Statement of the National Association of Mortgage Brokers
before the
House Banking and Financial Services
Subcommittee on Housing and Community Opportunity
Subcommittee on Financial Institutions and Consumer Credit
September 16, 1998
Chairman Lazio, Chairwoman Roukema, members of the Subcommittees and distinguished panelists, I am pleased to testify today about the pressing need for mortgage reform. On behalf of the National Association of Mortgage Brokers, I want to sincerely thank both Chairman Lazio and Chairwoman Roukema for their continued leadership in housing affairs and for their interest in achieving fundamental reform of the nation’s mortgage lending process.
NAMB is the nation’s largest organization exclusively representing the interests of the mortgage brokerage industry. NAMB now has more than 9,000 members and 39 state affiliates 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 which promote integrity, confidentiality, and above all, the highest levels of professional service to the consumer.
Today, America 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 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. Conversely, 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. While the number of traditional retail mortgage lenders continues to drop, the number of mortgage brokers is growing. Today, about 27,000 mortgage brokers originate more than half of all residential mortgages in America. The rise of the mortgage broker has been accompanied by a decline in mortgage interest rates and closing costs, an increase in the homeownership rate, 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 mortgage lending through mortgage brokers.
Yield Spread Premiums and Wholesale Lending
Yield spread premiums can be a perfectly legitimate way for borrowers to finance the costs of obtaining a loan instead of paying those costs out of pocket. The very popular "no cost" and "low cost" loans are made possible only through the use of lender-paid mortgage broker compensation, often called yield spread premiums (or "YSPs"). In the case of "no- or low-cost" loans, the mortgage broker’s compensation comes either in part or in whole from the YSP. Approximately 150 class action lawsuits have been filed alleging that the mere payment of a YSP to a mortgage broker constitutes a violation of RESPA’s anti-kickback provisions. The advancement of these suits as class actions relies largely on the argument that the payment or receipt of a YSP constitutes a "per se" violation of Section 8.
In wholesale lending, mortgage brokers perform many of the origination services that otherwise would be performed by lenders. Viewed one way, a mortgage broker provides the wholesale lender with a retail branch office without incurring any of the overhead expenses of a permanent presence. In exchange for the mortgage broker performing origination services that the wholesale lender would otherwise have to, lenders offer brokers wholesale loan rates which are not available directly to the consumer. In general, borrowers do not pay more for brokered loans than for loans originated by a lender’s retail office.
Mortgage brokers are typically involved in two variants on wholesale lending. In the first, the broker performs origination services and the note and security instrument are executed in favor of the lender. In the second, sometimes known as "table funded" loans, the broker provides origination services and closes the loan in its own name, but relies on a lender to fund the loan, and, by prior arrangement, immediately assigns the note and associated security instruments to the lender.
Typically, wholesale lenders offer different interest rates for a given loan product. If the borrower wants a lower interest rate, he must make an additional up-front payment, usually referred to as "discount points". If he does not wish to pay any discount points to lower the rate, he will receive a loan at the retail "par" rate and he will have to pay up-front closing costs. Alternatively, the borrower can have the lender compensate the broker (a yield spread premium) which pays for some or even all of the costs of the broker’s services. The use of the yield spread premium to finance closing costs such as the broker’s fee is critically important to those borrowers short on cash, or who plan to move or refinance within a few years. Moreover, many borrowers simply prefer to pay as little cash towards closing costs as possible. The yield spread premium allows these borrowers the freedom to elect an incrementally higher rate in exchange for the lender paying some or all of the broker’s compensation.
The fees that mortgage brokers receive from borrowers and lenders are permissible under RESPA because they are earned. Brokers provide valuable goods, services and facilities to both borrowers and lenders and in return are entitled to compensation that is reasonably related to the market value of these goods, services and facilities. HUD has identified at least fourteen different tasks performed by mortgage brokers, which include taking applications, preparing numerous required documents, credit counseling, and following up on any conditions of approval that the lender may have (see HUD Opinion Letter dated Feb. 14, 1995). The nature and extent of broker-provided services varies with each loan transaction, but in every transaction these services clearly benefit both the lender and the borrower because no loan would be made unless these services were performed.
