Confessions of a Subprime Lender: 3 Bad Loans

In his new book, author and ex-lender Richard Bitner owns up to some of his worst mistakes, offering an inside look at how his firm issued bad mortgages.

NEW YORK (CNNMoney.com) -- Richard Bitner opened his own mortgage shop in 2000, and had the good fortune to bail out of the business in 2005, before the housing crisis hit.

He saw the shoddy lending practices that got us into this crisis first hand, and has chronicled them in his book, "Confessions of a Subprime Lender." By the time he quit, said Bitner, "Lending practices had gone from borderline questionable to almost ludicrous."

He and his two partners ran Dallas-based Kellner Mortgage Investment, a small subprime lender that issued about $250 million in loans annually. The firm worked through independent mortgage brokers, and then sold the loans it closed to investors or to larger lenders, such as Countrywide Financial, which was recently bought by Bank of America.

Bitner, like so many other subprime lenders, was drawn to the field by the fat profits it promised - these loans paid three to five times more than prime loans. But, says the 41 year-old married father of two, he also took pride in the idea that he was helping people with damaged credit become homeowners.

Still, things eventually got out of control.

The Last Straw

One of Bitner's last clients, which he says was turning point for him, was Johnny Cutter and his wife Patti, from South Carolina. The deal illustrated what had become the fundamental problem with subprime lending: Nobody was bothering to determine whether borrowers could actually afford to make their payments. And so the Cutters, like millions of others, became a foreclosure waiting to happen.

"What really got to me," said Bitner, "is that we [usually] put people in positions to not fail. This loan didn't fit that."

The Cutters wanted a loan to buy a newly built, 1,800 square-foot house, but had been turned down for a mortgage twice because of bad credit. After that, they scrimped for three years and saved enough for a 5% down payment.

But, they still had only $2,200 in combined net monthly income, poor credit and employment histories, almost zero savings and no history of even paying rent. Their mortgage payment, property taxes and insurance came to $1,500, leaving them just $700 a month for all other expenses.

Patti fell ill right after the closing and the couple never made a single payment. Since the Cutters defaulted immediately, Kellner Mortgage was contractually obligated to buy the loan back from the investor it was sold to. That was a huge expense for the small lender.

When Bitner reviewed the loan to find out where his company went wrong he was shocked to see that, technically, no mistakes were made.

Neither the borrower nor the mortgage broker did anything dishonest or fraudulent to obtain the loan. The home's appraised value was correct, and the income stated on the application was accurate.

But the fact was that the Cutters simply didn't have enough income to handle this mortgage - the loan never would have been approved a few years earlier.

Their debt-to-income ratio was 54%, way higher than the 36% that most mortgage lenders recommend. But Kellner Mortgage made the loan because the firm knew that loose investor guidelines meant that the mortgage could be resold, at a profit of course.

"We were ultimately driven by the investor guidelines," said Bitner. "If it fit we closed the loan. It was an indication of how far the industry was willing to go."

In the end, the Cutter deal cost Kellner Mortgage $90,000.

Richard Bitner

Pump and Dump

In another highly regrettable deal, Bitner's company was simply scammed.

A criminal crew found a house, bought it for $140,000, and then resold it to a straw buyer for way more than it was worth - $220,000. To get a mortgage, the buyer used an appraisal for an entirely different, and much more valuable, property.

"The broker, buyer, appraiser, and realtor all conspired to perpetrate this fraud," said Bitner. Indeed, just about all the documentation was falsified.

The group collected the $220,000, and, minus their $140,000 outlay, disappeared with $80,000.

Kellner Mortgage wasn't aware of any problem until the investor that bought the loan set about investigating when it went unpaid. The investor sent Kellner a letter detailing the ruse and demanding that Bitner's firm make good on the loan.

Said Bitner, "You read through this letter and you see that the income statement was phony and the appraisal was on another house and you say to yourself, 'Am I a moron?'"

That cost the company about $100,000.

The Whole Truth

Of course, brokers dying to make deals also played a big role in pushing bad loans. Often they withheld or misrepresented information lenders needed to accurately assess a loan's risk.

"With so much money involved, people were willing to fudge to make deals work," Bitner said.

The Robinson's broker was a perfect example. The couple, who were divorcing, wanted to refinance their home, which had increased in value, and to take out $25,000 of that added home equity as cash. The plan was that Mrs. Robinson would keep the house and Mr. Robinson would get the cash.

Although the Robinson's told their broker about their split, the broker chose to not inform Kellner Mortgage of that detail, which would have been a deal breaker. Mrs. Robinson could never qualify for the mortgage based on her income alone, and indeed she defaulted soon after the loan went through, costing Bitner's company $75,000.

While dishonesty was rampant, the mortgage brokerage industry also suffered from plain incompetence. Many of the new brokers flooding the industry just knew the basics.

Bitner said his loan coordinator at Kellner, Annie Nguyen, once told him, "I had a loan officer ask me if we really needed an appraisal before closing. I thought he was joking."

Clearly, he wasn't.

The lack of professionalism, the crazy loans, the finagle factor and the open fraud finally drove Bitner from the business. Although he escaped the worst of the mortgage meltdown, the company he founded did not; it folded in early 2007.

You can find it memorialized on the Implode-O-Meter, an online list of mortgage lenders that have shut down since late 2006. Look for number 44.