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The Real Estate Settlement Practices Act (RESPA) was enacted in 1974 to address abusive practices in the real estate settlement services industry. After conducting hearings and debates for two years, Congress documented substantial evidence that various businesses participating in real estate settlement services-including lenders, mortgage brokers, title insurance companies, attorneys, and appraisers-were making payments to outside parties for customer referrals, either through fee splitting, referral fees, or kickbacks. These practices created an economic incentive for participants in real estate settlement services to steer businesses to the providers who paid the largest referral fees or kickbacks to the referrer, instead of rewarding the business with the lowest prices. Thus, consumers were harmed because this practice resulted in higher settlement costs.
Section 8 of RESPA specifically addresses this issue. It places significant restrictions on businesses participating in the mortgage services industry by prohibiting anyone involved in a federally related mortgage loan from giving or receiving referral fees or kickbacks and from fee-splitting charges.1 The Department of Housing and Urban Development (HUD), the agency charged with administering RESPA, enacted Regulation X to implement RESPA. Section 14 of Regulation X addresses referral fees, kickbacks, and fee splitting. This article addresses compliance with Section 14 of Regulation X when lenders make payments to mortgage brokers for loan originations.
Prior to RESPA's enactment, lenders routinely paid a referral fee to mortgage brokers for loan customer referrals that resulted in a consummated loan. Section 14(b) of Regulation X makes it illegal to pay or receive a fee for making a referral or taking a loan application only. This change created chaos and confusion in the real estate services industry, particularly among lenders and mortgage brokers, because the brokers' business model depended significantly on lenders' fees for an income stream.
To eliminate some of the confusion, Congress later directed HUD to clarify which payment practices were permissible and which were prohibited. HUD responded by issuing a policy statement in 1999.2 This policy statement examined the mortgage broker issue in depth and created a framework for determining when a lender can legally pay a mortgage broker a fee related to a loan origination. The overarching message from the policy statement is that fees paid in the mortgage service industry must be for actual services performed.
Because HUD is the agency Congress charged with implementing and enforcing RESPA, its interpretations of RESPA are entitled to deference from the courts-unless they conflict with the language of RESPA.3 Under HUD's interpretation of section 14(b), lenders can pay fees to mortgage brokers to compensate them for performing loan origination services if the fees pass a two-pronged test: 1) they are paid for services actually performed, and 2) they are reasonably related to the services provided and are competitively priced. These concepts are discussed in more detail below.
Services Actually Performed
The 1999 policy statement allows a lender to pay a mortgage broker a fee for performing loan origination services. The statement identifies 14 acceptable types of loan origination services.
If a mortgage broker completes a loan application (item 1 on the list) and performs at least five of the other services listed, the lender can permissibly pay the broker a fee for performing these services without violating RESPA. The policy statement also noted that mortgage brokers can perform other services besides those listed that would comply with RESPA. As explained in detail in the policy statement, HUD's criteria for evaluating other valid loan origination services are that they are meaningful and identifiable.
Reasonableness of Fees Charged
The policy statement makes clear that performing loan origination services is only part of HUD's analysis for approving fees paid to mortgage brokers. HUD also requires the fees to be reasonable in relation to the work performed and priced at market rate for similar services in the specific geographic market. To provide additional guidance about fees, the policy statement referred to a February 14, 1995, letter HUD provided to the Independent Bankers Association of America (IBAA). The letter approved a $200 fee for providing loan origination services. The policy statement also notes that the city in which the services are provided is relevant to the amount of the fee because "HUD recognizes that settlement costs may vary in different markets. The cost of a specific service in Omaha, Nebraska, for example, may bear little resemblance to the cost of a similar service in Los Angeles, California."
Another important issue under section 14(b) of Regulation X is broker fees based on a percentage of the loan. On its face, such a practice is troubling because the broker's fee is based on the size of the loan rather than the work performed. The policy statement does not say that such fees are illegal per se. However, if such a fee were challenged in a HUD enforcement action, it is likely that HUD would scrutinize a percentage-based fee carefully to determine whether the mortgage broker performed services commensurate with the fee charged.
In a 2000 interview with the Ohio Association of Realtors, Rebecca Holtz, then director of HUD's RESPA division, provided some additional, informal guidance on such fees. In discussing internet loan origination programs in which lenders pay real estate agents a fee to perform mortgage origination services, Holtz said that even if the real estate agent performs the required minimal number of services, HUD will ensure that the fee being paid for those services is reasonably related to the service provided. She declined to say what a "reasonable" fee would be for performing the minimal required mortgage processing services, but noted that HUD had not previously questioned an IBAA program that had paid $200. "There is a difference between a payment of 1 percent on a $150,000 loan ($1,500) and $200, which appeared to be reasonable in the IBAA context," she said.4
HUD also noted in the policy statement that it examines all of the compensation paid to the mortgage broker in determining whether a fee is reasonable-not just the fees the borrower pays directly to the broker. In some loan transactions, part of the broker's fee is paid by the consumer, and part is paid by the lender. Some mortgage brokers believe that only the portion paid by the consumer is subject to scrutiny under section 14(b). However, the policy statement makes clear that HUD examines the total compensation paid to the broker in assessing the reasonableness of the fee because "the consumer is ultimately purchasing the total loan and is ultimately paying for all the services needed to create the loanâ€¦Total compensation to a broker includes direct origination and other fees paid by the borrower, indirect fees, including those that are derived from the interest rate paid by the borrower, or a combination of some or all. All payments, including payments based upon a percentage of the loan amount, are subject to the reasonableness testâ€¦All fees will be scrutinized as part of total compensation to determine that total compensation is reasonably related to the goods or facilities actually furnished or services actually performed."
Disclosure of Fees to Consumers
One final issue addressed in the policy statement is the disclosure of fees to the consumer. HUD requires that all fees, direct and indirect, be disclosed on the Good Faith Estimate (GFE) and the settlement statement (HUD-1). HUD recommends that indirect fees, such as ones paid by the lender, be disclosed as follows: "Mortgage broker fee from lender to XYZ Corporation (P.O.C.)."5 Because indirect fees are not paid by the consumer directly, they do not affect the totals but still must be disclosed. Direct fees paid by the consumer must also be disclosed and will affect the totals on the GFE and HUD-1.
It is also important to remember that RESPA compliance is verified during consumer compliance examinations. If a violation of section 14(b) of Regulation X is noted during a compliance examination, the violation will be referred to the Board of Governors of the Federal Reserve System for further review and to HUD's RESPA enforcement group. HUD has the authority to order restitution to borrowers and to impose civil money penalties.
Banks should also be aware that HUD announced in August 2003 that it had tripled its RESPA enforcement staff and had hired outside specialists to assist with its enforcement efforts. HUD said it was coordinating its RESPA enforcement efforts with state attorney generals and federal and state financial regulatory agencies. The increased scrutiny has resulted in many HUD RESPA enforcement actions. HUD lists the details of its recent settlements with violators on its website.6
In summary, lenders and mortgage brokers should take certain steps to ensure that their loan transactions comply with Regulation X. First, policies and procedures should reflect that brokers are being paid for completing loan applications and performing at least five of the HUD-approved loan origination services. Next, the fees charged must be commensurate with the services provided to the consumer and should not exceed the market rate for similar services in the same geographic market. Finally, lenders and mortgage brokers should also incorporate the requirements of Regulation X and the HUD policy statement into their legal agreements, specifying that they will pay the mortgage broker a fee for performing loan origination services and detailing which services the mortgage broker must perform.
The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.