Loan Fall-Out And The Effects Upon Consumers

This is going to be a long article and somewhat technical in places, but it needs to be covered and it's important to everyone who is thinking about getting a real estate loan.

"Fall-Out" is very simple: The number and percentage of dollars of loans that get locked that do not eventually fund. If I lock $1 million worth of loans this month, and fund $650,000 of that, I have a fall out ratio of 35%, and a "pull through" of 65% (my personal "pull through" is much higher than that, but this is an industry wide issue). The secondary loan market is putting immense pressure upon lenders to deliver a very high percentage of what gets locked. This has implications for the way loan officers need to handle loan applications, when they lock your loan, and many other things.

I got this email sent to me the other day from headquarters. It's representative of tensions going on between the interests of consumers and the interests of lenders, and has implications for what can be done to advance the interests of consumers and the direction the loan industry is likely to go in the near future. Because the email is long, I'm going to break it up and respond in pieces. I'm going to put the email text in various block quotes, while my responses will be normal text style. If I need to change some jargon in the body of the email to render it comprehensible, I'm going to change it and put the changed text into parentheses. Specifically identifiable information (personal or corporate), I am going to show as DELETED.

The question has come up many times "Is the brokerage business going to survive?"

I recently had factors explained to me that moves my answer away from just having a positive faith into a more realistic understanding of what elements will determine the outcome. Economic systems live or die on economics. Seems simple enough. If the brokerage channel is economically viable, then it will survive; if not, it won't. If companies are economical, they will survive; if not, they won't. And of course, the same is true for (loan officers).

In my discussions with that lender, I now have a better understanding of how fallout plays into the economic model and what lenders are going to do differently now to ensure their own survival. Brokerage channels are inherently more unreliable and inconsistent on fulfilling lock promises than retail banking. As such, the secondary market is paying substantially less for broker commitments than the equivalent banking commitment. When bank retail (loan officers) lock loans, they don't have the ability to move the loan for a better rate. The pull through on locks in retail channels is 10-20% higher than DELETED. The reason I bolded above is broker (loan officers) vary on pull through from 10% to 45% back to 100%. It's that inconsistency that prevents lenders from picking, say 40% fallout as the number. When you want the lock to exist, you want your cake. It's just broker LO's want both.

It shouldn't come as any surprise to anyone that this is changing, driven by the secondary market. When a loan officer locks a loan, the bank turns around and orders funding from Wall Street Investors at the rates available at that time. This changes with market conditions, and that is the reason why there can be half a dozen loan repricings per day as the market waxes and wanes with events. If that money that gets ordered does not in fact get used, the bank is out the money.

This is going to have effects within the industry. Consumers are going to find it much harder to get a loan locked without paying a deposit to the lender. The only way - and only loan officers - which are going to be an exception to this are loan officers who either 1) Float the rate while telling you it's locked, or 2) Ruthlessly weed out their loan applications of anyone who is less than fully qualified and completely committed to this loan. Since one or the other of these latter conditions applies to the vast majority of everyone, the practical upshot of would be a loan officer passing upon the majority of their potential income, which just is not going to happen.

Mortgage Loan Rate Locks have always been the horns of a dilemma for loan officers. Lock now and you risk the consumer bailing out on you if the rates fall, or demanding a renegotiation. Float the rate, and you risk those rates rising to the point where the consumer is angry, starts shopping elsewhere, or even just blows off the idea of getting a loan entirely. Consumers have had this choice far too easy for the last ten years or so, free-riding upon the intense competition between lenders. In case you haven't noticed, there aren't nearly so many lenders in business today as there were a few years ago. Lenders are going to start charging for a rate lock because they are now able to do so. This may change back again in a few years, but for now you can look at it as the way things are going to be for the foreseeable future.

Lenders need to have 75% pull through in order to make money. Think about it: in order for them to sell their portfolios, roll in all the costs of their operation, roll in all the "touches" on files that close and all the files that don't close, the lost hedge fees on loans that don't close, plus all the losses that occur on buybacks - 75% is the bar they have set. When a company is below that, they lose money.

