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Mortgage industry regulators nationwide were warned recently to be on the lookout for a long-outlawed "churning" scheme in which unscrupulous mortgage brokers generate thousands of dollars in extra fees by convincing unwitting borrowers to refinance their loans every few months.
Though lenders maintain no consumers are getting hurt, authorities say the opposite is true. Not only do borrowers who participate in the multiple refinance schemes fail to build equity, said R.J. Harvey of the Illinois Office of Banks and Real Estate, they also could lose their good credit standings. "Each time they refinance, their credit scores drop," explained Harvey, who sounded the alarm at a conference late last month. "Eventually, they won't qualify and they'll be stuck with a higher [mortgage] rate."
Perhaps even worse, participants also could unwittingly be named as co-conspirators in a plot that investors in mortgage-backed securities say damages the integrity of their investments.
Churning was banned by the U.S. Department of Housing and Urban Development more than a dozen years ago. Fannie Mae and Freddie Mac, the two largest investors in mortgages, also prohibit the practice by refusing to take any loan in which the broker has taken another application from the same borrower for the same property or has entered into an agreement to do so within a certain number of months.
Because Fannie Mae and Freddie Mac touch perhaps 60 percent of all home loans and lenders like to have the option of being able to sell their loans at any time, most mortgages are written to conform to the their rules. Despite these prohibitions, several lenders in Illinois seem to have revived the ploy, Harvey said. And other industry experts say that it is alive and well in many other states, including New York.
The scheme works like this: Brokers, targeting borrowers with high interest rates, promise to refinance loans to the current market rate or sometimes even lower. But rather than make the jump down to the lowest rate in one fell swoop, lenders step the rate down in five- or six-month increments during an extended period.
Because the first refinancing is still above market, brokers can obtain a premium price for the mortgage when it is placed with a lender which actually funds the loan and then sells it on the secondary mortgage market, where Fannie Mae, Freddie Mac and other investors operate.
After a few months, the loan is refinanced again pursuant to a prearranged agreement with the borrower, but only to a slightly lower rate so the broker can once again sell the mortgage for a premium price. Then the process is repeated again and again until the rate that was originally promised is reached.
Each time the loan is refinanced, the broker establishes what's known as a "temporary buydown" by using all or part of the proceeds from the loan to pay the closing costs and fees on behalf of the borrower.
No charges have been filed against brokers in Illinois yet because it has yet to be determined whether churning is illegal. Harvey told regulators that he has alerted HUD, Fannie Mae and Freddie Mac, all of which are in the process of reviewing loan files to see if their rules have been broken.
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