Fee Splitting

Two Reg Tango?
Enticing offers to increase lenders' mortgage volume and profitability are flying. Your loan department may be considering a lucrative arrangement right now. When they finally tell the compliance department about it, they'll have stars in their eyes and be planning how to spend their bonuses. This is where compliance managers get their negative reputation: you might have to play the deal killer.

Without the right compliance attention before reaching an agreement, any such arrangement can bring serious trouble to the bank in two areas of law: Fair lending under both the Fair Housing Act and the Equal Credit Opportunity Act; and RESPA. How mortgage referral deals are structured and priced will determine whether you are in business or in court (sitting at the defense table.) Although the lenders may initially be too starry-eyed to listen, I find that their ears perk up when I mention "jail." They respond particularly well to: "Who would you like as a cellmate?"

RESPA
Here's the problem. There are only a limited number of ways to compensate settlement service providers - including banks and mortgage brokers - without violating RESPA's criminal provisions. One of the practices that led to the passage of RESPA was arrangements between different players in the real estate sales and financing business that were designed to line the pockets of the players at the expense of the consumer-purchaser. When a real estate broker, mortgage broker, or mortgage lender gives advice, the consumer tends to follow it. After all, they have hired that person for their expertise.

RESPA has two ways of controlling this practice. First, the act requires disclosure of settlement costs both at application and at closing. Second, the act makes certain types of fees illegal - even criminal. (This is where that jail cell comes in.)

One of the drawbacks to legislation is that drafters of the emerging new law tend to focus on the practices they want to stop. They do not look at the positive side of the equation. In fact, there are many "arrangements" between settlement service providers that are to the customer's benefit. Unfortunately, most of these go into the same jail cell as the bad practices. HUD has recognized that this is the case, but has not yet found a way to clarify what is permissible and what is not. As the mortgage finance market becomes increasingly complex, new types of arrangements are created. The difficulty for banks is to distinguish between the permissible and the criminal arrangements. There are several factors to look for.

First, is enough actual work done to earn the fee? If the work is to support the fee, it must not be duplicated by another settlement service provider down the line. For example, if a mortgage broker compiles credit history and income verifications, the broker can only be compensated if the lender accepts that work and does not re-do it.

Second, is the fee appropriate for the market and the work performed? To evaluate the validity of any fee, compare it to other fees in the same market for the same service.

Finally, is the customer paying a fair fee for the loan? Look carefully at what the customer actually pays under the arrangement and what the customer would pay if walking in the bank's door. The less difference between a brokered loan and a direct loan, the safer the practice is. Ideally, there should be no difference.

Fair Lending
The Department of Justice's case against Long Beach Mortgage stands for the proposition that differences in pricing by a prohibited basis, regardless of source, violates fair lending laws. Thus, one of the issues in any such arrangement is the type of customer the referrals will bring in. As long as the product and its pricing is the same as a direct loan, there should not be a problem. However, if there are any pricing differences, the identities of the borrowers in the two groups can quickly become a serious fair lending issue.

The bottom line for both regulatory concerns is that the pricing be fair. If loans are more expensive through referral networks, there will be both RESPA and fair lending questions.

ACTION STEPS

Review mortgage loan files to identify any referral relationships. Look for any pattern of referrals. Note any correlation between loan officers and loan sources.
Meet with loan officers to discuss how loans come in and whether and how anyone is compensated.
If you find a referral pattern, compare loan pricing for those loans to pricing for loans from other sources. If you find any patterns, act on this fast!
Do a demographic analysis of borrowers by source of loan. Look for any patterns by prohibited basis, especially race, ethnicity, gender, and age. Compare pricing by source.
If your bank accepts loan applications through a variety of sources, make it a regular part of your fair lending self-assessment to compare the pricing and terms for each source by prohibited bases.