WA State DFI Slaps “Cash Call” for Multiple Consumer Protection Violations

In 2011 I posted this article about the deceptive advertising practices of Cash Call.  Washington State DFI went after Cash Call for their deceptive and abusive acts and practices towards WA State Consumers and here is the result:

$14875 Investigation fee to be paid to WA DFI

$244,100 Fine

$6,131,694. RESTITUTION ordered to be paid back to consumers

Cash Call tried to defend itself in an interesting way, but that failed.  Please warn consumers about this company’s history of blatant violation of state and federal law.


The Moral Terrain of Mortgage Lending

General ethics applies to everyone in all spheres of life; in contrast, professional ethics is usually memorialized by written code and is intended to apply only to those individuals who have been identified as professionals in their field.  For example, in the legal industry, both lawyers and paralegals are considered professionals and must abide by certain written ethical codes, while legal secretaries and law clerks are not considered professionals and are not held to the same professional standards (although certainly the employers they work for can require it).  In the healthcare industry physicians owe specific moral duties that are captured by various ethical codes; in contrast, orderlies and certain other lower level functionaries are not considered professionals and do not have to abide by these codes of ethics, although they follow directives that are patterned after the applicable codes.

The essence of professional status requires one to take a licensing exam which tests substantive knowledge and codified standards of practice. Currently, the mortgage origination industry is in a state of transformation because, although loan originators working under a mortgage broker and non-depository lender must pass licensing exams, loan originators who work for depository banks are not required to do so.  A brief historical review of standards of practice indicates that the designation of mortgage originator is moving towards a clearly identifiable status as a profession.  We in the industry can now move mortgage originators clearly into professional status by implementing competency exams for all LOs and disciplinary procedures, once a code of ethics with sanctions is formally put into place. Until then, we revert to using general ethics in the workplace.

General ethics attempts to provide a rational framework for answering the paramount moral question “What ought I do?”  We all struggle with this question every day in all contexts, and we attempt to find answers through emotion, intuition, authority figures, religion, and hopefully, reason.  In answering these questions, we attempt to construct common and objective frameworks of values in order to solve these problems in a consistent fashion.  This gives our lives coherence and unity as we strive toward ethical ideals.  In contrast, the problems of professional ethics in a business setting, emerges from highly unique structural domains and thereby carry with them modified sets of values.  For example, in the criminal justice system there are specific players that play specific roles in that structure and the overlying value for lawyers is to protect the constitutional rights of clients. In the healthcare industry physicians have duties of informed consent to patients, and while doing no harm to the patient, they must also respect patients’ rights to self-determination.

We infer that anyone who is officially designated as a professional also has fiduciary duties toward his client.  Fiduciary duties arise in any circumstance where one person has greater authority, power, or knowledge than their client. This carries with it the duties to act in the highest good faith and to never put one’s own interests above the interests of any client with regard to the subject matter of their contractual arrangement.  Being designated as a professional carries correlative burdens and benefits.  One benefit is that a professional has greater industry prestige and greater earning power. A corresponding burden of this fiduciary duty is that there is a greater responsibility to protect the interest of clients.

At this point in time, we cannot assume a mortgage originator is a) a professional (which triggers a different set of ethical considerations than general ethics and b) is a fiduciary and as such owes duties of the highest good faith to his client.  Furthermore, this would imply that the mortgage originator also has the affirmative duty to ensure his subordinates are also protecting those fiduciary duties.  In some states, laws have been passed that designate a mortgage brokers and the loan originators licensed under the broker to owe fiduciary duties to their clients but this is not the case in all 50 states for all loan originators no matter where they work. Instead we would classify loan originators as an emerging profession.

It is not clear that an individual not officially designated as a professional owes fiduciary duties to clients, though many courts have held loan originators to a fiduciary standard during the last decade as borrowers attempted to balance the scales of justice after becoming victims of predatory lenders.  (See “Mortgage Brokers-What Fiduciary Duties Exist? By Andrea Lee Negroni, Mortgage Banking Magazine Oct 1, 2007.) Typically non-professionals deal at arm’s length with their clients. In this case, consumers do not expect that their mortgage loan originator is not self-interested in their dealings, which necessitates the need for broker shopping in order to get the best deal, yet many borrowers did believe the loan originator was working on behalf of the borrower when no such duty existed.

If a mortgage originator does not have professional status that results from national competency examinations and being held to a code of ethics with sanctions, then there is no good reason for a consumer to expect any kind of special duties above and beyond those prescribed by law.  The expectation again is that both parties are operating at arm’s length and the consumer must be held accountable for his choice in mortgage originators.  In situations where the mortgage originator does not have official professional status, the operative rule continues to be “caveat emptor.” In contrast, in situations where the mortgage originator has official professional status, the operative rule shifts to “caveat venditor.”

Frequently, all professionals face conflicts between professional obligations and their own personal senses of morality.  For example, a pharmacist may have to respect his clients wish to purchase a Plan B Emergency Contraception even though he is personally opposed on moral grounds.  While we do not intend to provide any definite answers to these sorts of conflicts that occur, we can offer some account of some of the moral considerations that go into thinking through these sorts of conflicts.

There are two ways that professionals can approach ethical problems.  One is called holism and the other is called separatism.  Holism is an approach that implies that one has an absolute set of standards that applies to all contexts and domains of one’s life.  In contrast, separatism means that a moral agent separates and isolates the moral domains of his life.  He does not have one single set of moral standards that applies in all contexts.  He may have a different set of standards for strangers, a different set of standards for home, and an even different set for work, especially because there may be a written code of ethics at work to which he must abide.

For example, many states have consumer protection statues within their mortgage loan originator licensing laws requiring a duty of honesty to all parties.  By becoming a loan originator that person agrees to abide by that absolute rule.  In comparison, that very same person, in his personal life, may have adopted a rule concerning telling the truth that allows occasional deviations if the consequences so warrant.  This person then is adopting the strategy of separatism because he is rigidly separating moral domains of his life with different moral rules.  Another individual, however, could follow the approach of holism by maintaining an absolute rule of lying in all contexts of his life if it is in his best interest to do so.  If one’s professional, ethical standards are vague and ambiguous, it is difficult, if not impossible to be a separatist.  This is so because there is no clear rational way to separate one’s professional moral obligations from one’s general moral obligations.  This, then, throws one into a holist approach, which leads to subjectivism and thereby risks an “anything goes” policy.  Moral chaos ensues.

Due to what we believe was a deficient motivational structure, rampant violations and the resulting public outcry, mortgage originators are now facing severe externally-imposed federal regulations which are quickly worsening the situation of a typical mortgage originator and business owner.

The National Association of Mortgage Broker Code of Ethics, while it mandates that members shall conduct business in a manner reflecting honesty, does not go far enough in clarifying what honesty means.  This allows a wide number of interpretations of honesty and unfortunately, because there is no precise definition of honesty there is no objective standard to which members can be held.  This is the very problem in this industry. Because code provisions are expressed with great ambiguity they are susceptible to moral subjectivism, which means that ultimately just about anything goes and the “anything goes” policy has caused huge amounts of political and legal machinery to gear up to create external regulations of our industry.  Laws come with far more serious sanctions than we would mandate through continuing education, disciplinary proceedings with retraining, and so forth, which we believe will be less efficient and will decrease industry profits.  The mortgage lending industry has a choice: We can either proactively, internally regulate ourselves with the attempt to educate, train, and improve the moral fiber of mortgage originators, or else we will risk constant and even greater external regulation by various legal bodies.

We believe the best way to elevate the moral fiber of any industry is to develop and provide an ethical structure of motivation for our industry that is not dependent on external rewards or punishments but instead helps loan originators develop a system of internal rewards based on ethical virtue, duty, and consequences.

NAMF is writing such a code. Contact Jillayne Schlicke for more information: 206-931-2241

Portions of the above article were originally published in Mortgage Originator Magazine in 2001 and authored by Kevin Boileau, Ph.D., and Jillayne Schlicke, M.A.

