Another December surprise.
Just what is it about the month of December that makes federal regulators think it's the perfect time, finally, to settle the real estate lending settlement costs controversy,
It was on December 22, 1974, after trying unsuccessfully for two years, that Congress finally managed to pass its first settlement cost legislation - the Real Estate
Settlement Procedures Act (RESPA) of 1974. That lasted all of a year, until December 1975, when Congress, bowing to repeated cause to scrap or revise its first try, passed the Real Estate Settlement Procedures Act of 1975. Even that attempt failed to deflect the continuing criticism, complaints and confusion surrounding RESPA - a statute initially enacted to address perceived abuses in the title insurance industry, but which from the beginning has been an enigma to mortgage bankers
As we embark upon yet another December - 18 Decembers after Congress first acted - long-awaited, comprehensive regulations reinterpreting RESPA are slated to take effect this month. Unless the vigorous efforts of various industry group to delay the scheduled implementation date of December 2 are successful this December, outgoing Bush administration officials say their "final" comprehensive RESPA regulations, published on the day before the presidential election, will become effective. This December, some federal regulators assert, the decades-old settlement cost controversy finally ends.
For this to occur, of course, would amount to quite a RESPA December surprise. Far more likely, however, is the prospect of continuing turmoil over the reach, meaning and impact of RESPA through many December months to come.
Why is this regulatory area so controversial? What is RESPA all about? What do these final regulations require of mortgage bankers, wholesale mortgage lenders, mortgage brokers, real estate brokers, title companies, consumers and other settlement service providers? What business opportunities are encouraged by these rules? Which are disfavored? What's changed? Who won, who lost, who may go to jail? What happens next?
Although it is a poorly written, ambiguous statute subject to many different interpretations, RESPA embodies one undeniable attribute - it is a consumer-protection statute enacted by Congress for the benefit and protection of the American homebuying public. Indeed, the stated purpose of RESPA as set forth in Section 2 of the Act was to effect changes in the settlement process so "that consumers throughout the Nation are provided with greater and more timely information on the nature and costs of the settlement process and are protected from unnecessarily high settlement charges caused by certain abusive practices that have developed in some areas of the country."
As it was initially enacted, and as it remains today, RESPA does three basic things. First, and most controversial Section 8 of the statute makes it a crime to pay certain kickback or referral fees for settlement service business; such fees tend to inflate costs to borrowers with-out any associated benefits. Second, it requires that certain disclosures be made by lenders and other settlement service providers to borrowers and sellers. These disclosures, as they have evolved with time, concern a variety of issues including settlement costs, escrow maintenance and servicing transfers. Third, RESPA Section 10 establishes certain limits on the size of escrow accounts that lenders may require for the payment of taxes and insurance. Although not historically controversial, the escrow-account-maintenance provision of Section 10 is very controversial today.
As the agency charged with the responsibility to interpret and enforce RESPA, HUD initially published comprehensive RESPA regulations (known as Regulation X) in 1975. Although it was readily apparent that these regulations did little to answer the many issues that arose under RESPA, and despite the fact that Congress required the issuance of new regulations more than eight years ago when it enacted the "Controlled Business Amendment" to RESPA in 1983, Regulation X has not been revised until now.
Almost five years have past since HUD'S 1988 publication of a proposed draft of Regulation X for notice and comment. The 2,600 comments received since then have highlighted for HUD the competing interests involved in the resolution of these issues, causing both the Reagan and Bush administrations to shy away from final implementation. Indeed, had it not been for a hotly contested presidential election and the intense lobbying efforts of industry groups viewed by the now-outgoing administration as essential to its efforts, it is doubtful that the regulations before us today would have been issued at this time.
It is the Section 8 criminal ban on kickback and referral fees, in combination with the disclosure and escrow-maintenance provisions of RESPA, that all but guarantee that the first two decades of RESPA controversy will not be the last.
First, the breadth of the RESPA statute is overwhelming. It reaches across the entire real estate settlement services industry, from pest inspection to credit reports. And, with the enactment of its latest statutory amendment on October 28 of this year, RESPA now unambiguously also encompasses the "taking of loan applications, loan processing and the underwriting and funding of loans," as well as subordinate lien and refinance loans.
