This summer, while you were watching "Forrest Gump" and "True Lies," the mortgage lending world was experiencing the premiere of a different type of potential blockbuster. The emerging issue is overages -- higher mortgage loan prices charged to some, but not all, borrowers by eager loan officers seeking extra profits for themselves and their companies.
This practice, which is anywhere from fairly common to uncommon depending on whom you talk to, is often utilized by mortgage lenders as an incentive to loan officers as part of the commission system. The overage typically reflects the upper limit of the loan officer's ability to adjust the pricing terms within a certain range.
Sometimes they can get more than the going rate, and sometimes they must lower the price to close a deal.
In late May, the Federal Reserve Board sent a letter about the subject to district banks for them to alert their members to the fact that the board had been discussing overages with other regulators, as well as the departments of Justice and Housing and Urban Development.
The Fed's letter recommends a careful review of mortgage lending policies to ensure that overages are not applied in a discriminatory manner. The Fed noted that more formal guidance on overages was likely to be developed in the future through the interagency Fair Lending Task Force.
Further regulatory comment on the subject came just last week in the form of a letter from HUD to FHA lenders urging that they review overage activities to ensure they are not violating the Fair Housing Act, the Equal Credit Opportunity Act, or the FHA's tiered-pricing rule. The letter further urged all FHA lenders to adopt a monitoring and supervisory system to prevent potential violations in the future.
Perhaps in anticipation of more formal guidance yet to come, some mortgage banking companies have eliminated the practice of permitting overages and others are studying the issue, according to the annual Mortgage Banking Compensation Survey compiled for the Mortgage Bankers Association of America by Carl D. Jacobs & Associates, Woodland Hills, Calif.
This year's results show that 38% of 175 mortgage bankers permit overages, compared with 43% of 100 last year. While the results appear to show a decline, the numbers may actually be comparable, given the small size of the sample and the margin for error.
Why all the fuss? Within the context of a free-market economy, permitting overages -- technically, higher interest rates, origination fees, or loan points -- is not an inherently discriminatory practice. After all, the rule of the marketplace is "buyer beware."
Were it not for the fact that the Department of Justice and other agencies eschew the concept of caveat emptor when it comes to consumer lending, that rule would operate equally in the car lot, the camera store, the real estate office, and the bank branch.
Under this rule of the game, some people wind up paying more for goods and services than other people. Is there anything wrong with that? No, and none of the federal agencies seems to think there is.
The problem arises not because some people pay more than others, but because some kinds of people pay more than other kinds, and because there are laws that prohibit practices that produce such a discriminatory impact when it comes to credit services. In short, mortgage loans are not automobiles and the federal government does not think they should be treated the same way.
Whenever loan officers are permitted the latitude to set prices, discrimination can occur in a number of different ways:
* Loan officers may quote different rates based on an instant assessment of the particular customer's ability to negotiate. It may occur that women or minorities are quoted higher rates because the loan officer thinks they don't bargain as toughly.
* Everyone might be quoted the same rate, but males who are not members of a minority group might be more likely to negotiate the price.
* The lending institution permitting overages might make loans in certain areas where there is a preponderance of minorities who may not be in a position to negotiate as well as nonminorities in other areas where it lends.
* Even if everyone is treated evenhandedly, permitting overages on loans of a certain amount, for example, under $100,000, could have the effect of discriminating against minorities because a disproportionate number of borrowers who receive loans under the threshold may be minorities.
* Paying loan officers incentives to book higher-end loans could stimulate them to greater use of overages on minority-intensive smaller loans in order to make up the difference in their paychecks.
* Permitting loan officers the ability to offer a better rate than a competitor by allowing them to negotiate below the going rate in order to close a deal can also have a discriminatory effect if they do not apply this practice universally.
Overages are emerging as a controversy as a result of a clash between two concurrent societal trends. The first is the movement on the part of lenders to become more sales oriented, in particular to offer incentives to loan officers. The second is the maturation of the baby-boom generation, with its lust for fairness and its need to be smart shoppers.
At a banking industry conference two years ago, Madelyn Hochstein, president of DYG Inc., Elmsford, N.Y., warned that 1990s' consumers are adversarial shoppers who will scrutinize every pricing policy and question every calculation on interest rates.
This trend will keep mortgage lenders on their toes and require that they spend time deciding how best to compensate their loan officers while at the same time meeting the needs of the marketplace.
Paying loan officers on commission is frowned upon in the commercial lending area because of its potential for abuse. But in the consumer lending area, particularly in the mortgage lending area, it has gained popularity in the past decade as bankers have attempted to evolve from a transaction-oriented to a relationshiporiented sales culture.
One conclusion to increased scrutiny of the charging of overages is that mortgage lenders could take the easy, but not most profitable, way out and eliminate the practice entirely. In a time of low loan demand, this would provide a hard hit to loan officers' already-squeezed paychecks.
Although it is an issue that has the potential to become the flavor of the day with federal regulators, there are other, more profitable, ways to handle overages than by eliminating them.
The first and most important step is to review the way that overages are being applied. This includes evaluating the mortgage lending policies and practices of your institution to see if potential price discrimination exists in the areas of race, income level, property value, geography, gender, age, or marital status.
A a review like this can help determine whether any pricing differentials are occurring at the corporate, regional, or individual level or are evident for certain loan products and not others.
If a problem is found, altering your practices might be as simple as providing increased training to loan officers who may not have any idea that their behavior is having a discriminatory effect. Or it might be solved just by moving loan officers from one branch to another. Some bankers who have undergone the overage review have even instituted a kind of reverse commission practice, offering incentives to loan officers to make smaller loans.
Whichever solution you consider, it is critical that you find out exactly where your loan policies may be having a discriminatory impact as a result of the practice of allowing overages. Once you have this knowledge, avoiding the problem in the future may not be as difficult as you think.