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Mortgage Profits: How Brokers are Reversing the Subprime Damage

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By Desiree French

RISMEDIA, June 28, 2007–Turmoil in the subprime mortgage market, what some call a correction or natural adjustment, has cast an air of caution over the lending industry. Gone are the go-go days of excessively layering risks, a practice that has contributed to recent spikes in defaults and foreclosures. Today, tighter credit standards are increasingly becoming the norm at a time when falling home prices, a glut of properties, and higher mortgage interest rates have already combined to dampen home sales. The confluence points to a dip in the revenue streams of mortgage lenders, including realty affiliates.

“Overall loan production is going to be way down this year. How much it will be down depends on what market segment a company was in,” says Thomas Lawler, a housing economist in Vienna, Virginia. “Any institution that doesn’t have state-of-the-art procedures and that doesn’t dot the i’s and cross the t’s, is going to have real problems. The industry went wild for a couple of years, but the old way of underwriting mortgages now makes more sense.

The Subprime Scandal

Subprime mortgages, offered to home buyers and homeowners with spotty credit who, for whatever reasons, can’t qualify under a securitized conforming product, carry higher interest rates and are basically short-term, high-risk loans. With home prices stabilizing and interest rates slightly higher, many of these loans, mainly the 2/28 adjustable rate mortgage, or ARM, the major subprime product, are hitting their adjustment period. Hence, the spike in delinquencies as mortgage interest rates climb.

But this latest debacle hasn’t just hit the subprime market. Lumped into the chaotic mix are some other nontraditional products such as Alt-A loans, where less documentation is required to qualify than with a conforming loan, option ARMs, which give borrowers the option to pay less than the monthly interest owed (resulting in negative amortization), no-money-down loans, and interest-only loan offerings, a favorite of speculative investors. There has been a tightening in underwriting standards across the board within many of these market segments.

How is all of this affecting the mortgage operations within real estate firms?

Gerry Griesser, principal at Prudential Fox & Roach and president of The Trident Group, the affiliated business of Prudential Fox & Roach in Pennsylvania, says the problems will impact profitability, although he cannot say by how much. The company is currently analyzing different loan alternatives that can help to fill the void caused by the correction in the subprime and Alt-A mortgage market.

Meanwhile, major underwriting changes have primarily affected the company’s alternative financing products. No substantial changes, however, have been made in the subprime arena, where plenty of time was spent early on carefully verifying those loan products, which account for a small percentage of the company’s business.

“The nontraditional group of loans have tightened up, which means that people in the past who used them won’t necessary be able to use them today under the old criteria,” Griesser concedes. “Some of the products that were used heavily by investors will be unavailable in the future.”

?Last year, the company closed about $300 million in subprime, Alt-A, and second mortgage loans out of a total of roughly $1.9 billion in settled loans.

Alternatives for Profitability

Long & Foster Companies expects to lose between 3-5% of its total production at Prosperity Mortgage, which has less than 10% of its business in the subprime market. To weather the storm, much like other lenders, it will look for products to replace existing offerings. One area of heightened interest: FHA-insured loans.

Many lenders are now turning to these loans that, ironically, they walked away from three or four years ago as growth in the subprime and Alt-A markets took off. With the subprime arena contracting, however, more companies are moving back to FHA. The National Association of Realtors supports legislation that will allow the Federal Housing Administration to better reflect consumer needs and demands. “A reformed FHA,” it contends, “would be perfectly positioned to offer borrowers a safer mortgage alternative.”

At Prosperity Mortgage, FHA loans have doubled from a year ago, climbing from roughly 4.5% to 10% year-to-date. That trend is expected to continue. Meanwhile, in areas where the company has had a high percentage of business in the subprime sector, it has taken a variety of steps to reach out to the real estate community to ensure awareness of the changes and alternatives that exist.

