April 19, 2013

In an effort to eliminate discriminatory pricing of home mortgage loans, the Federal Government now imposes a raft of regulations on how mortgage brokers can price loans and charge for their services. The new rules have not eliminated discriminatory pricing, but they probably have raised mortgage broker fees.   

Mortgage brokers are independent contractors who find borrowers, counsel and qualify them, take their loan applications, process the paperwork and deliver the package to a lender who funds it. Brokers usually deal with multiple lenders. Loan officers, while they perform much the same functions as brokers, are employed by a single lender. Collectively, they are “loan originators” or LOs. 

Historically, many if not most LOs charged borrowers what they could get away with, since their compensation was tied to the charge. The result was that some borrowers paid more than others for no better reason than their lack of resistance, and/or their LO’s powers of persuasion. LO’s were basically equal-opportunity over-chargers, they did it whenever they could get away with it. However, for a variety of cultural and other reasons, their behavior had disparate effects on different groups. Bottom line, black and Hispanic borrowers paid more than white borrowers.  

This situation was much noted but little was done about it until after the financial crisis, when the political environment became hostile toward brokers. They were viewed as willing accomplices in the process of saddling consumers with mortgages they could not afford.  

In 2011, the Federal Reserve issued a new Truth in Lending rule that prohibits LOs from collecting larger fees on loans with features desirable to lenders, such as a higher interest rate. The only exception is that LO fees can vary with the size of the loan, and almost all LOs set their fee as a percent of the loan amount. And while brokers can continue to be paid by the borrower or by the lender, they can no longer be paid by both.  

The wholesale lenders who deal with brokers responded to these new rules by requiring all their brokers to post their fee with the lender. If the broker posted a fee of 1.5%, for example, they would receive 1.5% of the loan amount from the lender on all loans delivered to that lender, regardless of the loan  features. Brokers remained free to charge the borrower as an alternative, but this option is no more used under the new rules than it was earlier, because brokers find it a harder sell.  

Contrary to its intent, these new rules did not prevent a broker from charging what the traffic would bear. A broker can post one price with lender A, a higher price with lender B, and a still higher price with C, selecting the lender (and his fee) based on what he can induce the borrower to pay. If black and Hispanic borrowers are largely channeled to lender C, we are back to where we were – a lot of burdensome rules that accomplish nothing.  

But it gets worse. Last year, Wells Fargo agreed to pay $175 million to settle a law suit brought by the Justice Department, which alleged that WF had “discriminated by charging approximately 30,000 African-American and Hispanic wholesale borrowers higher fees and rates than non-Hispanic white borrowers…” The term “wholesale borrowers” refers to borrowers who came to Wells from mortgage brokers. While the pricing of these loans was controlled entirely by the brokers, Wells as the lender was viewed as responsible.  

Shortly thereafter, Wells decided to exit the wholesale lending business, and other wholesale lenders were faced with a new reality: If broker A posted a fee of 1% and broker B a fee of 2%, and if B dealt with more minorities than A, then the lender who funded loans from both would be legally responsible for charging higher prices to minorities. The only sure way for a lender to avoid this risk is to make sure that all its brokers charged the same fee, which requires that the lender set a uniform fee. 

Two wholesale lenders have already done this, and I expect other lenders to follow suit. One lender varies the fee by state, at 1.5% in the states with the highest property values to 2% in states with the lowest values. The second lender has set a blanket fee of 2.25%.

Setting a uniform fee will protect the lender from being held responsible for discrimination, but it won’t eliminate discrimination. Brokers will still be able to direct high-fee loans to one lender and lower-fee loans to another.  

The general level of fees will rise, however, because lenders compete for the patronage of brokers. A broker I know would charge $3500 on a $500,000 loan, but if he delivered the loan to one of the two lenders that have set uniform broker fees, he would be required to charge $8750 or $11,250.  

I don’t think the Justice Department thought through the likely consequences of its action.