For this reason, virtually every aspect of the real estate industry is affected by the criminal provision. Under RESPA Section 8, it can be a felony to misstep in the business planning area.
Second, besides being overly broad, prior to the issuance of the December 2 "final" rule, HUD'S informal interpretations of RESPA have been inconsistent and oftentimes counterintuitive. Except in the narrowest and most blatant of circumstances - described by some in that most colorful of allusions as "naked" referrals - the Section 8 kickback rules, as informally interpreted to date by HUD, have made very little common sense.
The final RESPA rule expressly withdraws all previously issued informal opinion letters. In that respect, it blunts the second problem. The final rule does very little to right the first, however.
Now let's turn to an examination of what the final rule does and does not do in each of the three areas of referral fees, disclosure and escrow account maintenance.
RESPA Section 8 referral
RESPA Section 8(a) generally prohibits the payment or receipt of "any fee, kickback or thing of value" for the referral of settlement service business. One may, however, pay another who refers settlement service business for work actually performed, or goods and facilities provided, so long as that payment reflects the reasonable value of that work. Section 8(b) of the statute prohibits the splitting of fees received for a settlement service - again, other than for the reasonable value of service actually performed.
Adopting a somewhat literal, albeit impractical, reading of Section 8, in 1980 HUD published a now long-forgotten interpretive rule that conclude that the referral of settlement service business to an affiliated entity would violate Section 8 of RESPA if there was a distribution of income between the affiliated entities in the form of dividends or other payments based on a return of capital. HUD reasoned that these payments effectively were indirect kickbacks, because the referral of business between the two entities tended to improve their economic positions.
Finding this result undesirable, in 1983 Congress enacted the "Controlled Business Amendment" to RESPA, exempting from Section 8's proscriptions certain payments made between businesses within a "controlled business arrangement" (CBA), despite the existence of a referral.
A CBA, in general, is an arrangement in which a provider of settlement services receives a referral from an affiliated company in another settlement service business. Commonly owned or controlled, or franchised, real estate brokerage and mortgage lending companies, which refer settlement service business between each other, are typical examples of such CBAS.
If referrals are made within a CBA, Section 8 of RESPA will not bar the arrangement if three conditions are met: 1) the consumer timely receives the required disclosure about the nature of the affiliation between the two companies and of the settlement service provider's normal charges (this is known as the "Controlled Business Disclosure"); 2) the consumer is not required to use the company referred to, or any other particular settlement service provider; and 3) the entity making the referral does not receive anything of value from its affiliate beyond a reasonable return on its ownership interest in the affiliate.
Several major interpretive issues have arisen concerning the breadth and scope of the Controlled Business Amendment since its enactment. One involves a HUD informal opinion letter that concluded that it would be a violation of Section 8 if a corporate entity were to compensate its own employees for cross-selling and referring business to an affiliated entity. In that case, a parent savings association wanted to pay its own employees a fixed-dollar amount each time they referred a customer to the association's wholly owned mortgage banking subsidiary. No payment was to be made by the mortgage banking subsidiary to its parent or to the parent's employee for the referral. Breaking with precedent, and contrary to industry practices at the time, HUD opined that the payment by the parent corporation to its own employee would constitute an illegal referral fee. HUD concluded that "a corporation may not compensate its own employees by paying referral fees, when these employees, acting beyond the scope of their employment, refer business to an affiliated entity."
Recognizing the synergy between affiliated corporate entities that its prior opinions diffused, HUD reversed itself in this final RESPA regulation by expressly permitting employers to make bona fide incentive payments to their own employees to encourage referrals to affiliates. Based on advice received from the Department of Justice, the new regulation goes even further: it permits a company to pay its own employees for referrals made to nonaffiliated companies, as well.