Mortgage Folks: Stop Blaming Fannie, Freddie and the CRA for the Meltdown

Hi Everyone,

When the topic of blame comes up, lots of us in the mortgage lending industry always seem to want to point towards someone else instead of taking a look at our own role as loan originators, processors, underwriters, and so forth.  One thing I constantly hear is how it was the fault of Fannie Mae and Freddie Mac for lending money to subprime borrowers. First of all, Fannie and Freddie don’t lend money and second, that myth has already been debunked here and here.

Michael Bloomberg publicly blames Congress for passing laws encouraging Fannie and Freddie to do the same.  Read how ignorant that position is right here.

Others blame the Community Reinvestment Act saying the Act forced banks to make mortgage loans to subprime borrowers. Sorry folks, the CRA has been around since the 1970s and is not to blame for the real estate bubble and the meltdown.  Read why here. Most of the subprime loans made were originated by people not subject to the CRA.

It’s beyond time to stop blaming others and to take accountability for what we can do as a collective group of individuals so we can move forward.

Are the Cash Call radio ads advertising a “no fee” loan deceptive?

I listen to 97.3FM and am a longtime listener of Dave, Luke, Dori (accidentally listening since 1995), Ron, Don, John, @thenewschick and @joshkerns38. I am so sick and tired of hearing the Cash Call radio ads that everytime one of the ads run, I feel the need to switch the dial over to satellite radio and I’ve been meaning to write this blog post for many months so here it goes. 

Radio listeners: There’s nothing inherently wrong with mortgage companies that advertise on the radio. This is one business model of many but realize that radio ads are not inexepensive and there are a few ways that a mortgage company can pay for their advertising. One way is to charge you higher interest rates.  But wait, how could they do that when they’re advertising low, low mortgage rates? 

The answer is one you will not want to hear but I’m going to tell you anways:  The rates advertised are likely NOT the rate that you will get.  The rate advertised is for a loan program that only a very small percentage of people will qualify for.  People with credit scores above 740. People with lots of equity in their homes, people who want a 10 year mortgage, or in the case of Cash Call, people who ONLY live in the state of California.  That’s right, the radio ad that’s running in Seattle comes with one caveat: It’s only avail for California borrowers.

To their defense, the Cash Call radio ad airing on 97.3FM does state that the rate and APR advertised are for a 10 year mortgage but realize that only a very small percentage of people calling that firm will end up with a 10 year mortgage.  This might come very, very close to a classic bait-and-switch scheme without crossing over the line but we don’t have enough facts to make that determination.  Instead the reason for their radio ad is to motivate radio listeners to pick up the phone and call. 

So, who’s on the other end of the phone?  The answer shows us another way companies that advertise on the radio make money. 

Any consumer who is curious about the licensing status of their loan originator can use the Nationwide Mortgage Licensing System’s Consumer Access website to check on the status of a mortgage company or individual loan originator.  When searching for the company name CashCall you’ll see many, many licensed LOs, okay that’s good. But dig a little deeper and you’ll notice that each person’s employment history contains many months of unemployment right around the subprime meltdown and lots of jobs held at subprime shops or other companies that only do radio or TV ads…Ditech, Amerisave, Countrywide, and other low wage side jobs outside of the mortgage industry.  That leads to the second part of how these companies make money advertising on the radio.

If they can’t offer you the lowest rates they’re advertising, then another way to make money is for the radio-advertising mortgage company to pay their loan originators a really low fee.  This is justified by the firm because…the company is making the phone ring! All the LO has to do is sit there, answer the phone and close the customer.  This is loan origination at its worst and if you don’t believe me just simply google:  Cash Call Complaints or Quicken Loans Complaints and see how many dis-satisfied customers they’ve left in their wake.

Homebuyers and refinancing homeowners should be wary of ANY mortgage lender that operates out of state and has no physical prescence in your state and if they did have an office here, why aren’t you working with a local person? 

Homebuyers and refinancing homeowners should always check the licensing status of their loan originator here and if their LO is not in the NMLS system ask WHY and ask to speak with their manager. Mortgage brokers and non-depository mortgage lenders must license their LOs. Depository bank LOs begin registering their LOs within the NMLS system this year. Maybe the person on the phone calls himself/herself an intake specialist or a loan something or other. Ask to speak with a licensed LO. If there are no licensed LOs then you’re probably dealing with a lead generation company and I’ll do a serious smackdown on lead gen firms in another blog post.

Companies like Cash Call and Quicken hire the loan originators who have no client base, don’t want to work hard enough to earn repeat business, only work part time, will work for a low wage, and/or are paid to close deals and not serve the best interests of their clients.  Do you want low rates? Go ahead and use one of these companies but you should have extremely low expectations of your rate being as verbally promised or the transaction closing at all. Expect pain and suffering. Some people pay extra for that, but now we’re getting off track.

Do you want your transaction to close? Select a loan originator based on his or her experience and knowledge. Choose a local company with a loan originator located right in your city so you can go into the office and meet with him or her face to face at application.  Yes, this will take time. Do you want your transaction to close and also get a fair interest rate? Then that means you will have to invest some time into understanding your options and understanding the documents you’re signing and that means human interaction whether that’s email, text or facebook messages.  You will need someone to respond to your questions who knows what they’re doing.  It is impossible to be a part time loan originator and serve your clients efficiently because there are far too many changes taking place on a daily basis.  A part time salesperson’s time and energy are split between many competing interests and self interest will typically win out every time. 

Kiel Mortgage radio ads are great. The radio ads from TILA Mortgage have improved over the years.  Best Mortgage’s ads are fine.  These are all LOCAL Seattle area companies with local loan originators and company owners who have been serving homebuyers and homeowners for decades.

I notice that on the Cash Call website, and on KIRO 97.3 FM, they’re advertising a “no cost” mortgage loan.  Folks, there is no such thing as a zero cost loan.  It doesn’t exist unless you’re doing a straight interest rate reduction refinance with your same lender, going through that lender’s loan servicing department and I think it’s even rare that that would happen nowadays with so many banks and lenders immediately selling everything to Fannie Mae or Freddie Mac.  Mortgage loans will always have fees and costs involved.  Some of those fees will be to the bank funding the loan, other fees will benefit the loan originator helping you, and still more fees will go to third parties.  Any company that tries to sell you a “no fee” mortgage loan is lying to you. The fees ARE being charged….they’re just being covered by a higher rate or they’re not telling you about the other third party fees that you’ll pay at closing unless you decide to read the fine print. 

So the opening call-to-action phrase on the Cash Call home page is a lie, the radio ads are deceptive and their loan originators are sub-par. I’m sure they’ll make several million dollars this year, pay a very small percentage of their profits in fines, and keep on using the radio to find more rate shoppers.  It’s a business model that works. Expect more copycats.

Newest Scam: Assignment of Mortgage Payment System

I have received several emails from confused loan originators and Realtors wondering if this “Assignment of Mortgage Payment” system is real or just another scam.

There will always be a get-rich-quick scheme and people willing to take your money to sell you a system.  The people who are really making the money are the ones selling the system.

The idea behind an Assignment of Mortgage Payments is nothing more complicated than ABC.  That’s right.  A sells to C…and B collects a fee as the middleman.  Except Homeowner A is still in title to the property and Homeowner A’s name is still on the Deed of Trust owed to the bank.

For a fee, B acts as a middleman and finds C who will “take over” the monthly payments.  In the typical scenario C is a homebuyer who is unable to obtain a loan from a traditional bank or lender for various reasons such as poor credit or undocumented income.  Homeowners considering selling using one of these systems might want to consider that a person with poor credit and undocumented income is an extremely high credit risk. Read: Assume Homebuyer C WILL default.

For homeowners considering this type of scenario, get out your deed of trust and note and READ the whole thing. In there, I will bet you’ll find something called a “due on sale” clause which pretty much means that if you sell the home your lender can call the note due immediately.  The people behind the Assignment of Mortgage Payment System will tell you that this rarely happens and not to worry.  That’s exactly what the subprime mortgage loan originators said to their clients, too: “don’t worry, we can refinance you out of this loan.”  And that’s where these people come from….Subprimers went from there to predatory loan mods to being short sale negotiators to selling forensic loan audits to this.  Next year it will be something else. 

