Real Estate Settlement Procedures Act (RESPA); Simplifying and Improving the Process of Obtaining Mortgages To Reduce Settlement Costs to Consumers

Federal RegisterJul 29, 2002

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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 3500

[Docket No. FR-4727-P-01]

RIN 2502-AH85

Real Estate Settlement Procedures Act (RESPA); Simplifying and Improving the Process of Obtaining Mortgages To Reduce Settlement Costs to Consumers

AGENCY:

Office of the Assistant Secretary for Housing-Federal Housing Commissioner, HUD.

ACTION:

Proposed rule.

SUMMARY:

The Department of Housing and Urban Development is issuing this proposed rule under the Real Estate Settlement Procedures Act (RESPA), to simplify and improve the process of obtaining home mortgages and reduce settlement costs for consumers. The current disclosure requirements under RESPA have not been substantially revised in decades. The current disclosures were comprehensively reviewed as recently as 1998 by HUD and the Board of Governors of the Federal Reserve System, but the problems identified then remain. Nevertheless, since 1998, there have been continuing changes in the marketplace, new products, and greater accessibility of mortgage information via the Internet, all of which are reducing settlement costs and, if properly addressed by Government, could result in greater price reductions for consumers. First, to simplify and improve the mortgage loan process, this proposal would address the issue of loan originator compensation, specifically the problem of lender payments to mortgage brokers, by fundamentally changing the way in which these payments in brokered mortgage transactions are recorded and reported to consumers. Second, it would significantly improve HUD's Good Faith Estimate (GFE) settlement cost disclosure and HUD's related RESPA regulations to make the GFE firmer and more usable, to facilitate shopping for mortgages, to make mortgage transactions more transparent, and to prevent unexpected charges to consumers at settlement. Finally, the rule would promote competition by removing regulatory barriers to allow guaranteed packages of settlement services and mortgages to be made available to consumers, to simplify shopping by consumers and further reduce settlement costs. The proposed rule also includes proposed, revised forms and solicits comments on additional changes including changes to HUD's settlement disclosure form and disclosure requirements.

DATES:

Comment Due Date: Deadline for comments on this proposed rule, including comments on the proposed information collection requirements: October 28, 2002.

ADDRESSES:

Interested persons are invited to submit comments regarding this proposed rule to the Rules Docket Clerk, Office of General Counsel, Room 10276, Department of Housing and Urban Development, 451 Seventh Street, SW., Washington, DC 20410-0500. Communications should refer to the above docket number and title. Facsimile (FAX) comments are not acceptable. A copy of each communication submitted will be available for public inspection and copying between 7:30 a.m. and 5:30 p.m. weekdays at the above address.

HUD also invites interested persons to submit comments on the proposed information collection requirements of this proposed rule. Comments should refer to the above docket number and title, and should be sent to the Office of Information and Regulatory Affairs, Office of Management and Budget, Attention: Desk Officer for HUD, Washington, DC 20503.

FOR FURTHER INFORMATION CONTACT:

Ivy Jackson, Acting Director, Interstate Land Sales and RESPA Division, Room 9146, U.S. Department of Housing and Urban Development, 451 Seventh Street, SW., Washington, DC 20410; telephone (202) 708-0502 (this is not a toll-free number) or for legal questions Kenneth A. Markison, Assistant General Counsel for GSE/RESPA, or Steven J. Sacks or Teresa L. Baker (Senior RESPA Attorneys); Room 9262, telephone (202) 708-3137. Persons with hearing or speech impairments may access this number via TTY by calling the toll-free Federal Information Relay Service at (800) 877-8339. The address for the above listed persons is: Department of Housing and Urban Development, 451 Seventh Street, SW., Washington, DC 20410.

SUPPLEMENTARY INFORMATION:

I. Introduction

The American mortgage finance system is justifiably the envy of the world. It has offered unparalleled financing opportunities under virtually all economic conditions to a very wide range of borrowers that, in no small part, have led to the highest homeownership rate in the Nation's history. At the same time, however, the process of financing or refinancing a home, which is regulated under RESPA, 12 U.S.C. 2601

et seq.

, remains too complicated, too costly, and too opaque for many borrowers. The monies needed to close on a home are a significant impediment to homeownership, and settlement costs are a significant component of these costs. In light of the Administration's commitment to reach even higher levels of homeownership, the RESPA regulatory scheme deserves particular scrutiny and necessary reform.

The current disclosure requirements under RESPA have not been substantively revised in decades. Although the RESPA disclosures were comprehensively reviewed as recently as 1998 by both HUD and the Board of Governors of the Federal Reserve System, the problems identified in that review remain largely unaddressed.

