[Senate Hearing 107-857]
[From the U.S. Government Publishing Office]
S. Hrg. 107-857
PREDATORY MORTGAGE LENDING
PRACTICES: ABUSIVE USES
OF YIELD SPREAD PREMIUMS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
ON
THE ISSUES SURROUNDING THE USES AND MISUSES OF YIELD SPREAD PREMIUMS IN
LIGHT OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT'S ANNOUNCED
INTENTION OF PUTTING OUT A PROPOSED RULE ON THE REAL ESTATE SETTLEMENT
PROCEDURES ACT
__________
JANUARY 8, 2002
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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WASHINGTON : 2003
____________________________________________________________________________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PAUL S. SARBANES, Maryland, Chairman
CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii JOHN ENSIGN, Nevada
Steven B. Harris, Staff Director and Chief Counsel
Wayne A. Abernathy, Republican Staff Director
Jonathan Miller, Professional Staff
Patience Singleton, Counsel
Daris Meeks, Republican Counsel
Geoff Gray, Republican Senior Professional Staff
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
?
C O N T E N T S
----------
TUESDAY, JANUARY 8, 2002
Page
Opening statement of Chairman Sarbanes........................... 1
Prepared statement........................................... 40
WITNESSES
Beatrice Hiers, of Fort Washington, Maryland..................... 4
Rita Herrod, of Clarksburg, West Virginia........................ 6
Susan M. Johnson, of Cottage Grove, Minnesota.................... 7
Prepared statement........................................... 41
Howell E. Jackson, Finn M.W. Caspersen and Household
International
Professor of Law and Associate Dean for Research and Special
Programs,
Harvard University School of Law............................... 14
Prepared statement........................................... 54
Response to written question of Senator Sarbanes............. 85
John Courson, Chairman-elect, Mortgage Bankers Association and
President and Chief Executive Officer, Central Pacific Mortgage
Company
Folsom, California............................................. 18
Prepared statement........................................... 59
Joseph L. Falk, President, National Association of Mortgage
Brokers........................................................ 20
Prepared statement........................................... 64
Response to written question of Senator Schumer.............. 89
Ira Rheingold, Executive Director, National Association of
Consumer
Advocates...................................................... 22
Prepared statement........................................... 70
David Olson, Managing Director, Wholesale Access Mortgage
Research
and Consulting, Inc............................................ 24
Prepared statement........................................... 78
David R. Donaldson, Counsel, Donaldson & Guin, LLC............... 26
Prepared statement........................................... 81
Response to written questions of:
Senator Sarbanes......................................... 92
Senator Schumer.......................................... 94
Additional Material Supplied for the Record
Statement of ABN AMRO Mortgage Group, Inc........................ 105
``Another View of Predatory Lending'' by Jack Guttentag, dated
August 21, 2000................................................ 125
``Kickbacks or Compensation: The Case of Yield Spread Premiums''
by
Howell E. Jackson and Jeremy Berry............................. 155
Mortage Broker Fee Agreement submitted by John Courson........... 172
Letter submitted by the National Association of Mortgage Brokers. 173
Letter of Clarification submitted by Bren J. Pomponia on behalf
of
Rita Herrod, dated January 23, 2002............................ 175
Comsumer Analysis of HUD's 2001 Policy Statement on Lender
Payments
to Mortgage Brokers by Margot Saunders......................... 177
(iii)
PREDATORY MORTGAGE LENDING
PRACTICES: ABUSIVE USES
OF YIELD SPREAD PREMIUMS
----------
TUESDAY, JANUARY 8, 2002
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:40 a.m., in room SD-538 of the
Dirksen Senate Office Building, Senator Paul S. Sarbanes
(Chairman of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES
Chairman Sarbanes. Let me call this hearing to order.
There are a number of people outside waiting. Are there any
empty seats out there? We are going to try to move a few more
people in. We may have them standing in the back. But if there
is any way for people who are already in to tighten up a bit,
we would appreciate that. And to the extent that we can add
some others and they can stand in the back, we will try to do
that as well in order to accommodate people.
This morning the Committee on Banking, Housing, and Urban
Affairs will hold its third hearing on the subject of predatory
lending. Our previous two hearings on this subject focused
largely on the predatory loans and practices which have
resulted in stripping hard-earned equity away from many low-
income homeowners. These include folding high points and fees,
as well as products such as credit insurance, into the loan. We
examined in those hearings held this past July how unscrupulous
lenders and mortgage brokers target low-income, elderly, and
uneducated borrowers as likely marks for predatory loans.
Today, we are going to focus on the role of the broker in
the lending process and specifically, we are going to focus on
the use and misuse of what are referred to as yield spread
premiums.
Let me start by addressing briefly how yield spreads are
used in the marketplace. Typically, a mortgage broker will
offer to shop for a mortgage on behalf of a consumer, the
prospective borrower. In many cases, that broker will promise
to get the borrower a good deal, meaning low rates and fees.
Borrowers pay the broker a fee for this service, either out of
their savings or with the proceeds of the loan. Unbeknownst to
the borrower, however, that broker may also be paid a yield
spread premium by the lender if he can get the borrower to sign
up for a loan at a higher rate than the borrower qualifies for.
The higher the mortgage rate, the higher the payment. And we
will hear about such cases this morning.
Yield spread premiums, properly used, can be a tool in
helping a homebuyer or homeowner offset all or some of the
closing costs associated with buying or refinancing a home.
When used properly, the broker discloses his total fee to the
consumer. The consumer may then choose to pay that fee, and,
perhaps other closing costs as well, by accepting a higher
interest rate and having the lender pay the fee to the broker.
In such cases where the borrower makes an informed choice the
payment helps families overcome a barrier to homeownership--
namely, the lack of funds for closing costs.
It is very important that this be transparent and that the
borrower know exactly what their options are. But it appears
that in practice, perhaps in widespread practice, yield spread
premiums are not used to offset closing costs or broker fees.
Instead, these premiums are used to pad the profits of mortgage
brokers, without any regard to any services they may provide to
the borrowers.
Let me quote from a report issued by the Financial
Institutions Center at the Wharton School of Business at the
University of Pennsylvania. Professor Emeritus Jack Guttentag,
discussing the problem of rebate pricing--that is, payments by
lenders to brokers of yield spread premiums,writes:
In most cases, rebates can be pocketed by the broker,
unless the broker commits to credit them to the borrower, which
very few do. Rebate pricing--that is, yield spread premiums--
has been growing in importance, and one of the reasons is that
it helps mortgage brokers to conceal their profit on a
transaction.
Moreover, this does not just affect subprime borrowers, as
do most of the other egregious practices we heard about in our
previous hearings. The misuse of yield spread premiums affects
prime borrowers, FHA borrowers, VA borrowers. But, because of
the lack of openness and competition in the subprime market, it
hits subprime borrowers hardest of all. Even for those with the
best credit, yield spread premiums can cost thousands of
dollars in increased financing costs.
Yield spread premiums, when they are misused in this
manner, fall directly into the category of the kind of referral
fees or kickbacks that were so prevalent in the settlement
business prior to the passage of RESPA--the Real Estate
Settlement Procedure Act--enacted by Congress in 1974, after
years of hearings and reports, and specifically designed to
outlaw side payments of this kind because they increase the
costs of homeownership for so many Americans. Indeed, the plain
language of the law, the regulations, the 1998 Congressional
instructions to HUD to formulate a policy on this issue, and
the 1999 HUD policy statement, particularly when taking the
legislative history into account, all make it clear that RESPA
was intended to prohibit all payments that are not demonstrably
and specifically for actual services provided. That is to say,
each fee collected by the broker should be for a corresponding
service actually provided.
Because the majority of home loans are now originated
through brokers, lenders have less and less direct access to
borrowers. This means they must compete for the broker's
attention to gain access to the ultimate consumer--the
borrower. This competition means that, too often, lenders pay
yield spread premiums to the brokers simply for the referral of
business. As all of us know, this is prohibited under the law
precisely because it raises the cost of homeownership to the
consumers.
Regrettably, HUD's recent clarification of its 1999 policy
statement on the issue of yield spread premiums will open the
door to new and ongoing abuses of low- and moderate-income
homebuyers. Despite the Secretary's statement at his
confirmation hearing that he finds predatory lending
``abhorrent,'' I fear that the new policy statement will
facilitate the predatory practice of steering homeowners to
higher interest rate loans without their knowledge and, more
importantly, without any effective means of redress.
Now, Secretary Martinez has made increasing minority
homeownership a primary goal of his Administration. However, a
study done by Howell Jackson of the Harvard Law School, who
will be testifying on the second panel this morning, shows that
while the current use of yield spread premiums imposes extra
costs on all homebuyers, the burden falls especially heavy on
minorities. In other words, yield spread premiums, when they
are used in this abusive fashion, put the dream of
homeownership further out of reach for minority Americans.
Those who still manage to achieve the dream of homeownership
are forced to pay thousands of dollars in increased interest
costs over the life of their loans.
Many find themselves in more precarious financial positions
than they should be, thereby putting them at greater risk of
falling prey to the kind of repeated refinancing that we have
seen leading to equity stripping or even the loss of the home.
HUD has indicated both in testimony before this Committee
in December, and in a general announcement, that it intends to
publish a proposed regulation on this matter by the end of this
month. These issues are of such importance that they call for a
public airing at this time, and that is the purpose of this
hearing, so that the Department can take into consideration
today's testimony as it considers formulating the new
regulation.
We have two panels this morning. Let me just say in
reference, and then I will introduce them in greater detail
when they arrive, the second panel will consist of a number of
experts from the academic world, consumer advocates, and from
the business interests involved in the issues before us this
morning.
The first panel that we will now turn to involves three
witnesses who will testify about how their brokers steered them
into higher rate mortgages in exchange for payments of yield
spread premiums from the lenders. These are the mortgage
brokers that each of these consumers went to and in the course
of that process, they led them into a higher rate mortgage than
they otherwise would have had to undertake. And the difference
as a consequence was paid from the lender to the broker, not to
the benefit of the consumers.
Beatrice Hiers is a Supply Management Representative for
the General Services Administration and resides in Fort
Washington, Maryland. Susan Johnson lives in Cottage Grove,
Minnesota, outside of Minneapolis, and is a Manager at K-Mart.
And Ms. Rita Herrod is retired and lives with her daughter and
grandchildren in Clarksburg, West Virginia.
Before we take your testimony, let me express my very deep
appreciation to all of you for your willingness to leave your
homes and come here and be with us this morning and your
willingness to speak publicly about your stories. I know that
this can be a
difficult thing to do. I just hope you understand how much we
appreciate your willingness to contribute to a process that I
hope will lead to some action to stop the kinds of practices
that caused each of you such heartache, such difficulty, and
such trouble.
I want to point out that these three witnesses include a
prime borrower, a subprime borrower, and an FHA borrower. It is
important to mention this so that everyone understands how the
abuse of yield spread premiums can affect people, whatever
their credit rating and whatever type of mortgage they receive.
Now, I will turn to you, Ms. Hiers. We will hear from you
first and then we will go to Ms. Herrod and then Ms. Johnson.
We will just move right across the panel, and we will hear from
each of you first before I go to any questions.
Again thank you very much for coming and being with us this
morning.
Ms. Hiers, I think if you pull that microphone closer to
you and talk right into it, it will be more audible.
STATEMENT OF BEATRICE HIERS
FORT WASHINGTON, MARYLAND
Ms. Hiers. Good morning. I am Beatrice Hiers, and thank you
for inviting me here today.
I am 43 years old and live in Fort Washington, Maryland. I
have two children, Ebony, 22, and Zachary, 11. In addition,
prior to their recent deaths, my elderly parents lived with me.
I have worked hard and overcome many obstacles to purchase my
own home.
I grew up in Prince George's County, Maryland. My family
lived in a neighborhood that was not racially mixed. In fact,
we were the first blacks on the street. In 1974, I received a
general equivalency degree and went to work for Prince George's
County Department of Social Services. In 1979, I began working
for the Federal Government as a clerk/typist. Over the past 20
years, I have worked my way up to my current position as a
Supply Management Representative for the General Services
Administration.
Prior to purchasing my own home in August 1997, I struggled
financially. I was a single parent and also helped support my
parents. I began to think about moving and buying a home
because the neighborhood in which I lived had become a ``drug
haven.'' I felt that it was important for my children and
parents to get into a new environment that offered safety and
security.
In June 1997, after house hunting for close to a year, I
finally found a house that I wanted. I signed a contract to
purchase the house for $159,750, but was told by my real estate
agent that I needed to obtain my own financing. Because I was
inexperienced with real estate transactions, I engaged the
services of Homebuyers Mortgage Company, a mortgage broker
located in Prince George's County, and asked them to find me a
7 percent or better ``fixed'' rate FHA mortgage loan, a rate
equal to what another lender--Countrywide Home Loans--was
willing to offer me.
The closing on the home was scheduled for August 29, 1997.
As the settlement approached, I became increasingly nervous
because Homeowners had not confirmed that it had located a
mortgage for me. As late as just 2 days before the closing,
Homebuyers told me that a firm commitment on financing was not
yet available. Even though mortgage rates were low and
favorable in August 1997, on the day of closing, Homebuyers
finally told me that it had arranged a 7 percent ``adjustable
rate'' FHA insured mortgage loan through Inland Mortgage
Company, which is now Irwin Mortgage Company. Homebuyers told
me that Inland was providing me with the best rate and most
favorable financing terms that they could secure. Reluctantly,
and believing that I had no other options, I entered into the
mortgage loan transaction.
Homebuyers charged me extraordinary fees and points. My
HUD-1 Settlement Statement reveals that Homebuyers charged me
the FHA maximum 1 percent origination point, $1,544, plus loan
discount points of 3 percent, $4,736. On top of these fees,
Homebuyers also collected a yield spread premium from Inland of
nearly 3 percent--an astonishing $4,538.87. In other words, I
paid 3 discount points to reduce my interest rate and the
broker was paid 3 percent by Inland to increase my interest
rate.
Almost a year after I entered into the mortgage loan
transaction, I learned that Homebuyers had not obtained for me
the most favorable financing terms. In fact, I learned that
Homebuyers was paid the $4,538.87 Yield Spread Premium by
Inland Mortgage solely because Homebuyers was able to deliver
my mortgage well above par--that is, Inland would have been
willing to underwrite my mortgage loan at a lower interest
rate. Moreover, I learned that Homebuyers' yield spread premium
was increased because Homebuyers delivered the mortgage loan
with a short lock in period. Irwin's rate sheet, in fact, shows
that I qualified for the same loan at about 5\1/2\ percent
interest rate with no yield spread premium to the broker.
What truly amazes me is that for the small amount of work
performed for me, Homebuyers collected more than $10,800,
including the yield spread premium. Moreover, had I known that
Homebuyers had secured for me a mortgage with an above-par
interest rate, I would have secured other financing.
Eventually, because the payments under Inland's adjustable
rate mortgage were becoming prohibitive, I engaged the services
of another mortgage broker, Allied Mortgage, to assist me in
the refinancing of my loan. I have since learned that this
transaction included the payment of a yield spread premium, and
resulted in my receiving another loan at a higher interest rate
than I qualified for.
After completing these two mortgage transactions, I learned
what yield spread premiums are and how they affected my
mortgage loan and increased my monthly mortgage payments. As a
result, I recently refinanced my home a second time, but this
time directly with a lender. Because of my experiences with
mortgage brokers and yield spread premiums, I will never go to
a mortgage broker again.
Thank you again for inviting me and for your attention to
these important issues.
Chairman Sarbanes. Well, thank you very much for your
statement. It is a very clear statement of the problem that we
are quite concerned about.
You actually paid extra to try to get a lower rate,
interest rate, discount points, at the same time that your
broker led you into a higher interest rate in order to get the
yield spread premium. Is that correct?
Ms. Hiers. Correct.
Chairman Sarbanes. Ms. Herrod, we would be happy to hear
from you.
STATEMENT OF RITA HERROD
CLARKSBURG, WEST VIRGINIA
Ms. Herrod. I am glad to have the chance to come here today
and tell what happened to me so that others are not treated the
way I have been treated. My name is Rita Herrod, and I am a 62-
year-old mother, grandmother, and now, great-grandmother. I am
currently disabled and unable to work. I live with my daughter
and grandchildren, and I own my home with my daughter.
In July 1994, I bought a house in Clarksburg, West
Virginia, for $22,000 for my daughter, Jennifer, and her
children. About 4 years later, when I divorced my husband of 34
years, I moved into the house with my daughter and
grandchildren, and I live there today.
In 1999, my daughter and I took out a loan to make
improvements on the house. We got a decent loan from a local
bank for 15 years with a variable rate beginning at 7.8
percent. I would end up not getting much benefit of this loan.
In early 2000, my troubles started when we encountered a
mortgage broker we thought we could trust, Earl Young. My
daughter Jennifer was working for Heilig Myers, where she met
Mr. Young. Mr. Young, who worked for First Security,
distributed his card to my daughter for her to distribute to
others. Because my daughter knew Mr. Young and we had some
bills to pay, we responded to his solicitation in April 2000.
Mr. Young told us he would get us a home loan with a lower
interest rate on our current loan. He told us he was going to
search and find for us the best deal he could.
Mr. Young arranged for an appraisal of our house. He said
not to worry that I was not working and not to worry about the
rumors that my daughter would be laid off in the near future.
The appraisal he got for my house, I found out later, was for
far more than it was worth.
We closed the loan the next month. We had to meet at Mr.
Young's office. He seemed to have taken care of everything. He
told us he was giving us a good deal. He said that our
appraisal did not come back at what they wanted, so he agreed
to cut his own fees to work the deal.
I wonder now what part of his fees Mr. Young cut. He
charged us an origination fee of $4,000, a broker fee of
$2,600, and I learned from my lawyer that he got a kickback
from the mortgage company of $3,304 for getting me into a
higher interest rate.
My loan was for just under $85,000, and I ended up paying
over $10,000 in fees to Mr. Young. Now, I say that Mr. Young
appeared to take care of everything, but I do not think he did
$10,000 worth of work on my loan. He took our information and
arranged for an appraisal. I do not know what else he did, but
I know the mortgage company faxed him all the papers. I had no
idea I was going to have to pay him so much, and I cannot for
the life of me figure out what I got in return. And while I
guess Mr. Young charged me $4,000 commission for finding the
loan, and $2,600 for his fees, I have no idea what he did to
earn the extra $3,304. Had I known $10,000 was going to be
tacked onto the loan, I would never have done it. Had the
broker not taken a kickback, I would have at least had a rate
of 8.5 percent, maybe lower. Instead, I got a loan up near 10
percent.
I now have a loan that far exceeds the value of my house,
making it so I cannot take advantage of lower interest rates
and refinance. I am stuck with this loan, which requires that I
make over $275,000 in payments at an APR of almost 10 percent.
At the very worst, I could have stayed with my old loan,
avoided the extra fees, and dealt some other way with my bills
instead of putting them into my home.
I do not have any problem with people helping folks find a
loan to help them out of a bind, or get them a good deal. But I
do not think it is right for a broker to take a secret kickback
of over $3,300, when they already are getting almost $7,000 in
other fees. And I do not think it was worth $10,000 to get a
loan that is worse than what I had, when there are much better
deals out there. We trusted Mr. Young, because we thought it
was his job to find us the best deal. But instead, he cheated
us out of a lower interest rate and $10,000.
Thank you.
Chairman Sarbanes. Thank you very much, Ms. Herrod. We
appreciate your very powerful testimony.
Ms. Johnson.
STATEMENT OF SUSAN M. JOHNSON
COTTAGE GROVE, MINNESOTA
Ms. Johnson. Good Morning. My name is Susan Johnson and I
am from Cottage Grove, Minnesota. I am pleased to have the
opportunity to be able to address----
Chairman Sarbanes. I think you are going to need to pull
that microphone closer to you because it does not pick up very
well unless you get it right up close to you.
Ms. Johnson. I am pleased to have the opportunity to be
able to address the Senate Banking Committee today about the
$1,620 yield spread premium that was secretly paid by my
lender, ABN AMRO Mortgage Group, to my mortgage broker,
Allstate Mortgage, at my expense.
In April 2000, my husband David and I had just moved back
to the Twin Cities from Colorado Springs and were looking to
buy a house. Through a real estate agent, we were introduced to
David Schultz, the owner of Allstate Mortgage, a mortgage
broker in Plymouth, Minnesota. After meeting Mr. Schultz at a
local restaurant, we hired him to find us a mortgage loan.
From the outset, we were told by Mr. Schultz that he would
find us a loan with the best possible rate. Mr. Schultz
specifically told us that the fee of processing the loan would
be 1 percent of the loan amount. We signed a written broker
agreement with Mr. Schultz which allowed for a 1 percent broker
fee. No other fees were ever demanded by Mr. Schultz,
discussed, or agreed to.
When the closing occurred on May 23, 2000, to our surprise,
the interest rate was higher than we understood it would be and
the fees were far greater than the 1 percent fee we had agreed
to. In fact, the total fees were nearly four times that amount,
$5,242. This included what we only later came to learn after
the closing was a yield spread premium--a $1,620 payment from
the lender to our broker that was really paid by us since it
was tied to an inflated interest rate on our loan.
While we were upset about the fees, we had no choice but to
go through with the closing or risk losing the house, being
found in default of the purchase agreement; and forfeiting the
$5,000 earnest money down we had already given the sellers.
While we objected to the fees and higher interest rate, there
was no way for us to find another loan and still close on time.
We were stuck and the broker knew it.
As our HUD-1 Settlement Statement shows, we were charged
the following fees at closing, none of which was disclosed, or
agreed to, beyond the initial 1 percent origination fee: $1,296
loan origination fee; $1,292 loan discount fee; $395 processing
fee; $200 underwriting fee; $150 doc prep fee; $40 funding fee;
$350 commitment fee; and $285 admin fee.
Only after the closing did we discover the significance of
the $1,620 yield spread premium which was assessed to us
through an inflated above-par interest rate of 8.75 percent. At
the time of the closing, we had no idea what this premium was
because it was only vaguely disclosed on our HUD-1 Settlement
Statement as a Deferred Premium POC. In sum: The $1,620 yield
spread premium was not disclosed, discussed, or agreed to
before the closing; my husband and I were never informed that
our loan had an above-par interest rate because of the premium
payment from ABN AMRO to the broker; the broker never explained
how the yield spread premium affected our interest rate or that
our monthly mortgage payments would be any higher because of
the premium; no rate sheet or other document showing the direct
relationship between the inflated interest rate and the yield
spread premium payment from the lender to the broker was ever
shown to us; the yield spread premium did not offset or reduce
any fee we ever owed to the broker; the broker received all
fees that we owed and agreed to--and far more--directly in cash
from us at the closing.
After the closing, I wrote to the State of Minnesota
Department of Commerce complaining about the transaction. After
reviewing my letter, the Department of Commerce advised us to
seek private legal counsel. The matter remains pending in court
in Minnesota. In that case, we have agreed to be
representatives of other borrowers whose loans had yield spread
premiums paid by the same lender in the same manner as ours.
In conclusion, the $1,620 yield spread premium on our loan
was nothing more than a bonus paid by the lender to the broker
for securing a bad deal for my husband and me, and referring a
better deal to the lender. This conduct should be illegal
because: The yield spread premium was not paid in exchange for
any service fee we owed to the broker; We received no benefit
from the premium the lender paid at our expense, such as an
offsetting credit against any closing fees or costs we actually
owed, and the money was simply a kickback to the broker
referring our loan to the lender with a higher interest rate.
The standard for evaluating the legality of this practice
should not merely be whether the broker's total compensation,
including the yield spread premium and other fees we never
agreed to, is somehow reasonable based on the broker's after-
the-fact attempt to justify the higher fees he has already
taken. Rather, the true nature of the disputed premium should
be evaluated: That is, what was the premium actually paid in
exchange for.
To allow as lax a standard as ``reasonableness'' of total
broker compensation to govern these transactions will only
allow lenders and brokers like ABN AMRO and Mr. Schultz to
continue ripping-off unknowing consumers like us, with a catch-
us-if-you-can attitude. It will encourage brokers and lenders
to continue to try to slip additional bonus fees into mortgage
transactions regardless of what was agreed and without
providing any actual credit to the consumer bearing the cost.
If lenders are paying bonuses and incentives to brokers simply
for referring high-rate loans to them, that should be illegal
without concern for whether the broker or lender thought the
secret referral fee was reasonable.
Thank you again for giving me the opportunity to speak
today.
Chairman Sarbanes. Thank you for coming this morning.
One thing I find very interesting about all three of your
stories is that, in each case, you were led to believe that the
mortgage broker would work to find a loan that was in your best
interest. You all proceeded ahead on the impression or, really,
the understanding, that this broker was going to do the best
that he could for your interest. Is that correct?
Ms. Johnson. [Nods in the affirmative.]
Ms. Hiers. [Nods in the affirmative.]
Ms. Herrod. [Nods in the affirmative.]
Chairman Sarbanes. So you placed confidence in the broker.
You did not see the broker as a party on the other side of the
table. You actually saw him on your side of the table. Is that
correct?
Ms. Hiers. [Nods in the affirmative.]
Ms. Johnson. [Nods in the affirmative.]
Ms. Herrod. [Nods in the affirmative.]
Chairman Sarbanes. You had better say yes because he cannot
get nods.
[Laughter.]
Ms. Hiers. Yes.
Ms. Johnson. Yes.
Ms. Herrod. Yes.
Chairman Sarbanes. Now each of you ended up paying a higher
interest rate than you would otherwise qualify for, in addition
to paying substantial upfront costs.
And one of the things, your statements outline the extra
fees and charges involved at the time of settlement. We have
not gone into the extra cost to you over the life of the loan
as a consequence that you would be paying a higher interest
rate. That makes a very significant difference in your monthly
payment and your overall payment through the cost of the loan,
whether you got the lower or the higher interest rate.
So another cost to you that is not reflected in the
statement, one would have to calculate it out by what the
difference was in the interest rates and the amount of your
loan. But in any event, it is clear that there is a substantial
additional charge to each of you over the life of the loan
because you are paying at a higher interest rate than you
otherwise might have had available to you.
Now, I want to make sure that I understand what each of you
paid in fees for your loans.
Ms. Hiers, let me start with you first. When you went to
the mortgage broker, I gather you understood that you could
qualify for a 7 percent fixed-rate loan with another lender. Is
that correct?
Ms. Hiers. That is correct.
Chairman Sarbanes. And when you decided to move forward
with this broker, I take it it was in the belief that the
mortgage broker was going to get you a better rate and be able
to do better for you than that. Is that correct? That is why
you went ahead with using the broker.
Ms. Hiers. That is correct.
Chairman Sarbanes. Now, in the end, this broker got you an
adjustable-rate loan at 7 percent, not a fixed-rate loan. Is
that correct?
Ms. Hiers. That is correct.
Chairman Sarbanes. Which I gather was about one and a half
points above what you might have qualified for, as you
understood it, later understood it.
Ms. Hiers. At an adjustable rate, yes.
Chairman Sarbanes. Now, you did not know you would be
getting a less favorable loan until just before the closing. Is
that right?
Ms. Hiers. The day of closing.
Chairman Sarbanes. The day of closing.
Ms. Hiers. In the 12th hour.
Chairman Sarbanes. And, of course, at that point, I gather
you did not feel that you were in any position to walk away
from this and try to find another loan. Correct?
Ms. Hiers. Correct.
Chairman Sarbanes. I mean, did you find it out right at
closing?
Ms. Hiers. At closing.
Chairman Sarbanes. Right at closing.
Ms. Hiers. Right at closing.
Chairman Sarbanes. Did you know prior to closing that
because you were getting a loan at such a high interest rate,
the mortgage broker was being paid a yield spread premium of
almost 3 percent? Did the broker ever discuss this yield spread
premium with you and explain what the premium was for?
Ms. Hiers. No. No.
Chairman Sarbanes. That was just over $4,500 in the yield
spread premium that the broker was getting from the lender.
Ms. Hiers. Exactly.
Chairman Sarbanes. And, of course, you did not know about
that.
Ms. Hiers. I was not aware of it.
Chairman Sarbanes. Now, you say that you also paid 3
discount points as well. Did the broker explain to you that
these discount points would bring down the interest rate on
your loan, that that was the purpose of the discount points?
Ms. Hiers. The broker did not explain any of the fees to
me. The day that I was supposed to go to settlement, my loan
was not approved. It was not approved. It was a Friday evening.
My loan was not approved until about 4:00 in the afternoon. The
sellers had to go to settlement also that day and there was
nothing explained. Everything was held until the 12th hour.
Everything was held and none of the fees were explained to me.
I later found out about the yield spread premiums.
Chairman Sarbanes. And it was only subsequently that you
discovered that they had not gotten the most favorable
financing terms and that they had been paid a yield spread
premium.
Ms. Hiers. Right.
Chairman Sarbanes. So what happened to you, in effect, is
you took on this broker. You had a contract to purchase the
home for just under $160,000. The broker charged you a 1
percent origination point, the FHA maximum, I take it, at the
time, for $1,500. You paid these loan discount points of 3
percent, $4,736. That, of course, was to get your interest rate
down. Then the broker turned around and he got a nearly 3
percent yield spread premium from the lender, which was worth
to him $4,538.
So your broker got almost $11,000 out of this arrangement.
And the upshot of it was to put you into a significantly
higher-rate mortgage than would otherwise have been the case.
Is that correct?
Ms. Hiers. That is correct.
Chairman Sarbanes. In addition, I have a work sheet that we
have prepared here that indicates that over the life of this
mortgage, you will pay an extra $56,000 in interest, from what
you would have paid if you had had the interest rate for which
you qualified.
I know it is a little awkward to lay all of this out like
this, but I think it is important to do it because there are
lots of people out there that are subject to the same thing and
we want to send a very strong warning signal and we appreciate
your coming this morning to help us do that.
Now, Ms. Herrod, let me ask you just a few questions about
your situation. First of all, you are currently disabled. But I
gather that previously, you were working. Is that correct?
Ms. Herrod. Correct.
Chairman Sarbanes. What did you do, Ms. Herrod?
Ms. Herrod. I was a buyer at a pharmacy, customer service,
and buying and inventory. I had to have surgery on Valentine's
Day of 2000. And when I told my employer, I asked him if he had
any compensation for me. He said, no. He said, I have to make
some cuts, economic cuts, and I was one of the higher-paid
employees. So, I was given a 3 months severance pay, which
ended May 31. And I had told Mr. Young in April, I said, I am
going to be out of income next month. And he said, it does not
matter, as long as you have income today.
Chairman Sarbanes. Ms. Hiers, you worked for your general
equivalency degree and then worked for the Department of Social
Services in Prince George's County.
Ms. Hiers. That is correct.
Chairman Sarbanes. And then went to work for the Federal
Government, beginning as a clerk/typist, I gather.
Ms. Hiers. Yes.
Chairman Sarbanes. But then you worked your way up, and now
you are a Supply Management Representative for the General
Services Administration. Correct?
Ms. Hiers. That is correct.
Chairman Sarbanes. Ms. Johnson, were you employed?
Ms. Johnson. Yes.
Chairman Sarbanes. What were you doing? Or what do you do?
Ms. Johnson. I am a Unit Pricing Manager at K-Mart.