Another controlled business issue that the final regulation purports to resolve involves the propriety of packaging together a combination of settlement services and offering discounts or rebates to consumers for the purchase of multiple settlement services. Previous opinion letters issued by HUD prohibited an entity referring business to its affiliate from offering to pay a portion of the consumer's costs if the consumer chose to use that affiliate. So, for example, under the opinion letters, if a builder referred a purchaser to its affiliated mortgage company and agreed to pay the purchaser's closing costs if he or she chose to use that mortgage company, both the mortgage company and the builder would lose the protection afforded by the Controlled Business Amendment and would be in violation of Section 8.
Proponents of HUD's position argued that by offering to pay a portion of the consumer's cost only if the affiliate were used, the entity making the referral effectively was "requiring the use" of its affiliate, in violation of the statute. Proponents of this theory further argued that the best way of achieving Congress' intent to protect consumers and keep costs down is to erect impenetrable walls between the various settlement service providers and let each of them price services separately and independently, with the consumer choosing among competitors.
Opponents of the position taken by HUD in these opinion letters argued that the ban on price incentives created a result contrary to RESPKS purposes, because it was the consumer who was the direct beneficiary of the resultant, overall, lower settlement service costs. Opponents further argued that the true marketplace solution required freeing the industry to package or combine and offer a group of settlement services, thereby stimulating greater competition among producers and ultimately lowering prices to consumers.
Reversing its prior position, in its final rule HUD is very supportive of flexible controlled business arrangements. Not only does it back off its prior informal interpretation, which would have included as an impermissible required use any situation where the price of one service could vary to the consumer depending on whether or not the service of an affiliated entity was used, but it also explicitly acknowledges that the "offering of a package or combination of settlement services, or the offering of discounts or rebates to consumers for the purchase of multiple settlement services, does not constitute a required use."
origination (CLO) systems
The dispute that has pulled this industry apart, in some instances pitting mortgage banker against mortgage banker, but in most instances pitting mortgage banker against Realtor, revolves around the question of who, if anyone, may pay Realtors and other interested third parties for finding financing and effectively referring borrowers to the mortgage lender. Over the years, HUD had become increasingly permissive about the payment of such fees by borrowers to Realtors. In the course of securing HUD informal opinion letters blessing various mortgage broker and CLO programs, lenders, and others, had pushed HUD's permissiveness to its outer limits.
This trend peaked with the issuance of an informal opinion letter to Citicorp Mortgage, Inc., in 1986, approving the MortgagePower "borrower pay" program. Under the terms of that program, if not restricted by state law, borrowers could pay approved Citicorp program participants a fee for assisting them in obtaining financing from Citicorp. Ever since the HUD opinion was issued, the industry has been at odds as to its efficacy and legitimacy.
The Mortgage Bankers Association of America (MBA) and most of its constituency steadfastly have argued the such "borrower pay" programs should be illegal or severely restricted, because the payment of a fee by a borrower to real estate broker, or anyone else associated with the transaction, for advice an assistance related to the loan transaction merely constitutes a referral fee (even if it is an indirect one) prohibited by Section 8. "Borrower pay," they assert, is really "lender pay," because the borrower ultimately pays all costs of the loan.
Proponents of "borrower pay" programs argue that, of course, borrowers should be free to hire advisers to organize the mortgage marketplace for them and to pay them any amount that the adviser and the borrower may negotiate.
For the past six years, HUD has wavered back and forth on this issue. In official and unofficial statements, it often appeared to be favoring the restriction of such "borrower pay" programs, limiting the fee that the borrower could be charged to around $300; requiring the fee to be paid in cash, upfront; and insisting that the loan products of multiple lenders be displayed and evaluated by the borrower's mortgage marketplace advisor.
In its final rule, however, HUD (or, more accurately, the Bush administration) suddenly changed course. HUD's final rule is very supportive of "borrower pay" programs and the development of computerized loan origination systems, without defining in any real way what it thinks they are or do. Indeed, HUD abandons virtually all regulation in this area and instead permits the free market influence it expects to be provided by consumers, who are required to be informed of the cost of securing loan advisory services tied in some unspecified way to a computer, to reign in settlement service cost abuses.
