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AN OUTSIDERS INSIDE VIEW

(A MORTGAGE UNDERWRITERS OPINION)

I started saving articles, newspapers and mortgage documents in 2003 because I new the daywould come when the housing industry would implode. Eighteen months ago I started putting the information together. My original intent was to enlighten the public, not just mywife and friends, on what I believed was a mortgage meltdown in the works. One so largethat the money the government spent to bail out the S&Ls’ would seem like chump change.The catalyst was this headline:

Countrywide may cut 12,000 jobs:

twenty per cent of their workforce! Since that news story first broke 15 months ago all hell has broken loose, soinstead of explaining why I thought the mortgage industry was going to crash I would like toshare my opinions on why it did crash. I don’t’ claim to be an authority on mortgages but Ido believe my 30 years in the industry as an Appraiser, Loan Officer and for most of thattime a Underwriter gives me more knowledge than most people on the subject. Mycredentials also include being a FHA DE approved underwriter, FHA approved buildinginspector and VA/LAPP approved underwriter.Three years ago I was working for Clayton, a due diligence and mortgage underwritingcompany. We traveled throughout the country, at clients requests, to “perform” due diligence,(i.e. quality) control on mortgages they were interested in purchasing. The perspectiveinvestors gave Clayton the parameters they felt were stringent enough to risk a purchase. If the loans or the overall pool of loans met their criteria a deal was struck. It was a numbersgame; look to see if the loans met the investor’s guidelines, record the information on alaptop and move on.Mortgages were purchased by companies and added to portfolios. Although these higher yielding instruments were riskier, it was because of the risk that they were more profitable.Houses were appreciating at record rates so even the shakiest of loans was still worth therisk. And, when combined with the safer stocks, precious metals, gold, etc. it made a nice blend for higher returns.These are some sub-prime credit guidelines I remember that investors deemed acceptablecredit. You could have a combination of no late payments on the mortgage for the mostrecent year; or no late payments in the last 6 months on the mortgage combined with any 30day late payments on a credit card. The investor may require 3 major lines of credit be listedon the credit report, such as a Visa and major department stores or Visa, MC and AmericanExpress, most any combination worked.The third line of credit could be inactive for the last year but, when is it was active the payment history had to be good. Investors might accept a 2 times thirty late or a one times 60late within the last year combined with a FICO score as low as 575. In rare instances theFICO score could drop to 520 providing very good compensating factors were presented. Ionce saw a loan that was approved 1 day after a bankruptcy was dismissed. The majority of the loans using sub-prime credit standards were also using a 100% financing.If the person was breathing companies like New Century and Aegis made the loan becausethey knew some idiot investment banker or insurance company would buy it! I doubt the people who decided what the credit criteria should be ever underwrote mortgages or had anycredit experience. They were

INVESTMENT BANKERS!

2I was not very comfortable with this concept: being an old school underwriter I saw too muchrisk. These were poor loans from the start with borrowers that under any other scenariowould never have been approved. Nor was I very fast: I had a tendency to underwrite theloans instead of looking for just the investor’s requirements. One day I rejected 10 of 11loans only to have the Lead Underwriter override my decisions. Wonder who made thecorrect read on those loans? I was told more than once that the worst people for this positionwere former underwriters. I would think we were the best people for this loan work!Clayton was doing what they were hired to do. The only criticism I have of them is theywould use anyone, regardless of prior employment, that passed their 1 week training course.There is a stark contrast between the way I learned to underwrite and how sub-prime loanswere reviewed. They left me on the outside looking in. I am proud of that fact.Liberal guidelines and ill-conceived loan program are partially responsible for the collapse of the mortgage industry but, I believe there is another very strong and prevalent factor thathelped everything implode: GREED!!There is nothing wrong with making as much money as you can provided the mortgageapplicants being preyed on are given all the correct information so they can make aneducated decision.In an attempt to reach more would be buyers, different mortgage programs were introduced.The most well known one is the Adjustable Rate Mortgage. It was created in the late 70’s asan alternative to the sky high fixed interest rates do to inflation. In its’ original format andused in conjunction with conventional, not sub-prime lending, the ARM is a good alternative program. The interest rate is below fixed rates and it adjusts once a year, up or down, by amaximum of 1%. You can get an ARM with an initial fixed time for 1 to 5 years. For peoplethat move frequently, this is a wonderful loan. I am willing to bet there is not one adjustablesub-prime loan that resembles what I described. It is a good program that was a boost to theindustry. However, the majority of the Loan Officers selling this program didn’t know how itworked, thus, it was impossible to educate the consumer on the plus’s & minus’s.Until the early 80’s Loan Officers were salaried. Then they were taken off salary and put oncommission. Get paid what your worth; turn every opportunity into an application. You makemore money and so does the company. GREED, good as long as it doesn’t consume you, butfor most people, it does engulf them.Underwriters were instructed to “think outside the box”; stretch guidelines to the limits.While working at Fieldstone, a

