For Home Loan Broker, Troubles Come With Creative Refinancing
Real estate has been a swell deal for just about everyone who owned a home in California during the last few years.
For hundreds of Orange County homeowners, it’s been even better. Thanks to their mortgage broker, they essentially get paid to borrow money.
Mark Gallagher, the founder and president of Park Place Funding in Laguna Hills, uses a technique that unscrupulous brokers employ to bilk clients.
Gallagher’s innovation was to cut his customers in on the action, giving them a share of the premium he earns for placing loans with high interest rates.
The homeowners receive cash on a regular basis they can use for vacations, remodeling or to pay off that expensive house faster. Not surprisingly, they love their broker.
Mortgage lenders were once fond of Gallagher too, helping him become one of the biggest independent brokers in the state.
Recently, however, the relationship soured. No one disputes that Park Place’s system is completely legal, but it has suddenly become controversial as well.
Is Gallagher the consumer’s champion, as he bills himself? Or do his mortgages, which are refinanced almost as soon as the ink is dry, make implicit promises to lenders and investors they don’t keep?
In an attempt to clear his name, the broker has filed suit against some of his former partners. The case opens a window on a bigger issue: In a mortgage system that is loosely regulated but increasingly complicated, who is responsible for ensuring its integrity?
In the last five years, lenders have become increasingly ingenious in their effort to get people whose finances may have seemed dubious into homes.
At the height of the boom, borrowers got loans for 100%, or more, of the value of their property. They got loans without having to prove their income. They got loans with no requirement to pay the minimum interest due each month.
Park Place, by refashioning another part of the mortgage business, stoked demand for its exotic “structured refinancings” from both the loan suppliers and borrowers.
“In boom times, all sorts of crazy things happen,” said James Croft, executive director of the Mortgage Asset Research Institute near Washington. “New programs are invented that have no history. You say, ‘This is going to work,’ and then you find out three years later it wasn’t such a great idea.”
With the housing market cooling off, the evaluation period Croft is talking about seems set to begin. The mortgage industry, and some mortgage holders, may be in for an extensive period of second thoughts.
Bob and Kathy Urell of Mission Viejo would hate to see that happen. They refinanced three times last year with Park Place, making a profit of $6,000.
Park Place produces cash for the Urells -- and, not incidentally, for itself -- by taking advantage of mortgage lenders’ eagerness for profit.
One way lenders make money is by making loans at high interest. They are so eager for these loans that they pay brokers a bounty for them.
Gallagher, who will turn 45 at the end of this month, decided to share this bounty with clients who had good credit and met other criteria.
The process works like this: A Park Place agent might explain to a homeowner that he qualifies for a 6% mortgage.
“Why don’t we make it 7%?” the agent will ask. “Sure, you’ll pay a little more each month, but we’ll give you more than enough cash to make up for it.”
For the Urells, the math was simple: Their monthly house payment rose to $2,022, about $250 more than they would have paid with the prevailing interest rate.
Over four months, therefore, they pay $1,000 more than they could have. But that deficit is outweighed by a $3,000 check per refinancing, the Urells’ share of the lender’s bounty. Park Place pays all the fees too. This lucrative transaction can be repeated every four months.
A generation ago, a homeowner could live in his house for many years and never refinance. For Park Place customers like the Urells, however, it’s a routine event, somewhere between mowing the lawn and changing the oil in the car.
Traditionally, borrowers paid to refinance a mortgage. Park Place clients are often fuzzy about exactly why they’re getting paid instead. But if it’s legal, why worry?
“We can use the money for anything we want,” said Bob Urell, a 55-year-old accounting professor. “I’m getting near retirement. My goal is to pay down my loan.”
Broker bounties are standard in the home lending industry. The higher the interest rate is over the prevailing rate, the more valuable the loan and thus the greater the premium. The lender usually pays the broker 1% to 4% of the value of the loan.
In California, the bounties must be noted on the closing papers of the loan. But many brokers don’t talk much about them, consumer advocates say, and therefore few home buyers are fully informed. In the worst cases, a high premium can tempt a broker to put unwitting clients into expensive loans. Such fraud occurs regularly, according to authorities.
But Park Place, a relatively new brokerage that Gallagher started in his home in the late 1990s, saw opportunity in this type of arrangement. In radio ads, Park Place touted the way the loans could make a house help pay for itself, a sort of perpetual-motion real estate machine.
Some refinancing customers came in, were told the risks -- if rates rose before their next refinancing, for instance, they could be stuck paying more than they wanted -- and decided to pass on the idea. But most, Gallagher said, responded, “This sounds awesome. Where do I sign?”
Bill Cusato, who lives in Long Beach, refinanced with Park Place in September and was recently in the midst of doing it again. “It’s a very easy transaction, minimal fuss and muss,” he said. The Park Place agent was out of his kitchen in half an hour.
Most of Park Place’s loans in 2004 and early 2005 were provided by National City Mortgage, a division of National City Corp. in Cleveland. Park Place grew to become National City’s top broker, Gallagher said, with the lender opening an office in Tustin to capture the flow of loans.
