Earlier this week, I posted a blog entry here on FlippingFrenzy.com called “Stuck Between Rock Financial and a Hard Place,” which drew comments about my statement that “your loan officer is not your friend,” and about the concept of “churning.” Rather than burry my reply in the comment area of that post, I figured I’d highlight the issue further by posting my response here. (If you’re new to this thread, you may want to read “Stuck Between Rock Financial and a Hard Place” before reading the following.)

The term “churning” might not have the same “legal” or “business” understanding when used in the mortgage arena as it does when used in the securities arena, but the concept that is relayed by the use of the term helps most everyone understand what happened with the loan process.

The reason I used that term is because at no point in time did the loan officer ever tell his clients, “You can’t afford to borrow this much, because you can’t afford to repay it“, or “Borrowing this much, based on your income (risk tolerance) isn’t in your best interest.” That’s where the analogy fits in with the stock broker who continues to buy, sell, trade on a stock account in a way that: (1) Doesn’t benefit the account owner; (2) Is detrimental in the long run to the account owner; or, (3) Serves only to line the broker’s own pockets.

Granted the owner of the account still owns the stock and securities in the account and the owner may have taken dividends on that account (cash out from closing), but what the owner isn’t aware of is that their trust is ill placed.

Now, let me also say that not every loan officer is out to milk the equity out of a home (so too, not every stock broker is out trading against the risk tolerance of their client). The homeowner may very well have gone to another loan officer when told that this one couldn’t (or wouldn’t) place the loan. They may have found someone to place the loan and draw out the equity. But, with all that in mind, the loan officer at Quicken Loan’s Rock Financial didn’t even bother mention that continuing to increase the LTV (loan to value) and DIR (debt to income ratio) might cause financial strain. Instead, he encouraged them to refi time after time, and why—-one has to assume because he made very healthy commissions each time or because he was never trained in how to properly do his job. (As an aside, the Rock Financial loan officer not only encouraged Lisa and Peter, he altered numbers to make the transaction possible. Stated loan applications don’t mean you get to show income from a high paying job when the reality is much different. Yes, some homeowners fudge numbers, too, but more often now-a-days, we’re seeing unscrupulous loan officers doctoring the numbers to qualify borrowers and place loans.)

One commenter to my original post made a great point when he said that homeowners have to take responsibility for some of their actions, but where I think he fails is here: The loan would not have passed underwriting if the underwriter would have done his/her job. All the documents were in the loan application file to “red flag” the whole thing (they often are). Not just on the final loan, but for each refi. So even if you don’t believe that the loan officer owes some “duty” to the homeowner, they (and the underwriter) surely owe it to the lender to place a secure loan – and they did not.

The fact of the matter is that homeowners–especially novice or first-time homeowners–rely on professionals to help them understand the process. They expect (hope) that they (the loan officer, REALTOR, whoever) are looking out for their (owners) interests. They look to real estate industry insiders to be a financial advisor on the home loan issue because the loan officers have professional expertise on the matter. So when that “trusted advisor” (time and time again) sells you down the river, all the while continuing to pretend to be working for you…it’s pretty hard not to say: Be aware, your loan officer is not your friend! This is not an isolated incident, it happens to millions of people each year (and not just in real estate – look at the automobile financing industry and you see example after example of someone driving a car they simply cannot afford but were nevertheless approved for a lease or loan).

A commenter to my original post is also correct when he says that not coming out of pocket on a refi is common practice. That’s true. What is problematic is that very few people know how to read settlement statements or know what questions to ask about them. They see money coming to them and the rest is Greek (unless you speak Greek, then maybe its Russian or Chinese).

When we see “Yield Spread Premium” on the statement, does the average or first-time homeowner immediately think “Oh, that’s a bonus being paid (some would say kickback) to the loan officer for placing me in a product that will generate large returns for the lender/investor?” Or, when the homeowner sees POC (paid outside of closing), do they know to ask about it. Do they ask why it’s not being paid at closing since it looks like a pretty standard cost that is paid at closing? The truth is most don’t. They don’t even know to ask, and they aren’t being told.

I would venture to guess that there are not many loan officers who tell the homeowner “I could have placed you in product A–which actually makes more sense for you)–but because product B pays me more I went with that loan instead.” Then of course they’d follow up with, “Oh, but don’t worry, I’ll just get my cut from your equity; you won’t have to actually come out of pocket to pay me.”

If I sound disgruntled, it’s probably because I am. It seems there used to only be a few rotten apples in the industry (and it’s that way in every industry to address one commenter’s ‘real estate agent overselling a buyer ‘comment), but it looks more and more today like entire parcels of the crop are bad, with the exception being the few good apples like the commenter in question.

