The cost of originating a home mortgage is soaring and profits are dwindling to the extent lenders can't pass the increases on.
To ensure compliance with a slew of new regulations that recently took effect or are scheduled to over the next year, lenders are hiring armies of legal and quality-control specialists.
"Our profits on a per-loan basis are down considerably, and we're spending a lot more money on the back end with due diligence," said Daniel Grzywacz, the owner of Exchange Financial Mortgage, a Grand Rapids, Mich., lender. "We've doubled our staff just trying to get our loans closed and sold, and we're doing this on hundreds of thousands of loans, so it adds up."
Just complying with the Real Estate Settlement Procedures Act rule that took effect Jan. 1 adds hundreds of dollars per loan to the cost of origination, Grzywacz said.
It will be hard to measure the combined impact on lenders' bottom line of the Respa rule, the Secure and Fair Enforcement for Mortgage Licensing Act and a new Truth in Lending Act regulation. That's because rather than break out compliance costs, lenders typically lump them in under other expense categories, such as legal or technology.
"It's one of those things that gets baked into every single person's job function, and it's hard to come up with a figure for that," said Marina Walsh, the associate vice president of industry analysis at the Mortgage Bankers Association.
Any new regulation "first goes to the legal folks, who dissect it and figure out what they need to change in terms of business processes, then it goes to operations, who have to train underwriters and closers, and they need to change technology and protocols," she said.
"Long-term, the lenders are going to need to make a certain amount of profit, so whatever costs are added in, one way or another it will get transferred to the borrower in the form of fees or interest rate," said Curt Doman, the president of International Document Services Inc., a Salt Lake City provider of closing documents. "Short-term it's definitely going to cut into the costs of the lender, which will pass it on to the borrower sooner or later in the form of another fee."
Richard Triplett, a vice president and director of compliance at Allregs, an Eagan, Minn., firm that tracks changes in regulations and underwriting guidelines for lenders, said "no one has done the analytics yet" to determine all the additional compliance costs.
Beginning July 31, loan officers working for nonbank mortgage companies must pass state licensing exams, receive a minimum of 20 hours of education and register in a national database to comply with the SAFE Act. (Bank loan officers are subject to the law's registration requirements but exempt from the licensing and education ones.)
"Just the cost of licensing alone, the education and maintenance, is going to increase," Triplett said.
Like others in the industry, he questioned the Department of Housing and Urban Development's estimate that borrowers would save an average of $700 from Respa reform.
"Lenders are going to relay any costs back to the borrower," Triplett said. "They're not going to eat those costs, and there's no doubt that costs are increasing."
Doman said lenders also will have to start tracking the costs they may incur from the Respa rule. Under the rule, lenders have to pay the difference if certain fees in the good-faith estimate are more than 10% higher in the settlement statement presented to the borrower at the closing table.
"It's not just the cost of providing the good-faith estimate or technology, or even attorneys for compliance, which isn't cheap," Doman said. "Those are hard costs that will eventually go away. But you have this liability out there that could end up costing lenders money if they don't do it right, and there's no way to factor that in to the overall cost of originating a loan."
Large lenders could face significant costs just from one line item on HUD's standard good-faith estimate, known as "block six," where they are required to estimate the cost of on-the-ground services that are needed to close a loan, such as termite inspections and septic testing. If the lender requires the consumer to use a specific provider for one of these services, the 10% limit on price increases applies.
"Everyone in the banking industry was asking how they were going to figure out block six," said Kathleen Kuhn, president of DBR Franchising LLC. Her Bound Brook, N.J., company licenses the HouseMaster brand to home inspection firms around the country.
After being approached by several big lenders, including Wells Fargo & Co., the franchisor recently created a new subsidiary, Block 6 Services LLC. The unit keeps a database of providers of 10 different services, calculates the cost estimates and follows up to make sure services are performed so loan officers don't have to.
Last month, Thomas Perez, the assistant attorney general of the Justice Department's civil rights division, announced that a new unit will be investigating discriminatory mortgage lending and servicing practices.
"We will pursue cases of reverse redlining — where predatory lenders have targeted toxic products to minority communities," Perez said at the Rainbow PUSH Coalition's annual Wall Street conference. Thirty-eight investigations are under way, he said. The department also plans to examine data on loans reworked under the Treasury Department's Home Affordable Modification Program "so that we can be sure that those minority homeowners who have already been hit hardest by this crisis are not again subject to discrimination as they try to climb out of the hole."
Ed Kramer, an executive vice president at the consulting firm Wolters Kluwer Financial Services and a former New York deputy superintendent of banks, called Perez's speech "a shot across the bow of the banking and lending industry."
"If I now have to start adding people and adding technology to monitor servicing, it's going to increase my costs," Kramer said.
Meanwhile, aside from the new regulations and federal probes, lenders are increasingly having to buy back faulty loans from Fannie Mae and Freddie Mac, which began stepping up buyback requests in 2008.
The trend accelerated last year when mortgage insurers started to reject lenders' claims on defaulted loans and rescind coverage more frequently. (The mortgages in question typically have loan-to-value ratios above 80%, which means Fannie and Freddie cannot hold them without the insurance. So when insurers cancel policies, the government-sponsored enterprises in turn make lenders buy back the loans.)
In the second and third quarters, insurers denied 20% to 25% of claims, up from a historic rate of 7%, according to Moody's Investors Service Inc. Freddie said in its third-quarter financial report that servicers had repurchased $960 million of loans from it during the period, nearly double the amount a year earlier. Fannie does not disclose its volume of repurchase requests, but in its third-quarter report the GSE said that its repurchase requests had been increasing since the beginning of 2008, and that it expected them to remain high into 2010.
Lenders used to consider such risks once-in-a-blue-moon events that were factored into loan pricing. But Walsh at the MBA said lenders increasingly are worried about quality control because "rescissions and repurchase requests are at all-time highs right now."
As all these costs climb, revenues are under pressure. The MBA has forecast that origination volume will plunge 40% this year, to $1.28 trillion, as rising rates crimp demand for refinancings.
"Everyone is going to look back at 2010 and say, 'What did it cost us in terms of profits?' " Grzywacz said.