Some mortgage companies and loan officers, gambling on changes in interest rates that borrowers think are locked in, intentionally foul up loan applications when their gambles go awry-causing consumers to lose their loans, their agreed-upon rates, or both.
The practice of delaying a loan in order to renege on a commitment is called ”rate-busting,” and it surfaces when rates change direction. With mortgage-refinancing activity on the upswing again because of the dip in interest rates-now averaging under 8 percent for the first time in nearly two decades-the potential for abuse is increasing.
People in the lending industry say rate speculation is rife. It is not illegal in itself, and it enables speculators to rake in big profits on loans when they guess right on the direction rates are going.
When they guess wrong, however, they may stiff their clients by telling them something is ”wrong” with the loan application, and the promised loan rate can`t be delivered. Otherwise, the gambling loan officers would have to pay-out of their own pockets-to honor a customer`s agreed-upon rate.
”The loan is intentionally delayed and . . . (customers) are told, `Your lock is blown and you have to take a different rate,` ” said a loan officer for a Chicago-area mortgage broker who has written a book on mortgage lending. ”Few loan officers will pay out of pocket to close a loan.”
Patricia Cunningham, consumer affairs director for the Illinois Office of Savings and Residential Finance, which licenses mortgage bankers and brokers, acknowledged that delays resulting in expiration of the lock-in period often can be due to speculation, and it is something her office watches for.
”If rates go up,” she said, ”I expect a surge in complaints.”
Although there is nothing illegal about a lender gambling on interest rate movements, and versions of the practice are widespread even among reputable lenders, it can be extremely risky if carried too far.
And intentionally wrecking loan applications to avoid honoring commitments is a violation of state regulations that say a lender must make a good-faith effort to process mortgage applications in a timely fashion.
A speculator profits if interest rates fall during the period-usually 45 or 60 days-between the ostensible ”lock-in” and the actual closing of a loan. A loss comes if rates rise in the period.
Profiting by a movement in interest rates after a loan has been supposedly locked in is called getting ”excess” or ”overage.” According to a Chicago-area loan officer, who wished to remain anonymous for fear of job loss, getting the highest possible ”excess” on a loan is known as a ”grand slam.”
”You, as the consumer, need to realize that the friendly, concerned loan officer that you are dealing with is probably trying to get as much excess on your file as possible,” the officer wrote in a book, ”What You Always Wanted to Know About Mortgages But Didn`t Know Who to Ask,” which was written under the name L.C. Clements.
After rates went up in January, following last winter`s dramatic dip, a surge of rate-busting in Clements` office aroused a storm of anger.
Clements estimated 30 to 40 percent of the loans processed by the office at the time were delayed, intentionally or unintentionally.
Moreover, it does not make for happy customers. ”A common everyday nice person is turned into a raving maniac because of greed and stupidity on the part of loan officers,” said Clements.
”Back in January we had a guy threaten to bomb the office. That`s a desperate, upset person.”
Other lending industry sources were willing to talk about rate-busting abuses, but many also declined to be identified.
”When interest rates go up, many lenders find any way possible to reject a loan,” said a high-ranking executive for a large Chicago bank. He said if he gave his name he would be ostracized by fellow mortgage bankers.
Another loan officer for a large banking chain, who also requested anonymity, said lenders caught when rates go up ”have to do something about it. They screw around with the pile, ask for all kinds of loan documents. They don`t want the deal to go through.”
David Robbin, president of Kahn Realty and former head of the North Shore Board of Realtors, said he knows of the practice and tries to avoid dealing with lenders who engage in it.
”I knew back in the 1980s some big mortgage companies would take a position, and if rates went the wrong way they wouldn`t fund loans, and their comment was, `Sue me,` ” he said.
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”That`s why we spend time evaluating people who lend money to our buyers.”
Bruce Abrams, president of LR Realty, a North Side real estate and development firm that recently opened its own mortgage brokerage, said his new firm doesn`t speculate on rates, but others do.