Whatever disagreements commenters to the original post and I have, I hope we agree on at least one thing: that the system is broken (or corrupt) or at least pieces of it are. If the system is going to be fixed we have to address all the issues creating the problem. We need borrower education, system overhaul, and a whole lot of work by all of us.

Finally, one last thought (related to the whole ‘who is and is not your friend’ issue, which is raised in my original post ). To me, a friend is someone you can call anytime of the day or night and on the drop of a dime they’ll gladly drive 75 miles to help you change a tire or travel twice that distance or further to pick you up at the airport at one in the morning. If you live this life with three or four true “friends” by your side, you’re one lucky son-of-a-you-know-what; and unless you know him or her on a highly personal level, your loan officer is not your friend, just like your REALTOR, stock broker, auto mechanic, attorney, etc. is not your “friend” either. Loan officers—just like every other professional–have a job to do, and they will almost always protect their business interest over yours (just like most Realtors will). As more than one commenter likes to say, “buyer beware,” always!

A lot of Flipping Frenzy readers take the time to contact my office with their own suspicions surrounding real estate and mortgage fraud. One such reader, Lisa D. from Michigan, recently gave us permission to share her experience with the rest of our readers.

See if you can spot the fraud:

My husband Peter and I got married in 2002 when we were both 23-years old. Peter had a Bachelor’s degree in Fine Arts and was student teaching. We lived with my parents for a while and then moved into an apartment of our own. I previously worked waitressing a couple nights a week to help make ends meet. Peter eventually secured a job as a teacher at the local county jail. His pay was solid and steady, and he also went back to school to get his teaching license.

With our little family growing, we started looking around for a house we could afford (apartment living was fine but we needed more room). We finally came across the perfect house: A quaint little home in the town where Peter grew up. Since the home was in a state of foreclosure, we thought we might have a good chance to get the house at a discount. We tried to get approved through a traditional loan but were unable to. So we went through a private company and secured a land contract instead, and by Christmas of 2003 we were settling into our first new home.

We lived in the house for a year when Peter started hearing commercials on the radio for Rock Financial–a Quicken Loans Company. The company’s spokesperson promised to qualify people for a mortgage they could afford. We called Rock Financial, made an appointment, and got a really good feeling from our sales representative. He was a very nice man who seemed eager to help us get into a loan with a lowered interest rate. He was charismatic and told us not to worry about a thing.

At the time, after paying on our mortgage for a year and Peter having been at his job longer, Peter’s credit score was improving (it was in the 680’s). That was an important thing for us because my credit was blemished from uninformed college spending. We knew it would be important to keep Peter’s credit healthy so we could at least rely on it while we worked to correct mine.

The sales representative at Rock Financial was able to get us approved for a loan rather quickly. He arranged for an appraiser to come out and do an appraisal on our house and property, which they appraised at $135,000. Our sales representative wasn’t sure that he could get us straight into a 30-year fixed loan, so we started out with an adjustable and had to take out a second mortgage for $12,000 to help pay off some bills.

When we arrived at the closing, we learned that our Rock Financial sales representative was not able to be there. Two ladies that worked for Rock Financial were there instead to go over the closing materials. To say they rushed us through the closing process would be an understatement. We pretty much just signed paper after paper were they told us to do so. When we left, I told Peter I didn’t feel good about what had just happened; I felt rushed and uniformed, and Peter agreed. Together, we called our sales rep at Rock Financial and told him what had happened and how we felt. He apologized profusely and offered to come to our house and go over anything and explain everything we did not understand. We said that we didn’t want him to have to do that; talking to him put us at ease. A few days later we received a package from the sales rep that included a nice popcorn bowl from Crate & Barrel and a $5 Blockbuster Video gift card. That confirmed in our minds what a great guy the Rock Financial sales representative really was.

Our mortgage payment at this time was $720.94 (4.124%) with an adjustable rate mortgage and our payment on our second mortgage was $254 (5.75%), interest only. We felt that this was a good deal. Originally, we had paid $904.00 on our land contract. Even though our payment was a little higher we were able to pay some bills off and also build a garage. Peter and some of his friends built the garage, and we felt blessed to still be in this perfect little home of ours but at a manageable cost.

