Broker Fees: There's More Than One Way to Skin A Regulation

America is the land of opportunity. Our history is replete with examples of individuals who identified a service or product opportunity, filled it, and became a success. The latest entrepreneurs in this rapid channel to achievement seem to be loan brokers, individuals who bring together a lender and an applicant - and charge a fee for the service.

The practice of brokering loans is affected by several regulations and with slightly different results. Paying attention to one regulation won't suffice for purposes of compliance. Instead, it is necessary to run a fact situation through an analysis under several regulations.

Brokering practices for real estate loans are heavily regulated. RESPA and Truth in Lending place heavy restrictions and disclosure requirements for these transactions. However, non-real estate loans are subject to slightly different regulatory emphasis. for these loans, fair lending and even CRA may be more significant.

RESPA
When it comes to compensating loan brokers, RESPA has powerful prohibitions. Two principles contain the key to compliance with this law. First, there can be no fee paid for a referral because a referral - at least in the view of HUD - has no value. Thus, fees that compensate the broker only for a referral, whether a fixed cost per customer or a percentage of the loan amount, are prohibited.

Second, any compensation paid to a broker must be based only on the value of services actually performed. For example, if the broker prepared application documents and performed some tasks that would otherwise be performed by another settlement service provider, and the lender accepts the work of the broker, then the broker may be compensated only for the value of that service. Before entering into broker arrangements, the compensation structure should be carefully reviewed in the context of RESPA. The issue of charging the consumer broker fees, particularly when the fee structure motivates the broker to charge the customer as much as possible, are under close scrutiny. When a fee is considered to be excessive, it would violate RESPA. However this would only affect "federally related mortgage loans" - loans secured by a 1-4 family dwelling.

Truth in Lending
For purposes of Truth in Lending, the considerations are more complex, even if violations don't involve criminal sanctions. Regulation Z now contains the final provisions under amendments to the Truth in Lending Act that provide that mortgage broker fees are always finance charges. The mortgage broker's fee - if it passes scrutiny under RESPA - must be included in the finance charge. This rule now applies without regard to whether the lender required the applicant to use a mortgage broker. Thus, voluntary use of a mortgage broker still results in a finance charge. As a practical matter, all lending staff should routinely ask each mortgage applicant whether they use a loan broker and, if so, how much they paid the broker.

For non-real estate loans, broker fees may still be finance charges. If the bank requires the use of a third party, such as a loan broker, the fee is a finance charge, even if the consumer can choose the third party. ?226.4(a)(1). However, if the consumer voluntarily used a broker, but could have applied directly to the bank for the same credit, the broker fee would not be a finance charge. Thus, for brokers other than mortgage brokers, the lender should track the circumstances under which the broker was used.

Fair Lending
The use of loan brokers and the impact of broker fees on different groups of borrowers is getting close attention under fair lending. The concern is that brokers may charge less sophisticated customers more than experienced customers pay. When a creditor approves or purchases a loan for which the pricing was negotiated by a broker, the customer may be paying more than other customers. If the loans bought or approved through brokers show a pattern of minority borrowers, the resulting pricing may be or appear to be discriminatory.

The case brought by the Department of Justice against Long Beach Mortgage Company was based on this type of theory. It means that the lender's pricing structure and the decisions made about loans brought in by brokers may have a dramatic impact on the bank's fair lending performance. When a lender uses loan brokers or purchases loans, the lender should carefully monitor the impact of pricing for fair lending considerations as well as for RESPA concerns.

CRA
One of the ironies about effective CRA programs is that loan brokers can provide access to low- and moderate-income borrowers. In spite of the concerns about fair lending, loan brokers can be an effective means of finding customers who would not otherwise come to a bank for credit. Similarly, arrangements with community organizations, including some credit counseling and home purchase advisory services, can involve fees. Depending on the fee structure, these fees may be construed as broker fees. If so, the lender should look beyond the CRA concerns and also consider the impact of RESPA, Truth in Lending, and fair lending laws.

ACTION STEPS

Alert your lending and branch staff to the fact that broker relationships can have severe regulatory ramifications. Advise them to alert you whenever a broker opportunity arises. Remind them that your review is designed to keep them out of jail!
Brief the Board on the compliance problems that can result from broker relationships. Advise them to respond with caution when approached by brokers with a new "win-win" sales opportunity. Also suggest that any arrangements under consideration should be reviewed for compliance concerns before decisions are made.
Review your mortgage application procedures to be sure that they include asking each customer about the use of mortgage brokers. Also be sure that the guidance provided to lending staff instructs them to include such fees in the finance charge.
In your next training session with loan originators, review the fair lending concerns about loan pricing. Discuss their practices and make sure that they understand the legal consequences of negotiated pricing and broker fees to them and to the bank.
Notify your CRA manager (if it isn't you) to be alert to broker fees and negotiated pricing in different credit application procedures and loan programs. This includes referral arrangements with housing or community groups. Remind them that carrying out the good work of CRA does not excuse them from compliance with other regulations.
Meet with your CRA staff to determine precisely what kinds of fees and other financial arrangements they have made with community groups, counseling services, or brokers. Evaluate these for compliance with all pertinent laws.