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Money Talks

By Dr. Gregg Dimkoff
Professor, Grand Valley State University
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The flood of bad mortgage loans made to people who had no chance of making payments even in a strong economy was one of the most important contributors to the economy’s nosedive in 2008. Some lenders made loans without checking borrowers’ incomes, and without inspecting the properties. Many banks were coerced into making questionable loans by the Community Reinvestment Act. The result? Banks, borrowers and the U.S. economy paid a steep price for their mistakes.

However, this is old news. A good question today is whether borrowers and lenders have learned anything about such foolish behavior. Some have, but lenders and taxpayers continue to be defrauded, even here in West Michigan. I had the privilege of talking with a mortgage underwriter who explained how unqualified borrowers continue to be “qualified” by using any number of loopholes and tricks.

Loan originators and processors begin the mortgage approval process by collecting financial information from clients wishing to borrow money. The information is then submitted to underwriters. Underwriters approve or reject each mortgage application based on their analysis of the information. If the application is approved, the loan is sold in the secondary market, that is, sold to Fannie Mae or Freddie Mac, putting taxpayers on the hook if borrowers default.

If no one is looking — and that’s often the case — both loan originators and underwriters can just about get away with murder. For example, loan applicants who have insufficient income to qualify for mortgages can be coached to submit doctored federal income tax returns showing higher income levels. One of the easiest ways applicants doctor their returns is by “remembering” income they forgot to report to the IRS the two previous tax years. After a little doctoring, like magic, the higher reported income qualifies the applicant for the mortgage, but an updated tax form is not submitted to the IRS.

Unscrupulous originators and dishonest applicants often misrepresent or omit information on mortgage applications. Here’s an example. A loan originator submitted an application stating the applicant was unmarried and didn’t have a mortgage. The mortgage underwriter crosschecked that information by requesting a tax transcript from the federal government. It showed the client was married, lived with his wife in a house located less than five miles away from the house to be purchased, and had a mortgage on the marital house. In this situation, the borrower had a harder time qualifying for another mortgage because he had to meet the requirements for both his existing mortgage and the new one. Further, when someone tries to purchase a house located only five miles from the current residence, it is considered to be a rental property, not a primary residence. That’s important to both the originator and underwriter because the mortgage rate and fees change substantially. In this case, the underwriter caught the attempted fraud, but only because he was doing a thorough job. In other cases, these dirty tricks aren’t noticed, or even worse, the underwriter doesn’t care as long as he gets his commission and the application is placed with a naïve lender.

Here’s more proof the problems in real estate finance haven’t changed enough.

An underwriter received a loan application. The primary wage earner worked in an internship that was to last for only another two years according to a letter supplied by the applicant’s employer. To receive a FHA mortgage, there must be a reasonable belief income will continue for at least three years. Since this income was going to end in two years, and there was no guarantee the intern would be able to find a future job, the application was declined. The broker complained, and all of the sudden, the employer’s letter disappeared from the applicant’s file. All other evidence referring to the internship was destroyed. Instead, the applicant’s current paystubs were used as proof of income. Voila, the loan was approved and then sold in the secondary market.

The owner of the mortgage company makes money only when its mortgage files are approved and sold. If files are submitted and then declined, the owner still has to pay the staff. So what happens when the market is busy and the owner cannot find more qualified underwriters? The owner can hire someone with a Direct Endorsement qualification. The DE person reviews and certifies that mortgage documents are in compliance with the requirements of the Federal Housing Administration’s mortgage insurance program. Yet, many loans aren’t evaluated by a DE underwriter. Instead, they are submitted with the DE’s qualification number appearing on the documents, implying the file has passed muster. The secondary market then purchases the mortgage, not knowing there had been insufficient underwriting.

Turning a blind eye to this type of fraud rewards applicants, originators, processors and underwriters. Because of the conflict of interest, they all get more money than otherwise by being blind or abetting the fraud. Unfortunately, because fewer people are buying houses, originators, processors and underwriters aren’t making the money they used to. That sets up an inducement to push through questionable, if not outright unqualified loans, and it’s happening right here in West Michigan. One has to wonder if much has changed since the real estate market collapsed.

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