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Wednesday, March 29, 2006 | There are lots of ways to borrow money for a home purchase.
A prospective buyer has so many loan options that the spectrum can often seem confusing, contradictory and convoluted. As a result, a majority of borrowers work out how to finance their purchase with the help of a mortgage broker, who ideally shops around for the best deal to suit them.
But California’s Attorney General, Bill Lockyer, voiced concern this week about a loan structure that allows brokers to plausibly line their own pockets with higher commissions at the expense of clients.
Because lenders have begun to pay brokers a bonus for signing clients up for higher-interest loans, some officials worry that brokers have an incentive not to fully inform their clients of all the loan options available. Instead, the concern is that borrowers are being offered more costly loans that might not be best-suited to their needs.
Such bonuses, known in the industry as yield spread premiums, may pose an inherent conflict of interest, Lockyer’s spokesman said, and the lending practices of the mortgage industry are going to become a focus of attention for the California Attorney General’s Office.
“There’s the potential for a conflict of interest, in the sense that the broker may be more interested in getting the bonus than in providing the service that best fits the consumer,” said Tom Dresslar, the spokesman.
Representatives of the mortgage brokerage industry said there is little need for any more scrutiny of their business. Full disclosure is, and has always been an integral part of any loans that involve brokers getting bonuses, they said. No player in the real estate game is as closely watched as mortgage brokers, they said.
Loans incorporating these bonuses have become popular in California’s home-lending market over the last few years. Essentially, such loans offer consumers a trade-off. Instead of paying the broker a fee up-front for their services, the borrower pays a higher rate of interest to the lender and the lender in turn pays the broker a bonus for setting up the loan.
In a traditional loan, a San Diegan wishing to borrow $500,000 at a 6.5 percent annual interest rate could opt to pay their mortgage broker a one-time, one-percent fee of $5,000 for arranging the loan.
Alternatively, the mortgage broker could work with the borrower and the lender to set up a loan whereby the borrower pays no direct fee to the broker. Instead the broker gets a two-percent bonus, or $10,000, in a yield spread premium from the lender. The trade-off for the borrower? That 6.5 percent annual interest rate goes up to 7 percent.
That whole process is, ostensibly, beneficial to the consumer, giving them the option to spread out the cost of setting up the loan into their monthly payments.
“For example, if a customer really, really needs every penny he can get, in cash, out of a transaction, he chooses to offset his costs in the form of a yield spread premium,” said Ed Smith, president of the San Diego branch of the California Association of Mortgage Brokers.
But Lockyer and other critics point out that there aren’t many safeguards in place to ensure that mortgage brokers work out the best deal for their clients. Because they often stand to make a higher commission from setting their clients up with higher-interest loans, Lockyer is worried that customers could be duped into taking out loans that aren’t in their best interests.
Dresslar said Lockyer has received many complaints from consumer groups and consumer rights advocates about predatory lending by mortgage brokers. The problem has surfaced nationwide, he said, and many state attorneys general are trying to find a solution.
By law, a broker is required to disclose to their client any bonus they will receive for signing someone up for a loan, and that figure will be included in the loan documents.
But, one San Diego broker said that, only 1 percent her clients actually read their loan documents. That means people are relying on what the mortgage brokers are telling them, and that could spell trouble.
“I think there are a lot of slimy mortgage brokers,” said Rishon Wagner, vice president of The Mortgage Company in San Diego.
Eric Halperin, senior policy counsel at the Center for Responsible Lending in Washington, D.C., said the problem is with the system. The mortgage industry in California does nothing for the consumer and everything for the lenders and the brokers, he said.
“Right now the broker’s incentive and the lender’s incentive are to put the customer into the highest-rate loan,” Halperin said.
And though a broker is required to include how much they will make out of a home loan in the stack of documents they hand their clients, that figure is rarely picked up on by the consumer, Halperin said.
“It’s not referred to as the ‘premium that I get paid for putting you into a loan that is a higher rate than you would qualify for,’” he said.
Rather, it’s referred to as the “yield spread premium.”
The only way to ensure consumers are getting the best deal, Halperin said, is to impose a fiduciary duty on mortgage brokers. If mortgage brokers are forced to abide by a fiduciary duty, they could be held legally responsible for not acting in the best interest of their clients.
John Marcell, president of the California Association of Mortgage Brokers, said such a step is unnecessary. He said any reputable broker only has his client’s best interests at heart, and will work with borrowers to ensure that they are getting the best deal from their mortgage.
Marcell doesn’t think there is the possibility for a conflict of interests, but said it’s always better to work with a broker who is a member of an industry organization. He also stressed that he’s been campaigning for years to overhaul the licensing of mortgage brokers to ensure that licensed brokers are held to certain standards.
Smith, the Mortgage Brokers Association’s local president, puts it differently. He said the bonus brokers are getting on a loan is spelled out, plain and clear, for consumers to see for themselves. Mortgage brokers, unlike mortgage bankers, are required to take the extra step of disclosing their bonuses, he pointed out, and it’s up to the customer to read their paperwork and to shop around for the best deal.
“There is so much disclosure, you don’t need any more disclosure. How much more disclosure can you have?” Smith said.
“People need to read what they’re doing, they need to be an informed borrower,” he added.