This article examines the scope and disclosure requirements of the federal Real Estate Settlement Procedures Act (RESPA).
The scope of RESPA regulation
A lender or broker who makes or arranges federally-related loans must comply with the requirements of the Real Estate Settlement Procedures Act (RESPA), also known as Regulation X.
A federally-related loan is a loan secured by a trust deed lien on:
- one-to-four unit residential property; or
- manufactured housing;
- made by a lender who annually invests or originates loans retained in the lender’s portfolio totaling over $1,000,000;
- made by a federally insured bank or thrift;
- eligible for purchase in the secondary mortgage market by the Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) or the Government National Mortgage Association (Ginnie Mae); or
- is insured by the Federal Housing Administration (FHA) or the Veterans Administration (VA). [24 Code of Federal Regulations §3500.2(b)]
While a private lender or broker who makes or arranges a federally-related loan is subject to RESPA requirements, neither a carryback seller nor the broker who arranges a carryback sale are subject to RESPA requirements.
RESPA also establishes regulations for servicing and managing impound accounts on federally-related RESPA loans. [24 CFR § 3500.21]
RESPA and TILA disclosures
Under RESPA, any broker who originates, or any private lender who funds, the purchase of a principal residence must provide the buyer with a good-faith estimate (GFE) of all the transactional costs. The GFE discloses all loan related charges on loans used to purchase or refinance one-to-four unit residential properties, such as origination fees, credit report fees, insurance costs, and prepaid interest. [12 CFR §226.19]
The RESPA lender must provide the buyer with the following:
- a GFE of all loan related charges listed in lines 700-1305 of the HUD-1 statement within three days after the lender’s receipt of the borrower’s loan application [24 CFR §3500.7; see first tuesday Form 204 (Department of Real Estate Form RE 883)];
- a copy of the Department of Housing and Urban Development (HUD)-published Special Information Booklet within three days after the lender’s receipt of the borrower’s application [24 CFR §3500.6]; and
- if the lender is the settlement agent, a HUD-1 or HUD-1A closing statement detailing all charges, to be delivered upon closing of the purchase escrow. [24 CFR §3500.10(b); see first tuesday Form 402-1]
On adjustable rate mortgages (ARMs), the lender must inform the buyer not only of the interest rate, but also the index, margin, and payment and interest rate caps.
Additionally, Regulation Z, also known as the Truth in Lending Act (TILA), covers not only all RESPA loans, but extends to any loans which fund the borrower’s personal use. Reg Z personal use loan transactions include loans where the proceeds are used primarily to fund:
- the purchase of real estate for the borrower’s personal use, such as a principal residence or a vacation home;
- the purchase of other personal items, such as a car or household furnishings; or
- the refinancing of personal debts which may or may not be secured by real estate.
The purpose of TILA disclosure requirements is to promote homeownership through informed use of consumer credit and to discourage unnecessary or hidden costs to be charged to the buyer during a loan transaction. These objectives are accomplished through comparative analysis provided by a uniform set of disclosures from competing lenders. [12 CFR 226.1(b)]
For related reading providing a full review of the federal Truth In Lending Act (TILA), please [click here].
RESPA and the California-specific MLDS disclosure
In California, all brokers making or arranging a loan must provide a mortgage loan disclosure statement (MLDS) to a borrower within three business days of receiving a completed loan application, a legislative scheme called Cal-RESPA since it adds disclosures to those required by the federally regulated RESPA. The contents of the California MLDS include the RESPA-required GFE. It is required practice in California to provide the MLDS when arranging any real estate loan in order to cover both state-specific and federal requirements. [See first tuesday Form 204 (DRE Form 883)]
Duplicate charges for services
Real estate sales transactions during periods of rising property values are increasingly subject to duplicate charges imposed on both buyers and sellers by brokers, lenders, escrow agencies and title companies. Duplicate charges for integral services, called kickbacks or hidden costs based on who ultimately receives the funds, are redundant and constantly experienced by the buying and selling public.