Chairman Sarbanes. Okay. I ask these questions only to
underscore the fact that you are all three hard-working people
who have been gainfully employed and contributing to the
economy and, in a sense, playing by the rules and trying to own
a home and realize that, make things better for your family and
so forth and so on. It is extremely distressing to see these
efforts at exploiting you.
Now, Ms. Herrod, you had a variable rate loan which started
at 7.8 percent. Correct? In the beginning.
Ms. Herrod. In the beginning.
Chairman Sarbanes. You wanted to refinance, hopefully to
bring down your payments. And also, you wanted to consolidate
some debts and pay them off. Is that correct?
Ms. Herrod. Yes.
Chairman Sarbanes. But the loan that Mr. Young, your
broker, got--I am not sure I should call him your broker. The
loan that Mr. Young, the broker, got for you was close to 10
percent. Is that right?
Ms. Herrod. Right. I think it was 9, maybe 9 point
something.
Chairman Sarbanes. Yes. Did you understand prior to the
closing that your interest rate was going to be so much higher
than the loan you already had?
Ms. Herrod. No.
Chairman Sarbanes. Now in addition to paying this higher
interest rate, I see you paid Mr. Young an origination fee of
$4,000, while also paying a broker fee of $2,600.
Ms. Herrod. Right.
Chairman Sarbanes. Is that correct?
Ms. Herrod. Yes.
Chairman Sarbanes. So, $6,600 in all. Did you know at the
time you closed that he was also going to get another $3,300
from the lender for leading you into a higher-rate interest?
Ms. Herrod. No, we found that out from the attorney after
the fact when we were faced with losing our home.
Chairman Sarbanes. When you agreed to work with Mr. Young
at the beginning, after you met him, did you believe that he
would find you the best deal on a mortgage? Is that what was
indicated?
Ms. Herrod. Yes. I had excellent credit, above and beyond.
It was irreproachable.
Chairman Sarbanes. So, you thought that he was really going
to look after your interests.
Ms. Herrod. Correct.
Chairman Sarbanes. That is the assumption you worked on
when you went into this arrangement. Instead, he ended up
getting $10,000 out of this arrangement and you got a loan at
10 percent interest. Correct?
Ms. Herrod. Correct.
Chairman Sarbanes. Now, Ms. Johnson, I see you paid a large
amount of fees in addition to the broker receiving a yield
spread premium in your instance.
Ms. Johnson. Yes.
Chairman Sarbanes. He told you, the broker at the outset,
that his fees were 1 percent of the loan amount, or that is
what you understood. Is that correct?
Ms. Johnson. Yes, it is.
Chairman Sarbanes. And it was your understanding that this
would be what he received out of his efforts, 1 percent of the
loan amount. Correct?
Ms. Johnson. Correct.
Chairman Sarbanes. But, then, when you got to closing, you
found that the fees were far greater than the 1 percent that
you had agreed to.
Ms. Johnson. Yes.
Chairman Sarbanes. In fact, they were over $5,000, the
fees.
Ms. Johnson. Yes, they were.
Chairman Sarbanes. You did not know those extra fees were
coming. In fact, you were operating on the premise that the
broker fee would be 1 percent of the loan amount. Correct?
Ms. Johnson. Yes.
Chairman Sarbanes. Now, were you aware that the broker was
also over and above this $5,200 receiving a yield spread
premium from the lender because he was leading you into a loan
with a higher interest rate than what you qualified for?
Ms. Johnson. No, he never----
Chairman Sarbanes. You did not know that. And so, later on,
you found out that that was the case, that he was getting that
yield spread premium as well.
Ms. Johnson. Yes.
Chairman Sarbanes. You also, I take it, believed that the
broker was working on your side to put together the best
financing arrangement that he could on your behalf. Were you
proceeding on that assumption?
Ms. Johnson. Yes. We asked him to, and he said he had
several places he could go to and he would do the best for us.
Chairman Sarbanes. Well, I want to thank all three of you
for coming this morning. These, in a way, are very sad stories
because they are a very dramatic illustration of people being
exploited, in my view, being the victims of abusive practices.
People are entitled to get a fair return for services that
they provide. Brokers, along with everyone else, are entitled
to that. But they are not entitled to take advantage of people,
to abuse people, to lead people in placing their confidence in
them and then exploiting that confidence to gain an egregious
return at your expense, and that is what we are setting out to
try to accomplish with these hearings.
Not only to charge you these high fees, but by getting the
yield spread premium, about which none of you knew anything
about, leading you into a higher interest rate mortgage than
otherwise would have been the case and saddling you, then, with
those extra costs and charges over the life of the mortgage.
In each instance, I gather, all of you were in a sense
sacrificing or pushing yourselves to the limit in order to be a
homeowner, which of course would help you to meet very
important family responsibilities. And yet, you had people who
were in effect almost shoving you over the line in terms of
your ability to handle--I guess all of you, really, found
yourselves in a much more constrained financial position as a
consequence of these abuses that you were subjected to.
So thank you very much for coming this morning and giving
us this very powerful testimony. We appreciate it very much.
Ms. Johnson. Thank you.
Ms. Herrod. Thank you.
Ms. Hiers. Thank you.
Chairman Sarbanes. We will now turn to the second panel and
we will excuse our three witnesses.
[Pause.]
I want to welcome the second panel here this morning.
Because this is a relatively large panel, I will introduce each
witness separately, just before we hear from them. We will move
across the panel and take the testimony of all the witnesses
before we turn to the question period.
Your full statements will be included in the record and if
you can abbreviate it orally to something in the range of 5
minutes or so, we would appreciate that very much, although we
are anxious that you feel that you have had an opportunity to
make your major points. That is the prime objective, not the
time restraint. But we are trying to balance the two here this
morning.
Our first witness is Howell Jackson. Mr. Jackson is
Associate Dean for Research and Special Programs and the Finn
M.W. Caspersen and Household International Professor of Law at
Harvard Law School.
His research currently deals with problems in consumer
finance, comparative cost benefit analysis of financial
regulation and other topics.
Prior to joining the Harvard Law School faculty in 1989,
Professor Jackson served as Law Clerk to U.S. Supreme Court
Justice Thurgood Marshall and practiced law in Washington. He
received his law degree and an MBA from Harvard University in
1982.
Mr. Jackson, we would be happy to hear from you.
STATEMENT OF HOWELL E. JACKSON
FINN M.W. CASPERSEN AND HOUSEHOLD INTERNATIONAL
PROFESSOR OF LAW AND
ASSOCIATE DEAN FOR RESEARCH AND SPECIAL PROGRAMS
HARVARD UNIVERSITY SCHOOL OF LAW
Mr. Jackson. Thank you very much, Chairman Sarbanes.
I am pleased to be here and what I would like to do with my
oral comments is just to summarize my written testimony and, in
a sense, build on the testimony that we have already heard this
morning.
The impetus of today's hearings is the HUD's Statement of
Policy regarding yield spread premiums. What I want to talk
about initially is their factual assumptions about what was
going on in the industry with yield spread premiums.
They have a view that yield spread premiums are a
legitimate financing tool that is particularly useful for
borrowers who are short on cash and need to use the tool to
finance upfront costs.
This morning's witnesses have already demonstrated that
that is certainly not always the case, that there are often
instances when the yield spread premiums are often used to
raise the cost for individual borrowers.
But what I would like to talk about is a study that I have
conducted that looks at the practice more broadly. And in
brief, what my study shows is these witnesses are not atypical,
that this is actually going on on a widespread basis, across
the industry, and harming substantial numbers of consumers.
Let me just begin by saying that I would reiterate the
statements of the witnesses that yield spread premiums are not
being presented as an option to borrowers. The HUD consumer
guidance, the industry discussions of the subject, it is just
clear that these payments are not being described as optional
sorts of financing for particular consumers. They are being
imposed without consumers
understanding what is going on. I think that is fairly clear.
It is also fairly clear from my study that they are not
specialized sorts of financing that are used upon occasion.
Their practice is widespread. In my study, between 85 and 90
percent of consumers were paying some yield spread premiums.
The average amount of these payments was $1,800 per consumer,
which is a large amount of money.
They are the most substantial source of compensation for
the mortgage broker industry, according to my study. So, they
are very significant and they are very substantial for the
industry.
It is also the case that it is clearly not being limited to
borrowers who lack cash to pay upfront costs. Just the number
of 85 to 90 percent shows that there are many borrowers who
could pay the upfront costs in other ways, were they told that
that is what was going on. But we also examined the loans in
question and many of the borrowers could simply have increased
the loan amount. It would have been a much more efficient way
to finance their settlement costs, their costs of closing. Yet,
the brokers still steered them into yield spread premiums. So
this is not limited to a small number of borrowers. It is a
widespread practice and our study I think demonstrates that
quite clearly.
Another point that is important to understand is the
mortgage broker industry cannot be indifferent to yield spread
premiums. The HUD policy statement suggests that it is just
another kind of financing. But our analysis indicates that
mortgage brokers make substantially more money on loans with
yield spread premiums. The average amount of additional
compensation, according to our study, is over $1,000, $1,046 of
extra compensation from mortgage brokers receiving this kind of
payment than the compensation they would receive on other kinds
of loans without yield spread premiums. So the amount of money
is quite substantial. And I think that explains why this issue
is so hotly contested.
Now as an economic matter, one of the interesting questions
about the yield spread premiums is are they being used to
offset other costs? The additional compensation I just
mentioned would suggest that is not going on, and certainly
this morning's testimony, the witnesses we heard today,
suggested in their cases they were not getting any reduction.
In fact, it sounds like their other costs were quite high
compared to industry averages.
We did a large-scale study to see what the standard offset
was in a sample of 3,000 loans. And what we discovered is the
vast majority of yield spread premiums goes simply to increase
the compensation of mortgage brokers. They do not go to reduced
upfront costs.
Our best estimate, and there are definitely different ways
of doing this estimate, is that, on average, consumers get 25
cents on the dollar for every dollar extracted in yield spread
premiums.
So 75 percent, the vast majority, go to the mortgage broker
industry to increase their compensation. And I think that
really indicates the nature of the practice.
This is not a case of a small number of atypical consumers
who are paying exorbitant fees. Certainly that is also going
on. But the main point is, on average, the offset is very low.
The value, if you will, to the consumer of yield spread
premiums is very, very poor.
Now the industry sometimes likes to characterize yield
spread premiums as a form of financing as a way of financing
upfront costs. And we did this calculation similar to the
calculation that you were suggesting earlier--how much more in
additional interest payments down the road are consumers taking
on? What value are they getting for it? And if you work out the
numbers, it is frankly embarrassing. The interest rate is 114
percent per annum, according to our estimate. Maybe 90 percent
per annum. It is just off the charts of acceptable interest
rates. My study was dealing primarily with middle-class
borrowers who would have excellent credit histories and be
deserving of much lower interest costs. So as a form of
financing, these payments are just usurious.
Another factual point I would make about our study and its
implications is, on average, yield spread premiums generate
higher compensation and higher costs for borrowers. But it is
also the case that there are a lot of examples of individuals
who pay way more than average.
If you try to look at the average compensation to mortgage
brokers in these loans, it varies greatly. It seems to me that
there is a lot of price discrimination going on here. There is
a lot of picking off the soft targets--the less well-educated,
the less financially sophisticated consumers, and using this
disguise payment practice to charge them more. And this is
something that I want to examine more, but you mentioned this
aspect of my study and I just want to call the Committee's
attention to it.
If you look at the racial identity of the borrowers and
measure it against mortgage broker compensation, you see that
mortgage brokers are making a lot more money on minority
borrowers.
According to our study, African-Americans are paying about
$474 more on average. Hispanic-Americans, paying about $580
more on average than other borrowers. And that is after
controlling for the credit quality, the credit score they got,
the kind of loan they had, the loan-to-value ratio. It is
controlling for the credit aspects. And it seems to be that
these groups who are traditionally less well-educated, less
financially sophisticated, are being picked off here, and I
think that is one of the most disturbing things about our
findings.
Now the HUD policy statement goes on and talks about a
number of legal issues. I am happy to deal with them in
questions and answers. But I just want to focus on the
connection between what I think is the Department's
misunderstanding of the role of yield spread premiums and their
legal analysis. They characterize these payments as a way of
reducing upfront costs. And if the payment is for goods and
services, it is tested under a relatively liberal standard,
lenient standard, under the HUD rules.
What my study shows and what the evidence you heard this
morning suggests is these payments are not being used
principally for goods and services or principally for reducing
upfront costs. They are serving principally to increase
compensation. And for that reason, I think a more stringent
legal standard is appropriate.
Fortunately, the Department is considering a number of
rulemaking proposals to change practices to help consumers in
the
future. I think that there is a lot that can be done
prospectively to improve things for consumers with the right
changes. I have four changes, specific proposals in my
testimony. Let me just highlight them in conclusion here.
First, if mortgage brokers are going to be recommending
loans with yield spread premiums, it should be presented as an
option. The mortgage broker should also be required to say to
Ms. Johnson and her colleagues that another loan is available
at a lower rate. If it is going to be an option, it should be
presented as an option and the Department should mandate that.
Second, when a consumer chooses to take an above-par loan,
and sometimes it might make sense, the proceeds of the extra
interest, the yield spread premium, should be given to the
borrower. The borrower can use it to pay for the house, to pay
for other costs, to pay for other payments to the mortgage
broker, or to take home in his or her pocket. But the money
should be given to the borrower if it is used for the
borrower's benefit. What that means is it has to become a
credit on line 200 of the HUD-1 form.
Chairman Sarbanes. The theory being that the borrower, in a
sense, has paid for it by agreeing to a higher interest rate
over the life of the loan. Is that correct?
Mr. Jackson. That is exactly right. If the borrower is
getting this money through paying for it, the borrower should
receive it and then see specifically what services the broker
is trying to charge for. I think this is a very important step
that needs to be taken.
There are other steps, too. I think the practice of
mortgage brokers charging discount fees, as we saw in the case
of Ms. Hiers and Ms. Johnson this morning, is simply
misleading.
The brokers are not using those discount points to lower
interest rates. It is simply a disguised form of interest
spread premium and I think the best solution to this problem is
to ban it. There is an appropriate role for discount fees, but
it is not to pay to brokers in these contexts.
Chairman Sarbanes. Actually, if they do that, they can get
the consumer going and coming--getting him on the discount fees
and then they get him on the yield spread premiums. Right?
Mr. Jackson. That is right. It is unbelievable that brokers
are charging consumers fees for lowering interest rates on
loans that have interest rates above par. It is just
unfathomable how this practice could be tolerated, in my view.
Finally, I think the Department needs to look also at
direct lenders. There needs to be a quality in the industry
between direct lenders and mortgage brokers. However, I would
not let concerns about direct lenders stop the Committee and
the Department from going forward today.
Mortgage brokers are the primary supplier of mortgages in
the United States at this time. They should be the primary
focus of the HUD reforms. We should solve the problem here
first and then we can take care of other aspects of the
industry later. But I think the time is now to go forward.
Thank you.
Chairman Sarbanes. Thank you very much, sir.
Now, we will hear from John Courson, President and Chief
Executive Officer of Central Pacific Mortgage Company, and
Chairman-elect of the Mortgage Bankers Association of America.
Prior to assuming his current position, Mr. Courson served
as President and Chief Executive Officer of Westwood Mortgage
Corporation and as President and Chief Operating Officer of
Fundamental Mortgage.
Mr. Courson was a very helpful witness in previous hearings
held by this Committee and I am pleased to welcome him back
today.
John, we would be happy to hear from you.
STATEMENT OF JOHN COURSON
CHAIRMAN-ELECT, MORTGAGE BANKERS ASSOCIATION
PRESIDENT AND CHIEF EXECUTIVE OFFICER
CENTRAL PACIFIC MORTGAGE COMPANY
FOLSOM, CALIFORNIA
Mr. Courson. Thank you, Mr. Chairman. It is good to see you
again. And thank you on behalf of the Mortgage Bankers for the
opportunity to testify again and present our views as you
continue your series of hearings on the aspects of predatory
lending. I would like to just briefly summarize some comments,
if I may. I am going to really talk about three things--tools,
rules, and disclosures.
As you so eloquently said in your opening statement before
that, used properly, yield spread premiums can be an important
financing option. And we agree with that. It clearly is a
borrower choice issue when used properly, based upon a
borrower's individual financial goals, desires, and
circumstances, in that, as they make those choices, there has
been a wide use of yield spread premiums.
We find people in the industry of all types of loans, as we
have identified, be they conventional, be they FHA, VA, that
take advantage of the opportunities to have a financial choice
in how they want to use this tool to acquire their property or
refinance their mortgage loan.
It can be, and we know that one of the barriers to creating
homeownership is certainly the availability of cash resources.
And so it does provide an option for those who do lack the cash
to finance or, if you will, to pay the cash cost of obtaining
that mortgage, another alternative to achieve homeownership
when used properly.
As to the rules, we need rules in the lending business and
the broker business to run our businesses. Tell us the rules so
that we can conduct our business in accordance with the rules,
and not have to learn the rules through the courts and through
litigation, which is debilitating not only for us, but also for
consumers and could in fact do damage to the marketplace.
Tell us the rules and give us clarity. Give us some clarity
where we can understand what the parameters are under which we
can conduct our business appropriately--whether it is mortgage
brokers or mortgage lenders.
The Statement of Policy, both the 1999 and now the 2001, is
a move by the Department to provide clarity for those in the
mortgage origination business to conduct their business.
As for disclosure, as you well know, Mr. Chairman, and we
discussed in the last hearing, there are disclosures out there
today that are structured to address some of the issues we have
heard.
We know, for example, that yield spread premiums are to be
disclosed on a good faith estimate. We clearly know the issues
with the good faith estimate as we have discussed before. We
also know that yield spread premiums are to be included in
calculation of the APR, which is a number that a consumer has
to comparison shop, if you will.
We also know, obviously, that they are on the HUD-1, which
we have heard about. But having said that, in the 2001
Statement of Policy, the Department clearly sets out, both in
the Statement of Policy and in a mortgagee letter that was
issued very shortly after the Statement of Policy, some clear
guidelines for the disclosure of broker transactions and they
set forth very specific criteria to be included in those
disclosures.
As a result of that information, the Mortgage Bankers
Association, along with a coalition of other lending
organizations, have prepared and did prepare a prototype, if
you will, of a disclosure. And that disclosure is formatted to
address the specific criteria that are included in the
Statement of Policy and in the mortgagee letter. I would be
happy to submit a copy of that draft, which we have submitted
to HUD for their consideration for the record, if I may. And
finally, having said all of this, and despite the comments and
the specificity and the Statement of Policy, and in the
mortgagee letter and our draft proposed form, we really can do
better.
Beyond all of this, one of the keys, regardless of the kind
of disclosure we use in this specific instance, we have to
simplify the transaction. We can do better than what we have
done for the consumers out there with the myriad of paperwork
and disclosures, small print, and confusing information given
to them. Any predator likes that environment to deal in. It
makes it easier to operate. We need to strip that out, strip
the process down, simplify, and reform the mortgage process.
Thank you very much.
Chairman Sarbanes. Well, thank you very much.
We will now turn to Joseph Falk, President of the National
Association of Mortgage Brokers. Mr. Falk served as the
President of the Florida Association of Mortgage Brokers in the
mid-1990's. In addition to his activities with the National
Association of Mortgage Brokers, Mr. Falk serves on the Fannie
Mae National Advisory Council. He is currently President of
Erie Mortgage Services, a mortgage brokerage business
specializing in residential mortgage loans, regulatory
compliance, and government affairs.
Mr. Falk, we appreciate your coming to be with us this
morning. We would be happy to hear from you.
STATEMENT OF JOSEPH L. FALK, PRESIDENT
NATIONAL ASSOCIATION OF MORTGAGE BROKERS
Mr. Falk. Good morning, Mr. Chairman.
My name is Joseph Falk and I am President of the National
Association of Mortgage Brokers, the Nation's largest
organization representing the interests of the mortgage
brokerage industry. We appreciate this opportunity to be with
you today.
Mortgage brokers originate approximately 65 percent of all
of the residential loans in the United States. There are
hundreds of thousands of mortgage brokers, 23,000 licensed
brokers in my home State of Florida.
The market has spoken. Mortgage brokers are effectively
meeting consumers' desires for convenience, choice, products,
service, and very competitive prices. The industry originated a
record volume of loans in 2001, enabling thousands of
homeowners to refinance, reduce their monthly payments, and
thousands of others to get in their homes.
We are experiencing record homeownership rates in the
United States today. Mortgage brokers in part have enabled this
market to absorb this huge volume of transactions. Therefore,
it is important to our homeowners and the economy that we avoid
any new regulations, legislation, or unnecessary legal
uncertainty that could impede the effective and efficient
functioning of the wholesale mortgage market.
The ability to obtain loans with little or no upfront cost
is especially critical to consumers. Borrowers can finance some
or all of their upfront costs through a slightly higher
interest rate and the broker receives most or all of its
compensation indirectly from the lender in the form of a yield
spread premium. Such indirect compensation paid by lenders to
brokers is legal under RESPA, so long as the broker's total
compensation is reasonably related to the services performed,
goods provided, and facilities furnished.
Flexibility of indirect compensation allows mortgage
brokers to stay competitive with and in some cases beat the
prices of retail lenders. That is why the marketplace has
spoken. Mortgage brokers are chosen, by and large, because they
offer competitive prices to retail lenders.
Retail lenders perform similar functions, earn similar
income when they sell their loans in the secondary market.
There is nothing inherently different about the way retail
lenders and mortgage brokers earn their income. The only
difference is that consumers know how much a mortgage broker is
going to earn in a transaction because it is listed on the HUD-
1 and, of course, on the Good Faith Estimate form.
Although consumers clearly prefer mortgage brokers to
originate their loans, our industry is under attack. Over 150
class action suits have been filed against virtually every
major mortgage wholesaler claiming that all yield spread
premiums are illegal. Defending these suits, Mr. Chairman, is
difficult and managing the uncertainty that they impose is
costly.
On October 15, HUD issued policy statement 2001-1. We
believe it is simply a restatement of existing policy requested
by Congress in 1998 and originally issued in 1999. It has
already been accepted as correct by two court rulings and we
believe that others will follow suit. HUD's policy statement
importantly maintains the individual's right to sue and it
allows the marketplace to resume functioning normally. We
support the HUD policy statement.
We also support HUD's new RESPA enforcement policy. Illegal
uses of yield spread premiums should be prosecuted to the
fullest extent of the law.
NAMB also supports HUD's new rulemaking initiative which
improves disclosures to consumers. Better disclosures will put
consumers in a stronger position with more information to be
able to shop and compare, thereby decreasing the incidence of
abusive lending practices of all types.
NAMB has developed detailed proposals for this rulemaking
and we have shared these with HUD and with this Committee. We
support requiring a new disclosure to be provided by all
originators. We developed the prototype of this form back in
1998, together with MBA, and we have urged our members to use
this form since 1998, clearing up a number of the concerns that
we heard this morning. We support making this disclosure
mandatory.
We also support establishing tolerances for the Good Faith
Estimates and requiring redisclosure if those tolerances are
exceeded. This would also address the concerns we heard, the
legitimate concerns we heard this morning in the first panel.
In conclusion, Mr. Chairman, NAMB believes that HUD is
acting responsibly by clarifying the legality of yield spread
premiums, improving RESPA enforcement, and developing new and
improved disclosures that will help consumers avoid abusive
fees.
Thank you for this opportunity to allow us to share our
views with this Committee. I would be happy to answer your
questions.
Chairman Sarbanes. Thank you very much, sir. We appreciate
your contribution.
Our next witness is Ira Rheingold, who is the Executive
Director of the National Association of Consumer Advocates.
Previously, Mr. Rheingold worked at the Legal Assistance
Foundation of Chicago as a Supervisory Attorney in charge of
foreclosure prevention.
The major focus of his litigation practice was the
representation of senior and disabled homeowners victimized by
mortgage brokers, lenders, and contractors who were targeting
minority, low-income communities with high interest, high fee
home equity loans.
Prior to becoming a Legal Services Attorney, Mr. Rheingold
worked as a Legislative Advocate for low-income community
groups in southern Maryland. He is a graduate of Georgetown
University Law Center.
Mr. Rheingold, we are pleased to have you with us this
morning.
STATEMENT OF IRA RHEINGOLD, EXECUTIVE DIRECTOR
NATIONAL ASSOCIATION OF CONSUMER ADVOCATES
Mr. Rheingold. Thank you, Senator Sarbanes, it is my
pleasure. And thank you so much for inviting us here to testify
today.
I had prepared remarks and I have submitted testimony which
fully express our position in this matter. But instead of
talking about what I was going to say, I am simply going to
respond to some of the testimony I have heard today because
sometimes as I sit here, I think I live in a parallel universe,
that there are two universes--the people who deal with people
on a real basis every single day, who see homeowners every
single day, and then the theoretical universe out there about
how the system is supposed to work. And we just do not see it.
I was an attorney who represented homeowners for 5 years in
the poorest communities of Chicago. I looked at loan document
after loan document after loan document. What I heard here
testified to today and what Professor Jackson said today was
wonderful because it quantified what we saw and we know is
true. It is not atypical.
I never ever talked to a client who knew they had paid a
yield spread premium. In fact, I never met a client who, until
I sat down with them, showed them their HUD-1, and said, hey,
did you look at this line over here? You are being charged
$1,500. Did you know that? And they said, no. And I said to
them, did you know that because that yield spread premium was
paid, you had a higher interest rate? And they said, absolutely
not.
Nobody knows what is going on. You can give all the
disclosures in the world--and there are disclosures. We look at
the loan documents and there may be a disclosure about a yield
spread premium being paid. It is not happening and it has no
bearing on what consumers are seeing today. Point number one.
Point number two I would like to address is the mortgage
industry and their claim that there has not been clarity about
this issue. I think that is particularly cynical when we look
back at what HUD offered to us in 1999, when they issued their
first Statement of Policy. I am just going to quote some of the
language from this Statement of Policy, giving explicit
directions to lenders. And this is in our testimony, but I
think it is worth repeating.
The most effective approach to disclosure would allow a
prospective borrower to properly evaluate the nature of the
services and all costs for a broker transaction, and to agree
to such services and costs before applying for a loan. Under
such an approach, the broker would make the borrower aware of
the total compensation to be paid to the mortgage broker,
including the amounts of each of the fees making up that
compensation. If indirect fees are paid, the consumer would be
made aware of the amount of these fees and their relationship
to direct fees and an increased interest rate.
I do not think it could be any more explicit than that. I
think it was clear how the industry could comply with what HUD
was going to do. But did the industry comply? They did not
comply.
Why didn't they comply? Because they were making a lot of
money. They were making a lot of money continuing this practice
and there was no enforcement going on that would stop them from
engaging in this practice. So instead of changing their
practices, engaging in behavior that would be legal, would be
fair to the consumer, and creating a competitive marketplace,
instead what they did was they spent all their money fighting
lawsuits and obfuscating the policy statement and going into
court and saying, dealing with small lawsuits like me, I would
go to court and I would represent an individual homeowner and I
would come in and I was a little gnat. We were little gnats.
Here is a couple thousand dollars. Go away. We will not
foreclose on this person's home. It was the cost of doing
business. But it was a small cost of doing business because
they were making enormous profits.
The world changed for the mortgage industry when the 11th
Circuit Court issued the Culpepper decision because, finally, a
court found their hand, their arm, their elbow in the cookie
jar. They said, look, this is so obvious.
The thing that I find so interesting about this issue is it
really is very, very simple. The court looked at it and said,
in practice, the lender sends a mortgage broker a rate sheet
and it says to the broker, if you bring me a loan--here's the
par rate that the person qualifies for. If you bring me a loan
higher than that, I am going to pay you this amount of money.
Nowhere in that discussion is, if you bring me a higher
interest rate and perform more services, I am going to pay more
money. The sole source of whether or not the broker is getting
compensated is what the interest rate is going to be. No one
was looking at whether or not there were more services being
offered
because someone was getting a higher interest rate. The sole
reason for compensation was the higher interest rate.
The court said, what else do I need to know? And that
enabled a class to be certified. The industry got scared. They
got scared because, suddenly, the behavior that they had been
engaged in, that they had measured the cost of and figured this
is not going to cost us a lot of money, we are making so much
profit, was now threatened because it was a class action case,
which is an important enforcement mechanism we have in this
country because there is no other source of enforcement going
on. It will cost us real money and we will have to stop our
behavior.
But, again, did the industry stop its behavior? No, they
turned to HUD and they gave HUD an opinion. We met with HUD and
the industry met with HUD. And HUD, instead of coming down on
the side of consumers and saying, hey, your behavior is wrong,
stop it, let the Culpepper case go on. HUD came to the rescue,
adopted a clarification, changed the way and gave protection to
the industry. It said, no class actions allowed. It has to be
done on an individual basis. And that is so important because
individual cases cost the industry nothing. They are little
gnats. A class action case makes them change their behavior.
They do not want to change their behavior, and that is what is
happened here.
I will take questions later on about policy suggestions
that we have made. We agree wholeheartedly with Professor
Jackson's suggestions, but I just wanted to make those points
right now.
Chairman Sarbanes. Good. Thank you very much.
We will now turn to David Olson, Managing Director of
Wholesale Access Mortgage Research and Consulting, an
independent research firm located nearby in Columbia, Maryland,
that specializes in the mortgage industry. Mr. Olson has had
over 30 years' experience in the mortgage industry conducting
research for a variety of firms. He has served as Professor of
Economics at the University of Michigan, Smith College, Johns
Hopkins University, and the University of Maryland. He holds a
BS degree from Northwestern University and a master's in
economics from the University of Michigan.
Mr. Olson, we are very pleased to have you with us this
morning.
STATEMENT OF DAVID OLSON, MANAGING DIRECTOR
WHOLESALE ACCESS MORTGAGE
RESEARCH AND CONSULTING, INC.
Mr. Olson. Thank you very much, Senator Sarbanes, for
inviting me and I am pleased to be here with a fellow
Marylander.
There has been a lot of assertions made today. I thought I
would respond as others have done to some of the assertions. I
have submitted a printed statement of my formal remarks.
There are a lot of statements being made about how
profitable brokers are and how profitable lenders are. My
research has been partly in profitability. That is all our firm
does. We have seven professionals. We have been studying
various aspects of the mortgage industry and particularly
brokers and lenders for over 10 years and, as I say, I used to
be Director of Research at Freddie Mac and several other firms.
I have been researching many aspects of this industry for over
30 years. I started in 1969 with my first research project. So,
I have looked at a lot of these questions and I have a lot of
data. We have real data. One of the first points I will make,
it is not very profitable. And if it were so profitable, why
are we seeing a net exodus out of many areas of the field?
There are firms pulling out because they cannot make profit.
My initial research was, and in the Soviet bloc countries,
I did 10 years of work in that area, and I saw first-hand, I
spent time in the Soviet bloc and I saw what happens when you
have over-government regulation, government in effect running
everything, and it is a disaster. Consumers really lose out.
Today, we have heard some abuses. I am not denying abuses.
But we have to put it into context of the numbers. Last year,
we estimate there were 16 million transactions. What was a
representative transaction? Our research is mainly based on
random samples. And just the last study we did on brokers, we
interviewed 4,000 broker firms to find out what is actually
going on there. How representative is this? Is there a lot of
abuse? We would assert that there is not. And the reason that
brokers came from nothing 20 years is that in fact they can do
it cheaper. They have priced everyone else out of business.