Class Action Lawsuits
The lack of clarification on the issue of lender-paid broker fees has already cost the mortgage industry — and ultimately consumers — millions of dollars. The issue at the center of these lawsuits is whether payments by lenders to mortgage brokers are legal under RESPA. Such payments are commonplace and are a predominant source of compensation for mortgage brokers. These fees are legitimate payments for the goods, services, and facilities provided by the mortgage broker. More than 80 new lawsuits have been filed this year alone. Many wholesale lenders, increasingly concerned about their potential liability, are seriously considering withdrawing from wholesale lending if the litigation explosion continues unabated.
If Section 8 of RESPA becomes widely interpreted by the courts as prohibiting yield spread premiums, many of the nation’s mortgage brokers and bankers would be exposed to liability in amounts far in excess of their net worth. If these exposures were reduced to judgments, liability of over $20 billion could be visited upon the mortgage brokerage and mortgage banking industries. Many, if not most, mortgage brokers are sole proprietorships. The average broker exposure could be almost $900,000, an amount sufficient to bankrupt the typical mortgage broker. The insolvency of many current industry participants would significantly disrupt the provision of residential financing to consumers, and would result in the concentration of market power in those firms which manage to survive.
Recent decisions have placed the industry in a renewed state of crisis. On August 11, 1998, the U.S. District Court for the State of New Hampshire issued an order certifying the class of the plaintiffs’ case in Mulligan v. Choice Mortgage Corporation. This is the first time a federal court has granted class action status to a yield spread premium case. While Judge Barbadoro’s decision was not based on the merits of the claims argued in the case, the court certified the class status of three of the five allegations raised in the plaintiffs’ complaint. After a review of the Judge’s ruling, it is clear that the court did not understand the role of the mortgage broker in the origination process. Judge Barbadoro said several times throughout his order that Choice Mortgage provided no goods or services throughout the loan transaction in exchange for the yield spread premium. Furthermore, the court did not understand the difference between wholesale and retail rates, misconstruing that the wholesale rate was available directly to the consumer, and as such, the mortgage broker was charging more than the borrower otherwise would have to pay. Choice Mortgage filed a motion for reconsideration and NAMB has asked the court to accept an Amicus Curiae brief in an effort to help educate the court on the role of mortgage brokers and the differentiation between wholesale and retail lending.
Additionally, on September 4, 1998, the United States District Court for the District of Minnesota issued an opinion in Branchau v. Residential Mortgage and Mercantile Bank of St. Louis. This is the second case where a federal court has granted class certification in a mortgage broker premium pricing class action lawsuit. In this case, unlike Mulligan, the wholesaler, Mercantile Bank of St. Louis, is still a party to the litigation.
These unfavorable rulings stress the need for a legislative solution to the yield spread premium issue. We are certain that Congress never intended RESPA to be interpreted in such a way as to force lenders out of wholesale lending or mortgage brokers out of business. Yet this could happen if these lawsuits are allowed to continue. We have appealed repeatedly to the Department of Housing and Urban Development for clarification of RESPA to stop these lawsuits. But unfortunately HUD has been unable to provide the clarity consumers and mortgage brokers need. While some of this is due to indecision on HUD’s part, HUD officials have said on numerous occasions that they believe RESPA is a "fundamentally flawed" statute that required legislative reform, not regulatory revision.
NAMB has previously testified as to its efforts to provide clarity on the role of mortgage brokers through a straightforward model disclosure that informs the consumer of the nature of their relationship with the broker, and how the broker is compensated. NAMB and the Mortgage Bankers Association of America jointly developed this model disclosure and have distributed tens-of-thousands of copies over the past 14 months. NAMB continues to actively encourage all mortgage brokers to use this agreement.
