Predatory Mortgage Lending 2.0 (Larry versus Abe)

Here we go again! (Sort of). Let me start by saying I am only seeing this particular "predatory" lending practice on the new purchase, not the refinance lending.  

During 2007-2010 we experienced the Subprime Mortgage crisis, fueled, in part, by bank greed and a large decline in U.S. home prices. When the average U.S. home price declined, it became more difficult for borrowers to refinance their loans. As adjustable-rate mortgages began to reset at higher interest rates, home owners felt the pinch to their wallets as their monthly mortgage payments increased. Many fell behind on their monthly mortgage payments and the foreclosures began. If you haven't already watched it, "The Big Short" it a great movie that came out in 2015 which explains this dark time in our countries history and the culpability on the part of the banks. 

No, I do not foresee another Great Recession of the magnitude we experienced 10 years ago, (at least not yet) but I do see the banks, loan officers, specifically, starting to, once again, make questionable decisions in their lending/qualifying practices that financially benefit themselves, and put "you" the borrower at risk. 

This latest "questionable decisions in their lending/qualifying practices" involves your escrow for future property taxes. If you have financed a home in the last few years you are probably already aware that lenders are requesting, if not requiring, you to pay them money each month, in addition to your principal and interest, that they will hold in an escrow account to pay your property taxes, and sometimes home owner insurance renewal, when they come due. When I am conducting real estate closings, I often explain to the buyer/borrower that the lender is going to act as their personal assistant to collect some money each month to pay bills related to their property when these bills come due. My explanation is usually greeted by a smile and head nod on the part of the buyer/borrower that they understand and agree with my explanation.  

In theory, I think the idea of escrow is a great idea. It protects the lender in that they have the borrower's funds to pay these necessary bills when they come due, and it relieves the burden on the borrower to have to come up with a lump sum of money every 12 months to pay their property taxes and insurance premium renewals.  I know that many people have differing opinions on this topic, this is just mine. For what it is worth, my wife disagrees with my opinion on this topic and thinks it is condescending on the part of the banks to lend a person hundreds of thousands of dollars to then not trust that same person to pay their bills on time. When I think about it, she makes a lot of sense. I digress.

Now that we have established the concept of escrow accounts for future bills we need to address how the lenders are determining what amount of money to collect each month. And now we see the "predatory" part of this equation. Lets take a closer look at how your property tax bill is determined. 

Property Taxes are determined on a county level by applying a certain millage rate to the value of the property in order to arrive at the property tax amount.  The variable that fluctuates the most in this equation is the actual value of the home. When the seller of a home has the Homestead Exemption their property tax bill will be much lower that it would otherwise be without this exemption.. The Homestead Exemption, can reduced the tax base by up to $50,000 before the tax bill is calculated. This is huge, and creates a reduced tax bill for the resident homeowner. In addition to this Homestead exemption, there is an additional exemption called the "Save Our Homes" exemption. this exemption was created by the Florida State Constitution and limits the annual property tax increase to 3%, or the Consumer Price Index (CPI) whichever of the two amounts is the lower. I will post a future blog that goes more in depth on the benefits of Homestead Exemption in Florida. 

What I have been seeing Loan Officers due lately is use the current owner's property tax bill (yes, with the Homestead and Save Our Home Exemptions) as the basis to calculate the borrower's (future homeowner) escrow hold back for future tax bills. Why on earth would a loan officer intentionally use a tax bill they know it too low, for an escrow calculation? The answer I have been given by the loan officers is simple...because it qualifies more people for loans they may not qualify for it they use the actual estimated tax bill which is based on the new buyer's purchase price. WHAT!?! So Loan Officers (not all but some) are qualifying home buyers based on numbers they know are not accurate.

This practice has worked well for the Loan Officers over the past few years. Let me explain in my example below.

 Jack and Jill buy a Florida vacation home in 2019. They reach out to Larry the Loan Officer for their home loan. Larry gets them a $300,000.00 mortgage at 4.1% interest. Larry uses the previous homeowners property tax bill to qualify Jack and Jill for their new home loan. Lucky for Larry, the sellers have lived in the property for the last 20 years and they have had the Homestead Exemption in place the entire time. As a result, their property tax bill is very low. This allows Larry to qualify Jack and Jill for a loan they may not have been able to qualify for if  Larry has used the actual estimated property tax bill to calculate their monthly payment. Larry is the man! Larry gets Jack and Jill the loan that Loan Officer, Honest Abe was unable to get for them. Larry is Jack and Jill's new best friend and they recommend Larry to all their friends. 2019 comes to an end and Jack and Jill pay the property tax bill from the funds being held in escrow. Their property tax bill hasn't yet adjusted for their new purchase price so they are able to benefit from the previous owner's Homestead Exemption and lower tax bill. Fast forward a year and the trim notice for the 2020 tax bill arrives in the mail and the bill has increased by $4,000.00 over the previous years tax bill. Shortly after the trim notice arrives, Jack and Jill get a letter from their lender letting them know they have a tax escrow shortage and that there monthly escrow is going to increase by $1,000 to recoup for the escrow shortage and also adjust for next years tax bill. Jack and Jill can not afford and extra $1000 per month added to their monthly mortgage payment. Oh No! What are they going to do? Of course they are going to call the miracle maker, their best friend, Larry the Loan Officer. Having no idea that Larry is the one that put this ball in motion back in 2019, Jack and Jill are now looking to their trusted friend to help them out. "Not to worry" Larry tells them, "we can refinance your home for you at today's lower rate of 2.6%. we can take care of  tax increase and lower your monthly payment all at the same time." 

The above example has played out time and time again over the last several years. It has given the loan officers an opportunity to get two commissions from two loans. A purchase loan and a refinance loan a few years later. As interest rates have dropped this predatory lending practice has worked great for the Loan Officers and bolstered their credibility and abilities with the unsuspecting home buyers. However, now that we are starting to see an increase in the interest rates, what is going to happen next year when a home buyer similarly situated to Jack and Jill do not have the ability to refinance at a lower interest rate? How are they going to come up with the money for the increased monthly payment? Only time will tell. However, those of us that have been in real estate through several economic cycles know how it will turn out. Jack and Jill will be foreclosed upon and they will never know that Larry the Loan Officer had anything to do with it. 

WARNING; If you are purchasing a home, ask the Loan Officer how he/she is calculating your monthly escrow for future property taxes. Make sure they are using a tax calculator based on your purchase price and the current millage rate for the county in which your home is purchased, not the previous owner's tax bill.  Don't wait until you are at the closing table because it will be too late. 

If you are a Loan Officer reading this post, do everyone a favor, act more like Abe, and less like Larry.