NORTH COUNTY - When mortgage brokers sign up borrowers, they have a big financial incentive to promote risky loans, according to a variety of industry experts.
Over the last three years, risky loans have fueled the rise in mortgage defaults, foreclosures and bank auctions of distressed properties throughout the state, a loan industry watchdog said last week.
California mortgage brokers, most of whom are licensed by the state Department of Real Estate, are legally obligated to act in the best interest of the borrower.
"However, there is no enforcement mechanism in place to ensure that they (do so)," said Paul Leonard, director for the California office of the Center for Responsible Lending. Leonard told a state banking commission earlier this year that mortgage brokers "have strong incentives to make abusive loans that harm consumers, and no one is stopping them."
A mortgage broker's incentive "is to close the loan while charging the highest combination of fees and mortgage interest rates the market will bear," a 2004 study prepared by Harvard University's Joint Center of Housing Studies concluded.
Some brokers acknowledge that a few of their colleagues have been lured by greed to steer customers to high-risk mortgages. But, in their defense, these brokers say only a small minority succumb to such temptations.
Brokers also say that many borrowers knew or should have known what they were signing and must also take responsibility.
The Center for Responsible Lending, based in North Carolina, is a research-and-policy organization that describes itself as nonprofit, nonpartisan and dedicated to protecting homeownership. It is funded by the Ford Foundation and the Rockefeller Foundation, among others.
Brokers can earn higher commissions - up to 3 percent instead of the typical 1 percent - by having customers buy loans with interest rates that are higher than market rates, with prepayment penalties charged if the loan is paid off before a certain date, and with little or no verification of the borrower's income, known as "stated income" loans. That's the difference between a $12,000 and a $4,000 commission on a $400,000 loan.
Leonard said he believes such practices are common, partially because there is no state law requiring the broker to disclose that the borrower is eligible for a lower rate.
Many loans offering the highest commissions have been subprime loans, higher interest rate loans that often are sold to those who have low credit ratings or present other risk factors, such as undocumented earnings. Mortgage industry experts say the majority of defaults in the last two years are tied to these loans.
A San Diego attorney specializing in representing borrowers who say they have been the victims of financial abuse by mortgage brokers said Friday that two years ago, he was getting one or two calls a month from people seeking his advice.
"Now, I get maybe three calls a day," said attorney John Cleary, with the San Diego-based law firm Solomon Ward. "There has been a massive increase in that kind of business."
In the first quarter of this year, more than 1,800 North County homeowners defaulted on their loans in the cities of Escondido, San Marcos, Vista, Oceanside, Carlsbad, Poway and Encinitas. That is, they failed to make payments on their loans. Countywide, the 6,310 foreclosure notices issued in the first quarter of this year represented a nearly 50 percent increase from the 4,541 notices in all of 2005, according to RealtyTrac, an Irvine-based company that disseminates foreclosure information.
The county's foreclosure rate in the first quarter of this year, 10 for every 10,000 households, matches the highest level recorded in 1997, at the end of last decade's extended recession, according to a report issued by the UCLA Anderson Forecast on Tuesday.
Outrageous commissions
John Yeager, a Valley Center mortgage broker with more than 20 years in the business, said last week that brokers who are looking out for their own pocketbooks instead of the borrowers' best interests make up a small segment of the industry, but acknowledged there are some "bad players."
"Certainly, there is no denying that you have some who are putting people into the wrong loan product, making outrageous commissions," Yeager said, adding that in early 2005, lenders got really aggressive in offering complex and costly loans.
"I think greed had a lot to do with it," said mortgage broker Ralph Ciarlanti, who owns Breeze Financial Group in Escondido. "It drove a lot of people in the business to steer people to these loans."
Ed Smith, a spokesman for California Association of Mortgage Brokers, also said he believes a small number of brokers are the ones steering people to loans with unnecessarily high interest rates.
Smith, a San Diego broker who serves as the organization's vice president of government affairs and industry relations, said last week that the lending industry is already correcting itself, with some companies going out of business and some of the riskier loan products disappearing from the marketplace.
Believing their loan broker has their best interests at heart, many consumers are not aware the person offering them a loan has no legal requirement to offer them the best deal, Leonard said.
"They assume the broker is working to get them the best possible loan, and that is (often) not the case, Leonard said.
Borrowers owe it to themselves to do their homework and get a second or third opinion before signing for a home loan, he said.
While loans in California are also sold by agents representing banks and other lending institutions, brokers have sold the vast majority of the so-called subprime loans.
"There is no question that brokers played a fundamental role in the significant problems that we have seen with foreclosures and bad loans," Leonard said in a recent phone interview from his Oakland office.
Subprime role
Leonard said that 13 percent of all outstanding mortgages today are subprime and 20 percent of all mortgages sold in the United States in 2006 were subprime. Sixty percent of all foreclosures in the U.S. in 2006 were subprime, he added.
Most subprime loans had adjustable interest rates. One of the most common is known as an "2-28 adjustable rate" mortgage.
The borrower pays a "teaser," or low introductory interest rate for two years. Then, the teaser interest rate is adjusted to a significantly higher figure. Leonard said that in the current market, the typical interest rate for the first two years for this type of loan is 7 percent or 8 percent. Then, the number increases to 11 percent or more and is adjusted up or down with rates of inflation every six months for the next 28 years, he said.
Leonard, appearing in January before the state Senate Banking Committee, cited this example: A borrower with a 2-28 adjustable-rate mortgage of $300,000, with an initial teaser rate of 6.85 percent, would pay $1,966 a month. But when the two-year period ends, and the interest rate increases to 11.5 percent, the monthly payment would climb by $600 to $2,574 a month and increase again six months later to $2,921.
In testimony before the committee in March, Leonard recommended that the state require brokers and lenders ensure that borrowers can afford to make home payments after the initial, low teaser rate ends.
Mortgage broker Ciarlanti said that borrowers' lack of knowledge about complex loan products can contribute to their becoming victims.
"It made for easy prey," he said.
Who's selling loans?
In California, those selling mortgages fall into three categories: mortgage brokers, employees working for banks and credit unions, and employees of companies specializing in mortgage loans.
Most mortgage brokers are licensed real estate agents or real estate brokers who work under the auspices of the state Department of Real Estate. Real estate brokers must complete eight college-level courses, two of which focus on mortgages, and pass a test to get their license, a spokesman for the department said Monday.
By and large, the department's oversight of loan transactions is complaint-driven and not a systematic investigation of agents' transactions, spokesman Tom Pool said, adding that the department is keeping up with the complaints it does receive. He said, however, that the state Legislature is examining possible changes to investigative standards, changes that could come in the coming months.
"We have pounded on our brokers over the years to remind them of their fiduciary responsibility to the borrower," Pool said. "If it's our licensees, we ought to take a look at them."
Pool said that brokers are required by law to reveal to the borrower all of their earnings on the loan transaction.
He encouraged those who believe they have been victims of unethical behavior by mortgage brokers to contact the Department of Real Estate at http://search.dre.ca.gov/integrationaspcode/.
"If you feel like you were mistreated, file a complaint," Pool said.
During the 2005-06 fiscal year, the agency's 69 investigators and 31 auditors conducted 252 audits of the state's 20,000 or so real estate brokers who also do mortgages, Pool said.
Smith, of the state brokers association, said that more regulations are not the answer to problems in the mortgage industry. There are already plenty of laws, he said.
"We are strongly advocating for enforcement of laws that are already on the books," Smith said.
- Contact staff writer William Finn Bennett at (760) 740-5426 or wbennett@nctimes.com.