A new statutory framework should provide consumers timely and meaningful disclosures and industry high levels of certainty in compliance. These two elements are directly related. Without certainty in compliance there is little to no uniformity in disclosure. Without uniformity, a disclosure cannot meet the test of clarity or be an effective tool for comparison shopping. While a myriad of possible disclosure strategies remain under consideration, in the mortgage broker’s experience, which is consistent with the FRB’s survey results, consumers really only want to know a few fundamental things: 1) what is the interest rate and points that I qualify for under a given loan program (i.e., 30-year fixed)?; 2) what is my monthly payment?; and 3) how much money will I need at closing?
Mortgage Reform Working Group (MRWG)
NAMB has been a firm believer in mortgage reform and continues to participate and support the MRWG’s effort to reach consensus on reform. However, because mortgage brokers originate over half of all mortgages in America, they are the most prominent players in the front end of the mortgage lending process, where most of the problems with current laws and regulations are occurring. Mortgage brokers have the most experience dealing with the cumbersome and confusing disclosure rules, as well as with consumers who are often confused by the lending process. Most mortgage brokers are small businesses, and they have found compliance with two different statutes with different regulators to be especially difficult and costly. Mortgage brokers have sought regulatory relief, and absent such relief, the class action litigation crisis continues to threaten the viability of mortgage brokering and wholesale mortgage lending. In this context, mortgage brokers have perhaps the most vital interest in seeking comprehensive legislative reform.
In beginning our quest for an overhaul of RESPA and TILA two years ago, NAMB’s first and foremost pursuit was fundamental fairness and a level playing field for all retail mortgage originators. Other goals included ease in compliance, elimination of the APR, streamlined and more meaningful disclosures, and effective, yet appropriately-scaled, penalties and remedies.
In its involvement in the Mortgage Reform Working Group (MRWG), NAMB is pleased with the progress made in what has informally been known as the "Originators Caucus". This ad hoc group, comprised of the Mortgage Bankers Association of America (MBA), the National Home Equity Mortgage Association (NHEMA), the Consumer Mortgage Coalition (CMC), the Home Equity Lenders Leadership Organization (HELLO) and NAMB, has met extensively for almost a year and has reached consensus on a broad range of reform issues. The caucus just this week presented its joint recommendations to the full MRWG.
From NAMB's perspective, the following are some of the key areas of its reform proposal:
It has long been NAMB's contention that competitive market forces can continue to serve as the greatest and most effective deterrent to fraud and abusive practices. Tens-of-thousands of independent and competitive retail loan sources and uniform and simplified disclosure documents will arm borrowers with meaningful information and powerful leverage in the negotiation of loans which best suit their needs. The time is long gone when any given local market offered just a few competitive sources of residential mortgage loans. The explosion in consumer financial service offerings in general, and the growth of wholesale mortgage lending in particular, assures borrowers in any local market, at minimum, the opportunity for vigorous local competition. As market trends are currently progressing, even under today’s outmoded regulatory scheme, the barriers to entry continue to fall and new market participants continue to enter historically under-served markets. Any changes in public policy should embrace and foster these trends, not inhibit them.
The mortgage brokerage industry, at least that which is represented by NAMB, is willing to take on increased compliance burdens and liability in exchange for being allowed the continued freedom to compete vigorously for loan originations, and pursue further innovation in business practices and loan products. Further, it is NAMB's belief that it is in the very best interest of both industry and consumers to seek a functional regulatory approach, rather than one chained to static and inflexible statutory definitions of the types of market participants. The function, not the individual, should be the focus of a streamlined regulatory framework. The federal government should not artificially restrict the novel forms of organization that can most efficiently undertake originations, loan funding, post-closing asset disposition (so-called "secondary market transactions") and capital replenishment. The "cards" forming the many "decks" comprising the shifting alignments in the mortgage finance delivery system are being constantly reshuffled, with new cards dealt in and out every day. Any refinements in public policy should reflect and embrace these market realities.
