The following article is reprinted from Basis Points® , Vol. 1, Issue 9, Copyright © 2002, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

Love it or leave it, it is here. HUD's grand design is to fix the mortgage origination process so that borrowers will understand what they are paying and will not feel like they are taken being advantage of. Rather than follow its traditional approach of dealing with narrow, discrete issues, HUD has issued a proposal that, if promulgated in whole, would dramatically remake the mortgage origination process for consumers and trigger major realignments in the way that settlement service providers are selected and compensated.

Background

In 1974, Congress enacted the Real Estate Settlement Procedures Act after finding that "significant reforms in the real estate settlement process are needed to ensure that borrowers throughout the Nation are provided with greater and more timely information on the nature and costs of the settlement process and are protected from the unnecessarily high settlement charges that have developed in some areas of the country." RESPA's stated purpose is to "effect certain changes in the settlement process for residential real estate that will result:

• In more effective advance disclosure to home buyers and sellers of settlement costs;
• In the elimination of kickbacks or referral fees that tend to increase unnecessarily the costs of certain settlement services;
• In a reduction in the amounts homebuyers are required to place in escrow accounts established to ensure the payment of real estate taxes and insurance; and
• In significant reform and modernization of the local record keeping of land title information."

RESPA's requirements apply to transactions involving "settlement services" for "federally related mortgage loans." Under the statute the term "settlement services" includes any service provided in connection with a real estate settlement. The term "federally related mortgage loan" is broadly defined to encompass virtually all purchase money and refinance mortgages secured by one- to four-family residential real property.

RESPA requires HUD to develop and prescribe a standard disclosure form for use in all covered transactions. The form must conspicuously and clearly itemize all charges imposed upon the borrower and all charges imposed upon the seller in connection with the settlement. RESPA also requires HUD to create a form to disclose a good faith estimate of critical costs that will be sent to the borrower at the time an application is taken. The GFE must state the amount or range of charges for specific settlement services the borrower is likely to incur in connection with the settlement.

Section 8(a) prohibits any person from giving and any person from accepting "any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise," that real estate settlement service business shall be referred to any person. Section 8(b) prohibits anyone from giving or accepting "any portion, split, or percentage of any charge made or received" for the rendering of a real estate settlement service

"other than for services actually performed. Section 8(c) of RESPA provides, in part, that [n]othing in [Section 8] shall be construed as prohibiting * * * (2) the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed." * * * or "(5) such other payments or classes of payments or other transfers as are specified in regulations prescribed by the Secretary . . . ."

The GFE Today

RESPA requires the lender to provide a GFE to all applicants for federally related mortgage loans. The suggested GFE format lists 20 common settlement services and provides spaces for the lender to provide a good faith estimate of the charges related to those services. The instructions indicate that any other possible services and related charges must be added to the form. The GFE provides a place for the "amount of or range" of each charge that the borrower is likely to incur in connection with the settlement. Between the name and amount of each charge is a reference to where the same charge will be disclosed on the HUD-1 or HUD 1-A at settlement. If the lender requires the use of particular settlement service provider(s) and requires the borrower to pay for any portion of such provider's services, the rules require that the GFE state: that the use of the provider is required and that the estimate is based on the selected provider's price; the provider's name, address and telephone number, and the nature of any relationship between the provider and the lender. The GFE does not identify the particular items that the borrower may shop for after he has selected a lender or broker, such as a title or settlement agent, title insurance, and a pest inspector.

The RESPA rules require each settlement service fee to be disclosed on the GFE and HUD-1/1A. According to HUD, this rule has led to "an increasing proliferation of enumerated services by individual settlement service providers (e.g., loan originators, title agents, etc.) and an artificial separation and inflation of the total charges of certain settlement service providers resulting in higher total costs to borrowers than a more consolidated list would provide." For example, the current requirements encourage loan originators to charge for several separate "services" - origination, document preparation, and document review. Similarly, title service providers are required to separate their charges into "abstract," "document preparation," "attorney's fees," and other charges. Neither the GFE nor the HUD-1 specify the total amount of fees that each major recipient receives and retains, including the lender, the broker, and the title agent.

