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Saturday, September 30, 2006

The Mother of all Weekend News

Refinancing & Purchasing may have just become a bit tougher

In my opinion, of all the pieces written on the market, this one by syndicated columnist Ken Harney has the potential to really put the hammer down on mortgage qualifying under no-doc, low-doc or 'stated-income' loan products ('oft referred to as liar loans). The impact and ramifications of this little change initiated by the IRS is surely going to, at minimum, put concern into borrowers who have purchased a year or so ago and are looking to refinance again in the near future (read: those with ARM's and HELOC's).

There has been much discussion about the impact of non-traditional loan products that are driving the market, including the article The Tim refers to in the prior post. To pass the muster test, one should really ask the question, "if you take away the stated-income and 100% nothing down purchase loans used to purchase scores of homes across the country, where would the market be?" It would be a much different market and my income including many allied real estate professionals would be, well, less.

On Monday the IRS will be initiating an electronic mechanism to speed up audits on Form
4506 -T, which every borrower signs just prior to closing (and of which I am very familiar with in assisting clients with signing closing and lending paperwork).

The form authorizes the lender or the investor providing the money for the mortgage to obtain transcripts from the IRS summarizing the borrowers income and tax data for four years. The form must be signed by the borrower and can be used only during the 60-day period following the date of signing.
This development is huge.

By electronically (via secure internet I presume) allowing lenders to obtain IRS tax data on the borrower in only a business day or two will dramatically speed up audits and could potentially stop refinance and purchase closings dead in their tracks BEFORE the transaction closes—if data from the IRS is "curiously" different from what the borrower claims as income. This is huge. And, it is huge in that it will reduce F-R-A-U-D.

And it is big news for the following observations:

1) I think back on all the 100% borrowers that closed purchase transactions through our own office and across the country. Many will be refinancing again.

2) I think back on all the refinance business closed over the last three years, 2005 in particular. Many refinanced into other ARM products and increased their base loan amounts higher than that of their original mortgage Note (for debt consolidation, among other things of bling bling nature).

3) Forget about market conditions for the moment: If these borrowers refinance again, they will no longer be able to go 'no-doc or stated-income' without the potential for scrutiny by a quick IRS electronic audit, prior to closing. In other words, many will not be able to refinance, due to income discrepancies--including the potential to see prior IRS 1040 income which may not have jived with the EXISTING loan in which the borrower is trying to refinance again. In other words, it could trigger the potential to see earlier fraud.

If that's not enough,lending standards, outside of the IRS audit conduit, may make it difficult enough. Read below!

Federal Banking Regulators are poised to tighten lending standards as guidelines were published last week by the Office of the Comptroller of the Currency.
From Inman News: Testifying before members of the Senate Banking Committee last week, Kathryn E. Dick, deputy comptroller of the Office of the Comptroller of the Currency, said, "Underwriting standards that do not include a credible analysis of a borrower's capacity to repay their entire debt violate a fundamental principle of sound lending and elevate risks to both the lender and the borrower.

That could mean fewer borrowers will qualify for nontraditional loans that many in the banking and real estate industry say have helped buyers purchase homes they would not have been able to afford using a traditional mortgage.
Obviously I'm no fan of a difficult market, but it appears that the "perfect storm" analysis just might have more merit than I'd like to believe. This is one call where I really hope to be wrong.

13 comments:

Mikhail said...

Maybe I am missing something, but I fail to see why simplified (and electronic) audits of a person's income will help reduce fraud. My understanding is that lenders, and mortage brokers, could really care less as to the true financial state of the borrower. After all, these lenders just re-sell the loan as a package to some sap hedge fund as an Asset Backed Security.

So long as the ABS market continues to buy these mortgage tranches like there is no tomorrow, why would any lender even bother doing an audit of the borrowers?

I suspect we will only see audits, and verification of a lender's financial status, get really serious once there has been some spectactular defaults on ABS instruments, and a massive rise in the yields on mortgage ABSes.

In short, until the ABS market starts getting picky about the quality of what it buys I don't think there will be any incentive for lenders to undertake any due dilligence.

dalas said...

there are many possible mechanism that will require less than a tax audit to reveal possible frauds. they are much easier to process, much easier to reduce fraud, yet they are not in place. this may be a possible attempt, but just a show if anything.

S Crow said...

Mikhail- here's reasons why lenders care.
1)Countrywide Financial has an $80 Million dollar reason (mortgage fraud.)currently under investigtion.

2) Our office had a transaction in which a seller was the victim of ID & mortgage fraud--lender took a significant bath. How would you like to own a home you never purchased? This is only one sample of thousands across the country that will be found in the coming months.

3) Google 'mortgage fraud', it's all over the place and we are only into this problem at it's infancy.

4) A recent study by PMI found that of the 'stated-income loans' it audited, it found that roughly 60% (if I recall correctly)of borrowers exaggerated incomes by at least 50%. I think this is WAY low.

Previously, if an IRS 4506-T audit was done, it was a paper generated inquiry which took time.

One of the merits of this new program is to potentially catch the fraud before it occurs, prior to closing.

The lending industry,major banks etc..would probably resist the new regulations because it would pinch profits, which are already tight. But, they do care, and as you suggest, when some major losses hit Wall Street hedge funds or otherwise, a whole lot of "caring" is going to come home to roost.