SUB- PRIME

and

ALT-A

mortgage lender this incident took place. It is a perfect example of thinking TOO MUCH OUTSIDE THE BOX!! A loan had been underwritten and approved with several stipulations or “conditions.” My job was tocontact the broker, let them know what other paper work was needed for the file so it would be saleable on the secondary market. In other words, “have all the ducks in a row”. Being anunderwriter who was not underwriting at the time my curiosity got the better of me. I had thetax returns along with a current P&L statement, W2’s and a recent pay-stub. The applicantwas running a business out of his home cutting hair. The tax returns reflected this, however,when all the expenses were added up, the business was loosing money. This loss pushed thetotal debt to income ratio over the limit. Because Alt-A, stated income or sub-prime loanshave such liberal guidelines, ratios can not be exceeded.When I told the underwriter about the problem she instructed me to call the mortgage broker with instructions for the applicant to write a letter stating that because the business was

3losing money he was going to shut it down. The underwriter is coaching the applicant andmaking the loan fit the guidelines. If the next years’ tax return were reviewed, I am sure that business would still be listed. Funny thing is, that could be checked out because I still havethe paperwork. In my opinion, the Office and Production Managers at the Downers Grove,Illinois Fieldstone office only cared about the numbers, not ethics! It was always, “we haveto be number 1 in our region.” Could it be there were performance bonuses?!!This particular loan exemplifies is the worst case of greed I have ever seen. I was employed by a company that supplied “leads”; people that call interested in mortgage information.While on one of theses appointments, during the course of conversation, I found out theapplicant worked at home designing web sites. His sight was deteriorating. His wife, whowas at work, had just recovered from heart problems when she was diagnosed with cancer.They thought there might be something I could do to help ease their finances even thoughthey had refinanced within the last 6 months. After looking over the paperwork I told himthere really wasn’t anything I could do. They had signed note with a pre-payment agreement,which is standard for sub-prime financing. The penalty is hefty; usually a minimum paymentof 3 to 5% of the loan amount. As the loan ages the term for the pre-payment decreases. Normally, after 3 years or less this penalty drops off but until that happens the borrower doesowe more than what they borrowed.. They also had mortgage insurance, the one that pays off your mortgage if you happened to die: that is its only purpose. I asked why he agreed tomortgage insurance. It was the only way the lender would make the loan.Greed is the only excuse to sell mortgage life insurance. It pays a very lucrative commission.The borrower gave me a copy of their Good Faith Estimate. They were charged $10,000 in“fees” to do $100,000 loan. A pre-payment penalty, mortgage insurance and $10,000 in fees!At the outside the costs for getting this mortgage should have been around $3,500 to $4,300maximum. These people were desperate, willing to do most anything to help themselveswhen along comes this parasite mortgage company and loan officer willing to suck them dry.I find out where their office was, in the Biltmore section of Phoenix; a very posh area. As Iremember their office had mahogany woodwork and the desks fit the setting. There were 2owners who had moved from Minnesota to reap the riches of Arizona’s housing boom.Dressed in designer suites with the wet look combed back hair, they screamed success toanyone who met them. I am pointing this out because the image they want to present is far more important to them than ruining lives. When I started in the mortgage business a good loan was one with a 20% down payment andno late payments on the credit report for the most recent 2 year history. It used to be if a persons’ income was derived from commissions they needed to provide 2 years plus year todate commission income and the likely hood that the earnings would stay at the currentlevels. Verifying non commission income also required a 2 year history plus YTD earnings. Now it is 1 year to 18 months. If a person was putting less than 20% down private mortgageinsurance was required. Its’ purpose is to protect the lender in case of default.Interestingly, it was a private mortgage insurance company that thought up the 80/20 loan; an80% first mortgage followed by a 20% second mortgage. The loan afforded an applicant theopportunity to get 100% financing without any mortgage insurance; a savings to the borrower or a way to get a larger loan. The money that would be used to pay for mortgageinsurance could be applied to pay a higher P&I. Maybe the mortgage insurance companiesought to be investigated. Think about all the money they are saving; not having to pay claimson foreclosed properties!