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84–933 PDF 2003

S. HRG. 107–857

PREDATORY MORTGAGE LENDING

PRACTICES: ABUSIVE USES

OF YIELD SPREAD PREMIUMS

HEARING

BEFORE THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SEVENTH CONGRESS

SECOND SESSION

ON

THE ISSUES SURROUNDING THE USES AND MISUSES OF YIELD SPREAD

PREMIUMS IN LIGHT OF THE DEPARTMENT OF HOUSING AND URBAN

DEVELOPMENT’S ANNOUNCED INTENTION OF PUTTING OUT A PROPOSED RULE ON THE REAL ESTATE SETTLEMENT PROCEDURES ACT

JANUARY 8, 2002

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

DANIEL K. AKAKA, Hawaii

PHIL GRAMM, Texas

RICHARD C. SHELBY, Alabama

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN ENSIGN, Nevada

STEVEN B. HARRIS, Staff Director and Chief Counsel

WAYNE A. ABERNATHY, Republican Staff Director

JONATHAN MILLER, Professional Staff

PATIENCE SINGLETON, Counsel

DARIS MEEKS, Republican Counsel

GEOFF GRAY, Republican Senior Professional Staff

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator

GEORGE E. WHITTLE, Editor

(II)

CONTENTS

TUESDAY, JANUARY 8, 2002

Page

Opening statement of Chairman Sarbanes ........................................................... 1

Prepared statement .......................................................................................... 40

WITNESSES

Beatrice Hiers, of Fort Washington, Maryland ..................................................... 4

Rita Herrod, of Clarksburg, West Virginia ............................................................ 6

Susan M. Johnson, of Cottage Grove, Minnesota ................................................. 7

Prepared statement .......................................................................................... 41

Howell E. Jackson, Finn M.W. Caspersen and Household International

Professor of Law and Associate Dean for Research and Special Programs,

Harvard University School of Law ..................................................................... 14

Prepared statement .......................................................................................... 54

Response to written question of Senator Sarbanes ....................................... 85

John Courson, Chairman-elect, Mortgage Bankers Association and

President and Chief Executive Officer, Central Pacific Mortgage Company

Folsom, California ................................................................................................ 18

Prepared statement .......................................................................................... 59

Joseph L. Falk, President, National Association of Mortgage Brokers ............... 20

Prepared statement .......................................................................................... 64

Response to written question of Senator Schumer ........................................ 89

Ira Rheingold, Executive Director, National Association of Consumer

Advocates .............................................................................................................. 22

Prepared statement .......................................................................................... 70

David Olson, Managing Director, Wholesale Access Mortgage Research

and Consulting, Inc. ............................................................................................. 24

Prepared statement .......................................................................................... 78

David R. Donaldson, Counsel, Donaldson & Guin, LLC ...................................... 26

Prepared statement .......................................................................................... 81

Response to written questions of:

Senator Sarbanes ...................................................................................... 92

Senator Schumer ....................................................................................... 94

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Statement of ABN AMRO Mortgage Group, Inc. .................................................. 105

‘‘Another View of Predatory Lending’’ by Jack Guttentag, dated

August 21, 2000 .................................................................................................... 125

‘‘Kickbacks or Compensation: The Case of Yield Spread Premiums’’ by

Howell E. Jackson and Jeremy Berry ................................................................ 155

Mortage Broker Fee Agreement submitted by John Courson .............................. 172

Letter submitted by the National Association of Mortgage Brokers ................... 173

Letter of Clarification submitted by Bren J. Pomponia on behalf of

Rita Herrod, dated January 23, 2002 ................................................................. 175

Comsumer Analysis of HUD’s 2001 Policy Statement on Lender Payments

to Mortgage Brokers by Margot Saunders ......................................................... 177

(III)

(1)

PREDATORY MORTGAGE LENDING

PRACTICES: ABUSIVE USES

OF YIELD SPREAD PREMIUMS

TUESDAY, JANUARY 8, 2002

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, DC.

The Committee met at 9:40 a.m., in room SD–538 of the Dirksen

Senate Office Building, Senator Paul S. Sarbanes (Chairman of the

Committee) presiding.

OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

Chairman SARBANES. Let me call this hearing to order.

There are a number of people outside waiting. Are there any

empty seats out there? We are going to try to move a few more people in. We may have them standing in the back. But if there is any

way for people who are already in to tighten up a bit, we would

appreciate that. And to the extent that we can add some others and

they can stand in the back, we will try to do that as well in order

to accommodate people.

This morning the Committee on Banking, Housing, and Urban

Affairs will hold its third hearing on the subject of predatory lending. Our previous two hearings on this subject focused largely on

the predatory loans and practices which have resulted in stripping

hard-earned equity away from many low-income homeowners.

These include folding high points and fees, as well as products such

as credit insurance, into the loan. We examined in those hearings

held this past July how unscrupulous lenders and mortgage brokers target low-income, elderly, and uneducated borrowers as likely

marks for predatory loans.

Today, we are going to focus on the role of the broker in the lending process and specifically, we are going to focus on the use and

misuse of what are referred to as yield spread premiums.

Let me start by addressing briefly how yield spreads are used in

the marketplace. Typically, a mortgage broker will offer to shop for

a mortgage on behalf of a consumer, the prospective borrower. In

many cases, that broker will promise to get the borrower a good

deal, meaning low rates and fees. Borrowers pay the broker a fee

for this service, either out of their savings or with the proceeds of

the loan. Unbeknownst to the borrower, however, that broker may

also be paid a yield spread premium by the lender if he can get the

borrower to sign up for a loan at a higher rate than the borrower

2

qualifies for. The higher the mortgage rate, the higher the payment. And we will hear about such cases this morning.

Yield spread premiums, properly used, can be a tool in helping

a homebuyer or homeowner offset all or some of the closing costs

associated with buying or refinancing a home. When used properly,

the broker discloses his total fee to the consumer. The consumer

may then choose to pay that fee, and, perhaps other closing costs

as well, by accepting a higher interest rate and having the lender

pay the fee to the broker. In such cases where the borrower makes

an informed choice the payment helps families overcome a barrier

to homeownership—namely, the lack of funds for closing costs.

It is very important that this be transparent and that the borrower know exactly what their options are. But it appears that in

practice, perhaps in widespread practice, yield spread premiums

are not used to offset closing costs or broker fees. Instead, these

premiums are used to pad the profits of mortgage brokers, without

any regard to any services they may provide to the borrowers.

Let me quote from a report issued by the Financial Institutions

Center at the Wharton School of Business at the University of

Pennsylvania. Professor Emeritus Jack Guttentag, discussing the

problem of rebate pricing—that is, payments by lenders to brokers

of yield spread premiums,writes:

In most cases, rebates can be pocketed by the broker, unless the broker commits

to credit them to the borrower, which very few do. Rebate pricing—that is, yield

spread premiums—has been growing in importance, and one of the reasons is that

it helps mortgage brokers to conceal their profit on a transaction.

Moreover, this does not just affect subprime borrowers, as do

most of the other egregious practices we heard about in our previous hearings. The misuse of yield spread premiums affects prime

borrowers, FHA borrowers, VA borrowers. But, because of the lack

of openness and competition in the subprime market, it hits

subprime borrowers hardest of all. Even for those with the best

credit, yield spread premiums can cost thousands of dollars in increased financing costs.

Yield spread premiums, when they are misused in this manner,

fall directly into the category of the kind of referral fees or kickbacks that were so prevalent in the settlement business prior to

the passage of RESPA—the Real Estate Settlement Procedure

Act—enacted by Congress in 1974, after years of hearings and reports, and specifically designed to outlaw side payments of this

kind because they increase the costs of homeownership for so many

Americans. Indeed, the plain language of the law, the regulations,

the 1998 Congressional instructions to HUD to formulate a policy

on this issue, and the 1999 HUD policy statement, particularly

when taking the legislative history into account, all make it clear

that RESPA was intended to prohibit all payments that are not demonstrably and specifically for actual services provided. That is to

say, each fee collected by the broker should be for a corresponding

service actually provided.

Because the majority of home loans are now originated through

brokers, lenders have less and less direct access to borrowers. This

means they must compete for the broker’s attention to gain access

to the ultimate consumer—the borrower. This competition means

that, too often, lenders pay yield spread premiums to the brokers

3

simply for the referral of business. As all of us know, this is prohibited under the law precisely because it raises the cost of homeownership to the consumers.

Regrettably, HUD’s recent clarification of its 1999 policy statement on the issue of yield spread premiums will open the door to

new and ongoing abuses of low- and moderate-income homebuyers.

Despite the Secretary’s statement at his confirmation hearing that

he finds predatory lending ‘‘abhorrent,’’ I fear that the new policy

statement will facilitate the predatory practice of steering homeowners to higher interest rate loans without their knowledge and,

more importantly, without any effective means of redress.

Now, Secretary Martinez has made increasing minority homeownership a primary goal of his Administration. However, a study

done by Howell Jackson of the Harvard Law School, who will be

testifying on the second panel this morning, shows that while the

current use of yield spread premiums imposes extra costs on all

homebuyers, the burden falls especially heavy on minorities. In

other words, yield spread premiums, when they are used in this

abusive fashion, put the dream of homeownership further out of

reach for minority Americans. Those who still manage to achieve

the dream of homeownership are forced to pay thousands of dollars

in increased interest costs over the life of their loans.

Many find themselves in more precarious financial positions than

they should be, thereby putting them at greater risk of falling prey

to the kind of repeated refinancing that we have seen leading to

equity stripping or even the loss of the home.

HUD has indicated both in testimony before this Committee in

December, and in a general announcement, that it intends to publish a proposed regulation on this matter by the end of this month.

These issues are of such importance that they call for a public airing at this time, and that is the purpose of this hearing, so that

the Department can take into consideration today’s testimony as it

considers formulating the new regulation.

We have two panels this morning. Let me just say in reference,

and then I will introduce them in greater detail when they arrive,

the second panel will consist of a number of experts from the academic world, consumer advocates, and from the business interests

involved in the issues before us this morning.

The first panel that we will now turn to involves three witnesses

who will testify about how their brokers steered them into higher

rate mortgages in exchange for payments of yield spread premiums

from the lenders. These are the mortgage brokers that each of

these consumers went to and in the course of that process, they led

them into a higher rate mortgage than they otherwise would have

had to undertake. And the difference as a consequence was paid

from the lender to the broker, not to the benefit of the consumers.

Beatrice Hiers is a Supply Management Representative for the

General Services Administration and resides in Fort Washington,

Maryland. Susan Johnson lives in Cottage Grove, Minnesota, outside of Minneapolis, and is a Manager at K–Mart. And Ms. Rita

Herrod is retired and lives with her daughter and grandchildren in

Clarksburg, West Virginia.

Before we take your testimony, let me express my very deep appreciation to all of you for your willingness to leave your homes

4

and come here and be with us this morning and your willingness

to speak publicly about your stories. I know that this can be a

difficult thing to do. I just hope you understand how much we appreciate your willingness to contribute to a process that I hope will

lead to some action to stop the kinds of practices that caused each

of you such heartache, such difficulty, and such trouble.

I want to point out that these three witnesses include a prime

borrower, a subprime borrower, and an FHA borrower. It is important to mention this so that everyone understands how the abuse

of yield spread premiums can affect people, whatever their credit

rating and whatever type of mortgage they receive.

Now, I will turn to you, Ms. Hiers. We will hear from you first

and then we will go to Ms. Herrod and then Ms. Johnson. We will

just move right across the panel, and we will hear from each of you

first before I go to any questions.

Again thank you very much for coming and being with us this

morning.

Ms. Hiers, I think if you pull that microphone closer to you and

talk right into it, it will be more audible.

STATEMENT OF BEATRICE HIERS

FORT WASHINGTON, MARYLAND

Ms. HIERS. Good morning. I am Beatrice Hiers, and thank you

for inviting me here today.

I am 43 years old and live in Fort Washington, Maryland. I have

two children, Ebony, 22, and Zachary, 11. In addition, prior to their

recent deaths, my elderly parents lived with me. I have worked

hard and overcome many obstacles to purchase my own home.

I grew up in Prince George’s County, Maryland. My family lived

in a neighborhood that was not racially mixed. In fact, we were the

first blacks on the street. In 1974, I received a general equivalency

degree and went to work for Prince George’s County Department

of Social Services. In 1979, I began working for the Federal Government as a clerk/typist. Over the past 20 years, I have worked

my way up to my current position as a Supply Management Representative for the General Services Administration.

Prior to purchasing my own home in August 1997, I struggled financially. I was a single parent and also helped support my parents. I began to think about moving and buying a home because

the neighborhood in which I lived had become a ‘‘drug haven.’’ I felt

that it was important for my children and parents to get into a new

environment that offered safety and security.

In June 1997, after house hunting for close to a year, I finally

found a house that I wanted. I signed a contract to purchase the

house for $159,750, but was told by my real estate agent that I

needed to obtain my own financing. Because I was inexperienced

with real estate transactions, I engaged the services of Homebuyers

Mortgage Company, a mortgage broker located in Prince George’s

County, and asked them to find me a 7 percent or better ‘‘fixed’’

rate FHA mortgage loan, a rate equal to what another lender—

Countrywide Home Loans—was willing to offer me.

The closing on the home was scheduled for August 29, 1997. As

the settlement approached, I became increasingly nervous because

Homeowners had not confirmed that it had located a mortgage for

5

me. As late as just 2 days before the closing, Homebuyers told me

that a firm commitment on financing was not yet available. Even

though mortgage rates were low and favorable in August 1997, on

the day of closing, Homebuyers finally told me that it had arranged

a 7 percent ‘‘adjustable rate’’ FHA insured mortgage loan through

Inland Mortgage Company, which is now Irwin Mortgage Company. Homebuyers told me that Inland was providing me with the

best rate and most favorable financing terms that they could secure. Reluctantly, and believing that I had no other options, I entered into the mortgage loan transaction.

Homebuyers charged me extraordinary fees and points. My

HUD–1 Settlement Statement reveals that Homebuyers charged

me the FHA maximum 1 percent origination point, $1,544, plus

loan discount points of 3 percent, $4,736. On top of these fees,

Homebuyers also collected a yield spread premium from Inland of

nearly 3 percent—an astonishing $4,538.87. In other words, I paid

3 discount points to reduce my interest rate and the broker was

paid 3 percent by Inland to increase my interest rate.

Almost a year after I entered into the mortgage loan transaction,

I learned that Homebuyers had not obtained for me the most favorable financing terms. In fact, I learned that Homebuyers was paid

the $4,538.87 Yield Spread Premium by Inland Mortgage solely because Homebuyers was able to deliver my mortgage well above

par—that is, Inland would have been willing to underwrite my

mortgage loan at a lower interest rate. Moreover, I learned that

Homebuyers’ yield spread premium was increased because Homebuyers delivered the mortgage loan with a short lock in period.

Irwin’s rate sheet, in fact, shows that I qualified for the same loan

at about 51⁄2 percent interest rate with no yield spread premium

to the broker.

What truly amazes me is that for the small amount of work performed for me, Homebuyers collected more than $10,800, including

the yield spread premium. Moreover, had I known that Homebuyers had secured for me a mortgage with an above-par interest

rate, I would have secured other financing.

Eventually, because the payments under Inland’s adjustable rate

mortgage were becoming prohibitive, I engaged the services of another mortgage broker, Allied Mortgage, to assist me in the refinancing of my loan. I have since learned that this transaction included the payment of a yield spread premium, and resulted in my

receiving another loan at a higher interest rate than I qualified for.

After completing these two mortgage transactions, I learned

what yield spread premiums are and how they affected my mortgage loan and increased my monthly mortgage payments. As a result, I recently refinanced my home a second time, but this time

directly with a lender. Because of my experiences with mortgage

brokers and yield spread premiums, I will never go to a mortgage

broker again.

Thank you again for inviting me and for your attention to these

important issues.

Chairman SARBANES. Well, thank you very much for your statement. It is a very clear statement of the problem that we are quite

concerned about.

6

You actually paid extra to try to get a lower rate, interest rate,

discount points, at the same time that your broker led you into a

higher interest rate in order to get the yield spread premium. Is

that correct?

Ms. HIERS. Correct.

Chairman SARBANES. Ms. Herrod, we would be happy to hear

from you.

STATEMENT OF RITA HERROD

CLARKSBURG, WEST VIRGINIA

Ms. HERROD. I am glad to have the chance to come here today

and tell what happened to me so that others are not treated the

way I have been treated. My name is Rita Herrod, and I am a 62-

year-old mother, grandmother, and now, great-grandmother. I am

currently disabled and unable to work. I live with my daughter and

grandchildren, and I own my home with my daughter.

In July 1994, I bought a house in Clarksburg, West Virginia, for $22,000 for my daughter, Jennifer, and her children. About 4 years

later, when I divorced my husband of 34 years, I moved into the

house with my daughter and grandchildren, and I live there today.

In 1999, my daughter and I took out a loan to make improvements on the house. We got a decent loan from a local bank for 15

years with a variable rate beginning at 7.8 percent. I would end up

not getting much benefit of this loan.

In early 2000, my troubles started when we encountered a mortgage broker we thought we could trust, Earl Young. My daughter

Jennifer was working for Heilig Myers, where she met Mr. Young.

Mr. Young, who worked for First Security, distributed his card to

my daughter for her to distribute to others. Because my daughter

knew Mr. Young and we had some bills to pay, we responded to

his solicitation in April 2000.

Mr. Young told us he would get us a home loan with a lower interest rate on our current loan. He told us he was going to search

and find for us the best deal he could.

Mr. Young arranged for an appraisal of our house. He said not

to worry that I was not working and not to worry about the rumors

that my daughter would be laid off in the near future. The appraisal he got for my house, I found out later, was for far more

than it was worth.

We closed the loan the next month. We had to meet at Mr.

Young’s office. He seemed to have taken care of everything. He told

us he was giving us a good deal. He said that our appraisal did not

come back at what they wanted, so he agreed to cut his own fees

to work the deal.

I wonder now what part of his fees Mr. Young cut. He charged

us an origination fee of $4,000, a broker fee of $2,600, and I

learned from my lawyer that he got a kickback from the mortgage

company of $3,304 for getting me into a higher interest rate.

My loan was for just under $85,000, and I ended up paying over

$10,000 in fees to Mr. Young. Now, I say that Mr. Young appeared

to take care of everything, but I do not think he did $10,000 worth

of work on my loan. He took our information and arranged for an

appraisal. I do not know what else he did, but I know the mortgage

company faxed him all the papers. I had no idea I was going to

7

have to pay him so much, and I cannot for the life of me figure out

what I got in return. And while I guess Mr. Young charged me

$4,000 commission for finding the loan, and $2,600 for his fees, I

have no idea what he did to earn the extra $3,304. Had I known

$10,000 was going to be tacked onto the loan, I would never have

done it. Had the broker not taken a kickback, I would have at least

had a rate of 8.5 percent, maybe lower. Instead, I got a loan up

near 10 percent.

I now have a loan that far exceeds the value of my house, making it so I cannot take advantage of lower interest rates and refinance. I am stuck with this loan, which requires that I make over

$275,000 in payments at an APR of almost 10 percent. At the very

worst, I could have stayed with my old loan, avoided the extra fees,

and dealt some other way with my bills instead of putting them

into my home.

I do not have any problem with people helping folks find a loan

to help them out of a bind, or get them a good deal. But I do not

think it is right for a broker to take a secret kickback of over

$3,300, when they already are getting almost $7,000 in other fees.

And I do not think it was worth $10,000 to get a loan that is worse

than what I had, when there are much better deals out there. We

trusted Mr. Young, because we thought it was his job to find us the

best deal. But instead, he cheated us out of a lower interest rate

and $10,000.

Thank you.

Chairman SARBANES. Thank you very much, Ms. Herrod. We appreciate your very powerful testimony.

Ms. Johnson.

STATEMENT OF SUSAN M. JOHNSON

COTTAGE GROVE, MINNESOTA

Ms. JOHNSON. Good Morning. My name is Susan Johnson and I

am from Cottage Grove, Minnesota. I am pleased to have the opportunity to be able to address——

Chairman SARBANES. I think you are going to need to pull that

microphone closer to you because it does not pick up very well unless you get it right up close to you.

Ms. JOHNSON. I am pleased to have the opportunity to be able

to address the Senate Banking Committee today about the $1,620

yield spread premium that was secretly paid by my lender, ABN

AMRO Mortgage Group, to my mortgage broker, Allstate Mortgage,

at my expense.

In April 2000, my husband David and I had just moved back to

the Twin Cities from Colorado Springs and were looking to buy a

house. Through a real estate agent, we were introduced to David

Schultz, the owner of Allstate Mortgage, a mortgage broker in

Plymouth, Minnesota. After meeting Mr. Schultz at a local restaurant, we hired him to find us a mortgage loan.

From the outset, we were told by Mr. Schultz that he would find

us a loan with the best possible rate. Mr. Schultz specifically told

us that the fee of processing the loan would be 1 percent of the loan

amount. We signed a written broker agreement with Mr. Schultz

which allowed for a 1 percent broker fee. No other fees were ever

demanded by Mr. Schultz, discussed, or agreed to.

8

When the closing occurred on May 23, 2000, to our surprise, the

interest rate was higher than we understood it would be and the

fees were far greater than the 1 percent fee we had agreed to. In

fact, the total fees were nearly four times that amount, $5,242.

This included what we only later came to learn after the closing

was a yield spread premium—a $1,620 payment from the lender to

our broker that was really paid by us since it was tied to an inflated interest rate on our loan.

While we were upset about the fees, we had no choice but to go

through with the closing or risk losing the house, being found in

default of the purchase agreement; and forfeiting the $5,000 earnest money down we had already given the sellers. While we objected to the fees and higher interest rate, there was no way for

us to find another loan and still close on time. We were stuck and

the broker knew it.

As our HUD–1 Settlement Statement shows, we were charged

the following fees at closing, none of which was disclosed, or agreed

to, beyond the initial 1 percent origination fee: $1,296 loan origination fee; $1,292 loan discount fee; $395 processing fee; $200 underwriting fee; $150 doc prep fee; $40 funding fee; $350 commitment

fee; and $285 admin fee.

Only after the closing did we discover the significance of the $1,620 yield spread premium which was assessed to us through an

inflated above-par interest rate of 8.75 percent. At the time of the

closing, we had no idea what this premium was because it was only

vaguely disclosed on our HUD–1 Settlement Statement as a Deferred Premium POC. In sum: The $1,620 yield spread premium

was not disclosed, discussed, or agreed to before the closing; my

husband and I were never informed that our loan had an abovepar interest rate because of the premium payment from ABN

AMRO to the broker; the broker never explained how the yield

spread premium affected our interest rate or that our monthly

mortgage payments would be any higher because of the premium;

no rate sheet or other document showing the direct relationship between the inflated interest rate and the yield spread premium payment from the lender to the broker was ever shown to us; the yield

spread premium did not offset or reduce any fee we ever owed to

the broker; the broker received all fees that we owed and agreed

to—and far more—directly in cash from us at the closing.

After the closing, I wrote to the State of Minnesota Department

of Commerce complaining about the transaction. After reviewing

my letter, the Department of Commerce advised us to seek private

legal counsel. The matter remains pending in court in Minnesota.

In that case, we have agreed to be representatives of other borrowers whose loans had yield spread premiums paid by the same

lender in the same manner as ours.

In conclusion, the $1,620 yield spread premium on our loan was

nothing more than a bonus paid by the lender to the broker for securing a bad deal for my husband and me, and referring a better

deal to the lender. This conduct should be illegal because: The yield

spread premium was not paid in exchange for any service fee we

owed to the broker; We received no benefit from the premium the

lender paid at our expense, such as an offsetting credit against any

closing fees or costs we actually owed, and the money was simply

9

a kickback to the broker referring our loan to the lender with a

higher interest rate.

The standard for evaluating the legality of this practice should

not merely be whether the broker’s total compensation, including

the yield spread premium and other fees we never agreed to, is

somehow reasonable based on the broker’s after-the-fact attempt to

justify the higher fees he has already taken. Rather, the true nature of the disputed premium should be evaluated: That is, what

was the premium actually paid in exchange for.

To allow as lax a standard as ‘‘reasonableness’’ of total broker

compensation to govern these transactions will only allow lenders

and brokers like ABN AMRO and Mr. Schultz to continue rippingoff unknowing consumers like us, with a catch-us-if-you-can attitude. It will encourage brokers and lenders to continue to try to

slip additional bonus fees into mortgage transactions regardless of

what was agreed and without providing any actual credit to the

consumer bearing the cost. If lenders are paying bonuses and incentives to brokers simply for referring high-rate loans to them,

that should be illegal without concern for whether the broker or

lender thought the secret referral fee was reasonable.

Thank you again for giving me the opportunity to speak today.

Chairman SARBANES. Thank you for coming this morning.

One thing I find very interesting about all three of your stories

is that, in each case, you were led to believe that the mortgage

broker would work to find a loan that was in your best interest.

You all proceeded ahead on the impression or, really, the understanding, that this broker was going to do the best that he could

for your interest. Is that correct?

Ms. JOHNSON. [Nods in the affirmative.]

Ms. HIERS. [Nods in the affirmative.]

Ms. HERROD. [Nods in the affirmative.]

Chairman SARBANES. So you placed confidence in the broker. You

did not see the broker as a party on the other side of the table. You

actually saw him on your side of the table. Is that correct?

Ms. HIERS. [Nods in the affirmative.]

Ms. JOHNSON. [Nods in the affirmative.]

Ms. HERROD. [Nods in the affirmative.]

Chairman SARBANES. You had better say yes because he cannot

get nods.

[Laughter.]

Ms. HIERS. Yes.

Ms. JOHNSON. Yes.

Ms. HERROD. Yes.

Chairman SARBANES. Now each of you ended up paying a higher

interest rate than you would otherwise qualify for, in addition to

paying substantial upfront costs.

And one of the things, your statements outline the extra fees and

charges involved at the time of settlement. We have not gone into

the extra cost to you over the life of the loan as a consequence that

you would be paying a higher interest rate. That makes a very significant difference in your monthly payment and your overall payment through the cost of the loan, whether you got the lower or the

higher interest rate.

10

So another cost to you that is not reflected in the statement, one

would have to calculate it out by what the difference was in the

interest rates and the amount of your loan. But in any event, it is

clear that there is a substantial additional charge to each of you

over the life of the loan because you are paying at a higher interest

rate than you otherwise might have had available to you.

Now, I want to make sure that I understand what each of you

paid in fees for your loans.

Ms. Hiers, let me start with you first. When you went to the

mortgage broker, I gather you understood that you could qualify for

a 7 percent fixed-rate loan with another lender. Is that correct?

Ms. HIERS. That is correct.

Chairman SARBANES. And when you decided to move forward

with this broker, I take it it was in the belief that the mortgage

broker was going to get you a better rate and be able to do better

for you than that. Is that correct? That is why you went ahead with

using the broker.

Ms. HIERS. That is correct.

Chairman SARBANES. Now, in the end, this broker got you an adjustable-rate loan at 7 percent, not a fixed-rate loan. Is that correct?

Ms. HIERS. That is correct.

Chairman SARBANES. Which I gather was about one and a half

points above what you might have qualified for, as you understood

it, later understood it.

Ms. HIERS. At an adjustable rate, yes.

Chairman SARBANES. Now, you did not know you would be getting a less favorable loan until just before the closing. Is that right?

Ms. HIERS. The day of closing.

Chairman SARBANES. The day of closing.

Ms. HIERS. In the 12th hour.

Chairman SARBANES. And, of course, at that point, I gather you

did not feel that you were in any position to walk away from this

and try to find another loan. Correct?

Ms. HIERS. Correct.

Chairman SARBANES. I mean, did you find it out right at closing?

Ms. HIERS. At closing.

Chairman SARBANES. Right at closing.

Ms. HIERS. Right at closing.

Chairman SARBANES. Did you know prior to closing that because

you were getting a loan at such a high interest rate, the mortgage

broker was being paid a yield spread premium of almost 3 percent?

Did the broker ever discuss this yield spread premium with you

and explain what the premium was for?

Ms. HIERS. No. No.

Chairman SARBANES. That was just over $4,500 in the yield

spread premium that the broker was getting from the lender.

Ms. HIERS. Exactly.

Chairman SARBANES. And, of course, you did not know about

that.

Ms. HIERS. I was not aware of it.

Chairman SARBANES. Now, you say that you also paid 3 discount

points as well. Did the broker explain to you that these discount

11

points would bring down the interest rate on your loan, that that

was the purpose of the discount points?

Ms. HIERS. The broker did not explain any of the fees to me. The

day that I was supposed to go to settlement, my loan was not approved. It was not approved. It was a Friday evening. My loan was

not approved until about 4:00 in the afternoon. The sellers had to

go to settlement also that day and there was nothing explained.

Everything was held until the 12th hour. Everything was held and

none of the fees were explained to me. I later found out about the

yield spread premiums.

Chairman SARBANES. And it was only subsequently that you discovered that they had not gotten the most favorable financing

terms and that they had been paid a yield spread premium.

Ms. HIERS. Right.

Chairman SARBANES. So what happened to you, in effect, is you

took on this broker. You had a contract to purchase the home for

just under $160,000. The broker charged you a 1 percent origination point, the FHA maximum, I take it, at the time, for $1,500.

You paid these loan discount points of 3 percent, $4,736. That, of

course, was to get your interest rate down. Then the broker turned

around and he got a nearly 3 percent yield spread premium from

the lender, which was worth to him $4,538.

So your broker got almost $11,000 out of this arrangement. And

the upshot of it was to put you into a significantly higher-rate

mortgage than would otherwise have been the case. Is that correct?

Ms. HIERS. That is correct.

Chairman SARBANES. In addition, I have a work sheet that we

have prepared here that indicates that over the life of this mortgage, you will pay an extra $56,000 in interest, from what you

would have paid if you had had the interest rate for which you

qualified.

I know it is a little awkward to lay all of this out like this, but

I think it is important to do it because there are lots of people out

there that are subject to the same thing and we want to send a

very strong warning signal and we appreciate your coming this

morning to help us do that.

Now, Ms. Herrod, let me ask you just a few questions about your

situation. First of all, you are currently disabled. But I gather that

previously, you were working. Is that correct?

Ms. HERROD. Correct.

Chairman SARBANES. What did you do, Ms. Herrod?

Ms. HERROD. I was a buyer at a pharmacy, customer service, and

buying and inventory. I had to have surgery on Valentine’s Day of

2000. And when I told my employer, I asked him if he had any

compensation for me. He said, no. He said, I have to make some

cuts, economic cuts, and I was one of the higher-paid employees.

So, I was given a 3 months severance pay, which ended May 31.

And I had told Mr. Young in April, I said, I am going to be out

of income next month. And he said, it does not matter, as long as

you have income today.

Chairman SARBANES. Ms. Hiers, you worked for your general

equivalency degree and then worked for the Department of Social

Services in Prince George’s County.

Ms. HIERS. That is correct.

12

Chairman SARBANES. And then went to work for the Federal

Government, beginning as a clerk/typist, I gather.

Ms. HIERS. Yes.

Chairman SARBANES. But then you worked your way up, and

now you are a Supply Management Representative for the General

Services Administration. Correct?

Ms. HIERS. That is correct.