There are 8,000 lenders out there. Any consumer can always
go into one of these 8,000 lenders and get a quote. What would
it cost me to do this loan?
There are really two numbers that a consumer needs--
interest rate and fees, what are the total fees? Everything
else is really irrelevant. The other, of course, is will you do
the loan, period? And that has been one of the problems in the
industry. It is such a huge industry. There were $2 trillion of
loans done. Just to get a loan done is very difficult in
certain periods, such as last year.
So, consumers have sought out brokers merely to get a loan.
We have not looked at the alternative of no loan. What if the
consumer got nothing? We were saying that it was high and then
we are assuming that they could have gotten a better deal
elsewhere.
Well, why didn't they price it elsewhere? We have 33,000
mortgage broker firms, according to our records right now, plus
the 8,000 lenders. It is very easy to get a quote, find out
what it costs to do a loan.
Now, whether they will do your loan is the issue. Can they
do your loan for this price? Was it cheaper or more expensive?
We would always advise everyone, any consumer, to shop around
and go get quotes. And our experience is that most consumers do
get multiple quotes and make it difficult for brokers.
Most brokers are just breaking even. If this were so
profitable, we would have found that brokers would be staying
in this industry. But in fact, the average firm lasts only 5
years and then they are out because they go elsewhere. They
find that they can do better elsewhere. It is not that
profitable an industry. There has been this implication of how
profitable it is.
The same with mortgage lending. That field is not that
profitable. And if it were not the case, we would not see this
net exodus. Now, I will agree that there have been abuses in
so-called subprime lending and I think that is what we have
been really hearing. I can defend it from several reasons.
We do not have enough lenders offering these loans. The
less the competition, the more you will tend to find higher
prices. What we need is really more competition, more people
offering these loans. But what I have noticed--I publish a
quarterly magazine on this issue. There has been a huge exodus
out of subprime lending. Most of the major lenders that were in
operation 3 years ago have shut down. They have been generating
losses. They are still generating losses.
If this is so profitable, why are they all generating
losses? Why are we still seeing a net exodus? And so, I would
assert that, unless we do something else, if you kick all the
business out of the industry, who is going to be left to make
these loans, and where will the consumer go?
There has to be a real, live alternative for the consumer.
We have been talking about abstract alternatives. We have to
say, who offered you what? Could you have gotten something
better? Then, the other cases, were these instances
representative of the whole?
From my point of view, we have great regulation, probably
too much regulation. I would agree with some of the other
witnesses that it is extremely complicated. And it is because
it is so complicated that brokers have to do their job. Just to
go through all of those sheets of paper and get them right, it
costs about 2 points, 2 percent to do this job.
Government has an opportunity to make it simpler. If it
were so simple, it could be all done on the Internet for a
fraction of that cost. I think that we would be better served
by making it simpler and then this job of leading people
through all this paperwork would not be necessary and it would
be more transparent and it would be easier for everyone to
understand and focus on what is the most important thing?
We want the person in the house. We want a low interest
rate and we want low points. That is the objective. Who can do
the best job of getting us there? What is the best way?
From my perspective as an independent observer, the best
way is to get it as simple as possible, not put on another
layer of regulations, and certainly not try to assault the
industry through class actions. Our data shows that a typical
class action lawsuit costs the lender $1 million per suit, and
there are 150 suits. So that would add up to about $150
million. That cost is picked up by the lender and then passed
to the consumer. The lender does not operate for nothing. It is
a huge cost, a huge tax that has been added on to the industry
and is certainly unnecessary and incorrect.
I would be happy to work with you in any way I can in my
professional capacity, and thank you for inviting me today.
Chairman Sarbanes. Thank you, sir.
Our final witness this morning is David R. Donaldson, from
the law firm of Donaldson & Guin, LLC.
Mr. Donaldson has practiced law for over 20 years and has
extensive experience in consumer protection and real estate
litigation cases. He is a lecturer on topics related to lender
liability under the Real Estate Settlement Procedures Act, a
1975 graduate from the University of Alabama at Birmingham, and
a Dean's Scholarship to the Cumberland School of Law, where he
was an Associate Editor of the Cumberland Law Review.
Mr. Donaldson, we are pleased to have you with us this
morning. We would be happy to hear from you.
STATEMENT OF DAVID R. DONALDSON, COUNSEL
DONALDSON & GUIN, LLC
Mr. Donaldson. Thank you, Chairman Sarbanes, and thank you
for inviting me.
I am one of the plaintiff 's counsel in the Culpepper case,
which you have heard so much about here today. That litigation
and the U.S. Court of Appeals opinion in that case--and there
are three of those opinions--are based on a very simple
proposition. That simple proposition is that mortgage brokers
should not charge borrowers more than the broker agrees to
accept for his or her services. I do not believe that that is a
controversial proposition.
Yet, for some reason, when the Eleventh Circuit Court of
Appeals issued an opinion that said, this yield spread premium
was not a payment for services because nothing else was owed
for those services, it caused the industry to go into an
uproar. And that first decision was issued in 1998. That
message was sent a long time ago.
The mortgage industry, rather than amending and changing
their practices, believed that they could continue violating
the law simply by avoiding class certification decisions in
that class action and in other class actions.
I was interested to read when I read the prepared statement
of Mr. Courson, he describes the operation of the yield spread
premium in this way. He says, ``as the interest rate goes up,
the borrower's upfront cash contribution goes down.'' He then
goes on to say, ``I want to clarify, unequivocally, that the
yield spread premium mechanism should be restricted to the
function I just
described.''
I understood what he said, and if I am misunderstanding it,
he is here today and he can correct me. But as I understood it,
he is arguing the same thing I have been arguing for the last 5
years to the mortgage industry, which has turned a deaf ear.
Under the Culpepper rule that was established by the
appellate court, the only thing that a lender has to do to
avoid a class action lawsuit on yield spread premiums is to put
language in the lender's contract--and they all have standard-
form contracts that they use with their brokers.
If the lenders would simply put this same language in their
contracts--that is, we will pay yield spread premiums on over-
par loans where they are used to lower borrower's upfront
costs. And if they would actually enforce that, and it is easy
to see whether a yield spread premium is used to lower upfront
costs because there is a line for it on the HUD-1.
If that were done, and I and other plaintiff 's lawyers
have been advocating that now for 5 long years--if that had
been done 5 years ago, the industry would not be facing the
problems it is facing now. And if it were done tomorrow, it
would not be facing yield spread premium litigation under
Section 8 of RESPA the next day.
The industry claims, and I wrote this quote down this
morning, so I may not have gotten it verbatim, but it is
close--tell us the rules so we can conduct business. That is
what the industry says it wants. If that is what the industry
wants, I cannot understand why it went to HUD and demanded HUD
promulgate a rule that says a yield spread premium is legal, so
long as it is reasonable.
Mr. Falk claims that the RESPA statute says that yield
spread premiums are legal, so long as the total compensation is
reasonable. But the word reasonable is not contained, Chairman
Sarbanes, in that statute. In preparation for coming to talk to
you today, I went back and reread the Senate report issued by
this Committee's report in connection with that 1974 piece of
legislation.
HUD asked the Congress for authority to determine what was
a reasonable price for settlement charges and Congress refused
to grant HUD that power. In this Committee's report, it stated
several reasons why that was a bad idea. And one of the reasons
stated was that it would require an army of bureaucrats to look
at the transactions to determine what is reasonable.
I also heard this morning Mr. Olson say that there are 16
million transactions. The printed testimony from the Mortgage
Brokers Association says that brokers are responsible for
roughly two-thirds of those. So that would be something in
excess of 10 million transactions. I would submit to you that
it does not make any sense for HUD to attempt to examine 10
million transactions to determine whether a payment is
reasonable, whatever that is.
Apparently, the truth of the matter is, the reasonableness
standard, which is not the law and should not be the law, is
simply a way to legalize any kind of illegal practice so long
as it is widespread. As long as all of the brokers are getting
the payments, it becomes reasonable and, under that standard,
legal. Anything would be legal under that standard.
Chairman Sarbanes. Virtually anything, yes. I guess the
extreme, the very egregious might fall outside of the
parameter. But otherwise, they just make reference to what the
rest of the industry is doing and say, well, this constitutes a
reasonable practice. Is that the point?
Mr. Donaldson. Yes, sir.
Chairman Sarbanes. Yes.
Mr. Donaldson. Beatrice Hiers, who everyone heard from this
morning, is one of the plaintiffs in the Culpepper case. And
the defendant has argued long and hard that she received the
benefit of that yield spread premium and that it was
reasonable. That position was taken.
The 2001 policy statement purports to treat yield spread
premium payments to brokers in a totally different manner than
it treats all other up charges. The example that is given in
the policy statement is a situation where a lender obtains an
appraisal for $175, charges the borrower $200, and pockets the
$25.
Now, the 2001 policy statement says that that is a
violation of Section 8 of RESPA. While I do not disagree with
that, I suspect that if I were to bring a lawsuit under that
same fact situation, the response would be, look, from the
defendants, $200 is a reasonable cost for an appraisal, and in
fact, it may be a reasonable cost for an appraisal because a
lender that purchases thousands of appraisals a year can
probably force the appraiser to drive the price down.
It may be a reasonable cost. But HUD is saying that is
illegal. Yet, if a broker and borrower agree for a 1 percent
loan origination fee, and if no other compensation is agreed
upon, and at the closing table, the broker receives double that
amount, in HUD's view, that apparently is perfectly legal.
There is no legal distinction between those two situations
based under the same statute and there is certainly no
intellectual distinction that I can understand.
In closing, I would like to respond very briefly to the
statement about class actions that was just made by Mr. Olson.
The man sitting at the end of the table is a Harvard Professor
who prepared a study. It was not done at my request, but it was
done at the request of other plaintiffs' class action lawyers
in another RESPA case. We would not have that kind of
information today if we had to rely--that was done because a
class action lawyer has a lawsuit and it is a very expensive
study because it took a lot of intelligent people a lot of
hours to do it.
Lawyers are not going to spend that kind of money to
prepare those kinds of studies in order to get back $1,000 for
somebody. It does not make economic sense.
The idea that when litigation expenses are incurred, that
it drives up the cost, defies what I understand to be simple
economics, which is that retail prices are a function of supply
and demand. I do not see how suing 150 out of the 2,800 lenders
causes the price of mortgages to go up, and I do not think it
does. I think that is a red herring.
Last but not least, I have not conducted a study like
Professor Jackson, but I have talked to a lot of borrowers. And
it is my clear impression from those conversations that
supports what he found about discrimination in yield spread
premiums.
The Wharton study that you referred to at the beginning of
your comments here today, was not done for plaintiffs' lawyers.
It was done by a professor who is featured prominently on the
Mortgage Bankers Association's own web site. That study found
that the two determining factors for how much mortgage brokers
get paid are the size of the loan and the sophistication of the
borrower.
Thank you very much, Chairman Sarbanes.
Chairman Sarbanes. Well, thank you.
I want to thank all six panelists for their contribution.
This was a panel that embraced a number of varying viewpoints
and of course, it was our objective to get kind of a broad
presentation. So, I want to thank all of you for coming today,
for preparing what are obviously some very thoughtful
statements, all of which will be included in the record in
full.
Now let me turn to a few of the issues that I think have
emerged here. First of all, I want to address this question of
the class action suits as opposed to individual suits because
the new HUD directive is read to preclude the class action
suit, as I understand it, or it is being so interpreted by some
courts already across the country, if I am not mistaken, the
2001 statement.
Although it is then asserted, these individual suits can be
brought. I think everyone has conceded that the individual
suits can be brought. But it seems to me that what is going to
happen is that any recourse to the courts to remedy the
situation is going to be closed out because the amount of
recovery in an individual case is so small, that you are not
going to be able to mount the legal effort that is necessary to
bring these practices under control.
Now the counter to that is, well, if we allow the class
action suits to go ahead, they will recover huge amounts and
that will impose a very significant burden on the industry. Let
me ask you, Mr. Donaldson, the individual's suit really does
not provide much recourse to the courts, does it, to get at
these practices?
Mr. Donaldson. Well, it does not change the practices. When
the Circuit Court of Appeals issued its first opinion in
January 1998, the industry's response was, so long as the
plaintiffs cannot get classes certified, we can go on our merry
way and not change our practices. They said that publicly in
the press.
So, I think that answers that question. And you are
certainly correct. It is difficult to undertake litigation and
fight for long years, as we have in this case. It has been
going on for 5 years, even a large yield spread premium is a
small amount of money to fight over for years and years.
Chairman Sarbanes. Now what is the requirement that you
say, if the industry followed it, would in effect eliminate the
abuse of these practices?
Mr. Donaldson. I did not really say what I thought might
eliminate the abuse of the practices, and I am not sure, as far
as if you want my opinion on that question, certainly Secretary
Martinez's suggestions in his mortgagee letter that has been
discussed here today would be a good step in the right
direction.
Chairman Sarbanes. The Department is arguing that what they
have done is protective of the consumer. And I am having great
difficulty understanding why that is the case.
The industry went to them to get protection from the class
action suits. The class action suits would be a very heavy
discipline on the industry if they carried forward, proceeding
from Culpepper. So there was a discipline mechanism in place
to, in effect, compel the industry presumably to clean up these
practices. Otherwise, they were going to pay significant
penalties, or recompense.
It is not clear to me, if you take that out, what is left,
or where you will turn, then, to protect the consumer from
these practices. And so, despite the Department's assertion
that this is to help the consumer, I have difficulty in
following that, one of the reasons we are doing this hearing
here today.
Mr. Jackson, let me turn to you because you have done some
very careful studies and I would be interested in your response
to that question.
Mr. Jackson. Well, I think that the policy statement can be
interpreted as a significant impediment to litigation. As I
mentioned in my testimony, I think the Department misunderstood
the role of yield spread premiums at least for a large number
of mortgage lenders. And so, it is possible that, on different
facts, courts would proceed differently with the policy
statement. So it is still possible to maintain litigation, I
hope, against certain lenders.
I would say that the management of class actions is a
function for the courts to decide. I think the courts are
responsible for determining how to structure their cases. And
HUD does not have expertise in class action management, so the
court should take a look at these cases and see what the
sensible way to proceed is.
That having been said, I think that the Department must go
further on disclosure. The current disclosure techniques are
simply inadequate. The main problem is the yield spread
premiums, when they are disclosed, are disclosed as payments
from the lender to the broker. A consumer would reasonably
think it has nothing to do with them. And in fact, if you go on
the HUD's web page today and look for an explanation, HUD says
these payments have no cost to you. It is quite misleading for
consumers and I am quite sympathetic to people----
Chairman Sarbanes. Well, they have a cost to the consumer
in that they are paying a higher interest rate, don't they?
Mr. Jackson. I absolutely agree which is why I think the
current HUD instructions and glossaries that are on their web
page are just quite misleading.
Chairman Sarbanes. Now, Mr. Courson, I understand, is it
your position that if there is a yield spread premium, it
should go to the credit of the borrower?
Mr. Courson. Let me explain my statement in that regard.
Once the broker establishes what their compensation is going to
be in a transaction, as they enter into this transaction with
the consumer, whether at that point that compensation is agreed
upon is either paid in cash or paid through the use of the
yield spread premium, should be the same dollar figure.
In other words, you establish the compensation for which
you are going to provide the services and then, giving the
consumer some choices, which I talked about in my opening
statement, as to whether to pay that compensation in cash, pay
it through a higher interest rate in a yield spread, or through
a combination of both. It could be both.
Chairman Sarbanes. You think that the consumer should know
up front what the broker's charges will be?
Mr. Courson. Yes.
Chairman Sarbanes. Do you agree with that, Mr. Falk?
Mr. Falk. We believe that the compensation should be
included on the Good Faith Estimate, together with the rest of
the costs of the loan, so that consumers can adequately shop
and compare between different financing options. Yes, they have
to be disclosed, together with all of the other costs on the
Good Faith Estimate.
Chairman Sarbanes. So would you have the broker's
recompense separately disclosed to the consumer up front?
Mr. Falk. It is currently separately disclosed on the Good
Faith Estimate. Yes, it should be itemized under the current
system.
Chairman Sarbanes. How would you handle the yield spread
premium issue?
Mr. Falk. As a separate disclosure on the Good Faith
Estimate, which is current law.
Chairman Sarbanes. Mr. Jackson.
Mr. Jackson. I just disagree. I think that this is the kind
of misleading statement.
Chairman Sarbanes. Yes, let us talk about that.
Mr. Jackson. It is currently disclosed as a POC--paid
outside of closing--from lender to the broker.
Chairman Sarbanes. Right.
Mr. Jackson. It is absolutely unclear under current law
that the borrower is paying that through higher interest rates.
Chairman Sarbanes. Would you make it clear to the borrower,
Mr. Falk, that the borrower is paying it?
Mr. Falk. I would make it clear that all compensation is
clear and concise.
Chairman Sarbanes. Let me just deal with that very specific
thing that Professor Jackson referred to.
Mr. Falk. Yes.
Chairman Sarbanes. Would you make that clear to the
borrower, specifically?
Mr. Falk. Broker fees are in part, fees paid by the lender
for goods, services, and facilities provided to the lender by
the broker, and partially fees for goods and services provided
to the borrower. It is a combination of both. Therefore, that
is why we believe that the initial disclosure form, the model
loan origination agreement ``souped up,'' as we recommend to
HUD, should be clearer on the definition of these various fees
and charges.
Chairman Sarbanes. Mr. Courson, would you make it clear, by
responding to Professor Jackson?
Mr. Courson. Mr. Chairman, yes. I submitted for the record
and I have shared with the Committee a prototype, as I
described it, of a disclosure agreement that we think
incorporates what Mr. Donaldson discussed, and Mr. Jackson
discussed, as part of the statement of policy in the mortgagee
letter. And the thrust of this agreement, if you will, entered
into at the start of the application process discloses the
total broker compensation.
So, in that regard, it would include whether it was
compensation to be received through a yield spread, whether it
was compensation to be received through an origination fee. It
would be the total compensation from whatever source. And then
I think as you look through that prototype agreement that our
coalition put together, then it offers the consumer some
choices.
It says to the consumer that here is the compensation. The
compensation will not exceed X and you have some choices. And
then it goes through some choices as to paying in cash, paying
through a higher interest rate, paying through a combination
and so on. So that captures all elements of that compensation
into a number on a not-too-exceed number, and then gives the
consumer the opportunities I talked about in my statement of
options on how to deal with those costs.
Chairman Sarbanes. It seems to me that one of the
difficulties here is the way the system is working now, and
this goes to Mr. Rheingold's point about it is one thing to
talk about it in theory. It is another thing to see how it
works in practice, is that you have an option which you say, if
properly used, enables the consumer to have an additional
financing approach. Namely, a higher interest rate and then
they get some money with which they can cover their closing
costs. So, they do not need as much money up front. And that
sounds like a worthy objective. But in practice, since it is
not disclosed or disclosed in such a way that it is not
apparent that this option is available, in effect, it becomes a
rip-off of the consumer. It becomes an abuse.
Now that raises the question, and this goes to how
widespread the practice is, which goes back to Professor
Jackson's study, but that raises the question, if there is
substantial abuse, whether it is worth having this option
available, if the consequence of having it available is to get
the kind of instances that we heard from from the first panel
this morning. Now that approach, in a sense, would close out an
option that people say, if properly done, is desirable. On the
other hand, if we cannot figure out a way to close out the
abuses and sustain the option, and if the abuses are fairly
prevalent, that may be the only recourse.
Mr. Rheingold, you wanted to comment.
Mr. Rheingold. Yes. Although I have not read Mr. Courson's
disclosure of the model that he talks about, I can say that the
concepts he expressed, we would fully endorse. We do not oppose
yield spread premiums and we think, as you said, they actually
can work in a manner that would benefit consumers.
The point being here that if there is a total compensation
disclosed up front, this is what I am going to get paid. I am
your broker. This is what I am going to get paid. If the
consumer is given a choice as to the method of payment, that is
fine.
The system that we have here today is market-distorting.
One would think that if you have a broker, the broker will shop
for you so that you get the best available loan. In essence,
what we have here, in practice, as demonstrated by Mr.
Jackson's study, is that the broker is not finding you the best
available loan for your benefit, but they are looking for loans
where they will get paid more money.
In essence, the marketplace is not functioning right now.
And if you, in fact, have a scheme where the total compensation
is laid out upfront, and whether or not a yield spread premium
is paid or not, I am going to pay that broker $2,000. I may pay
it in cash. I may get it refinanced. I may have the lender pay
that $2,000. I will choose it.
But that money is set in stone and then there is no
incentive for the broker to find a higher interest rate for
that person because their compensation is not going to change
based on what the interest rate is.
Chairman Sarbanes. Because they will not get the yield
spread premium.
Mr. Rheingold. Well, they will get the yield spread
premium.
Chairman Sarbanes. But it will be credited to the borrower.
Mr. Rheingold. Right. It will be a way they get paid, but
there will not be an added incentive to find a higher interest
rate because they will get paid more. That will eliminate it
and the scheme that Mr. Courson describes, I believe will
actually eliminate that market-distorting incentive that
currently exists.
Chairman Sarbanes. Mr. Falk, what do you say about that?
Mr. Falk. Well, I think the marketplace is working for a
vast number of Americans who have refinanced this year and
saved billions of dollars of interest expenses.
Mortgage companies act in multiple capacities, Mr.
Chairman. Sometimes a mortgage company acts as a lender in a
transaction and sometimes the company acts as a broker in a
particular transaction. So, however you define the transaction,
total compensation should be disclosed fully. It should be as
transparent as possible. And it should meet with the wishes and
the guidelines and the desires of the consumer.
Therefore, I believe the market is working. We have
increased competition, which is what we want in the
marketplace. And I believe, by and large, mortgage brokers are
bringing reduced costs to the marketplace and doing an
excellent job.
Chairman Sarbanes. How do I know which broker to go to on a
competitive basis if they are not disclosing to me up front
what their charges are?
You say it is working on a competitive basis and I am then
led to wonder, well, a lawyer will tell me what his fee is, a
stockbroker tells me what his commission is, a real estate
agent tells me what their fee is. If I cannot get that specific
information from the broker, how do I shop amongst brokers as
to who is going to give me the best value.
Mr. Falk. We believe that consumers should always shop and
compare, not only between brokers, but also with retail
lenders, banks, credit unions and savings and loans. We are all
part of that system.
Chairman Sarbanes. Well, that is Professor Jackson's point,
and we may get to that. I mean, we are dealing with a broker
problem now and I can understand the brokers saying, well, if
you are going to deal with the broker problem, we want you to
deal with any comparable problem that may exist with the
lenders. And that is broadening the universe of what we have to
deal with. But let us for the moment operate with this limited
universe we are addressing. How do we ensure that we will not
get the kind of practices that we heard this morning from the
people on the first panel?
Let me ask this question first. Is there anyone on this
panel who, having heard what we heard from the first panel,
says, well, this is how the system operates and we get other
benefits out of the workings of the system and therefore, we do
not really think anything should be done to close out the
practices that we heard this morning? Is there anyone at the
table who takes that position?
Mr. Olson.
Mr. Olson. I think that those are exceptional
circumstances.
Chairman Sarbanes. Pardon.
Mr. Olson. I think they were exceptional circumstances and
not typical.
Chairman Sarbanes. Let me not argue whether they are
exceptional or not for the moment. Let me just get a response,
whether there is anyone on this panel who thinks, having heard
those practices, who says, well, it is regrettable, but we have
this system that works, or we have this system in place and it
moves a lot of transactions and people get credit and all the
rest of it, and therefore, we really cannot close out those
practices and we just have to, in a sense, accept them or
tolerate them. And then, presumably, one would argue that there
are not very many of them, and others would argue that there
are quite a few of them. But is there anyone who thinks we just
should accept those practices, at the table?
Mr. Olson. I think we have been given some alternatives. If
we make the compensation up front, then there would be less of
this practice. I would agree with that.
There is always imperfections in any market and I do not
know if you can always eliminate every problem. We could go to
shopping for a dress or going to the restaurant. There is
always cases where someone paid more than they wish they had.
Chairman Sarbanes. No, no, this is not a case where they
pay more than they wish they had. This, it seems to me, what we
heard this morning are cases in which they were clearly taken
advantage of. They placed their confidence in someone. They, in
effect, got representations that the person was really working
on their interests, and it turned out they were not working in
their interests and they put them into very difficult
situations.
Now, Professor Jackson says on the basis of his study, that
he thinks that such practices are fairly widespread. Am I
interpreting that correctly?
Mr. Jackson. That is correct. It is much more widespread
than several panelists this morning would suggest.
Chairman Sarbanes. Yes.
Mr. Jackson. It is a very generic practice and problem in
the
industry.
Mr. Donaldson. Mr. Chairman, could I respond to the
statement about the frequency of these occurrences?
Chairman Sarbanes. Sure.
Mr. Donaldson. With all due respect to Mr. Olson, Ms. Hiers
got a mortgage from Irwin Mortgage Corporation, the defendant
in the Culpepper case. I and other plaintiffs' lawyers who are
representing that class have looked through approximately 5,000
loan files. I did not find and, to the best of my knowledge, no
other person found a single situation where any borrower was
saved one thin dime in closing costs as a result of a yield
spread premium being paid. And the idea that these are not
commonplace problems simply cannot be--that allegation does not
withstand the light of day of scrutiny if you actually look at
the loan files.
Situations like Beatrice Hiers' are not the least bit
uncommon if you go look through these defendants' loan files.
And although the mortgage bankers and the mortgage brokers are
sitting before this Committee here today talking about how
willing they are to disclose, my reading of the Federal
Register of the negotiated rulemaking with HUD over the last
several years, starting in 1995, tells me that they have
vociferously fought against any disclosure whatsoever.
And in preparing to come here today, I went to NAMB's web
site and read their position paper, dated last month, talking
about this very question. And there is an entire topic devoted
to the proposition that, ``. . . originators should not be
required to disclose their compensation.'' I do not understand.
Chairman Sarbanes. Does anyone want to respond to that?
Mr. Falk.
Mr. Falk. Mr. Chairman----
Chairman Sarbanes. We have you all at the table this
morning for this purpose.
Yes.
Mr. Falk. Mr. Chairman, we as the mortgage brokers do
believe in comprehensive mortgage reform. I believe over the
last 5 or 6 years the National Association of Mortgage Brokers
has been calling on Congress and HUD to work on the various
problems that we have in our industry.
There are just too many pieces of paper. It is confusing to
the consumer. It can be faster and better, understandable to
the consumer, to facilitate shopping and comparing. It can be
better.
We believe also an important part of this is RESPA
enforcement that Secretary Martinez has called for and we
applaud that effort. We look forward to his efforts in
enforcing the rules that are currently on the books and
clarifying others that need clarification.
Last, we have called for more than what the HUD Secretary
called for in our press release recently. We have called for
Good Faith Estimate reform, which would have caused some of the
problems that we heard about this morning not to exist.
Right now, Mr. Chairman, when a Good Faith Estimate is
required, there is no Federal requirement to redisclose the
Good Faith Estimate of costs if the loan terms change
significantly from the time of application to the time of
funding.
What we are saying is develop tolerances. When the Good
Faith Estimate is initially constructed and delivered to the
consumer, if tolerances are exceeded, then a redisclosure is
necessary to avoid the surprises at the closing table, to avoid
some of the things that we heard this morning on a purchase
transaction, the story that we heard this morning from Ms.
Hiers, who felt forced to close a transaction. That should not
happen. And redisclosure on a Good Faith Estimate that exceeds
certain tolerances could be a valuable tool for consumers so
they are not taken advantage of.
Chairman Sarbanes. Well, all three people we heard from
before, I was struck by the fact that these are really hard-
working citizens. Every one of them.
Their dream was to own a home, and that was obviously a
very important part of providing security for their families.
Ms. Hiers actually had her parents living with her until they
passed away, along with her children. We have to get at these
practices.
Mr. Jackson, I know you have looked at the RESPA
legislation in detail. My own reaction to the HUD 2001 policy
statement was that, rather than clarifying the 1999 statement,
it actually muddied the waters.
My view of the RESPA law, in the 1999 statement was that
each fee had to be tied to a legitimate service. In fact, the
Senate report that accompanied the passage of RESPA indicates
that RESPA, ``. . . prohibits the acceptance of any portion of
any charge for the rendering of a real estate settlement
service other than for services actually performed.'' So my
understanding is that Congress wanted to prohibit referral fees
from being tacked onto or hidden in with other fees that were
for legitimate services or goods.
And that is why, Mr. Falk, I kept pressing you specifically
on the fee and the service because you can encompass the fee
within a broader concept. And I have some concern now that this
is what HUD is doing with this total compensation test, which
would allow for referral fees, or may well allow for referral
fees as long as HUD believes that the total payment to the
broker is reasonable, even though the law specifically
prohibits all referral fees.
Now do you share that concern, Professor Jackson?
Mr. Jackson. Senator Sarbanes, I do. This aspect of the
policy statement is quite puzzling. If you go back to the
legislative history of the Act that you are referring to, or
even the press accounts that preceded the Act, what Congress
was worried about were people in a trust relationship, like
attorneys or real estate agents, who were steering their
clients toward title insurance companies and other service
providers and getting a kickback. And what Congress concluded
was that these referral fees and kickbacks were increasing
substantially homeownership costs, and they should prohibit
them.
Chairman Sarbanes. Mr. Donaldson, the Culpepper case in
effect said, as I understand it, that these yield spread
premiums were being paid without any relationship to providing
any services.
Mr. Donaldson. Yes, sir.
Chairman Sarbanes. Is that correct?
Mr. Donaldson. Yes, sir, that is correct.
Chairman Sarbanes. In effect, you had the rate sheet and it
was all geared to the rate sheet. As long as you brought them
in at a higher interest rate, you got the yield spread premium
and you, the broker, did not really have to do anything for
that yield spread premium. Is that the essential thrust of that
case?
Mr. Donaldson. Yes, sir. And the form agreement between the
lender and the broker simply provided that yield spread premium
payments would be made when a borrower agrees to a higher than
par interest rate. It had nothing to do with services. And in
fact, at the outset of that litigation, the defendant did not
even argue that it had to do with services. It argued that it
was paying for a good which was the mortgage. This idea that
this is a payment for services is something that was cooked up
by industry lawyers after they lost their first argument.
Chairman Sarbanes. My understanding is that there has been
testimony in some of these class action suits--let me just
quote a couple of them.
A broker testified in a deposition that the only variable
that determines the yield spread is the interest rate. A lender
official was asked if there are any particular services that go
into the pricing on a rate sheet. His answer, ``No, I am not
aware of any services.''
Mr. Donaldson. That is correct.
Chairman Sarbanes. A lender offers to fund the same exact
loan provided by the same broker for the same borrower with the
same principle amount after the broker has done the work. The
only variable is the yield spread premium, which is
predetermined according to a rate sheet provided by the lender
to the broker. Isn't that what happens?
Mr. Donaldson. Yes, sir, that is exactly what happens.
Chairman Sarbanes. Mr. Jackson, let me ask you one other
question on this RESPA and the HUD statement. Apparently, now,
the 2001 statement is that HUD is going to determine what is a
reasonable fee. That is not the approach that the Congress took
when they passed the legislation, at least as I understand it.
