HUD's mortgage reform will increase loan costs

The mortgage broker compensation disclosure the Department of Housing and Urban Development proposed in its Real Estate Settlement Procedures Act (RESPA) reform will cause consumer confusion and mistaken loan choices that will increase mortgage costs for many consumers, a study released by the Federal Trade Commission concluded.

HUD’s July 2002 proposal included a requirement that mortgage brokers must disclose certain types of compensation in a home loan transaction.

The FTC study found that these disclosures are likely to confuse consumers, cause a significant number of consumers to choose loans that are more expensive than the available alternatives and create a substantial consumer bias against broker loans, even when the broker loans cost the same or less than direct lender loans.

A better way to help consumers obtain less expensive mortgages would be to encourage and facilitate comparison shopping on loan costs, according to the study. This approach is incorporated in other components of HUD’s RESPA reform proposal and would be far more beneficial for consumers, the FTC said.

A major part of mortgage broker compensation, and the focus of the proposed disclosure, is any yield spread premium (YSP) paid by the lender for a loan originated at an above-par interest rate. The YSP reflects the additional value to the lender of a loan originated at the higher interest rate. Lenders making loans directly to consumers may charge the same interest rate and earn the same compensation as a mortgage broker but would not be required to make the same disclosure under the proposed policy.

The study examined the disclosures in a controlled experiment with more than 500 recent mortgage customers. Participants were shown cost information about two hypothetical mortgage loans and asked to identify which loan was less expensive and which loan they would choose if they were shopping for a mortgage.

A broker compensation disclosure was included in the cost information shown to three of five groups, with the format and wording of the disclosure varying across the groups. In each of the groups, one loan was treated as a broker loan and one as a direct lender loan. The broker loan disclosed a YSP amount but the direct lender loan did not, following the policy proposed by HUD.

A broker compensation disclosure was not included in the cost information shown to the other two groups. About 90 percent of the respondents in those two groups correctly identified the less expensive loan, and 85 percent and 94 percent identified the less expensive loan as the one they would choose if they were shopping for a mortgage. Only 3 percent of the respondents in one of the groups identified the more expensive loan as the one they would choose if shopping. Others said they would choose either, neither or did not know.

In contrast, in the three groups shown cost information that included a broker compensation disclosure, only 63 percent to 72 percent of the respondents correctly identified the less expensive loan, and only 60 percent to 70 percent identified the less expensive loan as the one they would choose if they were shopping for a mortgage; 16 percent to 27 percent identified the more expensive loan as the one they would choose if shopping.