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Paul Kiesel
Paul Kiesel
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Fed Misses Major Lending Abuse Issue: Mortgage Brokers Steering Borrowers into Bad Loans for Fat Fees

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In 2007, mortgage brokers and loan officers received huge payouts by lenders like Countrywide, Bear Stearns and IndyMac to put unsuspecting borrowers into expensive loans (supbrime, ALT-A., etc.), according to the Department of Housing and Urban Development (HUD).

Howell Jackson, a professor at Harvard Law School, testified before Congress recently and said that he thinks the Fed has overlooked the problem and that it remains a “serious problem.” Ultimately, Mr. Jackson believes that that cost of borrowing for everybody goes up, because of the losses that stem from subprime loans that were issued and continue to be issued due to incentive-laced compensation for the mortgage broker and the high default rate of the loans.

The HUB estimates that this type of lending practice cost borrowers $16 billion in 2007 alone.

The Yield Spread Premium (YSP)

The YSP is the difference between the lowest interest rate that a borrower qualifies and the actual rate that a lender charges. The greater the YSP, the more a loan originator, like Countrywide, earns and that pushes the mortgage broker, based on avarice and compensation, to steer the borrower into a bad loan.

CNNMoney.com provides an excellent example of this YSP problem:

Say a couple buys a new house and qualifies for a 6.5% rate on a 30-year fixed mortgage. A greedy broker or loan officer might put the couple in a 7% loan so that he earns a bigger payday, or even a 7.25% loan. Loan originators usually earn about 1% of the loan value for every extra quarter point of interest they charge borrowers. So if they put naive home buyers into high-cost loans, such as hybrid adjustable rate mortgages or option arms, they could make 5% or more on a loan.

Due to the clever packaging of junk loans, like option-ARM loans and other teaser rate payment loans, and selling them off to investors (CDOs), the above situation occurred more often than it should have over the last few years, as mortgage brokers and loan originators were able to deceive borrowers into negative amortization loans via a mutlifarious of TILA violations.

The Fed says it plans to address this problem. However, a spokesman for the Fed has only said that it will focus its efforts on improving fee disclosures, which is a start, but still leaves the borrower at a disadvantage in determining the YSP.

A spokesman for the HUD, Brian Sullivan, said that “mortgage rules are 30 years old and don’t reflect the way people refinance their homes today.” This is true. Teaser rate payment options weren’t an option that long ago.

Even though the Fed announced new rules last week to help curb mortgage fraud, if further legislation isn’t introduced TILA violations and other mortgage fraud, through deceptively written loans, could emerge again.