In fact, we did not set up a structure to adjudge the
reasonableness of the fees.
Mr. Jackson. That is absolutely right.
Chairman Sarbanes. Mr. Courson, Mr. Falk, do you think we
should set up a structure to adjudge the reasonableness of
fees, a Government structure to do that?
Mr. Courson. Mr. Chairman, I think that is a very slippery
slope. I think it is very difficult to judge what, when one
loan may well be reasonable--we are talking about loans now in
this particular context--and whether another loan may be
unreasonable.
You have geographical issues. You have different types of
loans. I think that the Government setting standards, if you
will, in terms of defining reasonableness will be very
difficult over the hundreds of thousands of loans that are made
each year.
Chairman Sarbanes. Mr. Falk, I take it you would agree with
that.
Mr. Falk. I would add to the comment, yes, I do agree with
Mr. Courson's testimony. Many loan programs and different
products and services call for different types of services and
goods and facilities rendered. Therefore, it is impossible to
come up with a strict definition on a Federal level to deal
with all of the complexity that goes into a particular loan
transaction on a local level. It would just be very difficult.
Chairman Sarbanes. Actually, I do not think anyone at the
table is advocating establishing a governmental structure to
adjudge the reasonableness of fees. Is that correct?
Mr. Olson. That is correct.
Chairman Sarbanes. I mean, as I read it, that is not the
legislative scheme the Congress put in place.
Now what the Department is doing is, conceivably--we are
going to see now because they are working on a regulation--but,
conceivably, undercutting the existing regulatory scheme,
setting up this kind of reasonableness proposition.
I do not know how that is going to be implemented or
enforced. The industry, obviously, in its full-scale
manifestation, would be opposed to it. The Congress made the
judgment when we passed the legislation not to go down that
path. But if we are not going to go down that path, it seems to
me that HUD cannot abandon the two-stage testing process for
these practices that in part were reflected by the court's
decisions in the Culpepper case. So now if they are going to
come in and vitiate the Culpepper case, it is hard for me to
see what the remedy is going to be to preclude these practices
from taking place.
Mr. Rheingold. Senator.
Chairman Sarbanes. So, I think that is, in effect, the
challenge that HUD has presented to itself. They, in effect,
now, it seems to me, have maneuvered themselves into a corner.
And I am obviously very interested in how they are going to
work out of this corner.
Mr. Rheingold, you wanted to comment?
Mr. Rheingold. I apologize.
Chairman Sarbanes. That is all right. No, no.
Mr. Rheingold. The industry, in fact, supported HUD's
action and wanted them to apply a reasonableness test. HUD
adopted what the industry was asking them to do, and there was
one reason for it and one reason alone--everyone understands
that if the only test is reasonableness, you cannot have a
class action lawsuit.
HUD's actions were simple. Call it cynical. The only
purpose for their policy statement on October 15 was to
undercut Culpepper. They may come out now with new regulations
that are helpful. But the fact was that the October 15
Statement of Policy was caused by industry's reaction to the
Culpepper decision and their understanding that a
reasonableness test would undercut the ability of any class
action to go forward.
Chairman Sarbanes. Do you think that there are mandates
that could now be required of the industry that would preclude
a repeat of the practices we saw on the first panel?
Mr. Rheingold. I think there clearly are. Actually, I think
some of the suggestions that Mr. Courson made are very viable.
I think the notion that total compensation up front, that the
total compensation does not depend upon the interest rate the
person gets. The yield spread premium is simply a source of how
that compensation gets paid. So, in essence, there is no
incentive for a broker to get a higher rate mortgage because
they are not going to get compensated any more.
I think that would go a long way to solving the problems
that exist. I hasten to add that in my experience in
representing a lot of poor homeowners in this country, I never
underestimate the cynicism of the industry and I never
underestimate----
Chairman Sarbanes. Or some elements of the industry.
Mr. Rheingold. Some elements of the industry. I do not mean
the entire, but some elements. I do not underestimate that. But
I think that would go a long way forward in making things work.
Chairman Sarbanes. I think the industry has to face this
problem of the bad actors within their ranks. They just have to
face it.
Mr. Falk, do you want to comment?
Mr. Falk. Yes. Thank you, Mr. Chairman. I would
vociferously disagree with the other panelists who have tried
to characterize the 2001-1 policy statement of HUD. We believe
that the 1999-1 policy statement by Secretary Cuomo clearly
outlined the requirements. We believe that the 2001-1 statement
was merely a restatement of that existing policy that was
originally stated in 1999.
And so, to characterize it as some effort on the part of
the HUD Secretary to undermine or to take away certain rights
and privileges from consumers, we believe is a
misinterpretation, with all due respect to the other panelists.
Chairman Sarbanes. Yes. The difficulty I have with that
statement, though, is that under the 1999 guidance, a class
action suit was permitted in the Culpepper case. And since the
new guidance has come out, I understand that there have been a
couple of Federal courts across the country who have disallowed
the class action suit. So if you see the class action suit as
one effective remedy to eliminate these practices, then that
remedy has been in effect wiped out.
Also, HUD, by collapsing the two-step test, has markedly
altered the situation. If it is left for reasonableness to be
determined in a court case, that is not much remedy on an
individual basis.
They are not suggesting establishing a structure to
determine reasonableness administratively, and of course, both
of you would strongly disagree with going down that path, I
presume, from what you have said earlier.
So, we have a situation now in which the remedies are being
eliminated on the basis of a so-called clarifying statement
compared with where we were before. The rhetoric of the HUD
press releases in terms of what they are trying to accomplish
does not comport with the reality of their statement, in my
perception. It will really be put to the test, obviously, as we
look at the regulation that they are now seeking to formulate.
And obviously, we intend to follow that process very closely.
Well, I want to thank all the panelists. You have made a
very significant contribution. It is our intention that your
full statements and the transcript of this hearing will be
forwarded to the Department, along with a letter of
communication urging them to give the most careful
consideration to what has been said here.
This is a very important issue. As I said at the outset,
people who render services are entitled to appropriate
compensation for the services they render. But it ought not to
extend to the point where they can engage in abusive practices
and exploit people.
Mr. Olson, I was a little concerned you were suggesting
they are not making much money. That may or may not be the
case. But, in any event, in order to make money, I do not think
you are entitled to engage in abusive practices. I do not
concede that in order to turn a profit, you can engage in any
exploitative activity.
Mr. Olson. I did not mean to suggest that.
Chairman Sarbanes. Well, that was a possible implication. I
just want to be very clear about that.
I thank the panel very much.
The hearing is adjourned.
[Whereupon, at 12:10 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional materials supplied for the record follow:]
PREPARED STATEMENT OF SENATOR PAUL S. SARBANES
This morning the Committee will hold its third hearing on the
subject of predatory lending. Our previous two hearings on this topic
focused largely on the predatory loans and practices which resulted in
stripping hard-earned equity away from many low-income homeowners.
These include folding high points and fees, as well as products such as
credit insurance, into the loan. We also looked at how unscrupulous
lenders and mortgage brokers target the low-income, elderly, and
uneducated borrowers as likely marks for predatory loans. Today's
hearing will focus more on the role of the broker in the lending
process, specifically the use and misuse of yield spread premiums.
Let me start by addressing how yield spreads are used in the
marketplace. Typically, a mortgage broker will offer to shop for a
mortgage on behalf of a consumer. In many cases, that broker will
promise to get the borrower a good deal, meaning low rates and fees.
Borrowers pay the broker a fee for this service, either out of their
savings or with the proceeds of the loan. Unbeknownst to them, however,
that broker may also be paid a yield spread premium if he can get the
borrower to sign up for a loan at a higher rate than the borrower
qualifies for. The higher the mortgage rate, the higher the payment. We
will hear about such cases this morning.
Yield spread premiums can be a legitimate tool in helping a home
buyer or homeowner offset all or some of the closing costs associated
with buying or refinancing a home. When used properly, the broker
discloses his total fee to the consumer. The consumer may then choose
to pay that fee, and, perhaps other closing costs as well, by accepting
a higher interest rate and having the lender pay the fee to the broker.
In such cases where the borrower makes an informed choice the payment
helps families overcome a barrier to homeownership--the lack of funds
for closing costs.
However, it appears that in practice, perhaps in widespread
practice, yield spread premiums are not used to offset closing costs or
the broker fees. Instead, these premiums are used to pad the profits of
mortgage brokers, without regard to any services they may provide to
borrowers. Let me quote from a report issued by the Financial
Institutions Center at the Wharton School of Business at the University
of Pennsylvania. Professor Emeritus Jack Guttentag, discussing the
problem of ``rebate pricing'' that is, payments by lenders to brokers
of yield spread premiums, writes:
In most cases . . . rebates can be pocketed by the broker,
unless the broker commits to credit them to the borrower, which
very few do. Rebate pricing [that is YSP's] has been growing in
importance, and one of the reasons is that it helps mortgage
brokers conceal their profit on a transaction.
Moreover, this does not just affect subprime borrowers, as do most
of the other egregious practices we heard about in our previous
hearings. This misuse of yield spread premiums affects prime borrowers,
FHA borrowers, VA borrowers; however, because of the lack of openness
and competition in the subprime market, it hits subprime borrowers
hardest of all. Even for those with the best credit, the current use of
yield spread premiums can cost thousands of dollars in increased
financing costs.
Yield spread premiums, when they are misused in this way, fall
directly into the category of the kind of referral fees or kickbacks
that were so prevalent in the settlement business prior to the passage
of RESPA. After years of hearings and reports, the Congress passed the
Real Estate Settlement Procedures Act (RESPA) in 1974 specifically to
outlaw side payments of this kind because they increase the costs of
homeownership for so many Americans. Indeed, the plain language of the
law, regulations, 1998 Congressional instructions to HUD to formulate a
policy on the issue, and the 1999 HUD policy statement--particulary
when taking the legislative history into account--all make it clear
that RESPA was intended to prohibit all payments that are not
demonstrably and specifically for actual services provided. That is to
say, each fee collected by the broker should be for a corresponding
service actually provided.
Because the majority of home loans are now originated through
brokers, lenders have less and less direct access to borrowers. This
means they must compete for the broker's attention to gain access to
the ultimate consumer--the borrower. This competition means that, too
often, lenders must pay yield spread premiums to the brokers simply for
the referral of business. As all of us know, this is prohibited under
the law precisely because it raises the costs of homeownership to the
consumers.
Regrettably, HUD's recent ``clarification'' of its 1999 policy
statement on the issue of yield spread premiums will open the door to
new and ongoing abuses of low- and moderate-income homebuyers and
owners. Despite the Secretary's statement at his confirmation hearing
that he finds predatory lending ``abhorrent,'' I fear that the new
policy statement will facilitate the predatory and racially
discriminatory practice of steering homeowners to higher interest rate
loans without their knowledge, and, importantly, without any effective
means of redress.
Secretary Martinez has made increasing minority homeownership a
primary goal of his Administration. However, a study done by Howell
Jackson of Harvard Law School (who will testify on the second panel)
shows that, while the current use of yield spread premiums imposes
extra costs on all homebuyers, the burden falls especially hard on
minorities. In other words, yield spread premiums, when they are used
in this abusive fashion, put the dream of homeownership further out of
reach for minority Americans. Those who still manage to achieve this
dream are forced to pay thousands of dollars in increased interest
costs over the life of their loans. Many find themselves in more
precarious financial positions than they should or could be, thereby
putting them more at greater risk of falling prey to the kind of
repeated refinancings that we have seen lead to equity stripping or
even the loss of the home.
I recognize that it is unusual to have a hearing while the Congress
is in recess. HUD has indicated, both in testimony before this
Committee in December, and in the Federal Register, that it intends to
publish a proposed regulation on this matter by the end of this month.
These issues are so important that I wanted to make sure that there
would be a public airing of the issues for the consideration of the
Department while their deliberations were still ongoing.
----------
PREPARED STATEMENT OF SUSAN M. JOHNSON
Cottage Grove, Minnesota
January 8, 2002
My name is Susan Johnson and I am from Cottage Grove, Minnesota. I
am pleased to have the opportunity to be able to address the Senate
Banking Committee today about the $1,620 ``yield spread premium'' that
was secretly paid by my lender, ABN AMRO Mortgage Group, to my mortgage
broker, Allstate Mortgage, at my expense.
In April 2000, my husband David and I had just moved back to the
Twin Cities from Colorado Springs and were looking to buy a house.
Through a real estate agent, we were introduced to David Schultz, owner
of Allstate Mortgage, a mortgage broker in Plymouth, Minnesota. After
meeting Mr. Schultz at a local restaurant, we hired him to find us a
mortgage loan.
From the outset, we were told by Mr. Schultz that he would find us
a loan with the best possible interest rate. Mr. Schultz specifically
told us that the fee for processing the loan would be 1 percent of the
loan amount. We signed a written broker agreement with Mr. Schultz
which allowed for a 1 percent broker fee. (Exhibit 1, Loan Origination
Agreement) No other fees were ever demanded by Mr. Schultz, disclosed,
or agreed to.
When the closing occurred on May 23, 2000, to our surprise, the
interest rate was higher than we understood it would be and the fees
were far greater than the 1 percent fee we had agreed to. (Exhibit 2,
HUD-1 Settlement Statement at lines 801-812) In fact, the total fees
were nearly four times that amount! ($5,242.00) This included what we
only later came to learn after the closing was a ``yield spread
premium''--a $1,620 payment from the lender to our broker that was
really paid by us since it was tied to an inflated interest rate on our
loan.
While we were upset about the fees, we had no choice but to go
through with the closing or risk losing the house; being found in
default of the Purchase Agreement; and forfeiting the $5,000 earnest
money we had already given the sellers. While we objected to the fees
and higher interest rate, there was no way for us to find another loan
and still close on time. We were stuck and the broker knew it.
As our HUD-1 Settlement Statement shows, we were charged the
following fees at closing, none of which were disclosed, or agreed to
beyond the initial 1 percent origination fee:
$1,296 (1 percent) Loan Origination Fee
$1,296 (1 percent) Loan Discount Fee
$395 Processing Fee
$200 Underwriting Fee
$150 Doc Prep Fee
$40 Funding Fee
$350 Commitment Fee
$285 Admin Fee
Only after the closing did we discover the significance of the
$1,620 ``yield spread premium'' (1.25 percent) which was assessed to us
through an inflated above-par
interest rate of 8.75 percent. At the time of the closing we had no
idea what this ``premium'' was because it was only vaguely disclosed on
our HUD-1 Settlement Statement as a ``Deferred Premium POC.'' \1\ In
sum:
---------------------------------------------------------------------------
\1\ Line 814 ``Deferred Premium $1,620 ($1,620 Pd by ABN AMRO
Mortgage Group Inc., POC) to Allstate Home Mortgage.''
The $1,620 yield spread premium was not disclosed, discussed,
or agreed to before the closing;
My husband and I were never informed that our loan had an
above-par interest rate because of the premium payment from ABN
AMRO to the broker;
The broker never explained how the yield spread premium
affected our interest rate or that our monthly mortgage
payments would be any higher because of the premium;
No rate sheet or other document showing the direct
relationship between the inflated interest rate and the yield
spread premium payment from the lender to the broker was ever
shown to us;
The yield spread premium did not offset or reduce any fee we
ever owed to the broker;
The broker received all fees that we owed and agreed to (and
far more) directly in cash from us at the closing.\2\
---------------------------------------------------------------------------
\2\ We never owed the broker any fees on top of the 1 percent fee
Mr. Schultz told us he was charging before the closing. Mr. Schultz
later admitted this when he gave a deposition. (Exhibit 3: Excerpts
from Schultz deposition, March 15, 2001).
After the closing, I wrote to the State of Minnesota Department of
Commerce complaining about the transaction. After reviewing my letter,
the Department of Commerce advised us to seek private legal counsel.
The matter remains pending in Court in Minnesota. In that case, we have
agreed to be representatives of other borrowers whose loans had yield
spread premiums paid by the same lender in the same manner as ours.
In conclusion, the $1,620 yield spread premium on our loan was
nothing more than a bonus paid by the lender to the broker for securing
a bad deal for my husband and me, and referring a better deal to the
lender. This conduct should be illegal because:
(1) the yield spread premium was not paid in exchange for any
``service'' fee we owed the broker;
(2) we received no benefit from the premium the lender paid
at our expense, such as an offsetting credit against any
closing fees or costs we actually owed, and;
(3) the money was simply a kickback to the broker referring
our loan to the lender with a higher interest rate.
The standard for evaluating the legality of this practice should
not merely be whether the broker's ``total compensation,'' including
the yield spread premium and other fees we never agreed to, is somehow
``reasonable'' based on the broker's after-the-fact attempt to justify
the higher fees he has already taken. Rather, the true nature of the
disputed premium should be evaluated: that is, what was the premium
actually paid in exchange for.
To allow as lax a standard as ``reasonableness'' of total broker
compensation to govern these transactions will only allow lenders and
brokers like ABN AMRO and Mr. Schultz to continue ripping-off unknowing
consumers like us, with a catch-us-if-you-can attitude. It will
encourage brokers and lenders to continue to try to slip additional
bonus fees into mortgage transactions regardless of what was agreed and
without providing any actual credit to the consumer bearing the cost.
If lenders are paying bonuses and incentives to brokers simply for
referring high-rate loans to them, that should be illegal without
concern for whether the broker or the lender thought the secret
referral fee was ``reasonable.''
Thank you.
Attachments
Exhibit 1: Loan Origination Agreement with the broker for the
1 percent fee; HUD-1 Settlement Statements (Exhibit 1);
Exhibit 2: HUD-1 Settlement Statement on ABN AMRO Mortgage
Group Inc. loan, May 23, 2000;
Exhibit 3: Excerpts from Mr. Schultz's deposition testimony
admitting that the yield spread premium was never discussed
with us before the closing and offset no fee we owed.
PREPARED STATEMENT OF HOWELL E. JACKSON
Finn M.W. Caspersen and Household International Professor of Law and
Associate Dean for Research and Special Programs
Harvard University School of Law
January 8, 2002
Chairman Sarbanes and Members of the Committee, I am very pleased
to be here today to discuss the problem of yield spread premiums and
the Department of Housing and Urban Development's recent Statement of
Policy 2001-1, 66 Fed. Reg. 53,052 (Oct. 18, 2001) (Statement of
Policy). Yield spread premiums and related industry practices have
become a major problem for American homeowners. Payments of this sort
are inherently confusing and serve primarily to raise the cost of
homeownership for many Americans, particularly the less educated and
the financially unsophisticated, by billions of dollars a year. In my
opinion, yield spread premiums
represent the sharp practices that Congress should have prohibited when
it enacted the Real Estate Settlement Procedures Act of 1974 (RESPA)
more than 25 years ago. I urge both Congress and the Department of
Housing and Urban Development to redouble their efforts to eliminate
the substantial and widespread consumer abuses that yield spread
premiums have visited upon American homeowners in recent years.
Introduction
Over the past year, I have been investigating the economic impact
of yield spread premiums.\1\ A major component of my investigation has
been an empirical analysis of a nationwide sample of approximately
3,000 mortgages originated by one group of affiliated lending
institutions in the late 1990's. This study constitutes the most
extensive empirical investigation of yield spread premiums to date. In
my testimony before the Committee this morning, I would like first to
discuss the implications of my study for the Department's policy
statement and then to propose a number of specific actions I believe
the Department should take to prevent abusive uses of yield spread
premiums in the future.
---------------------------------------------------------------------------
\1\ I initially undertook this project as an expert for the
plaintiff class in Glover v. Standard Federal Bank, Civil No. 97-2068
(DWF/SRN) (U.S. District Court, District Court of Minnesota) (pending)
and am currently expanding the study into an academic article, the
current draft of which is attached to this testimony: Howell E. Jackson
& Jeremy Berry, Kickbacks or Compensation: The Case of Yield Spread
Premiums (January 8, 2002) (hereinafter ``Jackson & Berry'') [a
abridged draft of this paper is available at http://
www.law.harvard.edu/faculty/hjackson/pdfs/january__draft.pdf.
---------------------------------------------------------------------------
The Policy Statement
Let me begin by commending the Department for its willingness to
take on an issue as complex as the payment of yield spread premiums.
While my analysis of these practices differs from the Department's
views in many important respects, I wholeheartedly agree with the
Department's initial premise and the premise of the RESPA itself: That
real estate settlement practices are an area in which governmental
intervention is necessary both to protect consumers and to ensure the
efficient operation of market forces.
My comments about the policy statement are divided into two parts.
First, I will discuss the statement's factual assumptions about the
role of yield spread premiums in today's mortgage market. Second, I
will comment on several aspects of the Department's legal analysis of
how Section 8 of RESPA, which prohibits certain kickbacks and unearned
referral fees, should be applied to the payment of yield spread
premiums.
Factual Assumptions about the Role of Yield Spread Premiums
As explained in the policy statement, the Department conceives of
yield spread premiums as a valuable ``option'' that ``permits
homebuyers to pay some or all of the upfront settlement costs over the
life of the mortgage through a higher interest rate.'' \2\ This method
of financing upfront settlement costs, according to the Department, is
particularly suited to borrowers who are low on cash and ``whose loan-
to-value ratio has already reached the maximum permitted by the
lender.'' \3\ Based on these factual assumptions, the Department
concludes that the yield spread premium is a ``legitimate tool to
assist the borrower'' and a financing option that ``fosters
homeownership.'' \4\
---------------------------------------------------------------------------
\2\ 66 Fed. Reg. at 53,054.
\3\ Id.
\4\ Id.
---------------------------------------------------------------------------
As a purely theoretical matter, the Department's assumptions about
the role of yield spread premiums are plausible. Homeowners who are
short on cash could, theoretically, use yield spread premiums to
finance settlement costs. My study, however, offers compelling evidence
that yield spread premiums are not being used in this way.\5\ Rather,
the manner in which yield spread premiums are levied combined with the
complex structure of real estate settlement procedures serves
principally to allow mortgage brokers to impose higher prices on
borrowers who bear the cost of these charges--particularly on
individuals who are less educated and less sophisticated about
financial matters. This abusive form of price discrimination
substantially increases the overall costs to borrowers, thereby
imposing a hidden tax on homeownership for many Americans.
---------------------------------------------------------------------------
\5\ As indicated above, the sample upon which my empirical study is
based was limited to loans originated by an affiliated group of lending
institutions and thus does not include loans from all lending
institutions in the industry. It is possible that the abusive practices
uncovered in my study are peculiar to the lending institutions included
in my sample. However, I doubt that this is the case. Industry experts
have opined that the practices of the lenders in my study ``are typical
of other wholesale lenders.'' See Report of David Olson, Glover v.
Standard Federal Bank, Civil No. 97-2068 (DWR/SRN) (U.S. District
Court, District Court of Minnesota) (filed June 24, 2001) (expert for
defendants). At a minimum, the evidence uncovered in my study should
put the burden on the Department to demonstrate with comparable
evidence that the factual assumptions underlying the policy statement
are accurate for the industry generally.
---------------------------------------------------------------------------
Yield Spread Premiums Are Not Currently Presented to Consumers as an
Optional Way to Finance Settlement Costs
An initial problem with the Department's understanding of yield
spread premiums is its notion that these payments represent an option
consumers voluntarily choose. Consumers are given no such choice.
Mortgage brokers, in my experience, never describe yield spread
premiums as an optional method for financing settlement costs, nor do
the Department's own consumer publications or the most popular consumer
guides for buying a home. What is more, consumers are never given the
advice they would need to make a meaningful comparison between the cost
of higher interest rates over the life of a loan and direct cash
payments for closing costs.\6\ Rather, borrowers are simply told that
their loans will have a certain interest rate, and they never
understand that the interest rate is higher than it needs to be or that
the higher interest rate is used to finance a payment to the mortgage
broker.
---------------------------------------------------------------------------
\6\ What HUD regulations do require is ``disclosure'' of yield
spread premiums. However, this disclosure is inadequate in many
respects. Yield spread premiums are not reported in a consistent manner
in HUD-1 forms; oftentimes they appear on back pages of the form and
sometimes in a smaller font. Most important, these payments are almost
always denominated ``p.o.c. by lender,'' meaning that they are ``paid
outside of closing by the lender.'' It is inconceivable that more than
a tiny fraction of consumers can correctly evaluate this information.
For a more complete discussion of the problems consumers face in
deciphering this information, see Jackson & Berry, supra note 1, at 2-
5, 51-65.
One measure of inadequacy of current disclosure practices is the
difficulty my assistants had even finding the amount of yield spread
premiums on HUD-1 forms. Even after receiving explicit training on the
subject, a team of paralegals and certified public accountants was only
able to find yield spread premiums on about two-thirds of the forms on
which the payments were supposedly disclosed. See Jackson & Berry,
supra note 1, at 71-74 & n.112.
---------------------------------------------------------------------------
Incidence and Magnitude of Yield Spread Premiums Are Extremely High
Another erroneous factual assumption implicit in the policy
statement is the notion that yield spread premiums are paid by a
relatively small number of borrowers who lack adequate resources to pay
closing costs directly. To the contrary, my study indicates that the
vast majority of borrowers pay yield spread premiums--on the order of
85 to 90 percent of all transactions.\7\ Moreover, the average amount
of yield spread premiums is quite substantial, on the order of $1,850
per transaction, making these payments the most important single source
of revenue for mortgage brokers.\8\ In other words, contrary to the
Department's assumptions, yield spread premiums are not an ``optional''
form of financing made available to a limited number of borrowers with
special needs. Rather these payments constitute by far the largest
source of compensation for mortgage brokers and are imposed on almost
all borrowers who obtain mortgages or refinancings through this segment
of the industry.
---------------------------------------------------------------------------
\7\ See Jackson & Berry, supra note 1, at 73 (Table 2).
\8\ Id. at 78-81.
---------------------------------------------------------------------------
Most Borrowers with Yield Spread Do Not Need Extra Financing
Another fallacy in the Department's factual assumption is its
suggestion that borrowers who pay yield spread premiums have no other
means of paying closing costs. This assumption is clearly wrong.
According to my analysis, more than three-quarters of the borrowers who
were charged yield spread premiums had loans that were less than the
defendant lending institutions' maximum loan-to-value ratios and
therefore could easily have financed closing costs by increasing the
amount of their loans.\9\ In other words, most borrowers who are
charged yield spread premiums do not need an extra (and exorbitantly
costly) form of financing for their closing costs.
---------------------------------------------------------------------------
\9\ Id. at 147 & n. 180. My study did not consider other sources of
funding, such as cash reserves or credit cards or loans from family
members. Were these and other alternative sources considered, even more
borrowers would have had viable financing options other than paying
yield spread premiums. As explained below, the true costs of yield
spread premiums are so high that a borrower would be well advised to
employ almost any other form of financing.
---------------------------------------------------------------------------
Mortgage Brokers Earn on Average $1,046 More on Loans With
Yield Spread Premiums
Another erroneous premise of the policy statement is that industry
offers yield spread premiums as a service to their customers and is
indifferent to whether consumers pay closing costs directly or through
the imposition of yield spread
premiums. Mortgage brokers clearly much prefer making loans with yield
spread premiums. According to my study, mortgage brokers made an
average of $1,046 more on loans with yield spread premiums than they
did on comparable loans unaffected by these practices.\10\ Thus, on
average, borrowers who get loans with yield spread premiums pay their
mortgage brokers over a thousand dollars more than other borrowers.
This substantial difference, in my view, goes a long way to explain why
the industry has so zealously resisted efforts to police the payment of
yield spread premiums, and it clearly refutes the Department's premise
that yield spread premiums are just another form of payment.\11\
---------------------------------------------------------------------------
\10\ Id. at 91-97 (Figure 14).
\11\ Why mortgage brokers can earn more money on loans with yield
spread premiums is an interesting and important academic question. I
explore this issue in considerable detail in my academic writings on
the subject. In brief, I believe a number of factors are at work. In
this context, consumers are primarily concerned with buying homes and
being approved for financings; thus, they spend less time monitoring
the comparatively smaller costs associated with real estate settlement.
In addition, they trust their mortgage brokers to recommend appropriate
financing terms and cannot easily police these recommendations. In
addition, consumers have difficulty calculating costs of higher monthly
payments as compared with direct cash
payments and are not protected by market forces because these side
payments allow brokers to discriminate among sophisticated an
unsophisticated consumers and avoid creation of a single market price
for settlement services. See Id. at 51-65.
---------------------------------------------------------------------------
On Average, Seventy-Five Percent of Yield Spread Premiums Goes to
Mortgage Brokers
The most critical error in the policy statement is its assumption
that mortgage brokers use yield spread premiums to ``recoup the upfront
costs incurred on the borrower's behalf.'' \12\ In my study, I employed
a variety of statistical techniques to explore the relationship between
yield spread premiums and direct cash payments to mortgage brokers.
With the highest degree of statistical confidence, my studies refute
the proposition that borrowers receive a dollar for dollar offset for
yield spread premiums.\13\ My best estimate is that borrowers, on
average, enjoy 25 cents of benefit for each dollar paid in yield spread
premiums.\14\ In other words, the vast majority of yield spread
premiums--on the order of seventy-five percent--serve only to increase
the compensation of mortgage brokers. Contrary to the Department's
assumptions, consumers do not, by a long stretch, recoup the costs of
yield spread premiums.
---------------------------------------------------------------------------
\12\ 66 Fed. Reg. at 53,054.
\13\ Jackson & Berry, supra note 1, at 102-16.
\14\ Id.
---------------------------------------------------------------------------
Characterized as a Form of Financing, Yield Spread Premiums Are
Usurious
As explained above, I do not believe that yield spread premiums are
actually being offered to borrowers as a form of financing upfront
costs.\15\ However, if one were to accept this characterization and
then attempt to estimate the cost of this financing, the implicit
interest rates are absolutely outrageous. For an average borrower in my
study, the implicit interest rate on a ``yield spread premium loan'' to
finance closing costs would be in excess of 114 percent per year--on
the order of ten times higher than a typical credit card interest
rate.\16\ Had the Department been aware of the true costs of this
financing when it prepared its policy statement, I expect it would have
approached the problem in a very different manner.
---------------------------------------------------------------------------
\15\ See supra text accompanying note 6.
\16\ Jackson & Berry, supra note 1, at 144-47.
---------------------------------------------------------------------------
African-Americans and Hispanics Pay Much More for Mortgage Broker
Services
While my study suggests that yield spread premiums are a very bad
deal for the average consumers, I believe these practices are
particularly injurious to the least sophisticated members of society--
groups of which the Department has historically been most protective.
To test this hypothesis, I also examined the relationship between
mortgage broker compensation and the racial identity of borrowers. The
results indicated that mortgage brokers charged two racial groups--
African-Americans and Hispanics--substantially more for settlement
services than they did other borrowers. For African-Americans, the
average additional charge was $474 per loan, and for Hispanics, the
average additional charge was $580 per loan.\17\ While I expect to do
more work on this aspect of my analysis, these preliminary results are
consistent with my hypothesis that current industry practices allow
mortgage
brokers to exploit less sophisticated borrowers by imposing higher
charges.
---------------------------------------------------------------------------
\17\ Id. at 120-26. This analysis controls for a variety of
factors, including principal loan characteristics, credit quality of
borrower, loan-to-value ratios, and certain geographic variables.