Chairman SARBANES. Ms. Johnson, were you employed?

Ms. JOHNSON. Yes.

Chairman SARBANES. What were you doing? Or what do you do?

Ms. JOHNSON. I am a Unit Pricing Manager at K–Mart.

Chairman SARBANES. Okay. I ask these questions only to underscore the fact that you are all three hard-working people who have

been gainfully employed and contributing to the economy and, in

a sense, playing by the rules and trying to own a home and realize

that, make things better for your family and so forth and so on. It

is extremely distressing to see these efforts at exploiting you.

Now, Ms. Herrod, you had a variable rate loan which started at

7.8 percent. Correct? In the beginning.

Ms. HERROD. In the beginning.

Chairman SARBANES. You wanted to refinance, hopefully to bring

down your payments. And also, you wanted to consolidate some

debts and pay them off. Is that correct?

Ms. HERROD. Yes.

Chairman SARBANES. But the loan that Mr. Young, your broker,

got—I am not sure I should call him your broker. The loan that Mr.

Young, the broker, got for you was close to 10 percent. Is that

right?

Ms. HERROD. Right. I think it was 9, maybe 9 point something.

Chairman SARBANES. Yes. Did you understand prior to the closing that your interest rate was going to be so much higher than

the loan you already had?

Ms. HERROD. No.

Chairman SARBANES. Now in addition to paying this higher interest rate, I see you paid Mr. Young an origination fee of $4,000,

while also paying a broker fee of $2,600.

Ms. HERROD. Right.

Chairman SARBANES. Is that correct?

Ms. HERROD. Yes.

Chairman SARBANES. So, $6,600 in all. Did you know at the time

you closed that he was also going to get another $3,300 from the

lender for leading you into a higher-rate interest?

Ms. HERROD. No, we found that out from the attorney after the

fact when we were faced with losing our home.

Chairman SARBANES. When you agreed to work with Mr. Young

at the beginning, after you met him, did you believe that he would

find you the best deal on a mortgage? Is that what was indicated?

Ms. HERROD. Yes. I had excellent credit, above and beyond. It

was irreproachable.

Chairman SARBANES. So, you thought that he was really going

to look after your interests.

Ms. HERROD. Correct.

Chairman SARBANES. That is the assumption you worked on

when you went into this arrangement. Instead, he ended up getting

13

$10,000 out of this arrangement and you got a loan at 10 percent

interest. Correct?

Ms. HERROD. Correct.

Chairman SARBANES. Now, Ms. Johnson, I see you paid a large

amount of fees in addition to the broker receiving a yield spread

premium in your instance.

Ms. JOHNSON. Yes.

Chairman SARBANES. He told you, the broker at the outset, that

his fees were 1 percent of the loan amount, or that is what you understood. Is that correct?

Ms. JOHNSON. Yes, it is.

Chairman SARBANES. And it was your understanding that this

would be what he received out of his efforts, 1 percent of the loan

amount. Correct?

Ms. JOHNSON. Correct.

Chairman SARBANES. But, then, when you got to closing, you

found that the fees were far greater than the 1 percent that you

had agreed to.

Ms. JOHNSON. Yes.

Chairman SARBANES. In fact, they were over $5,000, the fees.

Ms. JOHNSON. Yes, they were.

Chairman SARBANES. You did not know those extra fees were

coming. In fact, you were operating on the premise that the broker

fee would be 1 percent of the loan amount. Correct?

Ms. JOHNSON. Yes.

Chairman SARBANES. Now, were you aware that the broker was also over and above this $5,200 receiving a yield spread premium

from the lender because he was leading you into a loan with a

higher interest rate than what you qualified for?

Ms. JOHNSON. No, he never——

Chairman SARBANES. You did not know that. And so, later on,

you found out that that was the case, that he was getting that

yield spread premium as well.

Ms. JOHNSON. Yes.

Chairman SARBANES. You also, I take it, believed that the broker

was working on your side to put together the best financing arrangement that he could on your behalf. Were you proceeding on

that assumption?

Ms. JOHNSON. Yes. We asked him to, and he said he had several

places he could go to and he would do the best for us.

Chairman SARBANES. Well, I want to thank all three of you for

coming this morning. These, in a way, are very sad stories because

they are a very dramatic illustration of people being exploited, in

my view, being the victims of abusive practices.

People are entitled to get a fair return for services that they provide. Brokers, along with everyone else, are entitled to that. But

they are not entitled to take advantage of people, to abuse people,

to lead people in placing their confidence in them and then exploiting that confidence to gain an egregious return at your expense,

and that is what we are setting out to try to accomplish with these

hearings.

Not only to charge you these high fees, but by getting the yield

spread premium, about which none of you knew anything about,

leading you into a higher interest rate mortgage than otherwise

14

would have been the case and saddling you, then, with those extra

costs and charges over the life of the mortgage.

In each instance, I gather, all of you were in a sense sacrificing

or pushing yourselves to the limit in order to be a homeowner,

which of course would help you to meet very important family responsibilities. And yet, you had people who were in effect almost

shoving you over the line in terms of your ability to handle—I

guess all of you, really, found yourselves in a much more constrained financial position as a consequence of these abuses that

you were subjected to.

So thank you very much for coming this morning and giving us

this very powerful testimony. We appreciate it very much.

Ms. JOHNSON. Thank you.

Ms. HERROD. Thank you.

Ms. HIERS. Thank you.

Chairman SARBANES. We will now turn to the second panel and

we will excuse our three witnesses.

[Pause.]

I want to welcome the second panel here this morning. Because

this is a relatively large panel, I will introduce each witness separately, just before we hear from them. We will move across the

panel and take the testimony of all the witnesses before we turn

to the question period.

Your full statements will be included in the record and if you can

abbreviate it orally to something in the range of 5 minutes or so,

we would appreciate that very much, although we are anxious that

you feel that you have had an opportunity to make your major

points. That is the prime objective, not the time restraint. But we

are trying to balance the two here this morning.

Our first witness is Howell Jackson. Mr. Jackson is Associate

Dean for Research and Special Programs and the Finn M.W.

Caspersen and Household International Professor of Law at Harvard Law School.

His research currently deals with problems in consumer finance,

comparative cost benefit analysis of financial regulation and other

topics.

Prior to joining the Harvard Law School faculty in 1989, Professor Jackson served as Law Clerk to U.S. Supreme Court Justice

Thurgood Marshall and practiced law in Washington. He received

his law degree and an MBA from Harvard University in 1982.

Mr. Jackson, we would be happy to hear from you.

STATEMENT OF HOWELL E. JACKSON

FINN M.W. CASPERSEN AND HOUSEHOLD INTERNATIONAL

PROFESSOR OF LAW AND

ASSOCIATE DEAN FOR RESEARCH AND SPECIAL PROGRAMS

HARVARD UNIVERSITY SCHOOL OF LAW

Mr. JACKSON. Thank you very much, Chairman Sarbanes.

I am pleased to be here and what I would like to do with my oral

comments is just to summarize my written testimony and, in a

sense, build on the testimony that we have already heard this

morning.

The impetus of today’s hearings is the HUD’s Statement of Policy

regarding yield spread premiums. What I want to talk about iniVerDate 11-MAY-2000 11:24 Mar 05, 2003 Jkt 000000 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 84933.TXT SBANK4 PsN: SBANK4
15

tially is their factual assumptions about what was going on in the

industry with yield spread premiums.

They have a view that yield spread premiums are a legitimate

financing tool that is particularly useful for borrowers who are

short on cash and need to use the tool to finance upfront costs.

This morning’s witnesses have already demonstrated that that is

certainly not always the case, that there are often instances when

the yield spread premiums are often used to raise the cost for individual borrowers.

But what I would like to talk about is a study that I have conducted that looks at the practice more broadly. And in brief, what

my study shows is these witnesses are not atypical, that this is actually going on on a widespread basis, across the industry, and

harming substantial numbers of consumers.

Let me just begin by saying that I would reiterate the statements

of the witnesses that yield spread premiums are not being presented as an option to borrowers. The HUD consumer guidance, the

industry discussions of the subject, it is just clear that these payments are not being described as optional sorts of financing for particular consumers. They are being imposed without consumers

understanding what is going on. I think that is fairly clear.

It is also fairly clear from my study that they are not specialized

sorts of financing that are used upon occasion. Their practice is

widespread. In my study, between 85 and 90 percent of consumers

were paying some yield spread premiums. The average amount of

these payments was $1,800 per consumer, which is a large amount

of money.

They are the most substantial source of compensation for the

mortgage broker industry, according to my study. So, they are very

significant and they are very substantial for the industry.

It is also the case that it is clearly not being limited to borrowers

who lack cash to pay upfront costs. Just the number of 85 to 90

percent shows that there are many borrowers who could pay the

upfront costs in other ways, were they told that that is what was

going on. But we also examined the loans in question and many of

the borrowers could simply have increased the loan amount. It

would have been a much more efficient way to finance their settlement costs, their costs of closing. Yet, the brokers still steered them

into yield spread premiums. So this is not limited to a small number of borrowers. It is a widespread practice and our study I think

demonstrates that quite clearly.

Another point that is important to understand is the mortgage

broker industry cannot be indifferent to yield spread premiums.

The HUD policy statement suggests that it is just another kind of

financing. But our analysis indicates that mortgage brokers make

substantially more money on loans with yield spread premiums.

The average amount of additional compensation, according to our

study, is over $1,000, $1,046 of extra compensation from mortgage

brokers receiving this kind of payment than the compensation they

would receive on other kinds of loans without yield spread premiums. So the amount of money is quite substantial. And I think

that explains why this issue is so hotly contested.

Now as an economic matter, one of the interesting questions

about the yield spread premiums is are they being used to offset

16

other costs? The additional compensation I just mentioned would

suggest that is not going on, and certainly this morning’s testimony, the witnesses we heard today, suggested in their cases they

were not getting any reduction. In fact, it sounds like their other

costs were quite high compared to industry averages.

We did a large-scale study to see what the standard offset was

in a sample of 3,000 loans. And what we discovered is the vast majority of yield spread premiums goes simply to increase the compensation of mortgage brokers. They do not go to reduced upfront

costs.

Our best estimate, and there are definitely different ways of

doing this estimate, is that, on average, consumers get 25 cents on

the dollar for every dollar extracted in yield spread premiums.

So 75 percent, the vast majority, go to the mortgage broker industry to increase their compensation. And I think that really indicates the nature of the practice.

This is not a case of a small number of atypical consumers who

are paying exorbitant fees. Certainly that is also going on. But the

main point is, on average, the offset is very low. The value, if you

will, to the consumer of yield spread premiums is very, very poor.

Now the industry sometimes likes to characterize yield spread

premiums as a form of financing as a way of financing upfront

costs. And we did this calculation similar to the calculation that

you were suggesting earlier—how much more in additional interest

payments down the road are consumers taking on? What value are

they getting for it? And if you work out the numbers, it is frankly

embarrassing. The interest rate is 114 percent per annum, according to our estimate. Maybe 90 percent per annum. It is just off the

charts of acceptable interest rates. My study was dealing primarily

with middle-class borrowers who would have excellent credit histories and be deserving of much lower interest costs. So as a form

of financing, these payments are just usurious.

Another factual point I would make about our study and its implications is, on average, yield spread premiums generate higher

compensation and higher costs for borrowers. But it is also the case

that there are a lot of examples of individuals who pay way more

than average.

If you try to look at the average compensation to mortgage brokers in these loans, it varies greatly. It seems to me that there is

a lot of price discrimination going on here. There is a lot of picking

off the soft targets—the less well-educated, the less financially sophisticated consumers, and using this disguise payment practice to

charge them more. And this is something that I want to examine

more, but you mentioned this aspect of my study and I just want

to call the Committee’s attention to it.

If you look at the racial identity of the borrowers and measure

it against mortgage broker compensation, you see that mortgage

brokers are making a lot more money on minority borrowers.

According to our study, African-Americans are paying about $474

more on average. Hispanic-Americans, paying about $580 more on

average than other borrowers. And that is after controlling for the

credit quality, the credit score they got, the kind of loan they had,

the loan-to-value ratio. It is controlling for the credit aspects. And

it seems to be that these groups who are traditionally less wellVerDate 11-MAY-2000 11:24 Mar 05, 2003 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 84933.TXT SBANK4 PsN: SBANK4
17

educated, less financially sophisticated, are being picked off here,

and I think that is one of the most disturbing things about our

findings.

Now the HUD policy statement goes on and talks about a number of legal issues. I am happy to deal with them in questions and

answers. But I just want to focus on the connection between what

I think is the Department’s misunderstanding of the role of yield

spread premiums and their legal analysis. They characterize these

payments as a way of reducing upfront costs. And if the payment

is for goods and services, it is tested under a relatively liberal

standard, lenient standard, under the HUD rules.

What my study shows and what the evidence you heard this

morning suggests is these payments are not being used principally

for goods and services or principally for reducing upfront costs.

They are serving principally to increase compensation. And for that

reason, I think a more stringent legal standard is appropriate.

Fortunately, the Department is considering a number of rulemaking proposals to change practices to help consumers in the

future. I think that there is a lot that can be done prospectively

to improve things for consumers with the right changes. I have four

changes, specific proposals in my testimony. Let me just highlight

them in conclusion here.

First, if mortgage brokers are going to be recommending loans

with yield spread premiums, it should be presented as an option.

The mortgage broker should also be required to say to Ms. Johnson

and her colleagues that another loan is available at a lower rate.

If it is going to be an option, it should be presented as an option

and the Department should mandate that.

Second, when a consumer chooses to take an above-par loan, and

sometimes it might make sense, the proceeds of the extra interest,

the yield spread premium, should be given to the borrower. The

borrower can use it to pay for the house, to pay for other costs, to

pay for other payments to the mortgage broker, or to take home in

his or her pocket. But the money should be given to the borrower

if it is used for the borrower’s benefit. What that means is it has

to become a credit on line 200 of the HUD–1 form.

Chairman SARBANES. The theory being that the borrower, in a

sense, has paid for it by agreeing to a higher interest rate over the

life of the loan. Is that correct?

Mr. JACKSON. That is exactly right. If the borrower is getting this

money through paying for it, the borrower should receive it and

then see specifically what services the broker is trying to charge

for. I think this is a very important step that needs to be taken.

There are other steps, too. I think the practice of mortgage brokers charging discount fees, as we saw in the case of Ms. Hiers and

Ms. Johnson this morning, is simply misleading.

The brokers are not using those discount points to lower interest

rates. It is simply a disguised form of interest spread premium and

I think the best solution to this problem is to ban it. There is an

appropriate role for discount fees, but it is not to pay to brokers

in these contexts.

Chairman SARBANES. Actually, if they do that, they can get the

consumer going and coming—getting him on the discount fees and

then they get him on the yield spread premiums. Right?

18

Mr. JACKSON. That is right. It is unbelievable that brokers are

charging consumers fees for lowering interest rates on loans that

have interest rates above par. It is just unfathomable how this

practice could be tolerated, in my view.

Finally, I think the Department needs to look also at direct lenders. There needs to be a quality in the industry between direct

lenders and mortgage brokers. However, I would not let concerns

about direct lenders stop the Committee and the Department from

going forward today.

Mortgage brokers are the primary supplier of mortgages in the

United States at this time. They should be the primary focus of the

HUD reforms. We should solve the problem here first and then we

can take care of other aspects of the industry later. But I think the

time is now to go forward.

Thank you.

Chairman SARBANES. Thank you very much, sir.

Now, we will hear from John Courson, President and Chief Executive Officer of Central Pacific Mortgage Company, and Chairmanelect of the Mortgage Bankers Association of America.

Prior to assuming his current position, Mr. Courson served as

President and Chief Executive Officer of Westwood Mortgage Corporation and as President and Chief Operating Officer of Fundamental Mortgage.

Mr. Courson was a very helpful witness in previous hearings

held by this Committee and I am pleased to welcome him back

today.

John, we would be happy to hear from you.

STATEMENT OF JOHN COURSON

CHAIRMAN–ELECT, MORTGAGE BANKERS ASSOCIATION

PRESIDENT AND CHIEF EXECUTIVE OFFICER

CENTRAL PACIFIC MORTGAGE COMPANY

FOLSOM, CALIFORNIA

Mr. COURSON. Thank you, Mr. Chairman. It is good to see you

again. And thank you on behalf of the Mortgage Bankers for the

opportunity to testify again and present our views as you continue

your series of hearings on the aspects of predatory lending. I would

like to just briefly summarize some comments, if I may. I am going

to really talk about three things—tools, rules, and disclosures.

As you so eloquently said in your opening statement before that,

used properly, yield spread premiums can be an important financing option. And we agree with that. It clearly is a borrower choice

issue when used properly, based upon a borrower’s individual financial goals, desires, and circumstances, in that, as they make

those choices, there has been a wide use of yield spread premiums.

We find people in the industry of all types of loans, as we have

identified, be they conventional, be they FHA, VA, that take advantage of the opportunities to have a financial choice in how they

want to use this tool to acquire their property or refinance their

mortgage loan.

It can be, and we know that one of the barriers to creating homeownership is certainly the availability of cash resources. And so it

does provide an option for those who do lack the cash to finance

19

or, if you will, to pay the cash cost of obtaining that mortgage, another alternative to achieve homeownership when used properly.

As to the rules, we need rules in the lending business and the

broker business to run our businesses. Tell us the rules so that we

can conduct our business in accordance with the rules, and not

have to learn the rules through the courts and through litigation,

which is debilitating not only for us, but also for consumers and

could in fact do damage to the marketplace.

Tell us the rules and give us clarity. Give us some clarity where

we can understand what the parameters are under which we can

conduct our business appropriately—whether it is mortgage brokers or mortgage lenders.

The Statement of Policy, both the 1999 and now the 2001, is a

move by the Department to provide clarity for those in the mortgage origination business to conduct their business.

As for disclosure, as you well know, Mr. Chairman, and we discussed in the last hearing, there are disclosures out there today

that are structured to address some of the issues we have heard.

We know, for example, that yield spread premiums are to be disclosed on a good faith estimate. We clearly know the issues with

the good faith estimate as we have discussed before. We also know

that yield spread premiums are to be included in calculation of the

APR, which is a number that a consumer has to comparison shop,

if you will.

We also know, obviously, that they are on the HUD–1, which we

have heard about. But having said that, in the 2001 Statement of

Policy, the Department clearly sets out, both in the Statement of

Policy and in a mortgagee letter that was issued very shortly after

the Statement of Policy, some clear guidelines for the disclosure of

broker transactions and they set forth very specific criteria to be

included in those disclosures.

As a result of that information, the Mortgage Bankers Association, along with a coalition of other lending organizations, have

prepared and did prepare a prototype, if you will, of a disclosure.

And that disclosure is formatted to address the specific criteria

that are included in the Statement of Policy and in the mortgagee

letter. I would be happy to submit a copy of that draft, which we

have submitted to HUD for their consideration for the record, if I

may. And finally, having said all of this, and despite the comments

and the specificity and the Statement of Policy, and in the mortgagee letter and our draft proposed form, we really can do better.

Beyond all of this, one of the keys, regardless of the kind of disclosure we use in this specific instance, we have to simplify the

transaction. We can do better than what we have done for the consumers out there with the myriad of paperwork and disclosures,

small print, and confusing information given to them. Any predator

likes that environment to deal in. It makes it easier to operate. We

need to strip that out, strip the process down, simplify, and reform

the mortgage process.

Thank you very much.

Chairman SARBANES. Well, thank you very much.

We will now turn to Joseph Falk, President of the National Association of Mortgage Brokers. Mr. Falk served as the President of

the Florida Association of Mortgage Brokers in the mid-1990’s. In

20

addition to his activities with the National Association of Mortgage

Brokers, Mr. Falk serves on the Fannie Mae National Advisory

Council. He is currently President of Erie Mortgage Services, a

mortgage brokerage business specializing in residential mortgage

loans, regulatory compliance, and government affairs.

Mr. Falk, we appreciate your coming to be with us this morning.

We would be happy to hear from you.

STATEMENT OF JOSEPH L. FALK, PRESIDENT

NATIONAL ASSOCIATION OF MORTGAGE BROKERS

Mr. FALK. Good morning, Mr. Chairman.

My name is Joseph Falk and I am President of the National Association of Mortgage Brokers, the Nation’s largest organization

representing the interests of the mortgage brokerage industry. We

appreciate this opportunity to be with you today.

Mortgage brokers originate approximately 65 percent of all of the

residential loans in the United States. There are hundreds of thousands of mortgage brokers, 23,000 licensed brokers in my home

State of Florida.

The market has spoken. Mortgage brokers are effectively meeting

consumers’ desires for convenience, choice, products, service, and

very competitive prices. The industry originated a record volume of

loans in 2001, enabling thousands of homeowners to refinance, reduce their monthly payments, and thousands of others to get in

their homes.

We are experiencing record homeownership rates in the United

States today. Mortgage brokers in part have enabled this market

to absorb this huge volume of transactions. Therefore, it is important to our homeowners and the economy that we avoid any new

regulations, legislation, or unnecessary legal uncertainty that could

impede the effective and efficient functioning of the wholesale

mortgage market.

The ability to obtain loans with little or no upfront cost is especially critical to consumers. Borrowers can finance some or all of

their upfront costs through a slightly higher interest rate and the

broker receives most or all of its compensation indirectly from the

lender in the form of a yield spread premium. Such indirect compensation paid by lenders to brokers is legal under RESPA, so long

as the broker’s total compensation is reasonably related to the services performed, goods provided, and facilities furnished.

Flexibility of indirect compensation allows mortgage brokers to

stay competitive with and in some cases beat the prices of retail

lenders. That is why the marketplace has spoken. Mortgage brokers are chosen, by and large, because they offer competitive prices

to retail lenders.

Retail lenders perform similar functions, earn similar income

when they sell their loans in the secondary market. There is nothing inherently different about the way retail lenders and mortgage

brokers earn their income. The only difference is that consumers

know how much a mortgage broker is going to earn in a transaction because it is listed on the HUD–1 and, of course, on the

Good Faith Estimate form.

Although consumers clearly prefer mortgage brokers to originate

their loans, our industry is under attack. Over 150 class action

21

suits have been filed against virtually every major mortgage wholesaler claiming that all yield spread premiums are illegal. Defending

these suits, Mr. Chairman, is difficult and managing the uncertainty that they impose is costly.

On October 15, HUD issued policy statement 2001–1. We believe

it is simply a restatement of existing policy requested by Congress

in 1998 and originally issued in 1999. It has already been accepted

as correct by two court rulings and we believe that others will follow suit. HUD’s policy statement importantly maintains the individual’s right to sue and it allows the marketplace to resume functioning normally. We support the HUD policy statement.

We also support HUD’s new RESPA enforcement policy. Illegal

uses of yield spread premiums should be prosecuted to the fullest

extent of the law.

NAMB also supports HUD’s new rulemaking initiative which improves disclosures to consumers. Better disclosures will put consumers in a stronger position with more information to be able to

shop and compare, thereby decreasing the incidence of abusive

lending practices of all types.

NAMB has developed detailed proposals for this rulemaking and

we have shared these with HUD and with this Committee. We support requiring a new disclosure to be provided by all originators.

We developed the prototype of this form back in 1998, together

with MBA, and we have urged our members to use this form since

1998, clearing up a number of the concerns that we heard this

morning. We support making this disclosure mandatory.

We also support establishing tolerances for the Good Faith Estimates and requiring redisclosure if those tolerances are exceeded.

This would also address the concerns we heard, the legitimate concerns we heard this morning in the first panel.

In conclusion, Mr. Chairman, NAMB believes that HUD is acting

responsibly by clarifying the legality of yield spread premiums, improving RESPA enforcement, and developing new and improved

disclosures that will help consumers avoid abusive fees.

Thank you for this opportunity to allow us to share our views

with this Committee. I would be happy to answer your questions.

Chairman SARBANES. Thank you very much, sir. We appreciate

your contribution.

Our next witness is Ira Rheingold, who is the Executive Director

of the National Association of Consumer Advocates. Previously, Mr.

Rheingold worked at the Legal Assistance Foundation of Chicago

as a Supervisory Attorney in charge of foreclosure prevention.

The major focus of his litigation practice was the representation

of senior and disabled homeowners victimized by mortgage brokers,

lenders, and contractors who were targeting minority, low-income

communities with high interest, high fee home equity loans.

Prior to becoming a Legal Services Attorney, Mr. Rheingold

worked as a Legislative Advocate for low-income community groups

in southern Maryland. He is a graduate of Georgetown University

Law Center.

Mr. Rheingold, we are pleased to have you with us this morning.

22

STATEMENT OF IRA RHEINGOLD, EXECUTIVE DIRECTOR

NATIONAL ASSOCIATION OF CONSUMER ADVOCATES

Mr. RHEINGOLD. Thank you, Senator Sarbanes, it is my pleasure.

And thank you so much for inviting us here to testify today.

I had prepared remarks and I have submitted testimony which

fully express our position in this matter. But instead of talking

about what I was going to say, I am simply going to respond to

some of the testimony I have heard today because sometimes as I

sit here, I think I live in a parallel universe, that there are two

universes—the people who deal with people on a real basis every

single day, who see homeowners every single day, and then the

theoretical universe out there about how the system is supposed to

work. And we just do not see it.

I was an attorney who represented homeowners for 5 years in

the poorest communities of Chicago. I looked at loan document

after loan document after loan document. What I heard here testified to today and what Professor Jackson said today was wonderful

because it quantified what we saw and we know is true. It is not

atypical.

I never ever talked to a client who knew they had paid a yield

spread premium. In fact, I never met a client who, until I sat down

with them, showed them their HUD–1, and said, hey, did you look at this line over here? You are being charged $1,500. Did you know

that? And they said, no. And I said to them, did you know that because that yield spread premium was paid, you had a higher interest rate? And they said, absolutely not.

Nobody knows what is going on. You can give all the disclosures

in the world—and there are disclosures. We look at the loan documents and there may be a disclosure about a yield spread premium

being paid. It is not happening and it has no bearing on what consumers are seeing today. Point number one.

Point number two I would like to address is the mortgage industry and their claim that there has not been clarity about this issue.

I think that is particularly cynical when we look back at what

HUD offered to us in 1999, when they issued their first Statement

of Policy. I am just going to quote some of the language from this

Statement of Policy, giving explicit directions to lenders. And this

is in our testimony, but I think it is worth repeating.

The most effective approach to disclosure would allow a prospective borrower to

properly evaluate the nature of the services and all costs for a broker transaction,

and to agree to such services and costs before applying for a loan. Under such an

approach, the broker would make the borrower aware of the total compensation to

be paid to the mortgage broker, including the amounts of each of the fees making

up that compensation. If indirect fees are paid, the consumer would be made aware

of the amount of these fees and their relationship to direct fees and an increased

interest rate.

I do not think it could be any more explicit than that. I think

it was clear how the industry could comply with what HUD was

going to do. But did the industry comply? They did not comply.

Why didn’t they comply? Because they were making a lot of

money. They were making a lot of money continuing this practice

and there was no enforcement going on that would stop them from

engaging in this practice. So instead of changing their practices,

engaging in behavior that would be legal, would be fair to the consumer, and creating a competitive marketplace, instead what they

23

did was they spent all their money fighting lawsuits and obfuscating the policy statement and going into court and saying, dealing with small lawsuits like me, I would go to court and I would

represent an individual homeowner and I would come in and I was

a little gnat. We were little gnats. Here is a couple thousand dollars. Go away. We will not foreclose on this person’s home. It was

the cost of doing business. But it was a small cost of doing business

because they were making enormous profits.

The world changed for the mortgage industry when the 11th Circuit Court issued the Culpepper decision because, finally, a court

found their hand, their arm, their elbow in the cookie jar. They

said, look, this is so obvious.

The thing that I find so interesting about this issue is it really

is very, very simple. The court looked at it and said, in practice,

the lender sends a mortgage broker a rate sheet and it says to the

broker, if you bring me a loan—here’s the par rate that the person

qualifies for. If you bring me a loan higher than that, I am going

to pay you this amount of money.

Nowhere in that discussion is, if you bring me a higher interest

rate and perform more services, I am going to pay more money.

The sole source of whether or not the broker is getting compensated is what the interest rate is going to be. No one was looking at whether or not there were more services being offered

because someone was getting a higher interest rate. The sole reason for compensation was the higher interest rate.

The court said, what else do I need to know? And that enabled

a class to be certified. The industry got scared. They got scared because, suddenly, the behavior that they had been engaged in, that

they had measured the cost of and figured this is not going to cost

us a lot of money, we are making so much profit, was now threatened because it was a class action case, which is an important enforcement mechanism we have in this country because there is no

other source of enforcement going on. It will cost us real money and

we will have to stop our behavior.

But, again, did the industry stop its behavior? No, they turned

to HUD and they gave HUD an opinion. We met with HUD and

the industry met with HUD. And HUD, instead of coming down on

the side of consumers and saying, hey, your behavior is wrong, stop

it, let the Culpepper case go on. HUD came to the rescue, adopted

a clarification, changed the way and gave protection to the industry. It said, no class actions allowed. It has to be done on an individual basis. And that is so important because individual cases cost

the industry nothing. They are little gnats. A class action case

makes them change their behavior. They do not want to change

their behavior, and that is what is happened here.

I will take questions later on about policy suggestions that we

have made. We agree wholeheartedly with Professor Jackson’s suggestions, but I just wanted to make those points right now.

Chairman SARBANES. Good. Thank you very much.

We will now turn to David Olson, Managing Director of Wholesale Access Mortgage Research and Consulting, an independent research firm located nearby in Columbia, Maryland, that specializes

in the mortgage industry. Mr. Olson has had over 30 years’ experience in the mortgage industry conducting research for a variety of

24

firms. He has served as Professor of Economics at the University

of Michigan, Smith College, Johns Hopkins University, and the

University of Maryland. He holds a BS degree from Northwestern

University and a master’s in economics from the University of

Michigan.

Mr. Olson, we are very pleased to have you with us this morning.

STATEMENT OF DAVID OLSON, MANAGING DIRECTOR

WHOLESALE ACCESS MORTGAGE

RESEARCH AND CONSULTING, INC.

Mr. OLSON. Thank you very much, Senator Sarbanes, for inviting

me and I am pleased to be here with a fellow Marylander.

There has been a lot of assertions made today. I thought I would

respond as others have done to some of the assertions. I have submitted a printed statement of my formal remarks.

There are a lot of statements being made about how profitable

brokers are and how profitable lenders are. My research has been

partly in profitability. That is all our firm does. We have seven professionals. We have been studying various aspects of the mortgage

industry and particularly brokers and lenders for over 10 years

and, as I say, I used to be Director of Research at Freddie Mac and

several other firms. I have been researching many aspects of this

industry for over 30 years. I started in 1969 with my first research

project. So, I have looked at a lot of these questions and I have a

lot of data. We have real data. One of the first points I will make,

it is not very profitable. And if it were so profitable, why are we

seeing a net exodus out of many areas of the field? There are firms

pulling out because they cannot make profit.

My initial research was, and in the Soviet bloc countries, I did

10 years of work in that area, and I saw first-hand, I spent time

in the Soviet bloc and I saw what happens when you have overgovernment regulation, government in effect running everything,

and it is a disaster. Consumers really lose out.

Today, we have heard some abuses. I am not denying abuses.

