October 3, 2001
The recent decision
of the US 11th Circuit Court of Appeals in the case of Culpepper vs
Irwin has suddenly swung the spotlight on HUD policy regarding yield spread
premiums (YSPs) retained by mortgage brokers.
To this date, HUD has been impotent in dealing with a festering sore in
the home loan market. Suddenly, it
has an opportunity to make a difference, if it acts wisely.
Or it can confirm its impotence, if it doesn�t.
This paper is
designed to lay the groundwork for a wise decision.
YSPs are points paid
by lenders for loans carrying interest rates above the par rate.
The par interest rate is the rate at zero points.
Points are an upfront charge expressed as a percent of the loan.
On rates below the par rate, lenders charge
points whereas on rates above the par rate, lenders pay
points. YSPs are also called
�negative points� or �rebates�.
For example, a
lender offering a 7% 30-year fixed-rate mortgage at par might offer the same
loan at 6.5% with 2 points, and at 7.50% with a YSP of 1.5 points.
What Good Are
YSPs provide a
useful option to some borrowers. For
those with little cash, YSPs make possible no-cost mortgages, on which
settlement costs are paid by the lender. For
those who expect to be in their house only a few years, YSPs permit a favorable
exchange of higher rate for lower fees.
Problematic About YSPs?
have examined the details of hundreds of brokered transactions, and there is
little doubt in my mind that YSPs increase costs to many borrowers.
The major reason is that borrowers don�t necessarily consent to paying
them. They frequently do not
understand that they are paying the YSP in the interest rate. Furthermore, the exact amount of the YSP is not known until
the terms of the loan are locked with the lender, at which point the borrower is
already committed to the transaction.
Here is a common
scenario where a broker collects a YSP from the lender without the knowledge or
consent of the borrower. Market
interest rates decline during the period between the initial price quote to the
borrower and the lock date, but the borrower is not aware of it.
For example, the price quote from the lender to the broker was 7% and
zero points, and from the broker to the borrower 7% and 1.5 points; the 1.5
points was the broker�s markup. When
the loan is locked, market rates have come down and the lender is offering a YSP
of 1 point for a 7% loan. The
broker retains the YSP as extra income. The
borrower may find out about it at closing, since the YSP is shown on the HUD1
Avoid the Problem By Dealing Directly With Lenders?
Retail lenders dealing directly with borrowers can also exploit those who
don�t shop, or who don�t monitor the market during the period prior to the
lock. In fact, it is easier for
lenders because they leave no incriminating evidence.
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
What Is the
Attitude of Wholesale Lenders Toward YSPs?
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
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
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.
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
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.
line: HUD has to this point been YSP-impotent.
Has Culpepper vs Irwin Changed the Situation?
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
They are now
looking to HUD for relief.
What Would Be
the Consequences If Wholesale Lenders Stopped Offering YSPs to Brokers?
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
What Should HUD
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.
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
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
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.
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.
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
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
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.
The largest group of states has enacted warning rules. These require that
brokers disclose exactly how they can take advantage of the borrower, without
doing anything to prevent it. California
falls into this group. The
California borrower learns that:
The retail price a mortgage broker offers you�your interest
rate, total points and fees�will include the broker�s compensation.
In some cases, either you or the lender may pay the mortgage
broker all of its compensation.
Alternatively, both you and the lender may pay the mortgage
broker a portion of its compensation. For
example, in some cases, if you would rather pay a lower interest rate, you may
pay higher upfront points and fees.
Also, in some cases, if you would rather pay less upfront, you
may wish to have some or all of our fees paid directly by the lender, which will
result in a higher interest rate and higher monthly loan payments than you would
otherwise be required to pay.
The mortgage broker also may be paid by the lender based on (i)
the value of the mortgage loan or related servicing rights in the marketplace or
(ii) other services, goods or facilities performed or provided by the mortgage
broker to the lender.
the states, California requires the largest number of words to say that the
broker may be paid both by the borrower and the lender.
But even when the point is made concisely, it doesn�t help the borrower
who is trying to compare broker fees. Knowing
that the broker may be paid by the lender helps only if the borrower knows what
that payment is, and he doesn�t learn that until the loan closes, if then.
of Compensation: An alternative
approach requires brokers to specify the range of total compensation from both
borrower and lender. In Florida,
for example, the required disclosure states that �Business will receive a sum
in range of
% of the total loan amount�the exact amount of which will be disclosed
may appears to protect the borrower, but appearances are deceiving.
The prevailing practice among brokers in Florida is to enter a range of
0% to 5%. One broker told me that
he was taught to do this in the course he took in mortgage brokerage.
This leaves the broker with complete freedom of action, while providing
the borrower with no usable information.
would it be any better to require disclosure of the maximum fee alone.
In that case, the brokers would all enter 5% and the result would be the
only approach that will really help the borrower compare broker fees is to
require that the broker disclose total compensation from the borrower and the
lender. I hope that HUD grasps this obvious truth in its forthcoming
disclosure rule, and has the political courage to adopt it.
If it adopts one of the half-baked approaches described above, it will
create more paperwork but not help borrowers a whit.
Broker Compensation Agreement
broker will quote a price to you before submitting an application to a lender.
The price may be a fixed dollar amount, a percent of the loan, an hourly charge
for the broker's time, or a combination of these.
price quoted by an UMB is the broker�s total compensation from the
transaction. Any payments made to
the broker by the lender reduce the borrower�s payment by the same amount.
For example, if the broker sets compensation at $3,000 and the broker
receives $1500 as a rebate from the lender, the borrower would pay only the
difference of $1500.
broker will inform you if there will be a separate charge for processing by a
other third party services ordered by the broker but paid by the customer, the
broker will provide the invoice from the third party service provider at the
customer�s request. Alternatively,
the broker may have the payment made directly by the customer to the third party
total compensation paid to [Name of Broker] will be:_____________
Acknowledgement by borrower