With the quicker IRS audit feasiblity,there may be people who cannot refinance out of existing financial strain and there will be cases where it's feasible that purchase transactions will be lost due to borrowers who cannot qualify, audit related or due to tighter general qualifying guidelines.

As cliche as it sounds, you have to be in escrow to understand all the stuff we see. I was very naive about real estate things prior to opening our office. Not anymore. Nothing suprises me anymore.

Mikhail said...

Dalas is correct that there are many ways to determine if someone is a good credit risk. But I just don't see why lenders would care since they can just unload the toxic paper to some hedge or pension fund. These buyers of mortgage ABSes just don't care about the quality of the mortgages they are getting. The only thing they seem to care about these days is that they get a slightly better rate of return than treasuries.

Heck, even BBB rates ABSes are going for ridiculously low premiums. Investors will just by ANYTHING that walks that offers a better than T-bill rate of interest.

Mikhail said...

S Crow may be right that lenders do have a stake in at least SOME of the loans they under-write (i.e. they might not sell all the loans to third parties). Nevertheless, I still think that we might not see any real change in lending practices until there is a massive uptick in foreclosures, causing pain all-round for mortgage creditors (be it the lenders themselves or the people who bought the loans).

The good times of swiftly appreciating real-estate have led to a point where too many people willfully turned a blind eye to borrower shenanigans. Appreciation made everyone whole in the end, regardless of how dodgy the loan circumstances, so who cared? Everyone made money, so it didn't matter.

Just give us a couple years of a flat, or declining market, though. That will change the lending attitudes.

S Crow said...

I agree. There are many things that are not utilized as they once were: VOE, VOI, Tax returns, etc..

The point is that existing homeowners who try to refi or those that try to buy may be suprised that they will need to cough up substantially more verifiable information to get a loan.

The IRS thing in conjuction with tightening of standards has the potential to slow the market further. Lenders don't want nor need that strain.

If I understand correctly, mortgage brokers could be on the hook to buy back loans that are in default or foreclosed due to fraud. I don't know the rules, maybe a mortgage broker can chime in.

seattle long term owner said...

This is just the government's way of sending a salvo across the bow to the mortgage industry...

basically telling them that there will be no excuse for fraud and those that participate may get burned...

whereas before they could pretend it was only the borrower who lied, now when they have the info and ignore it, they become part of the Fraud and can be held liable...

Walt Howard said...

I doubt lenders will care.

They've been closing their eyes all along, lending to people they very well knew couldn't pay.

Who cares when they are going to simply sell the loan, and all it's liability to someone else?

S Crow said...

If tougher underwriting standards have any teeth at all, I can envision a whole lot of loan officers acrosss the country thinking, "oh, @#$%!."

Loan officers will probably be reminiscing about all the clients they worked with in the past who were place with ARMS or 100% nothing down purchase deals in which they are planning on refinancing again in the future--ie....continual income stream due to shorter term ARM products.

I personally know of a couple loan officers who grin with glee knowing that their clients will probably HAVE TO refinance again. This smugness may come back to bite them when their clients cannot refi. out of trouble due to higher scrutiny.

Lending standards getting tighter in a tougher and falling market is not news that loan officers or lenders or any allied real estate professional would embrace (emphasis on builders).

seattle long term owner said...

I doubt lenders will care.

They've been closing their eyes all along, lending to people they very well knew couldn't pay.

Who cares when they are going to simply sell the loan, and all it's liability to someone else?


when house values kept rising, they didn't care, but now that values are flat, it won't be as easy selling those risky loans. Whereas foreclosure was rare in the past as you could just sell the house, now when you're upside down, you remain upside down (no equity bubble)...

The lack of equity means foreclosures, and that has the feds sweating...

You see for those who don't know... CHINA own's a big chunk of the United States Economy...

CHINA is the number one lender to the US (more than Japan now) and this month is the first time the US paid more to CHINA in interest than it got back from it's investments (the whole country is in a negative loan)... it was only 2.5B compared to 130trillion debt, but it is worrying economists...

CHINA has been a typical loan officer in recent years that it doesn't care that it only makes 1% on it's money loaned to the US as long as it stays there...

Now as MBA's get risky and defaults rise, that 1% return is turning negative and if CHINA decides to pull out all of it's money (and it will never do that, only pretend to do so to get its way) the US will go into a recession that will be the mother of all depressions...

All this political dancing on TV is all show, CHINA has the US by it's neck and the FEDS know it, so should you...

http://money.cnn.com/2006/09/27/news/international/bc.economy.china.bill.reut/index.htm?postversion=2006092707

http://money.cnn.com/2006/09/29/news/international/bc.markets.china.yuan.reut/index.htm?postversion=2006092910

Eleua said...
This comment has been removed by a blog administrator.
Eleua said...

I'm with S-Crow on this one.

Up to now, there has been absolutely no adult supervision of the mortgage industry. Just about every step in the process is wrought with fraud. Borrowers tell lenders they live in homes, in which they have never slept a night. Stated income - no income loans. Appraisals have to "hit the number," or "find the value." The latest generation of mortgage brokers are literally fly-by-night.

Don't get me started on real estate agents.

If the mortgage industry had a NORAD, this would be the initial report of multiple northbound heat blooms deep in Eastern Russia.

SWEAT-CON 1.

Knute Rife said...

Given the corporate reporting regulatory climate and the underwriting regulatory climate, due diligence obligations are still on a pretty steep climb. If obtaining IRS filings becomes this simple, there is no way it won't become an obligatory due diligence element.