---------------------------------------------------------------------------
Legal Analysis Proposed in the Policy Statement
The Department's misapprehension of the true economic impact of
yield spread premiums has substantial implications for the policy
statement's legal analysis. Had the Department understood how
disadvantageous yield spread premiums are for most consumers, the
Agency would, I believe, have proposed that the payments be treated
very differently under the two-step test used to determine whether
particular payments are prohibited under Section 8 of RESPA.\18\
---------------------------------------------------------------------------
\18\ In an earlier statement of policy, the Department proposed
this two-step test. Under the first step, courts are to consider
whether a particular payment is made for ``goods and services actually
furnished or services actually performed.'' If the answer to this
question is no, then liability is attached; if the answer is no, then
the court must proceed to the second step of the test, under which it
must determine whether the amount of the payment was reasonably related
to the goods and services provided. See HUD Statement of Policy 1999-1,
64 Fed. Reg. 10,080 (March 1, 1999).
---------------------------------------------------------------------------
Payment of Yield Spread Premiums Could Run Afoul of the First Step of
HUD's Test
In its policy statement, the Department summarily concludes that
yield spread premiums are paid for ``goods or services'' and thus
reasons that the payments passed the first step of the Department's
test. If one accepts the Department's factual assumptions--that yield
spread premiums are a bona fide option for financing closing costs and
that the payments are in fact recouped through offsetting reductions in
closing costs--this conclusion would be understandable. However, if
instead one credits the findings of my study--that the yield spread
premiums serve primarily to increase payments to mortgage brokers and
not to lower the upfront costs of borrowers--the legality of the
payments under step one of the HUD test is far from clear. As explained
above, my study suggests that only a fraction of each dollar of yield
spread premiums goes to financing goods and services. Under these
circumstances, I believe that it is more accurate to characterize the
payment of yield spread premiums as not being a bona fide payment for
goods and services. Under this view, the practice runs afoul the first
step of the Department's test for legality.
Allowing Payments of This Sort To Escape Liability Under Step One Does
Not
Square With the Congressional Policies Underlying Section 8 of RESPA
The alternative approach--that is, allowing settlement service
providers to escape liability under step one as long as the providers
could show they contributed some value to the transaction--flies in the
face of the legislative history that preceded the passage of RESPA. In
the early 1970's, real estate settlements were plagued by kickbacks and
referral fees. Typically, a firm with substantial influence over the
settlement--for example an attorney or a real estate agent--would
demand sidepayments from other service providers, such as title
insurance companies, as a quid pro quo for recommending the service
provider to preform the transaction. It was these referral fees that
Congress should outlaw with Section 8 of the RESPA, principally because
Congress believed these transactions increased the overall cost of
homeownership.\19\ Were the Department to adopt the position that
recipients of kickbacks have a defense from Section 8 liability if they
can demonstrate that they provided some other goods or service for the
transaction, it would seem to have created a major loophole for just
the kinds of sharp practices that the provision was
designed to eliminate. After all, almost all of the recipients of
kickbacks that motivated the passage of the Act also performed some
level of service for the settlement transactions in questions.
Certainly, where statistical evidence demonstrates that the payments in
question (here yield spread premiums) serve substantially--indeed
primarily--to increase the cost of homeownership, the activity should
be proscribed under Section 8.
---------------------------------------------------------------------------
\19\ Id. at 9-23.
---------------------------------------------------------------------------
Inappropriateness of Individualized Adjudication of Reasonableness
A further difficulty with the Department's legal analysis is its
apparent willingness to have the courts determine the reasonableness of
yield spread premiums on a case-by-case basis. As this aspect of the
policy statement concerns a matter of judicial management, it is a
matter that the courts themselves will have to resolve. But, on
multiple dimensions, individualized determinations of reasonableness of
the sort the Department appears to favor would be problematic. To begin
with, in order to measure the impact of yield spread premiums for a
particular borrower, a court must consider the impact of the payments
in a large number of cases, as I did in my study. As is well-developed
in other areas of the law--ranging from disparate impact cases to
securities litigation--it is impossible to assess the reasonableness of
one borrower's payments in a vacuum. For both litigants and courts, it
would be an inefficient use of resources to repeat this analysis on a
transaction by transaction basis. In addition, the Department's
approach invites the judicial rate regulation that Congress expressly
rejected when it enacted RESPA more than 25 years ago. In the early
1970's, many recommended ratemaking procedures for real estate
settlement services, but Congress chose instead to police the industry
through a combination of disclosure rules and the liability provisions
of Section 8. The policy statement threatens to resurrect judicial rate
regulation as the principal mechanism for controlling kickbacks in the
real estate settlement field. Arguably, under the Department's
approach, a Section 8 plaintiff would be forced to sustain the costs of
a hearing on reasonableness whenever a defendant demonstrates that it
provided any goods or services in connection with a settlement. In my
view, this approach subverts the intentions of Congress and leaves
consumers inadequately protected from predatory practices, such as the
payment of yield spread premiums. Moreover, the approach seems to
relieve from liability many of the abusive practices that Congress
intended to outlaw with the enactment of Section 8.
Proposals for Prospective Relief
One of the most heartening aspects of the policy statement is the
Department's willingness to propose changes in the disclosure rules
regarding yield spread premiums and related practices. In my view,
reforms in this vein could go a long way toward protecting consumers
and improving the efficiency of the market in this area. In particular,
I would recommend the following specific changes.
Requiring Disclosure of Par Rate Loan Option
One of the principal sources of confusion underlying yield spread
premiums is that most consumers are not aware that when they are
offered an above-par loan (on which a yield spread premium is paid),
they almost always have the option of receiving a par rate loan with a
lower interest rate and lower monthly payments. Whenever a mortgage
broker proposes an above-par loan, the Department should therefore
require the broker to offer the borrower a comparable loan with a par
interest rate. By offering consumers both types of loans, mortgage
brokers would make clear that above-par loans (and yield spread
premiums) are simply one option for home financing.\20\ Requiring such
offerings would also encourage both the Department and independent
consumer groups to educate consumers about the pros and cons of the two
options.
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\20\ Brokers might also be required to disclose the rate sheet
associated with the pricing of their loans. This would provide more
information than most consumers would need but could be useful to
consumer groups and the financial press.
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Direct Payment of Yield Spread Premiums to Consumers (on Line 200)
Whenever a mortgage broker presents a Good Faith Estimate or a HUD-
1 form for an above-par loan, the full amount of the yield spread
premium should be paid directly to the borrower in the form of a credit
on line 200. If yield spread premiums are to become a legitimate form
of financing, the proceeds of the financing must always be given to the
borrower. Then, the borrower can decide how to use those funds--whether
to pay for closing costs or some other purpose. A further advantage of
this reform is that it will force mortgage brokers to provide borrowers
with a full accounting of their costs elsewhere on the form. Under the
current rules, brokers use yield spread premiums to disguise their true
levels of compensation. Not only is the current practice inherently
deceptive; it also makes it all but impossible for consumers to compare
the true costs of loans from different brokers and lenders.
Prohibition on Discount Points Paid to Brokers
A further practice that should be eliminated is the payment of
discount points to mortgage brokers. Traditionally, consumers pay
discounts points to lenders in order to obtain a below-par loan--that
is, a loan with an interest rate below the rate on a comparable par
loan. Under current HUD regulations, however, mortgage brokers are also
permitted to charge discount points ``to lower'' the interest rate of a
loan. In my study, I discovered that mortgage brokers were routinely
charging discount points, even on par and above-par loans.\21\ This
practice is inherently deceptive. The only way a mortgage broker can
``lower'' the interest rate on such loans is to start by offering the
borrower an above-par rate. In this context, the payment of discount
fees to mortgage brokers simply serves to convert a yield spread
premium into a direct upfront cost for the borrower.\22\ In my view,
the term ``discount fees'' should be limited to payments made to the
lending institution that are actually used to lower a par rate loan
into a below-par loan.
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\21\ The incidence of discount fees to mortgage brokers ranged from
10 percent to 47 percent, depending on the sample, and averaged between
$744 and $1,335. See Id. at 77 (Table 4).
\22\ Not only does this practice needlessly complicate the true
compensation of mortgage brokers; but it also belies claims that above-
par loans are being used to lower upfront costs for consumers. How
could a consumer rationally request an above par loan for this reason
and then pay an upfront discount fee to turn the loan back into a par
loan?
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Comparable Reforms for Direct Lenders
A final area of regulatory reform concerns the development of
comparable disclosure requirements for direct lenders. Representatives
of mortgage brokers occasionally defend current disclosure practices on
the grounds that reforms of the sort outlined above would put mortgage
brokers at a disadvantage to direct lenders. The Department, I believe,
should reject claims of this sort. To begin with, mortgage brokers have
become the leading source of home mortgages in the United States. It is
imperative that the Department correct disclosure practices for this
dominant segment of the industry. To allow issues associated with other
sectors of the industry to stand in the way of such reforms would be
letting the tail wag the dog. Still, I agree with those who say that
disclosure reforms for direct lenders are also appropriate. After all,
when direct lenders charge above-par rates and then resell their loans
in the secondary market, they receive implicit yield spread premiums.
The solution to this problem, I believe, is to require direct lenders
to credit borrowers with an implicit yield spread premiums similar to
the ones to be required for mortgage brokers. For direct lenders who
actively participate in the wholesale purchase of loans, the
appropriate par rates could be derived from the institution's
contemporaneous rate sheets. For other direct lenders, the Department
might maintain and keep current a national listing of averages of par
rates for various categories of loans, derived from the contemporaneous
rates sheets of leading wholesalers. The Department would have to work
out the details of such a proposal, but the concept is well within the
Agency's expertise.
Let me conclude by again commending the Department for taking on
this issue. I would be delighted to work with the Department as it
moves forward in this area, and would welcome any questions that
Members of the Committee have.
----------
PREPARED STATEMENT OF JOHN COURSON
Chairman-elect, Mortgage Bankers Association and
President and Chief Executive Officer, Central Pacific Mortgage Company
Folsom, California
January 8, 2002
Good morning Mr. Chairman and Members of the Committee. My name is
John Courson, and I am President and CEO of Central Pacific Mortgage
Company, headquartered in Folsom, California. I am also Chairman-elect
of the Mortgage Bankers Association of America (MBA),\1\ and it is in
that capacity that I appear before you today.
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\1\ MBA is the premier trade association representing the real
estate finance industry. Headquartered in Washington, DC, the
association works to ensure the continued strength of the Nation's
residential and commercial real estate markets, to expand homeownership
prospects through increased affordability, and to extend access to
affordable housing to all Americans. MBA promotes fair and ethical
lending practices and fosters excellence and technical know-how among
real estate professionals through a wide range of educational programs
and technical publications. Its membership of approximately 2,800
companies includes all elements of real estate finance: Mortgage
companies, mortgage brokers, commercial banks, thrifts, life insurance
companies, and others in the mortgage lending field.
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This morning I have been asked to testify before your Committee to
present MBA's views regarding the issue of lender payments to mortgage
brokers, generally referred to as ``yield spread premiums,'' and how
they are to be judged under the antikickback provisions of the Real
Estate Settlement Procedures Act (RESPA). To ensure a clear
understanding of our position on this issue, it is important to lay the
groundwork by defining the term ``yield spread premium,'' and
highlighting the
important role that this financing tool plays in mortgage transactions.
Definitions
As a general rule, the term ``yield spread premium'' is used in the
mortgage lending industry to refer to a type of payment from a lender
to a mortgage broker, which is paid in the context of ``brokered'' loan
transactions. In such transactions, mortgage brokers generally operate
as intermediaries between consumers and lenders. In effect, they
function as the interface with prospective borrowers, serving as the
``storefront'' for mortgage loan products offered by lenders. In this
role, mortgage brokers are much more than ``retailers'' of loans; they
perform real and valuable services in the origination phase of the
mortgage transaction process. Among other things, mortgage brokers
bring borrowers and lenders together and match consumer needs with
lender products, they collect pertinent financial information, render
advice to consumers, and generate all documentation and verification
required for the loan transaction to occur.
It is important to clarify that, for the various goods, services,
and facilities they provide in the origination of loans, mortgage
brokers are entitled to be compensated. Generally, such compensation
will occur in either of two ways. Brokers may collect their full
compensation from the consumer directly, in the form of a cash payment.
Alternatively, they can be paid, in part or in whole, indirectly by the
lender, through the mechanism of a yield spread premium.
The yield spread premium mechanism works by allowing a consumer to
choose a higher interest rate in exchange for lower upfront costs.
Under this financing tool, the higher interest rate allows lenders to
tender an amount reflecting the value of that increased yield to
mortgage brokers as compensation for the goods, services, or facilities
that they render. In technical parlance, a ``yield spread premium'' is
thus defined as a payment that a lender makes to a mortgage broker that
reflects the increased yield over ``par'' on a particular loan. In
practical terms, a yield spread premium is a mechanism that provides
borrowers with a vital tool to allow for the financing of some or all
of their home loan closing costs.
The yield spread premium mechanism allows mortgage brokers the
flexibility to offer consumers numerous options and choices as to the
combination of upfront payments and interest rates that best suits the
borrower's individual needs. In short, as the interest rate goes up,
the borrower's upfront cash contribution goes down. The added financial
flexibility afforded by the yield spread premium is extremely important
because a vast number of borrowers--especially those who have limited
funds for downpayments, or who have reached borrowing limits--need the
flexibility to finance the required closing costs to achieve
homeownership. Those consumers who lack sufficient independent funds
literally depend on the YSP option to purchase and/or refinance a home.
I want to clarify, unequivocally, that the yield spread premium
mechanism should be restricted to the function I just described, which
is to compensate the broker for goods, services, or facilities provided
or to allow for the financing of other closing-related costs. If, on
the other hand, the yield spread payment does not fit this definition,
and the payment is used for purposes other than to compensate brokers
for the bona fide goods, services, or facilities they provide, or to
finance other required closing costs, then the payment may be
considered suspect, and should be dealt with appropriately. I want to
make clear that we do not consider it appropriate to use the yield
spread premium mechanism as a means to inflate interest rates in a way
that defrauds the consumer into higher loan prices. Nor do we consider
it appropriate to use the yield spread premium as a means of concealing
referral payments to brokers. To the extent that such abuses do occur,
they should be labeled for what they are--violations of the law.
HUD's Policy Statements
We are in agreement with HUD's formulation of the test for
determining the
legality of lender payments to mortgage brokers under RESPA. As you
know, the rules for determining the legality of payments to mortgage
brokers under RESPA's antireferral fee prohibitions are set forth in a
1999 HUD policy statement,\2\ and recently clarified through an
additional statement published on October 18, 2001.\3\ In those policy
statements, HUD has explicitly acknowledged that yield spread premiums
are very useful tools to assist consumers in financing homeownership.
The policy statement clarifies that yield spread premiums, so long as
they compensate the broker for goods, services, or facilities provided
in the origination of a mortgage loan, are not in themselves illegal
under RESPA. Under HUD's jurisdiction over RESPA's referral fee
prohibitions, the policy statement and the subsequent clarification
state unequivocally that yield spread premium payments are to be
considered illegal if they constitute referral payments or if they
incorporate referral fees in the payment. We agree.
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\2\ Real Estate Settlement Procedures Act Statement of Policy 1999-
1 Regarding Lender Payments to Mortgage Brokers; Final Rule, 64 Fed.
Reg. 10080-10087 (March 1, 1999).
\3\ Real Estate Settlement Procedures Act Statement of Policy 2001-
1: Clarification of Statement of Policy 1999-1 Regarding Lender
Payments to Mortgage Brokers, and Guidance Concerning Unearned Fees
Under Section 8(b), 66 Fed. Reg. 53052-53059 (October 18, 2001).
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HUD's formulation under Section 8 of RESPA correctly recognizes
that the legal test for analyzing yield spread premiums (or other
lender payments to mortgage brokers) must distinguish between those
payments that are legitimate compensation to brokers, and those that
are merely referral fees. In setting forth its formulation, HUD tracks
the RESPA statute quite closely. As mentioned above, RESPA sets a
strict prohibition against kickbacks and referral fees. The statute
also states that payments for real goods or services are not
prohibited. It is a simple and straightforward test. If you pay a
referral fee, you are breaking the law. If, however, the fee is
tendered as compensation for real goods, services, or facilities, then
the payment cannot, by definition, constitute a referral fee or a
kickback, and is therefore not prohibited under RESPA strictures.
This is precisely what HUD sets forth in the policy statement
formulation. When a lender pays a fee to a mortgage broker, first, one
has to lay the foundation and ensure that services, goods, or
facilities were actually furnished by the mortgage broker. If services,
goods, or facilities were actually furnished, then one has to make sure
that the payment to the broker does not incorporate a referral fee
portion that could be deemed illegal under RESPA. According to HUD,
this is done by scrutinizing the total of broker payments to ensure
that they are ``reasonably related'' to the value of the services,
goods, or facilities furnished. Any amount over the ``reasonable''
level could be deemed to constitute a ``referral fee.'' The
``reasonableness'' test is the test that HUD has consistently used to
judge Section 8 liability in all circumstances since RESPA was enacted.
Note that this ``two-prong test'' strikes the best possible balance
between RESPA's affirmation for fees paid as compensation for goods or
services actually provided, and the statute's proscription of referral
fees. Note also the internal logic of the HUD two-prong test--the first
prong focuses on what the broker provides in the transaction, and the
second prong analyzes the fees that were paid for those services. Each
step is grounded on statutory language and each step is necessary to
the legal analysis under Section 8 of RESPA.
HUD Clarifications
In large part, the controversy prompting today's hearing appears to
be the recent clarification to the 1999 policy statement issued by the
Department on October 18, 2001. In that clarificatory statement, the
Department declared that it should eliminate certain ambiguities with
respect to yield spread premiums.
The specific ``ambiguity'' that HUD should remedy stemmed from an
appellate decision entitled Culpepper v. Irwin Mortgage Corp., 253 F.3d
1324 (11th Cir. 2001) (Culpepper III). In that decision, the Eleventh
Circuit Court of Appeals reached a decision that was in direct conflict
with the ``two-prong'' formulation established by HUD under the 1999
policy statement. In that decision, the 11th Circuit described HUD's
1999 policy statement as ``ambiguous'' and created a new test that
resulted in per se liability for the payment of yield spread
premiums.\4\
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\4\ According to HUD, the Culpepper III decision results in per se
liability through its conclusion that a jury could find that yield
spread premiums are illegal kickbacks or referral fees where the
lender's payments are based exclusively on the interest rate
differentials reflected on the rate sheets and the lender has no
knowledge of what services, if any, the broker performs.
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In issuing the clarification, HUD was abiding by previous
Congressional directives to articulate clear legal standards. In
1998,\5\ Congress expressed concern about the ``legal uncertainty''
surrounding the test for liability in these cases, particularly in
light of the fact that ``Congress never intended payments by lenders to
mortgage brokers for goods or facilities actually furnished or for
services actually performed to be violations of [Section 8 of RESPA].''
\6\ Congress then specifically ``direct[ed]'' HUD to issue a ``policy
statement'' in order ``to clarify its position'' and provide ``guidance
to . . . the courts.'' \7\
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\5\ See Reform of the Real Estate Settlement Procedures Act (RESPA)
and the Truth in Lending Act (TILA): Hearing Before the House Committee
on Banking and Financial Services, 105th Congress at 22-28, 50, 275
(July 22 and September 16, 1998).
\6\ Conf. Rep. No. 105-769, reprinted in 1998 U.S.C.C.A.N. at 539,
568.
\7\ Id.
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The 1999 policy statement thus represented HUD's Congressionally
mandated effort to promote uniformity on the legality of yield spread
premiums under Federal law. After the issuance of the 1999 policy
statement, lenders and mortgage brokers, especially those who had faced
years of costly litigation in these cases, justifiably relied on HUD's
legal formulations as having finally eliminated litigable issues
relating to the governing standard for liability. Indeed, district
courts overwhelmingly agreed, and interpreted the 1999 policy statement
to articulate the ``two-prong test'' that I described above.
The Eleventh Circuit's Culpepper III decision, however, shattered
this legal clarity and returned the lending industry to the confusing
legal environment that existed before 1999. By finding the 1999 policy
statement ``ambiguous,'' and articulating a legal test resulting in per
se liability that was entirely separate from the one advanced by HUD,
Culpepper III plunged lenders, brokers, consumers, and courts into the
same chaotic state that led Congress to direct HUD to act in the first
place. A new wave of over 40 yield spread premium RESPA nationwide
class actions were filed in the immediate aftermath of Culpepper III.
Over 80 class actions were still pending in district courts around the
country, with a particularly heavy concentration in the Eleventh
Circuit. The risk of inconsistent determinations based on the solitary
Federal statute at issue in these cases was very real. In the meantime,
several district courts outside the Eleventh Circuit were refusing to
follow Culpepper III's RESPA liability analysis, and instead continued
to accord deference to HUD's policy statements.\8\
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\8\ See Bjustrom v. Trust One Mortgage Corp., No. C-001166P, 2001
U.S. Dist. LEXIS 17890 (W.D. Wash. October 26, 2001); Vargas v.
Universal Mortgage Corp., No. 01 C 0087, 2001 U.S. Dist. LEXIS 19635
(N.D. Ill. November 29, 2001).
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I note that inconsistencies in the governing legal standard are
extremely problematic for lenders. Most wholesale lenders make loans in
a variety of geographic regions, and a large number of lenders have
truly nationwide operations. There were many lenders who had already
successfully defended prior RESPA challenges to their payment of yield
spread premium, typically at costs ranging in the hundreds of thousands
of dollars. Many of these same mortgage bankers began facing renewed
litigation in the Eleventh Circuit where they were exposed to very
different standards under the unique rules established by Culpepper
III. This renewed legal con-
fusion forced many national lenders to give serious consideration to
halting or geographically limiting the practice of offering yield
spread premiums, despite its admitted consumer benefits.
It is in the midst of this environment of legal turmoil that the
Department decided to clarify RESPA through the 2001-1 policy
statement. To reestablish clarity, HUD declared that it expressly
``disagree[d] with the judicial interpretation regarding Section 8 of
RESPA and the 1999 Statement of Policy'' found in Culpepper III. 66
Fed. Reg. 53054-55. In the clarification, HUD sets forth its definitive
reading of the law that neither Section 8(a) of RESPA nor the 1999
Statement of Policy supports the conclusion that a yield spread premium
can be presumed to be a referral fee based upon the use of a rate
sheet, or because the lender does not have specific knowledge of what
services the broker has performed.
We believe that HUD acted properly and very responsibly as the
regulatory
agency that holds jurisdiction and bears the ultimate duty for the
proper administration of RESPA. Absent HUD's clarification, the
confused legal landscape would have been intolerable in terms of risk
and legal exposure. Not only was the Eleventh Circuit's decision
irreconcilable with HUD's reading of the law, but it threatened
catastrophic industry liability, and also threatened to eliminate from
the marketplace yield spread premiums and the critically important role
they play in promoting homeownership.
Class Action
An additional criticism has been that the legal articulation in the
2001 policy statement cuts off the possibility of consumer redress
under RESPA. The clarifications set forth in the 2001-1 Statement of
Policy do not eliminate a single consumer's legal rights. In the 2001
policy statement, HUD asserts that, in order to determine whether yield
spread premiums violate Section 8 restrictions, it is necessary to look
at each transaction individually. Far from immunizing the industry,
however, this ruling stems from HUD's longstanding recognition that the
origination of mortgage loans, the specific services provided by
mortgage brokers, and the difficulty of providing those services, all
differ with each loan, each applicant, and each marketplace or
geographical location.
In short, HUD's assertion that RESPA demands individualized loan-
by-loan analysis of the level of services performed in relation to the
fees paid does not reflect an attempt to relieve industry from
liability. It reflects the reality, as recognized by every
Administration since RESPA was enacted, that each transaction is
different and contains unique features that requires varying levels of
time, effort, and expertise.\9\ Just as the consumer disclosures
mandated by RESPA demand individualized disclosures reflecting the
specific costs that relate to the specific loan transaction at hand,
the analysis of legality under Section 8 of RESPA also demands a
tailored examination of the goods and facilities provided or services
performed by the broker in the transaction.
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\9\ For instance, HUD's official position on the test for liability
of yield spread premiums before the issuance of the 1999-1 Statement of
Policy confirms that this principle is longstanding policy at HUD.
Specifically, HUD's General Counsel from the Clinton Administration,
Gail Laster, gave testimony at a Joint Hearing on RESPA Reform,
convened on July 22, and September 16, 1998, before the House
Subcommittee on Financial Institutions and Consumer Credit and the
Subcommittee on Housing and Community Opportunity. In relevant part,
Ms. Laster testified as follows:
Ms. Velazquez. Thank you very much, Madam Chairwoman. . . . Could
you answer one simple question for me? Are yield spread premiums legal
or illegal?
Ms. Laster. It depends on whether or not the fee is reasonably
related to the goods or services provided. That is not a legalism, but
I think in terms of understanding the RESPA statute, it is not a
ratemaking statute. We cannot promulgate a rate that says this is
legal. By statute, Congress has prescribed that we examine on a case-
by-case basis whether or not a fee is reasonably related to the
services provided. (emphasis added).
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Additional Consumer Protections
As I mentioned above, we all recognize that there are instances
where yield spread premiums are used in ways that could be harmful to
consumers. We hear reports of consumers who pay egregious interest
rates due in whole or in part to wildly inflated yield spread premium
fees, or mortgage brokers that conceal yield spread payments in a way
that leads to the consumer's detriment.
In this regard, we commend the Chairman in his leadership in
holding these hearings, as such problems do require our full attention.
We also commend the Department for its initiative to ensure that
consumers receive full and meaningful disclosures in the mortgage
process. In the 2001 policy statement, HUD has articulated the need to
strengthen the information provided to consumers by brokers by adding
such disclosures as the types of services that the broker will perform,
the amount of the brokers total compensation for performing those
services (including yield spread premiums), and whether or not the
broker has an agency or fiduciary relationship with the borrower.
Additionally, the 2001 policy statement clarifies that borrowers should
be made aware of the trade-off between upfront costs and rates, and
that such information should be provided to the applicant early in the
loan transaction.
The Secretary has announced that he will push forth with rulemaking
in this area. MBA agrees with the Secretary's initiatives and will
strive to work with HUD to achieve the best possible regulatory outcome
to rid the market of abusive lending practices. We think it is
important to point out, that current Federal rules and regulations
already provide for a great deal of consumer disclosures. We note, for
example, that yield spread premium payments are today included as part
of the finance charge calculations, and thus, are fully disclosed to
consumers through the APR
disclosure under the Truth in Lending Act. We note also that these
yield spread premium payments must be specifically broken out and
separately itemized and disclosed on the Good Faith Estimate and HUD-1
forms under RESPA. That statute also requires that lenders and/or
mortgage brokers deliver to consumers a Special Information Booklet
that sets forth an explanation of mortgage broker compensation, points,
fees, and their interrelationship.
As an industry, we welcome additional disclosure requirements if
they truly serve to protect consumers from unscrupulous practices. We
note, for instance, that MBA took a leadership role in creating model,
voluntary and supplemental disclosures for its members to use. These
disclosures provide further explanations of the choices borrowers have
to compensate their mortgage brokers--through direct payments, yield
spread premiums financed through higher interest rates, or some
combination of the two. This additional disclosure was commended and
encouraged by HUD,\10\ and is now an accepted and routine part of the
disclosure process for our membership.
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\10\ 66 Fed. Reg. at 10087.
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MBA believes, however, that ultimately, we can do much better. We
can, and should, construct systems of consumer protection that go
beyond mere disclosures. In the end, consumers run the risk of being
tricked and deceived as long as consumers are subjected to the arcane
and outdated disclosure system that is now mandated by Federal law. As
with predatory lending, we believe that it is absolutely essential to
enact comprehensive reform of the current mortgage lending laws. So
long as the mortgage process remains confusing and perplexing,
consumers will run the risk of being gouged and defrauded, whether
through trickery involving yield spread premiums, or through other
schemes that unscrupulous actors will continue to develop to exploit
the unwary and unsophisticated. We look forward to working with HUD and
the Congress to enact the necessary legislative and regulatory changes
necessary to achieve the goals of lasting protections for all
consumers.
Conclusion
To summarize, Mr. Chairman, we reiterate that as we develop more
protections and disclosures in this area, we must keep in mind that
yield spread premiums are extremely valuable consumer financing
mechanisms, and that they are a crucial element in today's housing and
mortgage markets. As lenders, Government, and consumer advocates, we
all share in the responsibility of ensuring that this important
financing tool is not abused by unscrupulous actors or damaged by
frivolous class action claims. Going forward, we fully support HUD's
calls for improved consumer disclosures and we look forward to working
with the Department as we advance on this very important endeavor.
Thank you for the opportunity to share our views with the
Committee.
----------
PREPARED STATEMENT OF JOSEPH L. FALK
President, National Assocation of Mortgage Brokers
January 8, 2002
Mr. Chairman and Members of the Committee, I am President of the
National Association of Mortgage Brokers (NAMB), the Nation's largest
organization exclusively representing the interests of the mortgage
brokerage industry. We appreciate the opportunity to address the
Committee today on behalf of the Nation's mortgage brokers on the
subject of yield spread premiums.
NAMB currently has more than 13,000 members and 41 affiliated State
associations nationwide. NAMB provides education, certification,
industry representation, and publications for the mortgage broker
industry. NAMB members subscribe to a strict code of ethics and a set
of best business practices that promote integrity, confidentiality, and
above all, the highest levels of professional service to the consumer.
The Committee has asked for NAMB's views on the recent Statement of
Policy 2001-1 issued by the Department of Housing and Urban Development
concerning yield spread premiums, and our views concerning what HUD
should do going forward to prevent the ``abusive use'' of yield spread
premiums. Before discussing these two issues in detail, we would first
like to review the important role mortgage brokers play in our mortgage
market and our Nation's economy, and why yield spread premiums are so
important to the effective functioning of the market. We will then
discuss why NAMB believes the Statement of Policy issued by HUD was
both necessary and correct, and offer NAMB's views regarding HUD's
actions going forward.
The Importance of Mortgage Brokers in Today's Economy
Today, our Nation enjoys an all-time record rate of homeownership.
While many factors have contributed to this record of success, one of
the principal factors has been the rise of wholesale lending through
mortgage brokers. Mortgage brokers have brought consumers more choices
and diversity in loan programs and products than they can obtain from a
branch office of even the largest national retail lender. Brokers also
offer consumers superior expertise and assistance in getting through
the tedious and complicated loan process, often finding loans for
borrowers that may have been turned down by other lenders. Meanwhile,
mortgage brokers offer lenders a far less expensive alternative for
nationwide product distribution without huge investments in ``brick and
mortar.''
In light of these realities, it is no surprise that consumers have
increasingly turned to mortgage brokers. Today, mortgage brokers
originate approximately 65 percent of all residential mortgages in
America. In Florida alone, there are over 23,000 licensed mortgage
brokers. The rise of the mortgage broker has also significantly
increased competition in the mortgage industry, resulting in a decline
in mortgage interest rates and closing costs and an explosion in the
number of mortgage products available to consumers. These positive
developments are not mere
coincidences. They would not have been possible without the advent of
wholesale lending through mortgage brokers.
Mortgage brokers play an extremely important role in our economy.
