Know the motive behind the regulation
(TheNicheReport) - Understanding current regulatory changes – and the motives behind them - not only aids in your ability to stay compliant; it also strengthens your position or the positions of your loan originators and creates a significant advantage over your competitors.
Constantly shifting regulatory sound bites impact every aspect of the lending industry today. We often focus on the details of what we need to do to remain compliant as new bills are introduced, and lose sight of the motive behind their creation. But if you investigate and understand the motive, then the regulatory bills themselves begin to make more sense.
The Consumer Financial Protection Bureau (CFPB), for example, provides very telling hints of where the mortgage industry is headed and what mortgage companies and loan originators need to do in order to evolve with the industry.
Consumer Financial Protection Bureau
the motive? If you look at the heart of the CFPB, it’s all right there in the name. Their website states: “The central mission of the Consumer Financial Protection Bureau (CFPB) is to make markets for consumer financial products and services work for Americans — whether they are applying for a mortgage, choosing among credit cards or using any number of other consumer financial products.”
This incredibly well-funded government organization was founded on the basic idea that consumers are not smart enough to make good financial decisions. They need a great deal of protection for themselves, and from themselves, in addition to protection from industry predators. Some level of protection is a positive thing, as this type of oversight has been in place in the financial services industry for many, many years. It was simply a matter of time before a Mortgage-Backed Security sale was actually treated like a security sale from a regulatory perspective.
Clearly, the main focus of the CFPB and other parties within the regulatory environment is on mortgages and credit cards. This is why we have the three-sided balance sheet. Traditionally, we think of assets and liabilities as being the two sides of the balance sheet. What’s the largest single asset for most consumers? Their house. It’s the biggest single asset on their balance sheet. What’s unique about that asset? The house is rarely an asset uncoupled from an associated liability, a mortgage. The mortgage is the largest single liability for most consumers. The house is really an asset in name only; the house may be worth $200,000, but if we have a mortgage liability of $200,000, we actually have a net asset that is worth $0. As such, we propose that real estate is the third side of the balance sheet.
Why is that important, and how does that speak to the motive at hand related to compliance?
At the end of the day, real estate is both an asset and a liability for all balance sheets. Even if you own a piece of real estate free and clear, it requires taxes and insurance and other expenses that create a liability. Since 1985, we live in the FIRE Economy, an economy where finance, insurance and real estate outstripped manufacturing as the largest provider of gross domestic product – an economy of tremendous wealth circulating through the hands of consumers influenced by three very large industry groups: financial advisors, mortgage lenders, and real estate agents.
Testimony before Congress stated that much of the crisis stemmed from a lack of consumer education, and that only one industry group provided guidance to the consumer as a basis of fact. Financial advisors were selling financial products, but first and foremost they were advising consumers. Mortgage loan officers weren’t advising consumers, they were merely selling products. Real estate agents, who may be the next industry group to go under the microscope, were also focused on selling products, they were not advising clients. Whether you agree with this or not, Financial Advisors were considered advisors; Lenders and Realtors® were considered sales people.
Protecting the Consumer
If a large national group of consumers gets hurt, in a way that cripples the very fabric of our society; then you have to protect the consumer from the sales people that are selling them things that may not be in their best interest. That’s the view of policy makers today. The CFPB and other groups, legislation, and future laws will support and mandate that Lenders (and eventually real estate agents) work in the best interest of their clients. What exactly does that mean?
The dynamic of putting the client first is often based on eligibility versus suitability. When a prospective client comes to a financial advisor with $100,000, the advisor rarely thinks in terms of yes or no, but where? They must focus on suitability of the investment. The “yes, I’ll work with you,” or “no, I won’t work with you,” is something you’ll also want to consider, but assuming the $100,000 is available, you have to decide what is the most suitable investment for this person to meet their longer-term goals.
These goals are often expressed as safety (how much risk they can handle), liquidity (when might they need this money) and return (how much interest can they earn). These goals are often at odds with one another: the product that has the highest return might have the highest risk, and then we must figure out whether return or safety is more important to the client. That is a conversation based on suitability. The client may be eligible for any investment, but what is suitable for them? That is how the advisor is held to a higher standard.
