by Stephen H. Dunham

Everyone has heard of insurance claims, but what is a mortgage claim?

The answer is easy, though complex. Mortgage claims basically are claims that one mortgage company files against another.

While the borrower has a direct bearing on whether there is a mortgage claim, mortgage claims do not directly affect the borrower. As such, this article is more of an informative one for those who are curious than one of essential assistance. However, it has everything to do with what you have heard about failing lending institutions in the news.

MORTGAGE INDUSTRY BASICS

After borrowers have closed on their loans, the mortgages are bought and sold among mortgage companies and investors like commodities. That is because they are commodities. They are investments.

The mortgage industry is much more than just a lender making a loan and the borrower paying it back to that lender. The initial making of the loan is called the primary - or retail - market. But then the lender will often sell the note to an investor - usually another mortgage company. This is the secondary - or wholesale - market. The secondary market is HUGE - especially in subprime lending (subprime simply means the borrowers’ credit scores are lower than average, and sometimes significantly so).

When your loan is sold and bought, you should receive a “goodbye letter” from the seller, and a “welcome letter” from the buyer (but not necessarily in that order). Unfortunately for the consumer, she has little insight into these inner workings and can understandably become easily confused when she gets a late notice from the new mortgage company after having made her payment on time to the old mortgage company because she never got the memo that her note had been sold.

Many of the large mortgage banking institutions, such as Wells Fargo and Bear Stearns, will then securitize the loans. They bundle them together and put them into a bona fide Wall Street investment security that is traded on the stock exchange for investors to buy and sell.

Servicing is another component that makes things even more interesting. The servicing company is the one to whom you make your monthly payments. They are the ones you call with any questions. They are the ones who deal with the borrower on late payments or any other issue regarding the loan. However, they may not necessarily be the owner of the loan, though they might have been at one time.

So, here is a fun scenario for a quick review of what we just discussed… You get your loan from Bank A. You make your payments to Bank B, while your loan is actually owned by Bank C, all the while it is tied up in a security being traded in the stock exchange.

MORTGAGE CLAIMS

The buyer of a mortgage loan is eligible to file a claim against the seller of that loan when certain agreed-upon conditions stated in their contract terms (called representations and warranties) are not met for whatever reason. There are easily over 4 dozen different claim types. Some carry the recourse for monetary compensation (”Monetary” claims, sort of like a fine), while others can require the seller of the loan (which is usually the originating lender) to buy back the loan (”Repurchase” claims). We’ll take a look at a few of the most common. The first two, Premium Recaps and EPDs make up between 80%-90% of all claims filed.

PREMIUM RECAP

Premium Recapture means that the borrower paid off or refinanced the loan earlier than the lender/seller represented that he would, and therefore the seller owes the buyer of the loan some sort of monetary compensation. As a matter of protecting themselves against this, some lenders require their borrowers to pay a substantial penalty if they pay off their loan before a certain date.

For example in one of my situations, I had a 30 Fixed/ARM. It was at a set interest rate for the first two years, and then it was to go variable. If I paid it off before the first 12 months, then I was subject to paying an enormous percentage of the first year’s interest that would have equated to about $8,000.

My property was mostly land and the best rate I could find from a very small pool of eligible lenders was 10%. Knowing that my interest rate would ultimately go variable and could therefore go substantially higher, I was motivated to refinance as quickly as possible - as quickly as possible after the first 12 months that is, and definitely before the 24th month!

EARLY PAYMENT DEFAULT

Typically referred to as EPD, this is when the borrower fails to make the first x payments during the first n months. For example, the seller might represent and warrant that the borrower will make at least 4 of the first 6 payments on time and that no payments will ever exceed 60 days late. There can be lots of ifs, ands, and buts for the configuration of the conditions.

EPDs are usually repurchase claims, meaning that the buyer mandates the seller to buy that loan back right away. This can often involve having to desecuritize the loan if it is bundled into an investment security that is being offered on the market.

TAX

Tax claims usually stem from the buyer of the loan being notified by the property’s taxing authority that there are back taxes owed. That means that the taxes are the seller’s responsibility according to their agreement. This is a monetary claim for which the seller must pay the taxes (and deal with the borrower themselves if they want to be reimbursed).

QC & MISSING DOCS

Quality Control and Missing Documents claims are typically related to paperwork errors. Depending on the exact circumstances, they can be either monetary or repurchase claims.

OCCUPANCY MISREP

When a borrower tells the lender that the property is occupied (regardless of whether rental or primary residence), and then the seller/lender tells that to the buyer, and the buyer finds out that the property is not occupied as was represented, the buyer can file an Occupancy Misrepresentation claim against the seller.

BEHIND THE SCENES

If you have ever had to deal with a mortgage company, perhaps you experienced a little frustration or confusion. This would not be surprising given the complexity of their business. There are many different departments specializing in many different things.

The mortgage industry is about 15 years behind the times from a technology perspective (in this writer’s professional opinion), and it may be a while before it can totally catch up. While trying to synchronize all the different things going on with lots of different groups in a very chaotic environment, sometimes things can happen - or not happen.

There are people pushing big carts back and forth, stacked high with paper loan files. Lots of people handle these files. Files get misplaced. Emails are sent out company-wide asking if anyone has seen the Smith file or the Jones file, or the J file or the K file (like Will Smith and Tommy Lee Jones in MIB, get it!).

Usually the files are found within a few hours or a few days. But if you ever call your mortgage company with a question and they say that your information is not currently available in their computer, at least you will know why.

IT COULD HAPPEN

While most of us don’t like the idea of our sensitive, important, and personal financial information lost in the machine, imagine this scenario relating to claims. A seller finally pays a repurchase claim. The payment is received by one of the many groups working at the incumbent mortgage company.

The group receiving the payment sends it to the Deeds Department instead of the Claims Department. The Deeds Department thinks that the loan has been paid off and releases the deed to the borrower.
The borrower now legally owns her house free and clear - all for not having made payments on it! And, the buyer just gave away the house that the seller just bought back.

For the borrower, that’s better than winning the lottery since not only does it not cost anything, the player actually saved money. And yes, it has actually happened. However, not only it is unethical to not make your mortgage payments, it’s also a great way to lose your home, which is the most common outcome.

CONCLUSION

The secondary mortgage industry is gigantic, and therefore so are mortgage claims. A large mortgage company can easily file $1 billion to $2 billion per year. Now, if you recall the news headlines of early 2007 that said something like “Mortgage Meltdown Imminent - US Economy about to Crash!”, you can now have a little more insight into what was happening.

There are a lot of lenders who have no interest in owning or servicing loans, but who only want to originate them and sell them quickly. A lot of them over the past few years have worked hard to keep up their flow volume of new loans even though there was a national trend of declining credit among borrowers.

As such, the quality of the loans decreased in order to maintain the volume. Ultimately, the buyers of those loans are going to exercise their legal options to protect themselves. That means filing claims against the sellers. When a seller gets hit with claims it can’t pay, they close their doors.

Sebring Capital Partners, Mortgage Lenders Network (MLN), People’s Choice. These are just the top layer of dust on a big mound of failed or floundering players. Additionally, there are institutional giants that are downsizing their subprime lending activities or leaving them altogether, making massive employee layoffs as they go. This affects the job market, as well as the lending market.

So, while mortgage claims are an internal business among mortgage companies, you can see how they are integrated into the grand scheme of things and might affect the borrower.