But we have to put it into context of the numbers. Last year, we

estimate there were 16 million transactions. What was a representative transaction? Our research is mainly based on random samples. And just the last study we did on brokers, we interviewed

4,000 broker firms to find out what is actually going on there. How

representative is this? Is there a lot of abuse? We would assert that

there is not. And the reason that brokers came from nothing 20

years is that in fact they can do it cheaper. They have priced everyone else out of business.

There are 8,000 lenders out there. Any consumer can always go

into one of these 8,000 lenders and get a quote. What would it cost

me to do this loan?

There are really two numbers that a consumer needs—interest

rate and fees, what are the total fees? Everything else is really irrelevant. The other, of course, is will you do the loan, period? And

that has been one of the problems in the industry. It is such a huge

industry. There were $2 trillion of loans done. Just to get a loan

done is very difficult in certain periods, such as last year.

So, consumers have sought out brokers merely to get a loan. We

have not looked at the alternative of no loan. What if the consumer

25

got nothing? We were saying that it was high and then we are assuming that they could have gotten a better deal elsewhere.

Well, why didn’t they price it elsewhere? We have 33,000 mortgage broker firms, according to our records right now, plus the

8,000 lenders. It is very easy to get a quote, find out what it costs

to do a loan.

Now, whether they will do your loan is the issue. Can they do

your loan for this price? Was it cheaper or more expensive? We

would always advise everyone, any consumer, to shop around and

go get quotes. And our experience is that most consumers do get

multiple quotes and make it difficult for brokers.

Most brokers are just breaking even. If this were so profitable,

we would have found that brokers would be staying in this industry. But in fact, the average firm lasts only 5 years and then they

are out because they go elsewhere. They find that they can do better elsewhere. It is not that profitable an industry. There has been

this implication of how profitable it is.

The same with mortgage lending. That field is not that profitable. And if it were not the case, we would not see this net exodus.

Now, I will agree that there have been abuses in so-called

subprime lending and I think that is what we have been really

hearing. I can defend it from several reasons.

We do not have enough lenders offering these loans. The less the

competition, the more you will tend to find higher prices. What we

need is really more competition, more people offering these loans.

But what I have noticed—I publish a quarterly magazine on this

issue. There has been a huge exodus out of subprime lending. Most

of the major lenders that were in operation 3 years ago have shut

down. They have been generating losses. They are still generating

losses.

If this is so profitable, why are they all generating losses? Why

are we still seeing a net exodus? And so, I would assert that, unless we do something else, if you kick all the business out of the

industry, who is going to be left to make these loans, and where

will the consumer go?

There has to be a real, live alternative for the consumer. We

have been talking about abstract alternatives. We have to say, who

offered you what? Could you have gotten something better? Then,

the other cases, were these instances representative of the whole?

From my point of view, we have great regulation, probably too

much regulation. I would agree with some of the other witnesses

that it is extremely complicated. And it is because it is so complicated that brokers have to do their job. Just to go through all

of those sheets of paper and get them right, it costs about 2 points,

2 percent to do this job.

Government has an opportunity to make it simpler. If it were so

simple, it could be all done on the Internet for a fraction of that

cost. I think that we would be better served by making it simpler

and then this job of leading people through all this paperwork

would not be necessary and it would be more transparent and it

would be easier for everyone to understand and focus on what is

the most important thing?

26

We want the person in the house. We want a low interest rate

and we want low points. That is the objective. Who can do the best

job of getting us there? What is the best way?

From my perspective as an independent observer, the best way

is to get it as simple as possible, not put on another layer of regulations, and certainly not try to assault the industry through class

actions. Our data shows that a typical class action lawsuit costs the

lender $1 million per suit, and there are 150 suits. So that would

add up to about $150 million. That cost is picked up by the lender

and then passed to the consumer. The lender does not operate for

nothing. It is a huge cost, a huge tax that has been added on to

the industry and is certainly unnecessary and incorrect.

I would be happy to work with you in any way I can in my professional capacity, and thank you for inviting me today.

Chairman SARBANES. Thank you, sir.

Our final witness this morning is David R. Donaldson, from the

law firm of Donaldson & Guin, LLC.

Mr. Donaldson has practiced law for over 20 years and has extensive experience in consumer protection and real estate litigation

cases. He is a lecturer on topics related to lender liability under the

Real Estate Settlement Procedures Act, a 1975 graduate from the

University of Alabama at Birmingham, and a Dean’s Scholarship

to the Cumberland School of Law, where he was an Associate Editor of the Cumberland Law Review.

Mr. Donaldson, we are pleased to have you with us this morning.

We would be happy to hear from you.

STATEMENT OF DAVID R. DONALDSON, COUNSEL

DONALDSON & GUIN, LLC

Mr. DONALDSON. Thank you, Chairman Sarbanes, and thank you

for inviting me.

I am one of the plaintiff’s counsel in the Culpepper case, which

you have heard so much about here today. That litigation and the

U.S. Court of Appeals opinion in that case—and there are three of

those opinions—are based on a very simple proposition. That simple proposition is that mortgage brokers should not charge borrowers more than the broker agrees to accept for his or her services. I do not believe that that is a controversial proposition.

Yet, for some reason, when the Eleventh Circuit Court of Appeals

issued an opinion that said, this yield spread premium was not a

payment for services because nothing else was owed for those services, it caused the industry to go into an uproar. And that first decision was issued in 1998. That message was sent a long time ago.

The mortgage industry, rather than amending and changing

their practices, believed that they could continue violating the law

simply by avoiding class certification decisions in that class action

and in other class actions.

I was interested to read when I read the prepared statement of

Mr. Courson, he describes the operation of the yield spread premium in this way. He says, ‘‘as the interest rate goes up, the borrower’s upfront cash contribution goes down.’’ He then goes on to

say, ‘‘I want to clarify, unequivocally, that the yield spread premium mechanism should be restricted to the function I just

described.’’

27

I understood what he said, and if I am misunderstanding it, he

is here today and he can correct me. But as I understood it, he is

arguing the same thing I have been arguing for the last 5 years

to the mortgage industry, which has turned a deaf ear.

Under the Culpepper rule that was established by the appellate

court, the only thing that a lender has to do to avoid a class action

lawsuit on yield spread premiums is to put language in the lender’s

contract—and they all have standard-form contracts that they use

with their brokers.

If the lenders would simply put this same language in their contracts—that is, we will pay yield spread premiums on over-par

loans where they are used to lower borrower’s upfront costs. And

if they would actually enforce that, and it is easy to see whether

a yield spread premium is used to lower upfront costs because

there is a line for it on the HUD–1.

If that were done, and I and other plaintiff’s lawyers have been

advocating that now for 5 long years—if that had been done 5

years ago, the industry would not be facing the problems it is facing now. And if it were done tomorrow, it would not be facing yield

spread premium litigation under Section 8 of RESPA the next day.

The industry claims, and I wrote this quote down this morning,

so I may not have gotten it verbatim, but it is close—tell us the

rules so we can conduct business. That is what the industry says

it wants. If that is what the industry wants, I cannot understand

why it went to HUD and demanded HUD promulgate a rule that

says a yield spread premium is legal, so long as it is reasonable.

Mr. Falk claims that the RESPA statute says that yield spread

premiums are legal, so long as the total compensation is reasonable. But the word reasonable is not contained, Chairman Sarbanes, in that statute. In preparation for coming to talk to you

today, I went back and reread the Senate report issued by this

Committee’s report in connection with that 1974 piece of legislation.

HUD asked the Congress for authority to determine what was a

reasonable price for settlement charges and Congress refused to

grant HUD that power. In this Committee’s report, it stated several reasons why that was a bad idea. And one of the reasons stated was that it would require an army of bureaucrats to look at the

transactions to determine what is reasonable.

I also heard this morning Mr. Olson say that there are 16 million

transactions. The printed testimony from the Mortgage Brokers Association says that brokers are responsible for roughly two-thirds

of those. So that would be something in excess of 10 million transactions. I would submit to you that it does not make any sense for

HUD to attempt to examine 10 million transactions to determine

whether a payment is reasonable, whatever that is.

Apparently, the truth of the matter is, the reasonableness standard, which is not the law and should not be the law, is simply a

way to legalize any kind of illegal practice so long as it is widespread. As long as all of the brokers are getting the payments, it

becomes reasonable and, under that standard, legal. Anything

would be legal under that standard.

Chairman SARBANES. Virtually anything, yes. I guess the extreme, the very egregious might fall outside of the parameter. But

28

otherwise, they just make reference to what the rest of the industry is doing and say, well, this constitutes a reasonable practice. Is

that the point?

Mr. DONALDSON. Yes, sir.

Chairman SARBANES. Yes.

Mr. DONALDSON. Beatrice Hiers, who everyone heard from this

morning, is one of the plaintiffs in the Culpepper case. And the defendant has argued long and hard that she received the benefit of

that yield spread premium and that it was reasonable. That position was taken.

The 2001 policy statement purports to treat yield spread premium payments to brokers in a totally different manner than it

treats all other up charges. The example that is given in the policy

statement is a situation where a lender obtains an appraisal for

$175, charges the borrower $200, and pockets the $25.

Now, the 2001 policy statement says that that is a violation of

Section 8 of RESPA. While I do not disagree with that, I suspect

that if I were to bring a lawsuit under that same fact situation, the

response would be, look, from the defendants, $200 is a reasonable

cost for an appraisal, and in fact, it may be a reasonable cost for

an appraisal because a lender that purchases thousands of appraisals a year can probably force the appraiser to drive the price down.

It may be a reasonable cost. But HUD is saying that is illegal.

Yet, if a broker and borrower agree for a 1 percent loan origination

fee, and if no other compensation is agreed upon, and at the closing

table, the broker receives double that amount, in HUD’s view, that

apparently is perfectly legal.

There is no legal distinction between those two situations based

under the same statute and there is certainly no intellectual distinction that I can understand.

In closing, I would like to respond very briefly to the statement

about class actions that was just made by Mr. Olson. The man sitting at the end of the table is a Harvard Professor who prepared

a study. It was not done at my request, but it was done at the request of other plaintiffs’ class action lawyers in another RESPA

case. We would not have that kind of information today if we had

to rely—that was done because a class action lawyer has a lawsuit

and it is a very expensive study because it took a lot of intelligent

people a lot of hours to do it.

Lawyers are not going to spend that kind of money to prepare

those kinds of studies in order to get back $1,000 for somebody. It

does not make economic sense.

The idea that when litigation expenses are incurred, that it

drives up the cost, defies what I understand to be simple economics, which is that retail prices are a function of supply and demand.

I do not see how suing 150 out of the 2,800 lenders causes the price

of mortgages to go up, and I do not think it does. I think that is

a red herring.

Last but not least, I have not conducted a study like Professor

Jackson, but I have talked to a lot of borrowers. And it is my clear

impression from those conversations that supports what he found

about discrimination in yield spread premiums.

The Wharton study that you referred to at the beginning of your

comments here today, was not done for plaintiffs’ lawyers. It was

29

done by a professor who is featured prominently on the Mortgage

Bankers Association’s own web site. That study found that the two

determining factors for how much mortgage brokers get paid are

the size of the loan and the sophistication of the borrower.

Thank you very much, Chairman Sarbanes.

Chairman SARBANES. Well, thank you.

I want to thank all six panelists for their contribution. This was

a panel that embraced a number of varying viewpoints and of

course, it was our objective to get kind of a broad presentation. So,

I want to thank all of you for coming today, for preparing what are

obviously some very thoughtful statements, all of which will be included in the record in full.

Now let me turn to a few of the issues that I think have emerged

here. First of all, I want to address this question of the class action

suits as opposed to individual suits because the new HUD directive

is read to preclude the class action suit, as I understand it, or it

is being so interpreted by some courts already across the country,

if I am not mistaken, the 2001 statement.

Although it is then asserted, these individual suits can be

brought. I think everyone has conceded that the individual suits

can be brought. But it seems to me that what is going to happen

is that any recourse to the courts to remedy the situation is going

to be closed out because the amount of recovery in an individual

case is so small, that you are not going to be able to mount the

legal effort that is necessary to bring these practices under control.

Now the counter to that is, well, if we allow the class action suits

to go ahead, they will recover huge amounts and that will impose

a very significant burden on the industry. Let me ask you, Mr.

Donaldson, the individual’s suit really does not provide much recourse to the courts, does it, to get at these practices?

Mr. DONALDSON. Well, it does not change the practices. When

the Circuit Court of Appeals issued its first opinion in January

1998, the industry’s response was, so long as the plaintiffs cannot

get classes certified, we can go on our merry way and not change

our practices. They said that publicly in the press.

So, I think that answers that question. And you are certainly correct. It is difficult to undertake litigation and fight for long years,

as we have in this case. It has been going on for 5 years, even a

large yield spread premium is a small amount of money to fight

over for years and years.

Chairman SARBANES. Now what is the requirement that you say,

if the industry followed it, would in effect eliminate the abuse of

these practices?

Mr. DONALDSON. I did not really say what I thought might eliminate the abuse of the practices, and I am not sure, as far as if you

want my opinion on that question, certainly Secretary Martinez’s

suggestions in his mortgagee letter that has been discussed here

today would be a good step in the right direction.

Chairman SARBANES. The Department is arguing that what they

have done is protective of the consumer. And I am having great difficulty understanding why that is the case.

The industry went to them to get protection from the class action

suits. The class action suits would be a very heavy discipline on the

industry if they carried forward, proceeding from Culpepper. So

30

there was a discipline mechanism in place to, in effect, compel the

industry presumably to clean up these practices. Otherwise, they

were going to pay significant penalties, or recompense.

It is not clear to me, if you take that out, what is left, or where

you will turn, then, to protect the consumer from these practices.

And so, despite the Department’s assertion that this is to help the

consumer, I have difficulty in following that, one of the reasons we

are doing this hearing here today.

Mr. Jackson, let me turn to you because you have done some

very careful studies and I would be interested in your response to

that question.

Mr. JACKSON. Well, I think that the policy statement can be interpreted as a significant impediment to litigation. As I mentioned

in my testimony, I think the Department misunderstood the role

of yield spread premiums at least for a large number of mortgage

lenders. And so, it is possible that, on different facts, courts would

proceed differently with the policy statement. So it is still possible

to maintain litigation, I hope, against certain lenders.

I would say that the management of class actions is a function

for the courts to decide. I think the courts are responsible for determining how to structure their cases. And HUD does not have expertise in class action management, so the court should take a look

at these cases and see what the sensible way to proceed is.

That having been said, I think that the Department must go further on disclosure. The current disclosure techniques are simply inadequate. The main problem is the yield spread premiums, when

they are disclosed, are disclosed as payments from the lender to the

broker. A consumer would reasonably think it has nothing to do

with them. And in fact, if you go on the HUD’s web page today and

look for an explanation, HUD says these payments have no cost to

you. It is quite misleading for consumers and I am quite sympathetic to people——

Chairman SARBANES. Well, they have a cost to the consumer in

that they are paying a higher interest rate, don’t they?

Mr. JACKSON. I absolutely agree which is why I think the current

HUD instructions and glossaries that are on their web page are

just quite misleading.

Chairman SARBANES. Now, Mr. Courson, I understand, is it your

position that if there is a yield spread premium, it should go to the

credit of the borrower?

Mr. COURSON. Let me explain my statement in that regard. Once

the broker establishes what their compensation is going to be in a

transaction, as they enter into this transaction with the consumer,

whether at that point that compensation is agreed upon is either

paid in cash or paid through the use of the yield spread premium,

should be the same dollar figure.

In other words, you establish the compensation for which you are

going to provide the services and then, giving the consumer some

choices, which I talked about in my opening statement, as to

whether to pay that compensation in cash, pay it through a higher

interest rate in a yield spread, or through a combination of both.

It could be both.

Chairman SARBANES. You think that the consumer should know

up front what the broker’s charges will be?

31

Mr. COURSON. Yes.

Chairman SARBANES. Do you agree with that, Mr. Falk?

Mr. FALK. We believe that the compensation should be included

on the Good Faith Estimate, together with the rest of the costs of

the loan, so that consumers can adequately shop and compare between different financing options. Yes, they have to be disclosed,

together with all of the other costs on the Good Faith Estimate.

Chairman SARBANES. So would you have the broker’s recompense

separately disclosed to the consumer up front?

Mr. FALK. It is currently separately disclosed on the Good Faith

Estimate. Yes, it should be itemized under the current system.

Chairman SARBANES. How would you handle the yield spread

premium issue?

Mr. FALK. As a separate disclosure on the Good Faith Estimate,

which is current law.

Chairman SARBANES. Mr. Jackson.

Mr. JACKSON. I just disagree. I think that this is the kind of misleading statement.

Chairman SARBANES. Yes, let us talk about that.

Mr. JACKSON. It is currently disclosed as a POC—paid outside of

closing—from lender to the broker.

Chairman SARBANES. Right.

Mr. JACKSON. It is absolutely unclear under current law that the

borrower is paying that through higher interest rates.

Chairman SARBANES. Would you make it clear to the borrower,

Mr. Falk, that the borrower is paying it?

Mr. FALK. I would make it clear that all compensation is clear

and concise.

Chairman SARBANES. Let me just deal with that very specific

thing that Professor Jackson referred to.

Mr. FALK. Yes.

Chairman SARBANES. Would you make that clear to the borrower, specifically?

Mr. FALK. Broker fees are in part, fees paid by the lender for

goods, services, and facilities provided to the lender by the broker,

and partially fees for goods and services provided to the borrower.

It is a combination of both. Therefore, that is why we believe that

the initial disclosure form, the model loan origination agreement

‘‘souped up,’’ as we recommend to HUD, should be clearer on the

definition of these various fees and charges.

Chairman SARBANES. Mr. Courson, would you make it clear, by

responding to Professor Jackson?

Mr. COURSON. Mr. Chairman, yes. I submitted for the record and

I have shared with the Committee a prototype, as I described it,

of a disclosure agreement that we think incorporates what Mr.

Donaldson discussed, and Mr. Jackson discussed, as part of the

statement of policy in the mortgagee letter. And the thrust of this

agreement, if you will, entered into at the start of the application

process discloses the total broker compensation.

So, in that regard, it would include whether it was compensation

to be received through a yield spread, whether it was compensation

to be received through an origination fee. It would be the total compensation from whatever source. And then I think as you look

32

through that prototype agreement that our coalition put together,

then it offers the consumer some choices.

It says to the consumer that here is the compensation. The compensation will not exceed X and you have some choices. And then

it goes through some choices as to paying in cash, paying through

a higher interest rate, paying through a combination and so on. So

that captures all elements of that compensation into a number on

a not-too-exceed number, and then gives the consumer the opportunities I talked about in my statement of options on how to deal

with those costs.

Chairman SARBANES. It seems to me that one of the difficulties

here is the way the system is working now, and this goes to Mr.

Rheingold’s point about it is one thing to talk about it in theory.

It is another thing to see how it works in practice, is that you have

an option which you say, if properly used, enables the consumer to

have an additional financing approach. Namely, a higher interest

rate and then they get some money with which they can cover their

closing costs. So, they do not need as much money up front. And

that sounds like a worthy objective. But in practice, since it is not

disclosed or disclosed in such a way that it is not apparent that

this option is available, in effect, it becomes a rip-off of the consumer. It becomes an abuse.

Now that raises the question, and this goes to how widespread

the practice is, which goes back to Professor Jackson’s study, but

that raises the question, if there is substantial abuse, whether it

is worth having this option available, if the consequence of having

it available is to get the kind of instances that we heard from from

the first panel this morning. Now that approach, in a sense, would

close out an option that people say, if properly done, is desirable.

On the other hand, if we cannot figure out a way to close out the

abuses and sustain the option, and if the abuses are fairly prevalent, that may be the only recourse.

Mr. Rheingold, you wanted to comment.

Mr. RHEINGOLD. Yes. Although I have not read Mr. Courson’s

disclosure of the model that he talks about, I can say that the concepts he expressed, we would fully endorse. We do not oppose yield

spread premiums and we think, as you said, they actually can work

in a manner that would benefit consumers.

The point being here that if there is a total compensation disclosed up front, this is what I am going to get paid. I am your

broker. This is what I am going to get paid. If the consumer is

given a choice as to the method of payment, that is fine.

The system that we have here today is market-distorting. One

would think that if you have a broker, the broker will shop for you

so that you get the best available loan. In essence, what we have

here, in practice, as demonstrated by Mr. Jackson’s study, is that

the broker is not finding you the best available loan for your benefit, but they are looking for loans where they will get paid more

money.

In essence, the marketplace is not functioning right now. And if

you, in fact, have a scheme where the total compensation is laid

out upfront, and whether or not a yield spread premium is paid or

not, I am going to pay that broker $2,000. I may pay it in cash.

33

I may get it refinanced. I may have the lender pay that $2,000. I

will choose it.

But that money is set in stone and then there is no incentive for

the broker to find a higher interest rate for that person because

their compensation is not going to change based on what the interest rate is.

Chairman SARBANES. Because they will not get the yield spread

premium.

Mr. RHEINGOLD. Well, they will get the yield spread premium.

Chairman SARBANES. But it will be credited to the borrower.

Mr. RHEINGOLD. Right. It will be a way they get paid, but there

will not be an added incentive to find a higher interest rate because they will get paid more. That will eliminate it and the

scheme that Mr. Courson describes, I believe will actually eliminate that market-distorting incentive that currently exists.

Chairman SARBANES. Mr. Falk, what do you say about that?

Mr. FALK. Well, I think the marketplace is working for a vast

number of Americans who have refinanced this year and saved billions of dollars of interest expenses.

Mortgage companies act in multiple capacities, Mr. Chairman.

Sometimes a mortgage company acts as a lender in a transaction

and sometimes the company acts as a broker in a particular transaction. So, however you define the transaction, total compensation

should be disclosed fully. It should be as transparent as possible.

And it should meet with the wishes and the guidelines and the desires of the consumer.

Therefore, I believe the market is working. We have increased

competition, which is what we want in the marketplace. And I believe, by and large, mortgage brokers are bringing reduced costs to

the marketplace and doing an excellent job.

Chairman SARBANES. How do I know which broker to go to on

a competitive basis if they are not disclosing to me up front what

their charges are?

You say it is working on a competitive basis and I am then led

to wonder, well, a lawyer will tell me what his fee is, a stockbroker

tells me what his commission is, a real estate agent tells me what

their fee is. If I cannot get that specific information from the

broker, how do I shop amongst brokers as to who is going to give

me the best value.

Mr. FALK. We believe that consumers should always shop and

compare, not only between brokers, but also with retail lenders,

banks, credit unions and savings and loans. We are all part of that

system.

Chairman SARBANES. Well, that is Professor Jackson’s point, and

we may get to that. I mean, we are dealing with a broker problem

now and I can understand the brokers saying, well, if you are going

to deal with the broker problem, we want you to deal with any

comparable problem that may exist with the lenders. And that is

broadening the universe of what we have to deal with. But let us

for the moment operate with this limited universe we are addressing. How do we ensure that we will not get the kind of practices

that we heard this morning from the people on the first panel?

Let me ask this question first. Is there anyone on this panel who,

having heard what we heard from the first panel, says, well, this

34

is how the system operates and we get other benefits out of the

workings of the system and therefore, we do not really think anything should be done to close out the practices that we heard this

morning? Is there anyone at the table who takes that position?

Mr. Olson.

Mr. OLSON. I think that those are exceptional circumstances.

Chairman SARBANES. Pardon.

Mr. OLSON. I think they were exceptional circumstances and not

typical.

Chairman SARBANES. Let me not argue whether they are exceptional or not for the moment. Let me just get a response, whether

there is anyone on this panel who thinks, having heard those practices, who says, well, it is regrettable, but we have this system that

works, or we have this system in place and it moves a lot of transactions and people get credit and all the rest of it, and therefore,

we really cannot close out those practices and we just have to, in

a sense, accept them or tolerate them. And then, presumably, one

would argue that there are not very many of them, and others

would argue that there are quite a few of them. But is there anyone who thinks we just should accept those practices, at the table?

Mr. OLSON. I think we have been given some alternatives. If we

make the compensation up front, then there would be less of this

practice. I would agree with that.

There is always imperfections in any market and I do not know

if you can always eliminate every problem. We could go to shopping

for a dress or going to the restaurant. There is always cases where

someone paid more than they wish they had.

Chairman SARBANES. No, no, this is not a case where they pay

more than they wish they had. This, it seems to me, what we heard

this morning are cases in which they were clearly taken advantage

of. They placed their confidence in someone. They, in effect, got

representations that the person was really working on their interests, and it turned out they were not working in their interests and

they put them into very difficult situations.

Now, Professor Jackson says on the basis of his study, that he

thinks that such practices are fairly widespread. Am I interpreting

that correctly?

Mr. JACKSON. That is correct. It is much more widespread than

several panelists this morning would suggest.

Chairman SARBANES. Yes.

Mr. JACKSON. It is a very generic practice and problem in the

industry.

Mr. DONALDSON. Mr. Chairman, could I respond to the statement

about the frequency of these occurrences?

Chairman SARBANES. Sure.

Mr. DONALDSON. With all due respect to Mr. Olson, Ms. Hiers got

a mortgage from Irwin Mortgage Corporation, the defendant in the

Culpepper case. I and other plaintiffs’ lawyers who are representing that class have looked through approximately 5,000 loan

files. I did not find and, to the best of my knowledge, no other person found a single situation where any borrower was saved one

thin dime in closing costs as a result of a yield spread premium

being paid. And the idea that these are not commonplace problems

35

simply cannot be—that allegation does not withstand the light of

day of scrutiny if you actually look at the loan files.

Situations like Beatrice Hiers’ are not the least bit uncommon if

you go look through these defendants’ loan files. And although the

mortgage bankers and the mortgage brokers are sitting before this

Committee here today talking about how willing they are to disclose, my reading of the Federal Register of the negotiated rulemaking with HUD over the last several years, starting in 1995,

tells me that they have vociferously fought against any disclosure

whatsoever.

And in preparing to come here today, I went to NAMB’s web site

and read their position paper, dated last month, talking about this

very question. And there is an entire topic devoted to the proposition that, ‘‘. . . originators should not be required to disclose

their compensation.’’ I do not understand.

Chairman SARBANES. Does anyone want to respond to that?

Mr. Falk.

Mr. FALK. Mr. Chairman——

Chairman SARBANES. We have you all at the table this morning

for this purpose.

Yes.

Mr. FALK. Mr. Chairman, we as the mortgage brokers do believe

in comprehensive mortgage reform. I believe over the last 5 or 6

years the National Association of Mortgage Brokers has been calling on Congress and HUD to work on the various problems that

we have in our industry.

There are just too many pieces of paper. It is confusing to the

consumer. It can be faster and better, understandable to the consumer, to facilitate shopping and comparing. It can be better.

We believe also an important part of this is RESPA enforcement

that Secretary Martinez has called for and we applaud that effort.

We look forward to his efforts in enforcing the rules that are currently on the books and clarifying others that need clarification.

Last, we have called for more than what the HUD Secretary

called for in our press release recently. We have called for Good

Faith Estimate reform, which would have caused some of the problems that we heard about this morning not to exist.

Right now, Mr. Chairman, when a Good Faith Estimate is required, there is no Federal requirement to redisclose the Good

Faith Estimate of costs if the loan terms change significantly from

the time of application to the time of funding.

What we are saying is develop tolerances. When the Good Faith

Estimate is initially constructed and delivered to the consumer, if

tolerances are exceeded, then a redisclosure is necessary to avoid

the surprises at the closing table, to avoid some of the things that

we heard this morning on a purchase transaction, the story that we

heard this morning from Ms. Hiers, who felt forced to close a transaction. That should not happen. And redisclosure on a Good Faith

Estimate that exceeds certain tolerances could be a valuable tool

for consumers so they are not taken advantage of.

Chairman SARBANES. Well, all three people we heard from before, I was struck by the fact that these are really hard-working

citizens. Every one of them.

36

Their dream was to own a home, and that was obviously a very

important part of providing security for their families. Ms. Hiers

actually had her parents living with her until they passed away,

along with her children. We have to get at these practices.

Mr. Jackson, I know you have looked at the RESPA legislation

in detail. My own reaction to the HUD 2001 policy statement was

that, rather than clarifying the 1999 statement, it actually muddied the waters.

My view of the RESPA law, in the 1999 statement was that each

fee had to be tied to a legitimate service. In fact, the Senate report

that accompanied the passage of RESPA indicates that RESPA,

‘‘. . . prohibits the acceptance of any portion of any charge for the

rendering of a real estate settlement service other than for services

actually performed.’’ So my understanding is that Congress wanted

to prohibit referral fees from being tacked onto or hidden in with

other fees that were for legitimate services or goods.

And that is why, Mr. Falk, I kept pressing you specifically on the

fee and the service because you can encompass the fee within a

broader concept. And I have some concern now that this is what

HUD is doing with this total compensation test, which would allow

for referral fees, or may well allow for referral fees as long as HUD

believes that the total payment to the broker is reasonable, even

though the law specifically prohibits all referral fees.

Now do you share that concern, Professor Jackson?

Mr. JACKSON. Senator Sarbanes, I do. This aspect of the policy

statement is quite puzzling. If you go back to the legislative history

of the Act that you are referring to, or even the press accounts that

preceded the Act, what Congress was worried about were people in

a trust relationship, like attorneys or real estate agents, who were

steering their clients toward title insurance companies and other

service providers and getting a kickback. And what Congress concluded was that these referral fees and kickbacks were increasing

substantially homeownership costs, and they should prohibit them.

Chairman SARBANES. Mr. Donaldson, the Culpepper case in effect said, as I understand it, that these yield spread premiums

were being paid without any relationship to providing any services.

Mr. DONALDSON. Yes, sir.

Chairman SARBANES. Is that correct?

Mr. DONALDSON. Yes, sir, that is correct.

Chairman SARBANES. In effect, you had the rate sheet and it was

all geared to the rate sheet. As long as you brought them in at a

higher interest rate, you got the yield spread premium and you, the

broker, did not really have to do anything for that yield spread premium. Is that the essential thrust of that case?

Mr. DONALDSON. Yes, sir. And the form agreement between the

lender and the broker simply provided that yield spread premium

payments would be made when a borrower agrees to a higher than

par interest rate. It had nothing to do with services. And in fact,

at the outset of that litigation, the defendant did not even argue

that it had to do with services. It argued that it was paying for a

good which was the mortgage. This idea that this is a payment for

services is something that was cooked up by industry lawyers after

they lost their first argument.

37

Chairman SARBANES. My understanding is that there has been

testimony in some of these class action suits—let me just quote a

couple of them.

A broker testified in a deposition that the only variable that determines the yield spread is the interest rate. A lender official was

asked if there are any particular services that go into the pricing

on a rate sheet. His answer, ‘‘No, I am not aware of any services.’’

Mr. DONALDSON. That is correct.

Chairman SARBANES. A lender offers to fund the same exact loan

provided by the same broker for the same borrower with the same

principle amount after the broker has done the work. The only

variable is the yield spread premium, which is predetermined according to a rate sheet provided by the lender to the broker. Isn’t

that what happens?

Mr. DONALDSON. Yes, sir, that is exactly what happens.

