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Suppose the borrower in the example above had received the initial quote
of 7% and 1.5 points from a retail lender instead of a broker. If the
lender locked those terms despite a decline in market rates, the
borrower would be exploited in exactly the same way. The only difference
is that the broker leaves a paper trail – the YSP shows up in closing
documents – but the increase in the lender’s income is not disclosed.
What Is the Attitude of Wholesale Lenders Toward YSPs?
The wholesale lenders who acquire loans through mortgage brokers view
brokers as independent contractors who they cannot (and do not want to)
control. While lenders will cease doing business with brokers who cheat
them, they seldom if ever drop a broker for overcharging borrowers. Some
have tried to cap broker compensation, but if the cap is tight enough to
pinch, the brokers just shift to other lenders. Many lenders recognize a
need for concerted action, but none are prepared to assume a leadership
role because of fear of loss of business or concerns about anti-trust.
What Has Been HUD’s Policy on YSPs?
The Real Estate Settlement Procedures Act (RESPA) prohibits referral
fees. HUD, which administers RESPA, has taken the position that YSPs
retained by brokers are legal if they are “reasonably related” to the
value of the services provided to the borrower. Otherwise, such payments
are illegal referral fees, paid for steering borrowers to high-rate
loans.
However, HUD has never made any serious effort at enforcement. I could
find only a single enforcement action related to excessive broker
charges, and the action was directed against the lender funding the
loans rather than the brokers.
There is no effective way to enforce the rule by examining broker
compensation and the services performed in individual transactions.
Gathering the required data from brokers is far beyond HUD’s capacity.
It has never had more than 4 examiners for enforcing all RESPA rules, of
which the broker compensation rule is just one. Mortgage brokers will be
involved in about 3 million transactions this year.
Furthermore, there are no generally accepted standards as to what
constitutes “reasonable” compensation. Is, say, $4500 on a transaction
excessive? A HUD examiner has no way of determining how many hours the
broker spent educating the client, or how much money the broker may have
saved the client through astute loan selection and shopping. In
addition, any fair assessment should take into account small loans made
by the same broker on which the fee might be only $500. These quandaries
would defeat the wisest examiners.
Bottom line: HUD has to this point been YSP-impotent.
How Has Culpepper vs Irwin Changed the Situation?
The recent decision of the 11th Circuit Court held that lenders who had
paid YSPs to brokers could be vulnerable to class action suits by
borrowers. The court also held that whether YSPs were compensation for
services or illegal referral fees could be determined by the general
conditions under which the lender pays the broker. Assessment of
individual transactions was not necessary.
This decision has put the industry in a dither. Wholesale lenders feel
that unless it is reversed or counteracted in some way, they are
vulnerable to potential claims on existing loans where brokers retained
YSPs, and they will be forced to stop offering YSPs through most brokers
in the future.
They are now looking to HUD for relief.
What Would Be the Consequences If Wholesale Lenders Stopped Offering
YSPs to Brokers?
Not good. A major class of loan provider, and the borrowers who use
them, would be deprived of a valuable option. The option would not
disappear from the market, however. Business would shift from brokers to
retail lenders, where the abuses would disappear from sight, even though
they would still be there.
In addition, many brokers would join “net branches” of small retail
lenders as loan officer employees. Since net branches allow their loan
officers to maintain their operating independence, the predators among
them could abuse borrowers just as they did before. But because their
employers are lenders who are not required to disclose their income from
loans the way brokers are, their abuses would be invisible.
The only positive would be that wholesale lenders would continue
offering YSPs to Upfront Mortgage Brokers (UMBs). Since UMBs credit YSPs
to borrowers, they avoid abuses that might generate legal liability for
lenders. Long-term, the growth of UMBs would be encouraged, which would
be good for borrowers. Right now, however, there are only a handful of
UMBs, so in the short-term, this would be far outweighed by the shift of
brokers to net branches.
What Should HUD Do Now?
Making the Reasonable Compensation Rule Enforceable: There is a simple
way that HUD could make its rule, that YSPs are legal if they constitute
“reasonable compensation” for broker services, enforceable. HUD could
define “reasonable compensation” as any compensation that borrowers have
explicitly agreed to in advance.
More concretely, HUD should declare a broker to be in compliance if
borrowers on whose account the broker receives YSPs acknowledge the
broker’s total compensation, in writing, before the broker has submitted
an application to a lender. Total compensation is the amount paid the
broker by the borrower and the lender.
Suppose, for example, the borrower agrees to total compensation of
$4500, and the broker estimates the YSP at $3000, leaving a direct
borrower-paid fee of $1500. If the YSP turns out to be $4000 when the
terms are locked instead of $3000, the direct fee is cut to $500.
HUD could provide brokers with a standard form. The form I developed in
collaboration with Upfront Mortgage Brokers (UMBs), who voluntarily
follow the compensation rule proposed above, is appended to this paper.
Enforcement by Lenders: HUD’s rule will be enforced by wholesale
lenders. Since lenders will be safe in offering YSPs only to brokers who
comply, they have an incentive to monitor broker compliance. Wholesalers
should welcome this. For the first time they will have a way of
constraining broker pricing, without the danger of losing business to
other lenders. If they wish, lenders can delegate responsibility to the
Upfront Mortgage Brokers Association, a non-profit corporation set up
for the express purpose of certifying and monitoring UMBs.
Enforcement by Borrowers: Borrowers will also do their part to constrain
broker pricing -- in the time-honored way, by shopping and haggling. For
the first time, borrowers will become aware of how much brokers are
making at an early enough stage to do something about it.
Leveling the Playing Field: For purposes of this rule, HUD should define
“mortgage broker” to include loan providers who fund loans but have
price commitments from wholesale lenders. They receive the equivalent of
YSPs from their lenders, and should be subject to the same rules.
Otherwise, brokers who don’t want to comply with HUD’s rule will begin
funding loans, or become employees of firms that do. The problem will
disappear from sight, but it won’t go away.
Portfolio lenders and large mortgage banks that sell directly into the
secondary market would escape the enforcement net described above. A
simple way to subject them to comparable market discipline is to require
a new item on the Good Faith Estimate of Settlement: the par interest
rate. It should be placed right next to the actual interest rate. A par
rate below the actual rate will capture borrowers’ attention and put
them on their guard.
What Not to Do
The danger is that HUD, under political pressure, will take the path of
least resistance, enacting a disclosure rule acceptable to brokers and
lenders but worthless to borrowers. Such rules abound at the state
level.
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