Tuesday, May 15, 2007

Lender Beware

by Tanta on 5/15/2007 01:08:00 PM

I’m not sure, but this little anecdote from the Wall Street Journal may include at least one example of everything we have been complaining about for three solid years. It’s like a mystification buffet: you just don’t know where to start nibbling. I have added the emphasis to the following, which is from the paper edition (“Lenders Get Tougher," May 15, D1):

Increased scrutiny by lenders is meant to weed out problem loans and reduce mortgage fraud. But it also can inconvenience borrowers. Jordan Lipton, a physician, got waylaid by tougher appraisal standards when he recently applied for a mortgage to finance the $1.05 million purchase of a four-bedroom home in Charlotte, N.C.

The lender, American Home Mortgage Corp., requested two appraisals of the property, and then sought a price opinion from a real-estate broker, who said the home was worth just $750,000, well below the $885,000 Mr. Lipton wanted to borrow, according to Mr. Lipton's mortgage broker. Mr. Lipton was able to get the financing he needed from another lender two weeks later, but by that time the rate on his loan had risen a quarter percentage point to 6 3/8%. "It's ended up costing us a lot more over a 30-year period," he says. The higher rate could amount to tens of thousands of dollars in added interest payments over that time.

Mr. Lipton's broker, Daniel Jacobs, chief executive of Empire Equity Group's 1st Metropolitan Mortgage unit, says the two appraisals supported his client's purchase price. But he says getting a third layer of verification -- the broker's opinion -- was "an overreaction" to the rise in problem loans, especially because his client had good credit and provided full documentation of his income and assets.
Let’s just take these in order:

1. Lenders are certainly tightening credit guidelines to protect themselves. It is, however, an odd perspective to think that borrowers and lenders have entirely opposing interests here. As compared, for instance, to the way that the interests of borrowers and sellers might conflict. There is a theory that borrowers don’t want to spend more than they have to. We have a case where Mr. Lipton is being encouraged by his lender to not overpay for a property. Mr. Lipton sees himself as “inconvenienced.” Anyone who has ever been a fiduciary for a teenager can probably relate. To the lender.

2. A four-bedroom home for over $1MM? That would have required two appraisals during the boom from every lender except the ones that are currently bankrupt, and not all of those. So let’s put this “tightening” thing into some perspective.

3. A price opinion does not tell you what a home is “worth.” That is what an appraisal is supposed to do. A price opinion tells you what an informed market participant thinks the likeliest price is today. Since so many people struggle with this “value/price” distinction, let’s be clear on it. Simply put, “value” is the price you could expect in a market experiencing general supply/demand equilibrium, typical buyer and seller motivation (average distress levels), and sufficient transaction volume to produce reasonable estimates of market exposure. In periods of time when a given market is out of balance, experiencing seller distress, and slowing considerably, the likeliest price for a property is quite possibly substantially less than its value. Another way to say this is a borrower paying “appraised value” for a property in a declining market is not a bargain-hunter. This does not mean that the market in question will never return to conditions that allow an objective “value” to be determined. It does, however, suggest that a borrower wanting to pay more than the current BPO price needs to display to the lender more “durability” as a credit risk than someone else does, since this borrower will have a longer than usual wait in store if he’s counting on anything like appreciation.

4. I don’t think that odd shift from what Mr. Lipton “wanted to borrow” to “the financing he needed” in a matter of a sentence or two is just casual language. We just spent a whole long housing/mortgage/MEW/debt/spending boom being confused about how much we want to borrow and how much we need to borrow. Mr. Lipton’s lender was telling him he was overpaying for the property, and Mr. Lipton understood that as the lender not giving him what he needed. Mr. Lipton wants to be able to overpay for a property. Mr. Lipton’s lender suggests that he therefore make the “overpayment” part in cash. Mr. Lipton thinks he needs to be able to borrow the overpayment part. Mr. Lipton’s lender does not need to lend the overpayment part. Worlds collide.

5. Did Mr. Lipton’s rate go up because the market moved during the time he was struggling to find someone to make him a dumb loan, or because the lender who finally made a dumb loan charged more for it? Do we know this from the article? I have my suspicions, but I do love that business of it "costing us more." I also can't help wondering if our broker informed our new lender about that BPO. It doesn't matter if the new lender didn't order that. One represents and warrants that one has disclosed everything one knows that might be material to someone's estimation of the quality of a loan, and knowing that the last lender had a scary BPO is material. I confess that if I still worked for a lender I'd be doing a database search on a loan for a Mr. Lipton in Charlotte right about now, to see what was in that file.

6. Ah. Mr. Lipton’s broker is where the information, and presumably the "us," is coming from. What a surprise. Does Mr. Lipton think his interests are more aligned with his broker’s than with his lender’s?

7. The part we didn’t get: what about the seller? What about the neighborhood? How old were the comps? What was actually on those appraisals that made American Home—not my idea, by the way, of an overly cautious, traditional lender—get that BPO? Could it have been, precisely, that the appraisals appeared to do no more than "support" the contract price? There is another fruitful avenue of inquiry when an only moderately conservative lender goes out of its way to obtain deal-breaking information.

Look, folks, using a BPO in a booming market is nuts. That’s because they tend to err on the upside, if you get my drift. A BPO coming in not just under the appraised value but under the contract sales price by that much is a big flashing screaming DEFCON-5 DEFCON 1 [ed. note: duh] level alarm bell. It is also a powerful negotiation tool. Sanity suggests you confront the seller with one of two options: the contract falls through because the loan was denied, or the seller negotiates the price down to something consistent with the lender’s maximum loan amount.

Stalking off in a huff to find someone who will accept a higher LTV, on the other hand, gets you a pity party in the Wall Street Journal, but it doesn’t make you rational. Obviously we’ve got a lot more “tightening” to do, especially in the story-line. There is a possible way of reading this anecdote as a lender refusing to prey on a borrower. The WSJ seems to take seriously the right of the prey to be preyed upon if the prey is upper-middle-class and that’s what’s convenient at the time, which is unsurprisingly the point of view of the only perspective we're given: a mortgage broker's.

A mortgage broker who is not a fiduciary does his "duty" just by getting you a loan; there is no duty to get you a loan that is good for you. Proposals on the table these days to force brokers to become fiduciaries are not just about poor folks or fees and points.