Several fundamental aspects of the recently released Department of Housing and Urban Development proposal on disclosure and payment of compensation to mortgage brokers are flawed, if not totally unworkable.
The centerpiece of the proposed changes in the Real Estate Settlement Procedures Act is the draft mortgage broker contract, a binding agreement entered into by the borrower and mortgage broker before a loan application is taken.
The model mortgage broker contract features, among other things, three boxes that a broker can check:
I represent you.
I represent you, but I may receive a fee from a lender.
I do not represent you.
For deals in which the model mortgage broker contract is used, compensation to brokers would be protected by a "safe harbor."
HUD's attempt to prescribe more definitive regulation of mortgage broker compensation-an area that has hitherto eluded consensus in the mortgage industry-is problematic in the following respects.
First, the agency's statement in the preamble to the proposed rule that it "has never taken a position that yield spread premiums are per se legal" denies the mortgage broker industry a measure of relief that it had been seeking from the department.
Second, brokers checking either the first or second box would be deemed "agents" of the borrower and be obliged to obtain the most "favorable mortgage loan that meets the borrower's stated objectives." In this scenario, the broker is essentially rendered a fiduciary of the borrower, a relationship that traditionally has not existed between these parties.
Further, given the enormous choice of loan programs available to borrowers, it is unclear what constitutes "the most favorable mortgage loan." The proposal creates the perverse incentive for brokers to avoid these additional responsibilities by merely checking the third box.
Third, although HUD claims that the proposed contract is voluntary, the compensation arrangements of those brokers not using the form will be presumed to violate Section 8 of Respa. While this presumption may be rebutted by showing that total compensation is reasonably related to the value of the goods or services provided, such a burden would put brokers in the awkward position of having to justify their fees.
Further, because brokers not entering into the model contract would likely face consumer lawsuits, few brokers would opt not to use it.
Last, defining a safe harbor will be exceptionally difficult. In the past, HUD has generally not interpreted Respa to give regulators authority to dictate what the price of certain services should be. Rather, the agency has historically looked to the market to determine the reasonableness of fees or prices paid for services.
In light of these practices, any attempt by HUD to define the boundaries of total permissible compensation could be construed as rate-setting. Further, while such a de facto rate-setting scheme might be welcomed by lenders who offer conventional loan products and want assurance that broker fees paid in connection with such transactions do not violate Respa, subprime lenders would likely view the scheme as anathema. That's because broker fees charged in the B and C credit markets are generally significantly higher than those in traditional A credit transactions.
By contrast, if the agency defines the qualified safe harbor in terms of what other brokers are earning for similar services in a particular geographic region, it must ensure that the parameters of the test are not stated in such an open-ended way as to precipitate litigation. In any event, success in prescribing such a safe harbor-the Achilles' heel of the HUD proposal-may prove elusive.