Chairman SARBANES. Mr. Jackson, let me ask you one other

question on this RESPA and the HUD statement. Apparently, now,

the 2001 statement is that HUD is going to determine what is a

reasonable fee. That is not the approach that the Congress took

when they passed the legislation, at least as I understand it. In

fact, we did not set up a structure to adjudge the reasonableness

of the fees.

Mr. JACKSON. That is absolutely right.

Chairman SARBANES. Mr. Courson, Mr. Falk, do you think we

should set up a structure to adjudge the reasonableness of fees, a

Government structure to do that?

Mr. COURSON. Mr. Chairman, I think that is a very slippery

slope. I think it is very difficult to judge what, when one loan may

well be reasonable—we are talking about loans now in this particular context—and whether another loan may be unreasonable.

You have geographical issues. You have different types of loans.

I think that the Government setting standards, if you will, in terms

of defining reasonableness will be very difficult over the hundreds

of thousands of loans that are made each year.

Chairman SARBANES. Mr. Falk, I take it you would agree with

that.

Mr. FALK. I would add to the comment, yes, I do agree with Mr.

Courson’s testimony. Many loan programs and different products

and services call for different types of services and goods and facilities rendered. Therefore, it is impossible to come up with a strict

definition on a Federal level to deal with all of the complexity that

goes into a particular loan transaction on a local level. It would

just be very difficult.

Chairman SARBANES. Actually, I do not think anyone at the table

is advocating establishing a governmental structure to adjudge the

reasonableness of fees. Is that correct?

Mr. OLSON. That is correct.

Chairman SARBANES. I mean, as I read it, that is not the legislative scheme the Congress put in place.

Now what the Department is doing is, conceivably—we are going

to see now because they are working on a regulation—but, conceivably, undercutting the existing regulatory scheme, setting up this

kind of reasonableness proposition.

38

I do not know how that is going to be implemented or enforced.

The industry, obviously, in its full-scale manifestation, would be

opposed to it. The Congress made the judgment when we passed

the legislation not to go down that path. But if we are not going

to go down that path, it seems to me that HUD cannot abandon

the two-stage testing process for these practices that in part were

reflected by the court’s decisions in the Culpepper case. So now if

they are going to come in and vitiate the Culpepper case, it is hard

for me to see what the remedy is going to be to preclude these practices from taking place.

Mr. RHEINGOLD. Senator.

Chairman SARBANES. So, I think that is, in effect, the challenge

that HUD has presented to itself. They, in effect, now, it seems to

me, have maneuvered themselves into a corner. And I am obviously

very interested in how they are going to work out of this corner.

Mr. Rheingold, you wanted to comment?

Mr. RHEINGOLD. I apologize.

Chairman SARBANES. That is all right. No, no.

Mr. RHEINGOLD. The industry, in fact, supported HUD’s action

and wanted them to apply a reasonableness test. HUD adopted

what the industry was asking them to do, and there was one reason for it and one reason alone—everyone understands that if the

only test is reasonableness, you cannot have a class action lawsuit.

HUD’s actions were simple. Call it cynical. The only purpose for

their policy statement on October 15 was to undercut Culpepper.

They may come out now with new regulations that are helpful. But

the fact was that the October 15 Statement of Policy was caused

by industry’s reaction to the Culpepper decision and their understanding that a reasonableness test would undercut the ability of

any class action to go forward.

Chairman SARBANES. Do you think that there are mandates that

could now be required of the industry that would preclude a repeat

of the practices we saw on the first panel?

Mr. RHEINGOLD. I think there clearly are. Actually, I think some

of the suggestions that Mr. Courson made are very viable. I think

the notion that total compensation up front, that the total compensation does not depend upon the interest rate the person gets.

The yield spread premium is simply a source of how that compensation gets paid. So, in essence, there is no incentive for a

broker to get a higher rate mortgage because they are not going to

get compensated any more.

I think that would go a long way to solving the problems that

exist. I hasten to add that in my experience in representing a lot

of poor homeowners in this country, I never underestimate the cynicism of the industry and I never underestimate——

Chairman SARBANES. Or some elements of the industry.

Mr. RHEINGOLD. Some elements of the industry. I do not mean

the entire, but some elements. I do not underestimate that. But I

think that would go a long way forward in making things work.

Chairman SARBANES. I think the industry has to face this problem of the bad actors within their ranks. They just have to face it.

Mr. Falk, do you want to comment?

Mr. FALK. Yes. Thank you, Mr. Chairman. I would vociferously

disagree with the other panelists who have tried to characterize the

39

2001–1 policy statement of HUD. We believe that the 1999–1 policy

statement by Secretary Cuomo clearly outlined the requirements.

We believe that the 2001–1 statement was merely a restatement of

that existing policy that was originally stated in 1999.

And so, to characterize it as some effort on the part of the HUD

Secretary to undermine or to take away certain rights and privileges from consumers, we believe is a misinterpretation, with all

due respect to the other panelists.

Chairman SARBANES. Yes. The difficulty I have with that statement, though, is that under the 1999 guidance, a class action suit

was permitted in the Culpepper case. And since the new guidance

has come out, I understand that there have been a couple of Federal courts across the country who have disallowed the class action

suit. So if you see the class action suit as one effective remedy to

eliminate these practices, then that remedy has been in effect

wiped out.

Also, HUD, by collapsing the two-step test, has markedly altered

the situation. If it is left for reasonableness to be determined in a

court case, that is not much remedy on an individual basis.

They are not suggesting establishing a structure to determine

reasonableness administratively, and of course, both of you would

strongly disagree with going down that path, I presume, from what

you have said earlier.

So, we have a situation now in which the remedies are being

eliminated on the basis of a so-called clarifying statement compared with where we were before. The rhetoric of the HUD press

releases in terms of what they are trying to accomplish does not

comport with the reality of their statement, in my perception. It

will really be put to the test, obviously, as we look at the regulation

that they are now seeking to formulate. And obviously, we intend

to follow that process very closely.

Well, I want to thank all the panelists. You have made a very

significant contribution. It is our intention that your full statements and the transcript of this hearing will be forwarded to the

Department, along with a letter of communication urging them to

give the most careful consideration to what has been said here.

This is a very important issue. As I said at the outset, people

who render services are entitled to appropriate compensation for

the services they render. But it ought not to extend to the point

where they can engage in abusive practices and exploit people.

Mr. Olson, I was a little concerned you were suggesting they are

not making much money. That may or may not be the case. But,

in any event, in order to make money, I do not think you are entitled to engage in abusive practices. I do not concede that in order

to turn a profit, you can engage in any exploitative activity.

Mr. OLSON. I did not mean to suggest that.

Chairman SARBANES. Well, that was a possible implication. I just

want to be very clear about that.

I thank the panel very much.

The hearing is adjourned.

[Whereupon, at 12:10 p.m., the hearing was adjourned.]

[Prepared statements, response to written questions, and additional materials supplied for the record follow:]

40

PREPARED STATEMENT OF SENATOR PAUL S. SARBANES

This morning the Committee will hold its third hearing on the subject of predatory lending. Our previous two hearings on this topic focused largely on the predatory loans and practices which resulted in stripping hard-earned equity away from

many low-income homeowners. These include folding high points and fees, as well

as products such as credit insurance, into the loan. We also looked at how unscrupulous lenders and mortgage brokers target the low-income, elderly, and uneducated

borrowers as likely marks for predatory loans. Today’s hearing will focus more on

the role of the broker in the lending process, specifically the use and misuse of yield

spread premiums.

Let me start by addressing how yield spreads are used in the marketplace. Typically, a mortgage broker will offer to shop for a mortgage on behalf of a consumer.

In many cases, that broker will promise to get the borrower a good deal, meaning

low rates and fees. Borrowers pay the broker a fee for this service, either out of

their savings or with the proceeds of the loan. Unbeknownst to them, however, that

broker may also be paid a yield spread premium if he can get the borrower to sign

up for a loan at a higher rate than the borrower qualifies for. The higher the mortgage rate, the higher the payment. We will hear about such cases this morning.

Yield spread premiums can be a legitimate tool in helping a home buyer or homeowner offset all or some of the closing costs associated with buying or refinancing

a home. When used properly, the broker discloses his total fee to the consumer. The

consumer may then choose to pay that fee, and, perhaps other closing costs as well,

by accepting a higher interest rate and having the lender pay the fee to the broker.

In such cases where the borrower makes an informed choice the payment helps families overcome a barrier to homeownership—the lack of funds for closing costs.

However, it appears that in practice, perhaps in widespread practice, yield spread

premiums are not used to offset closing costs or the broker fees. Instead, these premiums are used to pad the profits of mortgage brokers, without regard to any services they may provide to borrowers. Let me quote from a report issued by the Financial Institutions Center at the Wharton School of Business at the University of

Pennsylvania. Professor Emeritus Jack Guttentag, discussing the problem of ‘‘rebate

pricing’’ that is, payments by lenders to brokers of yield spread premiums, writes:

In most cases . . . rebates can be pocketed by the broker, unless the

broker commits to credit them to the borrower, which very few do. Rebate

pricing [that is YSP’s] has been growing in importance, and one of the reasons is that it helps mortgage brokers conceal their profit on a transaction.

Moreover, this does not just affect subprime borrowers, as do most of the other

egregious practices we heard about in our previous hearings. This misuse of yield

spread premiums affects prime borrowers, FHA borrowers, VA borrowers; however,

because of the lack of openness and competition in the subprime market, it hits

subprime borrowers hardest of all. Even for those with the best credit, the current

use of yield spread premiums can cost thousands of dollars in increased financing

costs.

Yield spread premiums, when they are misused in this way, fall directly into the

category of the kind of referral fees or kickbacks that were so prevalent in the settlement business prior to the passage of RESPA. After years of hearings and reports, the Congress passed the Real Estate Settlement Procedures Act (RESPA) in

1974 specifically to outlaw side payments of this kind because they increase the

costs of homeownership for so many Americans. Indeed, the plain language of the

law, regulations, 1998 Congressional instructions to HUD to formulate a policy on

the issue, and the 1999 HUD policy statement—particulary when taking the legislative history into account—all make it clear that RESPA was intended to prohibit

all payments that are not demonstrably and specifically for actual services provided.

That is to say, each fee collected by the broker should be for a corresponding service

actually provided.

Because the majority of home loans are now originated through brokers, lenders

have less and less direct access to borrowers. This means they must compete for the

broker’s attention to gain access to the ultimate consumer—the borrower. This competition means that, too often, lenders must pay yield spread premiums to the brokers simply for the referral of business. As all of us know, this is prohibited under

the law precisely because it raises the costs of homeownership to the consumers.

Regrettably, HUD’s recent ‘‘clarification’’ of its 1999 policy statement on the issue

of yield spread premiums will open the door to new and ongoing abuses of low- and

moderate-income homebuyers and owners. Despite the Secretary’s statement at his

confirmation hearing that he finds predatory lending ‘‘abhorrent,’’ I fear that the

new policy statement will facilitate the predatory and racially discriminatory pracVerDate 11-MAY-2000 11:24 Mar 05, 2003 Jkt 000000 PO 00000 Frm 00044 Fmt 6633 Sfmt 6621 84933.TXT SBANK4 PsN: SBANK4
41

tice of steering homeowners to higher interest rate loans without their knowledge,

and, importantly, without any effective means of redress.

Secretary Martinez has made increasing minority homeownership a primary goal

of his Administration. However, a study done by Howell Jackson of Harvard Law

School (who will testify on the second panel) shows that, while the current use of

yield spread premiums imposes extra costs on all homebuyers, the burden falls especially hard on minorities. In other words, yield spread premiums, when they are

used in this abusive fashion, put the dream of homeownership further out of reach

for minority Americans. Those who still manage to achieve this dream are forced

to pay thousands of dollars in increased interest costs over the life of their loans.

Many find themselves in more precarious financial positions than they should or

could be, thereby putting them more at greater risk of falling prey to the kind of

repeated refinancings that we have seen lead to equity stripping or even the loss

of the home.

I recognize that it is unusual to have a hearing while the Congress is in recess.

HUD has indicated, both in testimony before this Committee in December, and in

the Federal Register, that it intends to publish a proposed regulation on this matter

by the end of this month. These issues are so important that I wanted to make sure

that there would be a public airing of the issues for the consideration of the Department while their deliberations were still ongoing.

—————

PREPARED STATEMENT OF SUSAN M. JOHNSON

COTTAGE GROVE, MINNESOTA

JANUARY 8, 2002

My name is Susan Johnson and I am from Cottage Grove, Minnesota. I am

pleased to have the opportunity to be able to address the Senate Banking Committee today about the $1,620 ‘‘yield spread premium’’ that was secretly paid by my

lender, ABN AMRO Mortgage Group, to my mortgage broker, Allstate Mortgage, at

my expense.

In April 2000, my husband David and I had just moved back to the Twin Cities

from Colorado Springs and were looking to buy a house. Through a real estate

agent, we were introduced to David Schultz, owner of Allstate Mortgage, a mortgage

broker in Plymouth, Minnesota. After meeting Mr. Schultz at a local restaurant, we

hired him to find us a mortgage loan.

From the outset, we were told by Mr. Schultz that he would find us a loan with

the best possible interest rate. Mr. Schultz specifically told us that the fee for processing the loan would be 1 percent of the loan amount. We signed a written broker

agreement with Mr. Schultz which allowed for a 1 percent broker fee. (Exhibit 1,

Loan Origination Agreement) No other fees were ever demanded by Mr. Schultz,

disclosed, or agreed to.

When the closing occurred on May 23, 2000, to our surprise, the interest rate was

higher than we understood it would be and the fees were far greater than the 1

percent fee we had agreed to. (Exhibit 2, HUD–1 Settlement Statement at lines

801–812) In fact, the total fees were nearly four times that amount! ($5,242.00) This

included what we only later came to learn after the closing was a ‘‘yield spread premium’’—a $1,620 payment from the lender to our broker that was really paid by

us since it was tied to an inflated interest rate on our loan.

While we were upset about the fees, we had no choice but to go through with the

closing or risk losing the house; being found in default of the Purchase Agreement;

and forfeiting the $5,000 earnest money we had already given the sellers. While we

objected to the fees and higher interest rate, there was no way for us to find another

loan and still close on time. We were stuck and the broker knew it.

As our HUD–1 Settlement Statement shows, we were charged the following fees

at closing, none of which were disclosed, or agreed to beyond the initial 1 percent

origination fee:

$1,296 (1 percent) Loan Origination Fee

$1,296 (1 percent) Loan Discount Fee

$395 Processing Fee

$200 Underwriting Fee

$150 Doc Prep Fee

$40 Funding Fee

$350 Commitment Fee

$285 Admin Fee

42

1Line 814 ‘‘Deferred Premium $1,620 ($1,620 Pd by ABN AMRO Mortgage Group Inc., POC)

to Allstate Home Mortgage.’’ 2We never owed the broker any fees on top of the 1 percent fee Mr. Schultz told us he was

charging before the closing. Mr. Schultz later admitted this when he gave a deposition. (Exhibit

3: Excerpts from Schultz deposition, March 15, 2001).

Only after the closing did we discover the significance of the $1,620 ‘‘yield spread

premium’’ (1.25 percent) which was assessed to us through an inflated above-par

interest rate of 8.75 percent. At the time of the closing we had no idea what this

‘‘premium’’ was because it was only vaguely disclosed on our HUD–1 Settlement

Statement as a ‘‘Deferred Premium POC.’’ 1 In sum:

The $1,620 yield spread premium was not disclosed, discussed, or agreed to

before the closing;

My husband and I were never informed that our loan had an above-par interest rate because of the premium payment from ABN AMRO to the broker;

The broker never explained how the yield spread premium affected our interest rate or that our monthly mortgage payments would be any higher because

of the premium;

No rate sheet or other document showing the direct relationship between the

inflated interest rate and the yield spread premium payment from the lender

to the broker was ever shown to us;

The yield spread premium did not offset or reduce any fee we ever owed to

the broker;

The broker received all fees that we owed and agreed to (and far more) directly in cash from us at the closing.2

After the closing, I wrote to the State of Minnesota Department of Commerce complaining about the transaction. After reviewing my letter, the Department of Commerce advised us to seek private legal counsel. The matter remains pending in

Court in Minnesota. In that case, we have agreed to be representatives of other borrowers whose loans had yield spread premiums paid by the same lender in the same

manner as ours.

In conclusion, the $1,620 yield spread premium on our loan was nothing more

than a bonus paid by the lender to the broker for securing a bad deal for my husband and me, and referring a better deal to the lender. This conduct should be illegal because:

(1) the yield spread premium was not paid in exchange for any ‘‘service’’ fee

we owed the broker;

(2) we received no benefit from the premium the lender paid at our expense,

such as an offsetting credit against any closing fees or costs we actually owed,

and;

(3) the money was simply a kickback to the broker referring our loan to the

lender with a higher interest rate.

The standard for evaluating the legality of this practice should not merely be

whether the broker’s ‘‘total compensation,’’ including the yield spread premium and

other fees we never agreed to, is somehow ‘‘reasonable’’ based on the broker’s afterthe-fact attempt to justify the higher fees he has already taken. Rather, the true

nature of the disputed premium should be evaluated: that is, what was the premium

actually paid in exchange for.

To allow as lax a standard as ‘‘reasonableness’’ of total broker compensation to

govern these transactions will only allow lenders and brokers like ABN AMRO and

Mr. Schultz to continue ripping-off unknowing consumers like us, with a catch-usif-you-can attitude. It will encourage brokers and lenders to continue to try to slip

additional bonus fees into mortgage transactions regardless of what was agreed and

without providing any actual credit to the consumer bearing the cost. If lenders are

paying bonuses and incentives to brokers simply for referring high-rate loans to

them, that should be illegal without concern for whether the broker or the lender

thought the secret referral fee was ‘‘reasonable.’’

Thank you.

Attachments

Exhibit 1: Loan Origination Agreement with the broker for the 1 percent fee;

HUD–1 Settlement Statements (Exhibit 1);

Exhibit 2: HUD–1 Settlement Statement on ABN AMRO Mortgage Group Inc.

loan, May 23, 2000;

43

Exhibit 3: Excerpts from Mr. Schultz’s deposition testimony admitting that

the yield spread premium was never discussed with us before the closing and

offset no fee we owed.

44

45

46

47

48

49

50

51

52

53

54

1 I initially undertook this project as an expert for the plaintiff class in Glover v. Standard

Federal Bank, Civil No. 97–2068 (DWF/SRN) (U.S. District Court, District Court of Minnesota)

(pending) and am currently expanding the study into an academic article, the current draft of

which is attached to this testimony: Howell E. Jackson & Jeremy Berry, Kickbacks or Compensation: The Case of Yield Spread Premiums (January 8, 2002) (hereinafter ‘‘Jackson &

Berry’’) [a abridged draft of this paper is available at http://www.law.harvard.edu/faculty/

hjackson/pdfs/januaryldraft.pdf. 2 66 Fed. Reg. at 53,054.

3 Id.

4 Id.

PREPARED STATEMENT OF HOWELL E. JACKSON

FINN M.W. CASPERSEN AND HOUSEHOLD INTERNATIONAL PROFESSOR OF LAW AND

ASSOCIATE DEAN FOR RESEARCH AND SPECIAL PROGRAMS

HARVARD UNIVERSITY SCHOOL OF LAW

JANUARY 8, 2002

Chairman Sarbanes and Members of the Committee, I am very pleased to be here

today to discuss the problem of yield spread premiums and the Department of Housing and Urban Development’s recent Statement of Policy 2001–1, 66 Fed. Reg.

53,052 (Oct. 18, 2001) (Statement of Policy). Yield spread premiums and related industry practices have become a major problem for American homeowners. Payments

of this sort are inherently confusing and serve primarily to raise the cost of homeownership for many Americans, particularly the less educated and the financially

unsophisticated, by billions of dollars a year. In my opinion, yield spread premiums

represent the sharp practices that Congress should have prohibited when it enacted

the Real Estate Settlement Procedures Act of 1974 (RESPA) more than 25 years

ago. I urge both Congress and the Department of Housing and Urban Development

to redouble their efforts to eliminate the substantial and widespread consumer

abuses that yield spread premiums have visited upon American homeowners in recent years.

Introduction

Over the past year, I have been investigating the economic impact of yield spread

premiums.1 A major component of my investigation has been an empirical analysis

of a nationwide sample of approximately 3,000 mortgages originated by one group

of affiliated lending institutions in the late 1990’s. This study constitutes the most

extensive empirical investigation of yield spread premiums to date. In my testimony

before the Committee this morning, I would like first to discuss the implications of

my study for the Department’s policy statement and then to propose a number of

specific actions I believe the Department should take to prevent abusive uses of

yield spread premiums in the future.

The Policy Statement

Let me begin by commending the Department for its willingness to take on an

issue as complex as the payment of yield spread premiums. While my analysis of

these practices differs from the Department’s views in many important respects, I

wholeheartedly agree with the Department’s initial premise and the premise of the

RESPA itself: That real estate settlement practices are an area in which governmental intervention is necessary both to protect consumers and to ensure the efficient operation of market forces.

My comments about the policy statement are divided into two parts. First, I will

discuss the statement’s factual assumptions about the role of yield spread premiums

in today’s mortgage market. Second, I will comment on several aspects of the Department’s legal analysis of how Section 8 of RESPA, which prohibits certain kickbacks and unearned referral fees, should be applied to the payment of yield spread

premiums.

FACTUAL ASSUMPTIONS ABOUT THE ROLE OF YIELD SPREAD PREMIUMS

As explained in the policy statement, the Department conceives of yield spread

premiums as a valuable ‘‘option’’ that ‘‘permits homebuyers to pay some or all of the

upfront settlement costs over the life of the mortgage through a higher interest

rate.’’ 2 This method of financing upfront settlement costs, according to the Department, is particularly suited to borrowers who are low on cash and ‘‘whose loan-tovalue ratio has already reached the maximum permitted by the lender.’’ 3 Based on

these factual assumptions, the Department concludes that the yield spread premium

is a ‘‘legitimate tool to assist the borrower’’ and a financing option that ‘‘fosters

homeownership.’’ 4

55

5 As indicated above, the sample upon which my empirical study is based was limited to loans

originated by an affiliated group of lending institutions and thus does not include loans from

all lending institutions in the industry. It is possible that the abusive practices uncovered in

my study are peculiar to the lending institutions included in my sample. However, I doubt that

this is the case. Industry experts have opined that the practices of the lenders in my study ‘‘are

typical of other wholesale lenders.’’ See Report of David Olson, Glover v. Standard Federal

Bank, Civil No. 97–2068 (DWR/SRN) (U.S. District Court, District Court of Minnesota) (filed

June 24, 2001) (expert for defendants). At a minimum, the evidence uncovered in my study

should put the burden on the Department to demonstrate with comparable evidence that the

factual assumptions underlying the policy statement are accurate for the industry generally. 6What HUD regulations do require is ‘‘disclosure’’ of yield spread premiums. However, this

disclosure is inadequate in many respects. Yield spread premiums are not reported in a consistent manner in HUD–1 forms; oftentimes they appear on back pages of the form and sometimes in a smaller font. Most important, these payments are almost always denominated ‘‘p.o.c.

by lender,’’ meaning that they are ‘‘paid outside of closing by the lender.’’ It is inconceivable that

more than a tiny fraction of consumers can correctly evaluate this information. For a more complete discussion of the problems consumers face in deciphering this information, see Jackson &

Berry, supra note 1, at 2–5, 51–65.

One measure of inadequacy of current disclosure practices is the difficulty my assistants had

even finding the amount of yield spread premiums on HUD–1 forms. Even after receiving explicit training on the subject, a team of paralegals and certified public accountants was only able

to find yield spread premiums on about two-thirds of the forms on which the payments were

supposedly disclosed. See Jackson & Berry, supra note 1, at 71–74 & n.112. 7See Jackson & Berry, supra note 1, at 73 (Table 2). 8 Id. at 78–81.

As a purely theoretical matter, the Department’s assumptions about the role of

yield spread premiums are plausible. Homeowners who are short on cash could,

theoretically, use yield spread premiums to finance settlement costs. My study, however, offers compelling evidence that yield spread premiums are not being used in

this way.5 Rather, the manner in which yield spread premiums are levied combined

with the complex structure of real estate settlement procedures serves principally

to allow mortgage brokers to impose higher prices on borrowers who bear the cost

of these charges—particularly on individuals who are less educated and less sophisticated about financial matters. This abusive form of price discrimination substantially increases the overall costs to borrowers, thereby imposing a hidden tax on

homeownership for many Americans.

Yield Spread Premiums Are Not Currently Presented to Consumers as an

Optional Way to Finance Settlement Costs

An initial problem with the Department’s understanding of yield spread premiums is its notion that these payments represent an option consumers voluntarily

choose. Consumers are given no such choice. Mortgage brokers, in my experience,

never describe yield spread premiums as an optional method for financing settlement costs, nor do the Department’s own consumer publications or the most popular

consumer guides for buying a home. What is more, consumers are never given the

advice they would need to make a meaningful comparison between the cost of higher

interest rates over the life of a loan and direct cash payments for closing costs.6

Rather, borrowers are simply told that their loans will have a certain interest rate,

and they never understand that the interest rate is higher than it needs to be or

that the higher interest rate is used to finance a payment to the mortgage broker.

Incidence and Magnitude of Yield Spread Premiums Are Extremely High

Another erroneous factual assumption implicit in the policy statement is the notion that yield spread premiums are paid by a relatively small number of borrowers

who lack adequate resources to pay closing costs directly. To the contrary, my study

indicates that the vast majority of borrowers pay yield spread premiums—on the

order of 85 to 90 percent of all transactions.7 Moreover, the average amount of yield

spread premiums is quite substantial, on the order of $1,850 per transaction, making these payments the most important single source of revenue for mortgage brokers.8 In other words, contrary to the Department’s assumptions, yield spread premiums are not an ‘‘optional’’ form of financing made available to a limited number

of borrowers with special needs. Rather these payments constitute by far the largest

source of compensation for mortgage brokers and are imposed on almost all borrowers who obtain mortgages or refinancings through this segment of the industry.

Most Borrowers with Yield Spread Do Not Need Extra Financing

Another fallacy in the Department’s factual assumption is its suggestion that borrowers who pay yield spread premiums have no other means of paying closing costs.

This assumption is clearly wrong. According to my analysis, more than three-quarters of the borrowers who were charged yield spread premiums had loans that were

56

9 Id. at 147 & n. 180. My study did not consider other sources of funding, such as cash reserves or credit cards or loans from family members. Were these and other alternative sources

considered, even more borrowers would have had viable financing options other than paying

yield spread premiums. As explained below, the true costs of yield spread premiums are so high

that a borrower would be well advised to employ almost any other form of financing. 10 Id. at 91–97 (Figure 14). 11Why mortgage brokers can earn more money on loans with yield spread premiums is an

interesting and important academic question. I explore this issue in considerable detail in my

academic writings on the subject. In brief, I believe a number of factors are at work. In this

context, consumers are primarily concerned with buying homes and being approved for

financings; thus, they spend less time monitoring the comparatively smaller costs associated

with real estate settlement. In addition, they trust their mortgage brokers to recommend appropriate financing terms and cannot easily police these recommendations. In addition, consumers

have difficulty calculating costs of higher monthly payments as compared with direct cash

payments and are not protected by market forces because these side payments allow brokers

to discriminate among sophisticated an unsophisticated consumers and avoid creation of a single

market price for settlement services. See Id. at 51–65. 12 66 Fed. Reg. at 53,054. 13 Jackson & Berry, supra note 1, at 102–16. 14 Id. 15See supra text accompanying note 6. 16 Jackson & Berry, supra note 1, at 144–47.

less than the defendant lending institutions’ maximum loan-to-value ratios and

therefore could easily have financed closing costs by increasing the amount of their

loans.9 In other words, most borrowers who are charged yield spread premiums do

not need an extra (and exorbitantly costly) form of financing for their closing costs.

Mortgage Brokers Earn on Average $1,046 More on Loans With

Yield Spread Premiums

Another erroneous premise of the policy statement is that industry offers yield

spread premiums as a service to their customers and is indifferent to whether consumers pay closing costs directly or through the imposition of yield spread

premiums. Mortgage brokers clearly much prefer making loans with yield spread

premiums. According to my study, mortgage brokers made an average of $1,046

more on loans with yield spread premiums than they did on comparable loans unaffected by these practices.10 Thus, on average, borrowers who get loans with yield

spread premiums pay their mortgage brokers over a thousand dollars more than

other borrowers. This substantial difference, in my view, goes a long way to explain

why the industry has so zealously resisted efforts to police the payment of yield

spread premiums, and it clearly refutes the Department’s premise that yield spread

premiums are just another form of payment.11

On Average, Seventy-Five Percent of Yield Spread Premiums Goes to

Mortgage Brokers

The most critical error in the policy statement is its assumption that mortgage

brokers use yield spread premiums to ‘‘recoup the upfront costs incurred on the borrower’s behalf.’’ 12 In my study, I employed a variety of statistical techniques to explore the relationship between yield spread premiums and direct cash payments to

mortgage brokers. With the highest degree of statistical confidence, my studies refute the proposition that borrowers receive a dollar for dollar offset for yield spread

premiums.13 My best estimate is that borrowers, on average, enjoy 25 cents of benefit for each dollar paid in yield spread premiums.14 In other words, the vast majority of yield spread premiums—on the order of seventy-five percent—serve only to

increase the compensation of mortgage brokers. Contrary to the Department’s

assumptions, consumers do not, by a long stretch, recoup the costs of yield spread

premiums.

Characterized as a Form of Financing, Yield Spread Premiums Are Usurious

As explained above, I do not believe that yield spread premiums are actually

being offered to borrowers as a form of financing upfront costs.15 However, if one

were to accept this characterization and then attempt to estimate the cost of this

financing, the implicit interest rates are absolutely outrageous. For an average borrower in my study, the implicit interest rate on a ‘‘yield spread premium loan’’ to

finance closing costs would be in excess of 114 percent per year—on the order of

ten times higher than a typical credit card interest rate.16 Had the Department

been aware of the true costs of this financing when it prepared its policy statement,

I expect it would have approached the problem in a very different manner.

57

17 Id. at 120–26. This analysis controls for a variety of factors, including principal loan characteristics, credit quality of borrower, loan-to-value ratios, and certain geographic variables. 18 In an earlier statement of policy, the Department proposed this two-step test. Under the

first step, courts are to consider whether a particular payment is made for ‘‘goods and services

actually furnished or services actually performed.’’ If the answer to this question is no, then liability is attached; if the answer is no, then the court must proceed to the second step of the

test, under which it must determine whether the amount of the payment was reasonably related

to the goods and services provided. See HUD Statement of Policy 1999–1, 64 Fed. Reg. 10,080

(March 1, 1999). 19 Id. at 9–23.

African-Americans and Hispanics Pay Much More for Mortgage Broker Services

While my study suggests that yield spread premiums are a very bad deal for the

average consumers, I believe these practices are particularly injurious to the least

sophisticated members of society—groups of which the Department has historically

been most protective. To test this hypothesis, I also examined the relationship between mortgage broker compensation and the racial identity of borrowers. The results indicated that mortgage brokers charged two racial groups—African-Americans

and Hispanics—substantially more for settlement services than they did other bor- rowers. For African-Americans, the average additional charge was $474 per loan,

and for Hispanics, the average additional charge was $580 per loan.17 While I expect to do more work on this aspect of my analysis, these preliminary results are

consistent with my hypothesis that current industry practices allow mortgage

brokers to exploit less sophisticated borrowers by imposing higher charges.

