The policy statement issued March 1 by the Department of Housing and Urban Development on the legality of lender payments to mortgage brokers has provided some guidance to the mortgage industry - but not much.
But a statement of policy is not what HUD really wanted to issue.
On Oct. 16, 1997, the department published a proposed rule, notice of proposed information, and request for comments and responses to specific questions. The deadline for comments of Dec. 15, 1997, is almost ancient history, but the proposed rule is still pending.
As part of the Conference Report on the 1999 HUD Appropriations Act, Congress directed HUD to issue a policy on the legality of lender payments to mortgage brokers under the Real Estate Settlement Procedures Act.
HUD complied, but its statement of policy includes numerous statements indicating that what it really needs is legislative reform.
Beyond that, HUD's statement seeks to clarify an existing position - nothing more. For example:
In 1997, when HUD published its proposed rule, numerous lawsuits had been brought seeking class-action certification. These lawsuits contended that certain fees lenders paid to mortgage brokers were for the referral of settlement service business, in violation of section 8 of the Settlement Act. The statement of policy says that payments by lenders to mortgage brokers are not illegal per se.
In the final analysis, the consumer is paying for all of the services required to originate, process, and close a loan. This makes the mortgage broker's total compensation subject to scrutiny.
HUD will apply a two-step test to determine if a payment from a lender to a mortgage broker is permitted under the Settlement Act, without regard to whether it was provided by the mortgage lender or by the borrower. It will ask whether services actually were performed for the payment, and whether the payment to the mortgage broker reasonably related to what was furnished.
HUD will continue to use its 1995 letters to the Independent Bankers Association of America to evaluate goods, facilities, or services provided. The letters list services that may be provided by mortgage brokers in the origination, processing, and closing of mortgage loans. (The IBAA is now known as the Independent Community Bankers of America.)
HUD encourages early and detailed consumer disclosures and would like to see more of them. But it admits that these disclosures are not required.
Remember that the proposed rule encouraged mortgage brokers to enter brokerage contracts with borrowers. The contracts would have included such elements as:
Disclosure of the mortgage broker's function, and whether the mortgage broker was representing the borrower or the lender.
Disclosure of the number of sources to which the mortgage broker would shop the loan, and whether the mortgage broker was shopping for the "most favorable mortgage loan" that met the borrower's objectives.
Disclosure of the compensation and its sources that the mortgage broker would receive, both direct (from the person or entity contracting with the mortgage broker) and indirect (from a source other than the person or entity contracting with the mortgage broker.)
Disclosure of the borrower's rights under the Settlement Act and the contract with the mortgage broker.
The idea set forth in the proposed rule was that if the broker used the contract and adhered to the Settlement Act, the broker's compensation would be deemed to have been received within a "qualified safe harbor" within which fees would be presumed legal.
If the mortgage broker did not enter into the specified contract, any mortgage broker compensation would be presumed to violate Sections 8(a) or 8(b) of the Settlement Act.
At first blush, there was very little in the statement of policy that could be said to have been helpful to mortgage lenders and brokers. Still, the statement could help reduce class-action lawsuits.
Recently, plaintiffs' lawyers have filed claims contending that the payment of yield spread premiums violate section 8.
Given that violations can be determined only case by case - as the policy statement strongly suggests - mortgage lenders and brokers who are defendants in these lawsuits should have a fairly easy time decertifying these classes. Without being able to file class actions, plaintiffs' lawyers will now have much less incentive to bring these actions.
On several occasions, HUD has noted that the secondary-market exemption of the Settlement Act and Regulation X is unchanged. This means that any mortgage broker capable of funding and closing loans in its own name may sell the loans later to a mortgage lender or investor for whatever price it is able to obtain, without regard to the referral fee prohibitions in the Settlement Act.
As HUD made clear, the policy statement applies only to loan transactions in which the mortgage broker is not the source of the funds.
This does not mean that all mortgage loans funded by mortgage brokers will be exempt. For example, HUD is not likely to regard a mortgage loan sale as being within the secondary-market exemption if the mortgage broker's primary source of funds is a warehouse line of credit provided by the purchaser of the loan.
The policy statement reminds us that HUD will apply a reasonableness test on a case-by-case basis. Some matters that have been left open for discussion or that are worthy of special mention:
The essence of the two-step test may not provide sufficient guidance or comfort to the mortgage brokerage industry, due to the inherently subjective nature of the analysis.
Except in cases of obvious abuse, the examination of the services, goods, or facilities provided and their relationship to total compensation may yield a result that is hard to measure and apply in a predictable, consistent, and fair manner.
The statement of policy may have no effect if HUD decides it would be hard to implement with more confidence or certainty than the Settlement Act or Regulation X alone.
In the final analysis, the policy statement is another very small step on the road to meaningful reform.