The majority of borrowers probably don’t understand the difference between mortgage lenders and mortgage brokers, especially in the practical sense. A google search for the term “mortgage broker” yields mostly stories related to scams and fraud. While this is helpful in one sense – by making potential borrowers aware of the potential for unscrupulous behavior – it does little to clarify what exactly mortgage brokers do.

In a nutshell, mortgage lenders originate (and often underwrite) mortgages directly, while mortgage brokers work as intermediaries, connecting mortgage lenders with borrowers. If that’s the case, those of you unfamiliar with this dilemma are probably scratching your head and asking yourselves, “Who would be dumb enough to voluntarily pay for the services of a middleman, when he could go just go directly to the source?” According to the most recent data, the answer is two-thirds of all borrowers.

In fact, the system is not as straightforward as you would think. In fact, most lenders operate on two levels: retail and wholesale, with corresponding prices and rates. An individual borrower, such as yourself, would be offered retail pricing, while a mortgage broker would be offered wholesale pricing. For their part, mortgage brokers naturally exact a healthy commission, which would more than eliminate the savings from buying wholesale, all else being equal.

Of course, using brokers offers certain key advantages. While lenders, especially regional or community-based lenders, only offer a handful of different mortgage products, a mortgage broker should have access to the complete spectrum. Of course, a resourceful borrower could certainly search out a lender that offers the type of mortgage that he is looking for, but this naturally assumes that he already knows what kind of mortgage he wants. In fact, most borrowers wait to make such a decision until further along the process. In addition, it could involve significant legwork to find a lender that has what you’re looking for, and is competitive in pricing.

Another advantage of working with a broker is that they can potentially save you time and energy, by helping with paperwork, gathering documents, and generally facilitating the process. A good broker should protect you from lender “abuse,” by negotiating down/away any junk fees. Borrowers with special circumstances (i.e. can’t document their income, need to close immediately) would also do well to consider engaging a broker, as certain lenders might not be amenable.

Before you accuse me of being a shill for the mortgage broker industry, let me also point out the disadvantages. The main disadvantage is price. While it’s impossible to say definitively that brokers are more expensive than lenders, common sense suggests that all else being equal, they are. Brokers that are most competitive on pricing tend to be smaller (less overhead), which could be considered a disadvantage, since it doesn’t offer the same sense of security that bigger firms tend to project.

For those caught in the middle, there is another option that represents a sort of compromise. It involves finding a broker that is willing to act as your agent, rather than as an independent contractor. The difference is largely semantic, but if negotiated properly, it could result in significant savings. Whereas most brokers earn money from charging a spread on the wholesale rate they receive from the lender, a borrower’s agent will work for a fixed commission, such that you will pay the actual wholesale rate. Sounds like the best of both worlds!

Two of last weeks’ posts were entitled “Distressed Housing Attracts Speculators” and “How to Spot Mortgage Fraud.” While seemingly unrelated, these topics actually speak to two trends that are closely intertwined. The first trend is that the housing bust is increasingly starting to resemble the housing boom, from the standpoint of businesses that market themselves to homeowners. The second trend is a rise in mortgage fraud, again practiced primarily by mortgage service providers.

Essentially, many such companies have retooled (or closed and then re-opened under new names) and our now offering new services under the same pretenses. Specifically, many former subprime lenders are now in the business of modifying loans. This is especially repugnant considering that it’s partially because of these subprime lenders that unaffordable loans were issued in the first place, and now require modification if foreclosure is to be avoided.

A new investigative report by the New York Times (A must-read!) details exactly how one such company operated. “For fees reaching $3,495, with most of the money collected upfront, they promised to negotiate with lenders to lower payments on the now-delinquent mortgages they and their counterparts had sprinkled liberally across Southern California.” Backed by misleading national advertising campaign, the company was quickly flooded with calls by people desperate to avoid foreclosure.

Sales people quoted exaggerated success rates and in some cases encouraged borrowers to take money that would otherwise be used for mortgage payments and instead advance it to the loan modification company. According to one agent, “They basically told us, ‘Do whatever you need to do,’ ” he said. “ ‘It’s a sales floor. You’re here to sell.’ People would quote success rates and just pull them out of thin air. People would say 60 percent, 80 percent, 90 percent. To the average Joe in Kansas, that sounded great. But the reality is that 50 percent were immediately declined by the lender.” Customers were further sold on the pretense that their loan modification would be vetted and submitted by a licensed attorney, which was little more than a deliberate falsehood.

The company, FedMod, now faces a lawsuit by the Fair Trade Commission, which has also brought legal action against several similar companies. Still, given that thousands of people made payments to FedMod in good faith and now face foreclosure, it’s hard to argue that justice is being served. In the end, the most important lesson to take away from this debacle is never make an upfront payment for a loan modification. Never, ever, under any circumstances. Even if you are guaranteed a 100% success rat and that a licensed attorney will review your application. Never.