Following the collapse of the savings and loan industry in the 1980's,
and then the rapid consolidation of mortgage banking firms in the
1990's, we now find that in many communities, particularly in central
cities and small towns, people may have a difficult time finding a
retail bank branch or retail mortgage lending branch. If they do find a
retail lender, their mortgage choices are limited to the products and
services offered by that lender, which often are very few. But almost
any consumer can find a mortgage broker right in their community that
can provide access to many loan programs, assist in clearing up credit
problems, help clear title defects, and provide other assistance to
help the consumer obtain a loan that suits his or her financial needs
and objectives.
Mortgage brokers are generally small business owners. The average
mortgage broker employs fewer than 10 people. Mortgage brokers know
their neighbors, build their businesses primarily through referrals
from satisfied customers, and succeed by becoming active members of
their communities. The fact that small mortgage brokerages originate
over half of all mortgages, indicates that mortgage brokers are
effectively meeting consumers' desires for convenience, service, and
competitive prices.
Since the middle of 2000, the Nation's economy has been
experiencing a slowdown, with increasing unemployment and business
failures, declining consumer spending, and other negative economic
indicators. The one bright spot in this cloudy picture has been the
housing and mortgage finance sector. Mortgage originations increased in
2000 from 1999, and again in 2001. Many mortgage lenders and mortgage
brokers experienced record volumes of business in 2001. Mortgage
lending has been a vital counterweight as the rest of the economy
entered a recession.
Even in today's weakened and uncertain economy, home sales and new
home construction continue to increase. This creates and sustains
hundreds of thousands of jobs in real estate, construction, and
ancillary industries. Mortgage refinances have benefited many
homeowners, allowing them to reduce their monthly payments, convert to
shorter term loans to save thousands of dollars in total interest, or
access their home equity to improve their financial situation. Today,
total home equity held by American households once again exceeds the
total value of other investments. When properly used, access to home
equity has become a lifeline for many seniors whose retirement funds
have been dramatically reduced by the decline in the stock market, and
for families who face layoffs or uncertain employment prospects in the
next several months.
Mortgage brokers provide the flexibility and capacity for the
market to absorb a huge volume of new originations, as has occurred in
the last few months. This capacity allows consumers to immediately take
advantage of interest rate declines and to access their home equity if
needed. If mortgage brokers did not exist, lenders with brick-and-
mortar offices would not have been able to handle the surge of purchase
and refinance business that has been so helpful to consumers and to our
economy in the last year.
It is thus vitally important to America's homeowners and to the
economy as a whole that we avoid any new regulations, legislation, or
legal decisions that could impede the efficient and effective
functioning of the wholesale mortgage market.
Yield Spread Premiums and Their Importance
One of the barriers to homeownership is insufficient cash for a
downpayment or to pay closing costs. Mortgage brokers have originated
hundreds of thousands of loans for people who were able to buy a home,
refinance an existing mortgage at a lower interest rate, or obtain a
home equity loan with little or no cash required for upfront closing
costs or broker fees. These costs are financed through a slightly
higher interest rate than the borrower would pay if he or she paid the
closing costs in cash. Most retail lenders (for example commercial
banks, thrifts, credit unions, and retail mortgage companies) also
offer ``no- or low-cost'' loans at slightly higher rates.
The ability of consumers to obtain loans with little or no upfront
costs is critical in today's economy. In uncertain times such as these,
people want to conserve and to build up their cash reserves and reduce
monthly payments. Interest rates have
fallen in the last year to the extent that homeowners can still often
reduce the rate on their existing mortgage through a refinance and save
thousands of dollars in interest payments, lower the payments, and
conserve cash, by paying some or all closing costs through a higher
interest rate. When a mortgage broker arranges such a loan, the broker
receives most or all of its compensation indirectly from the lender--a
yield spread premium.
Such indirect compensation paid by lenders to mortgage brokers is
legal under the applicable Federal law, the Real Estate Settlement
Procedures Act or RESPA, so long as the total compensation to the
broker is reasonably related to services actually performed, goods
actually provided, or facilities actually furnished. In all loans
originated by mortgage brokers, the broker is providing a facility to
the wholesale lender, in effect serving as the lender's branch office.
The broker also does most, if not all of the work in assembling the
loan package, which is creating a good, and which can often require a
great deal of time and expense. Brokers typically take the application,
order the appraisal and credit report, verify the borrower's income and
employment, and perform many other aspects of loan origination that
benefit the lender and enable it to underwrite and approve the loan.
Mortgage brokers also perform services directly for borrowers that
are legally compensable. These may include advising the borrower about
various loan programs and options to assist the borrower in selecting a
loan program that meets his or her financial situation and objectives;
helping the borrower improve his or her credit rating in order to
qualify for a lower interest rate or better loan terms, and other
assistance. Many brokers work late into the evenings and on weekends
taking applications, gathering documents, and meeting borrowers at
their homes and offices. Such personal and convenient service is one
reason mortgage brokers are preferred by many consumers.
Mortgage brokers clearly provide legally compensable services,
goods, and facilities to both wholesale lenders and to borrowers. These
services, goods, and facilities all ultimately benefit the borrower, by
enabling the borrower to qualify for and receive the loan the borrower
wants. Retail lenders perform similar origination functions and earn
similar fees when they sell mortgages into the secondary market, as
they do with the vast majority of loans they originate. However, retail
lenders do not disclose to borrowers their income on loans that are
subsequently sold in the secondary market. Mortgage brokers do.
We want to emphasize this. There is nothing fundamentally different
about the way retail lenders and mortgage brokers earn income. The only
difference is that consumers know how much the originator is being paid
only when the originator is a mortgage broker. This is because HUD
requires the disclosure and itemization of all such ``indirect
compensation'' by lenders to mortgage brokers, on both the Good Faith
Estimate and the HUD-1 settlement statement. Loan sales by retail
lenders are considered secondary market transactions, which are not
subject to RESPA.
Mortgage interest rates are highly competitive. Consumers today are
more sophisticated than ever in researching and shopping rates. A
mortgage broker determines the fee on a particular loan based on a
number of factors, including the work required to arrange the loan,
such as assisting the borrower in improving his or her credit rating.
Fees may also be determined based on the loan program, market
competition, and many other factors. The flexibility of indirect
compensation allows mortgage brokers to stay competitive with, and
often beat, retail lenders on price while still earning a reasonable
profit.
It is also important to note that in most cases involving payments
of yield spread premiums, the mortgage broker receives nothing until
the loan closes. Mortgage brokers often do a great deal of work to
arrange loans that never get to closing, for a variety of reasons. They
receive no compensation for this work.
HUD Statements of Policy 1999-1 and 2001-1
Despite the clear advantages of mortgages involving yield spread
premiums, the clear legality of such payments, and the clear choices
being made every day by consumers to obtain their mortgages through
mortgage brokers, the wholesale mortgage market is under assault in the
courts. Trial lawyers across America have continued to file and pursue
class action lawsuits claiming that all yield spread premiums are
illegal under Section 8 of RESPA. Over 150 such class action lawsuits
are active in courts across the country against virtually every major
wholesale mortgage lender. Some of these suits were first filed in
1996.
Many courts have dismissed such suits, rightfully in our view.
Others have been withdrawn after courts refused class certification.
However, some courts have allowed these suits to continue, and trial
lawyers continue to venue-shop and file new suits, in search of one
court that will agree with their inaccurate portrayal of the wholesale
mortgage market. This flood of litigation, and differing opinions of
various courts, has caused a great deal of uncertainty and anxiety in
the mortgage industry. The cost of defending these class actions is
staggering, already running into millions of dollars each for the
largest lenders involved. These costs are, of course, passed on to
consumers. The potential liability for the industry is tens of billions
of dollars. Lenders could be forced to cease all wholesale lending if a
judgment goes against even one lender, or if a major settlement occurs.
The only real winners here are the class action attorneys who stand
to win millions of dollars in contingency fees. Their clients stand to
receive only small refunds, or a few dollars off the cost of their next
loan. The real impact will be the exit from wholesale lending of most,
if not all, major mortgage lenders. The potential liability for them
will simply be too great to justify staying in the business. The real
losers will then be tomorrow's first-time homebuyers, tomorrow's
working families, and
tomorrow's entrepreneurs who will not be able to get a mortgage without
paying hundreds of dollars upfront--which, for low-income people
without cash, will mean no mortgages at all.
Many small businessmen and women may not be able to stay in
business as mortgage brokers without being able to offer consumers low-
or no-cost loans. As competition decreases, all potential mortgage
borrowers will experience higher costs and fewer choices--and in some
cases, no choices at all. The ripple effect on the overall economy, as
mortgage borrowing declines and employment in the housing and mortgage
finance sector falls, could be substantial.
In 1998, Congress made its views clear on this issue. In the
Conference Report accompanying the VA-HUD and Independent Agencies
Appropriations Act of 1999 [H.R. Conf. Rep. No. 105-769, 105th
Congress, 2d sess. 260] Congress explicitly stated that it was
``concerned about the legal uncertainty [regarding indirect
compensation] that continues absent such a policy statement.'' Congress
further stated that it ``never intended payments by lenders to mortgage
brokers for goods or facilities actually furnished or for services
actually performed to be violations of Sections 8(a) or (b) of the Real
Estate Settlement Procedures Act (12 U.S.C. 2601 et. seq.) Congress
directed the Department of Housing and Urban Development (HUD) to issue
a statement of policy clarifying the legality of mortgage broker
compensation paid by lenders. Congress further directed HUD to consult
with all interested parties in developing this policy statement.
HUD followed the directive of Congress with the release of
Statement of Policy 1999-1 [FR Vol. 64, No. 39, pp. 10080-10087] on
March 1, 1999. The policy statement says that:
In determining whether a payment from a lender to a mortgage
broker is permissible under Section 8 of RESPA, the first
question is whether goods or facilities were actually furnished
or services were actually performed for the compensation paid.
The fact that goods or facilities have been actually furnished
or that services have been actually performed by the mortgage
broker does not by itself make the payment legal. The second
question is whether the payments are reasonably related to the
value of the goods or facilities that were actually furnished
or services that were actually performed.
NAMB participated in the development of this Statement of Policy,
along with many other industry groups, as well as major consumer
advocacy organizations. HUD, to its credit, insisted that a consensus
of all the participating groups be reached. All who participated agreed
that Statement of Policy 1999-1 correctly interpreted RESPA as it
relates to mortgage broker compensation. The policy statement enjoyed
bipartisan approval from the Clinton Administration and Congress.
When Statement of Policy 1999-1 was released, most of us in the
mortgage industry believed the litigation crisis had been resolved.
Using the ``two-part test'' set forth in the statement meant that the
legality of any mortgage broker compensation would have to be judged on
a case-by-case basis, not as a class action. It is important to note
here that this test allows individual cases of abuse to be addressed
and remedied in court, while limiting inappropriate class actions.
Following the publication of the statement, the number of new class
action lawsuits dwindled. Several existing lawsuits were dismissed, and
class certification was denied, by courts that agreed with HUD's
interpretation of RESPA and agreed that broker compensation must be
judged on a case-by-case basis. However, other lawsuits continued to
proceed with the hope by the trial lawyers that a court might interpret
Statement of Policy 1999-1 in such a way that a class action could
still go forward.
Unfortunately, this occurred in June 2001, when the Eleventh
Circuit Court of Appeals affirmed certification of a class by the U.S.
District Court of Alabama in Culpepper v. Irwin Mortgage Corp. The
Eleventh Circuit found an ambiguity in Statement of Policy 1999-1, and
failed to complete its analysis of yield spread premiums by only
applying the first test. The Court also implied that a lower court
could, in fact, find that all yield spread premiums are illegal,
thereby justifying certification of the class. Not surprisingly, NAMB
believes this was a misinterpretation of both RESPA and Statement of
Policy 1999-1. It left the industry once again facing billions of
dollars in liability. It also left HUD in contravention of the 1998
Congressional directive to provide definitive guidance to the industry
and clarify any legal ambiguities surrounding mortgage broker
compensation. Dozens of new lawsuits have been filed since the Eleventh
Circuit decision. Clearly this is not because of a sudden rampant wave
of abuse in the mortgage market, but because class action attorneys see
an opportunity for multimillion dollar fees.
HUD immediately recognized the potential disaster created by this
decision, and recognized its responsibility to remove the ambiguity
found by the Eleventh Circuit by clarifying its existing policy. In the
process of developing its response, HUD once again met with a wide
range of interested parties, including NAMB, and including consumer
advocacy groups. On October 15, 2001, HUD issued Statement of Policy
2001-1 [Fed. Reg. 66, No. 202, pp. 53052-53059]. HUD states in the
preamble to this policy statement that:
This Statement of Policy is being issued to eliminate any
ambiguity concerning the Department's position with respect to
those lender payments to mortgage brokers charactenized as
yield spread premiums. . . . In issuing this Statement of
Policy, the Department clarifies its interpretation of Section
8 of the Real Estate Settlement Procedures Act (RESPA) in
Statement of Policy 1999-1 Regarding Lender Payments to
Mortgage Brokers (the 1999 Statement of Policy). . . . Today's
Statement of Policy reiterates the Department's position that
yield spread premiums are not per se legal or illegal, and
clarifies the test for the legality of such payments set forth
in HUD's 1999 Statement of Policy. As stated there, HUD's
position that lender payments to mortgage brokers are not
illegal per se does not imply, however, that yield spread
premiums are legal in individual cases or classes of
transactions. The legality of yield spread premiums turns on
the application of HUD's test in the 1999 Statement of Policy
as clarified today.
HUD is to be congratulated for Statement of Policy 2001-1. The
statement is simply a clarification of existing policy and the existing
views of HUD concerning yield spread premiums. As the regulator of
RESPA, HUD has a responsibility to provide all parties affected by
RESPA with clear rules and guidance so that the law can be effectively
understood and implemented nationwide, and so that nationwide lenders
can comply with the law. Continued ambiguity, whether created by court
decisions, market changes, or other factors, creates unnecessary and
costly uncertainty for both business and consumers. The only parties
that benefit from ambiguity are trial lawyers.
Statement of Policy 2001-1 has also been accepted by the courts in
two important court rulings in class action lawsuits, Vargas v.
Universal Mortgage Corp. and Bjustrom v. Trust One Mortgage Corp. In
Bjustrom, U.S. District Judge Marsha J. Pechman of the Western District
Court of Washington granted summary judgment to the defendant, Trust
One Mortgage Corp. Judge Pechman applied the new policy statement to
find that yield spread premiums are not illegal per se even though
there may be no ``tie'' between the premium and particular services
performed by the broker. The Court found that the Statement of Policy
is a permissible interpretation of RESPA and therefore must be given
deference.
In Vargas, Judge James B. Zagel of the U.S. District Court,
Northern District of Illinois, denied certification of a class. Judge
Zagel agreed with HUD that the fact that yield spread premiums are
calculated based on a rate sheet does not make them per se illegal
referral fees. He also found that there are legitimate reasons why a
borrower would choose to pay a higher interest rate on a loan that
included a yield spread premium. Importantly, Judge Zagel also found
that HUD's two-part test to determine legality of a yield spread
premium is faithful to the RESPA statute, and that:
. . . the Act [RESPA] compels a case-by-case analysis of
individual plaintiffs' claims every bit as much as the HUD
Statement. HUD's ``reasonableness requirement'' was not made
out of whole cloth; it is implicit in Sec. 2607(c) which
authorizes compensation for ``services actually performed.''
We expect other courts to agree with these two decisions. Yield
spread premiums that are properly disclosed and meet the HUD test
should be considered legal and not abusive. Any yield spread premium
that does not meet this test may be illegal, and HUD's policy statement
clearly allows consumers who believe their loan has included an illegal
yield spread premium to seek legal remedy. With the legal uncertainty
removed, our industry can now move forward and HUD can move forward to
address the real problems in the mortgage market.
HUD's Actions Going Forward
The other issue on which the Committee has asked us to comment is
what HUD should do going forward to address ``abusive use'' of yield
spread premiums. We fully agree that illegal uses of yield spread
premiums should be prosecuted to the full extent of the law. Any
compensation that does not meet the HUD test is illegal, and those
paying or receiving illegal payments should be punished. The NAMB
believes such abuses are rare, and we believe that HUD is moving
forward appropriately in two ways.
First, HUD is moving to more aggressively enforce RESPA and punish
violators. It is devoting more resources, reorganizing, and refocusing
to dramatically improve its historically poor record in enforcing
RESPA. Our industry has long been frustrated with the lack of RESPA
enforcement by HUD. Even a little enforcement can go a long way in
serving notice to all settlement service providers that there will be a
high price for violating the law. This includes the payment or receipt
of illegal yield spread premiums or any other fees that are paid to any
industry participant in violation of RESPA. NAMB applauds HUD's new
enforcement effort and hopes Congress will support it with increased
funding and personnel allocations.
The other way HUD is moving to address abuses is with a new RESPA
regulation. In Statement of Policy 2001-1, HUD announced:
This Statement of Policy also reiterates the importance of
disclosure so that borrowers can choose the best loan for
themselves, and it describes disclosures HUD considers best
practices. The Secretary is also announcing that he intends to
make full use of his regulatory authority to establish clear
requirements for disclosure of mortgage broker fees and to
improve the settlement process for lenders, mortgage brokers,
and consumers.
Secretary Martinez, in remarks before this Committee on December
13, 2001, further stated his commitment to RESPA reform:
To ensure that homebuyers have the information they need in
order to make an informed purchase, I have undertaken
comprehensive reform of the Real Estate Settlement Procedures
Act (RESPA). In addition to preserving yield spread premiums as
a valuable tool for opening the doors of homeownership, reform
will: (1) ensure better protections for new homebuyers and
those who refinance; (2) offer clarity for the mortgage lending
industry about their disclosure responsibilities, and; (3)
provide an additional tool to fight predatory lending.
The need for RESPA reform is even more urgent during times of
economic uncertainty. Homeownership helps create financial
stability for families, and in return brings economic stability
to our communities.
NAMB fully agrees with Secretary Martinez and we support a new
rulemaking to improve the disclosures provided to consumers. Mortgage
brokers are confronted every day with the frustrations of our customers
about the many confusing, and largely useless, disclosures and
paperwork we thrust at them. Consumers who may be desperate for cash or
credit may not always fully investigate their loan options or closely
examine the many disclosures they receive.
Consumers are entitled to better, simpler disclosures provided
earlier in the process, so they can more effectively compare loans.
Consumers should have simple disclosures without a lot of fine print.
They should easily be able to question and change terms and fees with
which they do not agree, well before closing. These improvements could
reduce compliance burdens and costs for originators, and the savings
would be passed on to consumers. Consumers would be in a stronger
position with more information, thereby decreasing the incidence of
abusive lending practices of all kinds--including, but not limited to,
any illegal yield spread premiums.
NAMB has developed detailed proposals for this rulemaking, and we
have shared these with HUD and with this Committee. NAMB supports a
new, mandatory disclosure to be required of all originators at or
before application, that clearly defines what the originator will do in
the transaction, how its compensation will be earned, and the choices
available that could affect both the way the originator is compensated
and whether the consumer will have to pay any fees upfront at closing.
NAMB also supports establishing tolerances for the Good Faith Estimate
and requiring redisclosure if the tolerances are exceeded, in order to
prevent surprise additional costs to consumers at closing, including
inappropriate increases in yield spread premiums.
This new disclosure would build upon the successful Model Loan
Origination Agreement that NAMB and MBA jointly developed in 1998, and
which both associations encourage our members to use. We believe this
new agreement will help consumers better understand the process, while
not adding significantly to the complexity of that process.
Conclusion
Wholesale mortgage lending through mortgage brokers, and
particularly the wide availability of loans requiring the borrower to
pay little or no cash at closing, is a key element in sustaining
America's economy through this period of great uncertainty and
difficulty. Used properly, yield spread premiums are an important part
of this market, and it is therefore important to consumers that the use
of legal yield spread premiums continue, without the threat of class
action litigation that could seriously impede the efficient functioning
of the market and damage the economy. When yield spread premiums are
properly disclosed and properly used, they are not illegal.
NAMB believes that HUD has acted responsibly as the regulator under
RESPA: First, by issuing Statement of Policy 2001-1 to clarify existing
policy concerning yield spread premiums, provide certainty to the
mortgage industry, and reduce the threat of class action litigation;
second, by significantly increasing and improving its investigation and
enforcement of RESPA violations; and third, by developing new and
improved disclosures that will help consumers avoid illegal and abusive
fees. NAMB supports a new, mandatory disclosure to be provided at the
earliest possible time by all originators that fully informs consumers
about the loan origination
process. NAMB also supports improving the Good Faith Estimate by
establishing tolerances and requiring redisclosure.
Thank you again for this opportunity to share NAMB's views with the
Committee.
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PREPARED STATEMENT OF IRA RHEINGOLD
Executive Director, National Association of Consumer Advocates
January 8, 2002
Mr. Chairman and Members of the Committee, the National Association
of Consumer Advocates \1\ thanks you for inviting us to testify today
regarding HUD's recent policy ``clarification'' on yield spread
premiums. We offer our testimony here today on behalf of our members,
as well as the National Consumer Law Center.\2\
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\1\ The National Association of Consumer Advocates is a nonprofit
organization designed to promote justice for all consumers by
maintaining a forum for information sharing among consumer advocates
across the country. Our mission is to serve as a voice for consumers in
the ongoing struggle to curb unfair and abusive business practices,
especially in the areas of finance and credit.
\2\ The National Consumer Law Center, Inc. (NCLC) is a nonprofit
Massachusetts corporation founded in 1969 at Boston College School of
Law and dedicated to the interests of low-income consumers. NCLC
provides legal and technical consulting and assistance on consumer law
issues to legal services, Government and private attorneys across the
country. Cost of Credit (NCLC 1995), Truth in Lending (NCLC 1996) and
Unfair and Deceptive Acts and Practices (NCLC 1991), three of twelve
practice treatises published and annually supplemented by NCLC, and our
newsletter, NCLC Reports Consumer Credit & Usury Ed., describe the law
currently applicable to all types of consumer loan transactions.
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At the outset, let me make it perfectly clear that while we believe
that the use of yield spread premiums can be a source of benefit for
American consumers, this practice as it is currently being used by the
mortgage lending industry, is both abusive and deceptive. Furthermore,
instead of carrying out its mandate to promote homeownership by
encouraging a fair, open, and honest marketplace, HUD has attempted to
use its policymaking authority to legitimatize the otherwise illegal,
anticompetitive nature of yield spread premium abuse. This testimony
will discuss how yield spread premiums currently operate in the real
world, explore previous efforts to regulate this practice, explain how
HUD's purported clarification in the 2001 policy statement ignores the
law and perpetuates and encourages bad lending behavior and finally,
offer proposals to make the use of yield spread premiums provide
American homeowners with real benefit.
Yield Spread Premiums in the Current Marketplace
Section 8(a) of RESPA prohibits any person from giving or receiving
any fee, kickback or thing of value pursuant to any agreement incident
to a real estate settlement involving a Federally related mortgage.\3\
This rather simple provision was the product of much debate in Congress
and was created in 1972 because of the widespread recognition that
referral fees and kickbacks were making the marketplace anticompetitive
(homebuyers were not being directed to a service provider who would
provide them with the best deal, but instead to the provider who would
pay the largest sum of money to the referring agent).\4\ The rationale
for this legislation was simple. Eliminate market-distorting incentives
and homeowners would have real opportunity to obtain the most
beneficial and cost efficient loan products available. While Section
8(a) of RESPA seems rational, fair, and explicit, current participants
in the home lending marketplace have gone to great effort to obfuscate
the law and preserve their ability to receive and provide kickbacks at
the great expense of American homeowners. This is where the practice of
yield-spread premiums (YSP's) enters our story.
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\3\ Reg. X Sec. 3500.14(b).
\4\ For a detailed discussion of RESPA's legislative history see
the Report of Howell Jackson in Glover v. Standard Federal Bank, pp. 3-
19.
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In a nutshell, the YSP's are payments made by a lender to a
mortgage broker in return for a referral of an ``above-par'' loan. An
above-par loan is a loan with a YSP paid to the broker and a higher
interest rate than the loan the borrower qualified for. A par loan is a
loan with an interest rate that an individual homeowner would qualify
for if she/he paid no discount points and was charged no YSP. For a
``below-par'' loan, the homeowner would pay discount points in exchange
for the lower interest rate.
In theory YSP's could offer homeowners using a mortgage broker a
valuable choice. Borrowers could choose the amount of points they would
want to pay (or not pay) and thus choose an interest rate. For
instance, a homeowner who did not want to pay an upfront broker fee,
could choose an above-par interest rate and have the lender pay the
broker in the form of a YSP. While this could all be so very neat and
clean (and legal), this scenario does not remotely reflect what is
happening in today's consumer marketplace.
Consumers who do business with mortgage brokers generally have the
understanding that the brokers will provide them the loan at the lowest
rate that the broker finds for them. Consumers have generally
understood and agreed to a specific broker's fee to be paid directly by
them--either in cash or by borrowing more--to the mortgage broker to
compensate the broker for obtaining the loan. What consumers do not
understand, and have not agreed to, is the mortgage broker receiving an
additional fee from the lender.
As an attorney for the last 5 years running a foreclosure
prevention project in Chicago, I have had the opportunity to review
hundreds and hundreds of loan documents. I have probably interviewed
thousands of homeowners, given countless seminars and trained and spoke
with scores of attorneys representing consumers. In all that time, I
have seen countless loans that contained both yield spread premiums and
borrower paid broker fees, yet not once, have I spoken to a homeowner
who knew that a YSP had been paid on their loan, or that because of the
YSP, the interest rate they received was greater than they were
otherwise qualified. To some, this evidence is anecdotal, but both
industry commentary \5\ and objective study \6\ bear this observation
out. This reality begs two questions. First, if YSP's are not being
paid for the benefit of consumers, why are they being paid? Second, if
these are referral fees why aren't these payments illegal?
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\5\ Professor Jack Guttentag, Professor of Finance Emeritus at the
Wharton School (whose nationally syndicated ``Ask the Mortgage
Professor'' columns are featured on the Mortgage Bankers Association of
America's own website) recently conducted a study of mortgage broker
fees. That study, Bankers Association of America's own website)
recently conducted a study of mortgage broker fees. That report,
entitled ``Another View of Predatory Lending'' (published by the
Wharton Financial Institutions Center and available as a free download
from its website), found that there is no correlation between the fees
paid to a mortgage broker on a given loan and the amount of work
performed by the mortgage brokers on that loan. The Guttentag Study
concluded that the only two ``major determinants'' of mortgage broker
profit are ``loan size'' and ``the sophistication of the borrower
relative to the sales skills of the loan officer.
\6\ Report of Howell Jackson.
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The answer to the first question is very simple. YSP's are
generally paid by the lender to the broker solely in compensation for
the higher rate loan. In other words, because the broker brings to the
lender a loan at a higher rate than the consumer would otherwise
qualify, the broker is paid a fee, or kickback. These fees are solely
an extra fee that the broker is able to extract from the deal. In
practice, the borrower is not only paying an upfront broker fee, but is
also paying a higher interest rate as a result of this kickback. As
this practice clearly provides an incentive for brokers to obtain
above-par loans for consumers, the dynamics of the marketplace closely
resemble the marketplace that Congress attempted to control with its
passage of RESPA.
Prior Attempts To Curb Yield Spread Premium Abuse
Because this problem has existed for over a decade (and because the
lending industry has attempted various justifications for this
seemingly obvious illegal practice), there has been extensive
litigation. The industry had sought assistance from Congress in the
past. Finally, in 1998, Congress issued a directive to HUD to write a
Statement of Policy. Consumer representatives worked diligently with
the mortgage industry and HUD to develop the language.\7\ The Statement
of Policy that was issued by HUD in 1999 met with both consumer
advocate and industry approval. Consumer advocates approved of the
policy statement in large part because of the explicit direction
provided to the lending industry on how a lender can properly pay a
broker fee:
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\7\ ``The conferees expect HUD to work with representatives of
industry, Federal agencies, consumer groups, and other interested
parties on this policy statement.'' See the Conference Report on the
Departments of Veterans Affairs and Housing and Urban Development, and
Independent Agencies Appropriations Act, 1999, H.R. Conf. Rep. No.
1050769 at 260 (1998).
Mortgage brokers and lenders can improve their ability to
demonstrate the reasonableness of their fees if the broker
discloses the nature of the broker's services and the various
methods of compensation at the time the consumer first
discusses the possibility of a loan with the broker.
[T]he most effective approach to disclosure would allow a
prospective borrower to properly evaluate the nature of the
services and all costs for a broker transaction, and to agree
to such services and costs before applying for a loan. Under
such an approach, the broker would make the borrower aware of .
. . the total compensation to be paid to the mortgage broker,
including the amounts of each of the fees making up that
compensation. If indirect fees are paid, the consumer would be
made aware of the amount of these fees and their relationship
to direct fees and an increased interest rate. If the consumer
may reduce the interest rate through increased fees or points,
this option also would be explained. [Emphasis added.] \8\
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\8\ Real Estate Settlement Procedures Act Statement of Policy 1999-
1 Regarding Lender Payments to Mortgage Brokers. 64 FR 10080 (March 1,
1999) at 10087.
With this clear direction on how to avoid liability for paying
broker fees, consumer advocates reasonably believed that the mortgage
industry would immediately adopt these recommendations and employ them
in all future loans. This belief was wrong. Instead the industry
continued as before--lenders continued to pay broker fees without
evaluating either the services provided by the broker or whether the
payment of the lender fee reduced the fees otherwise owed by the
borrower. Because the benefit to the brokers and lenders was so great
(higher fees for brokers, higher interest rates for lenders), the
mortgage industry's strategy was to continue its illegal practice, pay
off the few individual actions brought against it and mount a massive
effort to fight class action cases challenging the payment of these
fees, which might actually cost the industry real money and cause the
industry to change its behavior.
Initially after the 1999 Statement of Policy this strategy appeared
to be working. Most Federal courts generally denied class
certification, requiring an intensely factual analysis to determine
legality,\9\ while a few Federal district courts did permit the class
actions to proceed. \10\ This scene changed significantly however, when
the Eleventh Circuit Court of Appeals issued a comprehensive analysis
of RESPA's requirements regarding referral fees, the 1999 Statement of
Policy, and upheld class certification, on June 15, 2001.\11\
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\9\ See for example Golan v. Ohio Savings Bank, 1999 U.S. Dist.
LEXIS 16452 (N.D. Ill. October 15, 1999); Brancheau v. Residential
Mortgage, 187 F.R.D. 591 (D. Minn. 1999); Levine North Am. Mortgage,
188 F.R.D. 320 (D. Minn. 1999); Smitz v. Aegis Mortgage Corporation, 48
F. Supp. 2d 877 (D. Minn. 1999).
\10\ Heimmermann v. First Union Mortgage, 188 F.R.D. 403 (N.D. Ala.
1999); Briggs v. Countrywide Funding Corporation, 188 F.R.D. 645 (M.D.
Ala. 1999).
\11\ Culpepper v. Irwin Mortgage Corporation, 253 F. 3d 1324 (11th
Cir. 2001).
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The crux of the analysis in the Culpepper case is that for HUD's
Statement of Policy to be consistent with RESPA, a two-part test is
necessary to determine the legality of the lender paid broker fees.
