift from her father. The mortgage broker was submitting her to different wholesale lenders on a conventional Fannie loan.

The problem was that conventional lenders require 5 percent down from the borrowers’ very own funds if the gift represented less than 20 percent of the sales price of the home. The gift was for 10 percent. She didn’t have 5 percent of her own money saved up, and that’s why she kept getting declined. She applied on my website, I downloaded the application and ran her loan through FHA’s automated underwriting system. Voila! Approval!

FHA only requires a borrower to have $500 in a transaction when there is a gift involved. But the mortgage broker wasn’t familiar with FHA loans or apparently intelligent enough to know that submitting the same file over and over again under the same guidelines will have the very same result.

This client had been trying to close on her house for nearly two months and had thought she was going to lose the house. In fact, had she not called me or another experienced loan officer she might still be waiting.

If you can find a loan officer that has been in the business since before 1997, you can bet two things:

1. 1.The loan officer is good enough to be in the business for this long to weather the ups and downs in the industry.
2. 2.The loan officer knows the inner workings of loan programs and legitimate ways to get deals closed when others can’t.

It’s possible that you don’t know where to start to find the best loan officer.

There are some tips to help you find a good loan officer, but first, I’ll tell you where not to look: the Internet.

There are websites such as Bankrate.com that post interest rates from various lenders. Bankrate.com has plenty of market commentary and actually some very good articles about lending in general and some specific articles on mortgage loans. It also lets lenders pay to advertise on its site. Bankrate.com has a grid with different lenders (most likely none you’ve ever heard of) showing their company information, their rates, and the different loan programs they might offer.

It’s a real shell game, because it’s hard to determine who actually has the best rate. In fact, you’ll see some phenomenally good rates— some seen nowhere else! In truth, this can be nothing more than a bait-and-switch tactic. Remember, lenders set their rates on the very same index every day, and one lender can’t be remarkably lower than anyone else. It just can’t happen.

Even if you did decide to use one of those lenders, you’re likely to get hooked up with a 1–800 number and a customer service person who lives nowhere near where you do. Mortgage loans can be too complicated to leave to a customer service person. You need someone local who has established themselves in the lending industry.

If you don’t have a favorite loan officer you like to use or you can’t stand the last one you had, then I suggest finding some good real estate agents in your area and ask them for referrals. Good mortgage loan officers build their businesses around top agents, and they keep those top agents happy by providing their clients with competitive rates and solid customer service.

Okay, so maybe not all of the loan officers out there have gray hair. Maybe they’ve only been in the business for a few years. I’ll grant that everyone has to start in any business at some point, and someone is always a rookie at least once. But this is your mortgage, and you’ll be paying on it long after the loan officer shakes your hand thanking you for your business. You want all the competitive edge you can get.

SUMMARY

• Banks, savings and loans, credit unions, mortgage bankers, and mortgage brokers are all sources for mortgage money.
• Only mortgage brokers do not lend their own money but find it on behalf of the borrower.
• Mortgage brokers became increasingly regulated, along with a new national registration process for all loan officers.
• Mortgage brokers have the ability to compare rates from different wholesale lenders, but since rates are so competitive, the difference is often imperceptible.
• Shopping around for the “niche” loan program is no longer a benefit, as all lenders now offer the same programs since subprime and alternative lenders went away.
• The Home Valuation Code of Conduct dramatically changed the way appraisals are ordered and managed.
• Additional appraisal requirements add to the cost of an appraisal.
• “Pure play” mortgage bankers offer competitive rates, plus control of the loan process.
• The best loan officers have been in business prior to the introduction of automated underwriting systems.