Finally Suitability Test Arrives At The Mortgage Industrys GateHow Bad Does It Have To Get

Dale Rogers

A younger person can afford to put a good portion of their portfolio in aggressive high growth stocks with no earnings but lots of prospects. Time is on their side. An older persons portfolio may be a more weighted in fixed investment products that throw off a solid rate of return in the way of periodic distributions. From time to time, brokerage houses are coughing up settlements to stock customers who were sold a product that turned out to be unsuitable. Churning accounts to pump up the commissions for brokers is also a point of contention. Brokerage houses pay, but in many cases the NASD lifts the license of the offending broker and often bans the offender for life and can never work in the securities industry. It is harsh, but it culls out the offenders and gives a customer access to airing grievances and obtaining some restitution.

Who then speaks for the mortgage borrowers when the ether wears off and the customer finds themselves up to their chinney chin chins in a financial tornado the likes of which Pacos Bill would have a hard time riding for eight seconds. Mortgage products such as 2/28 (fixed for two years than adjusts every 6 months), 3/27 (fixed for three years then adjusts every 6 months), NO DOCs, NO RATIO, Stated Wage Earner, Stated Self-Employed, Option ARMs with heavy built in margins may stack the deck from the beginning against the customer. In all many cases this loan product will almost guarantee rapid rate increases and mortgage failure down the road. When a loan officer is setting across the desk from a borrower who fits perfectly into one of these esoteric mortgage products how much thought goes into the after effects of signing up for one of these less understood mortgage programs. In the electronic age, the online application has very little customer interaction and interview other than e-mails and perhaps the old standby, the telephone. So with the customer acquiescing with some of the offered programs the downside risks may not be sinking in to the cranium of the borrower, hey, this could destroy my family down the road. The focus at the time may be more on whats the monthly payment? A lender and mortgage broker role in looking at suitability for the borrower is a proven weak point in the process.

When a stock investors take a position in a mutual fund whatever the risk factor the fund is just looking at booking the shares. Its left to NASD and the brokerages to gage suitability. If a stock broker does a sloppy job with suitability the customer sues and usually collects and NASD may suspend a stock broker to do business OR render sever discipline with fines and such. There really is no such trigger mechanism in the mortgage industry other than after the horse is well out of the barn. In this case, the secondary financial markets are doing it for the originators. Statements like: Hey, we are not buying those products anymore. Our experience has shown that these are extremely risky loans that result in foreclosures and bad business. So in a position as a buyer of mortgages in the secondary market, originators are being conditioned to throttle down and restrict extending these loans products as being loans treated as persona non grata guests. Previous to the major mortgage turn down originated portfolios were commanding 103% to 106% range of face values as a premium over and above paid to the originating lenders. To keep the flow going, where cash is king, many lenders established warehouse credit lines based on originated business. This would insure the lender could table fund the loan through the warehouse line and thus stay liquid to make other loans. Delivery of the funded loan would be packaged up with other loans and forwarded it to the institutional buyers as mortgage backed securities. As this plays out, the securitized portfolio buyers are dictating the tune on customer suitability. This is totally backwards from the stock market business level of control of suitability and appears vested in the end buyer of the security instrument.

One of the main players in this mortgage fiasco has been Merrill Lynch. A warehouse line is based on a certain level of reserves maintained by the originating lenders. When the $2.00 window closed at Merrill Lynch then margin calls were made to the lenders to substantially increase their reserves. When the lenders could not sell their wares, all the originated pools were being sold somewhere at prices in the 98% to 95% or less range where instead of making money were losing money on every loan. Added with the margin calls from the likes of Merrill Lynch and like a row of cascading dominos, many lenders closed their doors and filled bankruptcy protection. In many cases, secondary mortgage buyers acquired the lenders, for better or worse, to protect any further loses coming by way of the warehouse loan deficits. As the fall out from mortgage foreclosures on many of these high-risk loans with built in rising rates continues it will take years to work through these troubled loans. If a borrower can, there is a current rush to refinance at a fixed rate to prevent any future increases. In some cases where the borrowers are upside down, owing more than the property is worth, time and appreciation may be the only allies in turning this increasing rate into a fixed rate loan.

This has been a harsh fix of the suitability test. Where the secondary market shuts down the origination of these left field products in the eyes of many in the industry. Many of these products will go by the wayside. After the 1929 stock market crash where margin limits were reeled in on stock accounts. Likewise, the concept of interest only mortgage and loans were suspended as no payments were being made on the principal. Now, some 70+ years later it came back. It went away for a reason. These other loan products tempered with risk may also go by the wayside.

So what is a borrower to do. Perhaps back to basics. Fully documented loans, higher down payments, and the return in some markets of FHA, VA and programs like My Community where there is a real emphasis on credit counseling and meeting minimum housing ratios. Family budgeting also will receive heavy emphasis where first time homebuyers are concerned. Collections may need to be paid and settled and not ignored by lenders. For the short term at least, these loan products may get kicked to the curb. Mortgages like the NO DOC, NO RATIO, STATED WAGE EARNER (W-2), STATED FIXED INCOME (persons on Social Security and such), 2/28 ARM LIBOR INDEXED BASED LOANS, 3/27, STATED SELF EMPLOYED, OPTION ARMS WITH LOW START RATES AND NEGATIVE AMORTIZATION all may be under heavy review and examination. One thing for sure, many of the $2.00 Windows is closed to betting on any of these loans by the financial markets. These ponies are finishing out of the money bringing up the rear and out of the race. Persona No Grata.

In the meantime, lenders and brokers who continue to show the rosy like Annual Percentage rates and scenarios that have low interest rate increase projections that tend to lull borrowers into a false sense of security are part of the problem not the solution. Rather, worse case scenarios can be selected within the loan origination software bringing home the message to borrowers that this left field loan can blow up in their face down the road causing severe financial hardship. Credit histories can be destroyed and make take years to rebuild. A few of the more sophisticated buyers know exactly what they are doing with a Negative Amortization loan and are putting the difference to work in their businesses and other ventures. Those people, unfortunately are far and few between. Anyone considering any of these loans will need to gather all the information and plan budgets very carefully and should be relegated to a status of last resort. There are other options that can bring better results on a long-term basis.

Dale Rogers http://www.brokencredit.com

Dale Rogers is a rapid rescore mortgage expert who contributes his credit repair and mortgage knowledge regularly to the Broken Credit Blog. Broken Credit Blog hosts the internet's #1 credit repair seminar. All are welcome to gain free knowledge on how to improve their credit score and obtain the lowest mortgage rates available in the market. [ www.BrokenCredit.com] (link: http://www.brokencredit.com)

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