Lenders will have to learn to think more like financial advisors. Lenders traditionally focus on the yes or no. “Yes, I’ll work with you if I can get you a loan.” “No, I won’t work with you if I can’t get you a loan.” To firmly instill suitability into lending culture, we see the bull’s eye shrink as Fannie and Freddie and other lenders dramatically reduce the criteria through which they would purchase a loan. That impacts your behavior so that you have a smaller product set to work with, and further protects the consumer from loans that might be unsuitable for them.
Let’s look at a practical example. An 80-year-old woman with no living spouse has $250,000 as her entire retirement savings in a CD. She wants to earn a higher return and an advisor says “Yes, I’ll work with you,” and proceeds to put her money into an ‘oil and gas’ partnership that has the potential to pay out 12% annually. This advisor has most likely violated the suitability requirements of his profession (and legally as well), because he should know that while that return is possible, he must also consider the safety and liquidity of the woman’s money, even though she just wants a higher return. Should the advisor place all her money in an ‘oil and gas’ partnership, which is very speculative by nature? Her total savings could be lost. She might not have any access or control of her original principal in an emergency. In court, the advisor will most likely lose every time if he didn’t show her other examples, and document in a presentation the ‘why’ behind his advice.
This seems obvious, but what if a young couple buying their first home wanted the lowest rate? Would giving them a 1% negative amortizing loan meet that need? Sure. The needs of lowest payment were met, but what of their other goals for safety and liquidity? Did they put down too much? Were they clearly aware of the payment risk over time? Essentially the eligibility of what you can do for a client is far less than it used to be, and the ultimate game will be played out on the basis of suitability – and your ability to communicate that to your client effectively.
From regulation to opportunity
The real opportunity of the current environment is to learn as a lender to incorporate suitability into your business to keep pace with the growing mandates. If you realize that your business is going to look much more like a financial advisor’s business, you’ll have a leg up.
Here are a few action items to get you started:
- Go visit two or three highly respected financial advisory firms in your local market. Take a camera and ask if you can take some pictures, meet with advisors and interview them about their business philosophy. Learn to think more like an advisor and upgrade your perceived value in your market.
- Think suitability first, eligibility second. What’s the right product for your clients based on their need for safety, liquidity and return? What would help them sleep well at night? What’s the most important consideration for them when they buy or refinance a mortgage with you?
- Learn to present like a pro. Financial advisors understand that a compliant sales presentation is critical to their success. It keeps them out of trouble, and helps them communicate the value of their advice at the beginning of the process. If a client engages, then they do the heavy lifting of all the paperwork, but not before the client is sold and ready to move forward. Lenders can profit from this experience, learning to make a compelling presentation based on both eligibility and suitability that eliminates your competition, providing you a higher return with less risk, and greater personal capital to invest in your future.
You are more regulated now than at any time in your history. There are many opportunities to learn from other industries. Real estate agents will deal with this more in the future, but you must deal with it now. Create a real win/win by helping your clients understand all their choices in a way that helps them meet their current borrowing goals.
Learn more about compliant loan presentations that satisfy disclosure rules, boost conversion rates and raise client retention rates and revenue per closing: register for a free 21-day membership to the ultimate loan presentation system, MSS Borrow SMART Analysis, at: www.mortgagesuccesssource.com/go/mssbsa or call (800) 963-1900.
Todd K. Ballenger, CEO, KendallTodd, has 23 years experience in the financial services industry as a licensed securities, insurance, real estate, and mortgage lending professional. Todd founded three companies: Capital Savings Co, Inc., Advantage Capital Mortgage, USA and PlanMax Financial. These three companies closed over $2 billion dollars in residential and commercial loans before being rolled into a Nasdaq IPO in 1999. Todd is considered an industry pioneer in the area of capital market and credit market convergence, and has published courses on lending and equity management currently approved for Realtors®, Appraisers, Builders and Lenders in over 42 states. Todd was a two-time Inc. 500 winner, a three-time KPMG Fast 50 winner, and the 1998 NC Mortgage Lender of the year. Todd was awarded the 2003 '40 Under 40' award by the Triangle Business Journal in NC as one of the top 40 young leaders. Todd can be reached at firstname.lastname@example.org