Predatory loan mod salesmen and predatory short sale negotiators also like to use phrases like “this is perfectly legal.” That’s the same thing the AMPS salesmen will say and a dead give-away that this is a scam.  Loan originators and Realtors: Do NOT pay the $900 (and monthly fee) to buy into this system. 

Is there a method of helping distressed homeowners and poor-credit homebuyers that’s legit? Yes, you could do lease-purchases and have a local attorney help draw up the paperwork.  However, I don’t know why a poor credit homebuyer would want to buy a home that’s worth less than what is owed.  With so many bank-owned REOs hitting the market and with FHA/USDA/VA guidelines still flexible, there is no reason to buy a home that’s worth more than what is owed unless you are unable to use the logical side of your brain due to being under the influence of a sociopathic salesman. 

Another legitimate way of selling an underwater home to a homebuyer with less than perfect credit is to have the homebuyer go through a formal assumption with the lender’s loan servicing department.  This can work with an FHA and also a VA loan (though I don’t recommend VA assumptions unless the new buyer is also a Veteran.) But again, why would a homebuyer want to buy a home where the mortgage is higher than the value?  There is NO good reason for doing so unless you’re the middleman making a fee out of putting this deal together.  With a lender approved assumption, typically there is no fee paid to a middleman and that’s why nobody will try and help sellers and buyers come together this way. 

Avoid Assignment of Mortgage Payment System Scams.  And realize that the people behind these scams are trying very hard to get their name at the top of the google search index by simply posting lots of articles with the word “scam” in them. In their article they try to explain why their system is not a scam.

LOs Who Attack Realtor Commissions Might Want to Look Inward

I was just asked to proof a very agressive manifesto penned by a mortgage broker who was attacking the, in his words, “outrageous” commissions Realtors make when helping people buy and sell a home.  It made me wonder why the LO was so angry with Realtors in general. 

Any Realtor who reads the article in its current form will take a direct attack back onto the author, attacking the structure of loan origination fees and the high, predatory, egregious YSPs LOs earned during the bubble run up. 
When someone initiates a direct attack,  most people want to steer clear, especially if the way they personally earn a living doesn’t match the stance of the article. For example, a Realtor who may agree that Realtor commission structures could be changed might not want to come out publicly on this side because he/she needs to keep earning a living under that commission structure to feed his/her own family!  A loan originator agreeing that Realtor commissions ought to change may not want to publicly agree because he/she might have many Realtors who refer him/her business on a regular basis.
Here’s my honest opinion, FWIW.
Everyone has been pointing the finger at everyone else, blaming them for the meltdown.  A direct attack by loan originators on Realtor comissions takes all the anger and points it at the Realtors and their commission thereby relieving the mortgage loan originator of any culpability.
In psychology we call this projection. LOs (all the time, in my classroom) tend to project their own issues onto anyone else nearby:  The banks, the wholesale lenders, the Realtors, the builders, the regulators, the greedy wall street investors, and so forth: 
“It was all their fault!”  Projecting outward keeps our own ego intact, so that we don’t have to personally look within (collectively speaking, as an entire nationwide group of LOs) and examine if we actually could have done something as a group, nationwide, to have stopped the mess/meltdown.
There are small pockets of people scattered around nationwide who want to raise the bar in the real estate industry and there are folks who want to or already do offer different real estate commission structures and they’re fighting an uphill battle but they are fighting the good fight.
I recommend starting from scratch and take a different stance.  Approach the idea of real estate commissions as if you were going to give advice to a young, first time homebuyer who knows nothing about lending.  Let go of the anger because we wouldn’t use an angry tone with a first time homebuyer. Instead, pretend like you’re teaching a class and the person reading your essay is a student.  Teach a new homebuyer how to succesfully negotiate a lower real estate commission. 
Now you’re educating and giving some valuable information back to the world.  Now the tone will be less agressive and more about teaching consumers to be assertive (slight but important difference) when hiring real estate agents.
As time moves on, LOs will become less angry and will start accepting that industry changes can and do happen but they happen in a much slower way than we’d like.

And then when you’re all done, consider that the same advice you’re giving homebuyers about negotiating Realtor commission, that same person could use your advice to negotiate a lower loan originator commission.  Now how motivated are you to change the world?

How to Think About Ethics

What do you remember from your last Ethics class?

When I ask this question, the room falls silent.  Then maybe a lone person might shout, “honesty.”  Someone else might say “The Golden Rule.”  It’s easier to talk about ethics in smaller groups rather than one large group so when the classroom is divided up into smaller working groups and I charge students to come up with a list of 10 things they learned, or to come up with a list of 10 character traits they admire in people (like honesty, courage, etc.) the task is easier because we have each other to talk with.

The SAFE Act now requires licensed LOs to take an ethics class every single year.  Along with that, course providers like NAMF have to insert additional topic categories inside our ethics class: Consumer protection, fraud, and fair housing.  So you’ll be taking an ethics class….every….single…year.  It might seem irritating that the government is mandating this every year but if you think about it, ethical dilemmas change from year to year and course providers are charged with making sure our courses are current each year.

But the mortgage lending industry doesn’t have a required, mandatory code of ethics which all members must subscribe to.  The codes that do exist are pretty lame and are only voluntary.

So we should ask the NMLS, if we are suppose to think about ethics, whose ethics are we suppose to be learning?  Without direction from NMLS, it would be pretty presumptive to assume that we’re suppose to teach/learn the NAMB, NAMPW, NAMF, MBAA codes of ethics. 

So where does an industry begin to learn how to use ethics to solve their professional ethical dilemmas? For example, if we were to sit down and write a brand new code of ethics for the industry (don’t worry, there’s not enough time to do that for the purpose of this article) we would have to start somewhere and here’s where it is: We’d look to normative moral theory.  (Read a very brief paragraph on descriptive, normative, and analytical ethics here.)  Normative moral theory can be applied to any profession such as law, medicine, and even the emerging profession of mortgage loan origination. If we were to sit down and write a code, we would create that code from elements of Aristotle’s virtue ethics, Kant’s duty-based ethics, and J.S.Mill’s Utilitarianism and apply these theories to ethical dilemmas faced by loan originators.

Someday the industry will be ready for mandatory, prescriptive code. If you’d like to take a look at an industry that’s created a prescriptive code, we can look at the Realtor Code of Ethics.  Make all the Realtor jokes you want to; their code has been around for over 100 years.  To me, this means the Realtor association is 100 years ahead of mortgage lending in terms of promoting the moral development of their profession. 

Ethical subjectivism is one of the many reasons that lead to the subprime meltdown. The industry is still in need of an objective, prescriptive code.  An argument against that position is that as long as we follow state and federal law, we don’t really need anything else to guide us.  That may be true, but then that person is arguing to keep himself/herself about as morally developed as a teenager. 

Consider an ethical dilemma you’ve faced during your time originating loans. If you are a new or newer LO, think about an ethical dilemma you’ve faced in another job position.

Q: What was the dilemma?
Q: How did you solve it?
Q: Do you identify more with Aristotle’s ideas, Kant’s duty-based ethics, or J.S. Mill’s Utilitarianism?  Or maybe your ethical style is a combination of each.

Remember, it’s okay to use intuition, emotion, and religion to start your thinking process but we can’t stop there. For example, our intuitions might be wrong. Emotions (example of fear-based thinking “if I can’t sleep at night I know it’s unethical) are a pretty self-serving way of solving problems, and there are literally thousands of different religions in the world so although it’s fine to reach back and think about the ideals you learn from your religion, once you become a professional, your code of ethics becomes your bible.  Since our industry doesn’t have that mandatory code of ethics just yet, we definitely CAN use normative moral theory to get us started. 

Case Study: NAACP v. Novastar

Novastar and its mortgage broker Bell South Mortgage (Bell) conspired to maintain a policy of denying all loans secured by row houses in Baltimore and discouraged the referral of such business. Over a period of time, HUD sent shoppers to Bell/Novastar who were repeatedly treated differently based on protected characteristics of race, color, racial composition, and national origin. Property type is strongly correlated to the racial composition of neighborhoods in Baltimore. Two thirds of all row houses in the city are occupied by African Americans.