Delivery Rule. The RESPA rules require the loan originator (usually the lender, but could be the broker if the broker is the lender's exclusive agent) to provide the GFE either by delivering it or placing it in the mail to the borrower not later than three business days after a loan application is received or prepared. In practice, some loan originators insist that the borrower complete a full application form and pay a significant fee to cover the costs of an appraisal and credit check before a GFE is provided. Therefore, by the time the borrower receives a GFE he or she has typically already selected a particular loan originator, and paid substantial fees, and is highly unlikely to shop further for another loan originator. In addition, because the GFE is not generally provided until the borrower applies for a loan, the form does not provide borrowers with enough time to focus on and compare the full costs of the originator and other major recipients of fees, nor does it indicate clearly other individual settlement services including title services that the borrower may shop for. As a result, consumers must shop on their own without the aid of a GFE, if they shop at all for mortgage loans.

Mortgage Brokers

At the time RESPA was enacted, single-family mortgages were mainly originated and held by savings and loans, commercial banks, and mortgage bankers. During the 1980s and 1990s, the rise of secondary mortgage market financing resulted in the emergence of new retail entities, notably mortgage brokers, to compete with traditional mortgage originators, lending institutions, and mortgage bankers. Today, mortgage brokers are estimated to originate more than 60% of the nation's mortgages.

Mortgage brokers provide retail lending services, including counseling borrowers on loan products, collecting application information, ordering required reports and documents, and otherwise gathering data required to complete the loan package and mortgage transaction. As retailers, brokers also provide the borrower and lender with goods and facilities such as reports, equipment, and office space to carry out retail functions. The amount of work mortgage brokers provide in particular transactions depends, in part, on the level of difficulty involved in qualifying applicants for particular loan programs. Differences in credit ratings, employment status, levels of debt, assets, and experience frequently translate into varying degrees of effort required to originate a loan. Also, mortgage brokers may be required to perform different components of origination services (i.e., underwriting) pursuant to specific agreements with individual wholesale lenders.

Mortgage brokers have various means of obtaining funding for the loans they originate. Some mortgage brokers close mortgage loans in their own name but, at the time of settlement, transfer the loan to a lender that simultaneously advances funds for the loan. Immediately after the loan is consummated, the mortgage broker delivers the loan package to that lender, including the promissory note, mortgage, evidence of insurance, and all rights in the loan that the mortgage broker held. This type of transaction is known in the lending industry, and defined in HUD's regulations, as "table funding."

Mortgage Broker Functions and Direct Compensation. Since the advent of mortgage brokers in the mid-1980s, borrowers have been confused concerning the mortgage broker's functions and fees, - i.e., whether brokers do or do not shop on the borrower's behalf, as well as how they are paid and how much they are paid, and by whom.

Some mortgage brokers promise borrowers that they will act as an agent to shop for the best mortgage loan for the borrower. Other brokers state that they work with a number of funding sources to provide loans, and will arrange a favorable loan with one of them for their borrower. Whether brokers serve as the borrower's agent as a strict legal matter, the fact is that many brokers try to create the impression that they are acting on behalf of the borrower to help the borrower find the best loan to meet the borrower's needs.

Mortgage brokers receive compensation for their services by various methods. A broker may be paid directly by the borrower, indirectly by the lender or wholesale lender who purchases the mortgage loan, or through a combination of both. Brokers may charge borrowers directly at or before settlement for loan origination as well as for other services including the application, document preparation and document review. In some cases, a broker may denominate its fees as an origination fee and other times as "origination points," plus additional fees for named services (e.g., application fees, document preparation fees, processing fee, etc.). Again, HUD's own rules on how to complete the HUD-1 are at fault to a great degree for this "menu of fees" approach. For years, HUD's philosophy was "disclose everything in the greatest detail possible and let the borrower sort it out." Only recently has HUD stepped back to look at the big picture and realized that borrowers have neither the time, the tools, nor the inclination to sort this out.

