Confessions of a Subprime Lender

by Richard Bitner

  The independent nature of brokers meant loyalty was a scarce commodity. With over 100 subprime lenders to choose from, most brokers would try a new company if they could make more money. As a result, the competition for broker business became fierce. One of my clients used to joke that he spent so much time fielding sales calls from reps, he didn’t have time to solicit his own customers. In large markets like Dallas, a broker could easily see a dozen different reps every day.

  The best brokers, however, operated with a different philosophy. They worked hard to develop relationships with referral sources such as realtors. To maintain the business, they had to consistently produce results. To do this required having a few subprime lenders who could deliver on what they promised. The high fallout rate that lenders experienced for subprime loans was driven by the difficult nature of the deals, but also by ineffective account executives. As the industry grew, the subprime business attracted its fair share of useless salespeople. The worst scenario for any broker was not closing a Realtor’s purchase transaction because they trusted an incompetent rep. The smart brokers avoided putting their business relationships in jeopardy by only working with a handful of top-notch account executives.

  Mortgage Fraud

  It’s easy to understand why the lending industry attracts unethical behavior—hundreds of millions of dollars in business are transacted on a daily basis. There are no official estimates, but it’s widely believed that lenders lose tens of millions of dollars annually as a result of fraudulent activity.

  For our purposes, mortgage fraud is any activity that’s intended to deceive or mislead a mortgage lender. When stories about mortgage fraud make the news, they usually portray the more heinous examples. These scams often involve multiple parties—brokers, appraisers, and title companies. Even though a thorough quality control (QC) review increases the likelihood a fraudulent loan will be identified prior to closing, it’s impossible to catch every one. At some point, most subprime lenders were victimized by one of these scams.

  While this type of fraud could prove costly, it was only a small piece of a bigger problem. The subtler forms of fraud, more difficult to detect, could also create problems for lenders. The following are just a few examples:• A borrower indicating that he will occupy a property when he’s purchasing it as an investment.

  • Falsifying a borrower’s employment history by having a friend or relative who owns a business say the person works there.

  • Hiding a critical piece of information or not disclosing something about the loan and hoping the lender won’t find out.

  The last one gave lenders fits. If a broker is hiding something from the lender, how do they know what to look for? Performing a thorough QC review can help but isn’t always effective. At times the lender-broker relationship resembles a game of hide-and-go-seek. When brokers try to conceal critical information, lenders search for clues to piece together the story.

  Here is an example of how this works. A broker submitted a loan to us indicating the borrower was doing a cash-out refinance on his primary residence. The borrower also owned another property, which he had purchased three years earlier. At the time he purchased this property his credit was damaged so the seller agreed to carry the note. The borrower turned the second property into a rental when he purchased his current residence. Unfortunately, the person who rented the home moved out unexpectedly, leaving him in a jam. With no tenant to replace the lost income, the borrower fell two months behind on the mortgage for the rental property.

  While filling out the loan application, the borrower disclosed the late payments to the broker. Since the mortgage was privately held, there was no record of it on the borrower’s credit report. The broker asked his customer, “What’s the chance the note holder will fill out the VOM (verification of mortgage) and say you’ve paid on time?” He rationalized to the borrower that since he was getting cash to catch up with the mortgage payments, the note holder would be motivated to help. Somehow fraud always seemed easier to justify when someone else had to do it. When the broker discovered the note holder was (surprise!) a man of principle and wouldn’t commit fraud, he devised an alternate plan. He submitted the loan application and left the schedule of real estate section blank. With no record of the mortgage on his credit report, we didn’t know the rental property existed. The broker was committing fraud through omission, and by signing the loan application, so was the borrower.

  The broker thought he fooled everyone. What he didn’t consider was the due diligence our underwriter would conduct on the loan. Part of her standard procedure was to use the county web site to obtain the property’s tax-assessed value. When she searched using the borrower’s name, both properties showed up, which caused the loan to be denied.

  The broker swore he did nothing wrong, insisting the borrower never disclosed the rental information. In a phone conversation with the borrower, he explained to me in great detail exactly what happened. It was obvious the broker had concocted the plan. Having previously suspected him of questionable activity, we terminated his account.

  We were lucky. The underwriter could have searched by the subject property address, in which case the rental would have remained a mystery. Had the property been located in a different county, it also would have gone undetected. With no system for sharing this information with other lenders, the broker could easily take the loan file to another company, which he did. A month later, our rep confirmed through a third party source that the loan closed with New Century.

  Broker Tactics

  The tactics brokers used for subprime loans can be divided into three categories: honest, dysfunctional, or corrupt. If a broker was dysfunctional, it doesn’t mean they acted improperly on every loan file—a broker could be honest on one deal and dysfunctional on the next. The tactics a broker used depended on two factors: what was required to close the loan, and how far the broker was willing to go. Of course, since brokers could operate with few consequences from their actions, subprime lenders treated them with a high degree of suspicion.