As you've seen, lenders are starting to differentiate between profitable companies and unprofitable companies. DELETED volume makes a lender's effort at rehabilitation worthwhile. That lure is always there, but if the relationship doesn't work, it doesn't work. DELETED has long talked about fallout as a major problem, but lenders and DELETED have been giving it only lip service in the past. No longer.

If the brokerage business is to survive, the broker has to make it so the lender wins. No lender, no broker. Since the lender knows the relationship is symbiotic, many lenders are creating pricing tiers to incentivize companies to figure it out. That is only the first step. Lenders are now dropping unprofitable mortgage as they try to improve their execution price with Fannie/Freddie. In other words, the brokerage business will be smaller, more focused, more partner-like than what has been in the previous "sales" model of mortgage brokering. DELETED plans to "partner" with its top lenders and assure top tier pull through in order to get the best from each company. We need to make that commitment to them which will assure our mutual survival.

A very important shift must occur to be successful. The (loan officers) must shift their thinking to make sure the lender wins 80+% of the time. The math is very, very simple: What's the dollar volume that gets locked? What is the dollar volume that closes? What's the ratio?

I would take issue with the contention that "the lender needs 75% pull-through to make money". Their own captive loan officers rarely achieve 75% pull through. Talk to me about it when lenders start firing their "in house" loan officers for less than 75% pull through. But there is a point at which it is no longer profitable to do business with a given brokerage or loan officer, and a large percentage of loan officers are below that point. The upshot is that lenders are increasingly serious about this, and are terminating relationships that don't measure up. For that matter, they are terminating their own loan officers, albeit for mostly unrelated reasons. Net result: fewer loan officers, less competition, and the balance of power shifts more towards those loan officers remaining in the business, away from consumers. Nor is this going to be an issue at brokerages only - direct lender loan officers are going to get hit by it.

This is also leading towards a dichotomy that the lenders which are more reluctant to lock a loan are going to be able to get better pricing for their loans once they do lock. The lenders are passing along the negative parts of the investor incentives to whomever is originating the loan. If you've been reading this site very long, you've heard me say upon multiple occasions that "It's not real if it's not locked." But if I lock a loan for someone who is playing games, it hurts all of my clients as well as my ability to attract future clients, so I'm going to be really careful about which loans I lock, and I am going to be very upfront about what it's going to take in order to lock a given loan. I'd rather lose one loan than the ability to compete as strongly as I do, let alone lose access to a lender with useful programs. I am still disposed against the cash deposit in order to lock, but I may have no choice in the long run. Loan officers, whether they're brokers or work directly for the bank, have to keep lenders happy or pay the consequences, which means all of their clients also pay those consequences.

This is why the backup loan is dead - even I can't do them any longer. What this means is that you have to do real due diligence ahead of time, nail down prospective loan providers by asking them all the necessary questions and insisting upon a loan quote guarantee. Alternatively, you'll probably be able to make a cash deposit - but the loan originators are going to get very hardcore about keeping it if you don't fund your loan. It won't matter why - your fault, my fault, nobody's fault. The downside of all of this is that instead of having a third option, consumers are going to be stuck with either loan A or no loan at all, giving unscrupulous originators even more of an edge than they've got already.

Here's the tough part. It doesn't matter:

* That the house didn't appraise

* That the borrower didn't qualify

* That the rates dropped significantly

* That the borrower walked

* That the borrower was related to someone who got them a better deal

* That the Lender changed their program mid stream

* Etc, Etc, Etc.!!!

If you locked, the lender lost money. Of course those are good (loan officer) reasons, but if DELETED loses our lender relationships due to those reasons, then something's got to change. The thing that has to change (and will change) is what factors must exist for the (loan officers) to lock. Ideally, after Clear to Close, lock it and doc it and get 'er done. But many (loan officers) don't work that way. Well, I am asserting that ultimately there is no home anywhere in the mortgage business for the (loan officer) who locks first and apps later. No home for the (loan officer) who locks before he's run (automated underwriting system), seen the documentation, determined value, and checked with the lender. No one will be able to lock as what will soon be referred to as "old school". All brokers will have to conform to this mode of thinking.