Indirect Compensation. When a broker receives a payment for compensation from someone other than the borrower, HUD calls this "indirect compensation." Indirect compensation paid by a lender is ordinarily based upon an above market interest rate on the loan. This type of compensation is often referred to as a "yield spread premium" (YSP), though it sometimes shows up under a different label, e.g. "servicing release premium." A YSP can reduce up front settlement costs to a borrower by building these costs into the borrower's interest rate and monthly payments over the life of the borrower's loan. HUD has consistently held that borrowers should have the choice of paying their total settlement costs up-front or using the yield spread premium payment as a credit to pay all or part of these costs. However, consumer advocates assert that, all too frequently, brokers place the borrower in an above par rate loan without the borrower's knowledge, provide the borrower with little or no benefit in the form of reduced up front costs, and use the YSP payment solely or primarily as a means of increasing their total compensation. Brokers, of course, view that same business transaction as an absolute right and argue that it is no different from what a lender does when it obtains an advance commitment to purchase from the secondary market and then builds the borrower's rate and fee combo base on what the lender would like to earn in the transaction.

The Proposed Rule

The Proposed Rule has three main objectives:

• Put the borrower in charge of yield spread premiums;
• Significantly improve the GFE so that the GFE facilitates shopping for mortgages and prevents brokers or other third parties from adding unexpected charges at settlement; and
• Permit guaranteed packages of settlement services and mortgages to be made available to borrowers, to make mortgage shopping easier.

The New GFE. A new format for the GFE is set out in Appendix C to the proposed rule. The "loan originator" must provide the following information in the model format:

• Property address;
• Loan amount;
• Interest rate used to calculate the estimated amounts;
• Annual Percentage Rate (APR) for the loan including mortgage insurance;
• Monthly payment for principal and interest and mortgage insurance;
• Whether the loan is an adjustable rate mortgage;
• Whether the loan contains a prepayment penalty clause;
• Whether the loan contains a balloon payment;
• Functions of the originator; and
• The total amount of charges for each category of the following service categories:
  • Loan origination,
  • Interest rate dependent payment,
  • Lender required and selected third party services,
  • Title services and title insurance,
  • Shoppable lender required third party services,
  • Government services,
  • Amounts for escrow/reserves, per diem interest, hazard insurance and optional owner's title insurance.

Attachment A-1 of the good faith estimate must indicate the subtotals of the origination charges to the lender and to the mortgage broker, and the subtotals of all the charges and fees for title and for settlement agent services.

Who is the "loan originator?" The GFE must be prepared and delivered by the "loan originator." Generally, this is the lender. However, if a mortgage broker who is not the lender's exclusive agent receives the application, then the broker must provide the GFE. The lender/broker must provide the good faith estimate either by delivering the good faith estimate or by placing it in the mail to the loan applicant, not later than three business days after an application is received or prepared. If the application is denied before the end of the 3-business-day period, the lender/broker need not provide the denied borrower with a good faith estimate.

What fees may the originator charge for the GFE? Neither the lender nor the broker may collect any fee in connection with the application or the good faith estimate beyond that which is necessary to provide the good faith estimate. Note that the rule is not at all clear on what type of fee falls into this category. However, one of the purposes of the new rule is to make it easier for consumers to obtain the GFE so that they can shop between loan originators more competitively. With this in mind, HUD would limit fees paid by the borrower for the GFE, if any, to the amounts necessary for the originator to provide the GFE itself. The fee could not include amounts to defray later appraisal or underwriting costs. While HUD recognizes that there may be costs attendant to obtaining credit information from third parties and evaluating that information manually and/or electronically, it does not believe that preparing/delivering the GFE requires you to undertake a full underwriting and appraisal process. Under the approach HUD takes in the proposal, the GFE is expressly subject to underwriting and appraisal. Therefore, according to HUD, any charge at the time of application should be limited only to those costs that result directly from providing the GFE.

Of course, HUD would also like the rate and terms disclosures to be accurate. It refuses to deal with the hard issue: how does one create an accurate estimate of the rate/loan program that the borrower can rely on for shopping purposes without incurring any cost? Reading between the lines, the answer is that HUD would like the industry to treat the preparation of GFEs as a marketing expense that gets folded into general overhead/cost of doing business rather than a cost that is recovered on a loan-by-loan basis. HUD would like originators to hand out accurate GFEs for no cost to the borrower. HUD would prefer that originators not impose any charge for a GFE, because providing a GFE before the payment of any fee will further facilitate shopping. We shall see how this one turns out.