“I believe when you’re an affiliated business of a real estate company, you have to live to a higher standard,” explains Dave Stevens, president of Affiliated Business at Long & Foster Companies. “We can’t afford to make any mistakes because we service our real estate offices and our agents. If we make a mistake, we have no where to go.”

Maintaining Standards

James Dinkel, board chairman of the Strategic Alliance of Mortgage Subsidiaries (SAMS), the business cooperative made up of 10 mortgage lenders affiliated with independent real estate companies, says the subprime predicament has not affected the group’s members to any great extent.

“We approach subprime lending much differently from what’s been happening in a lot of areas across the country. Because our independent members are owned by the real estate companies, those companies have direct affiliation and direct control over that market. As a group, we all pretty well agreed that some of the opportunities out there in subprime are not good for consumers. So we never jumped into it heavily, nor was it a focus of our business. Individually, we focused primarily on the best products for the consumer and have stuck with traditionally fixed-rate, conforming types of products. And, for the most part, most of the realtor affiliated businesses have not retained their subprime business. It’s all sold off.”

Dinkel, who heads FM Lending Services in Raleigh-Durham, adds that his company didn’t offer all the mortgage products that were available in the market because it just didn’t make sense. Option ARMS, for example, just are not good for the consumer because of negative amortization. I don’t think there’s any question that everybody who has experience in this business should have seen this trouble coming. You can’t continue to lower the lending standards simply because property values are going up. Sooner or later that bubble is going to burst,” and it has.

FM Lending offers interest-only loans, but not for speculative investing and only to consumers with good credit, a good job history, and assets. Loans that would fall into the subprime category account for no more than 5% of the company?s total loan portfolio. Says Dinkel: “We do two things differently in the subprime business that has probably minimized their overall impact on our operations. One, our loan officers have a disincentive, commission wise, to do subprime loans, which means they will make every effort to do a conforming loan before they do a subprime loan. Secondly, when done, these loans are handled by a separate department within the company. We don’t allow pricing margins for borrowers that are higher than the standard margins for our business.”

Like Stevens, Dinkel thinks realty affiliates are in a different league when it comes to interacting with consumers, even protecting them. An advantage to being associated with a real estate company, he says, “is that we have to protect the name and its reputation, as well as the buyers. You don’t look at a mortgage transaction as being independent. It’s part of a bigger piece because you also have the real estate transaction and, of course, from our standpoint, we need to protect the buyer during the entire transaction.”

Not the End of Subprime, But a Trend Toward Quality

Despite the alarming stories about the subprime mortgage market “fueled primarily by major troubles at New Century, Ameriquest and Harbourton” this is not the end of the subprime market, just more of a flight to quality. Yet, Lawler predicts the subprime market, which accounted for more than half of all loans that entered foreclosure last year, could drop by 25-40% this year. Housing experts predict tighter underwriting guidelines could also result in 100,000 to 250,000 fewer home sales.

“There will be a way that everybody can get through this,” reasons Griesser. “It’s gone way too far one way, and now it’s swinging back the other way. Somewhere in the not to distant future, they’ll be some alternative product. It’s the way the world works.”

What Lenders, Brokers and Consumers Can Do

Mortgage executives at realty affiliates offer the following advice in light of the latest flap surrounding subprime loans and other risky mortgage products:

- First and foremost, owner/brokers should be involved in their mortgage companies; if engaged in a joint venture, they should sit down with the venture partner and discuss the lending model being used.
- Lenders should educate agents in their realty firms about the consequences of putting people in homes they really cannot afford; now is a good time to also talk about mortgage insurance as an option.
- Consumers should be made fully aware of what they’re doing. If customers have no doc loans, they should be given separate disclosure statements that identify the loans and reveal that a lower mortgage interest rate loan could be obtained if more documentation is provided.
- Agents and lenders should talk to customers about getting qualified under the new standards and also discuss the pitfalls of subprime loans.
- Agents and lenders can also talk to customers about why they need to either improve their credit before trying to get a home loan or wait six months to build up enough money for an appropriate down payment.

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