As a result of this policy, individuals in the community were denied equal access to credit, capital, banking services and loan products; and made housing unavailable on a prohibited basis, a clear violation of Fair Housing law. Loan officers repeatedly told shoppers, “We don’t do row houses.” In some cases Novastar and Bell refused loans where the borrowers had more than adequate credit scores, income, financial stability and even low LTV ratios.

When Bell joined with Novastar it was given a Company Program Manual  listing Unacceptable Property Types. Row houses were not listed. Bell also secured an exclusive warehouse credit line from Novastar, agreeing that Novastar would fund all of Bell’s loans. At the time, Bell had several unclosed Baltimore row house loans, which Novastar refused to fund, and warned that using another warehouse line to close those loans would be a violation of their exclusive warehouse agreement. Bell assigned the loans to another lender for a fee. Bell and its staff continued to refuse loan applications on row houses in Baltimore even after being informed that this was a violation of Fair Housing laws.

Plaintiffs sought injunctive relief as well as money damages, cease and desist orders, attorney’s fees, and enjoining Defendants to modify their lending practices to comport with the law.   
The N.C.R.C. and N.A.A.C.P. in their COMPLAINT claimed the following:

I. Defendants policies and practices violated the provisions of the Home Mortgage Disclosure Act by redlining: refusing to grant credit in a community or neighborhood. Their actions have had a disproportionately adverse effect on African Americans and other people of color compared with Caucasian applicants by virtue of denying the financing of the type of property chosen for security purposes. This contributed to the economic destruction of a Baltimore neighborhood, depreciation of property values, higher foreclosure rates, street crime and the creation of housing ghettos.
II. Defendants policies and practices violated The Civil Rights Act of 1964, which prohibits racial discrimination in the formation and issuance of contracts, and intentional interference to pursue and hold real property. Defendants through their willful conduct contributed to racial hatred, and denied African Americans the right to own property.
III. Defendants policies and practices violated the provisions of The Equal Credit Opportunity Act which prohibits a creditor from discouraging an applicant from making application for credit by refusing to consider the security property offered.
IV. Defendants policies and practices, through the disparate impact theory,  a provision of The Fair Housing Act and other legislation by imposing different requirements or conditions on a loan on the basis of elements other than credit, the result of which was racial discrimination.

Before the trial was held, Bell asked the judge for summary judgment,  claiming it was only following the dictates of its “exclusive source of warehousing and funding.” Its agreement required that all loans must be sold to Novastar thus it had no other choice. At trial Novastar raised an unusually large number of issues with respect to the wording of the law, citing numerous cases and questioning the interpretation and meaning of whether or not the law applied to this case.

The lenders denied the accusations and set out these AFFIRMATIVE DEFENSES

I. Type of property. Independent appraisals show that row house properties in Baltimore are in a transitional state. Many are being converted to commercial or mixed-use enterprises. This, not lack of financing, has resulted in value depreciation. Our Company Program Manual at ¶5.3 Unacceptable Property Types reads: Commercial use or a mix of commercial and residential properties. Clearly, many row houses in Baltimore are “mixed use”, as most appraisals point out. This violates our written policy, which was not drawn frivolously. Empirical evidence we have provided demonstrates that losses on this property type exceed those of other type of dwellings. As further evidence of excessive risk, private mortgage insurers have refused to insure loans on row houses.

II. Intentional Interference. We have shown that there are other mortgage lenders in Baltimore and elsewhere that offer financing to row house buyers.  We fail to see how our actions prohibit borrowers from shopping the mortgage market for other sources willing to accept this type of security. Our Company Program Manual at ¶2.3 Regulatory Compliance reads: We comply with all federal and state regulatory requirements in granting mortgage loans. We have provided the court with a recent pipeline and portfolio report showing that a large number of our borrowers are African American and other minorities and the security properties are located in a variety of neighborhoods, towns, and rural areas  . We fail to see how our conduct in these cases intentionally interfered with these borrowers right to contract for the property desired.

III. Discouraging Applicants. We have shown a number of examples where national mortgage lenders regularly publish U. S. Postal zip codes showing geographic areas in which they will not grant credit.   These typically are areas where lending experience has shown that unreasonable business risks have been found through empirical evidence. We ask the court: How does this differ from avoiding row housing? We believe we should have the same right to define when, to whom, and where we will grant credit without the interference of government and claim this right specifically in this case. We deny discouraging borrowers from applying for credit because in every case cited we informed the borrower of our willingness to finance real property in many other locations.

IV. Racial Discrimination. Refusing to accept real property offered as security for a loan is not against the law. The decision to lower lending risk profiles and elect not to finance row houses is racially neutral – it is not directed toward any race –- it is directed toward real property and therefore cannot be found racially discriminatory.  As an example of our neutral policy we refer to our Company Program Manual, at ¶6.2 Minimum Value Requirements. There is no minimum value requirement for Citizens and Resident Aliens with our company because we long recognized that this is discriminatory by its very nature.  (Non-resident aliens and piggybacks are limited to $75,000 because of secondary market considerations not internal company policy). We have provided the court with example after example of lending companies that have loan minimums whose adverse and disparate effect is directly similar to the case at hand. We will make mortgage loans other companies refuse because we understand the need for making capital available in large or small amounts – a racially neutral policy. We contend that minimum loan amounts are also discriminatory but counsel can find no case in the court’s jurisdiction where lenders have been challenged under civil rights statutes.

Trial Notes
Mentioned in this suit is the fact that lenders have been sued by several cities using two theories of “Public Nuisance” In City of Cleveland v. Deutsche Bank Trust Company, et al. Common Pleas. January 10, 2008. The city claimed that lenders were the cause of high foreclosure rates, blocks of unoccupied residences that were more expensive to police and protect against fire damage and empty blocks of neighborhoods decreases property values and loss of revenue

Notes on the defenses raised:

I. Defendants provided audited internal data showing greater-than-average losses on row houses, together with an article from the Baltimore Sun newspaper, which reported that some units in Baltimore’s row houses were being used as boarding houses and even Bed & Breakfast Inns, in violation of the zoning laws. Zoning violations are often considered a default in mortgage lending.

II. The pipeline and application data used were taken from published HMDA reports, and the Mortgage Bankers Association provided data on the number of foreclosures and average losses to member companies in the same geographic region.

III. Copies of advertisements and loan program brochures of other lenders provided information on zip code lending restrictions. It was and is a common practice. Plaintiffs did not refute it.

IV. The disparate theory holds that when an action has a disproportionate effect on some group (racial, ethnic, etc.) it can be challenged as illegal discrimination even if there was no discriminatory intent.

The question is whether someone who does not engage in racial discrimination can violate the federal Fair Housing Act. The claimant need not prove that individuals were treated differently because of their race. Instead, it is enough to show that a neutral practice has a disproportionate effect – that is, a disparate impact – on some racial group.

However, the theory is difficult to apply. Suppose a landlord refuses to rent to people who are unemployed, and it turns out that this excludes a higher percentage of whites than Asians. A white would-be renter could sue. It would not matter that the reason for the landlord’s policy was race neutral and had nothing to do with hostility to whites. He would be liable, unless he could show some “necessity” for the policy. This would hinge on whether he could convince a judge or jury that the economic reasons for preferring the rent to the gainfully employed were in some way essential.


Did Novastar engage in racial discrimination?
Is it possible for a company that does not engage in racial discrimination to still be found in violation of Fair Housing laws?
If yes, how so? If no, why not?
Here is a link to the Fair Housing Laws for your review.

