Inside The Countrywide Subprime Lending Frenzy

The New York Times has a very interesting article about the business practices that resulted in Countrywide’s dramatic spiral into the dirt. Recently, the nation’s largest mortgage lender had to tap $11.5 billion in emergency credit and was the beneficiary of a $2 billion investment bailout from Bank of America.

What happened? Essentially, Countrywide’s operation was set up to squeeze the most amount of money from people who couldn’t afford to get a “conforming” mortgage, either because they were low-income borrowers or because they had poor credit. Subprime mortgages were much more profitable for Countrywide because of the early repayment penalties, fees, and the fact that they were a much more attractive investment for Countrywide to sell on the secondary market.

The NYT spoke to several Countrywide brokers who confessed that the commission structure was set up to encourage brokers to get as many subprime mortgages as possible—even if the borrowers could qualify for a much more attractive loan. From the NYT:

Regulatory filings show how much more profitable subprime loans are for Countrywide than higher-quality prime loans. Last year, for example, the profit margins Countrywide generated on subprime loans that it sold to investors were 1.84 percent, versus 1.07 percent on prime loans. A year earlier, when the subprime machine was really cranking, sales of these mortgages produced profits of 2 percent, versus 0.82 percent from prime mortgages. And in 2004, subprime loans produced gains of 3.64 percent, versus 0.93 percent for prime loans.

One reason these loans were so lucrative for Countrywide is that investors who bought securities backed by the mortgages were willing to pay more for loans with prepayment penalties and those whose interest rates were going to reset at higher levels. Investors ponied up because pools of subprime loans were likely to generate a larger cash flow than prime loans that carried lower fixed rates.

As a result, former employees said, the company’s commission structure rewarded sales representatives for making risky, high-cost loans. For example, according to another mortgage sales representative affiliated with Countrywide, adding a three-year prepayment penalty to a loan would generate an extra 1 percent of the loan’s value in a commission. While mortgage brokers’ commissions would vary on loans that reset after a short period with a low teaser rate, the higher the rate at reset, the greater the commission earned, these people said.

Persuading someone to add a home equity line of credit to a loan carried extra commissions of 0.25 percent, according to a former sales representative.

“The whole commission structure in both prime and subprime was designed to reward salespeople for pushing whatever programs Countrywide made the most money on in the secondary market,” the former sales representative said.

CONSIDER an example provided by a former mortgage broker. Say that a borrower was persuaded to take on a $1 million adjustable-rate loan that required the person to pay only a tiny fraction of the real interest rate and no principal during the first year — a loan known in the trade as a pay option adjustable-rate mortgage. If the loan carried a three-year prepayment penalty requiring the borrower to pay six months’ worth of interest at the much higher reset rate of 3 percentage points over the prevailing market rate, Countrywide would pay the broker a $30,000 commission.

When borrowers tried to reduce their mortgage debt, Countrywide cashed in: prepayment penalties generated significant revenue for the company — $268 million last year, up from $212 million in 2005. When borrowers had difficulty making payments, Countrywide cashed in again: late charges produced even more in 2006 — some $285 million.

The company’s incentive system also encouraged brokers and sales representatives to move borrowers into the subprime category, even if their financial position meant that they belonged higher up the loan spectrum. Brokers who peddled subprime loans received commissions of 0.50 percent of the loan’s value, versus 0.20 percent on loans one step up the quality ladder, known as Alternate-A, former brokers said. For years, a software system in Countrywide’s subprime unit that sales representatives used to calculate the loan type that a borrower qualified for did not allow the input of a borrower’s cash reserves, a former employee said.

A borrower who has more assets poses less risk to a lender, and will typically get a better rate on a loan as a result. But, this sales representative said, Countrywide’s software prevented the input of cash reserves so borrowers would have to be pitched on pricier loans.

This article should be required reading for anyone who is currently in the market for a mortgage. You cannot blindly trust your mortgage broker. You just can’t.

Inside the Countrywide Lending Spree [NYT]
(Photo:Chika)

Comments

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  1. badgeman46 says:

    My mortgage is with Countrywide, and I will tell you that their broker kept pushing and pushing for all the “voodoo” loans. It was almost like 30 year fixed was hidden better than 10 dollar DSL. She kept telling me, “you’ll sell in two years,” “look at the monthly savings” etc, etc. I ended up getting the 30 year fixed loan I asked for, but it came with much resistance, and more badgering than you would do trying to cancel an AOL account. Imagine what someone less savy would have been suckered into. These brokers must have been making crazy commissions off of these black magic morgatges, as it seemed like it was the only product available.