First, whether the lender paid fee was for goods, services, or
facilities provided. Second, whether the total fee paid was
reasonable.\12\ The court found class certification appropriate
because--
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\12\ A significant basis for this rationale is not only HUD's 1999
Statement of Policy, but also the language of RESPA's provision
distinguishing between legal fees and referral fees. Section 8(c) of
RESPA permits ``the payment of a fee . . . by a lender . . . for
services actually performed.'' 12 U.S.C. Sec. 2607(c)(1)(C). 253 F.3d
at 1328. (Emphasis added.)
The terms and conditions under which a lender pays the broker
a yield spread premium can determine whether the yield spread
premium is compensation for referring loans rather than a bona
fide fee for services. There is no suggestion from the evidence
or the argument here that Irwin negotiates yield spread
premiums loan-by-loan, rather than paying them according to
terms and conditions common to all the loans.\13\
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\13\ 253 F. 3d at 1329.
In essence, the Culpepper court was saying, if the lender paid a
broker a yield spread premium without looking at whether services were
provided, the lenders practice violated RESPA. Therefore, the first
step of the two-part test--whether the lender paid fee was for
services--could be answered without performing a factual analysis of
each individual loan. Therefore, the court concluded that there was no
reason that the case could not proceed as a class action. The court
noted that the formula by which a lender paid broker fee is paid ``does
not take into account the amount of work the broker actually performed
in originating the loan or how much the borrower paid in fees for the
broker services.'' \14\
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\14\ The factual basis for the court's conclusion was stated in
this way:
The ``yield spread premiums'' at issue in this case . . . are
payments from [the lender] to its mortgage brokers that the written
agreement between them contemplates, but does not define. Each business
day, Irwin distributes a rate sheet to its brokers, listing the terms
of the loans Irwin is offering that day. The loans' interest rates are
set with reference to a ``par rate.'' If the broker originates a loan
at a below-par rate, it gets no compensation from Irwin. On the other
hand, originating a loan at an above-par rate garners the broker a
yield spread premium, whose amount is determined by a formula that
includes the amount of the loan and the difference between the loan
rate and the par rate. The formula does not take into account the
amount of work the broker actually performed in originating the loan or
how much the borrower paid in fees for the broker's services. 253 F. 3d
at 1325.
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The mortgage industry responded to the Culpepper case by
immediately turning to HUD and seeking a ``clarification'' of the 1999
Statement of Policy removing all references to language, which would
support the Eleventh Circuit Court's analysis. The stated rationale was
simply to ``clarify'' the ``ambiguity'' in the policy statement.\15\
Despite the fact that the 1999 Statement of Policy was unambiguous
regarding how the industry could legally pay yield spread broker fees,
the industry coyly requested:
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\15\ See letter from Anne Canfield, Executive Director of the
Consumer Mortgage Coalition, to Secretary Mel Martinez, dated September
25, 2001. http://www.houselaw.net/alerts/092801a.pdf.
HUD must issue decisive and clear rules that benefit both
borrowers and lenders by creating a regulatory environment in
which consumers can make
informed choices and lenders can operate their businesses,
without the constant prospect of having industry practices that
benefit consumers challenged in litigation.\16\
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\16\ Id.
The industry portrayed a ``clear rule'' for the future as an
appropriate trade-off for the requested ``clarification of the 1999
Statement of Policy.'' \17\ This completely ignored the obvious--that
HUD had already provided a clear rule, just as the industry is now
requesting, in the 1999 Statement of Policy, which the industry had
simply ignored.
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\17\ See memorandum from Howard Glaser, Mortgage Bankers
Association, entitled ``What We Are Asking For.''
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HUD's Actions
In the weeks preceding the issuance of the 1999 Statement of
Policy, HUD officials met with consumer representatives on dozens of
occasions to work through many of the complex issues involved in this
problem. Many of these meetings were also attended by representatives
of the mortgage industry. In contrast, prior to the 2001 Statement, HUD
officials met with consumer representatives three times, despite
numerous requests and offers by these representatives to engage in a
more substantial dialogue.\18\
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\18\ On July 11, 2001 consumer representatives met with General
Counsel Richard Hauser and other HUD representatives. On September 11,
2001 consumer representatives met for a few minutes with Secretary
Martinez, FHA Commissioner Weicher, Mr. Hauser, and others. Given the
tragic occurrences of the day, this meeting was aborted and resumed on
September 19. On October 11, after numerous requests, consumer
representatives again met with Mr. Hauser, Commissioner Weicher, and
others.
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The consumer representatives tried to make clear to HUD officials
these essential points:
Providing the ``clarification'' of the 1999 Statement as
sought by the mortgage industry would have the effect of completely
eliminating class actions as a form of redress for illegal lender
paid broker fees.\19\
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\19\ This assumes that a court agrees that the 2001 HUD Statement
of Policy should be provided deference. There is substantial legal
question regarding the extent of reliance that a court may place on an
agency's interpretative statement which has not been subject to notice
and comment. The Supreme Court has distinguished between the deference
due regulations promulgated by formal notice-and-comment rulemaking or
formal adjudications and those made informally. See Christensen v.
Harris County, 529 U.S. 576, 120 S. Ct. 1655, 1662, 146 L. Ed. 2d 621
(1999).
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Without class actions as a means to litigate the legality of
these fees, the industry has no incentive to change their practices
or even to comply with a new regulation--because there are
insufficient legal resources in this Nation to represent consumers
in individual actions involving claims of only a few thousand
dollars.
The ``new'' disclosures offered by the industry--and proposed
by HUD--provide fewer actual protections for consumers than those
recommended by HUD in the 1999 policy statement. Unlike the 1999
recommendations which include the consumer's agreement to the
lender paid broker fee, the 2001 proposal only mentions
``disclosure.'' \20\
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\20\ Consumer representatives maintain that requiring the consumer
to agree to the payment of a lender paid broker fee is an essential
element in a regulatory structure that would truly protect consumers
from illegal yield spread premiums.
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Limiting illegal lender paid broker fees is an essential step
in redressing predatory mortgage lending.
The mortgage industry provided specific language to HUD to
``clarify'' the 1999 policy statement. HUD adopted every recommendation
made by the industry. The crux of HUD's ``clarification'' comes on page
11, with the statement:
HUD's position is that in order to discern whether a yield
spread premium was for goods, facilities, or services under the
first part of the HUD test, it is necessary to look at each
transaction individually . . .\21\
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\21\ Department of Housing and Urban Development, RESPA Statement
of Policy 2001-1: Clarification of Statement of Policy 1999-1 Regarding
Lender Payments to Mortgage Brokers, and Guidance Concerning Unearned
Fees Under Section 8(b) at 11.
Such a position, if deferred to by the courts, would almost
certainly preclude class action suits, thus removing the only effective
legal recourse to challenge and change this practice. In fact, the 2001
Statement of Policy collapses the two-part test articulated in the 1999
Statement into a single analysis; which represents a serious departure
from not only the 1999 Statement, but also the Congressional directive
in RESPA.\22\
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\22\ The new test ``requires that total compensation to the
mortgage broker be reasonably related to the total set of goods or
facilities actually furnished or services performed.'' Id. at 13.
Although HUD says there is still a two-part test, the two tests appear
identical.
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HUD's action is absolutely crippling to consumer rights, as it
removes any incentive the industry has to cooperate with any future
action that HUD might take to address the egregious practice of
upselling mortgage loans. In his press release,
Secretary Martinez claims to be pursuing a reform to require full
upfront disclosure of all total compensation to be paid to the broker.
However, even if HUD initiates a proposed rulemaking to do this (which
was not proposed in the October 15 Statement), and even if the
regulation goes beyond the meaningless recommendations in the 2001
Statement, it will be a regulation without any effective enforcement
mechanism.
Making Yield Spread Premiums Work for Consumers
Several years ago, Congress requested that the two Federal agencies
most familiar with the implementation of the laws involved in the
mortgage process--HUD and the Federal Reserve Board--evaluate the
complex issues of improving and streamlining the mortgage process,
while addressing predatory lending. In 1998, these two agencies issued
a comprehensive report.\23\ This Joint Report, in addition to proposing
comprehensive reform to address predatory lending, also proposed two
alternatives to address the fact that the current system does not
ensure a truly competitive marketplace for mortgage loans.
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\23\ Board of Governors of the Federal Reserve System, Department
of Housing and Urban Development,
Joint Report to the Congress Concerning Reform to the Truth in Lending
Act and the Real Estate Settlement Procedures Act, July 1998
(hereinafter ``Joint Report''). These two Government agencies listened
to the multitude of industry representatives, as well as consumer
representatives, and issued a complex and comprehensive report.
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One alternative would be a dramatic change in the system governing
the disclosures consumers receive both when they apply for the loan and
when they close the loan. The other alternative is to beef up the
current system and require information to be provided which is
meaningful.
Alternative One
In the Joint Report, HUD indicated its commitment to actually
improving the system of shopping for mortgages, rather than continue
the confusion. The primary mechanism for accomplishing a more open
system would be to require mortgage lenders (and brokers) to provide a
guaranteed interest rate and closing costs before collecting any
application fees from consumers.
As the charges for mortgage loans are often based on the borrower's
creditworthiness and the value of the collateral, some underwriting
would have to be performed by the creditors before the guaranteed rate
could be provided. To its credit, HUD agreed with consumer advocates
and proposed that ``consumers be provided guaranteed information about
closing costs, interest rate, and points early enough so that they can
shop and make informed choices.'' \24\
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\24\ Joint Report at XVII.
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On the other hand, the large mortgage lenders have been pushing
hard for a change in the law which would mandate a guaranteed closing
costs ``package,'' without a guarantee for rates and points. In this
way, the lenders could market their loans based on the closing cost
package. Consumer advocates have opposed the closing cost package by
itself because it would be like marketing tires to car buyers before
they purchase the car: A borrower would likely apply for a loan based
on the guaranteed closing cost package, without receiving any guarantee
of the interest rate or points. Encouraging borrowers to apply for
loans based only the closing cost package would end up costing
borrowers in at least two ways: (1) if the actual closing costs
incurred by the lender for the loan exceeds the anticipated amount,
there would be nothing to prevent the lender from increasing the
interest rate or the points charged on the loan to make up for the
difference; (2) in fact, there is nothing to prevent the lender from
increasing the price of the loan to borrowers who have already paid so
much money to apply for the loan, that they cannot afford to go
elsewhere for their home loan.
Alternative Two
HUD also proposed a change in the rules governing early
disclosures. These early disclosures need to be transformed into
commitments to deal with the issue of deceptive yield spread premiums.
The mortgage industry has consistently stated that it wants to
ensure that yield spread premiums remain legal so that borrowers can
benefit from their use--such as by reducing the upfront closing costs
required to be paid from cash or equity. We as consumer advocates
agree. We think the following principles,\25\ if followed, would
guarantee that yield spread premiums would be legal and beneficial for
consumers.
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\25\ See Appendix A for a full proposal that amends Reg. X and
adopts these principles.
1. Before any payment is made to the broker, the borrower and
the mortgage broker must enter into a binding fee agreement
regarding the total compensation, however denominated, to be
paid to the broker.
2. The borrower must be offered a choice of how to pay the
broker fee, whether in cash, by borrowing more, by increasing
the interest rate or points, or having the lender pay the
broker fee. This choice is offered after loan approval but
before the settlement.
3. The amount the broker is paid is the same whether paid by
the borrower or the lender. The amount paid the broker by the
lender reduces, by the exact amount, the amount owed by the
borrower to the mortgage broker.
4. The total amount paid by borrower and lender must be
reasonable and be compensation for goods, services, and
facilities actually provided.
These principles accomplish several things. First, the consumer
knows upfront how much the mortgage broker will charge. Second, the
consumer is given the opportunity to choose how this payment will be
paid. Third, and most importantly, the broker compensation remains the
same regardless of method of payment. This point is crucial, because it
eliminates any anticompetitive incentive the broker has to place the
borrower in a loan with an interest rate greater than they otherwise
would qualify. In other words, whether the borrower chooses a below-par
loan, a par loan or an above-par loan with a yield spread premium, the
broker compensation will remain the same. This is not how the system
works today and it must be changed.
In summary, yield spread premiums have been a source of mortgage
lending abuse for a number of years. Finally, when the Federal courts
began to seriously hold the mortgage lending industry liable, the
industry, instead of reforming its ways turned to HUD for salvation.
HUD, instead of protecting consumers, cast its lot with mortgage
lenders and attempted to protect the anticompetitive marketplace that
currently exists, HUD's ultimately cynical policy clarification was not
only disappointing but also an abdication of their mandate to protect
and promote homeownership. We can only hope that in the future, HUD
will rethink its decision and issue regulations that adopt principles
that not only claim to protect consumers, but also in practice actually
do.
Appendix A
Proposed Changes to Regulation X
1. Add Following Definitions to Sec. 3500.2(b)
Total compensation received by a mortgage broker for bringing
together a borrower and a lender to obtain a Federally related mortgage
loan for the borrower includes all payments made by the borrower
directly to the mortgage broker in cash or in the form of any thing of
value, all payments received from the proceeds of the loan, and all
payments received from the lender or any other settlement service
provider that are directly related to the brokering of the loan.
Par rate means the interest rate offered to a mortgage broker
(through lender's price sheets) at which the lender will fund 100
percent of the loan with no premiums or discounts to the mortgage
broker.\26\
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\26\ Source: HUD Statement of Policy 1999-1, 64 Fed. Reg. 10080,
10081 n.1 (March 1, 1999).
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2. Add the Following Addition to Sec. 3500.14(g)
Sec. 3500.14(g)(4): The payment of a fee by a lender to a mortgage
broker related to the making of a Federally related mortgage loan shall
not violate Section 8 of RESPA (12 U.S.C. Sec. 2607) or Sec. 3500.14 if
all of the conditions set forth in this subsection are satisfied.\27\
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\27\ Source: Language mirrors affiliated business arrangement
exemption in 24 C.F.R. Sec. 3500.15(b).
(i) The mortgage broker agrees to represent the borrower, to
act as the borrower's agent, and to get the most favorable
mortgage loan that meets borrower's stated objectives.\28\
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\28\ Source: HUD Proposed Rule, 62 Fed. Reg. 53912, 53927 (October
16, 1997) (proposed Mortgage Broker Contract, Appendix F). See also,
Federal Reserve/HUD Joint Statement to Congress on RESPA/TILA Reform
(1998).
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(ii) Prior to the preparation of the mortgage loan
application or receipt of any payment, whichever is first, the
mortgage broker and the borrower complete and execute a
Mortgage Broker Contract, in substantial conformity with the
form in Appendix F to this part, that states clearly and
conspicuously: \29\
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\29\ Source: HUD Proposed Rule, 62 Fed. Reg. at 53925 (proposed
Sec. 3500.14(g)(2)(I)(A).
(A) the mortgage broker's total compensation, expressed
both as a dollar amount and as a percent of the loan amount
requested by the borrower;
(B) the borrower owes any compensation to the mortgage
broker only if the borrower enters into a Federally related
mortgage loan with a lender to whom the mortgage broker
referred the borrower; and
(C) the available methods by which the borrower can choose
to pay the mortgage broker the total compensation in the
Mortgage Broker Contract.
(iii) Following loan approval, but no later than five (5)
business days before settlement, the lender and borrower enter
into a Broker Funding Contract, in substantial conformity with
the form in Appendix G to this part, that states clearly and
conspicuously:
(A) the available methods by which the borrower can pay the
mortgage broker the total compensation disclosed in the
Mortgage Broker Contract;
(B) the par rate, the proposed interest rate, and the
monthly payment (excluding escrow) of any method described in
Sec. 3500.14(g)(4)(ii)(A) when the lender offers to pay all or
part of the total compensation to the mortgage broker through
funds resulting from an interest rate higher than the par rate
for a mortgage loan with otherwise equivalent terms and fees;
(C) that the borrower may select one of the methods
described in Sec. 3500.14(g)(4)(ii)(A).
(iv) The total compensation paid to the mortgage broker
compensates the broker for goods, services, and facilities and
is reasonably related to the value of such good, services, and
facilities.
(v) Any fee paid by the lender to the mortgage broker for the
Federally related mortgage loan reduces, dollar for dollar, the
amount owed to the mortgage broker by the borrower pursuant to
the Mortgage Broker Contract described in
Sec. 3500.14(g)(4)(ii) and must be paid at or before the
settlement.
(vi) The borrower receives a copy of the Mortgage Broker
Contract described in Sec. 3500.14(g)(4)(ii), and the Broker
Funding Contract described in Sec. 3500.14(g)(4)(iii).
(vii) The mortgage loan, the Mortgage Broker Contract, and
Broker Funding Contract do not contain provisions that waive or
restrict the borrower's right to enforce the provisions of
RESPA and these regulations or other rights related to the
mortgage through judicial process.
3. Add Supplementary Information Regarding Applicable Date
These amendments apply to mortgage loans entered into on or after
January 1, 2002 [or other date in the future].
4. Add Appendix F, Mortgage Broker Contract
[TO BE DRAFTED]
5. Add Appendix G, Broker Compensation Contract
[TO BE DRAFTED]
PREPARED STATEMENT OF DAVID OLSON
Managing Director, Wholesale Access Mortgage
Research and Consulting, Inc.
January 8, 2002
Qualifications
I am the Managing Director of an economic research firm. I have
been studying the mortgage industry for over 30 years. Since 1991 our
firm has conducted much of the primary research on mortgage brokers in
the United States. Although I am a member of the MBA and NAMB, I do not
represent either association at these hearings. I merely represent
myself as an independent economist. I have been asked to comment on the
recent Statement of Policy 2001-1 by HUD concerning yield spread
premiums (YSP's), and what HUD should do to prevent their abusive use.
I also have some thoughts to share about markets, economics, and
predatory lending.
In the early days of my professional career, I was a student of
socialist systems and spent time in Russia and Eastern Europe. I saw
first-hand how miserably socialism operated. It led to slow growth, few
benefits to the consumer, and loss of political freedom. The first 10
years of my career made me passionate about market systems as the best
way to meet the economic needs of the population and preserve the most
freedom. From my experience, the best solution to most economic needs
is to let the market operate more freely. This will produce the most
goods at the lowest cost.
Mortgage Broker Market
The mortgage market in the United States is highly competitive--at
least that part concerning the origination of mortgage loans. Only
those firms that have low costs can compete today. No firm is earning
monopoly profits at the expense of the consumer.
Mortgage brokers have evolved fairly recently to meet the needs of
consumers. There were only a few operating before 1980. By 1987, they
had 20 percent of the market. In 2001, we estimate they had around 65
percent of the market. That is, of the $2 trillion of residential
mortgage loans originated, $1.3 trillion were made by mortgage brokers.
Mortgage brokers are the leading channel for the production of
mortgages. We
estimate there are 33,000 of these small, independent firms today. The
median firm has 5 workers, including the owner. The average firm has 9
workers, for a total employment of nearly 300,000 persons. They operate
throughout the United States. The median firm is only 5 years old. So,
they are quintessentially an industry of small firms competing
vigorously with one another. If they do not give the consumer good
service, they go out of business. In this sense, they are similar to
barber shops. No firm has any special factors with which to exact
extra-normal profits from the consumer other than personal service.
Market information is widespread. Any shopper can log onto a
computer and get instant market information from thousands of competing
firms. Prices also are available in newspapers and television.
Mortgages have become a commodity, with very little variation in price
among lenders. There are firms out there, especially internet firms,
that compete solely on price and offer little human interaction. Up
until now, consumers have not flocked to these firms, but have stayed
mainly with local brokers who can walk them through the complex process
of originating a mortgage. The paperwork to complete a mortgage is
highly regulated and complex and must be done correctly. If the loan is
not done correctly, the consumer does not get the loan and the loan
originator does not get paid.
Fifteen years ago, this industry was dominated by savings and loan
associations. Since then, a vigorous secondary market has evolved that
allows mortgages to be converted into securities and traded around the
world. The tasks to make a mortgage have become specialized. We now
have about 100 wholesale mortgage firms buying loans from 33,000
mortgage brokers. Mortgage servicing has become more centralized within
the hands of a few larger wholesale firms. But brokers are the low cost
producer of the origination process.
The mortgage industry is highly volatile, with periods of high
refinancing. Such peak volume years occurred in 1993, 1998, and 2001,
when volume nearly doubled from the prior year. It is especially in
such years that brokers are needed. The existing retail firms are not
equipped to grow their work forces that fast. But brokers are very
agile and can grow and contract more quickly to meet the needs of the
market. Without brokers, the market would have virtually collapsed last
year and many consumers who wanted the opportunity to refinance their
mortgage to a lower rate would have been frustrated. There would have
not been enough trained workers available to meet their need.
Yield Spread Premiums
The mortgage industry serves the housing industry. It has become
national policy to permit as many households as possible to own their
own home. The goal is get the share of homeowning households up to 70
percent. The main factor holding back more consumers from buying a
house is the downpayment. So the market has evolved several ways to
solve that problem--no downpayment or very low downpayment mortgages.
It costs about 2 percent of the mortgage amount or $2,800, which is
needed to compensate the broker for his cost, time, and profit in
originating a mortgage loan. Most buyers today either do not have that
amount to pay the origination fee or prefer to finance that fee. The
mortgage originator cannot perform his origination function without
being paid. From this has evolved the ``yield spread premium,'' which
is a way for the homebuyer to retain more of his cash and yet pay the
mortgage broker for his service--predominately saving the consumer
dollars by refinancing at a lower rate and thereby lowering the
consumer's cashflow. Mortgagors are saving on average about $100 per
month (assuming a 1 percent reduction in the interest rate from 7.5
percent to 6.5 percent on a $160,000 loan) by enlisting the mortgage
broker's services. In today's market, the consumer has the choice of
paying all of the fee upfront, part of the fee upfront, or financing
the entire fee. The typical homebuyer opts to pay part of the fee
upfront. So the income of the mortgage broker in today's market is 55
percent in fees from the consumer and 45 percent in the form of a
payment from the wholesaler.
Yield spread premiums are really a financing tool. They became
available around 1990 due to securitization. Their availability has
spurred mortgage finance and had various spillover effects, including
expanding the ranks of homebuyers; increasing refinance activity;
growing the ranks of originators, especially brokers; and aiding the
economic expansion of the 1990's. In particular, it has helped moderate
the current recession by promoting the financing of homes and keeping
the housing market vigorous.
If Congress outlawed yield spread premiums, the results would be:
(1) fewer mortgage originations, especially among middle- and low-
income consumers; (2) higher out-of-pocket expenses for homebuyers and
homeowners; (3) fewer mortgage originators; (4) reduced national income
and GDP.
Exactly how many fewer mortgage transactions would result with a
ban on yield spread premiums is conjecture. We believe the reduction
could be 33 percent. A ban would adversely affect mortgagors, and
broker mortgagees. There would absolutely be fewer of each group. The
declines in each would be proportional. These declines would ripple
through the mortgage sector, affecting realtors, builders, appraisers,
mortgage insurers, credit bureaus, escrow companies, etc. Mortgage
costs would rise due to less competition.
More disclosures would add complexity and cost to a mortgage
process which is already extremely confusing to the consumer. Predatory
mortgage legislation is probably superfluous. The existing laws protect
consumers from being bilked by swindlers and gougers. The number of
predatory victims is quite small compared with the size of the mortgage
industry. We estimate the number of mortgagors served with a new or
refinanced loan at 60 million in the past 5 years. Very few have been
harmed. There is no evidence to the contrary. Is it worth harming that
huge market with even more laws? Enforcement of existing laws is the
answer.
Reaction to HUD Clarification on YSP's
I was present in Toronto, Canada at the MBA annual meeting when Mel
Martinez announced his clarification of HUD's policy on yield spread
premiums. I support his clarification because it explained the earlier
statement HUD made in 1999 to the judiciary and thus should stop class
action law suits over the mere payment of yield spreads to brokers. The
mortgage industry has been plagued by class action law suits for
several years that have cost the industry tens of millions of dollars.
Ultimately, these costs are paid by consumers.
Impact on Brokers of Limiting YSP's
I have been a long time supporter of mortgage brokers, who in 2001
handled about 65 percent of all mortgage originations in the United
States. They did so because they are the low cost providers. Our firm
has studied this issue since 1991 and has been unwavering in its
conclusions that brokers provide consumers with better service at a
lower cost than their competitors. To restrict brokers is to hurt
consumers.
Brokers get half their income in the form of yield spread premiums.
I estimate that if yield spread premiums were made illegal, about one-
third of all brokers would drop out of the business; and the other two-
thirds could survive by charging higher upfront origination fees, but
it would dramatically change their customer profile. They would no
longer be able to serve as many consumers with credit problems or FHA
buyers. That means the market share of mortgage brokers would diminish.
This would be very anticonsumer because brokers do a majority of the
refinances in years such as 2001. Banks, thrifts, credit unions, and
mortgage lenders use the concept of yield spread premium but do not
have to report it. Any restriction on YSP's would only adversely affect
brokers and have no impact on these other mortgage lenders. In
addition, the retail channel (made up by banks, thrifts, etc.) just
could not handle the volume. That means in the next refinance wave,
many consumers would not get the refinances they desire, certainly not
compared to those who refinanced them in the past waves. You would in
effect frustrate about one-third of the 7 million households that did
refinances, or 2.3 million households. Do you really wish to frustrate
that many people? We estimate there are 33,000 independent mortgage
brokers processing and originating loans currently within the United
States. The average firm has 9 people working for them for a total of
297,000 employees across the brokerage industry. Do you wish to put
99,000 people out of work? In Maryland, there are 550 independent
mortgage brokers with total employment of about 5,000 people. Do you
wish to put 1,700 Maryland workers out on the street?
Maryland has lost many financial services firms over the past 30
years, including my former firm, Commercial Credit. There was MBNA,
Maryland National Bank, Equitable Banks, and Baltimore Federal Savings
Bank. In part, the 550 mortgage broker firms in Maryland have replaced
the mortgage departments of those once venerable firms. But if Congress
bans YSP's, you would put one-third of these
brokers out of business also and force further consolidation in the
industry. Nor would the consumer be benefited. You would force
consumers into the hands of larger firms, mostly based elsewhere, that
might charge higher rates and fees. Shrinking the supply given fixed
demand would shift supply to the left and the price would, of course,
rise. Consumers would pay a higher price consequently.
Impact on Consumers of Limiting YSP's
If yield spreads are eliminated and all consumers have to pay out-
of-pocket fees, a large number of lower-income people would be pushed
out of the market. This would fall most heavily on minorities. It would
lower the portion of households that can become homeowners. Past
Administrations have aimed toward 70 percent of all households becoming
homeowners. That percentage would have to fall greatly, perhaps back
down to 60 percent. As all these transactions are taken out of the
market, there are thousands of secondary market impacts--a reduction in
credit agents, appraisers, escrow agents, etc. Call them unintended
consequences.
What happens when Government protects consumers from borrowing
mortgage money? Some loans are not made or the consumer resorts to
credit cards and to personal loans at 18-21 percent interest or to hard
money lenders at even higher rates of interest. Right now the prime
mortgage industry is barely profitable and subprime mortgage lending is
unprofitable. There has been an exodus of capital for the past several
years. Consumers will not be benefited by causing more lenders to exit.
Disclosures to Curb Abuses
If we mandate even more disclosures, make it the same for all
lenders. The problem with asking brokers to estimate their YSP's at
time of application is that they do not know what it will be. Until the
loan application is complete, they do not know who they will be selling
the loan to or what their YSP will be. They can only say that typically
they earn half the cost of doing the transaction in that form. This is
also true of all other retail lenders, not just brokers but loan
originators at banks, thrifts, credit unions, and finance companies
too. If you mandate even more disclosure, make it the same for all
lenders. I would support uniform disclosures of all mortgage originator
payments as a way to curb abusive uses of yield spread premiums to the
extent they exist. But I do not think abuses are widespread, as
consumers are increasingly sophisticated about financial matters. Doing
away with yield spread premiums would not eliminate predatory lenders
who thrive on cheating uneducated customers.
Rather than trying to eliminate every vestige of overpricing,
Congress should foster more education about loans. Over the past 3
years, over half the firms in subprime lending have shut down. The
remaining firms are not very profitable and are trembling not to be
sued by the many new laws now on the books. I dare say, very few
predatory acts (however these are defined) are taking place. Flipping
has hurt Baltimore, but that has little to do with YSP's. Therefore,
any new legislation beyond uniform disclosures across the entire
industry would be redundant, counter-productive, and against the
consumer's best interest. The normal use of a YSP is not predatory
lending. It is part of doing business.
----------
PREPARED STATEMENT OF DAVID R. DONALDSON
Counsel, Donaldson & Guin, LLC
January 8, 2002
Chairman Sarbanes, distinguished Members of the Committee, thank
you for inviting me to testify on the abusive uses of yield spread
premiums. By way of introduction, I am a lawyer in private practice in
Birmingham, Alabama. I represent the plaintiff class in Culpepper v.
Irwin Mortgage Corporation, a damages suit brought under the Real
Estate Settlement and Procedures Act (RESPA). A 1998 Federal court of
appeals decision in Culpepper \1\ led to HUD's 1999 Statement of Policy
(SOP).\2\ Another decision by that same court in June 2001 resulted in
HUD's 2001 SOP \3\ that this Committee has asked me to discuss here
today.
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\1\ Culpepper v. Inland Mortgage Co., 132 F.3d 692, rehearing
denied, 144 F.3d 717 (11th Cir. 1998).
\2\ 64 Fed. Reg. 10080.
\3\ 66 Fed. Reg. 53052.
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I would like to begin by expressing my deep appreciation to this
Committee for its efforts to examine and curb abusive and deceptive
lending practices. The mortgage industry's current yield spread premium
practices that are reflected in HUD's 2001 SOP are an integral part of
the well-documented predatory problem that is crying out for
examination and remedy.
Irwin and many other lenders currently offer brokers yield spread
premium payments whenever brokers are able to convince borrowers to
accept higher interest rate loans. Consumers are, in effect, being
encouraged to borrow money that lenders use to bribe brokers to do
business with them. Consequently, brokers who have been fully
compensated by loan origination fees and other ``direct'' payments also
receive unearned additional ``compensation'' that costs homeowners
thousands of additional dollars in mortgage payments over the duration
of their loans.
RESPA outlaws all kickbacks and referral fees.\4\ Under Culpepper,
a yield spread premium can be legal if the evidence demonstrates that
the yield spread premium was paid in exchange for the broker's
services.\5\ HUD's 2001 SOP seeks to delete the ``for services''
requirement and thereby legalize ``reasonable'' referral fees even when
no additional compensation is owed to the broker. I believe HUD's
recent
actions to be misguided, irrational, and in direct conflict with
Congress's express intent in passing RESPA.
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\4\ This Committee's 1974 Report issued in connection with the
original RESPA litigation, states that RESPA is intended to ``prohibit
all kickback or referral fee arrangements whereby any payment is made .
. . for the referral of real estate settlement business.'' S. Rep. No.
93-866, 1974 U.S.C.C.A.N. 6546, 6551.
\5\ See Culpepper v. Inland Mortgage Co., 132 F.3d 692, rehearing
denied, 144 F.3d 717 (11th Cir. 1998). The 1999 SOP states: ``In the
determination of whether payments from lenders to mortgage brokers are
permissible under Section 8 of RESPA, the threshold question is whether
there were goods or facilities actually furnished or services actually
performed for the total compensation paid to the mortgage broker.'' 64
Fed. Reg. at 10085.