NAMB resolutely believes in its continuing role in raising the standards of practice of mortgage brokers. As we have testified earlier before these committees, NAMB members subscribe to a rigorous code of ethics and best business practices. We would hope that in any rewrite of RESPA and TILA, that some mechanism be established to recognize or encourage industry self-regulation and governmental liaison. NAMB has begun to work in earnest with the American Association of Residential Mortgage Regulators in developing universal educational requirements, common licensing criteria and industry credentialing.
NAMB remains firmly committed to consensus reform and to MRWG. We have already made plans, including the allocation of substantial funding, for continued reform consensus building with industry and consumer groups. However we would like to offer a few observations on MRWG’s progress and process to date.
While substantial progress has been made within the subgroups, both formal and informal (in particular the informal Originators Caucus), we have found the larger MRWG group unwieldy. We do not hold out high hopes for achieving a broad-based consensus under MRWG’s present mandate and composition. We believe that substantial future progress will continue to be found in the work of the subgroups. We also believe that the regulatory agencies need to remain involved.
Those who originally called for RESPA and TILA reform, and those who continue to remain most committed in our view, are the representatives of the mortgage finance delivery system. RESPA and TILA do regulate the activities of many other ancillary settlement service providers. However, as long as mortgage finance issues continue to be commingled with the many issues that ancillary settlement service providers have, despite their legitimacy, we believe that there is little hope for true consensus. NAMB suggests that the scope of MRWG be narrowed to mortgage finance issues exclusively.
HUD/FRB Joint Report to the Congress
NAMB wishes to formally acknowledge and thank both HUD and the Board of Governors of the Federal Reserve System for their substantial efforts in presenting a good-faith set of findings and recommendations for the reform of RESPA and TILA in their report. NAMB finds itself in many areas of agreement with the joint recommendations. Not surprisingly, we also disagree on some of the means identified in achieving many of our shared goals.
NAMB shares the agencies’ views that consumers need to be provided simple and effective shopping tools. The report stands as yet another vivid example of the complexity of the reform undertaking in reaching these elusive goals. For example, it is apparent that much work went into their proposed improvement of the APR. NAMB contends that the APR should be eliminated. We do not believe that any re-formulated APR can adequately address the needs of both industry and consumers. Calculation of the present APR, or any conceivable future version, presents a significant compliance burden fraught with a level of legal jeopardy that far outweighs the benefits conveyed to borrowers. The FRB’s own research shows spotty consumer understanding and use of the present APR. If some form of APR is retained, it should be given a different name to eliminate any confusion between the note rate and this composite index. The report’s APR exercise also illustrates the painful reality that once blessed by federal statute, it is extraordinarily difficult to "streamline" or remove anything, despite the very real compliance costs and lack of utility.
NAMB cannot agree with HUD's proposal that to qualify for section 8 exemption, interest rate and points should be guaranteed at the very early stages of a loan application. Such a guarantee at first contact, or within three days (as is the case with the current GFE requirements), is infeasible. NAMB also does not agree that there should be a separate disclosure of mortgage broker fees under any disclosure scenario. A unitary and functional (rather than entity-specific) regulatory approach, coupled with vigorous market competition, are the appropriate cures to any present market imbalances, not the perpetuation of intrusive and ultimately harmful governmental scrutiny.
NAMB agrees with the agencies’ overall goal in providing the earliest possible disclosures to consumers to facilitate shopping. For example, we agree that the Special Information Booklet should be provided essentially at first contact. In addition this booklet should be augmented to include more information, and should be distributed by a broader range of settlement service providers.
There is a delicate balance, however, between early disclosure and certainty. NAMB believes a feasible balance has been struck within the Originators Caucus. NAMB agrees with the Board that initial cost disclosures should be provided no later than three days after application. While the Board recognizes the increasingly important role that technology plays in compressing the time frames between application and loan closing, we believe that it is folly to rely on HUD's statutory recommendation in requiring initial cost disclosures to be provided as early as technology would in theory permit. It is one thing for public policy to foster efficient technological usage. It is quite another to foist the pillars of an important regulatory structure upon the sometimes fragile altar of information technology.
