LAS VEGAS - Subprime lenders are beginning to report marked increases in the number of borrowers either failing to make their first mortgage payment or falling behind shortly afterward - a trend some say is the result of overly aggressive mortgage brokers misrepresenting borrower income or home values.
Over the last two months, first payment defaults rose 40% in Saxon Mortgage Service's $26 billion servicing portfolio, which includes loans from Saxon Capital, along with those from other lenders, according to David Dill, president of Saxon Mortgage Services. "The biggest problem we are seeing is lack of income, or a change in income," Dill said, speaking on a panel discussion at Information Management Network's Subprime ABS conference held here last week. "Something is awry in the broker network."
Some say the surge in first and early payment defaults indicates a subprime market close to its tipping point. That is - the industry is running out of borrowers to keep itself afloat.
Fueling the chance for misrepresentation are product offerings that allow either little-to-no income verification. Roughly 40% of subprime loans are so-called stated income loans - meaning that borrowers do not have to back up their claims of annual income, according to Richard Benson, president of Specialty Finance Group. "The reason people are in affordability products is because they can't afford them," Benson said.
"I think mortgage fraud has always been there," said Ryan Thomas, an associate at Lanahan & Reilley LLP. "I think the slowdown in the mortgage market has brought it to the top. Thomas estimates that about 10% of mortgage applications maintain some sort of fraud, and about 40% of early payment defaults are due to some form of misrepresentation.
"The issue is not that subprime underwriting guidelines are getting worse," said Diane Pendley, a managing director at Fitch Ratings, "it is the holes in the guidelines." Pendley cited a scenario where a mortgage broker overlooks a recent credit inquiry from an auto lender coinciding with an applicant's mortgage application. This is a scenario that, if it resulted in the issuance of an auto loan on top of the mortgage, could have a substantial impact on a subprime borrower's ability to make his or her mortgage payments.
Conference participants tended to agree that about 90% of mortgage fraud occurs at the broker/third party originator level, which is not surprising in an industry that operates almost entirely in the wholesale realm.
Aside from avoiding stated income loans, industry participants recommended that loan buyers require the following conditions prior to purchasing loans, in order to weed out the possibility of fraudulent loans, or those containing inaccuracies. The first is that the lender employs "embedded appraisers" - meaning there are appraisers, employed by the lender itself, embedded throughout its areas of operation. The next is that the appraisers are both licensed and insured with errors and omissions coverage and that the lender uses some form of exclusionary list (there is one administered by MARI) in order to ensure individuals involved in mortgage transactions are not fraud suspects. Finally, the state in which the lender is operating should require brokers to maintain a surety bond.
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