Managing the Risks of
By Kathlyn “lyn” l. faRRell, cRcm, cams, amlp, and caRl g. pRy, cRcm
T IS OBVIOUS TO ANYONE who’s been paying attention that for the last few years
the major players in the mortgage lending industry—including brokers, appraisers, and
financial institutions—have all taken hits in the media, with regulators, and with the
public. With the collapse of the real estate bubble, fewer mortgage loan applications are
being generated and the number of mortgage loan brokers and mortgage companies
has declined. By some estimates, the number of mortgage brokers in the United States
is only half of what it was in 2005.
I
Due to this decrease in mortgage lending providers, some
financial institutions (including many community banks) sense
opportunity and have decided that the time is right to get back
into mortgage lending. In some cases, banks that have traditionally
made mortgage loans here and there to satisfy existing customers
are gearing up to offer mortgages in a much bigger way. While
this decision may make good business sense and can be beneficial
for the communities that need mortgage services, there are also
risks that should be considered. In fact, there are more regulatory
risks now in this mortgage lending area than ever before. Many
of these risks are specifically related to the use of partners and
service providers in the mortgage process.
Because it is difficult, if not impossible, to participate in the
mortgage lending space on any scale without relying on outside
service providers, a bank is forced to weigh the risks of dealing
with third parties against the benefits of building a profitable
mortgage lending operation. Third parties include application
brokers, property appraisers, and title insurers, as well as loan
servicers, escrow companies, and secondary market purchasers.
In this article, we’ll summarize some of the risks inherent in
dealing with mortgage partners and offer some ideas on ways to
mitigate the risks in an institution’s mortgage lending operations.
how did we get here?
First, let’s consider how this level of risk came to be in the first
place. While the causes of the mortgage meltdown and resulting
economic crisis will be debated for years to come, it is generally
agreed that lenders were at least partially responsible by allowing
underwriting standards to slip or, in some cases, by neglecting
the standards altogether. Some of those problems have been at-
tributed to the lenders’ mortgage partners, who at least enabled
some weaknesses. Who are some of the parties sharing the blame?
■ ■ Mortgage brokers: Because of aggressive and even abusive
use of overages and yield spread premiums, borrowers paid
much more for loans than they should have. These practices
fall under the umbrella of predatory practices but can also rise
to the level of a fair lending violation if borrowers in predomi-
nantly minority areas were disproportionately harmed. These
practices could have contributed to the current situation of
excessive foreclosures in many urban areas.
■ ■ Appraisers: There have been many anecdotal and documented
cases of appraised values being rigged to support a loan amount.
This practice is not only a regulatory violation but also a viola-
tion of the Uniform Standards of Professional Appraisal Practice
(USPAP) rules and in many cases a criminal offense. But lend-
ers were complicit in some of these cases, through suggestion,
coercion, or outright fraud to get the number necessary from
an appraiser to support the loan.
■ ■ Title companies: Less visible but still playing a role, these com-
panies would in some cases play along while mortgages were
flipped repeatedly, predatory loans were made, or in extreme
cases, loans were made to multiple borrowers on the same home.
the Backlash
After the mortgage crash and in the ensuing challenging economic
environment, several critical events occurred in the mortgage
marketplace:
Many banks got out of the indirect lending business. Due
to the risks presented by mortgage brokers, dealers, and other
third-party lead generators, some banks simply decided to get
out of that business entirely. They decided that from now on,
mortgage loans would be made directly; that is, that initial application would be taken at the bank or through bank channels.
Some markets became neglected. Whether a result of general
economic conditions or in areas where most mortgages traditionally came from brokers, the result is the same: in many markets,
mortgage lending has dried up. It’s become virtually impossible
to get a loan (or one that is affordable.) This in turn creates …
Regulatory and legal scrutiny began to grow stricter. The fact
that loans are less available in many areas creates redlining concerns (and also issues regarding “reverse redlining,” which means
predatory loans or practices are targeted to particular areas or