  Honest Brokers

  About 30 percent of all subprime loan applications require no manipulation or deception on the part of the broker because the borrower meets the credit requirements, documentation is readily obtainable, and the property values are easily justified. While few deals in subprime are a slam-dunk, these loans were usually the easiest to complete.

  Some brokers consistently operate with a high degree of professionalism. They understand the importance of treating the customer right. When the borrower chooses a loan program, it’s an informed decision. The fees these brokers charge are reasonable for the service they provide. Ask customers to rate their service experience and these brokers get high marks across the board.

  As a lender, working with this type of broker means getting the entire story the first time. If there’s a problem with the deal, the broker brings it up right away. These honest brokers treat the borrower and the lender as if they have a fiduciary duty to both parties. Full disclosure from start to finish is the only way these brokers conduct business.

  This could describe a strong salesperson in any industry, not just mortgage finance. Treating a customer fairly, communicating honestly with vendors, and doing the right thing for everyone are how things should work. Unfortunately, these brokers are in the minority.

  The goal of any lender is to work with brokers who consistently deliver credible deals. Even if the loan officer didn’t produce a lot of business, just knowing he would keep the lender out of harm’s way was invaluable. One of my customers, Ryan Miller, a former branch manager for Allied Home Mortgage Capital in Florence, South Carolina, epitomized the honest broker. One event early in our relationship convinced me he was a cut above the rest.

  We had just closed the Jenna Matthews loan and were preparing to release the funds when Ryan called me. He had just gotten a phone call from the closer at the attorney’s office because she overheard a conversation between the borrower and another employee i
n the office. Ms. Matthews was so excited about her good news that she had to tell someone—the day before closing she found a person to rent the property she was buying. The problem was that she had signed an occupancy affidavit indicating she intended to live in the property.

  Before calling me, Ryan contacted the borrower, confronted her with the facts, and confirmed the story. We had no choice but to deny the loan. So why did the borrower lie? By leading us to believe she would live in the property, Ms. Matthews could buy the home with no money down and get a lower interest rate. Had the deal closed, it’s likely our investor would have made us repurchase the loan.

  Ryan performed the ultimate selfless act. Since the loan didn’t close, he made no money. He was scheduled to close only two loans that month, which meant his income would be cut in half. He could have ignored the situation or delayed calling me and no one would have known the difference. Instead, he chose to do the right thing.

  By proving he was an honest broker, Ryan endeared himself to us. Over the next five years, he received a level of service that made up for the lost revenue. Whether it meant the underwriting department did a rush approval or an employee came in early to prepare closing documents, his good deed served him well in the long run. He wasn’t our biggest customer but that didn’t matter. We knew he had our backs, and in this business, that is worth its weight in gold.

  Dysfunctional Brokers

  With subprime mortgages, the majority of brokers operated in a dysfunctional manner. Since this can describe a broad range of impropriety, I’ll define a dysfunctional act as anything that creates an additional layer of risk for the lender or does not serve the best interest of the borrower.

  Even the most ethical brokers can be tempted to push in one area or cut corners in another. The practice of massaging loans, making them appear different from what they are, becomes standard operating procedure. With little accountability for their actions, brokers are left to decide how far they’re willing to go.

  There are three types of dysfunctional brokers: pushers, withholders, and manipulators. They aren’t mutually exclusive—a broker could act as a pusher and manipulator at the same time. Brokers used these dysfunctional tactics in approximately 65 percent of all loans sent to subprime lenders. What follows are examples of each.

  Pushers

  The word pusher has several connotations. It can represent any good salesperson who keeps selling the lender on the merits of a loan. The pusher will work the deal from every angle until the lender either approves or denies it. The act of pushing a lender isn’t dysfunctional—it’s the broker’s job.

  A loan can also be pushed when a broker’s actions increase the risk to the lender. Some brokers develop a reputation for pushing. After closing a few loans for this type of broker, a pattern would emerge—every deal submitted either stretched the guidelines to the limit or required a loan exception. When our staff discussed these brokers, they’d frequently refer to them in conversation by saying, “I know who you’re talking about. He’s the guy whose loans are always pushed.”

  Compared to other dysfunctional types of brokers, the pusher was the least harmful. In most cases, the lender had all the correct information to make a lending decision. The lender’s risk increased when the pusher also withheld or manipulated information in order to get a loan approved.

  Our Best Customer

  Steve McKay was our best customer. In the six years we were in business, he closed more loans with us than any other broker. Our second-best customer produced just over half as many loans. Steve was a pusher extraordinaire.

