The Mortgage Professor

Borrowers, Not Brokers, Should Be Getting Rebates

By Jack Guttenberg
Saturday, February 9, 2008

Last week, I criticized the Federal Reserve Board's proposed rule that would prohibit lenders from making loans that were not affordable and would require lenders to verify the information on which they base loan decisions. These rules are too vague to be enforceable, and it is too late for them to do any good even if they were enforceable.

This week I look at the Fed's proposed approach to curbing abuses by mortgage brokers. Timeliness is not an issue here, but doing it right is.

Mortgage brokers abuse borrowers when they collect a rebate from the lender for delivering a high-interest-rate loan without the borrower's knowledge.

Several years ago, I developed what I call the Upfront Mortgage Broker program largely to address this problem. Brokers who want this designation agree in writing with borrowers to a specified total fee, which includes any payment the broker receives from the lender. The borrower elects how to pay the fee, either in cash at closing or in a rate high enough that the lender will pay a rebate to the broker.

(To carry out this program, I founded a nonprofit group called the Upfront Mortgage Brokers Association. I am chairman of the association but receive no compensation from the group or from the brokers who participate. The association's membership includes only a small percentage of U.S. brokers.)

Under the Fed's proposal, lenders would be prohibited from making a payment to a broker unless the borrower and broker agreed in advance on the broker's total compensation. That obligation is the same as the voluntary commitment of an Upfront Mortgage Broker. However, complying with the Fed rule would not be voluntary, and most brokers don't want such an obligation. This makes enforcement a challenge.

The Fed would impose enforcement responsibility on wholesale lenders. Before paying a rebate to a broker, the lender would have to check the agreement between the broker and the borrower, as well as the HUD-1 closing statement, to make sure that the total amount received by the broker does not exceed the amount agreed upon.

But there is a better way to prevent brokers from getting paid by lenders behind the borrower's back, one that has no compliance burden. Lenders would simply be required to credit all rebates to borrowers. Lenders would inform their settlement agents that this is now the rule, and that would be it. There would be no need for case-by-case investigation because there would be nothing to investigate.

This approach would also be more effective. Under the Fed proposal, glib brokers would still be able to get trusting borrowers to sign off on rebates. This would be much more difficult if rebates are credited to borrowers, because then borrowers must be persuaded to sign over what they already have.

The rule should be applied not only to brokers but also to "correspondent lenders," who operate in the same way as brokers except that they close loans in their own name. Correspondent lenders receive rebates just as brokers do and should be subject to the same rules. If they are not, brokers who don't want to comply will become employees of correspondent lenders, which would allow them to keep functioning much as they did as brokers.

The Fed proposal, however, applies only to brokers, reflecting its failure to recognize that while correspondent lenders may be lenders under the law, operationally they more closely resemble brokers. Like brokers, they receive rebates from wholesale lenders on higher-rate loans and are similarly positioned to abuse borrowers.

Lenders who originate loans at their own risk raise a different issue. Such lenders don't receive rebates, but their loan officer employees can abuse borrowers just as easily as brokers do. Where opportunistic pricing by brokers usually involves pocketing rebates, opportunistic pricing by retail loan officers takes the form of overages -- prices above the retail prices posted by the firm. A loan officer who can induce a borrower to accept a rate above the one posted by the firm will typically share the value of the overage.

To maintain a level playing field between brokers and loan officers, rebates on loans delivered by brokers and correspondent lenders should be credited to borrowers, and overages on loans delivered by loan officers at other lending firms should be prohibited.

Next Saturday: How the Federal Reserve Board would curb loan servicing abuses.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site,

¿ 2008 Jack Guttentag

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