HUD's wide-open CLO exemption from all Section 8 referral limitations permits any payment by a borrower for undefined (but disclosed) computer and related loan origination services, so long as the required HUD disclosure is given to the consumer. It essentially reaffirms its earlier Citicorp Mortgage-Power "borrower pay" RESPA internal opinion letter.
The CLO exemption is not limited by either the number of lenders that must appear on the "system" (a single lender's or broker's loan products apparently will suffice); by the amount that the borrower may be charged for the service; or by a requirement that any charges be paid in advance (rather than financed) by the borrower. There also are no limits as to the type of entity that may be paid the CLO charge by the borrower, including no bar against Realtors or attorneys collecting this fee and another fee in connection with the same real estate transaction. (Note, however, that no changes are made by these final RESPA regulations to applicable FHA restrictions in this area, and that state law may restrict such fees or require the licensing of those who collect them.)
Table-funding and the secondary
Historically, the payment of servicing-release premiums and other fees by a wholesale mortgage banker to a broker or correspondent for the purchase of table-funded loans was considered to be a secondary market transaction exempt from Section 8's anti-kickback and referral fee proscriptions. In January 1991, however, when HUD leaked draft RESPA regulations without publishing them for notice and comment, the industry first became aware of the fact that the agency was beginning to have a change of heart concerning the treatment of table-funded loans. An example illustrating transactions subject to Section 8, contained in an appendix to the leaked regulation, provided that, to determine whether or not a bona fide transfer of the loan has taken place in the secondary mortgage market, rather than an illegal referral payment, HUD would examine the "real" source of funding of the loan and the real interest of the named settlement lenders.
Despite vehement protests from all segments of the mortgage banking community, the final RESPA regulations now reaffirm HUD's new treatment of table-funded transactions. Illustration five in appendix B to the final rule contains language virtually identical to the example contained in the January 1991 leaked draft, confirming HUD's newfound position that a table-funded transaction is not a secondary market transaction and that the anti-kickback and referral fee provisions of Section 8 apply to it.
Essentially, for the purposes of Section 8, HUD will not recognize a table-funded loan closed in the broker or correspondent's name and assigned at closing to the wholesaler as a "true" secondary mortgage market, RESPA-exempt sale. Rather, HUD will treat the loan as if it were originated by the wholesaler. This does not mean that table funding, in and of itself, is improper, but rather that compensation paid for a table-funded loan will be subject to the strict RESPA Section 8 referral fee limits.
The treatment of table-funded loans adopted by the final regulations not only can have potentially severe adverse consequences for the wholesale lending industry, but also sharply contrasts with the more reasoned approach to the same issue adopted by the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB). In determining when a table-funded loan should be treated as a sale, the task force recommended a five-part test focusing on the independence of the broker, not on its ability to fund the loan. Unfortunately, the final regulations do not even reference, let alone adopt, the FASB EITF recommendation.
folons and the RESPA police
As will be attested to by the scores of recipients of formal and informal inquiries from HUD's RESPA enforcement unit, or its field forces in HUD's mid-Atlantic region, or the U.S. attorneys, attorneys general, insurance commissioners and consumer groups in the more activist states with which that enforcement unit works, the absence of final RESPA regulations has not deterred attempts by HUD and its regulatory allies to document perceived RESPA abuses, particularly in the Section 8 referral fee area, and to extract penalties and consent agreements promising to refrain from the practices at issue.
For example, in its two most recent and well-publicized cases, HUD obtained a million-dollar penalty from a title agent that it alleged impermissibly was receiving title insurance premium proceeds without performing significant title services, and, in the other case involving a group of affiliated companies, it extracted a smaller penalty and consent judgment requiring the timely provision of complete controlled business disclosures.
In other cases, nondedicated equipment, such as computers and fax machines, have been determined by HUD to be things of value impermissibly given for the referral of settlement services business, and payments not solely related to the reasonable value of the services being provided but rather related, for example, to the number or amount of closed loans and have been pursued as RESPA violations.
