Under Dodd-Frank, a Broker Cannot Get Paid by Two Sources
Editor’s note: The following was written by Fernando Paez, an experienced mortgage professional and writer who lives and works in California and is a regular contributor to Bills.com.
On April 6, 2011, the Dodd-Frank Wall Street Reform Act went into effect as federal law. It changed everything we knew about mortgage lending for brokers. Combined with current super-strict underwriting guidelines from Fannie Mae and an uncertainty over the future of interest rates, this created a volatile cocktail that leaves many borrowers and mortgage brokers scratching their heads in disbelief.
The Dodd-Frank bill was intended to curb steering, where a broker pushes or steers a borrower to take a certain loan option that pays the broker a bigger rebate or commission over another option that is more beneficial to the borrower. The thinking is that by taking away the yield spread premium, which is the rebate brokers receive for selling a higher-interest loan, borrowers benefit through lower rates and fees.
Unfortunately, lawmakers did not consider all consequences of their actions. As a result, there is confusion in borrowers and brokers alike as to how the law works and how to best quote interest rates on a loan.
Under Dodd-Frank, the broker cannot get paid by two sources. They either get paid directly from the borrower (Borrower Paid compensation) or from the lender (Lender Paid compensation). This prohibits brokers from giving back any portion of their commission or origination fee to the borrower to help them pay for closing costs. Lenders must give brokers two options on their rate sheets:
- Borrower-Paid rates and fees, or
- Lender-Paid rates and fees
Confused? Wait, we're not even close to done yet.
Brokers must now sign up with their correspondent lenders in advance and state how much of a "commission" they are going to get from Lender Paid compensation. And this commission will be exactly the same for every loan, no matter how small or large the loan amount. That means that if the broker has chosen, for example, a commission of 1.25% on every loan, even if the loan amount is very large and will give them an overly large commission, the broker will have to choose that option from the lender with no flexibility to help pay for the borrower's closing costs. This almost ensures that the broker will not be competitive with the bank or direct lender because both of these entities are exempt from the Dodd-Frank's requirements.
This law was disguised as a consumer benefit. In fact, it was created so that brokers are no longer competitive with banks, which are exempt from Dodd-Frank. It will almost certainly force brokers out of business. This should come as no surprise since the banks lobbied hard and long for this type of law. The banks claim this is a reaction to the recent housing and mortgage debacle, but they were lobbying for a similar law in 2005 before the mortgage bubble burst. The only difference between 2005 and 2011 was that back in 2005, the lobby for the National Association of Mortgage Brokers (NAMB) was much stronger and NAMB fought the creation of the law successfully.
Unfair Rates and Fees
Let's look at an example. Based on a loan amount of $417,000 (Fannie Mae conforming loan limit), the interest rate might be set at 5% with a commission of 1.25% ($4,691) going back to the broker. Assuming that the broker's revenue threshold is, for example, $3,800, under the old system the broker could have chosen to pay as much as $890 back to the borrower to use for their third-party closing costs. This would have given the borrower a decent rate and lower closing costs and would have made the broker more competitive with other brokers and banks and direct lenders.
Under the new rules, brokers are not allowed to give back any of their commission to the borrower to use for third party closing costs. This means that the closing costs for the borrower at this rate will be higher. For the same loan a bank or direct lender may offer the borrower the same 5% but with little or no closing costs, again because they are exempt from the law. A bank or direct lender does not have to "show" the borrower how much money they are making, whereas a broker is required to.
Are you scratching your head yet? Wait, there's more.
The other option is the Borrower Paid option where the borrower pays the origination fees directly to the broker. These loans usually have lower interest rates but higher fees. The reason for the higher fees is simply because the lender is not paying the commission or origination, only the borrower can pay for these.
Once again, the broker cannot pay for any of the borrower's closing costs with these points they are charging. Only the lender can pay for a borrower's closing costs in this type of loan scenario.
The bottom line on Borrower Paid options is that the borrower will get a lower rate, but will have considerably higher fees to get the loan. Once again the direct lenders and banks have no such restrictions so they can price loans below what they are giving to brokers to drive brokers out of business.
Do brokers deserve this? Did unethical brokers cause the housing meltdown? Some unethical brokers made predatory loans and share blame. But those bad apples were weeded out by new strict licensing laws like the SAFE Act and state licensing laws and examinations. Also, there are no more predatory loan products left to sell. All subprime and negative amortization loans have gone the way of the dinosaurs.
Who are the lawmakers trying to protect consumers from by making these unfair laws that make loans less affordable to the average homeowner and limit the way honest brokers do business? In my opinion, lawmakers are protecting their fund-raising base — banks and direct lenders that lobbied furiously for these laws for many years. In other words, big campaign contributors, and the same interests that supported the pro-bank, anti-consumer bankruptcy rewrite in 2005.
What this country does not need are sanctions on brokers. What we really need is campaign reform.
Paez has more than 12 years of experience helping homeowners and home buyers with real estate financing. Paez also has experience doing commercial loans and loans for developers. He writes extensively on real estate financing and other subjects for several blogs and Web sites.