He's unfortunately correct - and it's going to apply to all loan officers, whether they work at a brokerage or for a direct lender. It's going to take a very sharp loan officer to be able to get away with locking before clearance to close. Loan officers who do that are going to have to know the standards cold, and still they will be taking risks. But here's the thing - you want a loan officer who is willing to lock sooner than that.

I'm not certain that any of these except "lender changing their program mid-stream" is unpreventable. At the end of January 2009, Fannie and Freddie suddenly imposed a requirement that almost half of everyone with a loan in progress fell afoul of, and that they suddenly became over-conscious of the fact that they've had a major fall-out surge is supremely ironic, because that surge was nobody's fault except their own. "House didn't appraise" did not used to be a factor if the buyer's agent knew what they were doing. This has changed because the new appraisal standards are a disaster for consumers, loan officers and appraisers, and only good for corporations in the appraisal management company business. It's a bad news/good news/horrible news situation. The bad news is that good ethical appraisers and good ethical loan officers basically can no longer develop or keep a working relationship. The good news is that the less ethical examples of each are going to start running up against the better ones on the other side of the relationship, and the good ones are going to complain. The horrible news is going to be that there is nothing that good loan officers can do about rotten appraisers. If you don't think this doesn't have consequences, let me know - I need a good laugh these days. The appraiser's professional organization has learned the hard truth about being careful what you ask for, as appraisers are making less despite appraisals being more expensive, and it's not the careful and honest appraisers who are getting the work.

When I first wrote this, "Borrower didn't qualify" was ninety nine percent preventable by going over income documentation on debt to income ratio, asset documentation and being mindful of how much cash a buyer has to play with so that you know how much you need for loan to value ratio and cash to close, and if necessary, the the buyer's agent writes the purchase offer and negotiates it with the loan in mind. It's been a long time since the necessity of buyer's agents consulting a loan officer before you make a purchase offer began, and listing agents to require that a lender's prequalification or preapproval letter must be offer-specific - tailored to this particular purchase offer on this particular property at this particular point in time. If not, you might as well use the that letter for toilet paper because it doesn't mean anything. You can't fake up a loan any longer with a 100% loan to value stated income negative amortization loan. Agents have got to learn to be clear whether a potential buyer can qualify before they write the offer - and definitely before you counsel your listing client to accept it. It's also smart to build in a bit of wiggle room in the qualification. Lender standards are cold and hard thin lines - on one side, the buyers qualify, while on the other, they don't. If buyers have stretched to the absolute limit and the tradeoff between rate and cost on loans shifts upwards just a little bit, that can put a buyer on the other side of a hard line that says "No way". For buyer's agents, the need to be able to work within a client budget, and also to persuade those clients to stay within that budget, is here to stay. There are no more Make Believe Loans.

"But what if rates drop half a percent and the lender has a bad re-lock policy?"

Don't use that lender if they have a horrible re-lock policy. The re-lock policy is a feature of the product they are selling. Don't buy from them if you don't like that feature.

"What if their rates are terrific?"

Then use them, but keep your pull through at 80% or be subject to consequences.

And that's the issue. The brokerage community has never really had to pay the consequences. Now brokers will. Therefore, brokers and (loan officers) have grown up in the industry with the mindset of the child whose parents constantly threatens and repeats, but never follows through. The shocking turnaround seems unfair. But what really is happening is a movement to align value with value. "For those that help us win, they get value. For those that don't, they're gone."

