RESPA and Its Impact on Small Business
E. In crafting RESPA rules, HUD should take into account that yield-spread premiums have been a primary driver of the subprime fiasco.
Although we are glad to see the effort to improve the disclosure of the service charge brokers earn from lenders in the first chart, “Your Loan Details,” on the top of page two of the proposed GFE, we believe that the proposed disclosure of the service charge and the “credit or charge for the specific interest rate chosen” is misleading and confusing and must be simplified.
In the Proposed Rule, HUD explains its desire to avoid disadvantaging mortgage brokers in the marketplace through its treatment of the service charge disclosure: “Many mortgage brokers offer products that are competitive with and frequently lower priced than the products of retail lenders, as evidenced by brokers’ large and growing share of the loan origination market, and HUD wishes to preserve continued competition and lower cost choices for consumers.”22
While this claim may be true in the prime market, empirical evidence demonstrates that in the subprime market, nothing could be further from the truth. In April, CRL released a study that found subprime borrowers pay significantly more for loans when using an independent broker than a retail lender. 23 In summary, subprime borrowers steered into higher rate loans pay additional interest payments ranging from $17,000 to $43,000 per $100,000 borrowed over the scheduled life of the loan.24 And it doesn’t take long for the disparity to become significant: at the four-year mark, a time period chosen to reflect average loan life, the difference in costs is stark: $5,000.25
What was the primary driver of this inequity? We believe it is the yield-spread premium. Simply put, Wall Street investors were willing to pay more for ARMs with prepayment penalties that locked borrowers into riskier, higher-rate loans. To satisfy this demand, lenders used yield-spread premiums to reward brokers for steering consumers into higher-rate loans than those for which they qualified, and then rewarded them even more for locking in those higher rates with a prepayment penalty. The high penetration of potentially dangerous loan products in the subprime and nontraditional markets is inextricably linked to the distortions produced by these perverse incentives.
Our data did not permit us to examine the relationship between yield-spread premiums and direct broker fees, but prior studies indicate that yield-spread premiums on subprime loans do not serve to reduce fees significantly. One study has shown that borrowers only receive 25 cents in reduced fees for every one dollar paid in yield-spread premiums to brokers and that upfront fees are actually lower for retail loans than for brokered loans.26
Most subprime loans carry significant direct upfront broker fees along with the yield-spread premium. They compensate the broker at both the front and back end, essentially buying the rate down, then buying it right back up.
This understanding of the way yield-spread premiums have operated in the market informs both our recommendations for HUD as to RESPA revisions, and our recommendations to the Federal Reserve Board as to the proposed HOEPA UDAP rules. In both cases, we hope the agencies will address the fundamental problem, not merely try to improve the gloss.
1. Yield-spread premiums, when paid in exchange for nothing but a higher interest rate or inclusion of a prepayment penalty, constitute illegal kickbacks under Section 8 of RESPA.
It is our long-held position that yield-spread premiums, when paid in conjunction with direct broker compensation or other closing costs or made contingent upon inclusion of a prepayment penalty, essentially overcompensate brokers in a way that is not transparent to consumers. In RESPA terms, it does not constitute a fee in exchange for any goods, services, or facilities as required by Section 8. The premium is either duplicative, or, in fact, may be paid for the “service” of steering consumers into higher-cost or riskier loans than those for which they qualify. Again, to put that in RESPA terms, we believe that such yield-spread premiums violate RESPA’s prohibition on kickbacks.
HUD in the past has said that yield-spread premiums are not compensation for services if they simply pay for “delivering a loan with a higher interest rate.”27 Rather than assuming that a yield-spread premium is a price trade-off, we believe that it is incumbent upon HUD to require that it be so, by clearly identifying the circumstances in which it is a “kickback” instead of compensation for services. Just as we hope the FRB will ensure that the purported trade-offs are real, we urge HUD to do the same.28 Our research suggests that such a requirement would help curb the abuses in the subprime market without interfering with the legitimate practice as it may prevail in the prime market.
2. The indirect compensation to a broker should be explicitly disclosed and should not suggest a price trade-off benefit of lower origination costs unless such trade-off actually exists.
The proposed disclosure of origination fees is structured as if there is definitely a price trade-off between back-end fees paid to the originator by the lender and upfront closing costs.
As discussed above, while this purported price trade-off may occur in the prime market, it virtually never occurs in the subprime market.29 The proposed disclosure even refers to the yield-spread premium as a “credit,” which we believe is misleading since the premium in fact results in an increase in costs. Indeed, even when there is a real price trade-off, a yield-spread premium is not a “credit,” but an alternative method of payment,30 one which, in the long run, could result in higher overall loan costs.
We hope that HUD will assure that real benefits accrue through clarifying when a yield-spread premium is a “kickback”.
Improvements to disclosures must follow reform of practices. Only then do we believe that the disclosure of indirect broker compensation can assume a price trade-off.
F. The GFE should educate consumers about their right to negotiate with mortgage originators.
While we hope that an improved GFE and other RESPA rules can facilitate mortgage shopping, the fact is, most consumers, especially those working with a mortgage broker, do not shop extensively for loans, and many of them do not understand that mortgage costs and rates are negotiable. The formal format of the proposed GFE may play a role in suggesting that the costs disclosed are fixed and are standard terms offered to every customer, much like the price of a gallon of milk. Because loan applicants need to understand that their mortgage terms are negotiable, we will recommend that the GFE provide consumers with that valuable information.31
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