Public policy and sound economics suggest that duplicate charges are improper and make the real estate market more inefficient. They usually result from the systematic elimination of more competent and less costly competition. Kickbacks to listing and selling brokers (and builders), which are a violation of federal RESPA laws, are openly undertaken by some mortgage bankers, to say nothing about the conduct of the largest title insurance companies, in an illegal effort to garner a larger share of the available business.
Kickbacks are a corrupting business policy. Legitimate operators find it difficult to compete with fraud without also stooping to the same fraudulent actions to meet the corrupt competition. Kickbacks, in the form of referral fees or other indirect financial benefits used to steer or capture business, interfere with the availability of lower rates and fewer charges. The buyer is referred to the lender (or title company) providing the kickback and away from the legitimate non-participating competition who will not take part in the consumer fraud.
All brokers and sales agents when acting in the capacity of a licensee are prohibited from accepting a referral fee for referring parties involved in the transaction they are negotiating. Referral fees from escrow companies, escrow officers, pest control operators, security providers, and title insurance companies are prohibited by state law. Legislation does not, but should, prohibit referral fees from lenders or anyone else who renders services as a third party in a real estate related transaction in which a broker is collecting a fee for acting on behalf of a principal. [Calif. Business & Professions Code §10177.4]
Real estate agents who are employed by a broker (which they must be to act as a licensee) face a similar prohibition in real estate transactions. Agents acting under their license are prohibited from accepting a fee or other benefit from any person other than their employing broker, or from themselves paying a fee to any other broker or agent without first directing the payment through their employing broker. [B & P Code §10137]
For example, a licensee, be he a broker or agent, refers a prospective client to another agent under an agreement to split the fee 50:50 between the other agent and the referring licensee. While the broker’s agent can agree to do so, unless prohibited by his employing broker, the agent is acting on behalf of his broker. Thus, the agent must instruct his employing broker to make the payment of the referral fee to the other agent’s broker out of the funds earned by the agent as a result of the referral. The agent may not first receive the fee due him from his broker and then pay the referral fee directly to the referring licensee.
Most importantly, the broker or his agent must advise their client of the dollar amount of any referral fee or benefit they receive from any provider of services relating to the real estate transaction the agent is participating in. If the fee or benefit received as compensation for the referral is not disclosed, this non-disclosure is punishable by suspension or revocation of the employing broker’s or his agent’s license, or both. [B & P Code §10176(g); see first tuesday Form 119]
Double fees, padded charges
Lenders improperly label all charges listed on loan disclosure estimates as fees. In truth, three types of lender charges exist:
- fees for lender-performed services integral to the administrative process of originating a loan;
- costs incurred and paid by the lender and passed on to the borrower for services performed by third parties (such as appraisers and credit reporting agencies); and
- prepaid interest in the form of loan discounts, points, and origination fees used to buy-down the interest rate from the lender’s par rate or to produce additional earnings for the lender to cover referral fees, etc.
Thus, three forms of lender kickbacks exist:
- fees charged twice for the same loan origination service, usually fragmented into several listed services, the aggregate of which are simply the minimum necessary loan origination activities for which lenders charge a fee;
- padded charges which overstate the lender’s actual out-of-pocket costs for third party services, or are paid to third parties for steering business to lenders; and
- higher interest rates charged on loans than the lender’s par rate to provide funds in excess of the note amount through table funding or later resale of the loan to provide additional earnings for the broker and pay referral fees to escrows, agents, builders, and others who already provide a non-lender service for which they are receiving a separate fee from the principal in the transaction.
RESPA restricts no-service, second-fee schemes
RESPA establishes a no-service, no-second-fee restriction on real estate brokers and agents who are already acting on behalf of a buyer or seller in a real estate transaction financed by a RESPA loan. A lender is prohibited from paying brokers and their agents a fee when the broker is already receiving a fee on the sale for brokerage services they have rendered on behalf of a buyer or seller, unless the broker performs significant services on behalf of the lender. Thus, a broker or agent may receive a second fee if they render loan origination services which would otherwise be performed by the lender. However, a second fee cannot be paid if it is to be received by the agent from the lender or loan broker for acting only as a referral agent in the lending process.
