Anatomy of a Mortgage Loan Flip

       This entry to my blog is about scam I learned about five years ago while working for a title company in Wisconsin.  I will refer to it as a mortgage loan flip.  Brokers utilize it to generate additional commissions for themselves, which costs borrowers and investors thousands of dollars.  To demonstrate how the scam works consider the following rate sheet:

Interest Rate %	Yield Spread Premium, i.e. Commission % of Loan Amount	What the Broker would make on a $130,000 loan
7.125	4.230	$5,499.00
7.000	3.980	$5,174.00
6.875	3.855	$5,011.50
6.750	3.730	$4,849.00
6.625	3.480	$4,524.00
6.500	3.355	$4,361.50
6.375	3.230	$4,199.00
6.250	2.855	$3,711.50
6.125	2.480	$3,224.00
6.000	2.230	$2,899.00
5.875	2.105	$2,736.50
5.750	1.605	$2,086.50
5.625	1.105	$1,436.50
5.500	0.605	$786.50
5.375	0.105	$136.50
5.250	-0.520	-$676.00
5.125	-1.020	-$1,326.00

The scam works like this: the broker finds a borrower who trusts the broker so much that they are not shopping the interest rate around with other brokers or banks—one broker got most of his/her borrowers from his/her church.  The broker tells the borrower that the best interest rate he can get him right now is 6.75% because the borrower has some credit issues that need to be worked out or because rates are high right now. So the broker gets the borrower a mortgage at 6.75% and pays the closing costs. The broker makes $3,649.00 ($4,849 in yield spread premium - $1,200 for closing costs). 

Four months go by and the broker calls the borrower and tells him that interest rates have dropped, or that because of time and things they have worked on together the borrower’s credit is now better, and that he can get the borrower a mortgage with a 6.5% interest rate and pay the closing costs. The broker makes $3,161.50 ($4,361.50 in yield spread premium - $1,200 for closing costs).

Another four months go by and the broker calls the borrower again and now says he can get the borrower a mortgage with a 6.25% interest rate and pay the closing costs.  The broker makes $2,511.50 ($3,711.50 in yield spread premium - $1,200 for closing costs).

Another four months go by and the broker calls again, now the broker offers to get the borrower a mortgage with a 6.0% interest rate and to pay the closing costs. The broker makes $1,699.00 ($2,899.00 in yield spread premium - $1,200 for closing costs). 

The Broker made the following amounts:

Mortgage 1 (6.75%): $3,649.00

Mortgage 2 (6.50%): $3,161.50

Mortgage 3 (6.25%): $2,511.50

Mortgage 4 (6.00%): $1,699.00

                                 Total : $11,021.00

So in around one year’s time, the broker made $11,021.00 obtaining mortgages for the borrower.  Notice I was using the same rate sheet the whole time.  That is the scam.  The borrower qualified for a lower interest rate the whole time but because the broker convinced the borrower that either rates where dropping, or that with time and a little work the borrower’s credit would get better and qualify for a better mortgage, the borrower went through 4 different mortgages instead of one. During this year the borrower is paying more in interest than necessary and is essentially being ripped off.  

I refer to the investor instead of bank because while banks usually retain the servicing on a mortgage, they generally sell the right to the payments.  The investor is also getting ripped off. This is because the investor is paying the broker the yield spread premium (i.e. commission) each time expecting to receive higher payments for the life of the loan, but the broker is making sure that the first three mortgage loans don’t last long—in our example 4 months each. Why 4 months? Because some investors require the borrower to keep the mortgage for at least 4 months in order for the broker to keep their entire fee (the yield spread premium).  If the borrower refinances earlier the investor may require the broker to repay back a portion of the yield spread premium. 

Note that because banks often sell their loans, it appears they also have an incentive to run this same scam.  Although if investors find out that a bank is doing this they will no longer buy loans from that bank, so banks are less likely to be as blatant about it.

As I mentioned in the beginning, it was five years ago that I learned about this scam while working in the title industry in Wisconsin.  Is this kind of thing still going on?  What other kinds of scams have you come across? 

THAT’S MY ARGUMENT.

© June 2013 Brandon J. Evans