A year later we started hearing the commercials on the radio again from Rock Financial saying that interest rates were on a rise and homeowners with adjustable rate mortgages should consider a fixed loan. Peter called the sales rep to see what he could do about getting us a fixed loan. We had bought a used truck in 2004 and our payments were $359 a month, and since we were falling behind in the payments, our Rock Financial sales rep said we could take our more money on our second mortgage and that he could get us a fixed rate on both. All he needed, he said, was to get an appraisal on our home for $158,000. Accordingly, the Rock Financial sales rep sent out an appraiser who saw the new garage and the few minor updates that we had done in the past year, and lo and behold, the home appraised for $158,000. This was especially great news seeing that we bought the house for $114,000. We took out more money on our second mortgage to bring the loan to $34,000, and used the money to pay off bills and pay down other debts. Our Rock Financial sales rep got us into a fixed rate of 6.25% on our first mortgage and 5.25% on our second mortgage. Our payments went up to $771.19 on our first mortgage and $148.75 interest only on our second mortgage.

Shortly afterwards, we started having a difficult time coming up with our payments. Not having enough money and having to use credit cards that we had paid off with our second mortgage money back was getting us nowhere.

We called our Rock Financial sales rep who indicated that he wasn’t sure what he could do but that he would look into it and get back with us.

When the sales representative called back, he said that he could help us but only if the house appraised in the $170’s. Knowing our neighborhood as we do, we were apprehensive. A comparable house next door to our own–a two-bedroom with an asking price of $150,000–was on the market for nearly two years. When it finally sold, it fetched only $120,000 or thereabouts. But to our excitement, our appraisal came back at $178,000. The Rock Financial sales rep said we could get some money back on our second mortgage raising the loan amount to $45,000 and our interest rate to 12.8%.

While we were nervous about the interest rate and our payment, our Rock Financial sales representative assured us that using the money we’d get back to pay down our credit cards and giving it three to six months, he would be ale to lower the interest rate on the second mortgage considerably. So we went on to do that and felt an immediate sense of relief.

Several months had past and the new payment of $501.00 on our second mortgage and $1,049.90 on our first mortgage, got us into the same predicament of using credit cards for daily expenses. Peter called Rock Financial to see if enough time had passed to get our interest rate lowered on the second mortgage. Unfortunately the sales rep we’d been dealing with since day one no longer worked there and the person Peter spoke with said there was nothing he could do for us because our credit was so damaged and our debt too high. We were devastated. I had always worked through all these years at night so I could stay home with the kids during the day. I had to start picking up more shifts. I began working five to six nights a week, leaving little time for Peter and I to even see one another. Peter would come home from work and I would leave to go to work as soon as he did.

Long story short, we stopped paying on our credit cards with the thinking being that the most important bill was our house. All of our credit cads are now in collections with one of the credit card companies placing a lien on our house. We have creditors calling daily, but there is nothing to give them. We are not sure how much longer we will be able to keep our heads above water let alone save for our children’s future.

Our worst fear is having to walk away from a house we love so much and put so much time and energy into, but we also feel there may be no other answer. Our dream home has now become a nightmare that we may just have to walk away from, but with such bad credit I’m not sure we’d even be approved for a local apartment.

~ Lisa D.

From what you read, were you able to spot the fraud? If not, read on.

The first thing that should raise the hair in the back of your neck is that the loan officer at Rock Financial placed Peter and Lisa into multiple loans with the promise he would refinance and consolidate them into one fixed rate loan. The problem here of course is that situations change and no one can ever guarantee that you can refinance at a later date in time. This tactic is known as “churning,” like stock and brokerage accounts. Sadly, some mortgage loan officers insure repeat business by placing people into loans that require refinancing or have larger or rising interest rates. When the time comes and the borrower doesn’t qualify, it’s not the loan officer left holding a note they cannot afford to make payments on. In Lisa and Peter’s case, the loan officer did refinance the loans. He did so three to four times in 24 months and made about $17,000 in refi commissions.

Next, in order to get loans approved, some loan officers jack up the borrowers assets to give the false impression that the borrower is more solvent than actually is the case. Other times, a good loan officer gone bad may increase the homeowner’s income to get them qualified. Most often though—and this was the case with Peter and Lisa—the loan officer uses a known appraiser and simply tells said appraiser what s/he needs the value to come in at in order to get the borrower qualified.

Notice too that Peter and Lisa were not required to present any cash at closing. While this is not a problem, per se, when homeowners don’t have to pay the refi costs out of pocket, it is much easier to churn the loans. Instead of coming out of pocket with the dollars, the loan officer uses the house’s equity to pay himself, and the homeowner simply sees it as another number on a settlement statement.

You may think trusting your loan officer is a good idea—as did Peter and Lisa—but at a core level, your loan officer is not your friend. Sure, legally, a loan officer has an obligation to uphold the law and operate within certain guidelines and commonly accepted practices, but not all loan officers—or anyone else who is party to a real estate transaction—operates with integrity. When a loan officer works in coordination with an appraiser—as was the case at Quicken’s Rock Financial—any benefit to you is temporary at best.