HUD recommends that binding initial disclosures be provided at first contact based on its reading of recent advances in technology. NAMB and other industry organizations are now addressing the many unintended consequences resulting from the rapid adoption of credit and mortgage scoring technologies. These technologies do in fact hold out the promise of continuing the trend of more rapid approvals, expanding mortgage credit opportunities and better industry risk management. However, anecdotes continue to cascade demonstrating the subordination of individual borrower needs to over-reliance on or misuse of some of these cutting-edge technologies. In many tangible and yet undiscovered ways, the full measure of the societal impact of the application of automated underwriting technologies remains yet unknown and unquantified.
NAMB believes that substantive consumer protections should be clarified and enumerated under a new legal framework. There has been, however, an unwarranted emphasis by consumer groups on alleged "black holes" in prevention and legal remedies in the protection of consumer interests. Some $1.2 trillion dollars in mortgage loan originations is anticipated in 1998. This unprecedented volume will involve 8 - 10 million individual mortgage loan transactions. NAMB acknowledges that some egregious and unacceptable examples of fraud and abuse have been uncovered during MRWG’s deliberations and the Congress’s inquiries. But NAMB also believes that much of the anecdotal evidence points to outright cases of fraud, for which state and federal law already provide abundant remedies. In addition, even by including the examples of clear fraud in the pool of transactions that could be deemed "abusive" or "predatory", or in technical violation of RESPA and TILA, the sum of these transactions would likely represent a tiny fraction of a mortgage finance marketplace that is functioning efficiently, within the boundaries of the law, and in the best interests of consumers and industry. Mortgage credit has never before been so universally available; homeownership rates have never before been so high. By any measure, this is the most effective and robust mortgage finance delivery system ever seen in the United States, and the envy of the industrialized world.
NAMB disagrees with the recommendations that HUD alone makes with regard to additional consumer protections. (See page 75, Joint Report). In particular, NAMB is unaware of the existence of any base of reliable empirical data demonstrating loan practices so pervasive and insidious as to require the adoption of a federal unfair and deceptive acts and practices standard for mortgage loans.
There is no need to separately define mortgage brokers as advocated by HUD. As stated earlier in this testimony, NAMB advocates a unified regulatory scheme for all retail loan originators, and readily agrees that mortgage brokers should live under the same disclosure rules and liabilities as any other retail loan originator, however denominated. If consumer confusion exists over the role of the various forms of retail mortgage originators, than all originators should be required to disclose the nature of their relationship to the borrower.
Of all the considerable and well-intended analysis and recommendations offered in the Joint Report, NAMB is disappointed with HUD's continued reliance on the flawed mortgage broker proposed rule and its piecemeal approach. Much has happened in the year since that proposal was published. In particular, NAMB commends HUD for its continued engagement in and encouragement of the reform process, as well as its openness, accessibility and continued interest in reasoned debate on mortgage broker and reform issues. It is in light of HUD's involvement and engagement over the past twelve months (and longer) that NAMB finds it particularly curious to see this regression into reliance on the published proposed rule, a piecemeal approach rooted much more in the past than in moving forward toward the goals of clarity, simplicity and certainty comprehensively addressed in this present fundamental reform effort. (For more details of NAMB’s views on the proposed rule, please see its filing in Docket No. FR 3780-P-08). NAMB continues to respectfully request that the Department withdraw this unworkable proposal.
Conclusion
We are well aware that comprehensive reform of RESPA and TILA is a difficult and controversial task for Congress. We are grateful to you, Mr. Chairman and Ms. Chairwoman, and to the other members and staff of these Subcommittees, for the interest you have shown in tackling this enormous reform process. Over the years, efforts to make piecemeal changes to RESPA and TILA have been fraught with controversy, delay, and political wrangling. A comprehensive overhaul of the statutes would resolve many of these controversies in a unified and rational manner. We in the industry have developed common-sense proposals and are seeking consensus. We remain committed to doing so. Once again, thank you for advancing the case for reform.