For example, a broker and his agent are entitled to a second fee in a sales transaction if the fee is for their handling the loan escrow or processing a loan application and loan documents, services which are significantly more involved than the act of a mere referral of the buyer in their sales transaction to a lender or loan broker.
A lender or sales broker are in compliance with the no-service, no-second-fee rule if the earnings the broker is to receive for the second service were due the sales broker as:
- payment for goods; or
- payment for services rendered, other than the referral. [12 United States Code §2607(c)]
Before a broker and his agent who are to receive a brokerage fee on a sales transaction can accept another fee for an additional second significant service, such as a fee paid by a lender to the sales broker (or agent), the broker or the agent must perform at least five loan origination activities normally performed by the lender or a loan broker. Further, if sufficient loan origination activities are performed by the broker or his agent, then the second fee for loan related services must be justified as a dollar amount others would be paid to competitively perform the same services.
The minimum number of loan origination services which must be performed by the sales broker or his agent before any fee can be justified begins with the sales broker’s or his agent’s preparation of the loan application based on information they obtained from the buyer seeking the purchase-assist loan, and must include at least five of the following loan origination services:
- pre-qualify the buyer/borrower to determine the maximum loan amount he can afford by analyzing the buyer’s/borrower’s income and debt;
- advise the buyer/borrower on the home-buying and purchase-assist loan process, about the different types of loans available, and the variations in costs, rates, and payments on the various loans;
- gather financial information from the buyer/borrower such as tax returns, profit and loss statements, bank statements, and balance sheets needed to complete the application process;
- order out verifications of employment and cash deposits;
- order out requests for loan verification on other debts owed by the borrower;
- order out the appraisal to determine the property’s fair market value (FMV);
- order out property inspection and engineering reports;
- review with the buyer/borrower the process for clearing credit problems which might arise;
- apprise the buyer/borrower, broker, and lender of the status of the application and what further information or documentation each needs to close by conducting regular contacts after taking the loan application and continuing until the close of the transaction;
- order out legal documents (statements) which are required for escrow to close, or a policy of title insurance to be issued;
- order out a flood hazard report on whether the property is located in a flood zone; and
- assist as an active participant in the closing of the loan. [HUD Policy Statement 1991-1, Section C]
However, should the broker or his agent complete an application, and the five loan origination activities performed are related only to counseling (as contrasted to loan documentation efforts), then the sales broker or his agent must:
- present and advise the buyer/borrower on the availability of loans from at least three different lenders (to avoid steering the buyer/borrower to a single lender):
- be paid a fee for his counseling services regardless of which lender is ultimately selected by the buyer; and
- inform the buyer/borrower that the fee paid for the broker’s loan origination services is a competitive rate based on the value of the services rendered, and not contingent or based on the loan amount or type of loan originated with the referred lender.
The yield spread premium (YSP)
Consider a buyer of real estate who contacts a loan broker for a purchase-assist loan. The loan broker assists the buyer in completing the loan application, counsels the buyer on loan programs, requests and gathers financial data on the buyer, analyzes the buyer’s debt and income ratios, arranges appraisals and inspections, and prepares and hands the buyer RESPA disclosures, Reg Z disclosures, and other required notices. The loan broker then submits the loan package to the lender for approval. [See first tuesday Forms 201 and 202]
As compensation, the loan broker agrees to receive a 1% loan origination fee under his loan broker retainer/listing agreement. In addition, the lender agrees in a rate sheet to pay the loan broker a fee should the buyer agree to a higher rate than the lender’s par rate quoted for the loan, a fee called the yield spread premium (YSP). Total compensation paid by the borrower and the lender to the loan broker is around 2.5% of the loan amount. [See first tuesday Form 104]
After closing, the buyer discovers the YSP paid to the broker which had not been previously disclosed to the buyer. The buyer claims the loan broker’s compensation when including the YSP was excessive, constituting a kickback prohibited by RESPA since the loan broker had “sold” the buyer a higher loan rate in order to earn an additional undisclosed and unapproved fee from the lender.
