This article reviews the changes made to mortgage loan broker (MLB) compensation by the Dodd-Frank Wall Street Reform and Borrower Protection Act.
Mortgage loan brokers (MLBs) were dealt another heavy blow in July 2010 by the Dodd-Frank Wall Street Reform and Borrower Protection Act. Among the various new consumer protection regulations, the legislation has redefined the roles of MLBs and, most importantly, the basis for the income they receive.
It was common practice for lenders to compensate MLBs when a homebuyer accepted a mortgage at a higher rate than the yield rate at which the lender “bought” the loan, called the par rate. This basis of earnings for MLBs, called a yield spread premium, is now prohibited.
Mortgage loan brokers have in the past generated income from borrowers and lenders through various avenues in connection with loan transactions, including:
- referral fees;
- loan origination fees;
- points, discounts and processing fees;
- yield spread premiums;
- administrative fees; and
- commissions based on principal.
MLB income from these sources was rarely disclosed or made known to the buyer. Agency duties owed to the buyer by most all MLBs when arranging a loan create disclosure conflicts for them under California agency law regarding their earnings and benefits for arranging the loan. Further, the income received by the MLB for arranging a loan is a direct result of the homebuyers paying more for their loan than they would otherwise pay if the MLB were not involved.
The new Truth in Lending Act (TILA) legislation has targeted these secret fees, and now requires full disclosure to homebuyers of all fees received by MLBs arranging a loan in a sales or refinance transaction.
The purpose of a mortgage loan broker
An MLB’s role is that of an intermediary between a borrower and a lender. The MLB is considered the agent of the borrower. Individuals becoming homebuyers are not naturally prone to shop for a loan, mainly because they do not know the details of what they are shopping for, other than the loan amount needed to close escrow on a home purchase. As the mortgage market becomes increasingly competitive in the coming recovery, the expertise of an MLB will become useful to homebuyers looking for the best rates and charges.
The traditional relationship between a borrower and a lender is competitive — adversarial in law. Homebuyers looking to finance the purchase of their home with the help of the bank are often ill-equipped to cope with such a tedious, multifaceted task. Most borrowers lack the experience needed to discover what the lender knows about the loan sought and then make an informed, educated decision that will either make or break their financial health for decades to come.
However, the purpose of engaging an MLB as an intermediary breaks down when the MLB receives compensation for helping the lender charge the borrower a higher interest rate, more fees or both. This will not legally happen in the future.
Is a yield spread premium a kickback or bona fide compensation?
MLBs began asserting influence in the real estate market during the late 1980s, which brought yield spread premiums to the forefront of consumer protection legislation efforts through the 1990s.
The Department of Housing and Urban Development (HUD) proposed an amendment to regulations in 1992 that would have required any fee received by an MLB from a lender or borrower, including yield spread premiums, to be disclosed on the HUD-1 Settlement Statement.
However, HUD, under political pressure from lenders who relied on broker- and agent-generated mortgage borrowers, chose instead to leave the legitimacy of yield spread premiums up to interpretation. The controversy surrounded the prohibition of kickbacks and referral fees in the Real Estate Settlement Procedures Act (RESPA), with the exception of bona fide compensation.
Consumer protection advocates argued a yield spread premium qualified as a righteous kickback — an indirect financial reward given out by lenders as incentive to bring them business. MLBs contended they received a yield spread premium as bona fide compensation related to the market value of the service they provided.
The Dodd-Frank Wall Street Reform and Borrower Protection Act, effective in 2012, finally clarifies what RESPA and TILA have hinted at for decades — a yield spread premium is a kickback; and kickbacks are prohibited as unlawful conduct by all involved.