In fact, you can theoretically achieve a loan modification free or charge- either by speaking directly to your lender or with the help of an organization that is not-for-profit and/or government-approved. If you still feel compelled to enlist the services of a for-profit entity, at the very least you should hold off remitting payment until after your loan has been modified.

One would have assumed that the housing bust and subsequent decline in mortgage lending would have been accompanies by a commensurate decline in fraud. Unfortunately, this isn’t the case, as scammers have simply devised new schemes to take advantage of desperate homeowners. Mortage-related “suspicious-activity reports referred to law enforcement increased 36 percent to 63,713 during fiscal 2008 from 46,717 the previous year. While the total dollar loss attributed to mortgage fraud is unknown, financial institutions reported losses of at least $1.4 billion, an increase of 83.4 percent from 2007.”

Perhaps some solace can be found in the notion that this time around, everyone is equally vulnerable: “The spike in fraud is likely due to the pressure put on lenders, brokers and homebuilders hurting for business in an ailing market, and on homeowners who are trying to sell properties that have collapsed in price. Fraudsters are using old mortgage standbys like fake short sales and foreclosure rescues but are also popularizing new schemes like reverse mortgage fraud, credit enhancements and loan modifications.”

Some of the specific foreclosure/loan modification scams to be on the lookout for include “phantom help,” lease buy-back, and the always popular equity stripping. Phantom help refers to a “type of foreclosure rescue scam in which a fraudster collects an upfront fee from homeowners trying to save their homes from foreclosure — and then disappears.”  Lease buy-backs typically involve equity stripping, in which victims are convinced by 11th hour “rescue” firms to sign over the deeds to their respective homes. The  homes are then leased back to them with unfavorable terms, such that when the inevitable foreclosure takes place, the borrowers find themselves with little equity left in their homes. Reverse Mortgage scams, meanwhile, don’t usually take the form of outright scams. Rather, “victims” are typically charged exorbitant fees and/or cajoled into buying annuity products in conjunction with reverse mortgages.

Disturbingly, scams are being increasingly complex, and hence, more difficult to discern. For example, I read about one recently indicted company that “would seek out homeowners in trouble with their mortgages, often by finding owners who had missed mortgage payments, and offer to take their homes off their hands. If the owners agreed, the defendants would recruit buyers with good credit histories who would apply for mortgages to buy the properties…Simultaneously, the defendants would use falsified documents to inflate the home’s value, to get the largest mortgage possible. Finally, at the closings the sellers’ lawyers…would essentially pocket the checks from the lenders. He said that the buyers, who were promised they could get out of the deal at some point, were stuck with mortgages they could not afford.” How’s that for a scam!

According to one source, the best way to prevent such scams is to “Be skeptical of people who make unsolicited contact,” especially if they make offers that sound too good to be true. Always ask for references and check credentials whenever possible. To be fair, I would be remiss if I didn’t point out that not all Lease buy-backs and reverse mortgages are scams. If sold genuinely, with full disclosure, it’s still possible for everyone to come out ahead under such arrangements. Ultimately, the best way to protect yourself by asking lots of questions and double checking everything.

The housing crisis has officially turned into a full-blow foreclosure crisis: “About 12.07 percent of mortgage loans were delinquent or in the foreclosure process during the quarter…That is the highest level ever recorded by the survey, which has been conducted since 1972.” According to experts, the foreclosure crisis has now entered a new phase. Initially, it was mainly speculators and those with adjustable-rate mortgages that experienced mortgage difficulties. The latest wave, in contrast, is affecting those with conventional mortgages.

Not only that, but the focus is shifting away from subprime borrowers; “Of the loans in foreclosure during the first quarter, 49.8 percent were prime loans and 43.2 percent were subprime.” In other words, while the first two waves of foreclosure were triggered by falling prices and rising interest rates, the most recent wave has been driven by the economic recession. Skyrocketing unemployment – which touched 9.4% last week – and faltering incomes are causing the most credit-worthy borrowers to fall behind on their payments, even to the point of default.

What then is the status of President Obama’s loan modification initiative? Less than two weeks after the Mortgage Calculator reported on the success of the program, it already appears that this praise was overblown. “Three months after the program was announced, a Treasury spokeswoman, Jenni Engebretsen, estimated the number of loans that have been modified at “more than 10,000 but fewer than 55,000.”