LEGAL ANALYSIS PROPOSED IN THE POLICY STATEMENT

The Department’s misapprehension of the true economic impact of yield spread

premiums has substantial implications for the policy statement’s legal analysis. Had

the Department understood how disadvantageous yield spread premiums are for

most consumers, the Agency would, I believe, have proposed that the payments be

treated very differently under the two-step test used to determine whether particular payments are prohibited under Section 8 of RESPA.18

Payment of Yield Spread Premiums Could Run Afoul of the First Step of HUD’s Test

In its policy statement, the Department summarily concludes that yield spread

premiums are paid for ‘‘goods or services’’ and thus reasons that the payments

passed the first step of the Department’s test. If one accepts the Department’s factual assumptions—that yield spread premiums are a bona fide option for financing

closing costs and that the payments are in fact recouped through offsetting reductions in closing costs—this conclusion would be understandable. However, if instead

one credits the findings of my study—that the yield spread premiums serve primarily to increase payments to mortgage brokers and not to lower the upfront costs

of borrowers—the legality of the payments under step one of the HUD test is far

from clear. As explained above, my study suggests that only a fraction of each dollar

of yield spread premiums goes to financing goods and services. Under these circumstances, I believe that it is more accurate to characterize the payment of yield

spread premiums as not being a bona fide payment for goods and services. Under

this view, the practice runs afoul the first step of the Department’s test for legality.

Allowing Payments of This Sort To Escape Liability Under Step One Does Not

Square With the Congressional Policies Underlying Section 8 of RESPA

The alternative approach—that is, allowing settlement service providers to escape

liability under step one as long as the providers could show they contributed some

value to the transaction—flies in the face of the legislative history that preceded the

passage of RESPA. In the early 1970’s, real estate settlements were plagued by

kickbacks and referral fees. Typically, a firm with substantial influence over the

settlement—for example an attorney or a real estate agent—would demand

sidepayments from other service providers, such as title insurance companies, as a

quid pro quo for recommending the service provider to preform the transaction. It

was these referral fees that Congress should outlaw with Section 8 of the RESPA,

principally because Congress believed these transactions increased the overall cost

of homeownership.19 Were the Department to adopt the position that recipients of

kickbacks have a defense from Section 8 liability if they can demonstrate that they

provided some other goods or service for the transaction, it would seem to have created a major loophole for just the kinds of sharp practices that the provision was

designed to eliminate. After all, almost all of the recipients of kickbacks that motivated the passage of the Act also performed some level of service for the settlement

transactions in questions. Certainly, where statistical evidence demonstrates that

the payments in question (here yield spread premiums) serve substantially—indeed

58

20 Brokers might also be required to disclose the rate sheet associated with the pricing of their

loans. This would provide more information than most consumers would need but could be useful to consumer groups and the financial press.

primarily—to increase the cost of homeownership, the activity should be proscribed

under Section 8.

Inappropriateness of Individualized Adjudication of Reasonableness

A further difficulty with the Department’s legal analysis is its apparent willingness to have the courts determine the reasonableness of yield spread premiums on

a case-by-case basis. As this aspect of the policy statement concerns a matter of judicial management, it is a matter that the courts themselves will have to resolve.

But, on multiple dimensions, individualized determinations of reasonableness of the

sort the Department appears to favor would be problematic. To begin with, in order

to measure the impact of yield spread premiums for a particular borrower, a court

must consider the impact of the payments in a large number of cases, as I did in

my study. As is well-developed in other areas of the law—ranging from disparate

impact cases to securities litigation—it is impossible to assess the reasonableness

of one borrower’s payments in a vacuum. For both litigants and courts, it would be

an inefficient use of resources to repeat this analysis on a transaction by transaction

basis. In addition, the Department’s approach invites the judicial rate regulation

that Congress expressly rejected when it enacted RESPA more than 25 years ago.

In the early 1970’s, many recommended ratemaking procedures for real estate settlement services, but Congress chose instead to police the industry through a combination of disclosure rules and the liability provisions of Section 8. The policy statement threatens to resurrect judicial rate regulation as the principal mechanism for

controlling kickbacks in the real estate settlement field. Arguably, under the Department’s approach, a Section 8 plaintiff would be forced to sustain the costs of a

hearing on reasonableness whenever a defendant demonstrates that it provided any

goods or services in connection with a settlement. In my view, this approach subverts the intentions of Congress and leaves consumers inadequately protected from

predatory practices, such as the payment of yield spread premiums. Moreover, the

approach seems to relieve from liability many of the abusive practices that Congress

intended to outlaw with the enactment of Section 8.

Proposals for Prospective Relief

One of the most heartening aspects of the policy statement is the Department’s

willingness to propose changes in the disclosure rules regarding yield spread premiums and related practices. In my view, reforms in this vein could go a long way

toward protecting consumers and improving the efficiency of the market in this

area. In particular, I would recommend the following specific changes.

Requiring Disclosure of Par Rate Loan Option

One of the principal sources of confusion underlying yield spread premiums is

that most consumers are not aware that when they are offered an above-par loan

(on which a yield spread premium is paid), they almost always have the option of

receiving a par rate loan with a lower interest rate and lower monthly payments.

Whenever a mortgage broker proposes an above-par loan, the Department should

therefore require the broker to offer the borrower a comparable loan with a par interest rate. By offering consumers both types of loans, mortgage brokers would

make clear that above-par loans (and yield spread premiums) are simply one option

for home financing.20 Requiring such offerings would also encourage both the Department and independent consumer groups to educate consumers about the pros

and cons of the two options.

Direct Payment of Yield Spread Premiums to Consumers (on Line 200)

Whenever a mortgage broker presents a Good Faith Estimate or a HUD–1 form

for an above-par loan, the full amount of the yield spread premium should be paid

directly to the borrower in the form of a credit on line 200. If yield spread premiums

are to become a legitimate form of financing, the proceeds of the financing must always be given to the borrower. Then, the borrower can decide how to use those

funds—whether to pay for closing costs or some other purpose. A further advantage

of this reform is that it will force mortgage brokers to provide borrowers with a full

accounting of their costs elsewhere on the form. Under the current rules, brokers

use yield spread premiums to disguise their true levels of compensation. Not only

is the current practice inherently deceptive; it also makes it all but impossible for

consumers to compare the true costs of loans from different brokers and lenders.

59

21The incidence of discount fees to mortgage brokers ranged from 10 percent to 47 percent, depending on the sample, and averaged between $744 and $1,335. See Id. at 77 (Table 4). 22 Not only does this practice needlessly complicate the true compensation of mortgage brokers; but it also belies claims that above-par loans are being used to lower upfront costs for consumers. How could a consumer rationally request an above par loan for this reason and then

pay an upfront discount fee to turn the loan back into a par loan? 1MBA is the premier trade association representing the real estate finance industry.

Headquartered in Washington, DC, the association works to ensure the continued strength of

the Nation’s residential and commercial real estate markets, to expand homeownership prospects through increased affordability, and to extend access to affordable housing to all Americans. MBA promotes fair and ethical lending practices and fosters excellence and technical

know-how among real estate professionals through a wide range of educational programs and

Continued

Prohibition on Discount Points Paid to Brokers

A further practice that should be eliminated is the payment of discount points to

mortgage brokers. Traditionally, consumers pay discounts points to lenders in order

to obtain a below-par loan—that is, a loan with an interest rate below the rate on

a comparable par loan. Under current HUD regulations, however, mortgage brokers

are also permitted to charge discount points ‘‘to lower’’ the interest rate of a loan.

In my study, I discovered that mortgage brokers were routinely charging discount

points, even on par and above-par loans.21 This practice is inherently deceptive. The

only way a mortgage broker can ‘‘lower’’ the interest rate on such loans is to start

by offering the borrower an above-par rate. In this context, the payment of discount

fees to mortgage brokers simply serves to convert a yield spread premium into a

direct upfront cost for the borrower.22 In my view, the term ‘‘discount fees’’ should

be limited to payments made to the lending institution that are actually used to

lower a par rate loan into a below-par loan.

Comparable Reforms for Direct Lenders

A final area of regulatory reform concerns the development of comparable disclosure requirements for direct lenders. Representatives of mortgage brokers occasionally defend current disclosure practices on the grounds that reforms of the sort outlined above would put mortgage brokers at a disadvantage to direct lenders. The

Department, I believe, should reject claims of this sort. To begin with, mortgage brokers have become the leading source of home mortgages in the United States. It is

imperative that the Department correct disclosure practices for this dominant segment of the industry. To allow issues associated with other sectors of the industry

to stand in the way of such reforms would be letting the tail wag the dog. Still, I

agree with those who say that disclosure reforms for direct lenders are also appropriate. After all, when direct lenders charge above-par rates and then resell their

loans in the secondary market, they receive implicit yield spread premiums. The solution to this problem, I believe, is to require direct lenders to credit borrowers with

an implicit yield spread premiums similar to the ones to be required for mortgage

brokers. For direct lenders who actively participate in the wholesale purchase of

loans, the appropriate par rates could be derived from the institution’s contemporaneous rate sheets. For other direct lenders, the Department might maintain and

keep current a national listing of averages of par rates for various categories of

loans, derived from the contemporaneous rates sheets of leading wholesalers. The

Department would have to work out the details of such a proposal, but the concept

is well within the Agency’s expertise.

Let me conclude by again commending the Department for taking on this issue.

I would be delighted to work with the Department as it moves forward in this area,

and would welcome any questions that Members of the Committee have.

—————

PREPARED STATEMENT OF JOHN COURSON

CHAIRMAN-ELECT, MORTGAGE BANKERS ASSOCIATION AND

PRESIDENT AND CHIEF EXECUTIVE OFFICER, CENTRAL PACIFIC MORTGAGE COMPANY

FOLSOM, CALIFORNIA

JANUARY 8, 2002

Good morning Mr. Chairman and Members of the Committee. My name is John

Courson, and I am President and CEO of Central Pacific Mortgage Company,

headquartered in Folsom, California. I am also Chairman-elect of the Mortgage

Bankers Association of America (MBA),1 and it is in that capacity that I appear before you today.

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technical publications. Its membership of approximately 2,800 companies includes all elements

of real estate finance: Mortgage companies, mortgage brokers, commercial banks, thrifts, life insurance companies, and others in the mortgage lending field.

This morning I have been asked to testify before your Committee to present

MBA’s views regarding the issue of lender payments to mortgage brokers, generally

referred to as ‘‘yield spread premiums,’’ and how they are to be judged under the

antikickback provisions of the Real Estate Settlement Procedures Act (RESPA). To

ensure a clear understanding of our position on this issue, it is important to lay the

groundwork by defining the term ‘‘yield spread premium,’’ and highlighting the

important role that this financing tool plays in mortgage transactions.

Definitions

As a general rule, the term ‘‘yield spread premium’’ is used in the mortgage lending industry to refer to a type of payment from a lender to a mortgage broker, which

is paid in the context of ‘‘brokered’’ loan transactions. In such transactions, mortgage brokers generally operate as intermediaries between consumers and lenders.

In effect, they function as the interface with prospective borrowers, serving as the

‘‘storefront’’ for mortgage loan products offered by lenders. In this role, mortgage

brokers are much more than ‘‘retailers’’ of loans; they perform real and valuable

services in the origination phase of the mortgage transaction process. Among other

things, mortgage brokers bring borrowers and lenders together and match consumer

needs with lender products, they collect pertinent financial information, render advice to consumers, and generate all documentation and verification required for the

loan transaction to occur.

It is important to clarify that, for the various goods, services, and facilities they

provide in the origination of loans, mortgage brokers are entitled to be compensated.

Generally, such compensation will occur in either of two ways. Brokers may collect

their full compensation from the consumer directly, in the form of a cash payment.

Alternatively, they can be paid, in part or in whole, indirectly by the lender, through

the mechanism of a yield spread premium.

The yield spread premium mechanism works by allowing a consumer to choose

a higher interest rate in exchange for lower upfront costs. Under this financing tool,

the higher interest rate allows lenders to tender an amount reflecting the value of

that increased yield to mortgage brokers as compensation for the goods, services, or

facilities that they render. In technical parlance, a ‘‘yield spread premium’’ is thus

defined as a payment that a lender makes to a mortgage broker that reflects the

increased yield over ‘‘par’’ on a particular loan. In practical terms, a yield spread

premium is a mechanism that provides borrowers with a vital tool to allow for the

financing of some or all of their home loan closing costs.

The yield spread premium mechanism allows mortgage brokers the flexibility to

offer consumers numerous options and choices as to the combination of upfront payments and interest rates that best suits the borrower’s individual needs. In short,

as the interest rate goes up, the borrower’s upfront cash contribution goes down.

The added financial flexibility afforded by the yield spread premium is extremely

important because a vast number of borrowers—especially those who have limited

funds for downpayments, or who have reached borrowing limits—need the flexibility

to finance the required closing costs to achieve homeownership. Those consumers

who lack sufficient independent funds literally depend on the YSP option to purchase and/or refinance a home.

I want to clarify, unequivocally, that the yield spread premium mechanism should

be restricted to the function I just described, which is to compensate the broker for

goods, services, or facilities provided or to allow for the financing of other closingrelated costs. If, on the other hand, the yield spread payment does not fit this definition, and the payment is used for purposes other than to compensate brokers for

the bona fide goods, services, or facilities they provide, or to finance other required

closing costs, then the payment may be considered suspect, and should be dealt with

appropriately. I want to make clear that we do not consider it appropriate to use

the yield spread premium mechanism as a means to inflate interest rates in a way

that defrauds the consumer into higher loan prices. Nor do we consider it appropriate to use the yield spread premium as a means of concealing referral payments

to brokers. To the extent that such abuses do occur, they should be labeled for what

they are—violations of the law.

HUD’s Policy Statements

We are in agreement with HUD’s formulation of the test for determining the

legality of lender payments to mortgage brokers under RESPA. As you know, the

rules for determining the legality of payments to mortgage brokers under RESPA’s

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2 Real Estate Settlement Procedures Act Statement of Policy 1999–1 Regarding Lender Payments to Mortgage Brokers; Final Rule, 64 Fed. Reg. 10080–10087 (March 1, 1999). 3 Real Estate Settlement Procedures Act Statement of Policy 2001–1: Clarification of Statement of Policy 1999–1 Regarding Lender Payments to Mortgage Brokers, and Guidance Concerning Unearned Fees Under Section 8(b), 66 Fed. Reg. 53052–53059 (October 18, 2001). 4 According to HUD, the Culpepper III decision results in per se liability through its conclusion

that a jury could find that yield spread premiums are illegal kickbacks or referral fees where

the lender’s payments are based exclusively on the interest rate differentials reflected on the

rate sheets and the lender has no knowledge of what services, if any, the broker performs. 5See Reform of the Real Estate Settlement Procedures Act (RESPA) and the Truth in Lending

Act (TILA): Hearing Before the House Committee on Banking and Financial Services, 105th

Congress at 22–28, 50, 275 (July 22 and September 16, 1998).

antireferral fee prohibitions are set forth in a 1999 HUD policy statement,2 and recently clarified through an additional statement published on October 18, 2001.3 In

those policy statements, HUD has explicitly acknowledged that yield spread premiums are very useful tools to assist consumers in financing homeownership. The

policy statement clarifies that yield spread premiums, so long as they compensate

the broker for goods, services, or facilities provided in the origination of a mortgage

loan, are not in themselves illegal under RESPA. Under HUD’s jurisdiction over

RESPA’s referral fee prohibitions, the policy statement and the subsequent clarification state unequivocally that yield spread premium payments are to be considered

illegal if they constitute referral payments or if they incorporate referral fees in the

payment. We agree.

HUD’s formulation under Section 8 of RESPA correctly recognizes that the legal

test for analyzing yield spread premiums (or other lender payments to mortgage

brokers) must distinguish between those payments that are legitimate compensation

to brokers, and those that are merely referral fees. In setting forth its formulation,

HUD tracks the RESPA statute quite closely. As mentioned above, RESPA sets a

strict prohibition against kickbacks and referral fees. The statute also states that

payments for real goods or services are not prohibited. It is a simple and straightforward test. If you pay a referral fee, you are breaking the law. If, however, the

fee is tendered as compensation for real goods, services, or facilities, then the payment cannot, by definition, constitute a referral fee or a kickback, and is therefore

not prohibited under RESPA strictures.

This is precisely what HUD sets forth in the policy statement formulation. When

a lender pays a fee to a mortgage broker, first, one has to lay the foundation and

ensure that services, goods, or facilities were actually furnished by the mortgage

broker. If services, goods, or facilities were actually furnished, then one has to make

sure that the payment to the broker does not incorporate a referral fee portion that

could be deemed illegal under RESPA. According to HUD, this is done by scrutinizing the total of broker payments to ensure that they are ‘‘reasonably related’’ to

the value of the services, goods, or facilities furnished. Any amount over the ‘‘reasonable’’ level could be deemed to constitute a ‘‘referral fee.’’ The ‘‘reasonableness’’

test is the test that HUD has consistently used to judge Section 8 liability in all

circumstances since RESPA was enacted.

Note that this ‘‘two-prong test’’ strikes the best possible balance between RESPA’s

affirmation for fees paid as compensation for goods or services actually provided,

and the statute’s proscription of referral fees. Note also the internal logic of the

HUD two-prong test—the first prong focuses on what the broker provides in the

transaction, and the second prong analyzes the fees that were paid for those services. Each step is grounded on statutory language and each step is necessary to the

legal analysis under Section 8 of RESPA.

HUD Clarifications

In large part, the controversy prompting today’s hearing appears to be the recent

clarification to the 1999 policy statement issued by the Department on October 18,

2001. In that clarificatory statement, the Department declared that it should eliminate certain ambiguities with respect to yield spread premiums.

The specific ‘‘ambiguity’’ that HUD should remedy stemmed from an appellate decision entitled Culpepper v. Irwin Mortgage Corp., 253 F.3d 1324 (11th Cir. 2001)

(Culpepper III). In that decision, the Eleventh Circuit Court of Appeals reached a

decision that was in direct conflict with the ‘‘two-prong’’ formulation established by

HUD under the 1999 policy statement. In that decision, the 11th Circuit described

HUD’s 1999 policy statement as ‘‘ambiguous’’ and created a new test that resulted

in per se liability for the payment of yield spread premiums.4

In issuing the clarification, HUD was abiding by previous Congressional directives

to articulate clear legal standards. In 1998,5 Congress expressed concern about the

‘‘legal uncertainty’’ surrounding the test for liability in these cases, particularly in

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6 Conf. Rep. No. 105–769, reprinted in 1998 U.S.C.C.A.N. at 539, 568. 7 Id.

8See Bjustrom v. Trust One Mortgage Corp., No. C–001166P, 2001 U.S. Dist. LEXIS 17890

(W.D. Wash. October 26, 2001); Vargas v. Universal Mortgage Corp., No. 01 C 0087, 2001 U.S.

Dist. LEXIS 19635 (N.D. Ill. November 29, 2001).

light of the fact that ‘‘Congress never intended payments by lenders to mortgage

brokers for goods or facilities actually furnished or for services actually performed

to be violations of [Section 8 of RESPA].’’ 6 Congress then specifically ‘‘direct[ed]’’ HUD to issue a ‘‘policy statement’’ in order ‘‘to clarify its position’’ and provide ‘‘guidance to . . . the courts.’’ 7

The 1999 policy statement thus represented HUD’s Congressionally mandated effort to promote uniformity on the legality of yield spread premiums under Federal

law. After the issuance of the 1999 policy statement, lenders and mortgage brokers,

especially those who had faced years of costly litigation in these cases, justifiably

relied on HUD’s legal formulations as having finally eliminated litigable issues relating to the governing standard for liability. Indeed, district courts overwhelmingly

agreed, and interpreted the 1999 policy statement to articulate the ‘‘two-prong test’’ that I described above.

The Eleventh Circuit’s Culpepper III decision, however, shattered this legal clarity

and returned the lending industry to the confusing legal environment that existed

before 1999. By finding the 1999 policy statement ‘‘ambiguous,’’ and articulating a

legal test resulting in per se liability that was entirely separate from the one advanced by HUD, Culpepper III plunged lenders, brokers, consumers, and courts into

the same chaotic state that led Congress to direct HUD to act in the first place. A

new wave of over 40 yield spread premium RESPA nationwide class actions were

filed in the immediate aftermath of Culpepper III. Over 80 class actions were still

pending in district courts around the country, with a particularly heavy concentration in the Eleventh Circuit. The risk of inconsistent determinations based on the

solitary Federal statute at issue in these cases was very real. In the meantime, several district courts outside the Eleventh Circuit were refusing to

follow Culpepper III’s RESPA liability analysis, and instead continued to accord deference to HUD’s policy statements.8

I note that inconsistencies in the governing legal standard are extremely problematic for lenders. Most wholesale lenders make loans in a variety of geographic regions, and a large number of lenders have truly nationwide operations. There were

many lenders who had already successfully defended prior RESPA challenges to

their payment of yield spread premium, typically at costs ranging in the hundreds

of thousands of dollars. Many of these same mortgage bankers began facing renewed

litigation in the Eleventh Circuit where they were exposed to very different standards under the unique rules established by Culpepper III. This renewed legal confusion forced many national lenders to give serious consideration to halting or geographically limiting the practice of offering yield spread premiums, despite its admitted consumer benefits.

It is in the midst of this environment of legal turmoil that the Department decided to clarify RESPA through the 2001–1 policy statement. To reestablish clarity,

HUD declared that it expressly ‘‘disagree[d] with the judicial interpretation regarding Section 8 of RESPA and the 1999 Statement of Policy’’ found in Culpepper III.

66 Fed. Reg. 53054–55. In the clarification, HUD sets forth its definitive reading

of the law that neither Section 8(a) of RESPA nor the 1999 Statement of Policy supports the conclusion that a yield spread premium can be presumed to be a referral

fee based upon the use of a rate sheet, or because the lender does not have specific

knowledge of what services the broker has performed.

We believe that HUD acted properly and very responsibly as the regulatory

agency that holds jurisdiction and bears the ultimate duty for the proper administration of RESPA. Absent HUD’s clarification, the confused legal landscape would

have been intolerable in terms of risk and legal exposure. Not only was the Eleventh Circuit’s decision irreconcilable with HUD’s reading of the law, but it threatened catastrophic industry liability, and also threatened to eliminate from the marketplace yield spread premiums and the critically important role they play in promoting homeownership.

Class Action

An additional criticism has been that the legal articulation in the 2001 policy

statement cuts off the possibility of consumer redress under RESPA. The clarifications set forth in the 2001–1 Statement of Policy do not eliminate a single consumer’s legal rights. In the 2001 policy statement, HUD asserts that, in order to

determine whether yield spread premiums violate Section 8 restrictions, it is necVerDate 11-MAY-2000 11:24 Mar 05, 2003 Jkt 000000 PO 00000 Frm 00066 Fmt 6633 Sfmt 6621 84933.TXT SBANK4 PsN: SBANK4
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9For instance, HUD’s official position on the test for liability of yield spread premiums before

the issuance of the 1999–1 Statement of Policy confirms that this principle is longstanding policy at HUD. Specifically, HUD’s General Counsel from the Clinton Administration, Gail Laster,

gave testimony at a Joint Hearing on RESPA Reform, convened on July 22, and September 16,

1998, before the House Subcommittee on Financial Institutions and Consumer Credit and the

Subcommittee on Housing and Community Opportunity. In relevant part, Ms. Laster testified

as follows:

Ms. VELAZQUEZ. Thank you very much, Madam Chairwoman. . . . Could you answer one

simple question for me? Are yield spread premiums legal or illegal?

Ms. LASTER. It depends on whether or not the fee is reasonably related to the goods or services provided. That is not a legalism, but I think in terms of understanding the RESPA statute,

it is not a ratemaking statute. We cannot promulgate a rate that says this is legal. By statute,

Congress has prescribed that we examine on a case-by-case basis whether or not a fee is reasonably related to the services provided. (emphasis added).

essary to look at each transaction individually. Far from immunizing the industry,

however, this ruling stems from HUD’s longstanding recognition that the origination

of mortgage loans, the specific services provided by mortgage brokers, and the difficulty of providing those services, all differ with each loan, each applicant, and each

marketplace or geographical location.

In short, HUD’s assertion that RESPA demands individualized loan-by-loan analysis of the level of services performed in relation to the fees paid does not reflect

an attempt to relieve industry from liability. It reflects the reality, as recognized by

every Administration since RESPA was enacted, that each transaction is different

and contains unique features that requires varying levels of time, effort, and expertise.9 Just as the consumer disclosures mandated by RESPA demand individualized

disclosures reflecting the specific costs that relate to the specific loan transaction at

hand, the analysis of legality under Section 8 of RESPA also demands a tailored

examination of the goods and facilities provided or services performed by the broker

in the transaction.

Additional Consumer Protections

As I mentioned above, we all recognize that there are instances where yield

spread premiums are used in ways that could be harmful to consumers. We hear

reports of consumers who pay egregious interest rates due in whole or in part to

wildly inflated yield spread premium fees, or mortgage brokers that conceal yield

spread payments in a way that leads to the consumer’s detriment.

In this regard, we commend the Chairman in his leadership in holding these

hearings, as such problems do require our full attention. We also commend the Department for its initiative to ensure that consumers receive full and meaningful disclosures in the mortgage process. In the 2001 policy statement, HUD has articulated

the need to strengthen the information provided to consumers by brokers by adding

such disclosures as the types of services that the broker will perform, the amount

of the brokers total compensation for performing those services (including yield

spread premiums), and whether or not the broker has an agency or fiduciary relationship with the borrower. Additionally, the 2001 policy statement clarifies that

borrowers should be made aware of the trade-off between upfront costs and rates,

and that such information should be provided to the applicant early in the loan

transaction.

The Secretary has announced that he will push forth with rulemaking in this

area. MBA agrees with the Secretary’s initiatives and will strive to work with HUD

to achieve the best possible regulatory outcome to rid the market of abusive lending

practices. We think it is important to point out, that current Federal rules and regulations already provide for a great deal of consumer disclosures. We note, for example, that yield spread premium payments are today included as part of the finance

charge calculations, and thus, are fully disclosed to consumers through the APR

disclosure under the Truth in Lending Act. We note also that these yield spread premium payments must be specifically broken out and separately itemized and disclosed on the Good Faith Estimate and HUD–1 forms under RESPA. That statute

also requires that lenders and/or mortgage brokers deliver to consumers a Special

Information Booklet that sets forth an explanation of mortgage broker compensation, points, fees, and their interrelationship.

As an industry, we welcome additional disclosure requirements if they truly serve

to protect consumers from unscrupulous practices. We note, for instance, that MBA

took a leadership role in creating model, voluntary and supplemental disclosures for

its members to use. These disclosures provide further explanations of the choices

borrowers have to compensate their mortgage brokers—through direct payments,

yield spread premiums financed through higher interest rates, or some combination

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10 66 Fed. Reg. at 10087.

of the two. This additional disclosure was commended and encouraged by HUD,10

and is now an accepted and routine part of the disclosure process for our membership.

MBA believes, however, that ultimately, we can do much better. We can, and

should, construct systems of consumer protection that go beyond mere disclosures.

In the end, consumers run the risk of being tricked and deceived as long as consumers are subjected to the arcane and outdated disclosure system that is now mandated by Federal law. As with predatory lending, we believe that it is absolutely

essential to enact comprehensive reform of the current mortgage lending laws. So

long as the mortgage process remains confusing and perplexing, consumers will run

the risk of being gouged and defrauded, whether through trickery involving yield

spread premiums, or through other schemes that unscrupulous actors will continue

to develop to exploit the unwary and unsophisticated. We look forward to working

with HUD and the Congress to enact the necessary legislative and regulatory

changes necessary to achieve the goals of lasting protections for all consumers.

Conclusion

To summarize, Mr. Chairman, we reiterate that as we develop more protections

and disclosures in this area, we must keep in mind that yield spread premiums are

extremely valuable consumer financing mechanisms, and that they are a crucial element in today’s housing and mortgage markets. As lenders, Government, and consumer advocates, we all share in the responsibility of ensuring that this important

financing tool is not abused by unscrupulous actors or damaged by frivolous class

action claims. Going forward, we fully support HUD’s calls for improved consumer

disclosures and we look forward to working with the Department as we advance on

this very important endeavor.

Thank you for the opportunity to share our views with the Committee.

—————

PREPARED STATEMENT OF JOSEPH L. FALK

PRESIDENT, NATIONAL ASSOCATION OF MORTGAGE BROKERS

JANUARY 8, 2002

Mr. Chairman and Members of the Committee, I am President of the National Association of Mortgage Brokers (NAMB), the Nation’s largest organization exclusively

representing the interests of the mortgage brokerage industry. We appreciate the

opportunity to address the Committee today on behalf of the Nation’s mortgage brokers on the subject of yield spread premiums.

NAMB currently has more than 13,000 members and 41 affiliated State associations nationwide. NAMB provides education, certification, industry representation,

and publications for the mortgage broker industry. NAMB members subscribe to a

strict code of ethics and a set of best business practices that promote integrity, confidentiality, and above all, the highest levels of professional service to the consumer.

The Committee has asked for NAMB’s views on the recent Statement of Policy

2001–1 issued by the Department of Housing and Urban Development concerning

yield spread premiums, and our views concerning what HUD should do going forward to prevent the ‘‘abusive use’’ of yield spread premiums. Before discussing these

two issues in detail, we would first like to review the important role mortgage brokers play in our mortgage market and our Nation’s economy, and why yield spread

premiums are so important to the effective functioning of the market. We will then

discuss why NAMB believes the Statement of Policy issued by HUD was both necessary and correct, and offer NAMB’s views regarding HUD’s actions going forward.

The Importance of Mortgage Brokers in Today’s Economy

Today, our Nation enjoys an all-time record rate of homeownership. While many

factors have contributed to this record of success, one of the principal factors has

been the rise of wholesale lending through mortgage brokers. Mortgage brokers

have brought consumers more choices and diversity in loan programs and products

than they can obtain from a branch office of even the largest national retail lender.

Brokers also offer consumers superior expertise and assistance in getting through

the tedious and complicated loan process, often finding loans for borrowers that may

have been turned down by other lenders. Meanwhile, mortgage brokers offer lenders

a far less expensive alternative for nationwide product distribution without huge investments in ‘‘brick and mortar.’’

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In light of these realities, it is no surprise that consumers have increasingly

turned to mortgage brokers. Today, mortgage brokers originate approximately 65

percent of all residential mortgages in America. In Florida alone, there are over

23,000 licensed mortgage brokers. The rise of the mortgage broker has also significantly increased competition in the mortgage industry, resulting in a decline in

mortgage interest rates and closing costs and an explosion in the number of mortgage products available to consumers. These positive developments are not mere

coincidences. They would not have been possible without the advent of wholesale

lending through mortgage brokers.