Recent judicial developments regarding lender

payments to mortgage brokers

(yield spread premiums and other named payments based on borrowers' transactions) have heightened the importance of increasing borrower awareness regarding how mortgage brokers are paid and how borrowers can benefit from payments made by lenders based on mortgages exceeding par interest rate.

Some borrowers

understand, agree to, and properly use higher interest rates to lower up front settlement costs. Others report, however, that they paid substantial origination costs in up front fees for mortgages and then learned that they were charged interest rates higher than those they qualified for merely to support an additional payment to their mortgage broker.

The term “lender” is used throughout this document to mean any person who is the “real source of funds” for a federally related mortgage loan.

Except as specifically described in footnote 17, the term “mortgage broker” is used throughout the document to mean a person (not an employee of a lender) who table funds or acts an intermediary in a federally related mortgage loan. Mortgage brokers that are the “real source of funds” for a federally related loan are not regarded as brokers in such transactions.

The term “par interest rate” is used throughout this document to mean the interest rate at which there is not payment made by the lender to the borrower or from the borrower to the lender.

The terms “consumer” and “borrower” are used interchangeably throughout the document.

Under the current rules, many borrowers are provided estimated settlement cost information on a GFE only after paying a significant fee required by a loan originator,

which prevents the borrower from shopping among additional originators using the

GFE. Also, when borrowers receive estimated settlement cost information after applying for a mortgage, the estimates are often unreliable and prove too low. Final charges at settlement often include additional surprise “junk fees,”

which increase the original estimates. HUD's current rules provide little guidance on the standards that originators should be held to in providing good faith settlement cost estimates.

The term “loan originator” is used throughout this document to refer to lenders and mortgage brokers.

“Junk fee” is a term used throughout this document to mean any fee charged for a service to a borrower that has little or no value in relation to the charge, and/or may be duplicative, to increase a loan originator's profits.

By requiring a long listing on the GFE of each estimated settlement charge, the current disclosure fails to highlight the major costs and seems to lead only to a proliferation of charges without any actual increase in the work performed or enhanced borrower understanding to assist in shopping for services and guard against unnecessary charges. The current requirements allow an individual such as a loan originator, to charge several fees for origination, document preparation, and document review. It is difficult for borrowers to distinguish or understand the precise purpose of these various itemized services provided by the same originator. Excessive itemization thus enables originators to charge more than if the borrower could review and shop the total origination charges. The same holds true for title and other third party services. The types of fees charged by loan originators, title agents and other service providers have multiplied in recent years making it steadily more difficult for borrowers to compare settlement costs.

Industry advocacy groups have indicated that they support better disclosure of mortgage broker compensation specifically and loan origination charges in general. Consumer groups have called for protections against yield spread premiums that were not bargained for, more shoppable settlement cost disclosures, and much firmer interest rates and settlement service costs.

Settlement cost disclosures need to be improved so that the information they provide is simpler, clearer, more reliable, and reasonably available to facilitate shopping, increase competition, and lower settlement costs. Although HUD has called for better disclosures in policy statements and opinions, its regulations need to be updated to establish requirements that are more useful to consumers.

While technology and market forces have played a significant role in lowering costs in the settlement process, it is not clear that under existing rules these benefits are passed on to the borrower in the form of lower settlement prices. HUD's rules implementing Section 8 of RESPA require originators to pass through third party costs without “mark-ups” or “upcharges,” and generally prohibits volume discount arrangements. Many industry and consumer advocates assert, however, that these regulatory restrictions prevent activities and innovations which would lower prices to borrowers. Many mortgage industry providers also report that while they follow the rules, they are competitively disadvantaged by those who do not because of the lack of adequate enforcement by HUD.

Specifically, some assert that HUD's RESPA rules impede arrangements for the packaging of settlement services, which would allow packagers to draw on their knowledge of the market and familiarity with the products offered by providers of specific services to develop lower settlement cost packages for borrowers. They assert that such packages would increase competition and enhance borrower shopping, lowering costs more effectively than restrictions against referral fees or unearned fees. In the joint HUD and the Board of Governors of the Federal Reserve System, Joint Report to the Congress Concerning Reform of the Truth in Lending Act and the Real Estate Settlement Procedures Act, (July 1998), (hereafter HUD-Federal Reserve Report) both agencies agreed that an exemption should be established to facilitate the provision of settlement services and to improve consumers' ability to shop effectively for a mortgage loan and thereby allow competitive forces to reduce the cost of financing a home. HUD-Federal Reserve Report at 33. At that time, some settlement service providers claimed that such an exemption would legalize kickbacks and referral fees. HUD has examined this concern and concluded that guaranteed packaging arrangements should be permitted in a carefully circumscribed safe harbor. Deregulation, transparency and a free market will wring out kickbacks, referral fees, and other excesses more effectively than the current restrictions and, for this reason, the establishment of a safe harbor is warranted. Under this proposal, settlement service providers may choose either to operate using an improved GFE disclosure, or to participate in packages qualifying for the safe harbor. Accordingly, this dual approach will provide industry and borrowers alike with an opportunity to test both methods where they should be tested, in the marketplace, to determine which is more effective in lowering settlement costs.

