Residential settlements may be totally reshaped under a system of lender-arranged closing services the Department of Housing and Urban Development will soon propose.
The recommendation for mandatory "lender packaging" is part of a congressionally required report on the effectiveness of the 1974 Real Estate Settlement Procedures Act (RESPA). Intended to streamline settlements, reduce home buyers' costs and reduce federal regulation, the proposal has drawn a mixed reaction from real estate professionals, industry analysts and congressional staff.
The report, now in department clearance, suggests that lenders arrange settlement services, such as appraisals and title searches, and pass their costs to home buyers in a front-end fee or higher interest rate. The change would improve price competition for these services, and, ultimately, reduce buyers' costs, the report says.
"Overall, the net social benefits from RESPA have been minimal at best," the report says, because the law expected that consumers would do comparison shopping for service providers if armed with enough information. But a study of the impact of RESPA, conducted by the accounting firm of Peat, Marwick, Mitchell and Co. for HUD, found that home buyers look primarily at the loan interest rate when choosing lenders, and accept whatever settlement-service providers the mortgagee suggests, regardless of their prices.
Because home buyers don't find out what services lenders require, or what these will cost, until they have applied for a loan, "the lender has little incentive to eliminate unnecesary requirements, or make existing procedures more efficient," the report concludes.Lenders, HUD assumes, can shop more effectively that home buyers for settlement services and secure the best services at the most reasonable costs. Problems with price competition, resulting from lender referrals, would be eliminated along with kickbacks or other payments that now swell consumer costs.
"Lender packaging capitalizes on the efficiency of current practices and provides profit incentives for further efficiency gains, simultaneously simplifying the process for consumers," HUD claims. Lenders, the department says, will not require services whose costs are not justified, so they can help their package price low.
There would be less federal regulation, HUD officials note, because most disclosure and anticompetition rules would be dropped. Lenders could forget reference to a loan's annual percentage rate -- now required under the Federal Trade Commission's Truth-in-Lending rules -- which includes the total loan price of simple interest, loan origination fee and other lender charges.
Lenders would only have to disclose the cost of the settlement package, the simple loan interest rate and any settlement costs not part of the package -- such as title recording fee and taxes escrow.
Some HUD officials oppose a mandatory program, believing it would cause substantial disruption within the lending industry that is unwarranted by the yet untried approach. If the system made economic sense, the officials say, the real estate market would have developed lender packaging on its own. To date only a handful of lenders offer service packages.
The department rejected the suggestion in an earlier draft of the RESPA report that lender packaging be voluntary, with lenders who offered the packaging exempt from certain federal loan disclosure requirements. There is no way to assure that all lenders would provide the same services package, or disclose the same information, without a uniform, mandatory system, the final reports says.
A voluntary system would also not solve the problem of "controlled business" -- in which one real estate firm refers business primarily to another firm in which it has a financial interest -- which reduces price competition and raises home buyers' costs, the report says. Because the referring firms receive dividends from the service providers to whom they send business, the practice effectively circumvents the RESPA ban on kickbacks, the department notes.
Kickback prohibitions and sanctions would not be needed under lender packaging, since no referrals would be made, officials say. The ban on lender designation of settlement-service providers would also be unnecessary.
If Congress does not impose lender packaging, if should deal with any antitrust provisions in a statute separate from RESPA, the report recommends. Criminal penalties should be replaced with the opportunity for civil action by a firm's competitors to recover punitive, as well as compensatory, damages.
Whatever Congress does about referrals, it should specifically ban consumer referral by one provider to a wholly or partially owned subsidiary, to deal with controlled business, the department says. Only kickbacks are prohibited under present law. HUD's stance, if approved, would block an attempt made recently by some department officials to exempt from RESPA regulation controlled business relationships, in which dividends from one provider firm bear no relationship to the amount of business the dividend recipient refers.
At least one HUD division reviewing the report has issued a statemenmt of nonconcurrence, noting there is no evidence that lender packaging would improve price competition and lower consumer costs. Officials there say there's no precedent for a federal requirement that an industry provide certain services.
While drafters of the report claim the lending industry will support the proposal in hearings Congress will hold this summer and fall, many analysts and real estate professionals won't back lender-packaging.
Some say use of a front-end fee, which allows lenders to recover settlement service costs immediately, is no incentive for lenders to reduce their costs, since home buyers will still select a mortgage based on the firm's loan interest rate. Others note that many lenders will add a charge to the package in exchange for rounding up the services, canceling out any savings consumers might realize by having lenders shop for them.
Giving lenders rather than real estate brokers the responsibility for matching buyers and service providers will eliminate an important market discipline, according to Ed Kane, real estate analyst at Ohio University. Because brokers rely on satisfied clients to refer business to them, they have a better reason to choose service providers who will save buyers money than do lenders, who are not referral dependent, Kane says.
Under lender packaging, consumers would have less control over the quality of providers, since they would not know the individual firms included in the package, notes Madison, Wis., title attorney Joseph Hildebrandt. While attorneys' familiarity with particular lenders' operations might allow them to reduce their prices, there is no guarantee of this, or that any savings would be passed on to consumers, he says.
Washington, D.C. appraiser William Harps, president of the American Institute of Real Estate Appraisers, says that at first glance there would seem to be a greater potential for conflict of interest in home appraisals under lender packaging than there is under the current system. Some appraisers might be tempted to slant home values in favor of the lenders they depend on for most of their business, he says. If a home value is set higher than it should be, the buyer will pay a greater sales price, a higher finance charge and spend more on other settlement fees that are based on a percentage of the home cost, Harps says.