More and more homebuyers today are choosing to finance their purchases with a minimum amount of cash. They are able to do this because the market offers a variety of no-closing-cost, no-point mortgages.
Without these types of mortgages, many first-time homebuyers would be unable to muster the cash necessary to buy a home.
But now such mortgages face extinction at the hands of class-action lawyers, who are encouraging borrowers to file suits against nearly every major mortgage lender.
The goal of these lawsuits is not the furtherance of good public policy. What they are after is money. If they succeed in winning large judgments and settlements, the homebuying public will be the ultimate losers; no- cost, no-point loans may cease to exist.
Mortgage brokers are not lenders, as they do not normally fund the loans they originate. There are an estimated 20,000 mortgage brokers nationwide. Collectively, they initiate more than half of all residential mortgages.
The blossoming of the brokerage industry in the past decade has given borrowers access to more lenders, given lenders more access to borrowers, and resulted in an explosion in the variety of competitively priced products available. Homebuyers have never before held such power and leverage in the mortgage marketplace.
Brokers, entrepreneurial and fiercely competitive, provide the retail function of originating loans funded by indirect lenders who are acting as wholesalers. The products and pricing that brokers offer are not otherwise directly available to the consumer.
The mortgages being contested in dozens of cases across the country are known by consumers as no-point loans, and in the industry as above-par loans. It is the small premium that results from an above-par loan that funds a consumer's closing costs.
Let's say the par interest rate for a given loan product on a given day is 8%. A borrower choosing this option might pay little or no fees to the lender at this par rate. This would significantly reduce required closing costs.
If a borrower wished to obtain a lower interest rate, say 7.5%, more up- front cash would be needed, because higher fees in the form of discount points would need to be paid. This 7.5% loan would be a below-par mortgage. The borrower must pay points to the lender to offset the loss this loan would incur on the secondary market.
The interest rate on an above-par loan might be 8.25%. No points would be charged, and possibly there would be no closing costs up front. This is made possible because the lender expects to receive a profit (or premium) on the secondary market, and usually passes a portion of this premium on to the broker.
The broker in turn, in consultation with the borrower, applies this premium to the closing costs of the transaction, part of which is the broker's fee. By applying the loan premium to these costs, the borrower's up-front cash requirement is minimized or eliminated. The borrower has in effect chosen to finance the closing costs.
The secondary market for mortgage obligations is valued in the trillions of dollars, and is highly liquid. Mortgage notes and mortgage-backed securities are bought and sold every day in the secondary market, with profits and losses being incurred in each transaction. The market value of a given note is adjusted by imposing discounts or premiums against par.
No-cost, no-point loans are available to consumers primarily because mortgage brokers pioneered their use. Because brokers have popularized the loans, direct lenders such as banks and thrifts have been forced to offer similar products to remain competitive.
But some class-action lawyers are claiming that payment of premiums is prohibited by federal law. These claims display great ignorance of the way the market works to the benefit of consumers.
If these lawsuits ultimately succeed, either through continued confusion in the courts or continued coercive tactics compelling large settlements, lenders would simply stop paying premiums to brokers. (Alarmingly, some already have.)
Brokers would therefore have to collect all their compensation directly from the consumer, resulting in higher closing costs. Brokers would thus cease to be a source of no-point no-closing-cost mortgages.
The only winner would be lawyers being compensated out of the proceeds of the settlements.
To make matters worse, despite the popularity of these loans direct lenders probably woudn't step in to fill the void. The higher the interest rate on a given mortgage (as compared to par), the more likely the borrower will prepay through a refinance. If a lender purchases loans with hard cash, the expected life of the loan is a very important part of the purchase price.
When the loan prepays, a large loss can result, because its value on the secondary market is greatly diminished. As no-closing-cost mortgages are available, more borrowers are choosing to refinance. This has put pressure on direct lenders to increase the cost of above-par mortgages, or to stop offering them completely.
But competition from mortgage brokers prevents them from doing so. If this competition were removed, direct lenders could very well stop offering or increase the cost of these types of loans.
Thousands of families with little cash have become homeowners in the past decade by choosing no-point mortgages, while thousands more have been able to refinance and reduce their monthly mortgage payments. This has helped stimulate home sales and provided an overall boost to America's economy. An increased rate of homeownership is not only good public policy, it's good business-everybody wins.
If no-cost mortgages disappeared, the ultimate losers wouldn't be mortgage brokers. The majority of consumers would still choose brokers, because they would continue to offer a combination of choice, service, and expertise at the lowest cost.
The real losers would be the homebuying public.