The loan broker claims the total compensation received for the services rendered to the lender by preparing the loan package was reasonable and not excessive.
The buyer claims that compensation exceeding the agreed-to 1% origination fee and costs is excessive.
Has the loan broker violated RESPA by collecting a YSP from the lender?
No! The loan broker has provided compensable loan-related services for payment of the YSP. The buyer was unable to show that the loan broker’s total compensation inclusive of YSP, exceeded fees charged by competing loan brokers for the same services. [Dominguez v. Alliance Mortgage Company (2002) 226 F. Supp2d 907]
However, a loan broker retained by a borrower must disclose to his borrower all compensation he receives, from any source, since they are benefits flowing from the employment by his principal — the borrower. If not disclosed, the borrower can recover the entire fee the loan broker received on the transaction. This recovery of all fees paid the loan broker also applies to a sales broker and his agent who are paid an undisclosed refund fee. [See first tuesday Form 119]
The broker-lender knot
This scenario is further aggravated by the conflicting adversarial relationship which naturally exists between the buyer’s selling agent, who owns a duty of care to the buyer in the sales transaction, and the lender with whom the agent collaborates in the sales transaction to receive additional earnings from the lender. The buyer’s agent has a duty to always perform in the buyer’s best interests, as well as to fully disclose any self dealings in the transaction (such as the referral fee) to avoid violation of state and federal law.
By negotiating any fee arrangement with the mortgage lender, the buyer’s agent aligns himself with the lender, who is a hostile third party with an interest economically adverse to the buyer in the purchase transaction negotiated by the agent. [Kruse v. Bank of America (1988) 202 CA3d 38]
The only fee a lender should charge, in addition to third-party provider costs, is an administrative/processing fee for the lender’s non- interest earning activities prior and necessary to document, fund and record the loan. Points and discounts, such as origination fees, are the prepayment of interest on the loan.
Origination activity for which the lender charges a processing fee by necessity must include all the basic services required of the lender to actually make a loan, such as review the loan application, underwriting risk analysis, processing loan documents, and funding the loan, in addition to any other service the lender must perform to originate a loan.
Consider these basic rules: All real estate brokers and their agents are prohibited from knowingly underestimating lender closing costs. A broker’s silence in the face of known lender misrepresentation constitutes a breach of his agency duty. Thus, it is the selling (buyer’s) agent’s duty to locate the best possible financial advantage readily available to the buyer – his client. [B & P Code §§10176; 10177]
Yet, ironically, buyers are all too often left by their selling agents to single-handedly wrestle with the only adversarial element remaining at the time of closing, the lender who has no duty to anyone but itself. [Drennan v. Security Pacific National Bank (1981) 28 C3d 764]
The prudent buyer’s agent, strangely called a selling agent, best fulfills his agency duty to his client by:
- bargaining with multiple lenders rather than forming a solitary alliance with a single lender or allowing only one loan application to be submitted, a condition where the buyer will, out of necessity, have to accept the terms of that lender at the time of closing;
- enlarging the number of lenders he regularly bargains with to obtain the most affordable and advantageous loan package for his clients (commonly called working the marketplace); and
- understanding that all oral representations made by lenders or their representatives to the agent or the client are worthless unless put in writing and signed by the lender’s representative.