Case Study: Carnell v. KMC

Carnell, a self-employed 64 year old single man with no dependents, applied to KMC Mortgage Co. (KMC) to refinance a first and second mortgage and get cash to buy tools for his small business. Besides what he earned as a general handyman, he received Supplemental Security Income (SSI) for a disability. At application he talked loudly to himself, had questionable personal hygiene and wore slightly ragged clothing. He boasted loudly how he “took care of himself,” doing his own cooking, etc. The broker determined that – subject to the appraisal – there was sufficient equity to pay off the underlying mortgages, cover loan costs, and leave about fifteen hundred dollars, but warned him that his monthly payment was likely to be much higher than his current payment. Carnell advised KMC to go ahead with the deal because he “needed the money.”

The appraisal was sufficient but noted that the home’s interior was so filled with personal items, books, magazines and debris that the owner had made high narrow lanes in order to use the rooms. A preliminary title report showed a junior lien in favor of King County Public Assistance securing a loan that was used to assist in purchasing the property. The loan terms required no monthly payments with interest at 4% per annum to accumulate as long as Carnell occupied the home as his principal residence. Upon sale of the home, the entire principal balance was payable. There was a property tax abatement certificate on the home as long as Carnell used it as his principal residence.

The credit report showed 1×30 and 2×60 in the last two years and the credit score was within the guidelines of KMC’s investor. His use of credit was sparse and included one very small balance, never exceeding three hundred dollars. An old pickup truck used in the business was paid for and the business was run on a cash basis. His tax returns showed an average combined monthly income for the last three years of $1,066. and the current monthly payment on the first mortgage was $454. He had little cash reserves with an average bank balance in the high threes.

The broker contacted CALFUND (the investor) by phone to discuss “how we can put this together.” The investor advised that this was a case where the underwriting theory of attributable income could be used.  Because Carnell’s SSI income was not taxable, and the property tax abatement lowers even more tax liability, it would allow KMC to “gross up” the SSI income “to an appropriate amount.” KMC adjusted Carnell’s income by 25%. The investor subsequently indicated by phone that the loan would be approved provided there were no debts other than the new mortgage; and he paid an additional 1% of the loan amount because of the increased risk.

The broker telephoned Carnell with the loan approval and informed him of the new monthly payment, then asked if he had any questions. He responded that he was quite happy and had no questions. KMC did not notify him of the additional cost at this time, explaining that they prepared a new GFE and mailed it to his residence as required by regulation. Carnell claims he never received the notice.

In preparation to close the loan, final payoff statements were ordered from the holders of the first and second mortgages. King County P.A. responded with a final principal amount that included all of the accumulated interest and a per diem charge.

Examination of the loan documents showed that KMC changed its initial GFE and final Settlement Statement to include an additional two percent with one percent going to the investor and an additional percent listed on line 808 of the closing statement as a brokerage fee. A brokerage fee had already been combined with the investor’s fee and reported on line 801 of the closing statement. Carnell signed all final documents without comment or question and the investor wired the funds to escrow.

Seven months later, failing to cure payment delinquencies, Carnell defaulted on the loan. The file showed that he had difficulty meeting monthly payments. The investor demanded that the broker buy the loan back. KMC responded that the investor itself had helped put the loan together. When asked for proof of this, KMC revealed the phone conversations it had with an employee of the investor. The investor found no record of the conversation. The issue between KMC and the investor remained unresolved.

Several months later, the property was foreclosed upon and Carnell lost his home. A lawsuit was brought against both KMC and the investor to recover damages and rescind the entire transaction, seeking to put Carnell in the position he was before applying to refinance. Several violations of state and federal law were claimed in the suit.

KMC’s position was that it did nothing wrong, claiming that a customer had applied to refinance his home; the company followed usual and customary lending procedures and gained loan approval.  It was not unusual for details to have been discussed with the investor. It followed all regular procedures of loan brokerage and complied with disclosure rules. After learning that the final loan costs were greater than estimated they acted in good faith by re-disclosing. They further pointed out that the final settlement statement revealed all of these charges but were not challenged at closing.

The investor claimed that it dealt with KMC at arms length and could find no record of offering “extraordinary assistance” in qualifying Carnell. It was against their policy to offer step-by-step procedures to brokers in order to customize a loan to fit corporate matrixes, “A loan either fit our program or it didn’t,” according to their testimony. Further, the contract between KMC and the investor contained a provision with regard to early defaults, which they chose to exercise.
A broker must use reasonable care in managing a file from application through closing to assure a standard of care commensurate with the duties of agency and brokerage. Some courts have even held licensed brokers to a higher than reasonable standards because the general public considers them experts. In considering how this case was handled, what would have caused you concern if it were given to you for review? Be prepared to discuss the following:

1. What kind of a borrower does Carnell look like on paper?  Does an applicant’s conduct and demeanor at application have relevance to the case or should they be overlooked? After all, they have nothing to do with credit – by law the only basis on which we are to judge credit worthiness.

2. Documentation. Are there any inquiries you would have made or any additional documents/exhibits you would have required before continuing to process and submit this case for approval? Explain what and why you would order more documentation.

3. Customer Service. Consider the position of the borrower before and after dealing with KMC Mortgage Company. Did the broker help the borrower achieve what he wanted? Was the borrower well served?

4. Verdict.  If you were on the jury would you find in favor of Carnell or the broker/lender?

Are Loan Originators Professionals?

When I ask the question “Are loan originators professionals?” to a group of loan originator students in ethics classes, almost everyone says “yes.” Anyone can do their job in a professional manner (adjective,) but not everyone is a Professional (noun.) Is your barista at Starbucks or the person who bags your groceries a professional? If you answer “yes,” what makes a barista different than a doctor or lawyer? When we use the word Professional as a noun, there’s a classic definition that we refer to here:

A Professional:

Has specialized knowledge in his or her field. This body of knowledge is generally agreed-upon by those in the industry and is typically described within state and federal law. A professional knows way more than the average random consumer about his or her area of expertise;
Is required to complete a minimum amount of formal, academic education;
Is tested for competency;
Is licensed;
Must maintain that license with mandatory continuing education;
Subscribes to a mandatory code of ethics in an industry that is self-regulating. This is different from state or federal government regulatory oversight. The industry itself regulates ethical conduct over and above state and federal law;
The self-regulating body enforces their code of ethics with sanctions for violations;
Owes fiduciary duties to clients. This means the professional has the highest prescribed duty of loyalty to the client, to put the client’s interests above his or her own interests.
Here is how loan originators (LOs) measure up against the above list:

Specialized Knowledge
There is a power imbalance between mortgage loan originators and the consumer. LOs know way more about how the machine we call mortgage lending works than the average random consumer will ever know.

The SAFE Mortgage Licensing Act of 2008 requires 20 hours of pre-licensing education for licensed loan originators. The Dodd Frank Act of 2010 requires equivalent education for depository bank registered LOs.

Competency Test
The SAFE Act requires licensed LOs pass a competency test.
The Dodd Frank Act requires registered LOs pass an equivalent competency test.

Continuing Education
Licensed LOs now complete 8 hours of continuing education and any state required CE
Registered LOs complete the equivalent of the above.

Code of Ethics
There is no mandatory code of ethics for mortgage lenders. What codes exist at the national trade level, are voluntary and offer insufficient guidance. Currently there is no ethical oversight in mortgage lending by the industry. There may be individual company codes of ethics for employees.

Fiduciary Duties
Some fiduciary duties exist between loan originators and their clients. For example, Washington State prescribes fiduciary duties for mortgage brokers and the loan originators who work under the supervision of a mortgage broker. Other states may have also added this duty. But no such duty exists in all 50 states at the federal level.

Loan originators are classified as an “emerging profession.” We are living through a historic, transformational phase. On the other side of the transformation, which could come sooner than some people think, I believe LOs, no matter where they work, will owe fiduciary duties to consumers, even with LOs who work at a bank. If you look at the narrative history of any profession you see, over time, a steady increase in the number of continuing education classes required, more mandatory pre-licensing education, an elevation of duties owed to clients, more expansive ethical codes, and tougher licensing exams. Loan originators, no matter where they work, will eventually transform into professionals.

Many in the industry believe fiduciary duties means higher liability to the company. However, if done right, this may actually have the reverse effect by lowering the mortgage company’s liability.

Looking after the best interests of customers is almost always in the best interest of the company.