Worst of all, the loan modification program has been beset by scams and controversy. “The New York attorney general, Andrew M. Cuomo, plans to sue a loan modification company and has subpoenaed information from 14 similar companies as part of a nationwide investigation,” and called the entire industry a “scam.” Apparently, homebuyers don’t realize that the loan modification program is designed to be free of charge, made possible by $75 Billion in federal subsidies made available to participating banks which will be passed on to qualifying homeowners. Those that don’t qualify for the federal program are still advised to read the fine print in their mortgages, some of which contain gratis loan modification provisions.

This hasn’t stopped “predatory” lenders from charging up to $5,000 for loan modification, much of it in the form of upfront costs. Some of the most unscrupulous have taken to soliciting unsuspecting victims to purchase a mortgage audit, ostensibly to review their rights as homeowners. The problem is that this is a legal issue and hence the province of lawyers, not untrained telemarketers with little more than a generic computer program.

According to the government “Making Home Affordable” website (which I strongly encourage you to consult, as qualifying homebuyers could see their monthly payments fall by half), “There is never a fee to get assistance or  information about Making Home Affordable from your lender or a HUD-approved housing counselor. Beware of any person or organization that asks you to pay a fee in exchange for housing counseling services or modification of a delinquent loan. Do not pay – walk away!” There you have it- straight from the horse’s mouth…

Consider this post a continuation of yesterday’s post, both of which aim to educate you on your rights as a (potential) mortgage borrower. Much like you are entitled not to be discriminated against, you are also entitled to honesty. Towards this end, the Federal Reserve Bank recently revised the Truth in Lending Act in the form of the Mortgage Disclosure Improvement Act.

Under this rule, “creditors must give so-called ‘early disclosures,’ or good faith estimates of mortgage loan costs, within three business days of receiving an application and before collecting any fees from a consumer in accordance with the Truth in Lending Act (TLA)…The final rules also require creditors to wait seven business days after they provide early disclosure before closing the loan and to provide new disclosures with a revised annual percentage rate (APR) — and wait an additional three days before closing — if any change occurs that makes the original APR inaccurate.”

Formally taking effect on July 30, 2009, the rule takes power away from banks and mortgage brokers and returns it to mortgage borrowers, by making the mortgage process more timely and straightforward. Consumers are now legally entitled to good faith estimates within mere days of filing a mortgage application. This is a reasonable requirement, since mortgage applications are inherently time-consuming, and can damage one’s credit score when a credit report is pulled.

When applying for a mortgage, it is recommended that you seek estimates from at least three potential brokers/banks, even if such banks discourage you from doing so. Under the amended rule, you will now be able to review/compare the resulting estimates almost immediately, in order to make an informed decision about which mortgage is most competitive.

Furthermore, mortgage providers will be barred (via a 1-week moratorium) from trying to pressure you into closing right away. During this period, it goes without saying that you should review the terms/costs of each mortgage very carefully. Before agreeing, make absolutely sure that there are no junk fees and questionable terms; signing your name will essentially commit you to the loan, regardless of whether the mortgage is actually fair. In other words, this rule change won’t protect you from exorbitant fees if properly disclosed and consented to. Pay special attention to ‘processing’ and ‘administrative’ and ‘transfer’ fees, which are almost always bogus.

Bank of America is among the banks taking the lead in implementing the Fed’s new disclosure requirements. Its website includes a home loan guide, and its new disclosure forms aim to explain mortgage terms in plain English, minus the legal jargon and fine print. Fees and costs should be broken down explicitly, along with broker commissions.

Meanwhile, “If the borrower has applied for an adjustable rate mortgage — where the rate varies, typically after a set period of five or seven years — the summary discloses the maximum possible monthly payment.” Personally, this strikes me as very reasonable, considering that the subprime crisis was at least partially caused by overly optimistic assumptions about adjustable rate mortgages. Specifically, holders of such mortgages assumed (and/or were misled into believing) that interest rates (and hence their monthly payments) wouldn’t rise much from the initial low base. When rates rose, naturally, many such borrowers were caught off guard.

It’s impossible to predict the extent to which other banks will follow the lead of BofA. Given the extensive fallout from the real estate crisis (now measured in Trillions of Dollars), however, it is probably now in the interest of banks, themselves, to make sure that consumers understand the terms of their mortgages. While banks are no doubt profit-maximizing, it is still in their best interest to avoid foreclosures by making sure that borrowers can ultimately repay their loans.

?It should come as no surprise to the cynics out there that the rise in loan modification services has been plagued by scams and fraud. After all, there will always be “opportunists,” even those willing to take advantage of desperate homeowners on the brink of foreclosure.

Hope Now has become a popular target, since its position in this “industry” is one of such high profile. In its own words, “HOPE NOW is an alliance between HUD approved counseling agents, mortgage companies, investors and other mortgage market participants that provides free foreclosure prevention assistance.”