Disaffected former employees, and business competitors, have proven to be steady providers of enforcement leads to the small, somewhat overwhelmed, but tenacious HUD RESPA enforcement unit, encouraged no doubt by its informal circulation of a "snitch" form that permits anonymous RESPA complaints to be lodged.
Armed now with newly minted final RESPA regulations that clarify many, though certainly not all, ambiguous requirements, an even more ambitious enforcement effort, including criminal prosecutions, would appear to be inevitable.
The final RESPA regulations also encourage action by lenders that own title insurance companies but that are restricted by state law in the amount of business the lender may do with its affiliate. Some half-dozen states, Kansas, California and Connecticut among them, impose such restrictions.
The final RESPA regulations expressly provide for the federal preemption of state controlled business arrangement laws that are inconsistent with RESPA, but restrict HUD from construing those provisions that impose more stringent limitations on controlled business arrangements as inconsistent with RESPA "so long as they give more protection to consumers and/or competition."
According to its Regulatory Impact Analysis, HUD defined its preemption authority in this manner expressly to provide support to lenders who own title insurance companies and who wish to overturn "competition-inhibiting" state law restrictions on title company referrals from lender affiliates.
Basic RESPA disclosure requirements
Lenders have had 18 years in which to adapt to the basic disclosure requirements of RESPA. These include the issuance of the HUD-written "Special Information Booklet" within three business days after the receipt of a loan application; the preparation and delivery of a Good Faith Estimate, which sets forth in dollars the amount or range for each settlement service charge a borrower is likely to incur; and the completion of a HUD-1 Settlement Statement, provided at settlement, but which, at the borrower's request, must be made available for his or her inspection at least one business day before the date of settlement. The uniformity provided by these disclosures was needed in the national mortgage banking industry, and has been welcomed.
Newer amendments to RESPA require certain additional disclosures concerning the transfer of servicing and the administration of escrow accounts.
The four newest RESPA disclosure
With publication of the December 2 final RESPA regulations, however, come four additional or refined disclosure requirements that mirror the new Section 8 referral fee rules.
CLO fee disclosure
First, a new disclosure must be provided to the borrower by the Realtor or
other third party operating a CLO of the amount of the fee that will be paid by the borrower for its services. No time is specified for the provision of the required CLO disclosure. It must, however, include a specified "warning" that the CLO fee may be avoided entirely if a lender or mortgage broker is approached directly and that lower rates or fees may be available from lenders not listed on a computerized system.
HUD's estimated cost to CLO service providers simply for completing this new CLO disclosure? $3.2 million annually as described in the "Regulatory Impact Analysis" that HUD was required to perform when it issued its final RESPA regulations.
CBA cost disclosure
Second, the regulations finally implement the CBA disclosures that have been required by law since 1983. The required CBA disclosure must be provided generally on a separate piece of paper and at the time of the referral (although an amended Good Faith Estimate may be adequate in some circumstances), and it must specify the nature of the affiliation between the two companies and the settlement service provider's estimated normal charges. It also must include a "warning" that, generally, the use of the settlement service provider to which the referral is made is not required and that "shopping" for a different settlement services provider may yield even lower costs.
HUD's cost estimate for those who must prepare CBA disclosures? $48 million annually as described in the Regulatory Impact Analysis.
Mortgage broker Good
The final RESPA regulations define a mortgage broker as a person (not an employee of a lender) who brings a borrower and lender together to obtain a loan, and who renders virtually any one of the 15 examples of "settlement services" listed in the regulations. A lender under the regulations is the secured creditor named as such in both the note and security instrument.
As a third required disclosure, mortgage brokers who are not an exclusive agent of a lender must now provide borrowers with a Good Faith Estimate within three days of receiving a loan application, in addition to the Good Faith Estimate that must be provided within three days of receipt by the lender. The mortgage broker Good Faith Estimate requires a special legend explaining that the lender also will provide a Good Faith Estimate.
In its Regulatory Impact Analysis, HUD conceded that the "social benefits" of the additional, newly required mortgage broker Good Faith Estimates are small," particularly when compared to an annual estimated cost of providing these duplicate forms of $57 million.
