Jack M. Guttentag The Mortgage Professor

This series of articles has explained recent proposals by HUD (the Department of Housing and Urban Development) to make the Good Faith Estimate of fees and charges (GFE) more useful to borrowers. The first two articles covered how the revamped GFE would make it easier for borrowers to shop alternative loan providers (LPs) and would eliminate critical weaknesses of the current GFE that encourage opportunistic pricing. This article looks at proposed revisions in the GFE to make mortgage broker pricing more transparent.

Perhaps the most important proposed change in the GFE -- certainly the most controversial -- is the way it handles payments by lenders to mortgage brokers on higher-rate loans, referred to as yield spread premiums (YSPs). It is alleged that YSPs are often excessive because they are embedded in the interest rate and borrowers are not always aware of them.

Consider the broker who receives wholesale price quotes on a $200,000 fixed-rate mortgage that includes the following possibilities: 6 percent at zero points (points are fees the borrower pays the lender at the time the loan is closed), expressed as a percent of the loan, 5.75 percent at 2 points, and 6.25 percent at -1.5 points. On the last option, the lender pays 1.5 points, the YSP, to get the 6.25 percent rate.

Disclosing the Fee

At 6 percent, the wholesaler does not expect to receive any points, and will not pay any either. If the broker selects the 6 percent rate, he must tell the borrower what his fee is because the borrower will have to pay that fee out-of-pocket: "The price is 6 percent, zero points, and $3,000 for me."

It can and does happen this way, but most brokers find the 6.25 percent option with the 1.5 percent YSP more attractive. It allows the broker to say, "The price is 6.25 percent, with no points and no broker fee." The statement is not correct -- there is a broker fee -- but the borrower is not told what it is.

Why does it matter? Because in the 6 percent case, the borrower might question whether $3,000 wasn't too much, and whether $2,000 might not be more appropriate. In the 6.25 percent case, the broker avoids this question. The proof of the pudding is that, in general, borrowers who pay brokers directly pay less than borrowers who pay through YSP.

Agreeing on Compensation

Under recent proposals by the Federal Reserve Board, a lender would be prohibited from making a payment to a broker unless the borrower and broker had agreed in advance on the broker's total compensation. Before paying a YSP to a broker, the lender would have to check the agreement between the broker and the borrower, as well as the HUD1 closing statement, to make sure that the total amount received by the broker did not exceed the amount agreed upon.

The Board's approach would work, but it is clumsy and places a non-trivial enforcement burden on the lender.

Under HUD's approach, any YSP must be included in the new GFE item "our service charge", which is made up of the total broker and lender fees exclusive of points. If the 6.25 percent rate with YSP were selected, "our service charge" would include the $3,000 YSP and any other LP charges.

The next item on the form is "our credit or charge for the specific interest rate chosen (points)." The GFE here shows whether the borrower is paying points or receiving them. In the case at hand, it would show the $3,000 as a credit for the 6.25 percent rate.

Not the End of Mortgage Brokerage

The third item on the GFE is "your adjusted origination charge", which consists of "our service charge" plus any charge or less any credit for the rate selected. In the case at hand, the "our service charge" of $3,000 less the $3,000 credit for the 6.25 percent rate leaves an adjusted origination charge of zero.

The borrower thus knows that the 6.25 percent rate generates a $3,000 credit to him, and he also knows that the credit is used to compensate the broker. Any inclination to negotiate the broker fee should be the same as in the 6 percent rate case, where the borrower knows he must pay the broker out of pocket.

Many industry trade groups, which defend the ways in which most brokers operate, are worrying that the new GFE will mean the end of mortgage brokerage. That is nonsense; it will merely mean the end of broker deception.