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Congressional Testimony
January 8, 2002 Tuesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 3484 words
COMMITTEE:
SENATE BANKING HOUSING AND URBAN AFFAIRS
HEADLINE: PREDATORY LENDING PRACTICES
TESTIMONY-BY: IRA RHEINGOLD, EXECUTIVE DIRECTOR
AFFILIATION: NATIONAL ASSOCIATION OF CONSUMER ADVOCATES
BODY: Hearing on "Predatory Mortgage Lending
Practices: Abusive Uses of Yield Spread Premiums."
Prepared Statement of
Mr. Ira Rheingold Executive Director National Association of Consumer
Advocates
Tuesday, January 8, 2002
Mr. Chairman and Members of
the Committee, the National Association of Consumer Advocates 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.
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. I. 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. This rather simple provision was the product of much
debate in Congress and was created in 1974 because of the widespread recognition
that referral fees and kickbacks were making the market place anti-competitive
(home buyers 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). 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 (ysps) enters our story.
In a nutshell, ysps 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
s/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 ysps 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 didn't
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 five years
running a foreclosure prevention project in Chicago, I have had the opportunity
to review hundreds and hundreds of loan documents. I've 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 and objective study bear this
observation out. This reality begs two questions. First, if ysps 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?
The answer to the first
question is very simple. Ysps 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.
II. 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. 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:
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.)
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, while a few federal
district courts did permit the class actions to proceed. This scene changed
significantly however, when the 11th 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.
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. The court found class certification appropriate
because - 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.
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."
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 11th Circuit court's analysis. The stated
rationale was simply to "clarify" the "ambiguity" in the Policy Statement.
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:
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.
The industry portrayed a "clear rule" for the future as
an appropriate trade-off for the requested "clarification of the 1999 Statement
of Policy." 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.
II. 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.
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.
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."
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. . .
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 the Congressional
directive in RESPA.
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 up-front 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.
III. 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. 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.
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."2
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
up-front closing costs required to be paid from cash or equity. We as consumer
advocates agree. We think the following principles , if followed, would
guarantee that yield spread premiums would be legal and beneficial for
consumers.
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 anti-competitive 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 anti- competitive marketplace that currently exists. HUD's
ultimately cynical policy clarification was not only disappointing but 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 in practice
actually do.
LOAD-DATE: February 4, 2002