HUD shields mortgage brokers from angry borrowers
By Holden Lewis • Bankrate.com

In the legal war between home buyers and the mortgage brokers accused of duping them, the federal housing department recently gave aid to the brokers.

The help came Oct. 15 in the form of a "policy clarification" issued by the Department of Housing and Urban Development. HUD Secretary Mel Martinez says the clarification will benefit homeowners. But it is designed to shield mortgage brokers and lenders from lawsuits by customers who believe they have been defrauded.

The mortgage industry cheered the announcement and consumer advocates fumed.

If there is any advice to give in response to HUD's policy clarification, it is this:

• Get quotes from more than one mortgage broker or lender.
• Make sure you understand the fees you're paying and comparison-shop to find out if fees are reasonable.
• Be vigilant if you use a mortgage broker and your loan has "back-end points" -- in other words, if you pay a higher interest rate in exchange for not having to pay closing costs.
• Be extra vigilant if you're paying a high interest rate and the loan has a prepayment penalty.
• If a mortgage broker hoodwinks you, don't expect help from the government.

Spread 'em
HUD's policy clarification of the Real Estate Settlement Procedures Act concerns "yield spread premiums." These are payments that lenders give to mortgage brokers for signing borrowers to high-rate loans. Sometimes the payments are called back-end points, rebates or negative points.

At its worst, a yield-spread premium is an illegal kickback. At its best, it allows cash-strapped people to buy houses without paying closing costs.

The mortgage industry says yield spread premiums help consumers, and that the unscrupulous lenders and brokers who cheat borrowers are just a few bad apples. On the other hand, the mortgage industry says it would be "catastrophic" for the whole industry if groups of homeowners were allowed to sue those few bad apples.

HUD's clarification makes two main points. First, it says that yield spread premiums live in legal limbo, being neither legal nor illegal. Second, it says the legality of each yield spread premium has to be judged by itself. If the courts defer to HUD's clarification, they'll toss out all class-action lawsuits challenging yield spread premiums.

"If there's no ability to bring a class action, there's no heavy hand to enforce the rule," says Margot Saunders, an attorney for the National Consumer Law Center, which has taken part in lawsuits against the mortgage industry over yield spread premiums.

Happy lenders helping home buyers
Yield spread premiums really do help some borrowers. Here's how one might work:

• After scrimping for a long time, you have saved $10,000 for a down payment and you've made an offer on a $100,000 house. You also have saved $2,000 to pay closing costs.
• You go to a mortgage broker, who tells you that you can qualify for a 7-percent mortgage paying no points. But closing costs will be a problem. You'll need $3,500 at closing to pay the broker's fee, taxes and other costs, but you've set aside $2,000. You're $1,500 short. Without the money, you can't buy the house.
• The broker offers a solution: Instead of paying points to the lender, the lender can pay back-end points to you. In exchange, you pay a higher interest rate. You can get a 7.75-percent loan and get 2 points back, or $1,800. That $1,800 is the yield spread premium.
• You accept the offer. At closing, your broker keeps the $1,800 yield spread premium and you write a check for $1,700 to pay the rest of the broker's fee and other costs.

If you had been able to scrape up the money for the closing and got a 7-percent loan of $90,000, your monthly principal and interest payment would have been $598.77. But you got a 7.75-percent loan instead, so your monthly principal and interest is $644.77. The difference is $522 a year.

The lender is happy in this situation because it has a high-interest loan on the books. The broker is happy after collecting that yield spread premium. And you? You're happy that you now own a house, but after a few years of paying that higher interest rate, maybe you start to wonder if you were played for a sucker. You wonder if the broker collected an unfairly large fee in exchange for signing you up for a high-rate loan.

Classless action
The courts probably would look kindly upon the above deal if the fees didn't seem out of line. But critics of yield spread premiums say that some mortgage brokers jack up borrowers' interest rates just to collect a big payoff. Someone with iffy credit might be able to qualify for an 11-percent loan, but the broker might push a 13-percent loan to collect a big yield-spread premium.

HUD says yield spread premiums have to be fair payment for services rendered. If a broker normally charges a $1,000 fee to put together a transaction, but collects a $3,000 yield spread premium for performing the same services for one client, that's illegal.