Mortgage brokers play an extremely important role in our economy. Following the

collapse of the savings and loan industry in the 1980’s, and then the rapid consolidation of mortgage banking firms in the 1990’s, we now find that in many communities, particularly in central cities and small towns, people may have a difficult

time finding a retail bank branch or retail mortgage lending branch. If they do find

a retail lender, their mortgage choices are limited to the products and services offered by that lender, which often are very few. But almost any consumer can find

a mortgage broker right in their community that can provide access to many loan

programs, assist in clearing up credit problems, help clear title defects, and provide

other assistance to help the consumer obtain a loan that suits his or her financial

needs and objectives.

Mortgage brokers are generally small business owners. The average mortgage

broker employs fewer than 10 people. Mortgage brokers know their neighbors, build

their businesses primarily through referrals from satisfied customers, and succeed

by becoming active members of their communities. The fact that small mortgage

brokerages originate over half of all mortgages, indicates that mortgage brokers are

effectively meeting consumers’ desires for convenience, service, and competitive

prices.

Since the middle of 2000, the Nation’s economy has been experiencing a slowdown, with increasing unemployment and business failures, declining consumer

spending, and other negative economic indicators. The one bright spot in this cloudy

picture has been the housing and mortgage finance sector. Mortgage originations increased in 2000 from 1999, and again in 2001. Many mortgage lenders and mortgage brokers experienced record volumes of business in 2001. Mortgage lending has

been a vital counterweight as the rest of the economy entered a recession.

Even in today’s weakened and uncertain economy, home sales and new home construction continue to increase. This creates and sustains hundreds of thousands of

jobs in real estate, construction, and ancillary industries. Mortgage refinances have

benefited many homeowners, allowing them to reduce their monthly payments, convert to shorter term loans to save thousands of dollars in total interest, or access

their home equity to improve their financial situation. Today, total home equity held

by American households once again exceeds the total value of other investments.

When properly used, access to home equity has become a lifeline for many seniors

whose retirement funds have been dramatically reduced by the decline in the stock

market, and for families who face layoffs or uncertain employment prospects in the

next several months.

Mortgage brokers provide the flexibility and capacity for the market to absorb a

huge volume of new originations, as has occurred in the last few months. This capacity allows consumers to immediately take advantage of interest rate declines and

to access their home equity if needed. If mortgage brokers did not exist, lenders

with brick-and-mortar offices would not have been able to handle the surge of purchase and refinance business that has been so helpful to consumers and to our economy in the last year.

It is thus vitally important to America’s homeowners and to the economy as a

whole that we avoid any new regulations, legislation, or legal decisions that could

impede the efficient and effective functioning of the wholesale mortgage market.

Yield Spread Premiums and Their Importance

One of the barriers to homeownership is insufficient cash for a downpayment or

to pay closing costs. Mortgage brokers have originated hundreds of thousands of

loans for people who were able to buy a home, refinance an existing mortgage at

a lower interest rate, or obtain a home equity loan with little or no cash required

for upfront closing costs or broker fees. These costs are financed through a slightly

higher interest rate than the borrower would pay if he or she paid the closing costs

in cash. Most retail lenders (for example commercial banks, thrifts, credit unions,

and retail mortgage companies) also offer ‘‘no- or low-cost’’ loans at slightly higher

rates.

The ability of consumers to obtain loans with little or no upfront costs is critical

in today’s economy. In uncertain times such as these, people want to conserve and

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to build up their cash reserves and reduce monthly payments. Interest rates have

fallen in the last year to the extent that homeowners can still often reduce the rate

on their existing mortgage through a refinance and save thousands of dollars in interest payments, lower the payments, and conserve cash, by paying some or all closing costs through a higher interest rate. When a mortgage broker arranges such a

loan, the broker receives most or all of its compensation indirectly from the lender— a yield spread premium.

Such indirect compensation paid by lenders to mortgage brokers is legal under the

applicable Federal law, the Real Estate Settlement Procedures Act or RESPA, so

long as the total compensation to the broker is reasonably related to services actually performed, goods actually provided, or facilities actually furnished. In all loans

originated by mortgage brokers, the broker is providing a facility to the wholesale

lender, in effect serving as the lender’s branch office. The broker also does most, if

not all of the work in assembling the loan package, which is creating a good, and

which can often require a great deal of time and expense. Brokers typically take the

application, order the appraisal and credit report, verify the borrower’s income and

employment, and perform many other aspects of loan origination that benefit the

lender and enable it to underwrite and approve the loan.

Mortgage brokers also perform services directly for borrowers that are legally

compensable. These may include advising the borrower about various loan programs

and options to assist the borrower in selecting a loan program that meets his or her

financial situation and objectives; helping the borrower improve his or her credit

rating in order to qualify for a lower interest rate or better loan terms, and other

assistance. Many brokers work late into the evenings and on weekends taking applications, gathering documents, and meeting borrowers at their homes and offices.

Such personal and convenient service is one reason mortgage brokers are preferred

by many consumers.

Mortgage brokers clearly provide legally compensable services, goods, and facilities to both wholesale lenders and to borrowers. These services, goods, and facilities

all ultimately benefit the borrower, by enabling the borrower to qualify for and receive the loan the borrower wants. Retail lenders perform similar origination functions and earn similar fees when they sell mortgages into the secondary market, as

they do with the vast majority of loans they originate. However, retail lenders do

not disclose to borrowers their income on loans that are subsequently sold in the

secondary market. Mortgage brokers do.

We want to emphasize this. There is nothing fundamentally different about the

way retail lenders and mortgage brokers earn income. The only difference is that

consumers know how much the originator is being paid only when the originator

is a mortgage broker. This is because HUD requires the disclosure and itemization

of all such ‘‘indirect compensation’’ by lenders to mortgage brokers, on both the Good

Faith Estimate and the HUD–1 settlement statement. Loan sales by retail lenders

are considered secondary market transactions, which are not subject to RESPA.

Mortgage interest rates are highly competitive. Consumers today are more sophisticated than ever in researching and shopping rates. A mortgage broker determines

the fee on a particular loan based on a number of factors, including the work required to arrange the loan, such as assisting the borrower in improving his or her

credit rating. Fees may also be determined based on the loan program, market competition, and many other factors. The flexibility of indirect compensation allows

mortgage brokers to stay competitive with, and often beat, retail lenders on price

while still earning a reasonable profit.

It is also important to note that in most cases involving payments of yield spread

premiums, the mortgage broker receives nothing until the loan closes. Mortgage brokers often do a great deal of work to arrange loans that never get to closing, for

a variety of reasons. They receive no compensation for this work.

HUD Statements of Policy 1999–1 and 2001–1

Despite the clear advantages of mortgages involving yield spread premiums, the

clear legality of such payments, and the clear choices being made every day by consumers to obtain their mortgages through mortgage brokers, the wholesale mortgage market is under assault in the courts. Trial lawyers across America have continued to file and pursue class action lawsuits claiming that all yield spread premiums are illegal under Section 8 of RESPA. Over 150 such class action lawsuits

are active in courts across the country against virtually every major wholesale mortgage lender. Some of these suits were first filed in 1996.

Many courts have dismissed such suits, rightfully in our view. Others have been

withdrawn after courts refused class certification. However, some courts have allowed these suits to continue, and trial lawyers continue to venue-shop and file new

suits, in search of one court that will agree with their inaccurate portrayal of the

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wholesale mortgage market. This flood of litigation, and differing opinions of various

courts, has caused a great deal of uncertainty and anxiety in the mortgage industry.

The cost of defending these class actions is staggering, already running into millions

of dollars each for the largest lenders involved. These costs are, of course, passed

on to consumers. The potential liability for the industry is tens of billions of dollars.

Lenders could be forced to cease all wholesale lending if a judgment goes against

even one lender, or if a major settlement occurs.

The only real winners here are the class action attorneys who stand to win millions of dollars in contingency fees. Their clients stand to receive only small refunds,

or a few dollars off the cost of their next loan. The real impact will be the exit from

wholesale lending of most, if not all, major mortgage lenders. The potential liability

for them will simply be too great to justify staying in the business. The real losers

will then be tomorrow’s first-time homebuyers, tomorrow’s working families, and

tomorrow’s entrepreneurs who will not be able to get a mortgage without paying

hundreds of dollars upfront—which, for low-income people without cash, will mean

no mortgages at all.

Many small businessmen and women may not be able to stay in business as mortgage brokers without being able to offer consumers low- or no-cost loans. As competition decreases, all potential mortgage borrowers will experience higher costs and

fewer choices—and in some cases, no choices at all. The ripple effect on the overall

economy, as mortgage borrowing declines and employment in the housing and mortgage finance sector falls, could be substantial.

In 1998, Congress made its views clear on this issue. In the Conference Report

accompanying the VA–HUD and Independent Agencies Appropriations Act of 1999

[H.R. Conf. Rep. No. 105–769, 105th Congress, 2d sess. 260] Congress explicitly

stated that it was ‘‘concerned about the legal uncertainty [regarding indirect compensation] that continues absent such a policy statement.’’ Congress further stated

that it ‘‘never intended payments by lenders to mortgage brokers for goods or facilities actually furnished or for services actually performed to be violations of Sections

8(a) or (b) of the Real Estate Settlement Procedures Act (12 U.S.C. 2601 et. seq.)

Congress directed the Department of Housing and Urban Development (HUD) to

issue a statement of policy clarifying the legality of mortgage broker compensation

paid by lenders. Congress further directed HUD to consult with all interested parties in developing this policy statement.

HUD followed the directive of Congress with the release of Statement of Policy

1999–1 [FR Vol. 64, No. 39, pp. 10080–10087] on March 1, 1999. The policy statement says that:

In determining whether a payment from a lender to a mortgage broker

is permissible under Section 8 of RESPA, the first question is whether

goods or facilities were actually furnished or services were actually performed for the compensation paid. The fact that goods or facilities have

been actually furnished or that services have been actually performed by

the mortgage broker does not by itself make the payment legal. The second

question is whether the payments are reasonably related to the value of the

goods or facilities that were actually furnished or services that were actually performed.

NAMB participated in the development of this Statement of Policy, along with

many other industry groups, as well as major consumer advocacy organizations.

HUD, to its credit, insisted that a consensus of all the participating groups be

reached. All who participated agreed that Statement of Policy 1999–1 correctly interpreted RESPA as it relates to mortgage broker compensation. The policy statement enjoyed bipartisan approval from the Clinton Administration and Congress.

When Statement of Policy 1999–1 was released, most of us in the mortgage industry believed the litigation crisis had been resolved. Using the ‘‘two-part test’’ set

forth in the statement meant that the legality of any mortgage broker compensation

would have to be judged on a case-by-case basis, not as a class action. It is important to note here that this test allows individual cases of abuse to be addressed and

remedied in court, while limiting inappropriate class actions. Following the publication of the statement, the number of new class action lawsuits dwindled. Several

existing lawsuits were dismissed, and class certification was denied, by courts that

agreed with HUD’s interpretation of RESPA and agreed that broker compensation

must be judged on a case-by-case basis. However, other lawsuits continued to proceed with the hope by the trial lawyers that a court might interpret Statement of

Policy 1999–1 in such a way that a class action could still go forward.

Unfortunately, this occurred in June 2001, when the Eleventh Circuit Court of

Appeals affirmed certification of a class by the U.S. District Court of Alabama in

Culpepper v. Irwin Mortgage Corp. The Eleventh Circuit found an ambiguity in

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Statement of Policy 1999–1, and failed to complete its analysis of yield spread premiums by only applying the first test. The Court also implied that a lower court

could, in fact, find that all yield spread premiums are illegal, thereby justifying certification of the class. Not surprisingly, NAMB believes this was a misinterpretation

of both RESPA and Statement of Policy 1999–1. It left the industry once again facing billions of dollars in liability. It also left HUD in contravention of the 1998 Congressional directive to provide definitive guidance to the industry and clarify any

legal ambiguities surrounding mortgage broker compensation. Dozens of new lawsuits have been filed since the Eleventh Circuit decision. Clearly this is not because

of a sudden rampant wave of abuse in the mortgage market, but because class action attorneys see an opportunity for multimillion dollar fees.

HUD immediately recognized the potential disaster created by this decision, and

recognized its responsibility to remove the ambiguity found by the Eleventh Circuit

by clarifying its existing policy. In the process of developing its response, HUD once

again met with a wide range of interested parties, including NAMB, and including

consumer advocacy groups. On October 15, 2001, HUD issued Statement of Policy

2001–1 [Fed. Reg. 66, No. 202, pp. 53052–53059]. HUD states in the preamble to

this policy statement that:

This Statement of Policy is being issued to eliminate any ambiguity concerning the Department’s position with respect to those lender payments to

mortgage brokers charactenized as yield spread premiums. . . . In issuing

this Statement of Policy, the Department clarifies its interpretation of Section 8 of the Real Estate Settlement Procedures Act (RESPA) in Statement

of Policy 1999–1 Regarding Lender Payments to Mortgage Brokers (the

1999 Statement of Policy). . . . Today’s Statement of Policy reiterates the

Department’s position that yield spread premiums are not per se legal or

illegal, and clarifies the test for the legality of such payments set forth in

HUD’s 1999 Statement of Policy. As stated there, HUD’s position that lender payments to mortgage brokers are not illegal per se does not imply, however, that yield spread premiums are legal in individual cases or classes of

transactions. The legality of yield spread premiums turns on the application

of HUD’s test in the 1999 Statement of Policy as clarified today.

HUD is to be congratulated for Statement of Policy 2001–1. The statement is simply a clarification of existing policy and the existing views of HUD concerning yield

spread premiums. As the regulator of RESPA, HUD has a responsibility to provide

all parties affected by RESPA with clear rules and guidance so that the law can

be effectively understood and implemented nationwide, and so that nationwide lenders can comply with the law. Continued ambiguity, whether created by court decisions, market changes, or other factors, creates unnecessary and costly uncertainty

for both business and consumers. The only parties that benefit from ambiguity are

trial lawyers.

Statement of Policy 2001–1 has also been accepted by the courts in two important

court rulings in class action lawsuits, Vargas v. Universal Mortgage Corp. and

Bjustrom v. Trust One Mortgage Corp. In Bjustrom, U.S. District Judge Marsha J.

Pechman of the Western District Court of Washington granted summary judgment

to the defendant, Trust One Mortgage Corp. Judge Pechman applied the new policy

statement to find that yield spread premiums are not illegal per se even though

there may be no ‘‘tie’’ between the premium and particular services performed by

the broker. The Court found that the Statement of Policy is a permissible interpretation of RESPA and therefore must be given deference.

In Vargas, Judge James B. Zagel of the U.S. District Court, Northern District of

Illinois, denied certification of a class. Judge Zagel agreed with HUD that the fact

that yield spread premiums are calculated based on a rate sheet does not make

them per se illegal referral fees. He also found that there are legitimate reasons why

a borrower would choose to pay a higher interest rate on a loan that included a yield

spread premium. Importantly, Judge Zagel also found that HUD’s two-part test to

determine legality of a yield spread premium is faithful to the RESPA statute, and

that:

. . . the Act [RESPA] compels a case-by-case analysis of individual plaintiffs’ claims every bit as much as the HUD Statement. HUD’s ‘‘reasonableness requirement’’ was not made out of whole cloth; it is implicit in

§ 2607(c) which authorizes compensation for ‘‘services actually performed.’’

We expect other courts to agree with these two decisions. Yield spread premiums

that are properly disclosed and meet the HUD test should be considered legal and

not abusive. Any yield spread premium that does not meet this test may be illegal,

and HUD’s policy statement clearly allows consumers who believe their loan has included an illegal yield spread premium to seek legal remedy. With the legal uncerVerDate 11-MAY-2000 11:24 Mar 05, 2003 Jkt 000000 PO 00000 Frm 00072 Fmt 6633 Sfmt 6621 84933.TXT SBANK4 PsN: SBANK4
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tainty removed, our industry can now move forward and HUD can move forward

to address the real problems in the mortgage market.

HUD’s Actions Going Forward

The other issue on which the Committee has asked us to comment is what HUD

should do going forward to address ‘‘abusive use’’ of yield spread premiums. We fully

agree that illegal uses of yield spread premiums should be prosecuted to the full

extent of the law. Any compensation that does not meet the HUD test is illegal, and

those paying or receiving illegal payments should be punished. The NAMB believes

such abuses are rare, and we believe that HUD is moving forward appropriately in

two ways.

First, HUD is moving to more aggressively enforce RESPA and punish violators.

It is devoting more resources, reorganizing, and refocusing to dramatically improve

its historically poor record in enforcing RESPA. Our industry has long been frustrated with the lack of RESPA enforcement by HUD. Even a little enforcement can

go a long way in serving notice to all settlement service providers that there will

be a high price for violating the law. This includes the payment or receipt of illegal

yield spread premiums or any other fees that are paid to any industry participant

in violation of RESPA. NAMB applauds HUD’s new enforcement effort and hopes

Congress will support it with increased funding and personnel allocations.

The other way HUD is moving to address abuses is with a new RESPA regulation.

In Statement of Policy 2001–1, HUD announced:

This Statement of Policy also reiterates the importance of disclosure so

that borrowers can choose the best loan for themselves, and it describes disclosures HUD considers best practices. The Secretary is also announcing

that he intends to make full use of his regulatory authority to establish

clear requirements for disclosure of mortgage broker fees and to improve

the settlement process for lenders, mortgage brokers, and consumers.

Secretary Martinez, in remarks before this Committee on December 13, 2001, further stated his commitment to RESPA reform:

To ensure that homebuyers have the information they need in order to

make an informed purchase, I have undertaken comprehensive reform of

the Real Estate Settlement Procedures Act (RESPA). In addition to preserving yield spread premiums as a valuable tool for opening the doors of

homeownership, reform will: (1) ensure better protections for new homebuyers and those who refinance; (2) offer clarity for the mortgage lending

industry about their disclosure responsibilities, and; (3) provide an additional tool to fight predatory lending.

The need for RESPA reform is even more urgent during times of economic

uncertainty. Homeownership helps create financial stability for families, and in

return brings economic stability to our communities.

NAMB fully agrees with Secretary Martinez and we support a new rulemaking

to improve the disclosures provided to consumers. Mortgage brokers are confronted

every day with the frustrations of our customers about the many confusing, and

largely useless, disclosures and paperwork we thrust at them. Consumers who may

be desperate for cash or credit may not always fully investigate their loan options

or closely examine the many disclosures they receive.

Consumers are entitled to better, simpler disclosures provided earlier in the process, so they can more effectively compare loans. Consumers should have simple disclosures without a lot of fine print. They should easily be able to question and

change terms and fees with which they do not agree, well before closing. These improvements could reduce compliance burdens and costs for originators, and the savings would be passed on to consumers. Consumers would be in a stronger position

with more information, thereby decreasing the incidence of abusive lending practices

of all kinds—including, but not limited to, any illegal yield spread premiums.

NAMB has developed detailed proposals for this rulemaking, and we have shared

these with HUD and with this Committee. NAMB supports a new, mandatory disclosure to be required of all originators at or before application, that clearly defines

what the originator will do in the transaction, how its compensation will be earned,

and the choices available that could affect both the way the originator is compensated and whether the consumer will have to pay any fees upfront at closing.

NAMB also supports establishing tolerances for the Good Faith Estimate and requiring redisclosure if the tolerances are exceeded, in order to prevent surprise additional costs to consumers at closing, including inappropriate increases in yield

spread premiums.

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1The National Association of Consumer Advocates is a nonprofit organization designed to promote justice for all consumers by maintaining a forum for information sharing among consumer

advocates across the country. Our mission is to serve as a voice for consumers in the ongoing

struggle to curb unfair and abusive business practices, especially in the areas of finance and

credit. 2The National Consumer Law Center, Inc. (NCLC) is a nonprofit Massachusetts corporation

founded in 1969 at Boston College School of Law and dedicated to the interests of low-income

consumers. NCLC provides legal and technical consulting and assistance on consumer law

issues to legal services, Government and private attorneys across the country. Cost of Credit

(NCLC 1995), Truth in Lending (NCLC 1996) and Unfair and Deceptive Acts and Practices

(NCLC 1991), three of twelve practice treatises published and annually supplemented by NCLC,

and our newsletter, NCLC Reports Consumer Credit & Usury Ed., describe the law currently

applicable to all types of consumer loan transactions.

This new disclosure would build upon the successful Model Loan Origination

Agreement that NAMB and MBA jointly developed in 1998, and which both associations encourage our members to use. We believe this new agreement will help consumers better understand the process, while not adding significantly to the complexity of that process.

Conclusion

Wholesale mortgage lending through mortgage brokers, and particularly the wide

availability of loans requiring the borrower to pay little or no cash at closing, is a

key element in sustaining America’s economy through this period of great uncertainty and difficulty. Used properly, yield spread premiums are an important part

of this market, and it is therefore important to consumers that the use of legal yield

spread premiums continue, without the threat of class action litigation that could

seriously impede the efficient functioning of the market and damage the economy.

When yield spread premiums are properly disclosed and properly used, they are not

illegal.

NAMB believes that HUD has acted responsibly as the regulator under RESPA:

First, by issuing Statement of Policy 2001–1 to clarify existing policy concerning

yield spread premiums, provide certainty to the mortgage industry, and reduce the

threat of class action litigation; second, by significantly increasing and improving its

investigation and enforcement of RESPA violations; and third, by developing new

and improved disclosures that will help consumers avoid illegal and abusive fees.

NAMB supports a new, mandatory disclosure to be provided at the earliest possible

time by all originators that fully informs consumers about the loan origination

process. NAMB also supports improving the Good Faith Estimate by establishing

tolerances and requiring redisclosure.

Thank you again for this opportunity to share NAMB’s views with the Committee.

—————

PREPARED STATEMENT OF IRA RHEINGOLD

EXECUTIVE DIRECTOR, NATIONAL ASSOCIATION OF CONSUMER ADVOCATES

JANUARY 8, 2002

Mr. Chairman and Members of the Committee, the National Association of Consumer Advocates 1 thanks you for inviting us to testify today regarding HUD’s recent policy ‘‘clarification’’ on yield spread premiums. We offer our testimony here

today on behalf of our members, as well as the National Consumer Law Center.2

At the outset, let me make it perfectly clear that while we believe that the use

of yield spread premiums can be a source of benefit for American consumers, this

practice as it is currently being used by the mortgage lending industry, is both abusive and deceptive. Furthermore, instead of carrying out its mandate to promote

homeownership by encouraging a fair, open, and honest marketplace, HUD has attempted to use its policymaking authority to legitimatize the otherwise illegal, anticompetitive nature of yield spread premium abuse. This testimony will discuss how

yield spread premiums currently operate in the real world, explore previous efforts

to regulate this practice, explain how HUD’s purported clarification in the 2001 policy statement ignores the law and perpetuates and encourages bad lending behavior

and finally, offer proposals to make the use of yield spread premiums provide American homeowners with real benefit.

Yield Spread Premiums in the Current Marketplace

Section 8(a) of RESPA prohibits any person from giving or receiving any fee, kickback or thing of value pursuant to any agreement incident to a real estate settleVerDate 11-MAY-2000 11:24 Mar 05, 2003 Jkt 000000 PO 00000 Frm 00074 Fmt 6633 Sfmt 6621 84933.TXT SBANK4 PsN: SBANK4
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3 Reg. X § 3500.14(b). 4For a detailed discussion of RESPA’s legislative history see the Report of Howell Jackson

in Glover v. Standard Federal Bank, pp. 3–19. 5Professor Jack Guttentag, Professor of Finance Emeritus at the Wharton School (whose nationally syndicated ‘‘Ask the Mortgage Professor’’ columns are featured on the Mortgage Bankers

Association of America’s own website) recently conducted a study of mortgage broker fees. That

study, Bankers Association of America’s own website) recently conducted a study of mortgage

broker fees. That report, entitled ‘‘Another View of Predatory Lending’’ (published by the Wharton Financial Institutions Center and available as a free download from its website), found that

there is no correlation between the fees paid to a mortgage broker on a given loan and the

amount of work performed by the mortgage brokers on that loan. The Guttentag Study concluded that the only two ‘‘major determinants’’ of mortgage broker profit are ‘‘loan size’’ and ‘‘the

sophistication of the borrower relative to the sales skills of the loan officer. 6 Report of Howell Jackson.

ment involving a Federally related mortgage.3 This rather simple provision was the

product of much debate in Congress and was created in 1972 because of the widespread recognition that referral fees and kickbacks were making the marketplace

anticompetitive (homebuyers were not being directed to a service provider who

would provide them with the best deal, but instead to the provider who would pay

the largest sum of money to the referring agent).4 The rationale for this legislation

was simple. Eliminate market-distorting incentives and homeowners would have

real opportunity to obtain the most beneficial and cost efficient loan products available. While Section 8(a) of RESPA seems rational, fair, and explicit, current participants in the home lending marketplace have gone to great effort to obfuscate the

law and preserve their ability to receive and provide kickbacks at the great expense

of American homeowners. This is where the practice of yield-spread premiums

(YSP’s) enters our story.

In a nutshell, the YSP’s are payments made by a lender to a mortgage broker in

return for a referral of an ‘‘above-par’’ loan. An above-par loan is a loan with a YSP

paid to the broker and a higher interest rate than the loan the borrower qualified

for. A par loan is a loan with an interest rate that an individual homeowner would

qualify for if she/he paid no discount points and was charged no YSP. For a ‘‘belowpar’’ loan, the homeowner would pay discount points in exchange for the lower interest rate.

In theory YSP’s could offer homeowners using a mortgage broker a valuable

choice. Borrowers could choose the amount of points they would want to pay (or not

pay) and thus choose an interest rate. For instance, a homeowner who did not want

to pay an upfront broker fee, could choose an above-par interest rate and have the

lender pay the broker in the form of a YSP. While this could all be so very neat

and clean (and legal), this scenario does not remotely reflect what is happening in

today’s consumer marketplace.

Consumers who do business with mortgage brokers generally have the understanding that the brokers will provide them the loan at the lowest rate that the

broker finds for them. Consumers have generally understood and agreed to a specific broker’s fee to be paid directly by them—either in cash or by borrowing more—

to the mortgage broker to compensate the broker for obtaining the loan. What consumers do not understand, and have not agreed to, is the mortgage broker receiving

an additional fee from the lender.

As an attorney for the last 5 years running a foreclosure prevention project in

Chicago, I have had the opportunity to review hundreds and hundreds of loan documents. I have probably interviewed thousands of homeowners, given countless seminars and trained and spoke with scores of attorneys representing consumers. In all

that time, I have seen countless loans that contained both yield spread premiums

and borrower paid broker fees, yet not once, have I spoken to a homeowner who

knew that a YSP had been paid on their loan, or that because of the YSP, the interest rate they received was greater than they were otherwise qualified. To some, this

evidence is anecdotal, but both industry commentary 5 and objective study 6 bear

this observation out. This reality begs two questions. First, if YSP’s are not being

paid for the benefit of consumers, why are they being paid? Second, if these are referral fees why aren’t these payments illegal?

The answer to the first question is very simple. YSP’s are generally paid by the

lender to the broker solely in compensation for the higher rate loan. In other words,

because the broker brings to the lender a loan at a higher rate than the consumer

would otherwise qualify, the broker is paid a fee, or kickback. These fees are solely

an extra fee that the broker is able to extract from the deal. In practice, the borrower is not only paying an upfront broker fee, but is also paying a higher interest

rate as a result of this kickback. As this practice clearly provides an incentive for

brokers to obtain above-par loans for consumers, the dynamics of the marketplace

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7 ‘‘The conferees expect HUD to work with representatives of industry, Federal agencies, consumer groups, and other interested parties on this policy statement.’’ See the Conference Report

on the Departments of Veterans Affairs and Housing and Urban Development, and Independent

Agencies Appropriations Act, 1999, H.R. Conf. Rep. No. 1050769 at 260 (1998). 8 Real Estate Settlement Procedures Act Statement of Policy 1999–1 Regarding Lender Payments to Mortgage Brokers. 64 FR 10080 (March 1, 1999) at 10087. 9See for example Golan v. Ohio Savings Bank, 1999 U.S. Dist. LEXIS 16452 (N.D. Ill. October

15, 1999); Brancheau v. Residential Mortgage, 187 F.R.D. 591 (D. Minn. 1999); Levine North Am.

Mortgage, 188 F.R.D. 320 (D. Minn. 1999); Smitz v. Aegis Mortgage Corporation, 48 F. Supp.

2d 877 (D. Minn. 1999). 10 Heimmermann v. First Union Mortgage, 188 F.R.D. 403 (N.D. Ala. 1999); Briggs v. Countrywide Funding Corporation, 188 F.R.D. 645 (M.D. Ala. 1999). 11 Culpepper v. Irwin Mortgage Corporation, 253 F. 3d 1324 (11th Cir. 2001). 12 A significant basis for this rationale is not only HUD’s 1999 Statement of Policy, but also

the language of RESPA’s provision distinguishing between legal fees and referral fees. Section

8(c) of RESPA permits ‘‘the payment of a fee . . . by a lender . . . for services actually performed.’’ 12 U.S.C. § 2607(c)(1)(C). 253 F.3d at 1328. (Emphasis added.)

closely resemble the marketplace that Congress attempted to control with its passage of RESPA.

Prior Attempts To Curb Yield Spread Premium Abuse

Because this problem has existed for over a decade (and because the lending industry has attempted various justifications for this seemingly obvious illegal practice), there has been extensive litigation. The industry had sought assistance from

Congress in the past. Finally, in 1998, Congress issued a directive to HUD to write

a Statement of Policy. Consumer representatives worked diligently with the mortgage industry and HUD to develop the language.7 The Statement of Policy that was

issued by HUD in 1999 met with both consumer advocate and industry approval.

Consumer advocates approved of the policy statement in large part because of the

explicit direction provided to the lending industry on how a lender can properly pay

a broker fee:

Mortgage brokers and lenders can improve their ability to demonstrate

the reasonableness of their fees if the broker discloses the nature of the broker’s services and the various methods of compensation at the time the consumer first discusses the possibility of a loan with the broker.

[T]he most effective approach to disclosure would allow a prospective borrower to properly evaluate the nature of the services and all costs for a

broker transaction, and to agree to such services and costs before applying

for a loan. Under such an approach, the broker would make the borrower

aware of . . . the total compensation to be paid to the mortgage broker, including the amounts of each of the fees making up that compensation. If

indirect fees are paid, the consumer would be made aware of the amount of

these fees and their relationship to direct fees and an increased interest rate.

If the consumer may reduce the interest rate through increased fees or

points, this option also would be explained. [Emphasis added.] 8

With this clear direction on how to avoid liability for paying broker fees, consumer

advocates reasonably believed that the mortgage industry would immediately adopt

these recommendations and employ them in all future loans. This belief was wrong.

Instead the industry continued as before—lenders continued to pay broker fees without evaluating either the services provided by the broker or whether the payment

of the lender fee reduced the fees otherwise owed by the borrower. Because the benefit to the brokers and lenders was so great (higher fees for brokers, higher interest

rates for lenders), the mortgage industry’s strategy was to continue its illegal practice, pay off the few individual actions brought against it and mount a massive effort to fight class action cases challenging the payment of these fees, which might

actually cost the industry real money and cause the industry to change its behavior.

Initially after the 1999 Statement of Policy this strategy appeared to be working.