“You’ve built a better mousetrap,” a National City senior executive told the broker, according to Gallagher. (A National City spokeswoman declined to comment because the matter is in litigation.)
National City became Park Place’s favorite mortgage supplier because it paid the richest rebate: as much as 5% of the loans, which were for amounts up to $350,000. Park Place’s customer rebate was as much as 1% of the loan value.
“It was a win-win-win situation for us, for National City and for the borrower,” Gallagher said. At the peak of Park Place’s business last year, 50 agents processed an average of four mortgages a month each.
National City also burgeoned during the heady times, becoming the 12th-largest mortgage lender in the country.
Like most lenders, National City doesn’t keep all the loans it makes. The Park Place loans were sold to the Federal Home Loan Mortgage Corp., the mammoth government-chartered lending institution known as Freddie Mac.
Freddie didn’t keep the loans either. It repackaged them into investment pools.
And here is where it all fell apart. One investor, Gallagher said he was told, bought an investment pool with an unusually large number of Park Place loans in it.
This investor apparently thought he was going to get nice, fat interest payments for at least a couple of years, courtesy of a bunch of foolish Southern California homeowners who were inexplicably paying more than they should have.
Instead, the investor got a surprise. The homeowners refinanced, and the investor’s rich yield disappeared almost instantly. He complained, which started a chain of accusations and recriminations.
Everyone involved with the loans promptly identified who was at fault, and it wasn’t them.
An executive with National City Mortgage, interviewed before it was sued by Park Place, said the lender was victimized by an unprincipled broker trying to pump up volume. Paying people to refinance, said Executive Vice President John Gellhausen, “created a lot of additional new business without finding new customers.” National City said it would no longer do business with Park Place.
Said a Freddie Mac spokeswoman: “We are the real victim here.” Calling National City “an extraordinarily valued customer,” Freddie put the blame on Park Place.
At the end of January, Freddie put Park Place on its exclusionary list, meaning that it will no longer buy the broker’s loans.
Sitting in his modest office in a Laguna Hills business park, Gallagher appeared to be more disappointed than angry at his former partners. His silence until now enabled National City and Freddie Mac to portray him -- in a December story in the Los Angeles Times as well as other venues -- as an anonymous rogue running a scheme just this side of fraud.
“National City encouraged us,” he said. “Now they’re demonizing us.”
To prevent brokers from churning loans, lenders have restrictions on how quickly they will refinance. A broker coming in before the end of this period -- in National City’s case, it was four months -- is required to repay any premium received.
Gallagher said, and National City did not dispute, that Park Place worked outside this boundary.
“We want to do as much business as we can, as often as we can, and make as much money as we can,” Gallagher said. “But we play according to the rules. If a lender says, ‘You can do this loan, get this high rebate, and 120 days from now redo it,’ why would we not want to do that?”
It’s unclear how many brokers use techniques similar to those of Park Place, but Freddie warned its lenders in September to be on the lookout for “inappropriate refinancing arrangements.”
That isn’t necessarily something lenders are inclined to do. “Loan officers and mortgage brokers look to make loans, not find reasons not to make them. This is their livelihood,” said Jack Guttentag, a former banking regulator who runs the Mtgprofessor.com website.
At Park Place, Gallagher is retrenching but says he’s still doing structured refinancings with other lenders.
On the wall next to his desk is a sign proclaiming, “The biggest troublemaker you’ll have to deal with all day watches you in the mirror each morning.”
In that spirit, he admitted to one mistake. If he hadn’t given so much business to National City, that firm wouldn’t have had so much to give to Freddie Mac, and maybe the investor who complained wouldn’t have been burned. Everyone would still be happy.
The California Department of Real Estate, which lists Park Place as a broker in good standing, isn’t looking into the controversy. “This is what courts are for,” said spokesman Tom Pool.
And that’s where the dispute arrived in January. Park Place sued Freddie Mac and National City in federal court here, charging that they were trying to damage its business. Last month, a judge denied Park Place’s request for a temporary restraining order that would have removed the broker from Freddie’s exclusionary list.
Some experts have a certain sympathy for Gallagher. “Some firms go on Freddie’s exclusionary list for fraud, some for incompetence,” said Croft of the Mortgage Asset Research Institute. “Maybe [Gallagher] is going to go on it for being too smart and successfully gaming the system.”
John Marcell Jr., president of the California Assn. of Mortgage Brokers, said the refinancings wouldn’t have worked unless everyone benefited.
“The customer got money, the broker and National City increased their volume,” he said. “Freddie had their head up their hind end. Everybody along the line was happy as a lark.”
Gallagher still thinks he had a great idea. So do his customers. It’s almost like being paid to live in Orange County.
David Eulberg’s last refinance on his Fountain Valley house raised his payments $176 a month but gave him a $3,596 rebate.
“It costs me nothing,” he said. “That’s the beauty of the deal.”
But he does have misgivings. Not about the refinancing but what he spent his rebate on.
“My wife talked me into going to Montana to see my sister-in-law,” he said. “We drove 3,600 miles with the price of gas above $3 and a baby in the back seat.”