As part of a recently discovered scam, “Hope Now and…New Hope Modifications of Bellmawr, scammed consumers who believed the businesses were affiliated with HOPE NOW Alliance,” and “encouraged vulnerable homeowners to stop making mortgage payments so it could funnel the money into its coffers.”

Such fraudulent companies are able to traffic on the reputation of the “real” Hope Now, which is known for the speed and efficiency with which it can help homeowners delay or forestall foreclosure. “These firms often collect their fees up front, without ever contacting a mortgage servicer on the borrower’s behalf. Furthermore, they are not affiliated with any local, HUD-certified counseling organization.”

While it’s unfair to blame the government directly for mortgage fraud, it certainly deserves some responsibility. A laissez-faire approach to regulation has created a hotbed for con artists. For example, “A Miami Herald investigation last year…showed 10,000 people with criminal histories — including bank robbers and racketeers — had been allowed to sell mortgages in Florida since 2000,” and stole at least $100 million collectively from naive borrowers.

Shamed from inadequate regulation during the height of the housing boom, authorities are now determined to get the upper hand. The US Senate, for example, has already allocated an additional $500 million in funding for enhanced supervision and enforcement. Also, “the FBI has increased the number of agents who investigate mortgage fraud from 120 in 2007 to more than 250 today.” In Florida, where regulation was especially lax, “A special state fund will be created to pay victims if they successfully sue their mortgage broker but can’t collect because the broker becomes insolvent.”

So what can you do to avoid becoming such a victim? First and foremost, don’t hand over money until you are reasonably certain that the company you are working with is both qualified/legitimate, and not until the papers are signed and you have been approved for a loan modification. Any company that promises an unqualified loan modification is either lying or misleading, since every lender has standards/requirements that must first be met.

It usually just comes down to common sense. Do your homework before selecting a broker. One mortgage relief organization advises borrowers against paying a large amount of money upfront, signing over title, and/or putting money in an escrow account, under any circumstances. In the end, if it seems too good to be true, it probably is.

This WSJ article highlights how lenders shoped their loan portfolios to a wide array of rating firms like Standard & Poor’s and Moody’s, looking for the best rating, and taking their business elsewhere if the ratings were not as high as they would have liked:

When Wall Street first began securitizing subprime loans, rating firms leaned heavily on lenders and underwriters themselves for historical data about how such loans perform. The underwriters, in turn, assiduously tailored securities to meet the concerns of the ratings agencies, say people familiar with the process. Underwriters, these people say, would sometimes take their business to another rating company if they couldn’t get the rating they needed.

“It was always about shopping around” for higher ratings, says Mark Adelson, a former Moody’s managing director, although he says Wall Street and mortgage firms called the process by other names, like “best execution” or “maximizing value.”

Every rating system gets worked, from the lanuage used to classify investments (junk vs subprime) to how investments are mixed and rated. The problem with this sort of cozy relationship is that end investors typically remain ignorant to the process until it stops working. And then nobody could have seen it coming, but once the rating firms give a bit here or there the relationship heads down a long slippery slope that virtually guarantees it will fail. Even Alen Greenspan endorsed subprime loans, but now Angelo R. Mozilo, the CEO of Countrywide, said home prices were falling “almost like never before, with the exception of the Great Depression.”

The NYT recently ran an article about how confusing the mortgage market is, discussing how adjustable rate mortgages are quickly sold to consumers under false pretense, then resold to other investment firms who are not held liable for fraud in the initial loan deal.

Even if circumstances suggest fraud when a loan was made, lawyers say, the various parties protect each other by refusing to produce documents.

Compounding the problem is a law stating that when a loan is passed to another party, that entity cannot be held liable for problems.

Even if the mortgage brokers outright lied to sell it, the consumer is stuck footing the bill until their house is foreclosed upon.

A borrower in good standing since 1998, she said a local broker persuaded her to combine her debts in a fixed-rate loan of $65,000 in 2003.

But at the closing, she was presented with an adjustable-rate mortgage from the Argent Mortgage Company, carrying a low teaser rate for two years. When she objected, the broker assured her that rates would fall and she could get a better fixed-rate loan later. She said she believed him.

The bait and switch pricing fraud may not be a few isolated incidents. In some cases, deceptive pricing may actually be a market standard. Last year the Pittsburgh Post Gazette published an article highlighting that Bankrate advertisers may offer one price on the Bankrate site, then charged another when consumers clicked through to the end merchant site.

If a consumer gets scammed it is their fault and they are stuck paying it. There is virtually no protection against mortgage fraud, especially for poor citizens who do not have enough capital to sue and reshape broken laws. Pretty sick, especially considering that the 2005 consumer bankruptcy bill was drafted by MBNA.