Last week I reported favorably on one part of HUD’s current reform proposals. A new and substantially improved good faith estimate (GFE) would make it easier for borrowers to shop alternative loan providers (LPs). The proposed GFE along with new rules as to how it must be used will also eliminate critical weaknesses of the current GFE that encourage opportunistic pricing — the practice of charging as much as you can get away with.
The current GFE is an open-ended list of settlement costs with no meaningful subtotals, encouraging lenders to invent new charges. Further, all of the charges on the current GFE are "estimates" subject to change, the only barrier to abuse being the "good faith" of the LP. In all too many cases, charges are raised in bad faith and there is nothing that HUD can do about it.
In the proposed GFE, settlement costs are divided into three categories. Category one includes all charges by the lender and mortgage broker, tabbed "Our Service Charge," and government recording and transfer charges. At settlement, these charges must be the same as those on the GFE. This rule is completely appropriate regarding lender’s own charges; it is also long overdue. Charges by governmental entities are another matter, and my experience suggests that these charges belong in category two, where the LP has a little latitude.
The second category now consists of services provided by third parties who are selected or identified by the LP. The most important of these is title insurance. The total of such charges can be as much as 10 percent higher at settlement than the total shown on the new GFE. This limit is better than no limit, but it doesn’t touch the dysfunctional system that makes third-party settlement services far more costly than they should be. I comment on this further below.
The third category consists of services that the borrower has elected to shop among service providers not selected or identified by the LP. It includes homeowners insurance, which borrowers typically purchase on their own, and it can include title insurance if the borrower solicits title agencies on his own. These charges are not subject to any limits on price increases. This is a reasonable exemption.
To help borrowers police their own transactions, HUD has proposed to change the HUD-1 closing document so that it corresponds closely with the new GFE. It will then be easy for borrowers to compare the final charges on the HUD-1 with those on the GFE. Good idea.
HUD also intends to seek authority to require that the HUD-1 form be made available three days before closing, rather than one day, which is the current requirement. Another good idea, but they ought to include the mortgage note in this requirement. There is no excuse for forcing borrowers to confront a complicated contract for the first time at the closing table.
The most disappointing part of the proposed new GFE is that it leaves untouched the odious network of relationships between loan providers and third-party service providers, which raise the cost of these services to borrowers. Mandating that a title charge of $1,000 on the GFE can’t be more than $1,100 on the HUD-1 closing document doesn’t accomplish much if the charge ought to be $300.
While it is not possible to know what the charge would be in a properly functioning competitive market, we do know that the perversely competitive markets we have now encourage high prices. Competition is perverse when service providers market not to purchasers but to the entities who refer the purchasers to them. The LPs who refer mortgage borrowers to third-party service providers share in the overcharges — sometimes legally, sometimes not.
The remedy is well-known and well-tested. It is to require lenders to pay for all services that they require from borrowers. If lenders want title protection, they should buy it and pay for it, passing the cost to borrowers in the rate and points. The cost passed through will be a small fraction of what borrowers pay now, as lenders are large and knowledgeable purchasers who can buy in bulk.
This is not a pie-in-the-sky idea. Indeed, since Bank of America adopted it last year, it can be viewed as an industry "best practice." Yet HUD, despite its legal mandate to lower settlement costs, ignores it. If this reflects HUD’s concern that they will receive no support, they are surely mistaken. If it were placed on the table, community groups would have to support it. How could they not?
To be sure, the mortgage bankers would oppose the idea because trade groups can’t advocate best practices without alienating a major segment of their membership. But the fact that a leading lender has adopted it voluntarily and successfully will make it difficult for them to argue that the market will collapse.
Next week: How broker charges are handled in the new GFE.
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.
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