Brokers key in lending crisis

Loan originators are blamed for mortgage defaults among borrowers with poor credit

WASHINGTON -- Mortgage brokers, who originate the majority of home loans, are being accused of exploiting a lack of federal regulation and loosening lending standards in ways that sparked high mortgage-default rates among borrowers with weak credit.

Hearings before Congress this year indicated that mortgage brokers and nonbank lenders took advantage of a regulatory gap to make unsound home loans to people with the weakest credit history, preying especially on minorities and the working poor.

Now Congress is grappling with how best to bring brokers, who originated about 70 percent of subprime loans over the past two years, under federal regulation.

In its latest report, the Mortgage Bankers Association found that in the first three months of this year, about 15.75 percent of subprime, adjustable-rate mortgages were behind on payments by 30 days or more.

That's an all-time high, and the figure is expected to grow. Experts predict that 1 in 5 sub-prime adjustable-rate home loans -- as many as 1.5 million -- will default by the end of next year. More than $2.28 trillion worth of adjustable-rate loans are scheduled to reset from 2007 to 2009.

Mortgage brokers are often the first link in the process of getting a home loan, so many borrowers think the brokers are working for them.

Wrong. No federal law says that mortgage brokers have any fiduciary duty to borrowers, and with the exception of California, most states don't stipulate that duty.

That's why brokers are front and center in the subprime debate. Federal law doesn't define whose interests they represent: borrowers or lenders?

Brokers work with lenders to offer home buyers finance choices. But unbeknown to many borrowers, lenders give brokers financial incentives to steer home buyers into loans with higher interest rates, especially adjustable-rate mortgages. Some such loan rates can spike up brutally high.

The resetting loans -- sometimes called exploding ARMs -- constitute the overwhelming portion of subprime loans that are now delinquent or in default.

Absent clear laws to hold brokers accountable -- as rules do for real estate agents and financial planners -- abuses in the sub-prime mortgage market will continue, said Michael Calhoun, president of the Center for Responsible Lending in Durham. "It's like a football game. If you don't prohibit holding, you're going to have a lot of holding," he told senators.

Brokers say that they are being singled out unfairly, noting that they are not alone in originating home loans. So do big banks, credit unions, mortgage bankers and lightly regulated nonbank lenders -- many of them now bankrupt or headed there because of their subprime loans.

"We feel like we're being picked on at this point," said Harry Dinham, until recently the head of the National Association of Mortgage Brokers in McLean, Va.

Even state regulators concede that new rules must apply broadly.

"The problem is that in the real market, you have a lot of folks who stratify more than one of these definitions," said William Matthews, a senior vice president for the Conference of State Bank Supervisors. "I may be a large mortgage-brokerage company or a local or regional lender, and some loans I will broker and on some loans I will lend. You have a lot of hybrid activity so you can have a full product line."

But brokers are uniquely problematic because of lenders' reward systems. Typically a broker receives a fee or commission equal to 1 percent to 3 percent of the loan's value as a reward for steering customers to a lender.

If a broker guides a borrower who qualifies for a lower-rate loan into a loan with a higher interest rate, the mortgage broker earns a higher bonus from the lender. This is called a "yield-spread premium."

Sometimes borrowers accept a higher interest rate in exchange for less cash down or improvements such as landscaping. Sometimes, borrowers are steered into unsuitable loans.

"Are yield-spread premiums abused? Absolutely. Do borrowers understand what they are paying in yield-spread premiums? The vast majority of time, they do not," John Robbins, chairman of the Mortgage Bankers Association, told senators.

Hearings have documented how brokers steer borrowers with weak credit into loans that reset and carry steep penalties if the borrowers try to pay off the loans before they reset. These make it difficult to refinance or pay off loans before they shift to punishing high interest rates.

To clarify that brokers should serve borrowers, Sen. Charles Schumer, D-N.Y., introduced legislation that would create suitability standards. It would make mortgage brokers and the lenders they work with liable for loans to borrowers who can't afford them.

The bigger question that Congress faces is how to impose federal regulation on mortgage brokers, who are now regulated at the state level, quite unevenly.