Once the mortgage industry decides to adopt a prescriptive and descriptive code of ethics AND ALSO a framework for industry self-regulation, an added benefit will be that government regulators and politicians will stop passing more laws directed at our industry.


1) Does your company have a code of ethics?  If so, post the link in the comment box and tell us if you think your company’s code has helped guide your (or your colleagues) as you’ve faced ethical dilemmas in your career.
2) Do you belong to a professional association?  (Example: NAMB, MBAA, NAPMW, NAMF, Mortgage Planners, and so forth)  If so, find their code of ethics and read it. Could their code of ethics be improved? If so, how?
3) The mortgage industry has lost thousands of loan originators over the past few years.  Some will eventually return.  When they do, what

Mortgage Industry Codes of Ethics

Read the Code of Ethics from these three trade organizations.  Don’t worry; it will be a very fast read.

National Association of Mortgage Brokers
National Association of Mortgage Women

For the Mortgage Banker’s Code, follow this link and click on “cannons” from the menu on the left.

What’s missing?
Could some of these phrases be re-worded?  If so how? 

For example from the Mortgage Broker’s Code, the phrase “Mortgage brokers shall conduct their business in a manner reflecting honesty.”  This could mean brokers simply have to look like they’re being honest.  I would re-word this to say something like, “brokers shall be honest when conducting the business of mortgage lending.” 

It seems to me that they all sound the same. I wonder if they all just copied and pasted from the Mortgage Banker’s Code.  Now let’s take a look at some of the newer trade associations.

Upfront Mortgage Brokers Association
National Association of Responsible Loan Officers
Certified Mortgage Planners

National Association of Mortgage Fiduciaries (link coming soon)

Can you see how the industry is beginning to transform?

Do you have a code of ethics at your company? If so, please provide the link in the comment box.  If not, ask your manager why and tell us what he or she says.

Fee Splitting

I recently wrote about a common question I often receive in which an unlicensed LO asks a licensed LO to act as the originator on a transaction, and pass part of the origination fee back to the unlicensed LO.  Read the story here.

What are the possible consequences for the licensed LO, the unlicensed LO, the consumer, the mortgage broker, and the lender? 

If you were the consumer on a transaction like this, would you want to know about this sort of fee-splitting arrangement? How much would you say would be a reasonable amount to pay the unlicensed LO and the licensed LO…if YOU were the consumer? 

Solutions to the Mortgage Lending Crisis

The mortgage industry crisis is a gift.  Mortgage lending can emerge from this mess and transform itself. I have been co-writing about predatory lending and the ambiguous professional status of retail mortgage salespeople for over 7 years. The industry has traded consumer respect for massive profits.  It does not matter where you work: banker, broker, credit union, consumer finance company. It does not matter what you call yourselves: Loan officer, loan originator, loan consultant, mortgage planner.  The average consumer does not understand the differences. 

Solution number 1
All retail mortgage salespeople, no matter where they work: bank, broker, credit union, consumer finance company, should owe fiduciary duties to consumers, just like a doctor or a lawyer does.  The process of purchasing or refinancing a home has become more and more complex over the past 20 years. This major financial decision is no less important than a medical procedure or legal matter.

Solution number 2
Let’s stop dancing around the ambiguous behavior we call “predatory lending” and define it.  We use to call such actions “fraud.” There are now 24 states that have passed anti-predatory lending legislation.  This means multi-state brokers must deal with a patchwork of state regulations.  A federal solution is in order, but we must also make sure that funds are set aside to regulate any new federal law. An un-regulated federal law is useless.

Solution number 3
If the industry does not like paying higher costs associated with more state and federal regulations, the industry has another choice: Self-regulation.  Any industry is far better of self-regulating rather than letting the government regulate for you.  The last time the mortgage industry had to swallow government forced regulation, we ended up with RESPA and the Truth-in-Lending Act. Oh, yes, these are such fine pieces of federal legislation and so easy to understand that the industry joyfully and voluntarily steps up to the plate every day to willfully comply with these two gems.

Every time I ask mortgage brokers the following question, I get the same answer, 100% of the time: “If you accidentally messed up and violated a federal or state law, would you want one of the competitors in your marketplace to give you a call and say, for example, ‘Hey there, I think you missed the APR on that piece of advertising’ or would you rather have your competitor turn you in to your state’s regulator?”  Everyone would rather have their competitor place a direct, friendly call to them.  There’s this really cool guy named Kant who came up with one way (well he came up with many ways but we’ll just focus on one right now) to help us figure out how to act ethically. He said that if we want something for ourselves (a courtesy phone call) then we must also want it for the other person.  “But, but,” you ask, “what if that other person is our competitor?”

Self-regulation means that the industry understands that consumer respect is only as high as it’s LOWEST player.  Self-regulation is a sign that an industry is moving forward and growing up.  Yes, it will mean requiring more pre and post education, tougher exams, and higher duties owed to consumers, but moving into the realm of professional status also means more prestige, less government oversight, and the fees emerging mortgage professionals will charge for their services and knowledge will be higher because their knowledge and duties will be worth more. If you regularly argue for less government intrusion and you are pro-business, you understand the value in self-regulation.

There are now four national professional associations where retail mortgage salespeople can voluntarily choose to act with professional status, or at least pledge a higher level of honesty than the existing industry associations.  Members of NAMB must simply look like they’re honest. 

Retail mortgage salespeople who join the Mortgage Professor’s Upfront Mortgage Brokers Association will guarantee, in writing, a fixed price for their services up front.  Members also pledge to put their client’s interests above their own.

The National Association of Mortgage Professionals has a Code of Ethics that is better than NAMB, MBAA or NAPMW.

The Certified Mortgage Planners have a more detailed Code of Ethics.  However, all a person has to do is attend a 3 day class and pass a test and I’m not sure I agree with their premise: To help consumers plan how to use their home equity.  This organization has some work to do in its intentionality.  Interestingly, a regular raincityguide.com reader sent me an entire slew of articles that catch lead Mortgage Planner instructor Barry Habib with his pants down recommending consumers choose subprime products, take their equity out of their home and invest it, and other “advice.”  Looks like CNBC hasn’t asked him for advice for a couple of months.

The National Association of Mortgage Fiduciaries Code of Ethics is prescriptive and detailed. We are the only professional organization whose code of ethics prescribes fiduciary duties and we are open to all people in the mortgage lending industry.

Ameriquest and Household Finance, two consumer loan lenders were forced by way of court settlement to cease rewarding their retail mortgage salespeople for steering trusting consumers into high cost, high rate loans. In contrast, Mike Dodge recently penned an Inman Guest Perspective in which his company, Internet Brands, voluntarily adopted a twelve point, detailed, home borrower’s Bill of Rights.

Solution Number 4
Require ratings agencies to do proper due diligence on pools of mortgage backed securities and dis-allow ratings agencies to be paid by the investment bankers; a conflict of interest that certainly should have been caught long ago.

Solution Number 5
Ban downpayment assistance programs which artificially inflate sales prices and are nothing more than seller money laundering according to Tanta. 

Solution Number 6
Require that mortgage companies that purchase leads be held accountable for the advertising used to harvest those leads.  Deceptive mortgage spam, deceptive radio ads, deceptive lead generation websites only serve to circumvent an ethical mortgage company’s attempts to advertise in accordance with state and federal laws.

Some view the mortgage industry meltdown as a threat. I see it as an opportunity to put the industry back on track ethically, to help retail mortgage salespeople transform into emerging professionals, rope predatory lending back into where it came from: the fraud corral, and open a national dialogue on self-regulation. What do you see? What solutions would you add to this list?

What the Space Shuttle Challenger Disaster Can Teach Us About the Current Mortgage Lending Crisis

In this mortgage ethics article about allegiance to rule-following, I will compare the mortgage industry crisis with a classic business ethics case study.

