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Mortgage brokers are taking a lot of heat over lending practices that helped bring on the credit crisis and ultimately the current economic situation. So can you trust mortgage brokers?

The mortgage broker industry has gotten a bad reputation lately.  Many buyers prefer to go directly to a lender to avoid dealing with mortgage brokers.

Here’s a story that illustrates some of the practices that are damaging mortgage brokers’ reputations.  Brian had little money for a down payment and barely enough income to qualify for the house Brian was interested in.  He went to his bank to ask for a loan, but was told he didn’t qualify because his debt to income ratio would be too high.

Brian heard from a friend that Sky High Lending would be able to get him a loan.  Brian went to Sky High Lending and met a broker there.  The broker told Brian he would be able to get him a loan to buy the house he wanted.

Brian was thrilled.  He was going to get the house he really wanted.  He didn’t want to ask the mortgage broker too many questions as long as he could buy his house.

The mortgage broker told Brian that he wouldn’t have to pay any broker fees, they would be paid by the lender.  Brian thought that was great since he didn’t have much money to pay closing costs.

What Brian didn’t know was that the mortgage broker went to the lender that would pay him the highest fees, not the lender that had the best loan for Brian.

The lender paid the broker a Yield Spread Premium of $2500 for getting Brian to agree to pay a 0.5% higher interest rate than the market rate.  Brian could have gotten the market rate if he had gone directly to the same lender.

The mortgage broker got Brian an option ARM loan so Brian could afford to make the interest only payments.  Brian also had options to pay more or less each month.  The mortgage also had a balloon payment due in 3 years.

The broker suggested that Brian refinance his house in two years to avoid making the balloon payment.  He told Brian that by then the appreciation should bring him enough equity to get a better loan.

The mortgage broker also hoped to get paid more fees in two years when Brian came back to refinance.  He knew Brian would have to refinance or lose his home when the balloon payment came due.

He also knew that with the option of paying less each month Brian would probably not have enough equity built up to qualify for a better loan, so he would refinance into another similar loan that would need refinancing in another two years.  Should Brian have trusted this mortgage broker?
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Comments (11) Jan 20 2009

Have you seen the increase in houses for sale over the past year? Do you wonder why? Here is an example to illustrate.

Bill bought a house in 2006 for as much as he could afford. He got an option ARM. Have you heard about those in the news lately? They are loans with a low introductory interest rate and give you the option to make different payments. You can pay a payment that will pay off the principal in 30 years, an interest only payment, or a minimum payment that doesn’t even pay all the interest.

Bill rented the house out for more than the minimum payment and had a positive cash flow on the property. So Bill did it again with another house. And another. Bill ended up with 6 properties and they were all rented for more than the minimum payment.

Bill thought he was doing well. He had $3000 extra cash from his rental properties each month. But then Bill’s loans started adjusting. One by one his minimum payments increased. Soon he was paying $2000 per month for people to live in his houses.

He tried to refinance, but the extra interest had added to his principal and he owed more than the properties were worth. No bank would lend him the money.

Bill stopped making the payment on one house and used the rent he received to help pay the mortgage on the other five. He still couldn’t make ends meet, so he stopped making payments on a second house.

Now he was able to make the payments on four of the houses by collecting the rent on all six. But after a few months, the bank foreclosed on the two houses he wasn’t making payments on.

The renters moved out and Bill was stuck again. Finally, Bill gave up making any payments at all. He lost all of his houses to foreclosure.

Now the bank owned six houses that they didn’t want, so they put them up for sale.

So do you wonder why so many houses are for sale lately? Of course not all of them were from Bill or people like him, but many of them had option ARM loans on them before the bank took them back. So how can you get the right financing for your house?
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Comments (0) Jan 18 2009