  2. Jean Naimard says:

    This is very great! It shows how the “frea mahkit” can be abused by “honez bidznesmen” to the point of bringing down the house.

    This considerably helps drive home the point that financial markets should be more regulated in order to protect Society against a little bunch of rogue unethical financiers.

  3. Anonymous says:

    @badgeman46: So are you selling in two years?

  4. dbeahn says:

    @JeanNaimard: “This is very great! It shows how the “frea mahkit” can be abused by “honez bidznesmen” to the point of bringing down the house.”

    Oh yes, and the poor consumers are the innocent victims. Right. Because how could ANYONE be expected to do the math and figure out that $1000 a month times 12 months times 30 years doesn’t add up to the price of the house, let alone figuring in interest.

    I have no sympathy for people that are too stupid to do basic math and smell a rat, and no sympathy for the people that having done the math and smelled the rat were too lazy to do the research and see what they were getting into.

    I say we let nature take it’s course, and have a field day in the foreclosure market.

    But what will probably happen is the Guverment will step in and spend MY tax dollars to bail these morons out.

  5. JustAGuy2 says:

    Shocking, a company incenting its salespeople to sell the most profitable products. Really, really surprising.

    Also, really shocking that you might benefit from comparison shopping the offer given to you by one vendor with other vendors. Or don’t bother, it’s not like the difference in interest rates can add up to tens of thousands of dollars.

    What’s the surprise here, people?

  6. JustAGuy2 says:

    @JeanNaimard:

    Actually, it says absolutely nothing about that, but nice try anyway. There’s no allegation of fraud here – the fact that people bought products from Countrywide when they could have done better elsewhere is nobody’s fault but their own.

  7. TheRealCMJ says:

    You mean a company incents their employees to sell the thing that makes them the most money? And those sales people then do the thing that their compensation plan incents them to do?

    Shocking.

    In other surprising news, water is wet and fire is hot.

  8. code0 says:

    Every comment I seem to see says that Countrywide pushed what was described before as “voodoo” mortgage. My mortgage is through Countrywide and I had no issues with the loan officer at my local office. I ended up with a 30 year fixed IFA (www.ifahome.com) loan at a bit over 6%.

  9. ArtDonovansDrunkenLovechild says:

    OK, well, Im not sure where they got this information but Countrywide commissions, like 90% of all mortgage companies, are based on fees collected. These include points on the front and back, and that is all. Commissions are not based on appraisals, titles fees, or any other fees or factors.

    A prepay penalty usually means a .125 or .25 lower rate. Now, what is usually the case is customers dont want to pay any upfront fees (and in the case of 100% loans they cant pay them). So what a loan officer will do is pitch an arm (.75 or so lower rate then a fixed) with a prepay. With that they can lower the rate 1% to justify an upfront fee, or they can sell the higher rate with points on the back (usually 2 points = 1% rate).

    The problem is some companies (Amerquest/Aegis among others) were selling 2/28 arms with a 3 year prepay. This needs to be addressed by congress to protect customers.

    Predatory lending laws have made it almost impossible to get a loan in some areas of the country (notably DC and West Virginia) and need to be universal. Brokers or Lenders who made predatory loans need to be prosecuted. Borrowers who took loans they couldnt afford should be foreclosed on if they cant find a new loan, as this will protect the market and force real dynamic change.

  10. ColoradoShark says:

    @badgeman46: So why did you put up with that crap when there are lots of places to sell you a mortgage? It’s a serious question, not a snide comment.

  11. nucleotide says:

    I refinanced with countrywide in 2003. I didn’t have any problems qualifying for a fixed rate loan with no points. However, there was some stuff that was slimy. They tried to slip a HELOC into the paperwork even though I clearly told the smarmy sales rep that I didn’t want it. Then there was the part were they quoted me 6% and tried to change it up later. It was a crazy fight to get these assholes to do what they promised. It’s sucked because it’s such a major pain to restart the process that I had to grit my teeth and bear it. I so wanted to tell them to fry ice.

  12. ironchef says:

    15 or 30 year fixed is the only way to go at these cheap interest rates.

    I still remember the days of 13% interest mortgages in the Ronald Reagan days (when he went out of control with spending and the deficits drove up interest like CRAZY)

  13. thepounder says:

    What worked out nicely for me 6 years ago when I bought my place was living right next to a huge Army installation, and being former Army I used my VA benefit. Also nice was that the mortgage broker and Realtor I worked with to help me slog thru all the paperwork were former military, and I never once felt like I was being shafted & I got exactly what I wanted – 30 year fixed, at 6.25%. Having served in the Army indeed has its perks.
    And I’m now with Countrywide, so I can’t wait to see what all becomes of this mess.