Any of the following fees listed in addition to an administrative fee are duplicate costs:
- document preparation fee: for preparing the loan documents needed to originate the loan;
- loan application fee: for examining the buyer’s credit history and determining whether the buyer/borrower qualifies for the loan (typically, the charge for this service is part of, or credited to, the loan administrative processing fee rather than charged separately);
- processing fee: for the preparation of loan-related documents;
- underwriting fee: for lender’s risk analysis and loan approval before funding a loan; and
- warehousing fee: for the mortgage lender’s acquisition of money on a line of credit extended by a bank so it can fund the loan.
Fees for inflated costs incurred by the lender and passed on to the buyer include:
- appraisal fee: appraisers are paid $250 to $500 by the lender, depending on the value of the property in question, while the lender will pass on the appraisal cost to his borrower at an increased amount;
- credit report fee: for obtaining the buyer’s credit and telecheck report from a credit reporting agency (agencies typically provide credit and telecheck reports for around $10, while lenders generally pass on the charge at $70 or more); and
- funding/wire fee: charged by the lender for the transfer of funds from one account to another (the wire transaction itself costs around $15, while the lender generally passes on the charge at $50 to $300).
Lenders occasionally omit or misrepresent fees during the initial good-faith cost estimate prepared for buyers/borrowers. Sensing their advantage in real estate sales transactions where timing is everything, lenders later add and increase fees by including them on the final (amended) Truth in Lending Act (TILA) statement at the time of closing, a moment in time too late for the buyer to change lenders or successfully challenge the increased fees. A competent buyer’s agent can prevent some of these unscrupulous charges from occurring by advising the buyer to submit another loan application to a separate lender as insurance against non-competitive, last-minute increases in fees and charges.
RESPA post-settlement requirements
After the loan has been originated, it is maintained by a mortgage servicer who is responsible for collecting payments from the borrower for:
- the loan payments; and
- impounded taxes or insurance. [24 CFR §3500.2]
The mortgage servicer then passes the payments on to the beneficiary of the loan and the respective insurers and tax collectors.
A transfer of servicing may occur, triggered by any of the following changes to service:
- an assignment of servicing;
- a sale of servicing; or
- a transfer of servicing. [24 CFR §3500.21(d)(1)]
Some changes in servicing are not considered transfers, and do not trigger the Notice of Transfer, including:
- transfers between affiliates;
- transfers resulting from mergers or acquisitions;
- transfers between master servicers if the subservicer remains the same; or
- National Housing Act assignments of service to the FHA. [24 CFR §3500.21(d)(1)]
RESPA requires the relinquishing servicer to give the borrower a written Notice of Transfer at least 15 days prior to the transfer of servicing to a new servicer.
In addition, the new servicer is required to give the borrower a written Notice of Transfer:
- within the 15 days following the transfer of servicing; or
- in combination with the relinquishing servicer’s notice. [24 CFR §3500.21(d)(2)]
The timeframe for delivering the Notice of Transfer is extended to 30 days, to be made by either the relinquishing or the new servicer, if the transfer of service is due to:
- a termination of the servicing contract for cause;
- bankruptcy of the servicer; or
- commencement of receivership proceedings by the Federal Deposit Insurance Corporation (FDIC) or the Resolution Trust Corporation (RTC). [24 CFR §3500.21(d)(2)(ii)]
The Notice of Transfer must include:
- the effective date of transfer;
- the new servicer’s information, including:
- address for written inquiries; and
- toll-free customer service phone number;
- the relinquishing servicer’s toll-free customer service phone number;
- the date the relinquishing servicer will stop accepting loan payments;
- the date the new servicer will begin accepting loan payments, which must be the same day or the day after the relinquishing servicer stops accepting payment;
- information of the effect of the transfer on mortgage insurance;
- a statement that the transfer of service does not affect any other part of the mortgage documents; and
- a statement of the borrower’s complaint resolution rights. [24 CFR §3500.21(d)(3); see first tuesday Form 238-1]
The borrower has a 60-day window beginning with the effective date of transfer, during which he is protected from late fees if he mistakenly makes a payment to the relinquishing servicer instead of the new servicer. [24 CFR §3500.21(d)(5)]