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Yield Spread Premiums Are Not Being Used To Lower Closing Costs
HUD's ostensible reason for the 2001 SOP was its claim that
Culpepper might prevent borrowers from using yield spread premiums to
lower their upfront closing costs.\6\ The court's Culpepper decisions,
however, expressly allow borrowers to finance closing costs through
yield spread premiums.\7\ A yield spread premium could be legal under
Culpepper III if the lender's form contract with the mortgage broker
required the broker to use the yield spread premium payment to reduce
borrowers' upfront closing costs.\8\
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\6\ The text of the 2001 SOP, as well as the Secretary's news
release announcing that pronouncement justified the SOP on the grounds
that ``[y]ield spread premiums serve to allow the borrower a lower
upfront cash payment in return for a higher interest rate. . . .'' See
66 Fed. Reg. at 53055; see also HUD News Release No. 01-105.
\7\ Culpepper I, 144 F.3d at 718.
\8\ A yield spread premium is legal under Culpepper III ``if the
agreement to pay it bore the hallmarks of a fee-for-service exchange.''
Culpepper III, 253 F.3d at 1331.
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HUD's and the industry's ``consumer benefit'' arguments are clearly
``red herrings.'' Under HUD's ``reasonableness test,'' YSP's are legal
regardless of whether they are used to lower closing costs. Moreover,
lenders and brokers do not, in fact, use yield spread premiums to lower
borrowers' closing costs. At the outset of the Culpepper litigation,
Irwin claimed that ``the yield spread premium was simply the market-
driven payment to [the broker] for an asset--the loan itself.'' \9\ It
was only after the courts rejected that argument that industry lawyers
concocted the idea that yield spread premiums were used to lower
borrowers' closing costs. My colleagues and I have examined thousands
of Irwin's borrowers' loan documents, and I have yet to find a single
class member whose closing costs were reduced as a result of yield
spread premiums. Among class members in other cases, I am only aware of
a tiny handful of settlement statements reflecting credits against the
borrowers' obligations resulting from yield spread premiums.\10\
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\9\ Culpepper v. Inland Mortgage Corp., 953 F.Supp. 367, 371 (N.D.
Ala. 1997).
\10\ The HUD-1 Settlement Statements required by RESPA and HUD to
be delivered at closing is required to reflect credits against closing
costs for payments made by the lender on the borrower's behalf if any
were given.
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If yield spread premiums were actually being used to lower
borrowers' closing costs, the lenders could expect to prevail in the
litigation. Indeed, if they are not violating the law, they will
prevail in court. But it is highly improper for HUD to attempt to
overrule the courts, alter the plain meaning of Congress' statute, and,
indeed, interfere with both procedural and evidentiary issues in the
judicial system. HUD has no such power, nor should it.
HUD's 2001 SOP Does Nothing To Curb Abusive YSP Payments
HUD and mortgage industry representatives have publicly admitted
that mortgage brokers frequently tack on unexpected charges at closing
when it is too late for borrowers to obtain other financing.\11\ This
should come as no surprise since the National Association of Mortgage
Brokers (NAMB) takes the position that brokers should be allowed to
hide yield spread premiums from borrowers.\12\ While the Culpepper
court's ``fee for services'' approach would help curb these nefarious
``bait and switch'' tactics, HUD's ``reasonableness'' test encourages
brokers to tack on additional charges at closing. Since the
``reasonableness'' of a charge is measured by what other brokers
charge, no referral fee or kickback can be illegal under HUD's test as
long as the practices are widespread.
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\11\ In HUD's Press Release No. 01-105 announcing the 2001 SOP,
Secretary Martinez stated: ``At closing, too many American families sit
down at the settlement table and discover unexpected fees that can add
thousands of dollars to the cost of their loans.'' In the December 23,
2001 edition of The Los Angeles Times, Mr. Falk, who is testifying here
today on behalf of the National Association of Mortgage Brokers, was
quoted as stating that ``horror stories abound of borrowers arriving at
closing to find that [the] actual cost of various services are hundreds
of dollars above what was disclosed on the Good Faith Estimate.''
\12\ During HUD's negotiated rulemaking on yield spread premiums
that led up to its 1997 proposed rule for providing for binding
contracts between brokers and borrowers, the NAMB argued
``strenuously'' that yield spread premiums should not be disclosed to
borrowers. See 62 FR at 53917. In the NAMB's December 4, 2001 Position
Paper entitled ``Mortgage Originator Disclosures--Position on
Prospective HUD Rulemaking Concerning Mortgage Originator Disclosures''
(available on the NAMB's website www.namb.org) has an entire section
(at para. 4) devoted to its contention that ``Originators should not be
required to disclose their compensation.''
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HUD's ``Reasonableness'' Test Amounts to Illegal Rate Regulation
When Congress passed RESPA, it expressly rejected HUD's proposals
for authority to impose caps on settlement charges. Congress chose to
allow the market to set prices and rejected HUD's request for a ``large
bureaucracy'' within HUD to set rates for various types of loans in
various locales.\13\ Since HUD lacks the legal authority and the staff
to set caps on settlement charges for various loans, it surely cannot
examine millions of individual loan transactions to determine if
individual broker payments are ``reasonable.'' HUD's ``reasonableness''
rule ignores the fact that allowing the ``market'' to set prices is a
two-way street. If brokers are free to set their own charges, they must
also be prohibited from collecting more than borrowers agree to pay.
---------------------------------------------------------------------------
\13\ See 1974 U.S.C.C.A.N. at 6550.
---------------------------------------------------------------------------
The 2001 SOP Test For Yield Spread Premium Payments To Brokers Is
Inconsistent With The Test For Other Types of Markups by Other
Settlement Service Providers
The 2001 SOP is also internally inconsistent in the way it treats
yield spread premium payments to mortgage brokers as opposed to other
types of mark-ups charged by other service providers. While imposing a
``reasonableness'' test for YSP pay-
ments to brokers, the 2001 SOP states that other settlement service
providers violate RESPA whenever they mark up the cost of a third
party's services without providing additional settlement services over
and above the services for which the provider has already been
paid.\14\ For example, the 2001 SOP states that a RESPA violation
occurs when a lender collects $200 from the borrower for an appraisal
fee, pays an independent appraiser $175 and pockets the $25 mark-
up.\15\ The ``reasonableness'' of the $200 charge is presumably
irrelevant. HUD has recently (and with great fanfare) \16\ brought
several RESPA enforcement actions arising from a variety of contexts
unrelated to yield spread premiums. None of these recent enforcement
actions would have been possible under HUD's ``reasonableness'' test
for yield spread premiums. Conversely, under the test applied to
appraisals and other settlement charges, if a broker charges a loan
origination fee and then marks up a borrower's interest rate a RESPA
violation would occur. There is no legal or logical basis for this
inconsistent treatment.
---------------------------------------------------------------------------
\14\ See 66 Fed. Reg. at 53059.
\15\ See 66 Fed. Reg. at 53058.
\16\ See HUD Press Release No. 01-118.
---------------------------------------------------------------------------
HUD Has Tacitly Admitted That Its 2001 SOP Is Inadequate To Protect
Consumers
HUD recognizes that its ``reasonableness'' test is inadequate to
protect borrowers. On the same day that HUD released its 2001 SOP, it
also sent a letter \17\ to all FHA approved lenders setting out HUD's
views on ``best practices'' regarding yield spread premiums. HUD urges
lenders to disclose the total amount of the broker's compensation,
including the yield spread premium and to obtain a written
acknowledgment by the borrower. HUD also suggested that lenders reflect
yield spread premiums as credits on borrower's HUD-1's.
---------------------------------------------------------------------------
\17\ Mortgagee Letter 2001-26 (available on HUD's website).
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HUD's Claim That The 2001 SOP Is A ``Clarification'' Is Unsupportable
HUD's claim that the 2001 SOP reflects its earlier intent is
disingenuous. In the 1999 SOP and in correspondence between HUD's
former General Counsel and Members of Congress, including a Member of
this Committee, HUD expressly stated that the 1999 SOP was not intended
to change existing law, which was expressed in the appellate court's
previous Culpepper decisions.\18\
---------------------------------------------------------------------------
\18\ See attached letter from Gail Laster to Senator Richard Shelby
dated March 21, 2000.
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Five years ago when the Culpepper case was filed, Irwin did not
even require brokers to disclose yield spread premium amounts on
borrowers' Good Faith Estimates. It was not until after the 1998
Culpepper decision that Irwin began requiring brokers to disclose yield
spread premium amounts on GFE's. Although the industry has been forced
by the ongoing yield spread premium class action litigation to make at
least minimal yield spread premium disclosures to consumers, much more
is needed if consumers are to be able to have any hope of protecting
themselves in mortgage loan originations.
Obviously, HUD is correct in the view expressed in its recent
mortgagee letter that brokers should disclose their total compensation
and that borrowers should be given credit against whatever is owed to
the broker when the broker receives a yield spread premium. Even with
that disclosure, however, it is doubtful that any but even the most
sophisticated borrower could make an informed decision about yield
spread premiums without additional disclosures being required. To make
an informed decision about yield spread premiums, borrowers would also
have to know how much their rates are being increased to generate the
yield spread premium and have to know how much additional monthly
interest payments they would incur as a result of the markup. Moreover,
in order to prevent unscrupulous brokers from overcharging and to
prevent borrowers from ``bait and switch'' tactics where yield spread
premiums are disclosed for the first time at closing on the HUD-1, HUD
must require the mortgage industry to use yield spread premiums to
lower closing costs as it now claims to be doing.
Finally, I would be remiss if I failed to point out my personal
opinion that current yield spread premium practices encourage
discrimination. After spending 5 years of looking at numerous
borrowers' closing documents it is clear to me that borrowers who are
black, female, or Hispanic pay higher total broker ``compensation''
than white males. That opinion is also supported by a recent Urban
Institute Study financed by HUD which found that ``[t]here is no
question that minorities are less likely than whites to obtain mortgage
financing and that, if successful, they receive less generous loan
amounts and terms.'' HUD News Release, No 99-191, New
Reports Document Discrimination Against Minorities by Mortgage Lending
Institutions, at 1 (September 15, 1999). The Urban Institute Study also
found that African-Americans and Hispanics tend to pay higher YSP's
than whites and that women pay more than men. Urban Institute Study at
95 n. 11. One of the Culpepper plaintiffs, Beatrice Hiers, is an
African-American female from Baltimore whose broker received over
$10,000 for assisting in her origination of a $160,000 FHA mortgage.
The $4,500 YSP would never have been paid under the Culpepper rule.
According to Irwin, that payment was legal because it was
``reasonable.''
Federal regulators require banks and other depository institutions
to implement safeguards to prevent racial and other types of
discrimination by their employees. Mortgage brokers, however, are often
nothing more than an individual or small group of individuals acting as
independent contractor loan officers. They are not subjected to any
oversight by institutional lenders or by regulators. Current yield
spread premium practices that base ``compensation'' on the broker's
ability to convince borrowers to accept higher interest rates encourage
discrimination.
Thank you again for inviting me and for your attention to these
important issues.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES FROM HOWELL
E. JACKSON
Q.1. During the hearing, Mr. Olson said that the mortgage
brokerage business ``is not very profitable.'' Do you have any
information on the profitability of the mortgage broker
industry?
A.1. While I have not undertaken an independent investigation
of the profitability of the mortgage brokerage business, I
reviewed several reports on the subject that Mr. Olson himself
prepared. Contrary to Mr. Olson's testimony at the hearing,
these reports indicate that mortgage brokers have been
extremely profitable in the past decade and, in particular,
during the 1996-2000 period during which the sample loans in my
study were originated.
To begin with, consider the growth of mortgage brokers.
According to Mr. Olson's Wholesale Access Report: Mortgage
Brokers 1998 (published in 1999), the industry grew
dramatically during the 1990's:
There were about 36,000 mortgage brokers in the United
States in 1998, up from 14,000 in 1991 and 31,000 in 1997.
There was a 14.5 percent average annual rate of growth in the
number of brokers from 1991 to 1998, which is parallel to the
15 percent average annual growth in originations over the same
period. (Page 1)
Without any further information, I would be skeptical of
any claims that an industry experiencing such a sustained rate
of growth ``is not very profitable.'' If the industry were not
profitable, why would so many new firms have been established
during the last decade? However, one does not have to rely on
inferences to assess the profitability of mortgage brokers in
the 1990's. Mr. Olson's report directly addresses the issue:
The median broker produced $20 million, had 5 employees,
produced 200 loans, earned $2,000 gross per loan, for a total
revenue of $400,000 per firm. In 1991, the median broker
produced $15 million with 5 employees. (Page 1)
So while the number of mortgage brokers more than doubled
between 1991 and 1998, the level of originations of the median
firm also increased by a third.
Finally, Mr. Olson's report offers the following evaluation
of the profitability of the mortgage brokerage business in
1998:
The median broker earned $2,000 gross income/loan for 200
loans, which means gross revenue of $400,000 (Table 94). The
mean broker earned $2,443 gross income/loan for 325 loans,
which means gross revenue of $794,000. Median expenses were
$240,000, for a net profit of $160,000 (40 percent). The mean
broker earned a profit of $203,000 on $794,000 (26 percent).
Our study covering 1992 shows a median
profit of $100,000 on revenue of $400,000. This suggests a
higher rate of profit in 1998 than earlier. Since brokers are
rarely C Corporations, they do not pay a corporate profits tax.
They do however pay taxes at their lower personal rate. This
suggests a total profit by brokers of $7.3 billion (36,000
$203,000) before taxes. This exceeds the amount
earned by the two Federal agencies combined and much of the
rest of the mortgage industry. (Page 14) (Emphasis added).
As the median firm operates as a sole proprietorship, Mr.
Olson's report suggests that a typical mortgage broker earned
$160,000 in 1998--an extraordinary median level of income for
an industry that does not require substantial training or
advanced degrees.
Last year, Mr. Olson issued an updated Whole Access Report:
Mortgage Brokers 2000 (published in 2001). In connection with
litigation for which I am serving as an expert witness for the
plaintiff class, I have reviewed a copy of this more recent
report. However, the 2000 report was supplied to me under
conditions of confidentiality and I am not free to reveal to
the Committee the detail of Mr. Olson's more recent work. I
can, however, provide the Committee my overall assessment of
the 2000 report. While there have been some changes in the
structure and the earnings of mortgage brokers since 1998, I am
highly confident that Mr. Olson would concur in my opinion that
there is little in this more recent report to suggest that
mortgage brokering does not remain a profitable enterprise.
Q.2. In your view, is the 2001 HUD ``clarification'' consistent
with the law, and should the courts give it deference?
A.2. In the 2001 policy statement, 66 Fed. Reg. 53,052 (October
18, 2001), the Department proposes a legal standard to
determine when the payment of yield spread premiums violates
Section 8 of RESPA. Under the Department's approach, a yield
spread premium constitutes a per se violation of Section 8 only
if the mortgage broker receiving the payment provides no goods
or services in connection with the transaction. If the mortgage
broker does provide either such goods or services, then the
payment is legal unless the borrower can demonstrate that the
broker's total compensation was unreasonable. Reasonableness,
under the Department's policy statement, is to be determined on
a case-by-case basis and not (by implication) in a class action
lawsuit.
In my testimony before the Committee I questioned the
factual assumptions underlying the Department's 2001 policy
statement.\1\ I also have serious questions about the policy
statement's fidelity to the statutory language of Section 8 of
RESPA. In my view, there are three principal difficulties in
the Department's legal analysis.
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\1\ As I explained in my testimony, an initial problem with the
policy statement is the Department's factual assumptions that yield
spread premiums are simply an alternative source of financing for
closing costs used by a discrete group of borrowers who cannot afford
to pay those costs directly. My own study of yield spread premiums
suggests that these payments are being imposed much more broadly and
that borrowers who incur these hidden charges end up paying their
mortgage brokers much more--on the order of $1,000 more--than do
borrowers with comparable loans unaffected by yield spread premiums.
The Department's misunderstanding of the true role of yield spread
premiums further weakens the legal basis of the policy statement.
---------------------------------------------------------------------------
The Policy Statement Appears to Create a Loophole for the
Market Abuses That Congress Clearly Intended for
Section 8 To Eradicate
In the legislative process leading up to the original
passage of RESPA in 1974, Congress was confronted with
substantial evidence that real estate professionals, such as
lawyers and real estate agents, were using their influence over
real estate transactions to extract kickbacks from title
insurance companies and other settlement service providers.
Concluding that such payments were inherently unfair and
needlessly increased the cost of homeownership, Congress
adopted Section 8 to outlaw these practices. A major difficulty
with the Department's 2001 policy statement is that it appears
to create a substantial defense for precisely the practices
that Congress intended to prohibit with Section 8. All of the
recipients of these pre-RESPA kickbacks provided some good or
service for the transaction in question and also received other
sources of compensation for their services. The Department's
new policy statement would, as best as I can tell, permit the
payments of kickbacks in real estate settlements unless the
recipient of the kickback could show that its total
compensation (including the kickback) was not unreasonable.
Such solicitude for the payment of kickbacks is wholly
inconsistent with Congress's purpose in enacting Section 8 of
RESPA.
The Department's 2001 Policy Statement Establishes a
Regime of De Facto Rate Regulation for Mortgage Services
in Direct Contradiction of Congressional Intent
When adopting RESPA in 1974, Congress expressly rejected
the proposals to establish a national system of rate regulation
for real estate settlement services and chose instead a
combination of prohibitions, such as Section 8, and disclosure
requirements. With its 2001 policy statement, the Department
effectively repeals this Congressional choice. As I read the
policy statement, courts would be called upon to evaluate the
legality of most kickbacks and referral fees based on the
reasonableness of the total compensation of the recipient.
While the Department does not delineate the precise contours of
this reasonableness standard, the courts would presumably have
to consider a kickback recipient's total costs, figure in
reasonable rates of return on investment, and come up with an
overall reasonable price for the recipient's goods and services
in light of contemporaneous market prices for other comparable
goods and services. Congress clearly did not want a Federal
administrative agency to engage in this rate regulation, and I
am highly doubtful that it would have intended for the courts
to play such a role.
The Policy Statement Gratuitously Intrudes Upon Judicial
Functions
A further problem with the 2001 policy statement is its
gratuitous intrusion into the management of judicial cases. In
an apparent effort to influence the certification of plaintiff
classes in pending cases, the 2001 policy statement includes
language suggesting that ``it is necessary to look at each
transaction individually'' and that reasonableness depends on
an evaluation of factors that can only be considered on a case-
by-case basis. This analysis strikes me as misguided and
inconsistent with prevailing judicial practices. First of all,
reasonableness in a particular case can only be determined in
comparison to a broader category. Of necessity, therefore,
litigation over yield spread premiums will involve
consideration of a large number of transactions. And the best
way to determine whether loans with yield spread premiums
entail unreasonable compensation to mortgage brokers is to
compare samples of loans with yield spread premiums to samples
without yield spread premiums.\2\ To require repeated analysis
of this sort in a host of individual cases strikes me as a
highly wasteful use of judicial resources. Moreover, the
Department's approach seems to confuse the question of how much
individual borrowers were injured through the payment of
illegal kickbacks--something that might well vary from
transaction to transaction and thus potentially influence the
amount of damages--with the question of underlying liability.
In many areas of the law, courts determine liability on a
class-wide basis and then base damage awards on individualized
determinations. Whether class certification would also be
appropriate for civil suits challenging yield spread premiums
under Section 8 of RESPA strikes me as a matter for the court,
not an administrative agency, to resolve.
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\2\ In the litigation in which I am serving as an expert witness,
experts for both sides defendants as well as plaintiffs--used this
statistical--analysis to evaluate the impact of yield spread premiums
on mortgage broker compensation.
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How much deference the Federal courts should accord the
Department's 2001 policy statement is an important question
that I did not address in my testimony before the Committee and
that I will only briefly touch upon in this supplemental
statement. As described above, I believe there are serious
inconsistencies between the 2001 policy statement and the
Congressional purposes in enacting Section 8 of RESPA. To the
extent that the courts agree with my analysis of these issues,
the policy statement would be subject to diminished deference
even under the high standards that the Supreme Court set forth
in Chevron U.S.A. Inc. v. Natural Resources Defense Council,
467 U.S. 837 (1984). Just last year, however, the Supreme Court
narrowed the scope of the Chevron doctrine by holding that when
an agency interpretation is not the product of either formal
adjudication or notice-and-comment rulemaking, the Chevron
deference standards may not even apply. See United States v.
Mead Corporation, 533 U.S. 218 (2001). While the implications
of the Court's recent ruling remain to be determined, I think
it is fair to say the decision reduces the degree of deference
that Federal courts are likely to show interpretative rulings
such as the Department's 2001 policy statement. Particularly to
the extent that the policy statement purports to dictate the
manner in which the judiciary should manage class certification
procedures, judicial deference to the agency's view should be
modest. See Adams Fruit Co. v. Barrett, 494 U.S. 638 (1990)
(inappropriate for courts to consult executive interpretations
to resolve ambiguities in the scope of a judicially enforceable
remedy).
Q.3. Currently, when individuals apply for loan assistance or a
home mortgage, they are unaware of their credit scoring, and
are therefore, under the Fair Credit Reporting Act (FCRA),
vulnerable to acts of predatory lending including taking on a
mortgage with a high-interest rate even though their credit
score may qualify them for a low-interest loan. I think this is
a serious issue, and Senator Allard and I have introduced the
Consumer Credit Score Disclosure Act of 2001, which amends the
FCRA to provide the consumer with a copy of: (1) the
information obtained from a consumer reporting agency or that
was developed and used by that user of the credit score
information; or (2) a copy of the information provided to the
user by a third party that developed the credit score, plus a
general description of credit scores, their use, and the
sources and kinds of data used to generate credit scores. As an
expert testifying before the Committee, would you agree, that
individuals should have access to their credit score in order
to protect themselves from acts of predatory lending?
A.3. Yes. I agree that it would be useful for consumers to be
given access to their credit scores. In addition, as I
indicated in my testimony, I think consumers should also be
provided information regarding the range of loans--including
par value loans--available to borrowers with their credit
scores. In addition to improving the fairness of loan
transactions, disclosures of this sort would allow consumer
groups and the financial press to provide better guidance to
borrowers and thereby enhance the overall operations of credit
markets.
* * * * *
Response to the Statement of ABN AMRO Mortgage Group
Following the Committee's hearing of January 8, 2002, ABN
AMRO Mortgage Group filed a statement disagreeing with certain
aspects of my testimony and appending statements by two expert
witnesses retained by defendants in the Glover v. Standard
Federal Bank litigation in which I am serving as an expert for
the plaintiffs. Having reviewed these materials, I remain
confident that my testimony before the Committee presents an
accurate picture of the abusive nature of yield spread
premiums, that these payments
impose substantial additional costs on consumers, and that the
reforms I advocated for HUD-1 disclosures are fully warranted.
RESPONSE TO WRITTEN QUESTION OF SENATOR SCHUMER FROM JOSEPH L.
FALK
Q.1. As an expert testifying before the Committee, would you
agree, that an individual should have access to their credit
score in order to protect themselves from acts of predatory
lending?
A.1. NAMB strongly believes that all consumers should have
access to their credit score in order to know where they stand
in the eyes of the lender, and to better understand how one's
credit history can affect his/her ability to purchase and own a
home. We do not believe accessibility should be a function of
whether the individual is a candidate for a prime or subprime
loan, but instead, available to any and all consumers seeking
to obtain a mortgage. More than just words, NAMB has taken
tangible steps to help educate consumers about the importance
of one's credit score. On November 19, 2001, NAMB released an
educational piece entitled, ``Buying A Home . . . How Will Your
Credit History Affect You?'' This is part of NAMB's efforts to
encourage consumers to ``Know the Score.'' The article
identifies the five key criteria used in determining a credit
score and lets consumers know that they can receive a copy of
``A Consumer's Guide to the Facts & Fiction About Credit
Scoring and Its Role in Lending'' from any NAMB mortgage broker
member.
RESPONSE TO WRITTEN QUESTION OF SENATOR SARBANES FROM DAVID R.
DONALDSON
Q.1. In your view, is the 2001 HUD ``clarification'' consistent
with the law, and should the courts give it deference?
A.1. No. HUD's 2001 ``clarification'' regarding yield spread
premium payments is inconsistent with RESPA's plain language
and its legislative intent. The courts should not afford HUD's
SOP 2001-1 any deference.
Section 8(a) of RESPA expressly outlaws all referral fees,
not just ``unreasonably'' high referrals fees.\1\ HUD and the
courts have recognized that yield spread premiums violate
Section 8 of RESPA unless they fall within the ``goods or
services'' language of Section 8(c), which states that RESPA
does not prohibit ``payment for goods or facilities actually
furnished or for services actually performed . . .'' 12 U.S.C.
Sec. 2607(c) (Emphasis added.) Thus, for a yield spread premium
to be legal under RESPA, the lender must demonstrate that the
yield spread premium was paid for legitimate ``services'' other
than the referral of the loan.
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\1\ Section 8(a) of RESPA states:
No person shall give and no person shall accept any fee, kickback,
or thing of value pursuant to any agreement or understanding, oral or
otherwise, that business incident to or a part of a real estate
settlement service involving a Federally related mortgage loan shall be
referred to any person.
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HUD's 1999 SOP on yield spread premiums contained the same
``for services'' requirement that is set out in the statute.
HUD's 2001 SOP, however, deleted the statute's ``for services''
language. According to the 2001 SOP, yield spread premium
payments are legal so long as the amount of money received by
the broker is ``reasonable.'' 66 Fed. Reg. at 53055. There is
nothing in the statute to support HUD's conclusion that
``reasonable'' referral few are legal. As this Committee
pointed out in its 1974 Report issued when Congress first
enacted the statute, RESPA was intended to ``prohibit all
kickback or referral fee arrangements whereby any payment is
made . . . for the referral of real estate settlement
business.'' S. Rep. No. 93-866, 1974 U.S.C.C.A.N. 6546, 6551
(Emphasis added.)
When Congress passed RESPA, it rejected proposals to allow
HUD to determine when rates are too high. Congress chose to
allow an open and honest market to set prices and rejected
HUD's request for a ``large bureaucracy'' within HUD to set
rates for various types of settlement services in various
locales. See 1974 U.S.C.C.A.N. at 6550. Nonetheless, HUD has
now unilaterally attempted to grant itself the power it was
denied by Congress to regulate the ``reasonableness'' of broker
payments. HUD's 2001 SOP is clearly illegal and inconsistent
with RESPA. HUD lacks the authority to set ``reasonableness''
caps that allow brokers to charge borrowers more than the
borrowers agreed to pay.
RESPA carries criminal as well as civil penalties. Yet
HUD's 2001 ``reasonableness'' test is so vague and ambiguous
that it could never withstand a constitutional challenge. As
the Court of Appeals pointed out, by focusing entirely on the
agreement between the broker and borrower and ignoring the
lender's purpose in making the yield spread premium payment,
the ``reasonableness'' test would place the lender in the
``bizarre position of not knowing whether its conduct was
illegal when it committed it.'' Culpepper v. Irwin Mortgage
Corp., 253 F.3d 1324, 1331 (11th Cir. 2001).
I also believe that the 2001 SOP is invalid due to HUD's
failure to comply with the requirements of Section 8(c)(5) of
RESPA, which allows HUD to make RESPA interpretations by
regulation after consulting with the Attorney General, the
Secretary of Veterans Affairs, the Federal Home Loan Bank
Board, the Federal Deposit Insurance Corporation, the Board of
Governors of the Federal Reserve System, and the Secretary of
Agriculture. The 2001 SOP was not adopted by regulation. Nor
did HUD consult with other agencies before issuing the SOP.
HUD's 2001 SOP is based on the misconception that the
purpose of yield spread premiums is to allow borrowers to lower
their ``direct'' closing costs, such as loan origination fees.
That idea is pure fantasy. It is an argument dreamed up in the
course of this litigation after the Court of Appeals rejected
Irwin's claim that YSP's are compensation for above-par
mortgages. Not one shred of evidence has been submitted in any
of the yield spread premium cases to support this fallacious
premise. Indeed, it is my understanding that mortgage industry
representatives were unable to locate a single borrower who was
helped by the use of yield spread premiums to testify at the
hearing on January 8 conducted by this Committee from among the
millions of borrowers whose brokers have received YSP's.
Lenders offer YSP's for one reason only, to encourage
brokers to send them business. Mr. Olson who testified as a
mortgage industry expert at this Committee's January 8 hearing,
has admitted under oath that he has conducted studies to
determine the amount of yield spread premium that lenders must
offer to obtain broker referrals. Likewise, Standard Federal's
Jeff Conner candidly admitted that Standard Federal offers
yield spread premiums ``to get business.'' Numerous witnesses
in the Standard Federal case have now admitted that the YSP's
are nothing but a program of inducements to brokers to refer
loans to Standard Federal or its subsidiaries rather than to
some competing lender. Others admit that the lender is merely
buying high-yield loans by offering the broker a financial
inducement to lock borrowers into high mortgage rates.
Similarly, in the Culpepper case, Irwin admitted that the
broker was owed no ``additional compensation'' for its services
and that ``the yield spread premium was paid to [the mortgage
broker in part] for the slightly above-par yield on the
mortgage note and [in part] for the right to service the
loan.'' Culpepper v. Inland Mortgage Corp., 132 F.3d 692, 697-
98 (11th Cir. 1998). Copies of some of the Standard Federal
testimony is enclosed. I can readily furnish additional
testimony if you desire it.
HUD's 2001 SOP is also based on the misconception that the
Eleventh Circuit Court of Appeals' Culpepper decisions made all
yield spread premiums illegal. Nothing could be further from
the truth. The Culpepper decisions made it crystal clear that
borrowers may legally use YSP's to finance closing costs and
that lenders may pay YSP's if their contracts with the brokers
provide for additional compensation for the broker's legitimate
services.\2\ The difference between HUD's approach and the
statute as interpreted by the Eleventh Circuit is that the
Culpepper court's decision limits YSP payments to situations
where brokers are owed additional compensation. HUD, on the
other hand, now advocates allowing brokers to charge more than
borrowers agree to pay.
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\2\ However, as Professor Jackson pointed out in his testimony
before the Committee, using YSP's to finance closing costs often
results in a shockingly high interest rate on the small increment of
additional money that is credited to the borrowers.
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HUD's 2001 policy statement is fundamentally inconsistent
with RESPA's referral fee prohibition. HUD has no power to
interpret RESPA in a manner that frustrates the statute or the
policy underlying the statute. HUD's 2001 policy statement
violates this fundamental rule and is accordingly not entitled
to any deference by the courts.
RESPONSE TO WRITTEN QUESTION OF SENATOR SCHUMER FROM DAVID R.
DONALDSON
Q.1. As an expert testifying before the Committee, would you
agree that individuals should have access to their credit
scores in order to protect themselves from acts of predatory
lending?
A.1. I agree that borrowers should be provided with a copy of
all information provided by the consumer reporting agencies to
third parties along with information explaining how credit
scores are calculated and used. If lenders are forced to stop
offering illegal incentives for brokers to jack up people's
interest rates and if brokers are forced to provide credit
scoring information to borrowers, borrowers will have a
``fighting chance'' to avoid being tricked into originating
``above-par'' mortgages that cost them millions of dollars in
unnecessary interest payments.