The space shuttle Challenger accident has frequently been used as a case study in the study of engineering safety, the ethics of whistleblowing, communications, and group decision-making.  With Challenger, an O-ring eroded on earlier shuttle launches. Morton Thiokol (MT) managers believed that because it had not previously eroded by more than 30%, that this was not a hazard. During a pre-launch conference call with NASA, the MT engineer most experienced with the O-rings, Roger Boisjoly, pleaded with management repeatedly to cancel or reschedule the launch. He raised concerns that the unusually cold temperatures would stiffen the O-rings, preventing a complete seal. MT senior managers overruled him and allowed the launch to proceed. Challenger’s O-rings eroded completely as predicted by Boisjoly resulting in the disintegration of Challenger and the loss of all seven astronauts. Boisjoly concluded that the caucus called by managers who decided to launch, was an unethical decision-making forum which came about because of intense customer intimidation. “Roger Boisjoly and the Challenger Disaster: The Ethical Dimensions” from the Journal of Business Ethics 8 (April 1989).  Everyone followed the rules, and the ensuing investigation determined the accident was nobody’s fault.  Boisjoly concludes that the Challenger accident occurred because of the existing institutional system and allegiance to the rules of protocol.

In real estate and mortgage lending, we all follow state and federal laws (rules), yet some consumers ended up with a mortgage loan they did not understand and were not qualified to pay back. Pressure was applied to many people all up and down the line in mortgage lending. For example, appraisers being strong-armed to hit a value or else risk losing referrals.  Some real estate agents and mortgage brokers still apply pressure to banks and lenders to approve loans fast, now and immediately, or else risk losing referral business, and a mortgage company’s culture has a remarkable influence over corporate workers. 

Let’s follow the origination of a random mortgage loan and see if we can spot all the possibilities for system failure. 

Lead generation companies such as NextTag, Lending Tree, and lowermybills.com scoop leads off of their deceptive banner ads and sell them to hungry mortgage retail salespeople.  Leads are also generated and sold by using deceptive mortgage spam, direct mail, direct home fax, deceptive radio ads, and so forth.

A real estate agent or Realtor is not suppose to become involved in the mortgage side of the transaction because it means the agent has stepped outside his or her area of expertise.  Attorneys advise real estate agents that an agent increases liability when this line is crossed.  Some agents are comfortable taking on this liability, others are not. Many let the homebuyer’s chosen lender take the lead on explaining the structure, consequences, and results of loan products.

Homebuyers and refinancing homeowners on average know very little about mortgage lending and spend little time reading required disclosures. Mortgage retail salespeople have no mandatory ethical duties to the homebuyer or refinancing homeowner to put the client’s interests above his or her own interests to make as much money as possible off a trusting consumer. Obviously there are some mortgage retail salespeople who do look after the best interests of their clients. But how is a consumer supposed to know where to find these folks?  Relying on the referrals of trusted friends and family shifts the responsibility off the self and on to another person. 

Government disclosure forms such as the Good Faith Estimate and the Truth in Lending Reg Z forms are confusing to the consumer. Predatory lenders use these forms to deceive a refinancing homeowner or homebuyer. This is well documented in both Household Finance and Ameriquest settlements.  There never has been nor will there ever be enough government resources to police every single transaction written by every single retail mortgage salesperson.

When a loan is brokered to a bank, the bank owes no duty to the consumer to make sure that the loan was not originated using deceptive or predatory lending sales tactics, or generated by advertising that did not comply with federal Truth-in-Lending laws. A bank’s duties are to its shareholders (to follow mortgage lending laws and to make a profit.)  Wholesale lenders and banks underwrite loans to guidelines set down by investors.  Profits are made by pooling loans and selling them as mortgage backed securities.  Hypercompetition to be the biggest and best wholesale lender led to paying higher and higher incentives to mortgage brokers to sell higher and higher yield (and now morally out-of-fashion) interest only, pay option, negative-am, adjustable rate mortgage loan with and without prepayment penalties to consumers, regardless of if the consumer understood how the loan product worked.  The selling point from wholesale lender to broker was: “when the rate adjusts, you can solicit them to refinance and earn another 4 points for yourself.” An entire breed of retail mortgage salespeople knows nothing but this business model.

Consumers are given standard state and federal disclosures to read, explaining how the loan product works, and some people argue that if a consumer signs documents he or she does not understand, then it is the consumer’s fault.  Mortgage lending is complex. Here is an analogy:  A person had to undergo surgery and the doctor hands the patient a set of medical books and tells the patient to read the books and make a decision.

Appraisers owe duties of good faith to mortgage banks and lenders. Problems with the relationship between the appraiser and the retail mortgage sales people were one of the first signs of O-ring failure in the space shuttle organizational structure called mortgage lending.  To their credit, the appraisal industry made a full frontal assault against pressures levied by retail mortgage salespeople, and they are now the first to once again work on solutions.

Escrow closers are at the end of the line. When a homebuyer or a refinancing homeowner is feeling uncomfortable about rates, fees, or terms of a loan, an escrow closer must remain neutral.  Escrow closers are in a perfect position to see blatant and ongoing abusive lending practices.  However, if they file a formal, public complaint, the business consequences are grave. Most state and federal agencies will not take anonymous complaints.

When wholesale lenders sell loans to Wall Street securities dealers, the dealer’s concern begins and ends with the contract: were state and federal laws followed, and what’s the rate of return on investment.  Pension fund managers, insurance companies and other institutional investors have no way of knowing if loans in a pool of mortgage-backed securities were originated using deceptive and abusive lending practices.

The institutional and structural systems of mortgage lending are broken in many places. The subprime problems and the resulting defaults are a major O-ring failure. Now the system failure has spread to Alt-A loans and prime ARMs.  Nobody wants to look up in the sky and admit that the shuttle is disintegrating. Well, perhaps if YOUR customers aren’t defaulting, then I guess there’s not a problem.

In the Challenger case, everyone followed proper institutional protocol and adhered to existing laws. Engineers like Roger Boisjoly work inside all our institutions. They are the loan processors, escrow closers, fellow mortgage retail salespeople, and others who know exactly what’s going on but believed they were powerless to make a difference, or chose not to make an anonymous complaint due to possible grave personal and/or professional consequences.

We’re going to have more state and federal laws before this entire mortgage industry crisis is behind us. The question then becomes, will those in the trenches stay silent again?

The Giant Pool of Money, by TAL and Chicago Public Radio

This NPR radio episode runs just under 54 minutes.  Click on the “download” button; it will take several minutes to download.   While you’re waiting, browse through some of our other articles on Ethics in Mortgage Lending! 

In order to better understand why we are currently facing massive mortgage loan defaults of epic proportions, this radio program takes us back in time and helps us understand how investors looking for high yields created a groundswell demand for risky mortgage loan products.

So are these investors to blame for the mortgage industry crisis? 

It’s safe to assume that no wholesale lending reps held guns to the heads of loan originators and demanded that the LOs originate pay option ARMs.

Perhaps it is a choice.  There is at least one bank that decided not to participate in subprime loans and now that bank is not seeing record default ratios on their residential loans, though their story has not yet been told in relation to commercial development loans and construction loans. 

Are Mortgage Loan Originators Professionals?

When I ask the question “Are loan originators professionals?” to a group of loan originator students in ethics classes, almost everyone says “yes.”  Anyone can do their job in a professional manner (adjective,) but not everyone is a Professional (noun.) Is your barista at Starbucks or the person who bags your groceries a professional? If you answer “yes,” what makes a barista different than a lawyer?  When we use the word Professional as a noun, there’s a classic definition that we refer to here:

A Professional:

  1. Has specialized knowledge in his or her field.  (Update: This body of knowledge is generally agreed-upon by those in the industry and is typically described within state and federal law.)  This person knows way more than the average random consumer about his or her area of expertise;
  2. Is required to complete a minimum amount of formal, academic education;
  3. Is tested for competency;
  4. Is licensed;
  5. Must maintain that license with mandatory continuing education;
  6. Subscribes to a mandatory code of ethics in an industry that is self-regulating. This is different from state or federal government regulatory oversight. The industry itself regulates ethical conduct over and above state and federal law;
  7. The self-regulating body enforces their code of ethics with sanctions for violations;
  8. Owes fiduciary duties to clients. This means the professional has the highest prescribed duty of loyalty to the client, to put the client’s interests above his or her own interests.

