Since the passage of the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act), states and governing agencies have been scrambling to enact new laws and amend existing procedures that facilitate the licensing of mortgage loan originators in order to meet the requirements of this new federal law. The SAFE Act has, in fact, had many benefits. For example, it has put a stop to the easy entrance/easy exit loan originator (now, it’s just easy exit). This should help ensure that the industry attracts more qualified and ethical individuals, rather than someone just looking for a fast buck when mortgages are in high demand.
Unfortunately, while enacted with the best intentions to protect the consumer and to mitigate fraud, and ultimately to assist in the recovery of the housing market, the act has also created confusion for mortgage professionals while engendering skepticism that it will adequately protect against deceptive lending practices.
A brief history
The SAFE Act arose out of the economic crisis that began in 2007. The Housing and Economic Recovery Act of 2008 (HERA) was put together quickly with the intent of mitigating the root causes of the crisis, and to implement sweeping reform over what many felt were long-standing problems in the real estate, lending and banking industries. These problems, critics assert, contributed to the boom and subsequent bust in the housing market, with its falling home prices, rising foreclosure rates and volumes of bad debt. The stated objective of the legislation was to “enhance consumer protection and reduce fraud.” This, in turn, seemed to imply that illegal or unethical practices on the part of mortgage originators were to be blamed for at least part of the industry’s troubles.
Enter Title V of HERA, the SAFE Act which, in essence, establishes the requirement to build and maintain a national registry of individuals who are engaged in originating loans on residential properties.1 The legislation holds that each state is responsible for complying with the SAFE Act standards. They are to be assisted in this by the Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (AARMR), which will establish and maintain a Nationwide Mortgage Licensing System and Registry (NMLS). The U.S. Department of Housing & Urban Development (HUD) then has the ultimate oversight in determining compliance and is responsible for ensuring that SAFE Act standards are met.
At the surface, there are several problems already apparent in defining and enforcing this Act. While painstakingly attempting to define a “loan originator,” various forms of lending institutions and agencies, and what a mortgage loan itself is, the Act goes on to discuss what a loan originator must now do in order to conduct business. In addition to current state licensing requirements, a loan originator must have a background check performed, which includes fingerprinting, the pulling of a credit report, and a criminal history profile. Furthermore, approved educational courses and tests must be taken and passed. Even a minimum net worth must be met or a surety bond posted.
A measure of protection, but at what cost?
Let’s now look at what the estimated potential cost of implementing the SAFE Act might be. Assuming $50 for fingerprints, $150 in educational classes, $300 in registration fees, and $20 for a credit report, that sums up to $520 for every individual who wants to be a loan originator. With an excess of 100,000 individuals (a conservative estimate, based on figures from the Mortgage Bankers Association) who will be subject to these rules, you can see that the price tag facing the industry for these requirements approaches $100 million. And since the bulk of these fees are recurring costs, the Act represents $100 million annually in additional costs.
Considering that between six and seven million loans are originated every year, this added amount comes to an extra $15 in pure cost for every loan. So, who will underwrite this cost? Ostensibly, the loan originator (or his or her company) is on the hook for these fees as a result of the legislation. However, basic economics and past precedents indicate that this increase will be passed along to the consumer, resulting in a higher cost in obtaining financing. Furthermore, the added administrative burden and fees may reduce the number of people approved to originate loans, potentially slowing down the origination process and further raising production costs.
By reducing the productivity of any one originator, per loan costs will likely further increase. Given that the lenders are beholden to their stakeholders to maintain margins and profit, these costs are likely to be reflected in the price of obtaining a loan.
The most troublesome conundrum arising out of the SAFE Act is that there is an embedded assumption in the resulting legislation that it is possible to weed out most, if not all, unscrupulous loan originators by regulatory fiat. However, in dealing with matters of human nature, and with complex transactions that involve multiple parties and data sources, it’s not that simple. Just because someone is entered in the NMLS, there is no guarantee that they will foreswear all future fraudulent activities. And of course fraud can occur at multiple points in the origination work flow continuum—even at the borrower level. The SAFE Act addresses only one element of a highly elaborate system.
Moreover, the SAFE Act does not provide for the continual monitoring of agents in the system. While the system may make it harder for someone to get registered initially, any registrant could later “turn bad” and cause a lot of damage before they are identified and stopped. Periodic agent reviews by the lenders or self-engendered re-certification by the agents themselves would also likely drive up the cost of doing business as yet another layer of red tape is added to an organization’s procedures.
A more holistic approach is required
Creation of a residential mortgage is a highly complex process involving numerous people and a multitude of tasks. The SAFE Act does not require mortgage underwriters or loan processors to go through a similar qualification or registry procedure. Fraud can be introduced anywhere along the line by these people or others who have access to loan data and files throughout the process. Even closing agents, post-closing activities and audit procedures, introduce the possibility of changes to data and paperwork.
The SAFE Act addresses the individual loan originator and really just one step in the origination process—that of the individual (loan originator) counseling the borrower on the appropriate financial product and the income they received as a result of the consultation. However, originators can also be involved in fraud later in the process, such as in the manipulation of appraisal information/appraised values, etc. in order to get loan approval and, thus, commissions paid.
Given this situation, a more holistic approach should be taken to ensure that fraud can be systematically identified across the entire mortgage loan origination process. Why focus solely on the agents when the process of the loan origination itself can be used to help identify, weed out and correct fraudulent information?
Technology offers a better way
“Trust, but verify” has long been a watchword of international relations. This recognizes a fundamental truth: It is virtually impossible to identify all of the bad actors in a process upfront, no matter how many safeguards are put in place.
Fortunately, for the mortgage industry, there is a better way. New cloud-based lending technologies provide the opportunity to monitor for and detect fraud throughout the lending process. This approach is both far less intrusive and more cost-effective than the NMLS, giving the lender the ability to check loan data throughout the process to ensure it is complete, accurate and unchanged through loan delivery. In this way, it is not dissimilar to the Six Sigma processes that were introduced in product manufacturing a decade or more ago—a system of continuous monitoring designed to drive quality.
Until recently, it has been difficult to replicate this kind of technology-driven quality control in mortgage origination. After all, creating a loan is not like building a widget: There is unpredictability to the process that does not exist in manufacturing. That is now starting to change.
Baby vs. bathwater
The mortgage industry has always been subject to periods of boom and bust, though the last several years have been extraordinary ones by anyone’s standards. Yet, the market has reacted to self-correct. Underwriting guidelines have adjusted dramatically to counter the years of easy credit. Exotic loan products have been eliminated.
Government regulators have stepped in to try and address the problems that developed over the last cycle. While there is an important role for regulation, it is not the only, or necessarily the first, line of defense. By its nature, regulation tends to be expensive, cumbersome and potentially off-target. Often, rules are designed to solve last year’s crisis, not the next impending crisis on the horizon.
On the other hand, some technological solutions offer a level of control and flexibility that can adjust to regulations and market conditions, as well as individual agent-level actions. Cloud-based technologies in particular are gaining adoption within the mortgage industry and are evolving rapidly to enable best business practices and to adjust to changing circumstances. Fraud and fraudsters are nothing, if not infinitely, malleable in their efforts to game whatever system is put in place. When it comes to detecting the latest iteration of their schemes, technology gives lenders a fighting chance.
Lawrence Fried is a mortgage market analyst with Dorado Corporation, a provider of cloud-based consumer lending solutions based in San Mateo, Calif. He may be reached at (650) 227-7300 or by visiting www.dorado.com.
1—For those who are interested in reading through the legal documentation, you can find it here: www.hud.gov/offices/hsg/ramh/safe/smlicact.cfm.