Disclosure by Brokers and Lenders Could Curb Overcharging

By Jack Guttentag
Saturday, April 14, 2007

Mortgage borrowers are overcharged when they pay more for the same loan or service than they would if they had the information needed to shop effectively among alternative sources.

There are consumer groups that say lenders should be held liable if they allow borrowers to take unsuitable mortgages. In previous columns in this series, I have argued that such a suitability standard would not be an effective way to deal with bad mortgage selection, unaffordable loans or refinancing that doesn't benefit borrowers. This week, I'll examine whether a suitability standard would help solve the problem of overcharges.

Types of overcharging include lender steering, excessive broker fees and loan-officer overages.

Lender steering refers to the unsavory practice of soliciting borrowers for loans that are priced higher than those for which the borrower would qualify. Steering is often associated with prime borrowers -- those with strong credit histories -- being targeted by subprime lenders and charged subprime prices.

No suitability rule can deal effectively with steering. There is no way to enforce rules barring lenders from charging particular borrowers higher prices than those available to the borrower elsewhere.

The best way to protect borrowers against aggressive solicitors of high-priced loans is to provide them with better alternatives. Vulnerability to solicitations is high when the soliciting loan provider is the only one the borrower knows about. If the borrower knows that there is a group of loan providers that has been certified by a trusted source, vulnerability declines sharply.

Over the years, I have tried to stimulate the development of certification as an accepted part of the home mortgage market. I have proposed a system I call Upfront Mortgage Brokers and Upfront Mortgage Lenders.

Such certified loan providers agree that they will not use their superior information to the disadvantage of borrowers. There are about 200 UMBs and three UMLs -- a small slice of the thousands of mortgage brokers and lenders nationally. Other certification initiatives are in the works elsewhere.

Excessive broker fees arise primarily from a lack of transparency in broker pricing. Most broker fees are paid by the lender to the broker as a rebate or "yield spread premium," known as a YSP. For example, the wholesale lender who quotes a rate of 6 percent at zero points might pay a YSP of 1.6 points for a 6.375 percent mortgage. (A point is an upfront charge equal to 1 percent of the face value of a mortgage.) The borrower pays the higher interest rate and is either not aware of the YSP or becomes aware of it too late to do anything about it.

Loan-officer overages are similar to YSPs, but they are paid by the lender to loan officers rather than to brokers.

Dealing with overcharges by applying a suitability standard to broker fees means making judgments about whether the fee in any particular case is too high. I find this idea repugnant. As long as society is not passing judgment on lawyer's fees or doctor's fees, it has no business passing judgment on mortgage-broker fees.

Yet a high mortgage-broker fee differs from, say, a high lawyer fee. The lawyer's client always agrees to the fee; the broker's client usually doesn't.

The appropriate solution is not fee-setting but transparency -- requirements that borrowers be told about everything they are paying. If borrowers know what the broker will make on their transaction, they will prevent overcharges far better than a suitability-based system for controlling fees.

One way to provide transparency is to require all brokers to operate as UMBs or something similar. Another workable remedy is to require that YSPs be credited to borrowers, who would have to agree to sign them over to the broker.

And overages that go to a lender's own loan officers should be made illegal. Lenders should remain free to charge what they want, but their loan officers should not be free to charge some borrowers more than others just because they can.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site,http://www.mtgprofessor.com.

Copyright 2007, Jack Guttentag

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