”I don`t think it`s rampant, but it certainly exists and can be a problem,” he said.
His firm`s policy requires that a solid commitment be obtained from a lender when a customer is told a loan rate is locked in. ”We will not let our loan officers play the market. If the rate is floating, the client knows it.” Letting a rate float when a customer is told there is a lock is
”absolutely deceptive, no question about it,” Abrams said.
”We`re not in business to play the interest-rate game,” he added. ”If we were, we`d go be traders down at the Board of Trade.”
Indeed, the ”interest-rate game” varies according to the player.
Mortgage banks, mortgage companies and many commercial banks sell loans they originate on the secondary market, usually to the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corp.
(Freddie Mac).
Fannie Mae and Freddie Mac hold a few of the loans, but package most as backing for securities they sell.
If rates are at, say, 8 percent, and the lender gets a commitment from the secondary market to buy a loan or a group of loans at 8 percent (or a narrow range around 8 percent), such loans are considered to be locked in ”at par.”
In these cases, the consumer whose 8 percent loan is backed by this commitment is truly locked in, and the lender will get no premium on the loan. Profits on the loan will come from loan-origination and other fees.
Getting a commitment on the secondary market to buy loans being originated is called ”hedging the pipeline,” and it is the routine practice of conservative lenders. The pipeline is the expected loan volume based on applications.
But if a speculating lender thinks rates will fall, he can tell a customer the 8 percent rate is locked in for, say, 60 days, but secure no commitment.
Rather, he watches the market. If within that time rates go down to 7.75 percent, the lender will get a premium when that loan is sold-the ”excess”- because an 8 percent loan is worth more on the secondary market when rates are less than 8 percent.
If rates go to 8.25 percent, however, an 8 percent loan will be worth less than par, and the lender will have to pay the secondary-market investor extra to take it. That`s money out of the lender`s pocket.
Mortgage brokers operate differently, in that they place loans with bankers or mortgage companies and are not in a position to play the rate game directly.
Their ”excess” comes from the points they charge (a point is 1 percent of a loan). If a broker gives a customer a lock on an 8 percent loan with two points and doesn`t immediately place it, that loan can earn the broker extra points if rates go to 7.75 percent.
While some companies forbid loan officers from gambling on rates, others have no set policy and some actively encourage it in order to share in higher profits. When rate-playing isn`t forbidden, the decision on whether to do it is usually up to the individual loan officer.
Industry sources differ on how much speculation goes on. Brian Chappelle, vice president for residential finance at the Mortgage Bankers Association of America, said that with steady or falling interest rates, lenders typically float 20 percent of their loan pipeline.
That might be simply prudent business practice, since not all applicants will get the loans they apply for, Chappelle said. ”It`s like overselling airline seats,” he added. ”You know historically, `X` amount of people don`t show up.”
Speculation isn`t the only reason reason locked-in loans fail to close. In some cases, inexperienced loan officers or loan processors may fail to keep up with the paperwork, for example.
Or when rates dip suddenly and lenders are swamped with applications, they may take more than they can handle.
In addition, other parties connected with the transaction, such as appraisers or credit companies, may not be able to keep up.
But industry observers agree that the rapid rise in consumer complaints about delays and lock-in expirations when rates bottom out and then rise suggests that speculation may be the reason.
”That`s the usual pattern,” agreed Michelle Meier, counsel for government affairs for Consumers Union.
”There`s a decline in rates, a lot of refinancing, and then when rates nudge up during the approval process, there`s a spate of complaints.”
Cunningham said her office has received an average of 100 complaints a month since January. Many were settled without her action when rates went down again earlier this summer, because the lender readily agreed to the originally promised rate.
In about a dozen cases in which she intervened, all were concluded when the lender made a payment to the aggrieved borrower or rewrote the loan.
”With little or no persuasion,” Cunningham added.
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