GEORGE DOWNEY ´Few aware of problem´

In the early 1990s regulators, cracking down on the wild and speculative ride some financial institutions had taken in the late 1980s, found that up to 30 percent of adjustable rate mortgages had errors.

The findings thrust the issue into the spotlight, if only briefly. However, the problem has crept up again, according to auditing firms. The difference this time around is that regulators aren’t taking as close a look because no one is sounding any alarms.

“I would say a large majority of the people in the industry would like to ignore that it’s there. They deal with it when something comes up, but they don’t take an assertive position to correct the problem,” said Robert W. Brown, chief executive officer of Mortgage Quality Assurance Corp. of Englewood, Colo.

Since its founding 11 years ago, the company has audited more than $60 billion in loan assets and lately is finding error rates comparable to those found in 1990.

“In adjustable rate and variable rate mortgages, our statistics have proven a 30 percent error rate on anything that is subject to any sort of adjustment,” Brown said. “Those are almost divided [equally] between undercharges of the borrower and overcharges of the borrower. On fixed-rate loans, there’s approximately a 10 percent error rate. In cases where people make a prepayment, it shoots up to over 50 percent.”

But while auditing firms like Brown’s are saying errors are a problem, industry insiders disagree.

“That isn’t to say that the situation is flawless,” said one source who manages the mortgage side of a mid-sized Massachusetts bank. “Errors can occur anywhere, whether it’s processing a mortgage application or writing a newspaper article – stuff happens.” Additionally, the source pointed out that some attorneys have, of late, been trying to draw undue media attention to ARM errors to create a “cottage industry” for themselves by suing on behalf of clients who were overcharged.

Not all local lenders share that view, however. George Downey, president of Braintree-based Harbor Mortgage Solutions, said that servicing errors haven’t disappeared simply because they no longer receive the scrutiny that accompanied the failure of financial institution during the last recession. “Very few people are terribly aware of it … To think that these problems went away is folly,” he said.

Brown maintains that most people usually never detect the problem. “What we have to do is start building a level of awareness among consumers. Most people, when they sign up for a mortgage, [arrange for] a payment they make every month or have automatically withdrawn from their checking or savings account and they don’t pay much attention to it,” he said. The likelihood of consumers checking to ensure all the points, fees, percentages and payments have been applied correctly is about the same as people checking to ensure their utility bills are in order.

Compounding Mistakes
Errors usually occur in two areas, said Brown. The first is when the loan is originally entered into a computer system. “There are almost 30 components that have to be done correctly. If they’re not put on the system correctly to begin with, then that loan is going to have an error from day one,” Brown said.

The other primary source for errors is at the servicing agency when clerks post payments. Although technology has helped alleviate some problems, it’s not always enough to eliminate all mistakes. “What we’ve done in the last five years of this blazing technology is that we have developed systems and methods to move a lot more erroneous information around faster,” said Brown.

Downey agrees that errors are a substantial, if unacknowledged, problem within the loan-servicing industry.

There’s another component to the error trail, as well. “These loans are commonly sold and resold. They are handed off from one servicing entity to another servicing entity. There is really a lack of standardization among the different types of servicing systems used. There isn’t a seamless interface of data system to data system. Many times the information has to be manipulated manually to get it into another system. This opens the entire process to additional infection,” said Downey.

The average loan is sold three times during its lifespan, Brown said.

Mortgage Bankers Association of America is addressing the conversion problem. A committee has been formed to develop standard data fields to reduce conversion errors. In early May, the MMBA announced it has reached an agreement with Fannie Mae on a framework for electronic mortgage transaction standards. Banker & Tradesman was unable to contact the MMBA by press time.

Although much was made in the 1990s about consumers being overcharged, investors also lose regardless of whether consumers are over- or undercharged, said Downey. “If, in fact, a given loan is overcharging and there is really more revenue coming in from that loan than there should be, that investor has a liability to the borrower. On the flip side of that, if the loan has been undercharged and the borrower now is being undercharged, there’s little hope for recovery of that and the investor is not realizing the yield that they thought they purchased,” he said.

Brown’s company found the average error on a residential loan to be about $1,500. On commercial loans, the errors can reach six figures. “We did find an error on a fixed-rate loan and it was a subprime [home mortgage] loan. It was originally an $80,000 loan. It was about 10 years old and it had a $10,000 overcharge,” he said.

An investor could easily purchase a bundle of loans with problems that the new servicer would have to correct, Brown said.

Although some auditors like Brown contend that servicing errors is a widespread problem, it has received little attention of late. Part of the reason, he said, is that borrowers rarely catch the error.

During the first five years of repayment, the majority of the payment usually is applied to the interest. Because of that, borrowers don’t expect to see much difference in the principal owed. “They [borrowers] figure the price of the house is going to go up by the time they sell it. [They believe] it will pay off whatever’s due, [adding to the chance of the borrower] not realizing they’re sitting on an error,” Brown said.

Today, the servicing errors easily can be overlooked given the number and frequency of refinancings, Downey said. The 30-year mortgage is the dominant product but the average loan is paid off in five to seven years either because people sell the property or refinance.

“With the passage of time, because compounding is working within the structure of the note, the error is going to grow larger with the compounding. When they refinance or sell the property, in all the flurry of activity that takes place at the closing, that loan balance is simply going to disappear” without people ever knowing it happened, Downey said. “The loan gets paid off, they start with a new loan and they start the process all over again. This is going on every single day.”

State and federal regulators do audit a sampling of loans, however, to ensure errors are not happening on a widespread basis.

According to David Cotney, deputy commissioner for consumer compliance at the state Division of Banks, mortgage-servicing error analysis is conducted within the usual examination process, which occurs every year or once every three years for entities that are considered sound, well-managed institutions. During that process, the DOB will examine account histories and escrow accounts, among other things. Additionally, it will investigate any complaints made.

“During the course of an examination we have, on occasion, seen someone who will have widespread problems that will require corrective action,” said Cotney. But, he added, he is “not aware” of any industry-wide problem with errors.

However, Downey maintains that state and federal regulators don’t have the means to adequately test for errors. “The labor intensity and the cost of the work to go in and do extensive auditing is virtually prohibitive in terms of what needs to be done … They really don’t drill down deeply enough,” he said.

Eastern Bank, of Boston, regularly conducts internal audits and employs an external auditor to monitor its servicing in addition to being audited by state and federal regulators. According to spokesman Joseph J. Bartolotta, most banks routinely perform as many internal audits as Eastern does in an attempt to ensure their loans are error-free.

The problems that do occur stem from human error in the back-office areas of the business, said Downey. “The front end of the business, the customer-facing activity, is generally where the resources are really committed. The back side of the business is pure cost to the lender. As a result, they make every effort to minimize the cost,” he said.

Generally, clerks who enter the data are paid between $8 and $14 an hour. Because of low pay and low skill level and monotony of the job, there’s a high burnout rate and frequent turnover, Brown said.

It should be noted that Brown’s company has developed software that would create a redundancy check when the data is entered. But Brown isn’t the only one saying there’s a problem with errors.

HSH Assoc., which publishes information for consumers about loans, has posted a check kit for adjustable rate mortgages on its Web site.

Harbor Mortgage also has developed a product to help consumers compare what the actual loan payment should be with the payment requested by the servicer.