Mortgage 101 and the Sub prime Mortgage Debacle
by Thomas R. Burton, CEO and President, Hampden Bank
It is safe to say that the mortgage business has undergone a significant amount of change. However, from what the politicians are saying and newspapers are printing, the mortgage market sounds like it works the way it did at the Bailey Brother’s Savings and Loan in “It’s A Wonderful Life”. Well, the mortgage market is now far more complex, and for the people suffering with an adjustable rate sub prime mortgage loan, it’s far from “It’s a Wonderful Life”. Prior to the 1970’s, banks wrote most mortgages and maintained them in their portfolio of assets. Since then, mortgages, primarily those written by mortgage companies and large banks, became an investment tool and a product of Wall Street through a vehicle called securitization. Securitization works as follows:
When a mortgage company, or a large bank, writes a mortgage it is broken down into two investment categories. The first category is the servicing component, where an organization sends out the monthly bill, collects and processes the payment and goes after the borrower if the payment isn’t made. This organization can be a local bank, a large regional or money center bank or a mortgage servicing company. The servicer of the mortgage collects a fee for this service and servicing rights can be bought and sold at any time.
The secondcategory is the mortgage itself. This is where Wall Street gets involved. Individual loans are pooled with hundreds or even thousands of other loans. Often the pools are sliced into “traunches”, breaking out various components for credit risk, interest rate risk, and cash flows. The new pools are then sold through brokerage houses to investors around the world.
The mortgage servicer has a contractual obligation to follow certain procedures to collect the payments. If the customer does not make payments in accordance with the mortgage contract, collection procedures and ultimate foreclosure must follow. Because the mortgage servicer does not own the loan, there is often little opportunity for negotiation or loan modification between the borrower and the servicer.
Most of the sub prime, adjustable rate loans were written by mortgage companies, not banks, and in almost all cases, not local community banks. The sales people who wrote these loans were often aggressive and had little incentive to build a financial relationship with the customer. Compounding aggressive sales tactics were “teaser interest rates” well below market that quickly ratcheted up to rates well above market. In addition, underwriting standards were so poor that many consumers were simply set up to fail.
Because the ownership of these loans is so diverse and disbursed, there is no easy legislative solution for those who have been hurt.
The lessons learned: 1) the unregulated mortgage industry needs to be subject to the same consumer protection regulations as the banking industry; 2) individuals should always deal with a reputable local company who will there for the life of their loan.
Hampden Bank is a Corporate Partner of the UMass Family Business Center