This is a fact of life for all loan officers, whether they're working for a brokerage or a direct lender. It is therefore going to be a fact of life for consumers, and it is going to have effects upon their loan choices. Consumers are going to have to decide between great rates and the ability to cancel a loan without consequences. Consumers are going to be forced to choose between locking early and not having to make a loan deposit. I despise deposits, but there it is. Consumers are going to have to learn that there are things which may not be obvious on the face of it that are important to their loan satisfaction, to do their due diligence first, and if they don't do it right, they are going to be stuck. Consumers are going to have to learn the difference between merely talking a good game, and actually delivering the loan that was talked about. Loan originators are not going to accept dual applicants (lest they lose hundreds to thousands of dollars per loan when their fall out ratio becomes unacceptably high), and while all credit reports run within fourteen days count as one, it's going to be more than fourteen days between credit reports if you've had a loan fall apart in between. And consumers are going to need to be far more in touch with the consequences of their choices, as the ability of loan officers to shelter their clients is disintegrating.

I've spoken with several small to midsize mortgage companies throughout the country. They are being cut off by lenders for several reasons: low volume, high fallout, high touches. DELETED have avoided that fate due to our volume; however, there could come a time that volume won't even help if we don't move our pull through and quality into the next era.

This is from a lender this morning that supports my point:

What does a "loan lock" mean? One top agent sent out a note to her staff. "I think as a consumer, or even a loan officer, when we lock a loan, we feel like we are simply "securing" or "holding" that rate for a client. That is only part of it. Once a lock is made, at that moment, the investor is expecting delivery of that loan at the interest rate as part of their portfolio. (In essence, the loan might not be closed, but it is already sold.) If you can't deliver, or don't close on time, or you are just simply "trying" to secure a "deal" based on rate, then the investor is going to call your lender and ask, "Where is my loan? Where is my money?" Then your lender might try to "replace" that loan with another loan, or just say to the investor, "Sorry." You are not just simply holding for you and your client an "Insurance Policy" to try to get that rate, if by some chance you get the loan, you are, in fact, impacting the investors who are trying to make money on those sold loans. It may be hard to miss that "single day" rates are awesome...but, if you are not in Contract, and you don't have an Appraisal...and you don't have a true file you can close in 30 days...then DON'T LOCK...UNTIL YOU DO! LOCK when you KNOW you are going to close it. Lock AFTER you have an approval. Don't lock at multiple Banks. A lock is a promise to deliver!"

The lenders are starting to enforce that promise to deliver, and putting loan originators who don't deliver into the penalty box if not throwing them out of the game entirely. Anywhere that loan originators go, their customers will follow. The loan originators that survive are going to be the ones who are careful about locking, and make it difficult for clients to bail out of a rate lock without an over-ridingly good reason. The ethical ones are honest about it. The less ethical ones are continuing to give you the same snowjob you've always gotten from them.

One of the practical effects of this is going to be to essentially kill online mortgage quotes as being of any actual use whatsoever to the public. I am sorry to see this happen, but that's economic reality. When loan officers can't honestly quote you a binding rate and cost without building in an an ungodly amount of slop to account for how much the market may move between quote and lock, there are going to be two kinds of quotes: High ones that the loan officer is prepared to stand behind, and low ones that are the result of lowballing, wishful thinking and just plain lying. There will be no exceptions. The originators can either quote you a rate and cost predicated upon the rate/cost tradeoffs not going up, or they can make an honest allowance for that. In the first case, if the rates go up, you're either paying the higher amount or you're not going to have a loan, as loan originators certainly aren't going to do loans which cost them money, as these would require them to do. The only alternative for this brand of loan officer is to play the "wait, delay, and hope" game in speculation of the rate/cost tradeoffs coming back down. In the second alternative, you're going to be expecting consumers to sign up for apparently high priced but real loans versus shameless lowballs that are not going to be delivered on those terms when the loan is ready to go. That hasn't been working out very well for consumers these last forty years or so - I see no reason to expect it to miraculously change now.

These developments have made a lot of changes to effectively shopping for a real estate loan. The one thing that isn't going to change is that you're going to have to have a real conversation with several loan officers, and ask each and every one of them all of the relevant questions. Just getting a quote and hanging up is going to become even more of a recipe for disaster than it already is, and those who believe otherwise are fooling only themselves.

Caveat Emptor

Origianl article here