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New York State Bar Association
January 1997
I would like to thank the New York Bar Association for asking me to speak to you this morning. My name is Don Romano. I am the President of the New York Association of Mortgage Brokers and a Director of the National Association of Mortgage Brokers.
I’ve been asked to discuss the various types of Mortgage Broker Fee Arrangements. I will be limiting my discussion to the Fee Arrangements in the State of New York only. Mortgage Brokers in this State operate within a unique set of guidelines. We cannot close loans in our own name. We cannot issue commitments. We cannot fund loans.
In most other states, Mortgage Brokers have the right to close loans in their own name. They do this through table funding, -- when the loan is sold to their investor immediately at the time of closing, --or close the loan through the use of their warehouse line of credit and sell it off at a later date. An individual conducting business in this manner would be required to be a Licensed Mortgage Banker in New York.
A registered New York State Mortgage Broker receives his compensation in the form of points. This is a percentage of the actual loan amount committed to by a lender and payable only when the commitment is accepted by the borrower. Points are paid by the borrower as a closing expense or through the interest rate. When the borrower elects to pay the brokerage fee through the interest rate, then the broker receives his points from the lender.
Lender paid points is called Premium pricing, Yield Spread Premium or numerous other names.
New York State Law requires that compensation received by the broker, from any source, be disclosed to the borrower prior to taking the application. The borrower acknowledges, in writing, that he is engaging the mortgage broker and has agreed to the compensation of the broker for his services.
Should the borrower not be satisfied with the commitment obtained by the mortgage broker he is under no obligation to accept it. By not accepting the commitment, the borrower frees himself of any further financial obligation to the broker. When the borrower accepts the rate and terms of the commitment he is again shown the amount of the brokerage fee and how it is being paid. By signing this commitment, the borrower has again acknowledged what the broker’s compensation is.
Since mortgage brokers are not permitted to close mortgages in their own name, these fees are again disclosed on the HUD-1 at closing. The broker’s fee has been disclosed to the borrower at 3 crucial points in the process- before applying for the mortgage; at the time the rate and terms of the mortgage have been committed to; and finally at the time of closing.
The disclosure requirements in this State were designed to ensure the fact that the borrower does not pay the mortgage broker any fees that have not been disclosed. These requirements seem to be doing the job.
The mortgage broker is engaged by the applicant. His services are purely advisory and administrative in nature. He has no loyalty to any one source of funding. His only goal is to obtain a mortgage for his client. His income is based on his ability to obtain the right financing for his client.
Based on his knowledge of the different products and programs available in the market place, the broker is able to advise his client as to the best way to proceed.
One of the most powerful tools that a broker has today is Premium Pricing.
Premium pricing allows a broker to put together a financial package with the least amount of out-of-pocket cash for his client. Statistics show that today the biggest obstacle to homeownership is availability of cash, not insufficient income. The mortgage industry is limited to what it can do to reduce the cost of closing in New York State. The most powerful tool available to the broker today is Premium Pricing. Through the use of Premiums, closing costs can be subsidized, reducing the cash needed to close.
This became most obvious two years ago.
Two years ago, rates were at an all time low and it was in every homeowner’s best interest to refinance.
Two years ago, home values were at an all time low.
Two years ago, personal savings were at an all time low.
Without the ability for the homeowner to access 0 point loans, many homeowners would not have been able to capitalize on that favorable rate environment.
Homeowners were faced with the problem that their homes were no longer worth what they paid for them. They discovered that the reduced appraised value was going to be the basis of their new mortgage amount. They were often forced to pay down their mortgage, carry mortgage insurance or both. Because of Premium Pricing, these homeowners were able to refinance their mortgages with less cash out of pocket. In many instances it was the only way the refinance was doable.
Today, our company is still doing most of our mortgages at 0 points to the borrower, utilizing only the premium for compensation. We’re finding most borrowers are either extremely tight on cash or feel that they won’t be keeping the mortgage long enough to benefit from the lower rate available by paying upfront points.
Ten years ago, people preferred to use adjustable rate mortgages because they were only going to keep the house for a few years, sell it at a ridiculous profit and buy a larger house. Today they believe rates will drop again and that they will be able to refinance at a lower rate. They just don’t know when it will happen, -- but they are convinced that it will happen. The lower their out-of-pocket expenses are, the better off they are at the time of refinancing.
Mortgage brokers fill a void in the mortgage process. That’s why better than 50% of the mortgages originated in the country are done through mortgage brokers. Banking institutions have been moving away from using personnel to interact with the consumer. They are relying more and more on automation as a delivery system to the public. This may make good economic sense but becomes questionable when looked at from a customer service standpoint.
A recent survey commissioned by the Mortgage Bankers Association found that 97% of the people interviewed were comfortable applying for a mortgage face to face. 29% were comfortable by phone or computer and 27% felt comfortable by mail. Studies done by Citicorp and Norwest also support the conclusion that removing the human element is bad for business.
People want to deal with another human being when going through the mortgage process. This may change over the years, but today “people need people”.
Customers NEED that personal touch. Banking institutions NEED to cut expenses. The mortgage broker solves the problem. Broker originated mortgages are cost effective to the lending institutions and at the same time provide the borrowers the personal relationship they demand.
Let’s take a closer look at broker fee disclosures. As I said earlier, an applicant utilizing the services of a mortgage broker in this State is shown the broker compensation at several points in the application process. Disclosure in a competitive environment works to prevent abuse.
