"I refinanced last year and negotiated the fee I paid the mortgage broker. Now, I want to refinance again to take advantage of lower rates, but my broker tells me that the arrangement we had last time is no longer possible under new rules. He says that his fee is set beforehand and that there is no way he can change it.
That fee would be twice as much as I paid him last time, and may change my mind about doing the deal. Is he being straight with me?"
Yes, the broker is being straight with you. The Federal Reserve amended Truth in Lending (TIL) last year to change the ways in which loan originators (mortgage brokers and loan officers, henceforth LOs) could be compensated. More changes may be coming when the new Bureau of Consumer Financial Protection authorized by Dodd-Frank implements similar provisions of that law.
Purpose and scope of the new rules
The purpose of the TIL amendments was to eliminate the ability of LOs to use their greater knowledge to take advantage of borrowers. The practice of "charging what the traffic will bear," which was how many LOs operated before the amendments, is gone.
The new rules come closer to requiring LOs to treat all borrowers alike. In the process, LOs have lost their ability to lower their compensation in cases where that is necessary to make a deal work. The letter cited above is one of several I have received on this unfortunate aspect of the new rules.
These rules prohibit LOs from collecting larger fees on loans with features desirable to lenders, such as a higher interest rate. The only exception is that LO fees can vary with the size of the loan, and almost all LOs set their fee as a percent of the loan amount. LOs cannot steer borrowers to a loan that pays the LO more if that loan is not in the borrower’s interest. And while LOs can continue to be paid by the borrower or by the lender, they can no longer be paid by both.
The detailed rules implementing these principles are voluminous and complex — and also unprecedented. While the government doesn’t dictate what LOs can charge, it requires them to declare and document their charge, and stick to it. LOs can change their fee but only at specified times — not to meet the circumstances of a particular case.
Firms in many industries, such as insurance, mutual funds and automobiles, rely on commission-paid salespersons to distribute their products and services, but to my knowledge none have ever been subjected to this type of regulation.
Were these rules really necessary?
The case for the new rules depends on two claims. The first is that the abuses associated with LO compensation were egregious and widespread. Having written about such abuses on numerous occasions over the last 12 years, I would not dispute that claim.
The second claim is that a less complex, less rigid, less costly remedy was not available — and that clearly is wrong. The Upfront Mortgage Broker (UMB) model eliminates pricing abuses by mortgage brokers by requiring the broker to "establish a fee for his/her services upfront and in writing, before the loan application is submitted. …" The fee covers all broker services, and holds whether the broker is paid by the borrower, the lender or both. The borrower is protected by the complete transparency of the process, while the price can be adjusted to the particular circumstances of each transaction. This is protection with flexibility as opposed to protection with rigidity.
The remedy is even simpler when the LO is an employee of a lender. A rule that eliminated LO discretion over prices, requiring them to quote and deliver only the prices posted by the lender, is all that was needed to eliminate pricing abuses.
Selecting a broker under the new rules
LOs have to live with the rules as they are, and so do borrowers. Ironically, while LOs are required to declare their fee and stick to it, they are not required to disclose it to borrowers! Some brokers are charging 1 percent of the loan amount and many are charging 2 percent, but there is no place borrowers can go to obtain this information except directly from the brokers they ask. If they don’t ask, they won’t discover the broker fee until they have applied for a loan and received a "good faith estimate," which is too late to help them select a broker. The exceptions to this are UMBs, which disclose their fees before taking an application.
In querying other brokers about their fee, you should frame the question so that they can’t provide an ambiguous or deceptive answer. Ask, "If I retain you, how much is the lender paying your firm?" This discourages the broker from telling you that you are not paying her anything because she is being paid by the lender. (The fee paid by the lender is paid by you in the form of a higher interest rate.) It also prevents the broker from citing the fee she gets rather than the fee paid to her firm, which is what it costs you.
Many thanks to Kevin Iverson for his help in developing this article.