  We knew what to expect from Steve because he had done business with my partner Ken for 10 years. Experience told us we could trust him about 90 percent of the time. While Steve was not inclined to put us in harm’s way, he wasn’t motivated to keep us out of it either. Other lenders weren’t always so lucky.

  In 2002, Steve needed additional office space to accommodate his growing staff. He bought a single-family residence, informing the lender he intended to occupy it as his primary residence. As mentioned earlier, any borrower who intends to live in a property must sign an occupancy affidavit at closing. After closing on the purchase, Steve hired a contractor who converted the home into offices for his employees. He had never intended to live in the property. We discovered this only because Steve chose to tell Ken, which is an odd situation—a broker told his best lender how he defrauded another mortgage company so he could get a better deal. Even if we had the nerve to commit fraud, I can’t imagine bragging about it to our top investor.

  Here is Ken’s account of working with Steve:

  Steve is a career mortgage broker. He was very methodical in how he pushed lenders to get things done. If he had a loan with multiple issues, he’d figure out the best way to sell us on the deal. He knew how to spin deals to make them sound better than they really were.

  The one area he consistently pushed was appraisals. An incompetent broker would submit appraisals that were so overvalued most lenders wouldn’t believe them. Steve was too smart for that. Since property valuation is not an exact science, he knew every lender had a certain variance they would accept. His appraised values came in high enough to make the deal work, but not so high that a lender or investor wouldn’t accept it.

  While Steve knew exactly how and where he could push, he also understood how far he could go before he crossed the line. That’s what made him an effective pusher.

  Here are some other tactics that brokers used to push loans:• A couple wanted to pull equity out of their property to pay some bills, but were concerned about the size of the loan payment. The broker convinced them to take an adjustable rate mortgage that came with a lower start rate, allowing them to get more cash. Since the broker’s commission was based on the loan amount, selling the higher loan amount made him more money.

  • A borrower purchased a home and two days before closing the lender received the appraisal and the property appeared to be overvalued. The lender ordered a field review through a third party service to confirm the value, which would take five days to complete. Since the property seller was scheduled to purchase a home on the same day using the proceeds from his sale, the broker tried to convince the lender that the deal had to close on time or it would create a domino effect, causing all of the transactions to fall apart. If the broker believed the property was significantly overvalued, he knew an independent appraisal review would likely reveal it, thus jeopardizing the deal and his income. Pushing the lender to close the deal was his way of insuring a paycheck.

  The challenge was determining whether or not the deal would fall apart if the closing was delayed. Getting this answer usually required the lender to initially deny the broker’s request in order to learn how real the threat was. The lender either closed the loan as scheduled and hoped the field review substantiated the appraised value, or let the deal collapse and risked aggravating the broker, borrower, and Realtor. In most cases, buyers and sellers had so much invested in the transaction, both financially and emotionally, they were willing to wait a few extra days.

  Withholders

  If a broker withholds information, the lender does not have the data he needs to make an underwriting decision. This creates a conundrum. What should a lender look for when he doesn’t know what’s missing? Without all the facts needed to make an informed decision, lenders are put at greater risk.

  Gathering income, employment, and credit documentation will usually tell the lender most of the story, but there are still opportunities for nondisclosure. If a broker is privy to information and thinks the lender will deny the loan if he discloses it, what should he do? Tell the lender and run the risk of a denial or pretend it doesn’t exist? If it’s the difference between getting paid or not getting paid, brokers are likely to stay quiet.

  For some brokers, withholding information is easier to justify than blatantly committing fraud. Most acts of deception require the broker to do something, like alter a pay stub or manipulate a veri
fication of employment (VOE). Nondisclosure only requires silence. The following loan scenario shows how a broker’s decision to keep quiet proved to be costly.

  The Robinsons wanted to refinance their home to get some cash. The broker put Mr. Robinson in a stated income program since he was self-employed and couldn’t prove his income through his tax returns. Mrs. Robinson’s credit was poor, so she was removed from the loan application altogether. When the loan closed the couple received $25,000.

  The Robinsons never made a mortgage payment. After doing some research, we found out what happened. At the time of loan application, the couple was planning to divorce. Their plan was that she’d retain the home, he’d keep the money from the refinance, and she’d be responsible for the mortgage. The problem was she couldn’t afford the payment based on her income. In separate conversations with the Robinsons, they each confirmed that the broker was briefed on their plan.

  When we confronted the broker, he admitted knowing there was a problem, but thought they were trying to work things out. By pleading ignorance the broker absolved himself of any wrongdoing. Since there was no legal separation agreement, it was his word against theirs. The broker knew exactly what he was doing. Disclosing their plan would have jeopardized the deal, so he said nothing. Had we known the facts, the loan would have been declined because Mrs. Robinson wasn’t able to qualify on her own. By the time the foreclosure was complete and the property resold, we had lost $75,000. That’s a heavy price to pay for nondisclosure.