Mortgage broker fee
Finally, the final rules require the disclosure on the Good Faith Estimate and HUD-1 Settlement Statement of the amount of the fee paid to a mortgage broker and its identity. Within that amount must be all fees arising from the "initial funding transaction, including a servicing-release premium or yield-spread premium." The disclosure requirement also applies to table-funded loans dosed by mortgage brokers.
To complaints that such a mortgage broker fee disclosure is unfair and confusing because there is no similar required disclosure of the commission paid a lender's loan solicitor, HUD's Regulatory Impact Analysis responded with the notions that the borrower needed the broker fee disclosure to determine how strong the broker's incentives were to steer loans to particular lenders and that, in any event, loan solicitors, unlike brokers, do not have the option to set above-par note rates.
Here, too, the ambiguous contours of the mortgage broker fee disclosure requirement, the flawed notions, in the eyes of some, supporting its adoption, and its adverse impact on flexible fee arrangements for wholesale mortgage lenders making table-funded loans in a time of severely restrained warehouse lending sources seems destined to stimulate, rather than quiet the agitation over this aspect of HUD's final RESPA rule.
Maintenance of escrow
The escrow- account- maintenance provisions contained in Section 10 of RESPA were enacted to prevent lenders from requiring unnecessarily large escrow accounts for the payment of borrowers' taxes and insurance. It basically provides that mortgage lenders and servicers can collect monthly payments but are prohibited from requiring borrowers from maintaining more than two months' worth of the total annual escrow payments as an escrow cushion.
Although the escrow provision contained in RESPA does not provide for either civil or criminal penalties in the event of a violation, individual borrower and class-action lawsuits against lenders for falling to follow proper escrow procedures are endemic, some of which have been settled with lenders making substantial payments to borrowers and their attorneys. These lawsuits allege breach of contract, violation of the Racketeer Influenced and Corrupt Organizations Act (RICO) and violation of various state deceptive trade practices acts.
HUD's December 2 final RESPA rule completely avoided this subject, thus ensuring that the pending controversy in this area of RESPA will continue unchecked. Ironically, in the one place where HUD may have played an important role in defusing an ongoing costly dispute, it remained silent.
Likely outcome of the rule
Several conclusions and predictions about the likely impact of these new, final RESPA regulations can be made, and the pace of change in the directions they chart will accelerate into the future, unless the new administration, the new Congress or the courts compel a different result.
Among the most visible changes produced by the rules:
* New controlled business arrangements, referrals between controlled business affiliates, joint between independent settlement services providers and incentive payments to employees paid by their employers to encourage such referrals will become commonplace.
* Packages of settlement services, including mortgage loans, will be offered to consumers at discounted prices.
* "Borrower pay" consumer advisory services, provided by Realtors, attorneys and others, actively will be pursued and implemented.
* Single lending or mortgage broker source CLO systems, some sophisticated, some computerized, will develop and become integrated into real estate brokerage offices.
* Wholesale mortgage lenders and mortgage brokers engaged in table-funded lending will be required to examine with care their loan compensation arrangements for compliance with RESPA Section 8 referral fee limitations, while mortgage brokers who close loans in their own names with their own credit lines will be able to sell their loans in the secondary mortgpge market free of such restrictions.
* Full mortgage broker fee disclosures, and other changes in the way in which mortgage brokers compete and get paid for their business, will be put into place, and required fee disclosures will be different for mortgage brokers and lenders, even for the same mortgage loan.
* A newly liberated RESPA enforcement unit, aided by civil and criminal regulatory and law enforcement officials and private attorneys, will make its presence known. Especially vulnerable will be those who fail to provide all required disclosures of mortgage broker and CLO fees and of controlled business arrangements; those giving or receiving "naked" and only half-clothed kickbacks; and those in the title insurance industry.
Finally, although HUD may believe that these are its final words on this most difficult subject, their controversial nature and pervasive impact assuredly will give new meaning to the term "final" in the December months to come.
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|Title Annotation:||real estate settlement cost legislation|
|Date:||Dec 1, 1992|
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