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Among the many articles documenting today’s mortgage industry problems, I ran across this Wall Street Journal piece describing how subprime lending guidelines were applied to credit-worthy applicants to drive up fees for mortgage originators. In what’s known as a Yield Spread Premium, mortgage originators received extra bonus pay when they sold borrowers loans that cost more than the market price — the average bonus equaled 1.88% of the loan balance for originating a sub-prime loan. Among other incentives, Yield Spread Premiums led some mortgage originators to bend the rules.

While most mortgage brokers don’t do business this way, some do. Texas mortgage brokers have no fiduciary duty to make you the best deal — comparing loan products, rates, and fees is essential when shopping for a mortgage. Despite the many missteps made by mortgage lenders in approving bad loans, borrowers must share some responsibility for understanding what they’re signing. If you’re not getting straight answers, then move on to the next lender, and speak to at least one mortgage banker from a federally-chartered lending institution.

The WSJ article gave the following example of troubled borrowers in risk of losing their home. Burdened with a high monthly note, they cannot refinance into a lower-priced fixed rate loan that would save their home.

Who was advising these borrowers? In Texas, mortgage brokers can charge as much as the borrower chooses to pay — they are in business to earn a profit and have no duty to make you the best deal. Some mortgage brokers are very circumspect in discussing how they price loans, because the less the borrower knows or understands, the more money the loan broker makes at closing.

So how did we get here? Part of today’s mortgage problems stemmed from competition between an increasing number of mortgage brokers. Texas finally required mortgage broker licensing effective in January 2000, but the entry hurdles remain small, making it easy to become a loan officer or mortgage broker. At one point, everybody seemed to be a mortgage broker. From personal experience, a previous customer visited my office on business – I helped him find a residential rental a few months earlier. A chef by trade, he joined the swelling ranks of mortgage brokers and was looking for new business. I knew we were in trouble then because, among all these new mortgage professionals, some were going cut corners to earn a living in an increasingly competitive field.

Investor cash created another dynamic that altered the credit landscape. Credit markets were flush with cash and lenders started making loans to borrowers that were marginally qualified. Wall Street investors wanted a share of the wealth generated by the housing boom and were making riskier loans. Mortgage originators were under pressure to find borrowers and their increasing numbers drove standards down as more brokers competed in a dwindling borrower pool. Dollar incentives to steer borrowers into unaffordable loans exacerbated the problem. The ride eventually came to a halt as investors were burned by bad loans and closed the money spigot.

What’s left now is to pick up the pieces and alter the credit system so that this won’t happen again. Many lenders are stepping in to alter loan agreements to stem foreclosures forced by the bad loans. Recognizing the economic threat, the federal government is working on various measures to reduce the number of bad loans. The mortgage industry knows it screwed up and is taking steps to mop up the mess before the class-action lawyers get any ideas. The mortgage industry says the system is working and is decrying any new regulatory measures, but their current efforts won’t be enough to prevent this from recurring because many of the incentives remain in place.

Typically, I’m one for letting the markets work freely, but without some regulatory curbs, this could happen again. As I’ve said before, this was easy to predict. — the incentives are just too great for the greediest to ignore. What’s needed are stronger lender guidelines defining subprime loans, how the loans are priced, and who qualifies. A full and complete disclosure of loan terms, lender fees and incentives must be made to each borrower. The remaining responsibility lies with the borrower and their real estate brokers.

First, it’s essential to shop around and find a trustworthy lender. Then borrowers must read and understand their loan documents, making sure they can comfortably afford the loan terms now and in the future. Finally, borrowers should select a knowledgeable real estate broker. Texas brokers have a fiduciary responsibility to look out for the best interests of their clients — and that includes helping them sort through the financing options.