What is an "application?" An "application" is a request for a federally related mortgage loan that includes very basic credit information such as Social Security number, property address, basic income information, the borrower's information on the house price or a best estimate on the value of the property, and the mortgage loan needed submitted by an applicant in anticipation of a credit decision. It could be oral, written or electronic. If the applicant does not state or identify a specific property, the request is an application for a pre-qualification and not an application for a federally related mortgage loan.

You must describe the loan originator's function. The proposed GFE requires that loan originators describe their services. Note that the proposed form imposes this requirement on both a lender acting as a loan originator and a on broker acting as a loan originator. In fact, the sample language for this disclosure is written so that the borrower will not know whether he or she is dealing with a lender or a broker. Ask yourself why you need a description that is so vague that a reasonable borrower will not even know whether he or she is dealing with a lender or a broker. No, better still. Ask HUD.

According to HUD, the new language will help borrowers avoid confusion about the role that brokers may play. It will disabuse borrowers of the notion that brokers are their agents, automatically shopping for the borrower. According to HUD, this magical disclosure combined with a revised "Settlement Costs and You" booklet will give borrowers the tools to understand that they must rely on themselves to know what is in their best interests instead of relying on the broker. Isn't that a wonderful accomplishment? A four-line disclosure that is so vague you can't even tell whether it comes from a lender or a broker, buried among about 20 pages of other mandatory disclosures (and this is just RESPA, it does not include the myriad other pages of mandatory application disclosures under other federal and state laws), is supposed to protect the borrower from the sales pitch of today's population of mortgage brokers. Who's kidding whom?

The yield spread premium disclosure. Under the new GFE, you would have to show borrowers the effect of alternative interest rates and their effect on monthly payments and cash needed for settlement. The GFE would inform borrowers that they have the options to pay settlement costs:

• Through cash payments at settlement;
• By borrowing additional funds to pay settlement costs;
• By paying settlement costs through a higher interest rate and higher monthly payment; or
• By lowering the interest rate and monthly payment by paying discount points.

Under HUD's current rules, the GFE must identify the broker's direct charges while all indirect payments, including yield spread premiums, are disclosed separately as "Paid Outside of Closing" (P.O.C.). The existing disclosure requirements and instructions do not make clear to the borrower the broker's total charges so that the borrower can focus on them, shop among brokers, or negotiate these total costs with the broker. According to HUD, many borrowers conclude incorrectly that such indirect payments have no effect on their loan costs.

Under the proposal, the borrower would instead receive a consolidated figure made up of the sum of total origination charges of the mortgage broker and the lender. This approach of providing total origination charges initially is taken to assist borrowers in comparing total origination charges of brokered loans to loans originated by lenders. At the same time, it ensures that the borrower knows the broker's and lender's charges. For mortgage brokers, these charges include all charges from the borrower that are paid to the mortgage broker for the transaction. For lenders, these charges include all or any portion of direct charges from the borrower that the lender receives for the transaction, other than discount points.

A major provision of this rule is the requirement that in all loans originated by mortgage brokers, any payments from a lender based on a borrower's transaction, other than a payment to the broker for the par value of the loan, including payments based upon an above par interest rate on the loan (including payments formerly denominated as yield spread premium), be reported on the GFE (and the HUD-1/1A Settlement Statement) as a lender payment to the borrower. Additionally, the rule would require that any borrower payments to reduce the interest rate (discount points) in brokered loans must equal the discount points paid to the lender, and be reported as such on the GFE (and HUD-1/1A) as a borrower payment to the lender. These changes would require mortgage brokers to disclose the maximum amount of compensation they could receive from a transaction, by including the amount in the "origination charges" block of the GFE, and indicating the amount of the lender payment to borrower that would be received at the interest rate quoted, if any. Mortgage brokers would be unable to increase their compensation without the borrower's knowledge, by placing the borrower in an above par loan and receiving a payment from the lender (yield spread premiums), or by retaining any part of any borrower payment intended to reduce the loan rate (discount points).

