In the newest scandal at the beleaguered Department of Housing and Urban Development, mortgage bankers have been promising homeowners nationwide the impossible: no monthly mortgage-interest payments for an agreed-upon period or "no costs" for a refinancing.
The kicker is that the bankers have actually been able to deliver on at least some of their promises.
That's the upshot of a new investigation completed by the HUD inspector general and obtained under a Freedom of Information Act request. The report details the operation of what's called the "live-free" refinancing game. Investigators say that hundreds of millions of dollars of such loans may have originated during the past several years.
Here's how they work: Say you bought a home with a Federal Housing Administration-insured mortgage in the mid-1980s with a then-typical 13.5 percent rate. You get a phone call from a mortgage banker offering a tantalizing opportunity. If you'll simply refinance the loan to 12 percent temporarily, the company will pay the first four months of your mortgage interest.
After about six months, the lender will then refinance you again to a still lower rate -- 11.5 percent. And if you're willing, you can go for a third refinancing -- this time to a rate near the prevailing market rate of 11 percent or 10.5 percent.
Sound attractive? Indeed. Here's another form of the scheme, as outlined by the inspector general. Instead of "living free," you get your series of two or three refinancings totally without closing costs. The lender guarantees you an end rate on the loan just above the regular market rate, as long as you consent to periodic refinancings along the way.
The concept has been so salable to consumers, HUD investigators say, that large numbers of homeowners have been enticed into the program during the past two years. In the case of just one of the mortgage lenders studied, the Carl I. Brown Co. of Kansas City, HUD says it identified 644 homes that had multiple refinancings at above-market rates during the past 24 months. Asked for comment on the HUD report, a Carl I. Brown official said she could not respond.
Nationwide, investigators said they have identified $462 million worth of recent "premium-rate" mortgage pools that may involve the multiple-refinancing technique.
What's the problem with the "live-free" and no-cost techniques? For starters, according to the HUD inquiry, they are not the bargains to homeowners that they appear to be at first blush. Because lenders never offer consumers the right to refinance directly to the current rate, but insist instead on a multi-step sequence through two or more separate transactions, the actual savings are not impressive.
In the case of one Phoenix homeowner, a mortgage company offered to refinance a $55,031 FHA loan at 13.5 percent to 13 percent at "no cost." After six months of payments, the loan could then be refinanced to 12.5 percent. Six months after that, a third refinancing would provide a rate of 12 percent.
The prevailing market rate when the offer was made, according to HUD investigators, was 10.5 percent. The first "no cost" refinancing saved the consumer barely $9 a month, dropping the payment from $629.83 to $620.66.
The flip side of this shows the true motivation for the mortgage company, according to the HUD report. By creating what is in effect a series of new mortgages priced far above market rates, the mortgage company can package these into pools and sell them -- with payments fully backed by the federal government -- at premium prices in the mortgage-securities market.
Investors in mortgage securities guaranteed by the Government National Mortgage Association (Ginnie Mae) will pay extra cash for loans yielding 12 percent in a 10 percent market. The investors, of course, assume the mortgages are like normal home loans and will keep paying for seven to 12 years before being refinanced or paid off fully.
But because these are "live-free" or no-cost refinance loans, they carry time bombs that are ticking away with six-month time fuses. They get paid off and disappear from the pool, wrecking the expected yield and forcing investors to reinvest the money somewhere else at a lower rate. The investors pay a premium for something they never receive.
HUD probers showed that a typical $50,000 FHA loan, refinanced twice from 12 percent to 11.5 percent to 11 percent, would produce $2,700 in quick net profits for the originating mortgage banker. Mortgage companies doing "live-free" loans by the hundreds profited greatly, while giving little to the consumer and deceiving Ginnie Mae mortgage investors.
C. Austin Fitts, commissioner of the FHA, said the mortgage firms involved with such programs have engaged in a "conspiracy to defraud investors," and called for a criminal investigation. An expert in the mortgage-securities field, Andrew Carron, manager of mortgage research for Wall Street's First Boston Co., calls the technique "an intentional rip-off."
But the HUD inspector general's report concluded that at the time of the study, the mortgage firms did not appear to violate existing FHA rules. Following the completion of the probe in June, however, the FHA announced that all forms of multiple-refinance and "live-free" loans henceforth will be ineligible for FHA insurance.