Affordable Housing Institute : US

[Continued from yesterday’s Part 1.]

 

Yesterday we discovered that, in being to thine own financial interests true, mortgage brokers claim they work neither for consumers nor for lenders.

 

“Neither a borrower nor a lender work for.

And it shall follow as the night the day.

Thou canst not be sued by any man.”

 

Imposing a fiduciary duty would increase the risk of litigation over whether brokers are to blame for loans that go bad, says Joseph Falk, legislative chairman of the association. He adds that the group favors clear disclosures to consumers and no hiding of important details.

 

Mr. Falk is right — litigation risk would rise.  Yet litigation is also the means of pursuing a legitimate grievance, so its possible rise is not ipso facto proof that adding fiduciary duty would be unwise.

 

 

For now, most states lack any legal provision spelling out whether brokers have a fiduciary duty. Many brokers sell a relatively small range of products without being obliged to make sure the consumer gets the best terms known to the broker on a suitable loan.

 

Yet that’s true of every salesman!  There’s a reason we all know the Latin for caveat emptor.

 

They receive fees — often totaling between about 1% and 3% of the loan, but occasionally even more — for finding customers and guiding them through the loan process.  

 

Even though the fees are expressed as percentages, it’s helpful to think of them in total dollars for the unit service.  Place a $150,000 loan, and the broker may make $1,500 to $4,500.  By itself that’s not a huge amount — provided the borrower (who’s paying it in economic reality) is aware of the charge.  Sometimes, unfortunately, the buyer is unaware:

 

These fees come either from borrowers or through payments from lenders known as yield-spread premiums, or YSP, or through a combination of the two.

 

Fee?  What fee?

 

For the moment this sounds simply like a commission embedded in the calculation of loan total proceeds, but it’s subtler than that:

 

… when the borrower is paying a higher interest rate than the best he or she could qualify for, which makes the loan more profitable for the lender.  

 

If the broker persuades the customer to take a loan whose rate, for one reason or another, is higher than that same lender would offer, one might think that either the lender or the broker would let the borrower know, and adjust the rate downward. 

 

Your broker told us your interest rate should be lower, so here’s a check

 

Not so:

 

Lenders pay YSP to the broker …

 

Got that?  The overcharge, if I may so call it, is pocketed by the intermediary.

 

The higher the rate, the higher the payment to the broker.  (Some lenders put a ceiling on YSP.)  Lenders may also pay brokers a bonus for loans with prepayment penalties, which make it expensive for borrowers to refinance within the first few years.

 

This sounds very much like a commission for overcharging borrowers.

 

YSP amounts to “a payment for giving the homeowner a worse deal,” says Prentiss Cox, an associate professor of law at the University of Minnesota who previously investigated lenders as an official in the state attorney general’s office.

 

It certainly is!

 

In some cases, paying a slightly higher rate and allowing the broker to receive YSP can make sense for cash-strapped borrowers who don’t want to pay an immediate fee to the broker. With YSP, the cost of the broker’s service is spread over the life of the loan in the form of higher interest.

 

If they know they’re being charged it!

 

Yield spread premium?  I can’t see any yield spread premium!

 

But Howell Jackson, a professor at Harvard Law School who has analyzed thousands of home loans, says YSP is confusing for consumers and can allow brokers to “extract excessive payments” from unwary borrowers.

 

For what it’s worth, I’ve never heard of YSP in a residential loan context, and I’m mortified that it’s considered standard practice.  There should be a duty to disclose and adjust before closing.

 

In Washington, legislation was introduced this month by Sens. Charles Schumer (D., N.Y.), Sherrod Brown (D., Ohio) and Bob Casey (D., Pa.) that would impose on brokers a fiduciary duty to put their customers’ interests first. The proposed legislation is considered a long shot for this year.

 

In Minnesota, legislation enacted last month specifies that brokers have “an agency relationship” with borrowers, meaning they must act in a borrower’s best interest and can’t put the broker’s interests first.

 

An ‘agency relationship’ is within putting distance of ‘fiduciary duty’, and gives the consumer the same reasonable expectation.

 

Colorado legislators recently shied away from imposing such a standard. Instead, the state House and Senate passed bills stating that brokers have only “a duty of good faith and fair dealing.”

 

California is an exception. A 1979 ruling by the state Supreme Court established that mortgage brokers there do have fiduciary duties. Pete Ogilvie, president-elect of the California Association of Mortgage Brokers says that hasn’t caused him any problems and clarifies his role.

 

How many mortgage brokers have a code to live by?

 

In AHI’s listing of the right policy questions, I asked:

 

Some systemic weaknesses we’ve seen suggested already are:

 

1.       Should consumers have more disclosure?  Many borrowers claim, very plausibly, that they were duped or at the very least under-informed.

 

As Polonius said it, four hundred years ago:

 

 

For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.

 

In view of the undisclosed and substantial yield-spread premium, and California’s painless adaptation to a fiduciary-duty standard, there’s no question: where California went 28 years ago, the other states should go tomorrow. 

 

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