May 10, 2018

“Did the new regulations issued in the wake of the financial crisis make mortgage loan officers more trustworthy?”

One regulation, issued by the Federal Reserve as part of Truth in Lending, has had that affect. This regulation made it illegal for a mortgage lender to compensate a loan officer (LO) for over-charging a customer. Such overcharges were called “overages”,

The Rule Restricting Overages

 An overage is a price above the price posted by the lender to its LOs. If a lender posts a price of 4% and 1 point and the LO prices the loan at 4% plus 2 points, the additional point would be the overage. Under the Fed’s rule, LOs no longer have an incentive to charge overages, and most lenders prohibit the practice altogether. There is one segment of the market, however, where overages remain pervasive (see below).   

How Overages Evolved

We have not always had overages. In the 1920s before there were secondary markets, consumers who wanted mortgages visited the offices of commercial banks, savings banks, or savings and loan associations, and dealt with salaried employees who had no discretion or incentive to adjust prices.  

Overages arose following the development of secondary mortgage markets after World War II. Secondary markets made it possible to go into the loan origination business without becoming a regulated financial institution. Once you had one or more reliable buyers, all you needed was a little capital and a line of credit. These firms are “mortgage companies”, or (as they much prefer) “mortgage banks”.  They are temporary lenders as distinguished from portfolio lenders who hold the loans they originate in their portfolios.

Mortgage banking developed its own operating methods and a culture to match that were very different from those of portfolio lenders. Mortgage banks invested very little in physical facilities designed to attract walk-in traffic during business hours. Instead, they retained loan officers (LOs) to actively pursue clients, as opposed to sitting behind a desk waiting for clients to appear.

To develop purchase loan business, LOs courted real estate sales agents,  making themselves available to take a loan application -- which might be on the hood of an automobile on a Sunday morning. To develop refinance business, LOs might camp out in the office of a public agency that maintains records of deeds and liens, developing lists of borrowers who might profit from a refinance.

Because LOs did most of their work out of the office subject to little supervision, they were compensated largely or entirely on a commission basis. While legally employees of the mortgage bank, LOs operated largely as if they were independent contractors. And the more loans they brought in, the more independent they were.

Overages were part of the package. Most LOs wanted to be free to charge what the traffic would bear, and profit from it. The lender who wouldn’t tolerate overages would lose LOs, and the most successful LOs would be the first to leave.

The LO-based mortgage origination system made the depository office obsolete as a source of mortgage loans. Depository institutions that wanted to be major players in the home loan market, had to hire their own LOs – or acquire an entire mortgage banking firm as an affiliate. The affiliate approach was the more popular because it avoided clash between very different cultures.

I recall my shock when I joined the board of a large savings and loan association in the 1980s and found that the CEO was the third most highly compensated employee of the association. The two who earned more were LOs, who had not yet been moved into a separate affiliate.

From a Public Policy Perspective, Overages Were Bad News

The practice of charging overages when possible made the home loan market similar to a middle eastern carpet market, with one difference. The typical carpet shopper knows that bazaar prices are subject to bargaining but many if not most mortgage shoppers did not. The result was that naïve and innocent borrowers paid more than those who were better informed. Over the years I must have written 10 or more articles on one or another aspect of avoiding overages.

Lenders Viewed Overages as a Necessary Evil

The general attitude of most mortgage lenders was that overages were a necessary evil that they would like to eliminate if they could do it without losing their best loan producers. The possibility that the incidence of overages might be systematically associated with one or another population group was an ever-present danger. In at least one case that I know about, a large lender was fined heavily by its regulator because overages were more pervasive among its black borrowers than among its white borrowers.

The Federal Reserve rule that barred LOs from being compensated for overages gave lenders the power to eliminate them without losing their LOs. For some reason, however, the rule did not apply to the reverse mortgage market.

Overages in the Reverse Mortgage Market

Because of the complexity of HECM reverse mortgages and the advanced age of borrowers, the public policy case for eliminating overages is even stronger than it is for standard mortgages. Yet this has not happened. The result is wide variability in the amounts a senior can draw on a reverse mortgage, depending on which loan provider the senior contacts. There is only one place a senior can go to compare the amounts offered by competing lenders, and that is my web site.