Broker Compensation

Maybe Kansas; Maybe Oz
HUD has published an official interpretation of RESPA to clarify when and how the payment of mortgage broker fees is legal or illegal. The new Statement of Policy, 1999-1, makes what is illegal easier to identify than what is legal, but this is one of the clearest interpretations to come out of HUD's RESPA office in some time.

The Policy Statement explains HUD's reasoning fairly thoroughly, making it possible for bankers and mortgage brokers to apply the analysis to individual situations. It is a useful document to keep on hand for briefings and training. The points in the interpretation are clear and well-explained. This time, let HUD say it for you.

Can a lender pay a mortgage broker?
Maybe yes, maybe no - it depends. But now we know for sure what it depends on. Essentially, HUD has officially decided not to upset the apple cart by making broker fees - even those that are percentage-based fees - illegal per se. HUD takes note of industry practices and chooses instead to base its interpretation of RESPA on the policy goals of the act.

No Free Lunches
According to RESPA and HUD's current interpretation of it, there is no such thing as a free lunch where referrals are concerned. In fact, RESPA is all about getting what you pay for and getting paid for what you earn.

It is legal to pay fees to brokers, whether calculated by fixed fee amounts or by a percentage of the loan amount if - and only if - the fees are fair and legitimate compensation for work performed by the broker.

The interesting - and potentially dangerous - aspect of this interpretation is that HUD specifically permits percentage-based fees. The dangerous part is that percentage-based fees are legal only as long as they are earned by work performed. So, although HUD accepts percentage based fees in principal, it leaves the industry to defend those fees in individual situations.

Fees must pass two tests in order to be considered legal. First, there must be goods or services actually furnished or performed. Without some tangible service or product, there can be no fee. Remember that referrals by themselves have no value. When HUD specifies that services must actually be performed, they don't mean referrals.

Second, any payments must be "reasonably related to the value of the goods or facilities that were actually furnished or services that were actually performed." Fundamentally, the question is the relationship of the fees to the services of goods.

Types of fees
The interpretation states that RESPA applies to all types of fees, no matter what the parties call them.

HUD looks at the total compensation package, not merely at certain fees. In addition, what the lender or broker calls the fees is not relevant. HUD will measure the total compensation in relation to the services performed.

Total compensation includes both direct and indirect payments to the broker. It also includes payments made by the borrower and by the lender at any point in the application and settlement process.

Note that HUD believes that a higher interest rate alone cannot justify higher total fees to the broker. Simply negotiating a higher interest rate with the customer is not sufficient to pass the service performed or goods delivered test.

HUD will also look at fees in other markets to assess the legitimacy of fees. Whether a fee passes the fair market value test depends as much on the market as on the nature of the services performed. Like the Good Faith Estimate, the fairness of the fee must be based on market knowledge.

Caveat: When analyzing a fair market fee, be careful that the fees in your market do not include any referral fees. Since RESPA prohibits these fees, they cannot become legitimate simply because everyone does it in your market.

Goods and services
The interpretation includes a list of activities ranging from taking application information through to counseling that constitute a service for which a broker may be compensated. When considering broker relationships and compensation packages, stick to this list. Also remind lenders (over and over) that the loan is not a "good" for purposes of RESPA. The two things that matter most to lenders - referrals and loans - have no value and cannot alone be the basis of compensation.

Because you will want to give lenders and others in your bank an easy reference guide, we enclose the list from the Policy Statement in a form that you can duplicate and distribute.

No-cost Loans
First, HUD doesn't believe that there really are no cost loans. HUD would rather accept the existence of the Tooth Fairy. The costs are in there somewhere. In no-cost loans, HUD believes that the correct RESPA analysis is to look at whether the interest rate (which is presumably where the costs are hidden) is appropriate given the value of the services.

Disclosing the Fees
Fees for any of the services covered by this interpretation must be included on the Good Faith Estimate and on the HUD-1. The purpose of the GFE disclosures is "to assure that consumers are shown the full amount of compensation to brokers and others early in the transaction."

HUD also advises that the disclosures be presented in a way that the consumer can be expected to understand. This means no secret code words or acronyms. Describe the fee for what it is. If it is part of the deal, the consumer has a right to know about it. After all, the consumer is paying it.

HUD recommends that broker fees be clearly labeled as such. For fees paid directly by the lender to the broker, HUD recommends specifying this rather than simply labeling it "p.o.c." for paid outside of closing.

Table Funding v. Secondary Market
The Policy Statement incorporates RESPA's exception for secondary market transactions, explaining that by virtue of being exempt from RESPA, the question of Section 8 violations regarding brokers fees does not arise. The Policy Statement includes a detailed discussion of table funding.

The distinction between table funding (which is subject to RESPA) and the secondary market (which is exempt from RESPA) is the actual movement of money. When a loan is made, at some point it is subject to RESPA. In table funding, the transaction may be set up to look like a secondary market loan sale. But HUD won't buy the "Look Ma - no hands!" argument. Somewhere, there is a lender and the lender is the party that funds the loan.

What about fair lending?
We issue a warning to users of this interpretation: this is an interpretation of RESPA and a policy statement of how HUD intends to interpret and enforce that law. It has nothing whatever to do with fair lending. So, if your bank is considering (or already has) broker relationships, look at the fair lending implications of those relationships independently from the RESPA issues.

ACTION STEPS

Brief your lending staff on this interpretation. Use the opportunity to discuss any such arrangements they presently have or are contemplating. Manage this exchange in a way to keep the door open. You can't help them unless they are comfortable coming to you.
Review all compensation arrangements in your lending department and evaluate their consistency with this Statement of Policy.
Audit selected loans subject to RESPA and look for fee payments. Specifically include construction loans because these often involve cooperative arrangements between your bank and a broker or another lender.
While you are at it, look carefully at how all fees are treated for purposes of Regulation Z. Make sure that all the finance charges are counted.