Harry L. Jensen's

The Mortgage 'Aria'.

Operatic Mortgage Theater

The mortgage loan origination industry, Third Party Originators (TPO), also known as a Mortgage Broker, and funding lenders are held responsible for loan defaults.

Recent print media articles steer clear of the real issues relating to the current U.S. housing loan delinquency and foreclosure problems. Was it underwriting or investor greed?

The answer to the question, of what prompted the current housing meltdown, rest with an understanding of the mortgage banking industry's earnings and profits.

In my mortgage origination career of 35 years, the mortgage loan foreclosure scenario has always been presented in the same simplistic manner. The mortgage loan originator caused the problems associated with a failed borrower's loan after loan closing. It does not matter that lender's underwriters approved the loan request, because the loan officer, loan processor or some other party altered the documentation. There are many opportunities from loan application to loan funding for effective due diligence to intervene and cause the denial of any loan application.

Borrowers search for lenders that will fund the mortgage loan for the lowest cost and interest rate. There are instances where the mortgage originator seeks a willing consumer to be pre-approve for a mortgage loan prior to any real estate purchase. Regardless, the consumer must be looking to borrower mortgage money and therefore, all foreclosures must be the originator's responsibility.

There is an alternative reason for all loan defaults. Greed.

As Mozart composed an opera using voice and instruments controlled by a conductor, the mortgage industry is controlled by the investor that orchestrates mortgage loan originations.

The investor orchestration begins with yield requirements and acceptable underwriting standards. In today's mortgage world, the Mortgage Backed Security (MBS) and Mortgage Obligation Bonds (MOB) dictate underwriting standards. FNMA and FHLMC set underwriting standards that must be followed by approved seller/servicers. The fannie/freddie standards are not applied to loans backed by securities issued by a mortgage banker, investment bank or other MBS issuers.

Here is a simple look at a loan trail:

Originator > funding lender > loan servicer > loan investor > MBS > secondary market > investor.

What's missing, from this loan trail, are yield spread premiums, service release premiums and mortgage lender rebate premiums to Third Party Originators(TPO) that are paid to each entity along the loan trail. These premiums represent the value of a mortgage loan in the secondary mortgage market. The profits generated by the funding lender's secondary mortgage market operation are used to pay each entity involved in the loan origination and closing. It comes down to investor's yield demands and the mortgage borrower's acceptance of the offered interest rate.

"Yield Spreads" are what generates mortgage industry profits. If the investor is willing to accept a return on investment (ROI) of 6.500% and a borrower is willing to accept an 8.000% mortgage loan, the gross yield spread is 1.500%. This represents a gross annual income of $1,500 for a $100,000 mortgage loan. If all interested parties believe the loan will be on the books for seven (7) years, the 7 year gross income is $10,500.

At some point along the loan trail, some servicing entity must be employed to collect monthly mortgage payments and insure that property insurance and taxes are current. In this example, let's assume the servicing entity is charging an annual fee of 0.375% (3/8%) or $375/yr. Over 7 years the servicing income charged by the servicer amounts to $2,625.

The gross monetary value of this $100,000 mortgage loan is equal to $10,500 - $2,625 = $7,875. There will be cost associated with securitizing the loan and let's assume that this cost amounts to $1,000. Let's also assume that cost of marketing the security is $2,000.

The following is the net value of the $100,000 mortgage loan to the funding lender:

$10,500 - $2,625 - $1,000 - $2,000 = $4,875.

If a Mortgage Broker (MB) originated the $100,000 loan, how much of the $4,875 expected profit will the funding lender be willing to pay the MB for directing the loan to the funding lender? Remember, the $4,875 represents the loan's monetary value in the secondary mortgage market and is not associated with any lender charges (other than a higher rate) at time of loan closing.

Let's say that lender competition requires the funding lender to pay the MB $3,000 in "Compensation To Broker Not Paid From Loan Proceeds" to entice the MB to submit the $100,000 loan for approval and funding. In this example the funding lender earns $1,875 in marketing profits. Every entity in the loan trail is paid for their expertise and the borrower has paid a higher interest rate to insure mortgage market liquidity and associated excessive loan profits.

Technically, the funding lender could have charged 7.500% with a yield spread of 1.0%, or a $7,000 mortgage value over seven years. Same cost, but lower secondary market profit of $1,375.

Greed determines the investor's desired yield and loose underwriting will allow challenged borrowers the opportunity to close a real estate loan. The mortgage industry takes advantage of challenged borrowers by offering to make the loan, but at a higher interest rate. This is the world of the subprime mortgage borrower. If the loan amount is $500,000, the cost of servicing remains constant and all other aspects of the secondary mortgage market remain relative to the loan size.

The marketing profits are astronomical.

A million dollar MBS consisting of two (2) loans could generate as much as $40 to $60 thousand or higher in secondary market profits. The secondary market and the final investor will reap wild profits, but non paying borrowers could cause the investor to lose money.

It's not fraudulent documentation that is causing the current home loan meltdown, it's the lack of credible underwriting.

Borrowers who want to own a home, but have been declined by 1st tier lenders, will be willing to pay any price to obtain home ownership. The real estate industry is willing to use all available resources to earn a commission. The mortgage industry is more than willing to orchestrate and conduct loan programs that creates initial harmony, but lacks the underwriting structure necessary to identify the borrower that will end up in foreclosure.

A bad loan decision is not correctable.

It's greed that has taken advantage of the mortgage industry and is directly responsible for the 2007 mortgage meltdown.

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