Most Federal courts generally denied class certification, requiring an intensely factual analysis to determine legality,9 while a few Federal district courts did permit

the class actions to proceed. 10 This scene changed significantly however, when the

Eleventh Circuit Court of Appeals issued a comprehensive analysis of RESPA’s re- quirements regarding referral fees, the 1999 Statement of Policy, and upheld class

certification, on June 15, 2001.11

The crux of the analysis in the Culpepper case is that for HUD’s Statement of

Policy to be consistent with RESPA, a two-part test is necessary to determine the

legality of the lender paid broker fees. First, whether the lender paid fee was for

goods, services, or facilities provided. Second, whether the total fee paid was reasonable.12 The court found class certification appropriate because—

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13 253 F. 3d at 1329. 14The factual basis for the court’s conclusion was stated in this way:

The ‘‘yield spread premiums’’ at issue in this case . . . are payments from [the lender] to

its mortgage brokers that the written agreement between them contemplates, but does not define. Each business day, Irwin distributes a rate sheet to its brokers, listing the terms of the

loans Irwin is offering that day. The loans’ interest rates are set with reference to a ‘‘par rate.’’

If the broker originates a loan at a below-par rate, it gets no compensation from Irwin. On the

other hand, originating a loan at an above-par rate garners the broker a yield spread premium,

whose amount is determined by a formula that includes the amount of the loan and the difference between the loan rate and the par rate. The formula does not take into account the

amount of work the broker actually performed in originating the loan or how much the borrower

paid in fees for the broker’s services. 253 F. 3d at 1325. 15See letter from Anne Canfield, Executive Director of the Consumer Mortgage Coalition, to

Secretary Mel Martinez, dated September 25, 2001. http://www.houselaw.net/alerts/

092801a.pdf. 16 Id. 17See memorandum from Howard Glaser, Mortgage Bankers Association, entitled ‘‘What We

Are Asking For.’’ 18On July 11, 2001 consumer representatives met with General Counsel Richard Hauser and

other HUD representatives. On September 11, 2001 consumer representatives met for a few

minutes with Secretary Martinez, FHA Commissioner Weicher, Mr. Hauser, and others. Given

the tragic occurrences of the day, this meeting was aborted and resumed on September 19. On

October 11, after numerous requests, consumer representatives again met with Mr. Hauser,

Commissioner Weicher, and others.

The terms and conditions under which a lender pays the broker a yield

spread premium can determine whether the yield spread premium is compensation for referring loans rather than a bona fide fee for services. There

is no suggestion from the evidence or the argument here that Irwin negotiates yield spread premiums loan-by-loan, rather than paying them according to terms and conditions common to all the loans.13

In essence, the Culpepper court was saying, if the lender paid a broker a yield

spread premium without looking at whether services were provided, the lenders

practice violated RESPA. Therefore, the first step of the two-part test—whether the

lender paid fee was for services—could be answered without performing a factual

analysis of each individual loan. Therefore, the court concluded that there was no

reason that the case could not proceed as a class action. The court noted that the

formula by which a lender paid broker fee is paid ‘‘does not take into account the

amount of work the broker actually performed in originating the loan or how much

the borrower paid in fees for the broker services.’’ 14

The mortgage industry responded to the Culpepper case by immediately turning

to HUD and seeking a ‘‘clarification’’ of the 1999 Statement of Policy removing all

references to language, which would support the Eleventh Circuit Court’s analysis.

The stated rationale was simply to ‘‘clarify’’ the ‘‘ambiguity’’ in the policy statement.15 Despite the fact that the 1999 Statement of Policy was unambiguous regarding how the industry could legally pay yield spread broker fees, the industry

coyly requested:

HUD must issue decisive and clear rules that benefit both borrowers and

lenders by creating a regulatory environment in which consumers can make

informed choices and lenders can operate their businesses, without the constant prospect of having industry practices that benefit consumers challenged in litigation.16

The industry portrayed a ‘‘clear rule’’ for the future as an appropriate trade-off

for the requested ‘‘clarification of the 1999 Statement of Policy.’’ 17 This completely

ignored the obvious—that HUD had already provided a clear rule, just as the industry is now requesting, in the 1999 Statement of Policy, which the industry had simply ignored.

HUD’s Actions

In the weeks preceding the issuance of the 1999 Statement of Policy, HUD officials met with consumer representatives on dozens of occasions to work through

many of the complex issues involved in this problem. Many of these meetings were

also attended by representatives of the mortgage industry. In contrast, prior to the

2001 Statement, HUD officials met with consumer representatives three times, despite numerous requests and offers by these representatives to engage in a more

substantial dialogue.18

The consumer representatives tried to make clear to HUD officials these essential

points:

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19This assumes that a court agrees that the 2001 HUD Statement of Policy should be provided deference. There is substantial legal question regarding the extent of reliance that a court

may place on an agency’s interpretative statement which has not been subject to notice and

comment. The Supreme Court has distinguished between the deference due regulations promulgated by formal notice-and-comment rulemaking or formal adjudications and those made informally. See Christensen v. Harris County, 529 U.S. 576, 120 S. Ct. 1655, 1662, 146 L. Ed. 2d

621 (1999). 20 Consumer representatives maintain that requiring the consumer to agree to the payment

of a lender paid broker fee is an essential element in a regulatory structure that would truly

protect consumers from illegal yield spread premiums. 21Department of Housing and Urban Development, RESPA Statement of Policy 2001–1: Clarification of Statement of Policy 1999–1 Regarding Lender Payments to Mortgage Brokers, and

Guidance Concerning Unearned Fees Under Section 8(b) at 11. 22The new test ‘‘requires that total compensation to the mortgage broker be reasonably related to the total set of goods or facilities actually furnished or services performed.’’ Id. at 13.

Although HUD says there is still a two-part test, the two tests appear identical. 23 Board of Governors of the Federal Reserve System, Department of Housing and Urban Development,

Joint Report to the Congress Concerning Reform to the Truth in Lending Act and the Real Estate Settlement Procedures Act, July 1998 (hereinafter ‘‘Joint Report’’). These two Government

agencies listened to the multitude of industry representatives, as well as consumer representatives, and issued a complex and comprehensive report.

• Providing the ‘‘clarification’’ of the 1999 Statement as sought by the mortgage industry would have the effect of completely eliminating class actions as a form of

redress for illegal lender paid broker fees.19

• Without class actions as a means to litigate the legality of these fees, the industry

has no incentive to change their practices or even to comply with a new regulation—because there are insufficient legal resources in this Nation to represent

consumers in individual actions involving claims of only a few thousand dollars.

• The ‘‘new’’ disclosures offered by the industry—and proposed by HUD—provide

fewer actual protections for consumers than those recommended by HUD in the

1999 policy statement. Unlike the 1999 recommendations which include the consumer’s agreement to the lender paid broker fee, the 2001 proposal only mentions

‘‘disclosure.’’ 20

• Limiting illegal lender paid broker fees is an essential step in redressing predatory mortgage lending.

The mortgage industry provided specific language to HUD to ‘‘clarify’’ the 1999

policy statement. HUD adopted every recommendation made by the industry. The

crux of HUD’s ‘‘clarification’’ comes on page 11, with the statement:

HUD’s position is that in order to discern whether a yield spread premium was for goods, facilities, or services under the first part of the HUD

test, it is necessary to look at each transaction individually . . .21

Such a position, if deferred to by the courts, would almost certainly preclude class

action suits, thus removing the only effective legal recourse to challenge and change

this practice. In fact, the 2001 Statement of Policy collapses the two-part test articulated in the 1999 Statement into a single analysis; which represents a serious departure from not only the 1999 Statement, but also the Congressional directive in

RESPA.22

HUD’s action is absolutely crippling to consumer rights, as it removes any incentive the industry has to cooperate with any future action that HUD might take to

address the egregious practice of upselling mortgage loans. In his press release,

Secretary Martinez claims to be pursuing a reform to require full upfront disclosure

of all total compensation to be paid to the broker. However, even if HUD initiates

a proposed rulemaking to do this (which was not proposed in the October 15 Statement), and even if the regulation goes beyond the meaningless recommendations in

the 2001 Statement, it will be a regulation without any effective enforcement mechanism.

Making Yield Spread Premiums Work for Consumers

Several years ago, Congress requested that the two Federal agencies most familiar with the implementation of the laws involved in the mortgage process—HUD

and the Federal Reserve Board—evaluate the complex issues of improving and

streamlining the mortgage process, while addressing predatory lending. In 1998,

these two agencies issued a comprehensive report.23 This Joint Report, in addition

to proposing comprehensive reform to address predatory lending, also proposed two

alternatives to address the fact that the current system does not ensure a truly competitive marketplace for mortgage loans.

75

24Joint Report at XVII. 25See Appendix A for a full proposal that amends Reg. X and adopts these principles.

One alternative would be a dramatic change in the system governing the disclosures consumers receive both when they apply for the loan and when they close the

loan. The other alternative is to beef up the current system and require information

to be provided which is meaningful.

Alternative One

In the Joint Report, HUD indicated its commitment to actually improving the system of shopping for mortgages, rather than continue the confusion. The primary

mechanism for accomplishing a more open system would be to require mortgage

lenders (and brokers) to provide a guaranteed interest rate and closing costs before

collecting any application fees from consumers.

As the charges for mortgage loans are often based on the borrower’s creditworthiness and the value of the collateral, some underwriting would have to be performed

by the creditors before the guaranteed rate could be provided. To its credit, HUD

agreed with consumer advocates and proposed that ‘‘consumers be provided guaranteed information about closing costs, interest rate, and points early enough so that

they can shop and make informed choices.’’ 24

On the other hand, the large mortgage lenders have been pushing hard for a

change in the law which would mandate a guaranteed closing costs ‘‘package,’’ without a guarantee for rates and points. In this way, the lenders could market their

loans based on the closing cost package. Consumer advocates have opposed the closing cost package by itself because it would be like marketing tires to car buyers before they purchase the car: A borrower would likely apply for a loan based on the

guaranteed closing cost package, without receiving any guarantee of the interest

rate or points. Encouraging borrowers to apply for loans based only the closing cost

package would end up costing borrowers in at least two ways: (1) if the actual closing costs incurred by the lender for the loan exceeds the anticipated amount, there

would be nothing to prevent the lender from increasing the interest rate or the

points charged on the loan to make up for the difference; (2) in fact, there is nothing

to prevent the lender from increasing the price of the loan to borrowers who have

already paid so much money to apply for the loan, that they cannot afford to go elsewhere for their home loan.

Alternative Two

HUD also proposed a change in the rules governing early disclosures. These early

disclosures need to be transformed into commitments to deal with the issue of deceptive yield spread premiums.

The mortgage industry has consistently stated that it wants to ensure that yield

spread premiums remain legal so that borrowers can benefit from their use—such

as by reducing the upfront closing costs required to be paid from cash or equity. We

as consumer advocates agree. We think the following principles,25 if followed, would

guarantee that yield spread premiums would be legal and beneficial for consumers.

1. Before any payment is made to the broker, the borrower and the mortgage broker must enter into a binding fee agreement regarding the total

compensation, however denominated, to be paid to the broker.

2. The borrower must be offered a choice of how to pay the broker fee,

whether in cash, by borrowing more, by increasing the interest rate or

points, or having the lender pay the broker fee. This choice is offered after

loan approval but before the settlement.

3. The amount the broker is paid is the same whether paid by the borrower or the lender. The amount paid the broker by the lender reduces, by

the exact amount, the amount owed by the borrower to the mortgage

broker.

4. The total amount paid by borrower and lender must be reasonable and

be compensation for goods, services, and facilities actually provided.

These principles accomplish several things. First, the consumer knows upfront

how much the mortgage broker will charge. Second, the consumer is given the opportunity to choose how this payment will be paid. Third, and most importantly, the

broker compensation remains the same regardless of method of payment. This point

is crucial, because it eliminates any anticompetitive incentive the broker has to

place the borrower in a loan with an interest rate greater than they otherwise would

qualify. In other words, whether the borrower chooses a below-par loan, a par loan

or an above-par loan with a yield spread premium, the broker compensation will remain the same. This is not how the system works today and it must be changed.

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26Source: HUD Statement of Policy 1999–1, 64 Fed. Reg. 10080, 10081 n.1 (March 1, 1999). 27Source: Language mirrors affiliated business arrangement exemption in 24 C.F.R.

§ 3500.15(b).

28Source: HUD Proposed Rule, 62 Fed. Reg. 53912, 53927 (October 16, 1997) (proposed Mortgage Broker Contract, Appendix F). See also, Federal Reserve/HUD Joint Statement to Congress

on RESPA/TILA Reform (1998). 29Source: HUD Proposed Rule, 62 Fed. Reg. at 53925 (proposed § 3500.14(g)(2)(I)(A).

In summary, yield spread premiums have been a source of mortgage lending

abuse for a number of years. Finally, when the Federal courts began to seriously

hold the mortgage lending industry liable, the industry, instead of reforming its

ways turned to HUD for salvation. HUD, instead of protecting consumers, cast its

lot with mortgage lenders and attempted to protect the anticompetitive marketplace

that currently exists, HUD’s ultimately cynical policy clarification was not only disappointing but also an abdication of their mandate to protect and promote homeownership. We can only hope that in the future, HUD will rethink its decision and

issue regulations that adopt principles that not only claim to protect consumers, but

also in practice actually do.

Appendix A

PROPOSED CHANGES TO REGULATION X

1. Add Following Definitions to § 3500.2(b)

Total compensation received by a mortgage broker for bringing together a borrower and a lender to obtain a Federally related mortgage loan for the borrower includes all payments made by the borrower directly to the mortgage broker in cash

or in the form of any thing of value, all payments received from the proceeds of the

loan, and all payments received from the lender or any other settlement service provider that are directly related to the brokering of the loan.

Par rate means the interest rate offered to a mortgage broker (through lender’s

price sheets) at which the lender will fund 100 percent of the loan with no premiums or discounts to the mortgage broker.26

2. Add the Following Addition to § 3500.14(g)

§ 3500.14(g)(4): The payment of a fee by a lender to a mortgage broker related

to the making of a Federally related mortgage loan shall not violate Section 8 of

RESPA (12 U.S.C. § 2607) or § 3500.14 if all of the conditions set forth in this subsection are satisfied.27

(i) The mortgage broker agrees to represent the borrower, to act as the borrower’s agent, and to get the most favorable mortgage loan that meets borrower’s stated objectives.28

(ii) Prior to the preparation of the mortgage loan application or receipt of any

payment, whichever is first, the mortgage broker and the borrower complete

and execute a Mortgage Broker Contract, in substantial conformity with the

form in Appendix F to this part, that states clearly and conspicuously: 29

(A) the mortgage broker’s total compensation, expressed both as a dollar amount and as a percent of the loan amount requested by the borrower;

(B) the borrower owes any compensation to the mortgage broker only

if the borrower enters into a Federally related mortgage loan with a lender

to whom the mortgage broker referred the borrower; and

(C) the available methods by which the borrower can choose to pay the

mortgage broker the total compensation in the Mortgage Broker Contract.

(iii) Following loan approval, but no later than five (5) business days before

settlement, the lender and borrower enter into a Broker Funding Contract, in

substantial conformity with the form in Appendix G to this part, that states

clearly and conspicuously:

(A) the available methods by which the borrower can pay the mortgage

broker the total compensation disclosed in the Mortgage Broker Contract;

(B) the par rate, the proposed interest rate, and the monthly payment

(excluding escrow) of any method described in § 3500.14(g)(4)(ii)(A) when

the lender offers to pay all or part of the total compensation to the mortgage broker through funds resulting from an interest rate higher than the

par rate for a mortgage loan with otherwise equivalent terms and fees;

(C) that the borrower may select one of the methods described in

§ 3500.14(g)(4)(ii)(A).

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(iv) The total compensation paid to the mortgage broker compensates the

broker for goods, services, and facilities and is reasonably related to the value

of such good, services, and facilities.

(v) Any fee paid by the lender to the mortgage broker for the Federally related mortgage loan reduces, dollar for dollar, the amount owed to the mortgage

broker by the borrower pursuant to the Mortgage Broker Contract described in

§ 3500.14(g)(4)(ii) and must be paid at or before the settlement.

(vi) The borrower receives a copy of the Mortgage Broker Contract described

in § 3500.14(g)(4)(ii), and the Broker Funding Contract described in

§ 3500.14(g)(4)(iii).

(vii) The mortgage loan, the Mortgage Broker Contract, and Broker Funding

Contract do not contain provisions that waive or restrict the borrower’s right

to enforce the provisions of RESPA and these regulations or other rights related

to the mortgage through judicial process.

3. Add Supplementary Information Regarding Applicable Date

These amendments apply to mortgage loans entered into on or after January 1,

2002 [or other date in the future].

4. Add Appendix F, Mortgage Broker Contract

[TO BE DRAFTED]

5. Add Appendix G, Broker Compensation Contract

[TO BE DRAFTED]

78

PREPARED STATEMENT OF DAVID OLSON

MANAGING DIRECTOR, WHOLESALE ACCESS MORTGAGE

RESEARCH AND CONSULTING, INC.

JANUARY 8, 2002

Qualifications

I am the Managing Director of an economic research firm. I have been studying

the mortgage industry for over 30 years. Since 1991 our firm has conducted much

of the primary research on mortgage brokers in the United States. Although I am

a member of the MBA and NAMB, I do not represent either association at these

hearings. I merely represent myself as an independent economist. I have been asked

to comment on the recent Statement of Policy 2001–1 by HUD concerning yield

spread premiums (YSP’s), and what HUD should do to prevent their abusive use.

I also have some thoughts to share about markets, economics, and predatory lending.

In the early days of my professional career, I was a student of socialist systems

and spent time in Russia and Eastern Europe. I saw first-hand how miserably socialism operated. It led to slow growth, few benefits to the consumer, and loss of

political freedom. The first 10 years of my career made me passionate about market

systems as the best way to meet the economic needs of the population and preserve

the most freedom. From my experience, the best solution to most economic needs

is to let the market operate more freely. This will produce the most goods at the

lowest cost.

Mortgage Broker Market

The mortgage market in the United States is highly competitive—at least that

part concerning the origination of mortgage loans. Only those firms that have low

costs can compete today. No firm is earning monopoly profits at the expense of the

consumer.

Mortgage brokers have evolved fairly recently to meet the needs of consumers.

There were only a few operating before 1980. By 1987, they had 20 percent of the

market. In 2001, we estimate they had around 65 percent of the market. That is,

of the $2 trillion of residential mortgage loans originated, $1.3 trillion were made

by mortgage brokers.

Mortgage brokers are the leading channel for the production of mortgages. We

estimate there are 33,000 of these small, independent firms today. The median firm

has 5 workers, including the owner. The average firm has 9 workers, for a total employment of nearly 300,000 persons. They operate throughout the United States.

The median firm is only 5 years old. So, they are quintessentially an industry of

small firms competing vigorously with one another. If they do not give the consumer

good service, they go out of business. In this sense, they are similar to barber shops.

No firm has any special factors with which to exact extra-normal profits from the

consumer other than personal service.

Market information is widespread. Any shopper can log onto a computer and get

instant market information from thousands of competing firms. Prices also are

available in newspapers and television. Mortgages have become a commodity, with

very little variation in price among lenders. There are firms out there, especially

internet firms, that compete solely on price and offer little human interaction. Up

until now, consumers have not flocked to these firms, but have stayed mainly with

local brokers who can walk them through the complex process of originating a mortgage. The paperwork to complete a mortgage is highly regulated and complex and

must be done correctly. If the loan is not done correctly, the consumer does not get

the loan and the loan originator does not get paid.

Fifteen years ago, this industry was dominated by savings and loan associations.

Since then, a vigorous secondary market has evolved that allows mortgages to be

converted into securities and traded around the world. The tasks to make a mortgage have become specialized. We now have about 100 wholesale mortgage firms

buying loans from 33,000 mortgage brokers. Mortgage servicing has become more

centralized within the hands of a few larger wholesale firms. But brokers are the

low cost producer of the origination process.

The mortgage industry is highly volatile, with periods of high refinancing. Such

peak volume years occurred in 1993, 1998, and 2001, when volume nearly doubled

from the prior year. It is especially in such years that brokers are needed. The existing retail firms are not equipped to grow their work forces that fast. But brokers

are very agile and can grow and contract more quickly to meet the needs of the market. Without brokers, the market would have virtually collapsed last year and many

consumers who wanted the opportunity to refinance their mortgage to a lower rate

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would have been frustrated. There would have not been enough trained workers

available to meet their need.

Yield Spread Premiums

The mortgage industry serves the housing industry. It has become national policy

to permit as many households as possible to own their own home. The goal is get

the share of homeowning households up to 70 percent. The main factor holding back

more consumers from buying a house is the downpayment. So the market has

evolved several ways to solve that problem—no downpayment or very low downpay- ment mortgages. It costs about 2 percent of the mortgage amount or $2,800, which

is needed to compensate the broker for his cost, time, and profit in originating a

mortgage loan. Most buyers today either do not have that amount to pay the origination fee or prefer to finance that fee. The mortgage originator cannot perform his

origination function without being paid. From this has evolved the ‘‘yield spread premium,’’ which is a way for the homebuyer to retain more of his cash and yet pay

the mortgage broker for his service—predominately saving the consumer dollars by

refinancing at a lower rate and thereby lowering the consumer’s cashflow. Mortga- gors are saving on average about $100 per month (assuming a 1 percent reduction

in the interest rate from 7.5 percent to 6.5 percent on a $160,000 loan) by enlisting

the mortgage broker’s services. In today’s market, the consumer has the choice of

paying all of the fee upfront, part of the fee upfront, or financing the entire fee. The

typical homebuyer opts to pay part of the fee upfront. So the income of the mortgage

broker in today’s market is 55 percent in fees from the consumer and 45 percent

in the form of a payment from the wholesaler.

Yield spread premiums are really a financing tool. They became available around

1990 due to securitization. Their availability has spurred mortgage finance and had

various spillover effects, including expanding the ranks of homebuyers; increasing

refinance activity; growing the ranks of originators, especially brokers; and aiding

the economic expansion of the 1990’s. In particular, it has helped moderate the current recession by promoting the financing of homes and keeping the housing market

vigorous.

If Congress outlawed yield spread premiums, the results would be: (1) fewer mortgage originations, especially among middle- and low-income consumers; (2) higher

out-of-pocket expenses for homebuyers and homeowners; (3) fewer mortgage originators; (4) reduced national income and GDP.

Exactly how many fewer mortgage transactions would result with a ban on yield

spread premiums is conjecture. We believe the reduction could be 33 percent. A ban

would adversely affect mortgagors, and broker mortgagees. There would absolutely

be fewer of each group. The declines in each would be proportional. These declines

would ripple through the mortgage sector, affecting realtors, builders, appraisers,

mortgage insurers, credit bureaus, escrow companies, etc. Mortgage costs would rise

due to less competition.

More disclosures would add complexity and cost to a mortgage process which is

already extremely confusing to the consumer. Predatory mortgage legislation is

probably superfluous. The existing laws protect consumers from being bilked by

swindlers and gougers. The number of predatory victims is quite small compared

with the size of the mortgage industry. We estimate the number of mortgagors

served with a new or refinanced loan at 60 million in the past 5 years. Very few

have been harmed. There is no evidence to the contrary. Is it worth harming that

huge market with even more laws? Enforcement of existing laws is the answer.

Reaction to HUD Clarification on YSP’s

I was present in Toronto, Canada at the MBA annual meeting when Mel Martinez

announced his clarification of HUD’s policy on yield spread premiums. I support his

clarification because it explained the earlier statement HUD made in 1999 to the

judiciary and thus should stop class action law suits over the mere payment of yield

spreads to brokers. The mortgage industry has been plagued by class action law

suits for several years that have cost the industry tens of millions of dollars. Ultimately, these costs are paid by consumers.

Impact on Brokers of Limiting YSP’s

I have been a long time supporter of mortgage brokers, who in 2001 handled

about 65 percent of all mortgage originations in the United States. They did so because they are the low cost providers. Our firm has studied this issue since 1991

and has been unwavering in its conclusions that brokers provide consumers with

better service at a lower cost than their competitors. To restrict brokers is to hurt

consumers.

Brokers get half their income in the form of yield spread premiums. I estimate

that if yield spread premiums were made illegal, about one-third of all brokers

80

would drop out of the business; and the other two-thirds could survive by charging

higher upfront origination fees, but it would dramatically change their customer

profile. They would no longer be able to serve as many consumers with credit problems or FHA buyers. That means the market share of mortgage brokers would diminish. This would be very anticonsumer because brokers do a majority of the refinances in years such as 2001. Banks, thrifts, credit unions, and mortgage lenders

use the concept of yield spread premium but do not have to report it. Any restriction

on YSP’s would only adversely affect brokers and have no impact on these other

mortgage lenders. In addition, the retail channel (made up by banks, thrifts, etc.)

just could not handle the volume. That means in the next refinance wave, many

consumers would not get the refinances they desire, certainly not compared to those

who refinanced them in the past waves. You would in effect frustrate about onethird of the 7 million households that did refinances, or 2.3 million households. Do

you really wish to frustrate that many people? We estimate there are 33,000 independent mortgage brokers processing and originating loans currently within the

United States. The average firm has 9 people working for them for a total of

297,000 employees across the brokerage industry. Do you wish to put 99,000 people

out of work? In Maryland, there are 550 independent mortgage brokers with total

employment of about 5,000 people. Do you wish to put 1,700 Maryland workers out

on the street?

Maryland has lost many financial services firms over the past 30 years, including

my former firm, Commercial Credit. There was MBNA, Maryland National Bank,

Equitable Banks, and Baltimore Federal Savings Bank. In part, the 550 mortgage

broker firms in Maryland have replaced the mortgage departments of those once

venerable firms. But if Congress bans YSP’s, you would put one-third of these

brokers out of business also and force further consolidation in the industry. Nor

would the consumer be benefited. You would force consumers into the hands of larger firms, mostly based elsewhere, that might charge higher rates and fees. Shrinking the supply given fixed demand would shift supply to the left and the price

would, of course, rise. Consumers would pay a higher price consequently.

Impact on Consumers of Limiting YSP’s

If yield spreads are eliminated and all consumers have to pay out-of-pocket fees,

a large number of lower-income people would be pushed out of the market. This

would fall most heavily on minorities. It would lower the portion of households that

can become homeowners. Past Administrations have aimed toward 70 percent of all

households becoming homeowners. That percentage would have to fall greatly, perhaps back down to 60 percent. As all these transactions are taken out of the market,

there are thousands of secondary market impacts—a reduction in credit agents, appraisers, escrow agents, etc. Call them unintended consequences.

What happens when Government protects consumers from borrowing mortgage

money? Some loans are not made or the consumer resorts to credit cards and to personal loans at 18–21 percent interest or to hard money lenders at even higher rates

of interest. Right now the prime mortgage industry is barely profitable and

subprime mortgage lending is unprofitable. There has been an exodus of capital for

the past several years. Consumers will not be benefited by causing more lenders to

exit.

Disclosures to Curb Abuses

If we mandate even more disclosures, make it the same for all lenders. The problem with asking brokers to estimate their YSP’s at time of application is that they

do not know what it will be. Until the loan application is complete, they do not know

who they will be selling the loan to or what their YSP will be. They can only say

that typically they earn half the cost of doing the transaction in that form. This is

also true of all other retail lenders, not just brokers but loan originators at banks,

thrifts, credit unions, and finance companies too. If you mandate even more disclosure, make it the same for all lenders. I would support uniform disclosures of all

mortgage originator payments as a way to curb abusive uses of yield spread premiums to the extent they exist. But I do not think abuses are widespread, as consumers are increasingly sophisticated about financial matters. Doing away with

yield spread premiums would not eliminate predatory lenders who thrive on cheating uneducated customers.

Rather than trying to eliminate every vestige of overpricing, Congress should foster more education about loans. Over the past 3 years, over half the firms in

subprime lending have shut down. The remaining firms are not very profitable and

are trembling not to be sued by the many new laws now on the books. I dare say,

very few predatory acts (however these are defined) are taking place. Flipping has

hurt Baltimore, but that has little to do with YSP’s. Therefore, any new legislation

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1 Culpepper v. Inland Mortgage Co., 132 F.3d 692, rehearing denied, 144 F.3d 717 (11th Cir.

1998). 2 64 Fed. Reg. 10080.

3 66 Fed. Reg. 53052.

4This Committee’s 1974 Report issued in connection with the original RESPA litigation, states

that RESPA is intended to ‘‘prohibit all kickback or referral fee arrangements whereby any pay- ment is made . . . for the referral of real estate settlement business.’’ S. Rep. No. 93–866, 1974

U.S.C.C.A.N. 6546, 6551. 5See Culpepper v. Inland Mortgage Co., 132 F.3d 692, rehearing denied, 144 F.3d 717 (11th

Cir. 1998). The 1999 SOP states: ‘‘In the determination of whether payments from lenders to

mortgage brokers are permissible under Section 8 of RESPA, the threshold question is whether

there were goods or facilities actually furnished or services actually performed for the total compensation paid to the mortgage broker.’’ 64 Fed. Reg. at 10085. 6The text of the 2001 SOP, as well as the Secretary’s news release announcing that pronouncement justified the SOP on the grounds that ‘‘[y]ield spread premiums serve to allow the

borrower a lower upfront cash payment in return for a higher interest rate. . . .’’ See 66 Fed.

Reg. at 53055; see also HUD News Release No. 01–105. 7 Culpepper I, 144 F.3d at 718. 8 A yield spread premium is legal under Culpepper III ‘‘if the agreement to pay it bore the

hallmarks of a fee-for-service exchange.’’ Culpepper III, 253 F.3d at 1331.

beyond uniform disclosures across the entire industry would be redundant, counterproductive, and against the consumer’s best interest. The normal use of a YSP is

not predatory lending. It is part of doing business.

—————

PREPARED STATEMENT OF DAVID R. DONALDSON

COUNSEL, DONALDSON & GUIN, LLC

JANUARY 8, 2002

Chairman Sarbanes, distinguished Members of the Committee, thank you for inviting me to testify on the abusive uses of yield spread premiums. By way of introduction, I am a lawyer in private practice in Birmingham, Alabama. I represent the

plaintiff class in Culpepper v. Irwin Mortgage Corporation, a damages suit brought

under the Real Estate Settlement and Procedures Act (RESPA). A 1998 Federal

court of appeals decision in Culpepper 1 led to HUD’s 1999 Statement of Policy

(SOP).2 Another decision by that same court in June 2001 resulted in HUD’s 2001

SOP3 that this Committee has asked me to discuss here today.

I would like to begin by expressing my deep appreciation to this Committee for

its efforts to examine and curb abusive and deceptive lending practices. The mortgage industry’s current yield spread premium practices that are reflected in HUD’s 2001 SOP are an integral part of the well-documented predatory problem that is

crying out for examination and remedy.

Irwin and many other lenders currently offer brokers yield spread premium payments whenever brokers are able to convince borrowers to accept higher interest

rate loans. Consumers are, in effect, being encouraged to borrow money that lenders

use to bribe brokers to do business with them. Consequently, brokers who have been

fully compensated by loan origination fees and other ‘‘direct’’ payments also receive

unearned additional ‘‘compensation’’ that costs homeowners thousands of additional

dollars in mortgage payments over the duration of their loans.

