Federal Reserve Chairman Ben Bernanke
See also: “Pressure is Mounting on Mortgage Brokers“.
Mortgage brokers do 60 to 80 percent of home loan origination across the country. These people are major players in the mortgage industry, yet their role is entirely misunderstood by the public. Is it intentional deception or myth that mortgage brokers shop for the best deal for their clients? Of course there may be some document somewhere in the stack signed at closing that explains in complicated terms that the mortgage broker is out to make himself/herself the most money and will push high cost, high risk loans to do just that. But, when you talk to brokers, they will often expressly state otherwise or imply that they have found the best deal just for you. (Of course there are some good and decent mortgage brokers out there, just like there are good and decent lawyers, journalists, politicians and used car salesmen.)
Need proof of the public’s perception? How about a national study ordered by the Federal Reserve Bank. The study asked people familiar with the process of buying or refinancing a home and had done so within the last two years. In the study, agreements and disclosures where shown to the folks and then questions were asked of them. Time and time again, regardless of the language of the documents, the prospective borrower believed the broker was looking out for their best interest:
Most participants who read the agreements did not understand how lender payments to brokers created a financial incentive for brokers to provide loans with higher interest rates. While some initially understood that brokers receive more compensation for providing loans with a higher interest rate, this fact was extremely counter-intuitive to participants—many of whom had previously assumed that a broker would work in their best interest. As a result, a significant number had difficulties comprehending and rationalizing the conflict of interest described in the agreement.
Consumer Testing of Mortgage Broker Disclosures, Macro International, Executive Summary, July 10, 2008 (complete report here).
In short, the public ignores what the documents say and bases their opinion on their perceptions. These perceptions are exactly why mortgage brokers are a major player – brokers say or imply they are looking for the best deal for their clients. Brokers want it both ways — they want the public to think they are on their side while sticking borrowers with loans that make them the most money. This defeats the mortgage brokers’ reason for existence. Thus, whether it is intentional deception or myth is irrelevant – a regulatory change is desperately needed.
Noticeably absent from the new amendments to Regulation Z that were published this week by the Federal Reserve (summary here), were changes to disclosures by mortgage brokers. In late 2007, the Federal Reserve was considering better disclosure rules to attempt to notify borrowers how mortgage brokers were getting paid and their duties, or lack thereof. The Fed also commissioned the study above, and as a result, scrapped the new rules. Some were less than pleased with the Fed’s failure to act:
The Fed’s own report states that 60% of loans were originated through mortgage brokers in the last several years. The report candidly acknowledges that consumers “often are unaware, however, that a broker’s interests may diverge from, and conflict with, their own interests.” And yet the Fed left the brokers alone.
Particularly problematic has been the abuse of yield spread premiums, which gave brokers higher compensation for placing a consumer in a higher-interest, riskier loan. Instead of stamping out this perverse abuse, the Fed withdrew its proposal for even a modest rule requiring brokers to disclose whether they were getting a premium.
Article here.
While the Fed’s rules are certainly nothing to be proud of, they are an improvement. (More later on the rules they did enact – but no hurry since none of them become effective until 2009.) But it is clear that the Fed is not done looking at this issue: “Based on compelling evidence from consumer testing, the Board is withdrawing the proposed rule regarding yield-spread premiums. The Board, however, intends to analyze alternative approaches to this issue as part of its ongoing review of the rules for closed-end loan rules under Regulation Z.” Fed Press Release, July 14, 2008 (here).
While brokers scramble to raise more money from their borrowers to hire more lobbyists, they explain that a duty to treat their clients as clients, rather than paychecks, invites borrowers to sue them every time they have trouble paying the mortgage. The response is easy:
Medical doctors, lawyers, and realtors do not have to promise that they will get their clients/patients the best surgical results, the best legal results, or the best deal on the house in order to discharge their clear fiduciary duties. Instead, they are promising to do the best job they can; to fully inform their clients of all relevant information and risks; and to carefully make sure that their clients have been provided with the necessary tools and understanding to make a fully-informed decision. Mortgage brokers, bankers, lenders, and consumer finance companies could easily adopt a fiduciary standard for their loan originators if they chose to, and it would be both practicable and fair.
Ethical Lending Foundation (article here)
Hopefully, because of the results of their study, the Fed is not merely planning to require more disclosures, but something more meaningful. Rather than merely eliminate mortgage brokers from the mix, the Center for Responsible Lending, National Consumer Law Center, and others have reasonably called for formalizing what the public already believes — mortgage brokers have a duty of care toward their clients. This duty was just enacted in New York two weeks ago (here) and was recently enacted in Minnesota. See article. North Carolina has had something in place since 2002 (here) and the courts have found a duty to exist in other states in certain circumstances (see article here). Rather than a patchwork of state statutes and legal decisions, the country needs one federal law to provide protection from mortgage brokers out to make money on the backs of the borrowers, lenders, investors, and the rest of world. The Fed knows the effects of abusive lending practices are no myth and maybe they will do something about it rather than wait until the next crisis and consider better disclosures.
Filed under: Advice for Borrowers, Minnesota, National Foreclosure News, New York, North Carolina, State Foreclosure News
I believe all loan originators, no matter where they work, will eventually owe fiduciary duties to their clients.
We should expect bankers and brokers alike to resist this natural progression.
Some people are already acting in this way, others will have to be dragged, kicking and screaming.
You know, the continuing demonization of brokers really does nothing to fix the problems of the past. They’ll just switch to bankers which require even LESS disclosure.
What you’re pissed about and describe as “mortgage brokers out to make money on the backs of the borrowers, lenders, investors, and the rest of world” is, in reality, a market. Before brokers, people put 20% down and paid around 9% on average, or more. In the early 1980′s, most prime ARMs were pricing in the teens and the 30 year fixed pricing was off the charts. Brokers do, on balance, give a better deal to borrowers than retail banks. As for what they get paid to deliver a loan at a set interest rate, if they borrower doesn’t like it or feels like they deserve a better deal, then they can leave.
It’s rare, despite what you’ve heard, for terms and conditions to change at closing.
If you REALLY want to do something about cleaning up the industry, come by my place later today. You’d do well to actually LISTEN to someone on the inside and really knows where the bodies are buried.