The Federal Reserve Board is proposing a ban on incentive payments to mortgage originators that are based on a loan’s interest rate or other terms, and revisions to loan disclosures provided to consumers that would include factoring in the cost of settlement services such as title insurance.
The Fed says its proposed changes to Truth in Lending Act (TILA) loan disclosure forms would make them more compatible with another set of disclosures mandated by the U.S. Department of Housing and Urban Development under the Real Estate Settlement Procedures Act (RESPA).
But the Fed’s revisions, if finalized, would still fall short of meeting calls by the lending industry and lawmakers for regulators to draw up a single loan disclosure form that meets both TILA and RESPA requirements (see story).
The Fed’s proposal to ban some types of incentive payments to mortgage originators may also prove controversial, as the ban goes beyond new restrictions on "yield-spread premiums" proposed by HUD under RESPA and set to go into effect Jan. 1.
While the Fed and HUD appear to be moving closer to a long-standing industry desire to have a single set of loan disclosures, significant differences remain in the approaches taken to ensure lenders comply with TILA and RESPA.
In the past, the Fed has said its TILA disclosures are focused on helping consumers see the true cost of mortgage offers by comparing loan terms — especially the annual percentage rate (APR) after lender fees are factored in. Until now, the Fed hasn’t required lenders to include the cost of settlement services in calculating APR.
But HUD maintains that consumers need to consider the trade-off between the cost of settlement services and interest rates when choosing a loan package, and know that the loan with the lowest APR is not always the best deal.
HUD’s proposed RESPA disclosure form does not even include APR, because HUD says that might distract consumers from the goal of choosing the best deal on a complete loan package.
In announcing that the Fed plans to require lenders to provide more extensive disclosures, Fed Chairman Ben Bernanke said the one-page TILA disclosure lenders currently use "is not adequate to convey the features and risks of today’s complex products."
The Fed says its proposed changes to TILA disclosures would:
- Capture most fees and settlement costs paid by consumers in the disclosed APR.
- Require lenders to show how the consumer’s APR compares to the average rate offered to borrowers with excellent credit.
- Require lenders to provide final TILA disclosures at least three business days before loan closing.
- Require lenders to show consumers how much their monthly payments might increase for adjustable-rate mortgage (ARM) loans.
Bernanke vowed that the Fed is working with HUD to make TILA disclosures "compatible and complementary" with HUD’s RESPA forms, and potentially develop a single disclosure form that lenders could use to satisfy both laws.
If the Fed and HUD don’t make progress in achieving that goal, one of the first tasks of the Obama administration’s proposed Consumer Financial Protection Agency would be to develop a uniform mortgage disclosure form and put it forward for public comment within a year of the agency’s creation (see story).
But there’s more to creating a uniform mortgage disclosure then deciding what information should be provided. The Fed and HUD have taken significantly different approaches on the issue of incentive payments to loan originators, whether they be independent mortgage brokers or bank loan officers.
Yield-spread premiums — rebates paid by lenders when mortgage brokers place borrowers in loans with higher interest rates than they might otherwise have qualified for — aren’t necessarily bad for consumers, HUD has said, as long as they are not pocketed by mortgage brokers without a borrower’s knowledge.
A borrower may want to take out a loan with a higher interest rate in order to apply a yield-spread premium to their closing costs, reducing the amount of cash they need to bring to the closing table, HUD maintains.
The new standardized loan disclosure form HUD will require lenders to use beginning Jan. 1 does not ban yield-spread premiums, but requires that they be credited against a borrowers’ closing costs.
The National Association of Mortgage Brokers (NAMB) has sued HUD over its proposed handling of yield-spread premiums, saying bank loan officers and other mortgage originators are also paid incentives — called "overages" or "service release premiums" — for placing borrowers in higher-interest-rate loans.
HUD’s new RESPA disclosure requirements would place mortgage brokers at a competitive disadvantage, NAMB says, because banks won’t have to disclose payments of the fees and consumers will be unfairly biased against independent mortgage brokers.
HUD maintains that consumer testing shows the new Good Faith Estimate, or GFE, allows consumers to choose the best overall loan package and does not bias borrowers against mortgage brokers.
But the Fed says its own consumer tests of a different method of tackling the problem of incentive payments to loan originators showed consumers were confused when yield-spread premiums were singled out for attention.
In a previous update of Regulation Z, the rules governing implementation of TILA, the Fed initially proposed that mortgage brokers be required to enter into written agreements before accepting a loan application in order to accept yield-spread premiums from lenders.
The Fed withdrew that aspect of the update because of concerns that the written agreements and disclosures were confusing (see story).
In one-on-one interviews conducted as part of the consumer testing, consumers often concluded — not necessarily correctly — that mortgage brokers were more expensive than banks and other lenders, the Fed said in explaining its new approach. Another problem was that some institutions may act as mortgage brokers in some transactions and as lenders in others.
The Fed’s latest proposal would ban incentive payments to all loan originators — regardless of whether they are mortgage brokers or bank loan officers — when those incentives are tied to higher interest rates or other loan terms, such as prepayment penalties, that increase the lenders’ profits.
In a 674-page Federal Register notice, Fed staff said they recognize that "consumers potentially benefit" from having the option to accept a higher interest rate in exchange for a lender’s payment of a yield-spread premium.
But the incentive yield-spread premiums create for originators to steer consumers into riskier loans means they pose "a significant risk of economic injury to consumers," which HUD’s solution is "not likely by itself to prevent," Fed staffers said.
Many consumers are unaware yield-spread premiums even exist, the Fed said, and even those who wish to take advantage of them are in no position to negotiate if they do not know the lowest rate they would otherwise be able to obtain, the Fed said.
"Yield-spread premiums are complex and may be counterintuitive even to well-informed consumers," Fed staff concluded. "Based on … consumer testing, the (Fed) believes that disclosures are insufficient to overcome the gap in consumer comprehension regarding this critical aspect of the transaction."
While consumer groups like the Center for Responsible Lending welcomed the Fed’s proposed changes, the reaction of the lending industry was mixed.
The Mortgage Bankers Association said it was "extremely pleased to see that the Federal Reserve Board has committed to working with the Department of Housing and Urban Development to better synchronize its TILA forms with HUD’s RESPA forms."
But the MBA said the Fed’s proposed rule "contains broad restrictions" on compensation for mortgage originators "that will require considerable analysis" during a 120-day public comment period.
Speaking for mortgage brokers, NAMB commended the Fed "for recognizing that all competitors in the mortgage market receive indirect compensation inside the mortgage rate." But the group also said it looked forward to working with the Fed to "improve its proposed rule" for "the benefit of consumers."
NAMB once again called on Congress to suspend implementation of HUD’s RESPA rule changes while HUD and the Fed work on creating a uniform loan disclosure. In passing HR 1728, legislation aimed at aimed at curbing predatory lending, the House amended the bill to suspend HUD’s RESPA rule changes for one year (see story).
The Center for Responsible lending said a ban on yield-spread premiums and other incentive payments to loan originators would help restore fairness in home lending, "particularly in communities of color, which were targeted disproportionately for expensive, wealth-draining yield-spread premiums," the group said in a statement.
The center also backed the Fed’s proposal for new prohibitions against steering consumers into loans with a higher interest rate than they might otherwise qualify for, a practice the group said was often employed in lending to African Americans and other people of color.
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