(This is Part 2 of a two-part series. Read Part 1.)
YSP abuse, as explained in my first column, arises when mortgage brokers steer borrowers into high-rate loans on which the broker collects a rebate from the lender, without the knowledge of the borrower. To eliminate it, I suggested a simple and easily enforceable rule that would help the naive as well as the informed borrower. The rule is that lenders must credit all rebates to borrowers. The borrowers would then have to authorize the payment to brokers.
One of the important objectives of The Mortgage Reform and Anti-Predatory Lending Act of 2007 (HR 3915), which passed the House of Representatives Nov. 15, is to prevent YSP abuse. Will it?
The first version of the bill that I looked at would indeed have prevented YSP abuse, but it also would have eliminated mortgage brokers. The version passed by the House, modified after inputs were received from brokers, would not put them out of business, but neither would it prevent YSP abuse. Section 123b1 reads as follows:
AMOUNT OF ORIGINATOR COMPENSATION CANNOT VARY BASED ON TERMS – No mortgage originator may receive from any person, and no person may pay to any mortgage originator, directly or indirectly, any incentive compensation, including yield spread premium or any equivalent compensation or gain, that is based on, or varies with, the terms (other than the amount of principal) of any loan that is not a qualified mortgage. …
Let’s start with the clearest part of this statement, which is the last phrase. Whatever restrictions are called for, they will not apply to qualified mortgages. A qualified mortgage, as defined elsewhere in the bill, is one with an interest rate that is no more than 3 percent above the comparable Treasury rate, or 1.75 percent above the average conventional rate.
This indicates that the framers of the bill believe that YSP abuse is a problem only for the highest-rate loans, which is absurd. The problem cuts across the entire market. Indeed, high-rate and high-cost are not the same thing — a loan with a rate only 2 percent above the average could be loaded with superfluous fees and charges.
Will the restriction on incentive payments at least eliminate YSP abuse on the high-rate loans to which it applies? The bill says that originators (which include loan officers employed by lenders as well as mortgage brokers) cannot be paid more on high-rate loans than on low-rate loans. Since YSP abuse is exactly that, this provision is right on target. It defines YSP abuse accurately, and declares it to be illegal.
Unfortunately, this provision is unenforceable. The standard for determining whether compensation on a high-rate loan is excessive is the compensation received on a low-rate loan, which is unknown and in many cases unknowable. Originators collecting YSP on high-rate loans don’t report what they would have charged on low-rate loans.
To enforce this rule, regulators would have to do a statistical analysis of the originator’s charges on different loans so as to determine whether or not compensation is higher when a loan involves YSP. This is not feasible because there are too many originators and not nearly enough regulators. Even if it were feasible, it won’t work for brokers who get paid only from YSP, which is very common, and it won’t work for loan officers employed by lenders who originate at their own risk, for whom there is no YSP.
Indeed, the only originators who would leave a trail for the enforcement police would be the brokers who give their customers the choice of whether they want to pay the broker out of pocket or have the broker paid with YSP. Because these brokers offer borrowers a choice, fees will be shown with and without YSP, allowing a statistical analysis of whether there are any differences. There won’t be, because these are the good guys. The bad guys will be beyond reach.
In contrast, a rule requiring lenders to credit rebates on high-rate loans to borrowers, who would have to explicitly authorize its payment to the brokers, would impact all brokers alike, and impose no onerous enforcement burden on regulators. Indeed, because wholesale lenders would welcome such a rule, there would be no regulatory burden at all. Poof, YSP abuse would disappear overnight. To level the playing field between lenders and brokers, a comparable rule is needed that would prohibit loan officers from charging prices above those posted by the lender.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.