I like to think of myself as an ethical person. Then again, I am sure that most people feel that way about themselves too. We all are victims to the Lake Wobegon effect at some point in our lives. But in general I obey all laws, pay my taxes, am a good father and husband, run an honest business and try to make my customers happy. So I am faced with an interesting dilemma that the current market has brought upon me. I don’t think my dilemma is unique; in fact I bet it is so commonplace that it is on the desk of a large percentage of loan originators at mortgage institutions all across the country. It is an important issue to discuss, so important that I originally planned on penning this post for my blog, but figured the traffic and exposure of Bloodhound would be a better platform for debate and discussion.
Here is the dilemma. I was given a referral to a woman who I do not know personally. She lives in Florida, is a substitute teacher and lives in a condominium with a waterfront view. She has a good credit and a decent rate, interest only loan right now — it does have a prepayment penalty. She is also at 90% with her current loan to the value of the property. Unfortunately she has a bit of a cash crunch right now and would really like to lower her mortgage payments.
There is no way that using traditional mortgage products can drop her payment any further. First, I know interest only loans are not traditional. Second, before you talk to me about 40 and 50 year terms remember she’s already in an interest only loan — there won’t be much change, certainly not when you factor paying off a prepayment penalty in to the new loan. The only loan that would dramatically lower her payments is a payment option, negatively amortizing loan. If she made the minimum payment she would drastically lower her monthly cash outflow. I’ve explained to her the negative amortization part of the loan, faxed and emailed her a bunch of information on how it works, etc.
As a rule I don’t like payment option loans. I believe they have their purpose in some very narrow range of instances that were more relevant when we were seeing large property value increases. I also am very honest and upfront with customers; I always explain these loans in full detail.
The dilemma is this. Here is a nice woman who really needs to lower her mortgage payments. They are eating up a ton of her monthly take home income right now. She is stretched thin. She has no interest in selling her property. She likes the payment option loan idea. My problems are as follows: (1) she has credit that could get her any mutation of stated income, stated asset loan products out there; which she would need to use because her income doesn’t qualify her for the loan currently. (2) Her property value would need to increase by approximately $20,000 to cover the costs of the prepayment to keep her at 90% LTV. This would require an appraiser to “push” the value of her home from when she last refinanced 8 months ago. (3) She would be going in to a negative amortization loan at a time when property values are either stabilizing or declining.
So what do you do as a mortgage professional? It’s not a question of can this loan be done. This loan can definitely be done for her with current underwriting guidelines. The question is should this loan be done? This loan has a mix of good benefit and terrible elements. The bad: stated income and assets that would clearly have to be overstated, property value that would have to be “aggressively” appraised to be achieved, and the loan would have to be negatively amortizing. The good: she gets to keep her home and “afford” the payments until she is able to earn more income (which she assures me is only a few months away). The choice is tougher knowing that if I say no, she can call anyone else and get it done, with a snap of the fingers.
Question: What would you do?
Disclaimer 1: I don’t need the money. As you may or not be aware, negative amortizing loans can make the loan officer up to 3.5% on the back of the loan — paid from the bank to the originator. The money that could be earned is not the question.
Disclaimer 2: I’ve already made my decision.
Jay Thompson says:
The choice, poor as it is, to go negative amort is hers to make. All you can do is educate and advise on that portion.
But overstating income and assets is fraud, IMHO. Pushing the appraisal may be too.
As for the choice being tougher knowing there are a bunch of others who could and would do it… not a factor. I’m sure if I really wanted to, I could find someone who could and would whack my ex-wife. Pleasing as that thought may be, it’s still wrong.
And so is doing this loan.
April 22, 2007 — 7:22 am
Jeff Chasin says:
Does her income fluctuate – is she self-employed, is she in a career field where she even has the potential to earn substantially more money in certain months? Does her financial picture show her ability to manage her money well? i.e. – has she ever paid additional principal on her current loan or accumulated reserves/assets? In other words – apart from her need for cash and her current LTV, is she a good candidate for a neg am loan?
Since you’re talking about Stated Income, Stated Asset products, probably not.
