The advantages of builders owning mortgage companies are huge and easy-to-see. Capturing customers' loan business ensures control over the entire transaction from making sure buyers are credit-worthy to guaranteeing the closing date. And they can provide another revenue stream to boot.
But companies like Beazer Homes USA are learning that being a builder in the mortgage business can have a significant downside, too.
The news that the U.S. Attorney's Office in the Western District of North Carolina recently subpoenaed Beazer Homes' documents related to its mortgage origination services rocketed and reverberated through the builder community with the speed and impact of a cruise missile, no doubt sending other builder executives scrambling to assess potential risk in their own lending operations.
The subpoena and inferred investigation likely were sparked by a series of articles by The Charlotte Observer exposing the high-foreclosure rates on FHA-backed loans that Beazer originated on starter houses in neighborhoods in the Charlotte area.
But Beazer isn't alone. Dominion Homes ran into problems related to its mortgage business last year and KB Home the year before that.
Last year, HUD, which administers the FHA loan program, found Dominion's customers were defaulting on FHA loans more than twice as often as other FHA borrowers. HUD found problems with one in every four of the 151 Dominion loans it investigated at random. The problems included overstating buyers' incomes, enticing them with improper incentives, and failing to verify their employment. Dominion ended up abandoning its auxiliary finance business to create a joint venture with Wells-Fargo Home Mortgage.
That's a similar path KB took in 2005, when it partnered with Countrywide Financial Corp. to create a joint-venture-affiliated lender. The partnership came after KB agreed to settle 13 alleged violations of HUD requirements by paying a $3.2 million fine, the largest ever collected in the 30-year history of HUD's Mortgagee Review Board. The alleged violations included approving loans to borrowers who were not eligible, approving loans based on overstated or incorrect income, failing to include all borrowers' debts, failing to properly verify sources of funds, and failing to ensure gift letters met HUD requirements.
Patterns of unusually high-foreclosure rates often trigger audits by HUD's Office of the Inspector General. And with default rates likely to continue climbing, some builders' mortgage companies soon could be under scrutiny.
Appreciating home prices in the past boom years covered up a host of issues, including overpaying for a home or putting no equity in. But, like an outgoing tide, a market in which home prices are falling exposes a lot of things nobody thought much about while they were underwater.
"The homeowner might not notice," that the home is becoming unaffordable or is losing value, says William Apgar, senior scholar at the Joint Center for Housing Studies at Harvard University. "They get through the first couple of years, but when they get stuck and look back and start thinking they've been had ? It gets tricky if you end up with a house that has a mortgage that is bigger than the true market value of the home ? That comes back to bite everybody."
Apgar surmises that some builders already may be getting out of their affiliated mortgage businesses. After, all they are home builders first; their lending arms were designed mainly to smooth business operations and add to the bottom line.
However, making money through mortgage affiliations is just a lucky bonus if it happens, says Jim Graf, vice president and partner in the Sharrow Group consulting firm. It's really all about control over closings, customer satisfaction, and carrying costs.
"Builders do not look at the mortgage company as much as a profit center as they do a control center," says Graf. "Their biggest concern is when that house is done on the 26th that it closes on the 27th."
Still, operating a mortgage company isn't for sissies. Making sure it is compliant with the many rules that govern lending is paramount. "There is no room for error on that," says Graf. "You have to make absolutely certain that everybody out in the field is doing everything according to Hoyle. That is incredibly difficult."
In his years of experience overseeing builders' lending operations, Graf would make unannounced office visits and ask each of the processors to look at the files in their drawers. "The chances are extremely slim that you are ever going to find something wrong, but the mere fact that you do it makes processors cognizant that you are going to do that when you come in. You have to do it and if you see something being done incorrectly, you have got to take action immediately," he explains.
It's also important that loan underwriters don't cave under the inevitable pressure from the builders' sales agents and write a loan that shouldn't be written. "Every sales person you come across is going to do that," says Graf. "It's not the deviation. That is the norm."
And having firewalls that screen credit information flow between mortgage and sales also are critical for affiliated mortgage companies.
"You have to serve two masters on this and it's not an easy thing to do," says Graf. However, he thinks affiliated mortgage companies are almost essential for builders. "The mere fact that all the big boys have it kind of makes you think that it does make sense," he says.