But who's going to challenge the $2,000 overcharge? Judging from its record, HUD is unlikely to punish the broker and get the money back. Few attorneys would take the case for a measly $2,000 because there's no profit in it.

The only affordable way to go after an unscrupulous lender or broker is for one attorney to represent many borrowers: a class-action lawsuit. HUD's clarification asks the courts to toss out class-action lawsuits that challenge yield spread premiums, regardless of whether the lawsuits have merit.

Instead, HUD says, the lawsuits should be heard individually, case by case. Under those rules, few cases would be heard at all.

Hungry rodents
Lenders and brokers pleaded with HUD to issue the clarification after the mortgage industry lost a big legal battle in June, when a federal appeals court affirmed class certification in an Alabama lawsuit called Culpepper vs. Irwin Mortgage.

In that ruling, the 11th Circuit Court of Appeals said that yield spread premiums are illegal unless the lender scrutinizes every transaction to make sure the broker is paid a reasonable fee for the work done. Otherwise, the court ruled, a yield spread premium is just a kickback that a broker gets for persuading a borrower to get a high-interest loan. Such kickbacks are illegal.

Mortgage bankers and brokers reacted to the ruling as if a rat had walked across the dinner table. They jumped out of their chairs and screamed loudly for the appeals court to reconsider. They grabbed the ear of HUD Secretary Martinez. Or, in the polite language of the Mortgage Bankers Association: "MBA worked intensively and diligently to educate policymakers on the catastrophic implications of the decision for consumers and lenders."

Four months after the appeals court's decision, HUD announced its policy clarification.

"This lifts a great legal cloud that was forming against the mortgage broker and mortgage lender community, and we can now get back to business," says Joseph Falk, president of the National Association of Mortgage Brokers.

MBA president Andrew D. Woodward applauds HUD's announcement and says it will "increase legal certainty in the area of yield spread premiums, which will help to preserve an important consumer financing tool."

Saunders, of the National Consumer Law Center, says the battle isn't over. She says it's up to the courts, not HUD, to interpret the Real Estate Settlement Procedures Act.

David Donaldson, the plaintiff's attorney in Culpepper vs. Irwin Mortgage, asked the court to follow its own interpretation of the law and not HUD's interpretation. In a court document, he characterized HUD's action as not a clarification but "a reversal of HUD's prior position" and "an attempt at revisionist history."

He also noted that HUD boasted in a news release that its policy clarification will save borrowers from discovering unexpected fees at closing. The clarification will do no such thing and is designed to close the courthouse door to cheated borrowers.

Prepayment penalty tip-off
Even Saunders acknowledges that yield spread premiums benefit some borrowers who don't want to write a big check at closing. However, she says her clients typically are people who have shaky credit and who could qualify for a 12-percent loan but are conned into taking 13-percent loans by brokers who pocket hefty yield spread premiums.

She says borrowers should ask brokers lots of questions to find out exactly how the broker is paid, whether the fees are comparable to what others charge, and whether some or all of the fee payment is via a yield spread premium.

Here one tip-off that a loan might not be in your best interest: the existence of a prepayment penalty. That's a fee for paying off the loan early -- something you might want to do if you sell the house, refinance the mortgage or win the lottery. Saunders says that many loans with yield spread premiums also have prepayment penalties.

A typical prepayment penalty might require you to pay six months' worth of interest if you pay the balance in full within five years of getting the mortgage. A lender or broker is unlikely to point this out to you when you're looking at the loan papers.

The best thing to do is ask if there's a prepayment penalty. And if a broker or lender tells you that there's no prepayment penalty, say, "Show me where this document says that there's no prepayment penalty." If the lender or broker says there is no such place, that person is ignorant or a liar and you should take your business elsewhere.

The bottom of the Truth in Lending Disclosure Statement (which you are required to sign) will tell you if there's a prepayment penalty. Just above the signature area, this document says, "Prepayment: If you prepay this loan in full or in part, you [ ] may [ ] will not have to pay a penalty." If the "may" box has a checkmark in it, there's a prepayment penalty.