Case Exposes Many Failings in the Mortgage Industry

According to the Sun Times, the Attorney General of Illinois is aggressively moving foward with legal action in this case of purported mortgage fraud.

The McBees received a call from Advantage Mortgage Consulting offering to lower their $700 monthly payments by $100 a month. The couple decided to refinance
through Advantage. According to the lawsuit, the McBees were told that to get the lower payment, they would first need to be refinanced into a monthly mortgage with payments of roughly $1,400 for two months, and then they'd be refinanced into a mortgage with a payment of roughly $600 a month, about $100 less than they paid under their original monthly mortgage. The suit says the couple informed the company they wouldn't be able to afford a $1,400 monthly payment for long.

The couple said they had to use money from their credit cards to make the two payments on their 4½-bedroom, two-bath home, where they had lived since 1999. After they made the two $1,400 mortgage payments, Advantage refused to refinance them into the lower mortgage, the suit alleges. Ozell, 86, a retired nurse's assistant, and J.W., 67, a retired janitor, couldn't meet the increased payments, fell behind, the house was foreclosed and they were evicted. The lawsuit states Advantage misrepresented the McBees' monthly income in order to secure the loan.

Now, this case exposes many of the failings of the industry. First, the main reason that everyone signs so much paperwork is because it ultimately doesn't matter what you say, but rather what is said in writing and what you signed. There is going to be no loan document that is going to say that you are doing a loan temporarily in order to then obtain a better loan. In other words, they likely didn't understand what they were signing.

Now, I have long pointed out that the ridiculous amount of paperwork becomes a practical counter productive endeavor. I would be willing to bet that one of the main reasons the couple didn't know what they were signing was because they had signed so much that it was totally overwhelming. Here is a revealing part of the case...

The couple said they had to use money from their credit cards to make the two payments on their 4½-bedroom, two-bath home, where they had lived since 1999. After they made the two $1,400 mortgage payments, Advantage refused to refinance them into the lower mortgage, the suit alleges. Ozell, 86, a retired nurse's assistant, and J.W., 67, a retired janitor, couldn't meet the increased payments, fell behind, the house was foreclosed and they were evicted. The lawsuit states Advantage misrepresented the McBees' monthly income in order to secure the loan.

You will notice that the only fraud the government thinks they can prove is misrepresented income. In other words, the promise of lowering their rate later is much more difficult to prosecute because the couple never signed paperwork guaranteeing this. Proving the misrepresentation of income is easier because the amount put down on the application can be measured against what they really made. Still, this sort of situation could have happened without necessarily needing to misrepresent income.

I call it a situation rather than a scam because it is possible that this was mere incompetence or even more, market forces at work. I have myself structured loans in similar fashion. Sometimes, borrowers need to wrap up a bunch of bills and pay them off in order to get their credit score higher in order to qualify for a good loan. I don't know if that happened here. Loan programs can disappear or change guidelines at any time. It is possible that the mortgage company thought they had a final home for the loan, and then that program was removed or changed.

Given the enormous increase in the size of their temporary payment, I doubt that is true. I believe that this was much more likely a flat out scam. That said, this lawsuit reveals many of thd difficulties and contradictions of the mortgage market.

For instance, in Illinois there is something called the net tangible benefit disclosure. Each loan done is supposed the have a benefit to the borrower, and the disclosure clarifies what that benefit is (consolidating debt, lowering the interest rate, getting a fixed rate, getting a lower payment, etc) Keep in mind that their payment doubled, and yet somehow there was still a "net tangible benefit", and that's because the disclosure should have been signed as part of the loan process. What was that benefit, and what good is the rule or the disclosure if it is met and such a loan is still allowed to move forward.

The mortgage industry is wraught with paperwork that is meant to protect folks against fraud by spelling out exactly what the terms of their mortgage will be. Yet, the paperwork is so overwhelming that it contrbutes to many borrowers only being confused about what their terms are. Thus, it allows for unscrupulous mortgage brokers to say one thing and have borrowers sign something totally different. Since, in real estate, it all comes down to what you signed and not what was said, unscrupulous mortgage brokers actually use the system to their advantage.

All of this is very important because most new legislation involves new regulations which will mostly also create new paperwork. Until the powers that be understand that the plethora of paperwork that their regulations are creating is only contributing to the problem, they are not going to do anything that will tangibly resolve it.