Mortgage Ethics?

With foreclosures mounting and ill trained loan officers running rampant, the phrase “mortgage ethics” is seen by many to be an oxymoron.  Maybe just maybe I’m a little cynical today – perhaps that’s true.  Yet my misanthropic disposition results from recent strange and bizarre encounters with so-called mortgage professionals.  Not all are bad mind you, and in fact some are a breath of fresh air; however, those aren’t the ones that are causing my fingers to type on this keyboard.  Rather think I, I’ll focus on those in this mortgage industry who don’t belong.  Focus?  A better word is EXPOSE.  You see I have magic mortgage glasses and I wear them at all times.  With these glasses I can see things that no consumer can.  Important things.  Things I will share with our readers, as they are things that will help you, the consumer, to discern between a ‘good deal’ and a farce.  What are these things that the special glasses can see?  I see a rate sheet and it’s not the one that is offered to you, it’s the one that’s offered to them.  Let me tell you why those snake oil salesmen are dying to sell you the Option ARM.

Before we get any further into the Option Arm, please read these previous articles on the subject. 

1, 2, 3%…..Can You Say Negative Amortization?

Hybrid Option ARM

As you can see from the previous articles, it’s not a bad loan for everyone.  On the contrary, it is an appropriate loan for some savvy investors, seasonal workers, and those who will experience a considerable increase in income in coming years.  The problem has been (and is) that the Option ARM hasn’t been sold to just them – it’s been sold to e-v-e-r-y-o-n-e.  Grandma’s on a fixed income – GET AN OPTION ARM!  Frank is a schoolteacher and wants to buy a $500,000 home – GET AN OPTION ARM!  Mary is a first time homebuyer – GET AN OPTION ARM!  And on and on and on…

So, what’s the problem?  Admittedly, to the untrained eye, the 1% payment is quite enticing.  Hey, wait a second; if you really read the article ’1, 2, 3%…Can You Say Negative Amortization?’ then you wouldn’t be asking me that.  Get back up there and read it.

(waiting)

OK, why do unscrupulous loan officers sell the Option ARM to every Tom, Dick & Harry regardless of circumstances?  It’s because of how something called Yield Spread Premium (YSP) is calculated.  YSP is the money the lender pays the mortgage broker on the sale. (Bank loan officers make YSP too, but our Government presently does not require lenders to disclose the commission that banks make and that’s a subject for another article altogether).  Before I get carried away, let me assure you that YSP is not all bad.  It is the calculation of YSP on an Option ARM that’s bad.  What is important for the magic mortgage glasses to reveal in this Mortgage Ethics article is how just how that YSP is calculated.  YSP is a function of the ‘margin’.

Did you see how when I typed the word ‘margin’ the room shook a little?  That’s because the shady mortgage brokers who only sell the Option ARM got scared.  They don’t want you to know about margin.  They don’t want you to ask about margin.  It frightens them.  Your knowledge of the margin and how it works threatens the payments on their plasma TV.  Yes, when you do a transaction with this unscrupulous kind, you trade in your equity and hand it over to them for pretentious spending.  But not when you know to ask about margin.  Asking an Option ARM mortgage broker about margin is like spraying a can of raid and the cockroaches scurry and wither or better yet, the lights get turned on. 

Pay attention, we’re going to do some math and I want you to tell me which is the better deal. 

First, let me share with you that a mortgage broker/loan officer deserves to make money and there is no shame in that.  A service is provided and based on a level of expertise and efficiency a commission should be received.  It’s a number in the four-figure zone.  The commission can legitimately be paid in the form of YSP.  In essence, the lender pays the mortgage broker the commission and you, the borrower, pay the lender back for the YSP in the form of a higher interest rate.  No problem with that if it is done ethically.  The calculation we are going to do here will teach you how the unethical mortgage broker tricks you into handing over the equity in your home to pad his commission check.  Again, it’s hidden in the margin.

For the loan officer/mortgage broker to make 1% of the loan amount as YSP on a typical fixed rate loan, your interest rate is .25% higher.  This means, your loan must remain in existence (not paid in full) for four years for the lender to recoup the commission that the mortgage broker was paid.

For a loan officer/mortgage broker to make 1% of the loan amount as YSP on an Option ARM, your interest rate is 0% higher.  0%?  Sounds great, right?  What’s wrong with the Option ARM you ask?  No harm no foul.  Remember, it’s the margin.  The margin must be 1% higher for the loan officer/mortgage broker to make 1%.  The index plus the margin is your real rate.  This means the lender makes four times the amount of money over the same period as the above fixed rate example.  Sure, the lender likes it, but the mortgage broker likes it better.  The fun doesn’t stop there.

Some Option ARM lenders pay 4.5% YSP and offer the same ridiculously, artificially low 1% rate with an extra 4.5% added to your margin.  The mortgage broker on your $1M loan made $45,000 YSP and you pay back an extra $45,000 each and every year to your lender.  That $45,000 is in addition to what the margin should normally be and it’s added to the index value.  In other words, it’s overindulgence at your expense.  You’re paying dearly for the unethical mortgage broker’s breach of trust.  Yes, this excess is deferred and added back into your mortgage amount, but that negative amortization doesn’t continue forever and with an extra 4.5% added to your margin you will reach the limit fast.  Once you’ve reached the maximum neg am (could be as low as 10% of the loan amount) the loan becomes a fully amortizing loan for the remaining term.  Can you say skyrocketing payment?  Can you say foreclosure time bomb?

Well, I don’t know if you’ve followed everything that’s been typed above.  As I glance at it now I see how it may appear to be a hodgepodge of numbers.  Suffice it to say that the 1% interest rate is not reality but merely a short-lived illusion.  Nevertheless, in this present market it may meet some short-term objectives for a select few borrowers.  To learn this week that an ethical mortgage broker characterized it as a “screen door on a submarine” was fitting and a breath of fresh air.  And finally, if after all of this, you still feel the Option ARM suits you and you’re looking to separate the ethical mortgage brokers from the unethical ones, then have them first fax/email you a Good Faith Estimate and then later call them back on the phone to specifically ask them about the margin.

Remember, the lower the margin the better.