In a victory for proponents of real estate settlement cost reform, a federal appeals court has ruled that "marking up" mortgage fees -- charging home buyers hundreds of dollars for services or documents that cost the lender less than $50, for example -- violates federal law if the lender performs no additional services that justify the increased charge.

The decision by the U.S. Court of Appeals for the 2nd Circuit, in New York, opens the way to possible Supreme Court consideration of the controversial settlement fee markup issue. Three other appellate courts already have sanctioned the widespread practice of marking up fees, finding that federal law is ambiguous.

Markups of credit report fees, appraisals, title work, document preparation, flood zone certifications and underwriting fees can be significant revenue sources for some mortgage lenders and settlement agents, but they can also add substantially to the cost of buying a house or refinancing a mortgage.

The Department of Housing and Urban Development and the Justice Department have fought markups aggressively during the past three years but have had rough going in federal courts. Now, they have one solid win.

The New York ruling involves a class-action suit filed by home buyers against Wells Fargo Home Mortgage Inc. The suit alleged that Wells Fargo, one of the country's highest-volume lenders, routinely marked up fees charged to its customers without adding any additional, valuable services of its own.

For instance, according to the complaint, Wells Fargo contracted for loan origination documents from third-party vendors that cost the company $20 to $50. It then allegedly charged borrowers "flat fees of between $150 and $300" for the same documents -- a markup the plaintiffs claimed was prohibited by federal law.

In one claim that may have a longer reach, the suit challenged Wells Fargo's alleged markups of Fannie Mae and Freddie Mac automated underwriting fees. When lenders take home loan applications, they frequently run the applicants' credit and property information through Fannie's or Freddie's electronic underwriting systems online. The systems render quick, low-cost underwriting decisions indicating whether, and on what terms, Fannie or Freddie might purchase the applicants' mortgages.

The online systems, which evaluate millions of loan applications a month, cost lenders about $20 per application. Yet many lenders charge borrowers substantially more at settlement for "underwriting" -- often $250 or $300. In their class-action complaint, the buyers alleged that Wells Fargo's charges of up to $300 for underwriting constitute an unlawful markup of the $20 Fannie or Freddie fees.

Wells Fargo denied the allegations in its response and said in a statement that the decision by the appellate court "does not in any way address the specific claims of the plaintiffs," but instead sent the case back to a lower court for reconsideration.

A Wells Fargo spokesman said the firm has not decided whether to appeal directly to the U.S. Supreme Court, given the sharp differences in conclusions reached by other appellate courts. Lenders, title agencies and other settlement service providers in 15 states are free to mark up fees charged to home buyers without limit as the result of three federal appellate court decisions. Those states are Maryland, Virginia, the Carolinas, West Virginia, Illinois, Wisconsin, Indiana, Minnesota, Missouri, Iowa, Arkansas, Nebraska and the Dakotas.

In the states covered by the 2nd Circuit decision -- New York, Connecticut and Vermont -- lenders and settlement service providers are prohibited from marking up fees without providing additional services. In the rest of the states, federal housing officials say closing cost markups are illegal, but lenders and title industry lawyers argue that that's not necessarily the case, absent a Supreme Court ruling.

Where does that leave you as a home buyer or refinancer who would prefer to pay as little as possible at settlement and avoid junk fees and padded charges? For the time being, if you are buying or refinancing in the 15 states where appellate courts have sanctioned markups, you have no protection from federal law, but you may have recourse under state law. Check with your state attorney general's office if you suspect you are a victim.

In the three states covered by the 2nd Circuit ruling, you can challenge settlement cost markups and expect success in federal court, provided you can demonstrate that no additional services were rendered to justify the extra fees. Everywhere else, consumers are left in doubt until either a federal appellate court for their area hands down a ruling, or the Supreme Court ends this long-running legal battle with a decision covering the entire nation.

Kenneth R. Harney's e-mail address is