    Does anyone have reason to believe that there’s a general concentration of sheisty mortgage brokers in, for example, bigger cities? I ask because where I live has a lot of “country living” and a lot of military folk & the big city is over an hour away, and I’ve not personally heard of anyone I know getting shafted while buying a house. Just curious.

  14. ArtDonovansDrunkenLovechild says:

    @thepounder: Its not so much smaller towns, as people who use brokers they live near, mainly cause you wind up seeing your customers out and about. More often then not most of the problems we hear about are from the call center brokers or lenders. In a lot of cases those borrowers never meet the LO in person. Thats not always a bad thing as those big shops can get better rates, and often times are quicker and more organized. On the other hand, in smaller communities you have that extra incentive to be honest, as you can get destroyed by bad word of mouth.

    The military factor is another plus. When I was hiring new LOs I always gave former military people a shot. They were usually solid workers, and often could tape into the large local military population (I didnt care for the VA loans though, not usually the best deals). I had a former AF officer who is now making about 40k in fees a month just doing FHA style loans near APG. He doesnt charge much per loan but he has a great rep on base and does 10-12 loans a month just on word of mouth.

  15. anatak says:

    This is exactly what should happen to companies that engage in shady, stupid business practices – sans the bailouts. Screw you too, Countrywide.

  16. shiwsup says:

    @dbeahn: … except that the companies get bailed out as well. They knew the business model when they got the ball rolling. The whole thing is built on (mis)calculated risk.

  17. Trai_Dep says:

    A friend worked out a fixed-rate and midway thru the process, noticed that the broker switched the papers on her. Clean swapped them out for an ARM. “Accidentally”, of course. Tee Hee.

    In spite of being midway through a laboreous process, she walked.

    It’s fraud. Blatent in her case, more nuanced in others.

    Sure, the borrower has some responsibility, but a bank’s JOB is to approve loans in a responsible manner. Which they didn’t. So, no sympathy. Let them hang. And the Wall Street houses that created the vehicles for shifting risk away from the lendor, which is the core flame igniting this mess.

  18. GearheadGeek says:

    Caveat Emptor. If some schmuck walks up to me and says “Hey, I’ve got a nice shiny car that was 10′ underwater in New Orleans during Katrina, CHEAP!” and I buy it, it’s my fault. If he’s hidden the fact that it was flooded, “cleaned” the title, and pretended the car was from the desert somewhere, he’s guilty (I’d still probably be stupid to buy it, but that’s another story.)

    If they’re pushing stuff that makes them money but they TELL you what they’re pushing, and they really sign you up for what they’ve been talking about, there’s no crime and I’d say no real moral dilemma on their part.

    Consumers really do have a duty to at least pay attention to what they’re signing and what they’re promising to do for the next 30 years. Mortgage brokers and lender reps have a duty to be truthful about the terms of what they’re offering.

    This whole real estate disaster is a lesson in social darwinism. The scummy bottom-feeding mortgage companies are taking it in the shorts. The mouth-breathing marks..er..customers who can’t figure out that they can’t afford a $600k mortgage on $60k per year if they like to eat occasionally are taking it in the shorts. Many of the slimy mortgage brokers who knew they didn’t have any long term exposure are looking for jobs (insurance agents? used cars?) because marks won’t be refinancing every year for a while. Investment banks and mortgage companies that didn’t forget that it’s bad to have all your eggs in one basket will lose some money on their riskier paper, keep making money on their solid loans, and miss their earnings targets for a while because the market is going to suck.

    There’s plenty of blame to go around, and Countrywide doesn’t deserve all of it.

  19. D-Bo says:

    I agree that the blame doesn’t fall solely on Countrywide, however the article demonstrates how they employed tactics to aggressively push people into these loans, even ones who should have qualified for better loan products. Good article.

  20. badgeman46 says:

    Colorado shark: Countrywide was the prefered lender with my homebuilder. I wasn’t contractually obligated to them, but the builder would pay closing costs if I used them. In the end I got what I wanted, but the broker was like a brick wall, which highlights why consumers really need to be educated about mortgages.

  21. jetmore says:

    @Justaguy2:

    There’s no allegation of fraud yet, but I wouldn’t be surprised. According to the article, the way Countrywide’s loan-figuring software was written, there was no place for the broker to add in any cash the borrower could contribute. So people were being sold more expensive loans than they should have gotten. I think that will probably raise some questions.

  22. G1ZM0 says:

    Countrywide is very deceptive in their descriptions.
    Their “30 year fixed 15 first” is an interest only.
    The agent we spoke with was more than willing to fudge the numbers to get us a loan that was way more than we could handle.