Over the last 2 years there have been 3 high profile suits brought against large lenders in the mortgage industry. Fleet, Ford and Long Beach Mortgage have been sued on the basis of the compensation they paid to their mortgage brokers. All these cases have one thing in common. The mortgages in question were written in States that did not have the same broker disclosures that New York State has.
The real key to the issue in these three cases was that the borrower had no idea of what his total payment to the broker was.
Last month the Washington Post ran an article entitled “Standing up to Mortgage Broker Referral Fees” in which Ed O’Brien was quoted. Mr. O’Brien said negotiated fees paid by the loan applicant to the mortgage broker are not the problem. But the fee that the borrower doesn’t know anything about up front, the fee that the wholesale mortgage broker pays the local real estate broker, violates the federal anti-kickback law.
Complete disclosure early enough in the application process allows the borrower the time to consult his attorney or any other advisor prior to accepting a commitment and closing on the mortgage. My reading of Mr. O’Brien’s comments is that, he too, feels full broker disclosure eliminates the question of kickbacks.
In looking at the issue of Premium pricing, we must keep in mind that this is not something unique to the broker-banker relationship. Let’s say I went out and bought a $10,000.00 - 30 year Treasury Bond today that carries a note rate of 6.5%. Next year I want to sell that bond. The current yield for a 30- year bond has dropped to 6.25%. I no longer expect to sell my bond for $10,000. I expect a higher price, to reflect the higher note rate. That difference in price is a premium.
Similarly, when a banker closes on a mortgage, he now has a note with a given yield. When that note is sold into the secondary market, the banker receives a premium. Just like when my 6.5% bond was sold in a 6.25% market a premium was earned, the banker also receives a premium.
When the broker receives a premium from the banker, the banker is sharing his profits from the sale of the note into the secondary market. The banker has elected to outsource his origination service through the use of the broker and is paying for it on a loan-by-loan basis.
I know of no State that requires a banker to disclose his profits on a loan-by-loan basis. So although broker disclosure inhibits broker abuse, it has no impact on potential banker abuse.
A competitive marketplace is the best protection for the consumer. The common element in the 3 high profile cases mentioned is that they are all dealing with borrowers who are applying for a specialty type product. They have credit problems, loan to value problems, collateral issues or whatever. For one reason or another they do not fit into plain vanilla underwriting commonly known as agency quality.
When dealing with “agency quality mortgages”, otherwise know as “A” credit, it is easy for the consumer to shop different origination sources. They can base their decision on price, timing and services provided. The competitive forces of the market place keep the pricing differential from source to source very narrow and encourages all origination sources to provide the best service they possibly can.
When dealing with mortgages for non-creditworthy borrowers, commonly called Subprime or “B-C Credit” things become complicated. Since each mortgage application comes with its own credit issues, it is priced accordingly.
With so many variables involved and most of them intangible, it becomes difficult to understand the range of pricing that different lenders quote on the same submission package.
Because of the increasing demand for this type of product, a secondary market is developing. Lenders are pooling large numbers of these mortgages and going to Wall Street. Since these pools offer high yields and a diversity of profiles, they are attractive to investors. An investor receives a higher yield than he normally could and has the diversity to protect him from major capital losses.
As securitization grows, underwriting and pricing standards will evolve imposing a structure to this specialty market. Until a solid industry standard is established, we are going to have to deal with large pricing disparity from lender to lender. This makes it difficult for a consumer to comparison shop.
This leaves the door wide open for abuse, both real and perceived.
For example, if a particular mortgage was closed five years ago at, say, 15% and it is performing well today, should it have been closed at 10% instead? The average person looking at this would say, “yes” concluding that this is yet another example of a consumer being “taken” by big business. While this could have been the case, it could also be that this lender took a gamble and won. The lender backed this borrower, betting that the borrower would use the money and straighten out his finances. Now he is ready to refinance at a lower interest rate. Typically, this mortgage would have been monitored closely and a refinance would have been offered as the
profile improved.
Now, Why would a lender want to refinance this loan when they are receiving such a high rate? …to keep a good borrower! Remember, if this lender doesn’t offer the refinance, other lenders and brokers will. This loan WILL indeed be refinanced; it is only a matter of when and by whom!
On the other hand, this mortgage could be one of a small percentage that actually performed. The lender could be taking major losses on the rest. Looking at a wider sampling than just one loan, could lead a person to the conclusion that the rate should have been 19% across the board to reflect the magnitude of the risk.
Every broker in our industry has an obligation to the public to conduct his/her business in a professional manner. A manner that treats the public fairly, by providing the services that they were hired to provide, at a price that has a direct relationship to the service delivered.
The mortgage broker deserves the respect of the public. The vast majority of the brokers in our industry operate in a professional manner. The industry fulfills a public need – mortgages. Mortgages for the first time homebuyer; mortgages to pay for college; mortgages to pay for medical bills; mortgages for a hundred other reasons.
This industry needs every tool imaginable to be able to do its job. The public brings us new challenges everyday. From trying to start their lives in a new house to trying to keep their house out of foreclosure.
We need the tools to do the job properly and we need the trust of the public. We can then look at what the applicant brings to us and address it, fulfilling the needs of the applicant, with the right mortgage at the right price.
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