New Arizona law helps shield buyers from mortgage abuses

New state licenses required for anyone handling a mortgage application could help prevent a repeat of the bad loans that contributed to Phoenix's housing crash.

Backed by mortgage brokers and real-estate regulators, the law quietly went into affect on July 1.

The law, passed in 2008, creates state oversight for people who take loan applications, gives consumers an avenue for reporting misconduct and establishes a fund to help repay borrowers who lose money because of unethical or illegal acts by their loan officers.

The law faces hurdles, as cash-strapped Arizona struggles to process thousands of new applications.

Still, advocates call it a success. Many of the risky - and sometimes illegal - home loans that helped lead to record foreclosures in Arizona might not have been made if the more than 10,000 unlicensed loan officers working then had been subject to more oversight.

During the housing boom, borrowers were sometimes misled about what their real payments would be or other terms of their loans, and some loans were given to people who never should have qualified. In some cases, officers were untrained or had little experience; others were unscrupulous and intentionally made bad loans so they could be paid a commission.

Either way, consumers had little recourse once they realized they had been wronged. The new law is aimed at changing that.

Now, in Arizona, any person who handles a loan application or takes a borrower's financial information will be fingerprinted and subject to a background check. Officials at the Arizona Department of Financial Institutions can reject applicants with a record of misconduct.

Applicants also have to pass a test to prove their understanding of federal law, mortgage standards and ethics.

So far, 4,336 people have applied to be loan originators in Arizona and 2,413 licenses have been issued, according to the department. About 1,000 of the applications are on hold because not all the necessary information was provided or the state agencies found problems with them. The rest are still being processed.

"Loan-officer licensing is long overdue in Arizona," said Felecia Rotellini, who for five years served as superintendent of the Department of Financial Institutions, the state agency regulating the mortgage industry. She is running for Arizona attorney general.

"A lot of bad loans wouldn't have been made if we had it before," Rotellini said. "It gives me peace of mind for consumers to know we have licensing now."

In Arizona, the housing boom and crash were partly fueled by loan officers, how they operated and how they were paid.

Mortgage brokers, who run firms that connect borrowers with the best loans, have long been regulated by the Department of Financial Institutions.

Brokers employ loan officers, who work directly with borrowers, collecting their Social Security numbers and financial information to determine whether they qualify for a loan. Loan officers usually recommend types of mortgages and lenders.

These officers, sometimes called originators, weren't subject to state scrutiny. They worked under the licenses of their brokers, much the way an apprentice would work for a licensed contractor. Previously, that oversight was considered sufficient.

Flood of loan officers

But, in recent years, thousands of loan officers began working to handle the flood of new and refinanced loans triggered by the housing boom.

Those new loan officers often got little scrutiny. Some simply operated on their own, writing up loans and selling them to lenders and Wall Street firms without working for a broker at all - technically illegal but difficult to track. Many others worked for big national lenders like Countrywide and weren't subject to state oversight.

Loan officers were paid fees based on the size and type of loans they wrote up. Some lenders paid bigger fees for riskier loans and loans with higher interest rates.

Subprime loans, given to borrowers with lower credit ratings, were the riskiest type of loans and carried higher interest rates. The fee structure gave loan officers an incentive to push more subprime loans - often, the riskier the deal, the more money they could make. The result was loans that borrowers couldn't afford and homes that often ended up in foreclosure.

Because mortgage brokers were licensed, consumers may have assumed the officer who took their financial information and recommended a loan was licensed and regulated as well. Many found out otherwise when they tried to file complaints.

Arizona regulators have issued indictments in a record number of mortgage-fraud cases that stem from unlicensed loan officers. Arizona ranks among the top 10 states for mortgage-fraud cases, according to the FBI. But many of the lending industry's worst offenders have left the state with their profits and are avoiding prosecution because regulators can't track them down.

New federal rules are changing the system for loan officers and mortgages. The Wall Street Reform and Consumer Protection Act, passed last month, ensures loan originators must now be registered under a new federal system that is tied to state licensing systems.

The act also makes it illegal for mortgage brokers and loan officers to be paid higher commissions for riskier loans with higher interest rates and fees. Now, loan brokers and officers can be paid a commission based only on the principal amount of a mortgage and bonuses on the number of loans they complete.

Arizona's new law takes other steps. A recovery fund, using money from licensing fees and bonds, allows consumers damaged by the actions of a loan officer to recover up to $200,000.

"Through the licensing process, the state of Arizona has been able to weed out loan officers that did not pass a background check or did not have the sophisticated knowledge of the industry to pass the testing requirements," said Sherry Olsen, president of the Arizona Mortgage Lenders Association.

"The public can be assured that the licensed mortgage professional that they choose to work with has a minimum of 20 hours of education, including courses on federal law, lending standards and ethics, and must have passed a rigorous state and origination exam."

Oversight delayed

Licensing advocates tried four times over a decade to get lawmakers to pass the new requirements. More than 30 other states required loan officers to be licensed before Arizona.

"As other states like Washington and California started licensing loan officers, the bad ones went to states like Arizona, where they did a lot of damage," said Richard Hagar, a Seattle mortgage-fraud expert who works with Arizona regulators to educate real-estate firms about illegal lending and appraisal practices. "Before the law, Arizona couldn't even stop convicted felons from becoming loan officers."

Although the new law creates oversight, it also faces challenges. Enforcement was pushed back from Jan. 1 to June 30 of this year because, like many state agencies, the Department of Financial Institutions has been dealing with a smaller budget and staff. The agency doesn't have funding for investigators to look into complaints.

"We are reviewing approximately 45 (loan originator) applications a day . . . with all hands on deck," said Lauren Kingry, department superintendent. "Some companies dropped 50 to 300 applications on us at the last minute. Of those applying for mortgage-originator licenses, I believe we are getting the cream of the crop."

He said the rejection rate for Arizona loan-originator licenses is less than 1 percent of all applications.

Loan officers who work for a federally chartered bank or credit union are exempt from state oversight, including the new license. But those originators have to be registered through the federal system, which mandates testing requirements for loan officers across the country.

"Many in the mortgage industry have adapted well to the changes, many have not," said Amy Swaney, vice president of Phoenix-based Peoples Mortgage Co.

"New laws have weeded out some who decided that it just wasn't worth the time, energy or money to be licensed, those who were not capable to comply with the licensing standards and those who just decided it was time to move on."

by Catherine Reagor The Arizona Republic Aug. 11, 2010 12:00 AM



New Arizona law helps shield buyers from mortgage abuses