  23. ARP says:

    I keep seeing rants about how THEIR tax money is being used to bail out stupd consumers. While I share your frustration, I haven’t seen an instance where this has actually happened (yet). What I HAVE seen, is the Fed, contributing money to the market to help those poor little mortgage companies who sold mortgages to people they probably knew could not repay. Where are all the rants about that? Actual question: is the Fed funded by taxpayers? I get the impression that its indirectly funded since its technically private.

  24. philipbarrett says:

    @dbeahn:
    Exactly – do the math! Better still, Google “Time Value Money,” buy one of these [www.shopping.hp.com] and watch the color drain from from the loan shark’s face when you start punching numbers in their office! Car salesmen get really squirmy.

  25. Mr. Gunn says:

    @d-bean: It’s all about miscalculating risk, I.E. getting greedy. This is an example of looking at the short-term profit available, and not considering the long-term. The rising crime rates are another example of short-term thinking coming home to roost. We could have been trying our hardest to educate the underprivileged, but no, we decided to hide out in the suburbs and in private schools, because we didn’t want the governmenr taking our tax money and wasting it on those worthless criminals. Look what’s happened now. Those people you’re hiding from are knocking on your door! They’re selling your kids crack. They’re molesting your kids in gym class, and you can’t hide anymore, and all because you didn’t want to pay an extra $100 a year out of your paycheck.

    There’s no cure for stupid, dbean, and I wish I could hide from y’all, but I can’t. I don’t know what to do.

  26. Trai_Dep says:

    @GearheadGeek: “Caveat Emptor. If some schmuck walks up to me and says “Hey, I’ve got a nice shiny car that was 10′ underwater in New Orleans during Katrina, CHEAP!” and I buy it, it’s my fault.”

    Sure. But in many cases, the situation is more like, some guy walks up to a sixteen-year-old kid and offers a car. Says that it’s in great condition. Offers a free iPod and a $1,000 cash rebate on the spot. While loading him up on marguiritas. Served by bikini babes. Says the car’s perfect since it’s been sitting under a dropcloth in the desert for the last three years, when it’s not being lovingly maintained by the owner who only drives it to rescue puppies 4x/yr.

    After said car is bought, the new owner is flipping thru the car owner manual, all 300pp of it. And on page 258, sees a faintly-written waiver paragraph of inexplicable legalese that, when given to a lawyer, explains that the car “may” have been a Katrina car.

    The subprime brokers aren’t (haha: should say, WEREN’T!) known for their sense of giving back to the community while selflessly educating a group uneducated in economic matters. Relying only on contracts that explained, simply and clearly, with charts, the fiscal implications of every permutation of the loan. Quite the opposite. And, again, it’s broker’s JOB to evaluate credit-worthy customers.

  27. Keter says:

    I fired my first mortgage broker for continually trying to force me into weird loans when I had great credit and all I wanted was 30 year fixed. I found a local bank and got exactly the loan terms I wanted. I think it helped that I specifically told the loan officer about my experience with the mortgage broker and told him that “any surprises would mean I would walk and not look back.” Then the bank turned around and sold that loan to Countrywide. That was OK, because the loan officer might have been sharp, but the bank’s customer service turned out to be staffed with morons.

    In six years now, there’s been no problem with Countrywide, and I hope it continues that way. This whole thing is making me nervous…

  28. mac-phisto says:

    i think they should help all these people stay in their home by levying a tax ONLY on people in fixed 15′s & fixed 30′s. if you really think about it, the only reason you’re sitting pretty in your holier-than-thou historic low conventional is b/c a few schmucks got in over their heads on exotics.

    ain’t no way banks would be lending a couple hundred K for a measly 5% unless they had a line of suckers willing to subsidize that crap-ass ROI.

  29. SybilDisobedience says:

    @Badgeman46:
    Do you mind me asking why you stuck with Countrywide after the broker gave you such a hard time? I’m not trying to sound confrontational – I really want to know if there was some other incentive there that made you put up with that crap. When we were shopping around for a mortgage, we nearly went with Quicken – until they tried to change our loan terms to something not nearly as desirable as the original ones, and became so obnoxiously pushy that we called off the deal with them. We’re with Chase now and we’re pretty happy.

  30. badgeman46 says:

    @SybilDisobedience:

    Sure, there were more incentives. No closing costs, and an extra 2500 towards my down payment, as they were the builder’s preference. In the end I got the rate and financing I wanted. And this wasn’t really limited to countrywide either, it was pretty prevalent. I don’t know how it is now, but asking for a 30 year fixed loan a year ago was like asking for an old school tube TV. They couldnt figure out why you would want such a thing!