Academic journal article ABA Banking Journal

Stop the Junk Originations

Academic journal article ABA Banking Journal

Stop the Junk Originations

Article excerpt

By James C. Miller

Mortgage insurers, not surprisingly, are vitally interested in quality loan originations. Their business success depends on it.

Unfortunately, the mortgage market has more than its share of junk. Some evidence of this was apparent in 1989, when mortgage insurers committed to insure only 80% of the applications they received. That means 20% of the applications were not of insurable quality-Nuite an economic waste for both the originators and the insurers.

Further evidence of low quality in today's mortgage industry is the often unsatisfactory reasons for foreclosure. Our company-Common-wealth Mortgage Assurance Co.-recently summarized our foreclosure experience over the last three years and found that one-third of those foreclosures was due to "natural causes"-illness, loss of employment and/or income-and one-third was attributed to a questionable "use of credit" or to a "disregard of obligations."

The remaining one-third was attributed by the servicer to "other" reasons. To our company, that means we don't know why the foreclosure occurred, and we feel it probably occurred for undesirable reasons.

We know we're not the only ones to see the need for improvement in quality. The Federal Home Loan Mortgage Corp. has taken actions to improve quality by staffing a fraud unit. Effective Aug. 1, 1989, they required all seller/servicers to have an active, independent quality control effort.

What went wrong? The reasons for the decline in quality may have to do with the segmentation of responsibilities within the industry. The mortgage lending industry has become an industry of specialists. There are the originators, who have no idea what happens to the mortgage after it's sold. There are the servicers. In our opinion, it seems that servicing today is less likely to be treated as an important job than as a commodity to be bought and sold to adjust your current period's reported net income.

Then there are the investors. Some of these investors treat mortgage defaults just like a stock that has declined in value and should be dumped. The borrower's situation and the condition of the property are not seriously considered.

Another problem is the big incentive for originators to produce. Builders, realtors, brokers, and commission solicitors all get paid, regardless of the quality of a loan.

Fighting back. It's one thing to complain about the lack of quality loans. But then what exactly does quality loan" mean? Simple: quality loans are loans that close, that are repaid timely, and that can be sold in the secondary market.

Let's expand on that a bit. A quality loan is one that closes so that everyone gets paid and the borrower gets the home. To produce that kind of quality loan, we need good screening of borrowers up front, and we need to be sure that they are properly guided in making a sound decision about what property they are going to buy and what kind of loan instrument they are going to use for their mortgage.

Quality loans are repaid on time so that servicers and investors get paid. For that, mortgages need to have acceptable risk characteristics.

But risk characteristics are a funny thing, because different people have different attitudes about what makes good risk and what makes bad risk. To accomplish that and satisfy these different appetites for risk, we need loan packages that fully disclose the situation of the borrower and the property. Years ago, Congress gave us truth in lending; we now need truth in borrowing, with loan applications that fully and accurately describe the borrower's ability and willingness to pay and the value of the property. …

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