Consumer groups believe that lenders should be held liable if they allow borrowers to take home mortgages that aren't suitable for them. In prior articles in this series, I concluded that a suitability standard was not an effective way to deal with bad mortgage selection, unaffordable loans or refinances that don't benefit borrowers. This article looks at suitability in connection with the problem of overcharges.
Borrowers are overcharged when they pay more for the same service than they would if they had the information needed to shop alternative sources effectively. For example, you pay 6 percent and one point whereas if you had known where and how to shop you could have paid 5.875 percent and one point.
I examine three categories of overcharging: lender steering, excessive broker fees, and loan officer overages.
Lender steering refers to the unsavory practice of soliciting borrowers for loans priced higher than those for which the borrower would qualify. Steering is often associated with prime borrowers targeted by subprime lenders and being charged subprime prices.
No suitability rule can deal effectively with steering. There is no way to monitor and enforce rules barring lenders from charging higher prices to particular borrowers than those available to the borrower elsewhere.
The best way to protect borrowers against aggressive solicitors of high-priced loans is to provide them with better alternatives. Vulnerability to solicitations is high when the soliciting loan provider is the only one the borrower knows about. If the borrower is even dimly aware that there is a group of loan providers that has been certified by a trusted source, vulnerability declines sharply.
I have tried to stimulate the development of certification as an accepted part of the home mortgage market by starting Upfront Mortgage Brokers (UMBs) and Upfront Mortgage Lenders (UMLs). These certified loan providers agree that they will not use their superior information to disadvantage borrowers. UMBs meet that charge by setting a fixed fee for their services upfront. UMLs do it by maintaining Web sites that disclose all the information borrowers need to shop effectively.
At this writing, there are about 200 UMBs and three UMLs. Other certification initiatives are in the works, though none are from the ranks of the consumer groups advocating suitability as a remedy.
Excessive broker fees arise primarily from a lack of transparency in broker pricing. Most broker fees are paid by the lender as a rebate or "yield spread premium" (YSP). For example, the wholesale lender who quotes a rate of 6 percent at zero points might pay a YSP of 1.6 points for a 6.375 percent mortgage. The borrower pays the higher interest rate but no cash out of pocket, and is either not aware of the YSP or becomes aware of it too late to do anything about it.
Dealing with this problem by applying a suitability standard to broker fees means making judgments about whether the fee in any particular case is too high. I find this idea morally repugnant: as long as society is not passing judgment on lawyer's fees or doctor's fees, it has no business passing judgment on mortgage broker fees.
Yet a very high mortgage broker fee differs in an important way from, say, a very high lawyer fee. The lawyer's client always agrees to the fee, whereas, unless the broker is a UMB, the broker's client usually doesn't.
The appropriate solution is not fee-setting but transparency. If borrowers know what the broker will make on their transaction, they will prevent overcharges far better than any suitability-based system for controlling fees.
One way to provide transparency is to require all brokers to operate as UMBs. Another workable remedy is to require that YSPs be credited to borrowers, who would have to agree to sign them over to the broker.
Whatever rule is adopted should apply to any transaction on which the loan provider receives YSPs from a wholesale lender. The legal status of the loan provider should not matter. It thus would cover the so-called correspondent lenders who operate just like brokers, and compete with them, except that they close loans in their own names.
Loan officer overages are an amount above the prices posted by a lender to its loan officers. The posted price is the acceptable price; the overage is gravy. For example, the lender posts a price of 6 percent and one point but the loan officer gets the borrower to agree to pay two points. The additional point is the overage.
Overages should be made illegal. Lenders should remain free to charge what they want, but their loan officers should not be free to take advantage of ignorance and naivet to charge some borrowers more than others just because they can.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania.