The Role of Mortgage Brokers in Residential Financing
Mortgage brokers play a vital role in the homebuying process. It is estimated that half or more of all residential loans are originated by mortgage brokers.
Mortgage brokers can provide real value-added services for both home buyers and lenders. By tracking the offerings of a variety of lenders, they can help borrowers “shop” for the best deal. With their familiarity with the financing system and the lenders’ requirements, they can help borrowers negotiate their way through the loan application process. They also help lenders, by marketing their products and by taking care of application paperwork. In exchange for bringing borrowers and lenders together, mortgage brokers typically charge the borrowers an origination fee (which may or may not be financed as part of the loan). Fees may also be paid by lenders to mortgage brokers and charged back to the borrowers as higher “points” and/or higher interest rates.
Where all such charges to the borrower are reasonable in amount and fully disclosed to the borrower, no reasonable objection can be made to them. What happens sometimes, however, is that some mortgage brokers take advantage of naïve or uninformed borrowers by charging them exorbitant fees for loan origination services and/or by inducing borrowers to pay higher-than-necessary interest rates on their loans.
Yield Spread Premiums
Delivering loans to a lender at rates higher than the lender’s published rate can be very profitable for a mortgage broker. If a lender has a published rate of 7% for a certain type of loan and a broker delivers such a loan to the lender with a 7.5% interest rate, the lender will normally pay the broker a bonus or premium because the 7.5% loan is worth much more to the lender than a 7% loan. The bonus or premium paid by the lender to the mortgage broker is called a “Yield Spread Premium” (“YSP”). Depending on the lender, the amount of the loan and the “spread”, this premium can amount to thousands of dollars per transaction.
What makes YSPs so hard to deal with is that they have many legitimate uses. For example, to the extent that a higher interest rate compensates the lender for taking additional credit risk and/or allows a borrower to purchase a home with less money down – financing the normal closing costs over the term of the loan – it can be a real boon to the cash-strapped borrower. The only way to compensate a mortgage broker for its services in such a transaction may be for the lender to pay the broker a YSP for arranging the loan.
Under the Federal Real Estate Settlement Procedures Act (RESPA), administered by the U.S. Department of Housing and Urban Development (HUD), it is perfectly legal for lenders to pay fees to mortgage brokers for services provided to the borrower. What is illegal is for lenders to pay mortgage brokers premiums for duping borrowers into paying higher than necessary fees and/or interest rates on their loans. The line between the two is very, very fine and, as noted by HUD, itself, in a policy statement released in 1999, the propriety of each transaction depends upon the unique circumstances of that particular transaction.
The uncertainty created by the application of general legal principles to very fact-specific individual situations has spawned, by some estimates, over 150 lawsuits nationwide and generated widespread confusion and anxiety among lenders and mortgage brokers alike. They need to pay and receive YSPs in order to be competitive and stay in business, but they are justifiably fearful of prosecution and/or civil lawsuits which could result in treble damages and legal fees being assessed against them.
Consequences for REALTORS®
Anything that makes buying a home more expensive than necessary hurts sales, either by cutting into the sales price or by driving buyers out of the market. Higher-than-necessary costs to close and higher-than-necessary monthly payments all mean fewer potential buyers and buyers qualifying for less house. REALTORS® need to keep an eye on those parts of the overall homebuying process that add to the cost without providing any real benefit to buyers.
Here is where REALTORS® – especially buyer agents – can help buyers: Educate them about the lending process and encourage them to compare rates and terms from several reputable lenders; keep a watchful eye out for undisclosed or misrepresented fees and premiums in the borrowing process; caution buyers to make sure that the lender fully discloses all fees and charges up front in the Regulation Z Truth-in-Lending Disclosing form and that the lender fees and charges on the HUD-1 match the Reg. Z Disclosure.
Even if you are the selling agent, it is worthwhile to encourage unrepresented prospective buyers to shop around for their loans, compare terms, and ask hard questions about fees and interest rates. If more cash goes to the seller and the buyer faces lower payments, the buyer will qualify for more house and the likelihood of a successful transaction will increase.
Ed McClure and Beau Brincefield are attorneys with the Alexandria law firm of Brincefield Hartnett Maloof & Paleos, P.C. Mr. Brincefield has been on the NVAR Mortgage Finance Committee for more than 30 years.