HUD believes that these changes will eliminate virtually all disputes regarding broker compensation in table-funded transactions and intermediary transactions involving yield spread premiums will be resolved. All mortgage broker compensation will be reported as direct compensation in the origination block of the GFE, maximum broker compensation will be clear and brokers will have no incentive to seek out lenders paying the largest yield spread. They will, instead, be motivated to find the best loan product they can for the borrower.

At the same time HUD has not taken away from borrowers the ability to select a higher rate loan in order to pay settlement costs (including, where the borrower so chooses, broker compensation), or to pay additional sums at settlement in order to lower their interest rate and monthly payments.

HUD has long recognized that these financing tools provide flexibility and have value to borrowers in specific circumstances. The Department emphasized this point most recently in Statement of Policy 2001-1. HUD's proposed rule, therefore, preserves these options, but seeks, to the maximum extent possible within the Department's statutory and regulatory framework, to eliminate the possibility of abuse in the application of these financing tools, by ensuring that the full value of selecting either option is known and redounds to the borrower.

Accuracy. The amounts disclosed in the categories of loan origination charges, lender-required and selected third party settlement service provider charges, lender selected title services and title insurance, and governmental fees and charges may not vary from the time the loan originator delivers the GFE to the borrower absent unforeseeable and extraordinary circumstances. The estimates in the good faith estimate must be open to the borrower for a minimum of 30 days from when the document is delivered or mailed to the borrower. Within the 30 days the borrower must agree to go forward and pay the additional money to complete the underwriting process. If the offer expires, the borrower may ask the loan originator to ratify the estimate or request a new one. If the cost at settlement exceeds the estimate reported on the GFE, absent unforeseeable and extraordinary circumstances, the borrower may withdraw the application and receive a full refund of all loan-related fees and charges. The loan originator must document any such circumstances and retain the document for five years after the settlement.

The amounts for lender required third party services must include an estimate of the maximum mortgage insurance premium to be charged upfront to the borrower based upon the borrower's assertion of the value of the property and loan amount needed and indicate that the mortgage insurance premium may decrease or be removed after full underwriting.

The amounts of the categories of borrower-selected title services and title insurance, shoppable lender-required third party services, and reserves/escrow deposits charged to a borrower may not vary at settlement by greater than a tolerance of 10% from the amounts for such categories reported on the good faith estimate, except when a borrower chooses to purchase a more expensive service, absent unforeseeable and extraordinary circumstances.

The amounts of the categories of per diem interest, hazard insurance and optional owner's title insurance must be prepared based upon the originator's knowledge of relevant prices, but are not subject to tolerances.

In mortgage broker loans, the borrower payment to the lender for a lower interest rate must be paid in full to the lender and the lender payment to the borrower for a higher rate must include any lender payments for the transaction other than for the par value of the loan.

Loan originators must include all charges correctly within their prescribed category on the good faith estimate and not include any "mark ups" or "up charges" in their estimates of charges for categories III(C) through (J) of the good faith estimate. The loan originator must include all of its charges in the origination charges and interest rate dependent categories.

No loan originator may be held responsible for charges imposed on the borrower at settlement for shoppable lender required third party services unless the borrower asked where the services could be obtained within the tolerance, used a settlement service provider identified by the originator, and was charged an amount in excess of the tolerance.

The Guaranteed Mortgage Package

Somebody up there in L'Enfant Plaza was smoking something good. How else could they decide that the best way to prohibit kickbacks and referral fees is to legalize them all? Nothing in the proposal is as creative or controversial as the "Guaranteed Mortgage Package" or the "GMP." From its inception, if RESPA has stood for anything, it has stood for the proposition that it is unlawful to pay and unlawful to receive kickbacks, referral fees and unearned payments. HUD has even gone so far as to suggest that you commit a crime under RESPA if you mark up the price of your own services. Now, all of that angst drifts away like smoke on the water, replaced by the new miracle baby, the GMP. It's like the DEA deciding to solve its ongoing battle against the marijuana trafficking problem by declaring it lawful when smoked in groups. Or like our President saying that the best way to preserve the Alaska National Wildlife Refuge is to let the oil companies pump oil out of it. You get the picture.

What is a GMP? It is a guaranteed package of mortgage related settlement services and an interest rate guarantee for a federally related mortgage loan that is offered to a consumer under a Guaranteed Mortgage Package Agreement (GMPA). We'll try to say that again in English a little bit later.