Forget for a minute that Stated Income, Stated Asset, Negative Amortization loans are *scarce* and priced at a premium in today’s market. Forget for a minute that “pushing” the property value and “over-stating” the income is both fraud and a breach of several reps and warranties of your lender agreements. Forget for a minute that she can walk down the street to your competitor and get this loan done in a heartbeat.
Don’t forget for a second that less financially sophisticated borrowers, like this nice woman, are the one’s that need our counsel, advice and protection from predators, the most.
April 22, 2007 — 7:48 am
Kelly Kilpatrick says:
No sense in putting a Bandaid on a cut that needs stitches. It’s tanamount to medical malpractice. Unless this nice substitute teacher has a reasonable assurance of money coming in the near future (inheritance, legal settlement, winning lotto ticket in hand) the smart thing to do would be to explain to her the reasons why the available loan alternatives will not put her in a better position. The tight cash crunch she’s experiencing now will be nothing in comparison to the press she’ll feel at retirement. I have found that referring prospects to their CPA or investment counselor can be highly effective. You’ll look like a hero when your opinion is seconded by other professionals and your prospect will likely refer you others. You may even get a referral or two from her CPA who will recognize and appreciate your integrity. Above all though, you’ll be able to sleep at night.
April 22, 2007 — 9:26 am
Morgan Brown says:
Jay, Jeff, Kelly –
Thanks for your responses. I did in fact tell her I couldn’t help her with a new loan. I explained to her that she didn’t qualify based on her income for a new program.
What did it for me in terms of not doing the loan was the one-two punch of having to over state her income and find an “aggressive” appraiser to get the value of her property to a point where the LTV would be 90%. Both of those choices were ones that I didn’t want to make.
I thought it was an interesting delimma for the following:
1. If I was a struggling LO with out a pipeline, not a financially secure owner of the company, would my decision change?
2. What good options does this lady have? Besides moving or cutting down other expenses there isn’t much. And while those look easy on paper to many Americans they aren’t.
So as Kelly puts it I chose “sleep” over money, which is what I’ll take any day. This dilemma reminded me of why I started my company in the first place: to be different from everyone else. Not doing this loan makes us different from the other companies who will try to give her this loan.
April 22, 2007 — 10:35 am
Jeff Brown says:
Morgan – This is a story I heard recently from a stranger at a wedding of all places.
Potentially your Florida woman could do one of two things.
1. Do what many single women do and bring in another woman as a roommate. No doubt this would easily make the difference, and would probably not have to be permanent.
2. She could rent the place out, and move into a very cheap rental until her financial situation improved.
Of the two, the roommate almost always works best. This is because the rent isn’t enough to avoid a negative cash flow, which when added to the rent on the new place doesn’t represent an improvement.
In this instance, and based on the info you provided, taking in a roommate could potentially do the trick.
April 22, 2007 — 12:20 pm
David Losh says:
Oh my God.
This person has two alternatives. One is to try to sell the unit or send it back to the bank. Sending the mess back to the bank is by far the best option. There is the moral obligation that, I think, we all have to look out for one another. You’re in the business. How likely is it that a substitute teacher with an interest only ninety per cent loan will dig out of this hole? We are after all talking about a condo in Florida.
My monied investors have given up on Florida as over priced. The market there was immigrants or retirees. Used condos aren’t fitting either buyer pool. It might be different if we were talking about the family home. The fact is that holding out, given these terms, will only cost the borrower more than the future value will be.
April 22, 2007 — 1:45 pm
Chris says:
Well it sounds like to me that she really cannot afford her currant home at this time. I know its easy to type online, but what she needs to do is to sell it and get something that is cheaper. From what I read it seems like she is digging a financial hole, she needs to stop digging.
I would have made the same choice, even though she will probably get the loan somewhere else. At least you can sleep at night, and regardless of what she may think were looking out for her best interests.
Chris
April 22, 2007 — 1:50 pm
Morgan Brown says:
Jeff,
The roommate idea is a great one. I might recommend that, although David and Chris are right. She really cannot afford this home the way it stands right now. It is much easier to type online than pick up the phone and let the customer know the news.