RESPA outlaws all kickbacks and referral fees.4 Under Culpepper, a yield spread

premium can be legal if the evidence demonstrates that the yield spread premium

was paid in exchange for the broker’s services.5 HUD’s 2001 SOP seeks to delete

the ‘‘for services’’ requirement and thereby legalize ‘‘reasonable’’ referral fees even

when no additional compensation is owed to the broker. I believe HUD’s recent

actions to be misguided, irrational, and in direct conflict with Congress’s express intent in passing RESPA.

Yield Spread Premiums Are Not Being Used To Lower Closing Costs

HUD’s ostensible reason for the 2001 SOP was its claim that Culpepper might

prevent borrowers from using yield spread premiums to lower their upfront closing

costs.6 The court’s Culpepper decisions, however, expressly allow borrowers to finance closing costs through yield spread premiums.7 A yield spread premium could

be legal under Culpepper III if the lender’s form contract with the mortgage broker

required the broker to use the yield spread premium payment to reduce borrowers’ upfront closing costs.8

HUD’s and the industry’s ‘‘consumer benefit’’ arguments are clearly ‘‘red herrings.’’ Under HUD’s ‘‘reasonableness test,’’ YSP’s are legal regardless of whether

they are used to lower closing costs. Moreover, lenders and brokers do not, in fact,

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9 Culpepper v. Inland Mortgage Corp., 953 F.Supp. 367, 371 (N.D. Ala. 1997). 10The HUD–1 Settlement Statements required by RESPA and HUD to be delivered at closing

is required to reflect credits against closing costs for payments made by the lender on the borrower’s behalf if any were given. 11 In HUD’s Press Release No. 01–105 announcing the 2001 SOP, Secretary Martinez stated: ‘‘At closing, too many American families sit down at the settlement table and discover unexpected fees that can add thousands of dollars to the cost of their loans.’’ In the December 23,

2001 edition of The Los Angeles Times, Mr. Falk, who is testifying here today on behalf of the

National Association of Mortgage Brokers, was quoted as stating that ‘‘horror stories abound of

borrowers arriving at closing to find that [the] actual cost of various services are hundreds of

dollars above what was disclosed on the Good Faith Estimate.’’ 12During HUD’s negotiated rulemaking on yield spread premiums that led up to its 1997 proposed rule for providing for binding contracts between brokers and borrowers, the NAMB argued

‘‘strenuously’’ that yield spread premiums should not be disclosed to borrowers. See 62 FR at

53917. In the NAMB’s December 4, 2001 Position Paper entitled ‘‘Mortgage Originator Disclosures—Position on Prospective HUD Rulemaking Concerning Mortgage Originator Disclosures’’

(available on the NAMB’s website www.namb.org) has an entire section (at ¶ 4) devoted to its

contention that ‘‘Originators should not be required to disclose their compensation.’’ 13See 1974 U.S.C.C.A.N. at 6550.

use yield spread premiums to lower borrowers’ closing costs. At the outset of the

Culpepper litigation, Irwin claimed that ‘‘the yield spread premium was simply the

market-driven payment to [the broker] for an asset—the loan itself.’’ 9 It was only

after the courts rejected that argument that industry lawyers concocted the idea

that yield spread premiums were used to lower borrowers’ closing costs. My colleagues and I have examined thousands of Irwin’s borrowers’ loan documents, and

I have yet to find a single class member whose closing costs were reduced as a result of yield spread premiums. Among class members in other cases, I am only

aware of a tiny handful of settlement statements reflecting credits against the borrowers’ obligations resulting from yield spread premiums.10

If yield spread premiums were actually being used to lower borrowers’ closing

costs, the lenders could expect to prevail in the litigation. Indeed, if they are not

violating the law, they will prevail in court. But it is highly improper for HUD to

attempt to overrule the courts, alter the plain meaning of Congress’ statute, and,

indeed, interfere with both procedural and evidentiary issues in the judicial system.

HUD has no such power, nor should it.

HUD’s 2001 SOP Does Nothing To Curb Abusive YSP Payments

HUD and mortgage industry representatives have publicly admitted that mortgage brokers frequently tack on unexpected charges at closing when it is too late

for borrowers to obtain other financing.11 This should come as no surprise since the

National Association of Mortgage Brokers (NAMB) takes the position that brokers

should be allowed to hide yield spread premiums from borrowers.12 While the Culpepper court’s ‘‘fee for services’’ approach would help curb these nefarious ‘‘bait and

switch’’ tactics, HUD’s ‘‘reasonableness’’ test encourages brokers to tack on additional charges at closing. Since the ‘‘reasonableness’’ of a charge is measured by

what other brokers charge, no referral fee or kickback can be illegal under HUD’s

test as long as the practices are widespread.

HUD’s ‘‘Reasonableness’’ Test Amounts to Illegal Rate Regulation

When Congress passed RESPA, it expressly rejected HUD’s proposals for authority to impose caps on settlement charges. Congress chose to allow the market to set

prices and rejected HUD’s request for a ‘‘large bureaucracy’’ within HUD to set rates

for various types of loans in various locales.13 Since HUD lacks the legal authority

and the staff to set caps on settlement charges for various loans, it surely cannot

examine millions of individual loan transactions to determine if individual broker

payments are ‘‘reasonable.’’ HUD’s ‘‘reasonableness’’ rule ignores the fact that allowing the ‘‘market’’ to set prices is a two-way street. If brokers are free to set their

own charges, they must also be prohibited from collecting more than borrowers

agree to pay.

The 2001 SOP Test For Yield Spread Premium Payments To Brokers Is

Inconsistent With The Test For Other Types of Markups by Other

Settlement Service Providers

The 2001 SOP is also internally inconsistent in the way it treats yield spread premium payments to mortgage brokers as opposed to other types of mark-ups charged

by other service providers. While imposing a ‘‘reasonableness’’ test for YSP payments to brokers, the 2001 SOP states that other settlement service providers violate RESPA whenever they mark up the cost of a third party’s services without providing additional settlement services over and above the services for which the proVerDate 11-MAY-2000 11:24 Mar 05, 2003 Jkt 000000 PO 00000 Frm 00086 Fmt 6633 Sfmt 6621 84933.TXT SBANK4 PsN: SBANK4
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14See 66 Fed. Reg. at 53059. 15See 66 Fed. Reg. at 53058. 16See HUD Press Release No. 01–118. 17Mortgagee Letter 2001–26 (available on HUD’s website). 18See attached letter from Gail Laster to Senator Richard Shelby dated March 21, 2000.

vider has already been paid.14 For example, the 2001 SOP states that a RESPA violation occurs when a lender collects $200 from the borrower for an appraisal fee,

pays an independent appraiser $175 and pockets the $25 mark-up.15 The ‘‘reasonableness’’ of the $200 charge is presumably irrelevant. HUD has recently (and with

great fanfare) 16 brought several RESPA enforcement actions arising from a variety

of contexts unrelated to yield spread premiums. None of these recent enforcement

actions would have been possible under HUD’s ‘‘reasonableness’’ test for yield

spread premiums. Conversely, under the test applied to appraisals and other settlement charges, if a broker charges a loan origination fee and then marks up a borrower’s interest rate a RESPA violation would occur. There is no legal or logical

basis for this inconsistent treatment.

HUD Has Tacitly Admitted That Its 2001 SOP Is Inadequate To Protect

Consumers

HUD recognizes that its ‘‘reasonableness’’ test is inadequate to protect borrowers.

On the same day that HUD released its 2001 SOP, it also sent a letter 17 to all FHA

approved lenders setting out HUD’s views on ‘‘best practices’’ regarding yield spread

premiums. HUD urges lenders to disclose the total amount of the broker’s compensation, including the yield spread premium and to obtain a written acknowledgment by the borrower. HUD also suggested that lenders reflect yield spread premiums as credits on borrower’s HUD–1’s.

HUD’s Claim That The 2001 SOP Is A ‘‘Clarification’’ Is Unsupportable

HUD’s claim that the 2001 SOP reflects its earlier intent is disingenuous. In the

1999 SOP and in correspondence between HUD’s former General Counsel and Members of Congress, including a Member of this Committee, HUD expressly stated that

the 1999 SOP was not intended to change existing law, which was expressed in the

appellate court’s previous Culpepper decisions.18

Five years ago when the Culpepper case was filed, Irwin did not even require brokers to disclose yield spread premium amounts on borrowers’ Good Faith Estimates.

It was not until after the 1998 Culpepper decision that Irwin began requiring brokers to disclose yield spread premium amounts on GFE’s. Although the industry has

been forced by the ongoing yield spread premium class action litigation to make at

least minimal yield spread premium disclosures to consumers, much more is needed

if consumers are to be able to have any hope of protecting themselves in mortgage

loan originations.

Obviously, HUD is correct in the view expressed in its recent mortgagee letter

that brokers should disclose their total compensation and that borrowers should be

given credit against whatever is owed to the broker when the broker receives a yield

spread premium. Even with that disclosure, however, it is doubtful that any but

even the most sophisticated borrower could make an informed decision about yield

spread premiums without additional disclosures being required. To make an informed decision about yield spread premiums, borrowers would also have to know

how much their rates are being increased to generate the yield spread premium and

have to know how much additional monthly interest payments they would incur as

a result of the markup. Moreover, in order to prevent unscrupulous brokers from

overcharging and to prevent borrowers from ‘‘bait and switch’’ tactics where yield

spread premiums are disclosed for the first time at closing on the HUD–1, HUD

must require the mortgage industry to use yield spread premiums to lower closing

costs as it now claims to be doing.

Finally, I would be remiss if I failed to point out my personal opinion that current

yield spread premium practices encourage discrimination. After spending 5 years of

looking at numerous borrowers’ closing documents it is clear to me that borrowers

who are black, female, or Hispanic pay higher total broker ‘‘compensation’’ than

white males. That opinion is also supported by a recent Urban Institute Study financed by HUD which found that ‘‘[t]here is no question that minorities are less

likely than whites to obtain mortgage financing and that, if successful, they receive

less generous loan amounts and terms.’’ HUD News Release, No 99–191, New

Reports Document Discrimination Against Minorities by Mortgage Lending Institutions, at 1 (September 15, 1999). The Urban Institute Study also found that AfricanAmericans and Hispanics tend to pay higher YSP’s than whites and that women pay

more than men. Urban Institute Study at 95 n. 11. One of the Culpepper plaintiffs,

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Beatrice Hiers, is an African-American female from Baltimore whose broker received over $10,000 for assisting in her origination of a $160,000 FHA mortgage.

The $4,500 YSP would never have been paid under the Culpepper rule. According

to Irwin, that payment was legal because it was ‘‘reasonable.’’

Federal regulators require banks and other depository institutions to implement

safeguards to prevent racial and other types of discrimination by their employees.

Mortgage brokers, however, are often nothing more than an individual or small

group of individuals acting as independent contractor loan officers. They are not

subjected to any oversight by institutional lenders or by regulators. Current yield

spread premium practices that base ‘‘compensation’’ on the broker’s ability to convince borrowers to accept higher interest rates encourage discrimination.

Thank you again for inviting me and for your attention to these important issues.

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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES

FROM HOWELL E. JACKSON

Q.1. During the hearing, Mr. Olson said that the mortgage brokerage business ‘‘is not very profitable.’’ Do you have any information

on the profitability of the mortgage broker industry?

A.1. While I have not undertaken an independent investigation of

the profitability of the mortgage brokerage business, I reviewed

several reports on the subject that Mr. Olson himself prepared.

Contrary to Mr. Olson’s testimony at the hearing, these reports indicate that mortgage brokers have been extremely profitable in the

past decade and, in particular, during the 1996–2000 period during

which the sample loans in my study were originated.

To begin with, consider the growth of mortgage brokers. According to Mr. Olson’s Wholesale Access Report: Mortgage Brokers 1998

(published in 1999), the industry grew dramatically during the

1990’s:

There were about 36,000 mortgage brokers in the United States in 1998, up from

14,000 in 1991 and 31,000 in 1997. There was a 14.5 percent average annual rate

of growth in the number of brokers from 1991 to 1998, which is parallel to the 15

percent average annual growth in originations over the same period. (Page 1)

Without any further information, I would be skeptical of any

claims that an industry experiencing such a sustained rate of

growth ‘‘is not very profitable.’’ If the industry were not profitable,

why would so many new firms have been established during the

last decade? However, one does not have to rely on inferences to

assess the profitability of mortgage brokers in the 1990’s. Mr.

Olson’s report directly addresses the issue:

The median broker produced $20 million, had 5 employees, produced 200 loans, earned $2,000 gross per loan, for a total revenue of $400,000 per firm. In 1991, the

median broker produced $15 million with 5 employees. (Page 1)

So while the number of mortgage brokers more than doubled between 1991 and 1998, the level of originations of the median firm

also increased by a third.

Finally, Mr. Olson’s report offers the following evaluation of the

profitability of the mortgage brokerage business in 1998:

The median broker earned $2,000 gross income/loan for 200 loans, which means

gross revenue of $400,000 (Table 94). The mean broker earned $2,443 gross income/

loan for 325 loans, which means gross revenue of $794,000. Median expenses were

$240,000, for a net profit of $160,000 (40 percent). The mean broker earned a profit

of $203,000 on $794,000 (26 percent). Our study covering 1992 shows a median

profit of $100,000 on revenue of $400,000. This suggests a higher rate of profit in

1998 than earlier. Since brokers are rarely C Corporations, they do not pay a corporate profits tax. They do however pay taxes at their lower personal rate. This suggests a total profit by brokers of $7.3 billion (36,000 × $203,000) before taxes. This

exceeds the amount earned by the two Federal agencies combined and much of the

rest of the mortgage industry. (Page 14) (Emphasis added).

As the median firm operates as a sole proprietorship, Mr. Olson’s

report suggests that a typical mortgage broker earned $160,000 in

1998—an extraordinary median level of income for an industry that

does not require substantial training or advanced degrees.

Last year, Mr. Olson issued an updated Whole Access Report:

Mortgage Brokers 2000 (published in 2001). In connection with litigation for which I am serving as an expert witness for the plaintiff

class, I have reviewed a copy of this more recent report. However,

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1 As I explained in my testimony, an initial problem with the policy statement is the Department’s factual assumptions that yield spread premiums are simply an alternative source of financing for closing costs used by a discrete group of borrowers who cannot afford to pay those

costs directly. My own study of yield spread premiums suggests that these payments are being

imposed much more broadly and that borrowers who incur these hidden charges end up paying

their mortgage brokers much more—on the order of $1,000 more—than do borrowers with comparable loans unaffected by yield spread premiums. The Department’s misunderstanding of the

true role of yield spread premiums further weakens the legal basis of the policy statement.

tiality and I am not free to reveal to the Committee the detail of

Mr. Olson’s more recent work. I can, however, provide the Committee my overall assessment of the 2000 report. While there have

been some changes in the structure and the earnings of mortgage

brokers since 1998, I am highly confident that Mr. Olson would

concur in my opinion that there is little in this more recent report

to suggest that mortgage brokering does not remain a profitable

enterprise.

Q.2. In your view, is the 2001 HUD ‘‘clarification’’ consistent with

the law, and should the courts give it deference?

A.2. In the 2001 policy statement, 66 Fed. Reg. 53,052 (October 18,

2001), the Department proposes a legal standard to determine

when the payment of yield spread premiums violates Section 8 of

RESPA. Under the Department’s approach, a yield spread premium

constitutes a per se violation of Section 8 only if the mortgage

broker receiving the payment provides no goods or services in connection with the transaction. If the mortgage broker does provide

either such goods or services, then the payment is legal unless the

borrower can demonstrate that the broker’s total compensation was

unreasonable. Reasonableness, under the Department’s policy

statement, is to be determined on a case-by-case basis and not (by

implication) in a class action lawsuit.

In my testimony before the Committee I questioned the factual

assumptions underlying the Department’s 2001 policy statement.1

I also have serious questions about the policy statement’s fidelity

to the statutory language of Section 8 of RESPA. In my view, there

are three principal difficulties in the Department’s legal analysis.

The Policy Statement Appears to Create a Loophole for the

Market Abuses That Congress Clearly Intended for

Section 8 To Eradicate

In the legislative process leading up to the original passage of

RESPA in 1974, Congress was confronted with substantial evidence

that real estate professionals, such as lawyers and real estate

agents, were using their influence over real estate transactions to

extract kickbacks from title insurance companies and other settlement service providers. Concluding that such payments were inherently unfair and needlessly increased the cost of homeownership,

Congress adopted Section 8 to outlaw these practices. A major difficulty with the Department’s 2001 policy statement is that it appears to create a substantial defense for precisely the practices that

Congress intended to prohibit with Section 8. All of the recipients

of these pre-RESPA kickbacks provided some good or service for

the transaction in question and also received other sources of compensation for their services. The Department’s new policy statement would, as best as I can tell, permit the payments of kickbacks

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2 In the litigation in which I am serving as an expert witness, experts for both sides defendants as well as plaintiffs—used this statistical—analysis to evaluate the impact of yield spread

premiums on mortgage broker compensation.

in real estate settlements unless the recipient of the kickback could

show that its total compensation (including the kickback) was not

unreasonable. Such solicitude for the payment of kickbacks is wholly inconsistent with Congress’s purpose in enacting Section 8 of

RESPA.

The Department’s 2001 Policy Statement Establishes a

Regime of De Facto Rate Regulation for Mortgage Services

in Direct Contradiction of Congressional Intent

When adopting RESPA in 1974, Congress expressly rejected the

proposals to establish a national system of rate regulation for real

estate settlement services and chose instead a combination of prohibitions, such as Section 8, and disclosure requirements. With its

2001 policy statement, the Department effectively repeals this Congressional choice. As I read the policy statement, courts would be

called upon to evaluate the legality of most kickbacks and referral

fees based on the reasonableness of the total compensation of the

recipient. While the Department does not delineate the precise contours of this reasonableness standard, the courts would presumably

have to consider a kickback recipient’s total costs, figure in reasonable rates of return on investment, and come up with an overall

reasonable price for the recipient’s goods and services in light of

contemporaneous market prices for other comparable goods and

services. Congress clearly did not want a Federal administrative

agency to engage in this rate regulation, and I am highly doubtful

that it would have intended for the courts to play such a role.

The Policy Statement Gratuitously Intrudes Upon Judicial

Functions

A further problem with the 2001 policy statement is its gratuitous intrusion into the management of judicial cases. In an apparent effort to influence the certification of plaintiff classes in pending cases, the 2001 policy statement includes language suggesting

that ‘‘it is necessary to look at each transaction individually’’ and

that reasonableness depends on an evaluation of factors that can

only be considered on a case-by-case basis. This analysis strikes me

as misguided and inconsistent with prevailing judicial practices.

First of all, reasonableness in a particular case can only be determined in comparison to a broader category. Of necessity, therefore,

litigation over yield spread premiums will involve consideration of

a large number of transactions. And the best way to determine

whether loans with yield spread premiums entail unreasonable

compensation to mortgage brokers is to compare samples of loans

with yield spread premiums to samples without yield spread premiums.2 To require repeated analysis of this sort in a host of individual cases strikes me as a highly wasteful use of judicial resources. Moreover, the Department’s approach seems to confuse the

question of how much individual borrowers were injured through

the payment of illegal kickbacks—something that might well vary

from transaction to transaction and thus potentially influence the

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amount of damages—with the question of underlying liability. In

many areas of the law, courts determine liability on a class-wide

basis and then base damage awards on individualized determinations. Whether class certification would also be appropriate for civil

suits challenging yield spread premiums under Section 8 of RESPA

strikes me as a matter for the court, not an administrative agency,

to resolve.

How much deference the Federal courts should accord the Department’s 2001 policy statement is an important question that I

did not address in my testimony before the Committee and that I

will only briefly touch upon in this supplemental statement. As described above, I believe there are serious inconsistencies between

the 2001 policy statement and the Congressional purposes in enacting Section 8 of RESPA. To the extent that the courts agree with

my analysis of these issues, the policy statement would be subject

to diminished deference even under the high standards that the

Supreme Court set forth in Chevron U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984). Just last year, however, the Supreme Court narrowed the scope of the Chevron doctrine by holding that when an agency interpretation is not the

product of either formal adjudication or notice-and-comment rulemaking, the Chevron deference standards may not even apply. See

United States v. Mead Corporation, 533 U.S. 218 (2001). While the

implications of the Court’s recent ruling remain to be determined,

I think it is fair to say the decision reduces the degree of deference

that Federal courts are likely to show interpretative rulings such

as the Department’s 2001 policy statement. Particularly to the extent that the policy statement purports to dictate the manner in

which the judiciary should manage class certification procedures,

judicial deference to the agency’s view should be modest. See

Adams Fruit Co. v. Barrett, 494 U.S. 638 (1990) (inappropriate for

courts to consult executive interpretations to resolve ambiguities in

the scope of a judicially enforceable remedy).

Q.3. Currently, when individuals apply for loan assistance or a

home mortgage, they are unaware of their credit scoring, and are

therefore, under the Fair Credit Reporting Act (FCRA), vulnerable

to acts of predatory lending including taking on a mortgage with

a high-interest rate even though their credit score may qualify

them for a low-interest loan. I think this is a serious issue, and

Senator Allard and I have introduced the Consumer Credit Score

Disclosure Act of 2001, which amends the FCRA to provide the consumer with a copy of: (1) the information obtained from a consumer

reporting agency or that was developed and used by that user of

the credit score information; or (2) a copy of the information provided to the user by a third party that developed the credit score,

plus a general description of credit scores, their use, and the

sources and kinds of data used to generate credit scores. As an expert testifying before the Committee, would you agree, that individuals should have access to their credit score in order to protect

themselves from acts of predatory lending?

A.3. Yes. I agree that it would be useful for consumers to be given

access to their credit scores. In addition, as I indicated in my testimony, I think consumers should also be provided information reVerDate 11-MAY-2000 11:24 Mar 05, 2003 Jkt 000000 PO 00000 Frm 00092 Fmt 6633 Sfmt 6601 84933.TXT SBANK4 PsN: SBANK4
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garding the range of loans—including par value loans—available to

borrowers with their credit scores. In addition to improving the

fairness of loan transactions, disclosures of this sort would allow

consumer groups and the financial press to provide better guidance

to borrowers and thereby enhance the overall operations of credit

markets.

*****

Response to the Statement of ABN AMRO Mortgage Group

Following the Committee’s hearing of January 8, 2002, ABN

AMRO Mortgage Group filed a statement disagreeing with certain

aspects of my testimony and appending statements by two expert

witnesses retained by defendants in the Glover v. Standard Federal

Bank litigation in which I am serving as an expert for the plaintiffs. Having reviewed these materials, I remain confident that my

testimony before the Committee presents an accurate picture of the

abusive nature of yield spread premiums, that these payments

impose substantial additional costs on consumers, and that the reforms I advocated for HUD–1 disclosures are fully warranted.

RESPONSE TO WRITTEN QUESTION OF SENATOR SCHUMER

FROM JOSEPH L. FALK

Q.1. As an expert testifying before the Committee, would you

agree, that an individual should have access to their credit score

in order to protect themselves from acts of predatory lending?

A.1. NAMB strongly believes that all consumers should have access

to their credit score in order to know where they stand in the eyes

of the lender, and to better understand how one’s credit history can

affect his/her ability to purchase and own a home. We do not believe accessibility should be a function of whether the individual is

a candidate for a prime or subprime loan, but instead, available to

any and all consumers seeking to obtain a mortgage. More than

just words, NAMB has taken tangible steps to help educate consumers about the importance of one’s credit score. On November

19, 2001, NAMB released an educational piece entitled, ‘‘Buying A

Home . . . How Will Your Credit History Affect You?’’ This is part

of NAMB’s efforts to encourage consumers to ‘‘Know the Score.’’

The article identifies the five key criteria used in determining a

credit score and lets consumers know that they can receive a copy

of ‘‘A Consumer’s Guide to the Facts & Fiction About Credit Scoring and Its Role in Lending’’ from any NAMB mortgage broker

member.

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1Section 8(a) of RESPA states:

No person shall give and no person shall accept any fee, kickback, or thing of value pursuant

to any agreement or understanding, oral or otherwise, that business incident to or a part of a

real estate settlement service involving a Federally related mortgage loan shall be referred to

any person.

RESPONSE TO WRITTEN QUESTION OF SENATOR SARBANES

FROM DAVID R. DONALDSON

Q.1. In your view, is the 2001 HUD ‘‘clarification’’ consistent with

the law, and should the courts give it deference?

A.1. No. HUD’s 2001 ‘‘clarification’’ regarding yield spread premium payments is inconsistent with RESPA’s plain language and

its legislative intent. The courts should not afford HUD’s SOP

2001–1 any deference.

Section 8(a) of RESPA expressly outlaws all referral fees, not just ‘‘unreasonably’’ high referrals fees.1 HUD and the courts have recognized that yield spread premiums violate Section 8 of RESPA unless they fall within the ‘‘goods or services’’ language of Section

8(c), which states that RESPA does not prohibit ‘‘payment for goods

or facilities actually furnished or for services actually performed

...’’ 12 U.S.C. § 2607(c) (Emphasis added.) Thus, for a yield

spread premium to be legal under RESPA, the lender must demonstrate that the yield spread premium was paid for legitimate

‘‘services’’ other than the referral of the loan.

HUD’s 1999 SOP on yield spread premiums contained the same ‘‘for services’’ requirement that is set out in the statute. HUD’s

2001 SOP, however, deleted the statute’s ‘‘for services’’ language.

According to the 2001 SOP, yield spread premium payments are

legal so long as the amount of money received by the broker is

‘‘reasonable.’’ 66 Fed. Reg. at 53055. There is nothing in the statute

to support HUD’s conclusion that ‘‘reasonable’’ referral few are

legal. As this Committee pointed out in its 1974 Report issued

when Congress first enacted the statute, RESPA was intended to

‘‘prohibit all kickback or referral fee arrangements whereby any

payment is made . . . for the referral of real estate settlement business.’’ S. Rep. No. 93–866, 1974 U.S.C.C.A.N. 6546, 6551 (Emphasis added.)

When Congress passed RESPA, it rejected proposals to allow

HUD to determine when rates are too high. Congress chose to

allow an open and honest market to set prices and rejected HUD’s

request for a ‘‘large bureaucracy’’ within HUD to set rates for various types of settlement services in various locales. See 1974

U.S.C.C.A.N. at 6550. Nonetheless, HUD has now unilaterally attempted to grant itself the power it was denied by Congress to regulate the ‘‘reasonableness’’ of broker payments. HUD’s 2001 SOP is

clearly illegal and inconsistent with RESPA. HUD lacks the authority to set ‘‘reasonableness’’ caps that allow brokers to charge

borrowers more than the borrowers agreed to pay.

RESPA carries criminal as well as civil penalties. Yet HUD’s

2001 ‘‘reasonableness’’ test is so vague and ambiguous that it could

never withstand a constitutional challenge. As the Court of Appeals

pointed out, by focusing entirely on the agreement between the

broker and borrower and ignoring the lender’s purpose in making

the yield spread premium payment, the ‘‘reasonableness’’ test

would place the lender in the ‘‘bizarre position of not knowing

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whether its conduct was illegal when it committed it.’’ Culpepper

v. Irwin Mortgage Corp., 253 F.3d 1324, 1331 (11th Cir. 2001).

I also believe that the 2001 SOP is invalid due to HUD’s failure

to comply with the requirements of Section 8(c)(5) of RESPA, which

allows HUD to make RESPA interpretations by regulation after

consulting with the Attorney General, the Secretary of Veterans Affairs, the Federal Home Loan Bank Board, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, and the Secretary of Agriculture. The 2001 SOP was

not adopted by regulation. Nor did HUD consult with other agencies before issuing the SOP.

HUD’s 2001 SOP is based on the misconception that the purpose

of yield spread premiums is to allow borrowers to lower their ‘‘direct’’ closing costs, such as loan origination fees. That idea is pure

fantasy. It is an argument dreamed up in the course of this litigation after the Court of Appeals rejected Irwin’s claim that YSP’s

are compensation for above-par mortgages. Not one shred of evidence has been submitted in any of the yield spread premium cases

to support this fallacious premise. Indeed, it is my understanding

that mortgage industry representatives were unable to locate a single borrower who was helped by the use of yield spread premiums

to testify at the hearing on January 8 conducted by this Committee

from among the millions of borrowers whose brokers have received

YSP’s.

Lenders offer YSP’s for one reason only, to encourage brokers to

send them business. Mr. Olson who testified as a mortgage industry expert at this Committee’s January 8 hearing, has admitted

under oath that he has conducted studies to determine the amount

of yield spread premium that lenders must offer to obtain broker

referrals. Likewise, Standard Federal’s Jeff Conner candidly admitted that Standard Federal offers yield spread premiums ‘‘to get

business.’’ Numerous witnesses in the Standard Federal case have

now admitted that the YSP’s are nothing but a program of inducements to brokers to refer loans to Standard Federal or its subsidiaries rather than to some competing lender. Others admit that the

lender is merely buying high-yield loans by offering the broker a

financial inducement to lock borrowers into high mortgage rates.

Similarly, in the Culpepper case, Irwin admitted that the broker

was owed no ‘‘additional compensation’’ for its services and that

‘‘the yield spread premium was paid to [the mortgage broker in

part] for the slightly above-par yield on the mortgage note and [in

part] for the right to service the loan.’’ Culpepper v. Inland Mortgage Corp., 132 F.3d 692, 697–98 (11th Cir. 1998). Copies of some

of the Standard Federal testimony is enclosed. I can readily furnish

additional testimony if you desire it.

HUD’s 2001 SOP is also based on the misconception that the

Eleventh Circuit Court of Appeals’ Culpepper decisions made all

yield spread premiums illegal. Nothing could be further from the

truth. The Culpepper decisions made it crystal clear that borrowers

may legally use YSP’s to finance closing costs and that lenders may

pay YSP’s if their contracts with the brokers provide for additional

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2 However, as Professor Jackson pointed out in his testimony before the Committee, using

YSP’s to finance closing costs often results in a shockingly high interest rate on the small increment of additional money that is credited to the borrowers.

compensation for the broker’s legitimate services.2 The difference

between HUD’s approach and the statute as interpreted by the

Eleventh Circuit is that the Culpepper court’s decision limits YSP

payments to situations where brokers are owed additional compensation. HUD, on the other hand, now advocates allowing brokers to charge more than borrowers agree to pay.

HUD’s 2001 policy statement is fundamentally inconsistent with

RESPA’s referral fee prohibition. HUD has no power to interpret

RESPA in a manner that frustrates the statute or the policy underlying the statute. HUD’s 2001 policy statement violates this fundamental rule and is accordingly not entitled to any deference by the

courts.

RESPONSE TO WRITTEN QUESTION OF SENATOR SCHUMER

FROM DAVID R. DONALDSON

Q.1. As an expert testifying before the Committee, would you agree

that individuals should have access to their credit scores in order

to protect themselves from acts of predatory lending?

A.1. I agree that borrowers should be provided with a copy of all

information provided by the consumer reporting agencies to third

parties along with information explaining how credit scores are calculated and used. If lenders are forced to stop offering illegal incentives for brokers to jack up people’s interest rates and if brokers

are forced to provide credit scoring information to borrowers, borrowers will have a ‘‘fighting chance’’ to avoid being tricked into

originating ‘‘above-par’’ mortgages that cost them millions of dollars in unnecessary interest payments.

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