What do you get for a GMP? The people participating in a GMP get a safe harbor from all of the criminal and civil liability that attaches to Section 8 violations. No questions asked. All payments, however structured, regardless of incentive - lawful.

In order to qualify for the safe harbor, you must deliver a guaranteed mortgage package offer to the borrower within 3 days of application or such time as may be reasonable in special cases but prior to the borrower paying any fee. The offer must include the following.

• Guaranteed price for origination services. A package of settlement services at a guaranteed price. The borrower has 30 days (or longer if you want to be generous) from the date the offer is delivered or mailed, to accept the offer. The package must include all application, underwriting, origination, appraisal, pest inspection, flood review, tax review, title services, insurance, and governmental charges and any other services the lender requires the borrower to pay for in order to get the loan.
• Guaranteed rate and APR. A guaranteed interest rate and Annual Percentage Rate (APR) provided that the interest rate may float or adjust based on movement in a observable and verifiable index or other appropriate measure; and
• Written agreement. A written agreement that conforms with the format set out in the rule and that:
  • Explains that the guaranteed mortgage package includes necessary settlement services required by the lender and guarantees a package price for these services through settlement provided that the borrower accepts the GMPA within 30 days, or such greater period offered by the packager, from when the document is delivered or mailed to the borrower;
  • Commits the packager to provide all settlement services and includes all charges required to complete your mortgage except those specified as other required settlement costs and advises the borrower if the packager anticipates whether a pest inspection, lender's title insurance, credit report, and/or appraisal will be anticipated;
  • Identifies and provides estimates for other required settlement costs, such as per diem interest, reserves/escrow, and hazard insurance, and optional owner's title insurance and explains that any required settlement costs not separately itemized and estimated are the responsibility of the packager;
  • Identifies and explains any borrower option to utilize payments to or from the lender as a result of the interest rate to pay settlement costs or adjust the interest rate and mortgage payments;
  • Identifies any reports such as the pest inspection, lender's title insurance, appraisal or credit report that are available to the borrower at the borrower's request;
  • Specifies that the packager will ensure that a mortgage loan is provided as part of the package and that, after acceptance by the borrower and the lender, the lender participating in the package will provide a loan with the same terms as set forth in the agreement;
  • Advises the borrower of whether the loan is an adjustable rate mortgage and the terms of the mortgage, whether there is a prepayment penalty and that the borrower can request its terms, whether there is a balloon payment, whether the guaranteed mortgage package price includes an upfront maximum mortgage insurance premium based upon the borrower's assertion of the value of the property and loan amount needed and that the mortgage insurance premium may decrease or be removed after full underwriting; and
  • Commits the packager to the terms of the guaranteed mortgage package agreement upon borrower acceptance and payment of any fee, subject only to acceptable final underwriting and property appraisal.

Final thought. Where will all of this take us? It cries out for some one to become the portal for the industry. Who will that be? The lenders? The title companies? Will it turn the settlement business from a bunch of small Mom and Pop businesses to a couple of large conglomerates? No one knows. Least of all HUD. The comment period remains open until October 28, 2002. For more information, look for 67 FR 49134 (July 29, 2002).

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Basis Points® is a concise, easy-to-read, monthly legal update for the mortgage lending industry. Basis Points® addresses complex legal issues from an industry perspective and keeps you informed on new legal developments affecting your business. Written in plain English, Basis Points® provides familiar factual scenarios, identifies the legal issues involved, presents real court resolutions and suggests how you might avoid similar legal pitfalls. Topics featured in Basis Points® include: Predatory Lending; Yield-Spread Premiums; RESPA - Fee Splitting and Up charges; Privacy; RESPA - Joint Venture; Bankruptcy; Fair Lending and Discrimination; and Truth in Lending/ Regulation Z. Basis Points® is published by CounselorLibrary.com, LLC, an affiliate of the Hudson Cook, LLP law firm. The CounselorLibrary.com, LLC is also the publisher of CARLAW®, HouseLaw®, Spot Delivery®, and the Counselor Library Series. For more information, please visit: www.counselorlibrary.com.