Here is how loan originators (LOs) measure up against the above list:

  1. LOs, there is a power imbalance between you and the consumer. You know way more about how the machine we call mortgage lending works than the average random consumer will ever know.
  2. In many states, including WA, no education is required to begin originating loans. (However, this may be changing at the federal level.)
  3. Testing LOs for competency finally began in 2007 for LOs in WA state
  4. Licensing of LOs is currently not required in all states and for originators employed by all types of lending institutions.
  5. Continuing education requirements are very low if they exist at all (WA state only requires LOs to take two classes per year.)
  6. There is no mandatory code of ethics for mortgage lenders. What codes exist at the national trade level, are voluntary and offer insufficient guidance.
  7. Currently there is no ethical oversight in mortgage lending by the industry. There may be individual company codes of ethics for employees. Were you asked to read and sign a company code of ethics before or during the hiring process?
  8. Fiduciary duties are now required for mortgage brokers and loan originators as of June 12, 2008.

One of the ways we can better understand the current crisis facing the mortgage industry is that loan officers, loan originators, mortgage planners, loan consultants, or whatever their job title, had absolutely no duty to put their client’s interests above their own. The relationship between a loan originator and the consumer was (and still is in many states) a retail relationship.  During the mortgage-lenders-gone-wild days, many consumers (based on countless interviews held by regulators, consumer advocacy groups and even the mainstream media) held a false belief that a loan originator is a “professional” and owes a duty to the consumer not to harm him or her.

Loan originators are classified as an “emerging profession.”  We are living through a historic, transformational phase. On the other side of the transformation, which could come sooner than some people think, I believe LOs, no matter where they work, will owe fiduciary duties to consumers, even with LOs who work at a bank.  If you look at the narrative history of any profession you would see, over time, a steady increase in the number of continuing education classes required, more mandatory pre-licensing education, an elevation of duties owed to clients, more expansive ethical codes, and tougher licensing exams.  Loan originators, no matter where they work, will eventually transform into professionals, though some will have to be dragged kicking and screaming.

Many brokers believe fiduciary duties means higher liability.  However, if done right, this may actually have the reverse effect by lowering the mortgage broker’s liability.

The Subprime Meltdown

When I entered the mortgage industry in 1985, Conventional loans were only for those who could put down 10%. Most folks opted for an FHA or VA loan. There was no risk-based pricing. Everyone received the same interest rate on their mortgage loan whether they had great credit or a few late payments. Homeowners with very poor credit, lack of job stability, zero cash reserves, and unverified source of funds to close, were not approved for a mortgage. It was a very big deal to decline a loan. As a mortgage loan underwriter, I was told our job was to make loans, not decline loans. We had to try our very best to help our company figure out a way to help the homebuyer. Declining a loan was serious. We had to state rational, good reasons why a homebuyer did not qualify. That all changed with the introduction of risk-based pricing into the mortgage lending market.

20% down
10% down
5% down use to be considered very risky.
3% down buyers were directed to FHA loans
0 down use to only be available to Veterans
Then came 0 down with seller-paid closing costs
Finally we had 0 down, seller-paid closing costs combined with a variety of exotic mortgage products that were previously only offered to the most credit worthy and financially savvy borowers.

Hard money lending was re-named subprime lending and moved into the mainstream as the mortgage brokerage industry grew to originate over 50% of all mortgage loans in the U.S. Subprime started out years ago with high interest rates along with a large downpayment. As Greenspan lowered interest rates, competition heated up and we saw a relax of credit standards in the same direction. This pushed a huge amount of homebuyers into the market, and infused the industry with a tremendous amount of job growth in the lending, banking, title, escrow, appraisal, and real estate agent arena. Corporations must earn a profit (within the bounds of the law) so corporations continued to push for profit growth.  It doesn’t matter which political party holds power: Democrats or Republicans. BOTH parties push homeownership onto the American public as the dream every person in America ought to be able to achieve. Downpayment assistance homeownership programs sprung up all over the country and on a side note, it’s interesting to see FHA blasting these programs as having high default rates; high enough to possibly bring down FHA. 

With little regulatory oversight in existence for mortgage brokers and consumer loan companies, (although they argue that they are HEAVILY regulated) the mortgage brokers, consumer loan companies, and the wholesale lenders had a field day with profits during the bubble run-up years of 2002 through 2006. All the real estate agents I talk to, and I meet thousands of real estate agents every year, with regards to predatory lending considered this a problem of the mortgage lending industry, acknowledging that there “could” be effects on the real estate market, but without actually feeling any of those effects it was always someone else’s problem. It has been pointed out that real estate agents also made lots of money with the relaxation of credit standards and the resulting housing boom.

Our state regulators DO have money set aside to go after the most egregious cases of predatory lending and mortgage fraud. However, government was never intended to police every single deal written by mortgage brokers and consumer finance companies. There is just not enough government re$ources available to do this, and there never will be. 

In March of 2007, I predicted that every one of us in the industry WILL feel the effects of the subprime meltdown. Now that the subprime defaults have spilled over into Alt-A, prime ARMs, and HELOCs, we have a major national financial crisis that has resulted in an official housing recession. A full blown economic recession is underway with the FDIC preparing for bank failures and the FBI shifting its focus toward mortgage fraud. The mortgage industry will continue to see defaults rise into 2009 as more pay-option ARMs reset.  Underwriting guidelines will continue to tighten until the loans we are originating today can be proven to have lower default rates than the current vintage of Residential Mortgage Backed Securities. 

Some mortgage lenders have seen an increase in loan applications from homeowners seeking to refinance into fixed rate mortgage loans, but not all of these borrowers qualify under today’s tightening underwriting guidelines.  Mortgage companies that blatantly ripped off consumers will not see repeat business. Those customers will go elsewhere, as they should. Mortgage brokers who have ONLY done subprime will find it challenging to become approved as an FHA lender as FHA has many rules to follow including the requirement for loan originators to be W-2 employees (many brokers pay their originators as contract workers.) Consumers are sick and tired of bait and switch advertising and hopefully won’t fall for it this time around. Those companies will go down, their loan originators finding jobs scarce since their only training has been hard-core, script-memorizing, pressure-laden sales tactics. They specifically chose to be in subprime for the money and only the money. Former mortgage lending workers are reporting that they’re having trouble finding jobs in other industries and are being blackballed by recruiters.  The recruiters say employers want all candidates screened out if they were previously in the mortgage industry. 

Treating home buyers (and refinancing homeowners) only as a tool to maximize profits is one business model that is no longer growing profits at previous rates. These companies are refi machines built on marginally to blatantly deceptive direct mail, email spam, deceptive radio ads, or by purchasing leads generated off of deceptive advertising and they exist in every market in the United States. This market is now seeing a decline in profitability and in a capitalist system, profit drives morality: what’s profitable is good, what’s not profitable is bad.

Brokers, lenders, and banks that have always operated their business with a foundation of treating consumers with respect will survive and thrive. By respect, that means declining some loans because sometimes this is the most respectful thing to do.

It is way past time for a mortgage market correction and I am hopeful that the current crisis of epic proportions will lead us to a better place in the mortgage lending industry.

We should expect to see at least four more federal laws directly targeting the mortgage lending industry, similar to the wave of consumer protection legislation that swept the U.S. in the 1970s.  There have now been many laws introduced, some have passed the house but not the senate, some have passed committees, and who knows if anything at all will happen during these last few months before and after the next presidential election.  Therefore we should also expect to see many, many states jump up to enact legislation aimed at the mortgage industry. 

Watch for underwriting guidelines to continue to tighten, back to what they were like in 1985. Watch for interest rates to up, up UP! Because banks have to try and offset their foreclosure losses by…what else? Making new loans.  The industry underpriced risk for subprime borrowers, offered loan products to borrowers who did not fully understand how the product worked, and rewarded loan originators for selling the most risky products to the most credit-unworthy borrowers.  Instead of blaming everyone but themselves, the industry would do better to look within, systemically, for the solution.