What I might tell her is that (1) if she insists on staying she should strongly consider a roommate (2) she should take to a CPA or other financial advisor about figuring out a way to limit her other expenses or (3) consider selling the home (if she’s not already upside down in it – the comps don’t look THAT promising).
April 22, 2007 — 4:33 pm
John Michailidis says:
Regardless of who gives her the loan, this woman WILL get the loan, which she most likely will come to regret. Some people just can’t be saved from themselves. All we can do as ethical counselors is tell it like we see it, and refuse to participate in any shenanigans — after that, they’re on their own. She’s apparently addicted to the high life and her pretty view when she should be selling and downsizing. In the end, this woman is grown and she has every right to ruin herself financially if that is what she chooses to do. With liberty comes responsibility for ones own actions. I feel sorry for her.
April 22, 2007 — 10:11 pm
Brian Brady says:
Let me throw a wrinkle into the discussion. Why own the house in the first place? Does she think values are going up? If she does, then why is the neg-am loan bad?
It does give her a chance to hold onto an appreciating asset so she can focus attention on some way to generate more income for herself.
If the argument is that this loan is “risky” because it eats into her equity, then the investment itself (the house) is probably flawed. The analysis should be to see if the asset might appreciate faster than the deferred interest.
April 23, 2007 — 1:13 am
David Saks says:
She won’t have to sell the property. The court will. It’s either a cheaper place or a Winnebago.
April 23, 2007 — 2:52 am
Rhonda Porter says:
Brian, can’t you all ready hear the borrower when her mortgage recasts? It won’t matter how much advice she receives if she’s obtaining the mortgage for the neg. am. payment.
Great post, Morgan. I’ve had some similar situations. It’s tough because you know that the borrower may go elsewhere and might get hosed by a different lender. Especially when the client is vulnerable or desparate.
And they don’t seem to do what is best for themselves, such as sell the home now while she still has equity to do so.
April 23, 2007 — 7:11 am
Morgan Brown says:
Brian,
You make a great point. If the market was appreciating and the property had some great characteristics that made it a sure fire appreciation winner that would outprice the deferred interest I would have no problem with a neg am loan. In those types of situations I think they can be effective investment products.
Unfortunately this property is just not one of those properties. Without disclosing too much about the file let us just say that this property will not be seeing significant, if any, appreciation in the near future.
April 23, 2007 — 8:11 am
Morgan Brown says:
Rhonda,
That is exactly the hard part. For all the warts on this loan this borrower could go in to any branch office of any mortgage shop around and would find a loan officer more than happy to help her in to a 1% neg am loan. I’m sure they won’t mind maxing out the margin and prepay to enjoy that 3.5% paid by the lender as well.
I am just going to try to educate her and see if I can talk her in to getting a roommate. I am not even sure if she could sell profitably right now due to the large amounts of property on the market in her area. It could depress her sales price to a point where after commissions are paid, etc. she could be break even which would leave her with out anything to put down on something more conservative.
April 23, 2007 — 8:14 am
Brian Brady says:
“Without disclosing too much about the file let us just say that this property will not be seeing significant, if any, appreciation in the near future.”
Easy decision, then. Sell the property and bank the profit (if she gets some). David is correct when he says sell it before someone else does it for you.
This post was great because I experienced this in 2006 in the Inland Empire. Prices spiked there and people “cashed out” in 2004 and 2005. People were calling me and telling me that they had absolutely no ability to repay the loan but they wanted “one of those 1% loans”.
I advised over 20 people to sell and bank the profit; they could come back and buy a home when their financial situation improved (many were expecting a spouse to enter the workforce in a few years). Most people lamented that “their neighbors” would know that they were “renters” and exhibited wounded pride.
I showed a few of them the PIMCO housing outlook. One lady took my advice; she has $90,000 in the bank and a nice leased home.
The concern you addressed well is the newbie who rapes the customer for 4 points rebate
April 23, 2007 — 9:55 am
Joel McDonald says:
Good for you Morgan!
It’s always a good feeling to to walk from a commission because it is the right thing to do — even when that commisison might be being handed to you on a silver platter.
April 24, 2007 — 1:28 pm