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December 17, 2001
�The
Federal appellate court in the 7th circuit recently ruled that it is
legal for lenders to make a profit on third party services sold to borrowers,
such as appraisals and credit reports. In contrast, HUD has always said that
markups were illegal if there were no services provided in connection with them.
Who is right, and if the court ruling stands, how can borrowers protect
themselves against excessive charges?�
I�m
with the court on this one. HUD�s rule is essentially unenforceable and was widely
violated before the recent court decision.
Having unenforceable laws on the books that are routinely violated does
not protect the borrower, and undermines respect for the law.
There is a case
for prohibiting markups in this market. Loan
providers are not restricted in their ability to charge directly for their
services. Indeed, the list of fees
that one or another loan provider charges is bewilderingly long.
Markups aren�t needed to assure that loan providers are adequately
compensated, and create one more layer of complexity for consumers.
Indeed, if I were
mortgage czar rather than professor, I would prohibit all markups, and limit
loan providers to two fees: one expressed as a percent of the loan (�points�),
and one expressed in dollars (�total fees�).
This would drastically simplify life for borrowers without in any way
restricting the ability of loan providers to charge for their services.
In the world that
exists, however, it is better to permit markups.
The alternative to permitting markups is not my ideal rule but an actual
HUD rule that allows markups if additional services are provided but prohibits
them otherwise. While the HUD rule
may appear fair, it is not because it is not enforceable -- except very
selectively, which is unfair. The
vast majority of loan providers know they are beyond HUD�s reach.
Violations of the
HUD rule were pervasive before the recent court decision.
Hence, the problem that markups on third party services pose for
borrowers will be little different in the future than it was before the recent
court decision.
What does a
borrower do to protect against unjustified markups?
Let me begin with
what not to do. Another
columnist advises borrowers:
�Don't
be asleep at settlement -- demand to know why you're being charged $60 for a
credit report instead of much less, and take a hard look at other fees if they
seem high.�
If the borrower
doesn�t wake up until settlement, he might as well go back to sleep for all
the power he will have to affect the outcome.
To expect that a borrower will be able to talk down fees at settlement
because they �seem high� is unrealistic.
The lender will have ready explanations for every charge, and the
borrower�s clout in protesting them is zilch.
For example, the
loan provider can explain that the $60 charge for the credit report includes the
lender�s cost to extract the critical information from the report and analyze
it. That will end the discussion
and the charge will remain.
A borrower who
awakens prior to closing may have more success.
If it is a refinancing, the borrower can threaten to walk from the deal.
If it is a home purchase and a real estate agent recommended the lender,
the borrower can enlist the agent to intervene with the lender.
Another not-so-great
idea is for borrowers to order their own services.
Loan providers will strongly resist it, for good reason.
They know they will have to instruct the borrower how to do it, and then
monitor the results, which takes more of their time than if they did it
themselves. Loan providers expect
to be compensated for their time, so if you demand more of it to reduce
their fees on third party services, they will look to make it up elsewhere.
The fact is that
markups on third party services, when they occur, are the smallest part of a
loan provider�s compensation. It
makes no sense to try to save $150 on the appraisal if it costs you the
equivalent of $500 elsewhere in the deal.
Borrowers should be concerned with the total, not one part of the total.
There
are two approaches to this problem that I�ll call the shopping approach
and the agent approach. Both
approaches are part of broader strategies toward shopping, and are deployed
during the process of selecting your loan provider.
Neither approach focuses on markups in isolation, because markups are the
smallest part of your total credit cost.
The
shopping approach simply means that you shop total fees paid to the loan
provider, and to third parties providing services ordered by the loan provider.
This total is what matters. You
don�t worry about individual fees � for example, why A charges for courier
service when B down the street doesn�t. And
you don�t worry about markups because they are included in the total.
While
it is the total that matters, to get it you must tell the loan provider exactly
what you want. The relevant categories are:
Fees
Paid Before Closing: Most
settlement costs are paid at closing; if the loan doesn�t close, there is no
payment. There are two types of costs, however, which are paid before closing
and may not be reimbursed if the loan doesn�t close.
One is an application fee, which is due at the time the application is
submitted. The second is a
commitment or lock-in fee, due at the time the terms are locked by the lender. Neither of these fees are common today.
Fees
Retained by the Lender Expressed as a Percent of the Loan:
This includes two charges: "points" and "origination
fee". While lenders always quote points when they quote the
interest rate, they often delay disclosing an origination fee.
Fees
Retained by the Lender Expressed in Dollars:
This includes a wide variety of charges imposed by and paid to the lender or
broker, which are expressed in terms of dollars rather than as a percent of the
loan. They are sometimes known
collectively as �junk fees�.
Charges
paid to third parties: These
are payments to third parties for services that lenders require.
The most common are appraisals and credit reports.
Lenders and brokers know what these charges are, even though they do not
receive the payments, and they may mark them up.
Fees
paid to mortgage broker:
If you are dealing with a mortgage broker, the broker's fees to you
should be included. The major fee will usually be expressed as a percent
of the loan, and is therefore similar to points. Brokers will also often
charge a processing fee expressed in dollars.
Convert
the fees expressed as a percent of the loan into dollars and add up the total.
Assuming the interest rate quoted by loan providers is the same, you
select the one offering the lowest total fees.
If
loan provider A quotes lower fees but a higher interest rate than B, you need to
know which will cost the most over the period you expect to be in your house.
For this purpose, you can use one of the �interest cost comparison�
calculators on my web site.
All
the fees listed above are included in a required disclosure called the �Good
Faith Estimate of Settlement Costs" (GFE).
However, the lender has until 3 business days after you complete an
application to provide this statement, which makes it useless for shopping
purposes. Even if you received it earlier, it is so poorly designed that it can
as easily lead you astray as help. See
Does the Good Faith Estimate Help?
The
agent approach to avoiding excessive markups is simpler.
You negotiate a fee with a mortgage broker to act as your agent in
shopping for a loan. The broker fee
is all-inclusive, so any markups are included, and it is net of any payment to
the broker by the lender. The broker then shops on your behalf for the best deal
available from lenders, including lender fees.
The mortgage
broker must be willing to deal with you as your agent, rather than as an
independent contractor, which is the general practice.
Upfront Mortgage Brokers prefer
to work this way, but many other brokers
would be willing to if customers requested it.
Copyright Jack
Guttentag 2002
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