Late last year, in 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 FR 53052 (October 18, 2001), the Secretary announced his intention to make full use of his regulatory authority to provide clear requirements and guidance regarding the disclosure of mortgage broker fees, and more broadly, to improve the mortgage settlement process to better serve borrowers. The Secretary has established the following principles to guide HUD's RESPA reform and enforcement efforts:

1. Borrowers should receive settlement cost information early enough in the process to allow them to shop for the mortgage product and settlement services that best meet their needs;

2. Disclosures should be as firm as possible to avoid surprise costs at settlement;

3. Regulatory amendments should be utilized to remove unintended barriers to marketing new products, competition, and technological innovations that could lower settlement costs;

4. Many of the current system's problems derive from the complexity of the process; with simplification of disclosures and better borrower education, the loan origination process can be improved; and

5. RESPA should be vigorously enforced to protect borrowers and ensure that honest industry providers have a level, competitive playing field.

In accordance with these principles, this proposed rule would first fundamentally change the way in which mortgage broker compensation is reported by requiring, in all loans originated by mortgage brokers, that any payments from a lender based on a borrower's transaction, other than the payment for the par value

of the loan, including payments based upon an above par interest rate on the loan (payments commonly denominated “yield spread premiums”), be reported on the Good Faith Estimate (and the HUD-1/1A Settlement Statement) as a lender payment to the borrower. Additionally, in brokered loans, any borrower payments to reduce the interest rate (“discount points”) must

equal the discount in the price of the loan paid by the lender, and be reported on the GFE (and HUD-1/1A) as borrower payments to the lender. These changes would require mortgage brokers to disclose, at the outset, the maximum amount of compensation they could receive from a transaction, and include the amount in the “origination fees” block of the GFE and separately on the GFE Attachment A-1. They would then disclose the amount of the lender payment to the borrower that would be received at the interest rate quoted, if any. Mortgage brokers would be unable to increase their compensation without the borrower's knowledge, either by placing the borrower in an above par loan, and receiving a payment from the lender (yield spread premiums), or by retaining any part of any borrower payment intended to reduce the loan rate (discount points).

The term “par value” of the loan is used throughout this document to mean the principal amount of the loan.

Through these changes in reporting requirements, HUD believes that virtually all disputes regarding broker compensation in table funded transactions and intermediary transactions involving yield spread premiums would be resolved. Maximum broker compensation would be clear and brokers would have no incentive to seek out lenders paying the largest yield spread. They would instead be motivated to find the best loan product they can for the borrower. At the same time, HUD believes that since these new disclosure requirements will allow borrowers to focus on the total origination costs for shopping purposes, they will not disadvantage brokers in competition with lenders.

Second, the proposed rule would improve the existing RESPA disclosure scheme by establishing a new required format for the Good Faith Estimate providing greater accuracy and usefulness for borrowers, which would: (1) Inform the borrower that mortgage brokers and other loan originators do not offer loans from all funding sources and cannot guarantee the lowest price or best terms available in the market; (2) explain to the borrower the option of paying his or her settlement costs through the use of lender payments based on higher interest rates, or reducing the interest rate by paying the lender additional amounts at settlement; (3) disclose the loan originators' fees, including the mortgage broker's and lender's total charges to borrowers; and (4) require, in transactions originated by mortgage brokers, that all payments from a lender other than for the par value for the loan (including “yield spread premiums,” servicing release premiums, and all other payments from lenders), be reported on the GFE and the HUD-1 Settlement Statement as a lender payment to the borrower and any discount points charged to the borrower must equal the discount in the price of the loan paid by the lender and be reported on the GFE and the HUD-1 Settlement Statement as borrower payments to the lender. These changes will ensure that borrowers receive the full benefit of any payments from or to lenders in brokered transactions, either by reducing their up front settlement costs in exchange for accepting a loan with a higher rate, or by reducing their interest rate and monthly payments by paying additional amounts to the lender at settlement.

The new GFE would also better inform borrowers of the costs of obtaining a mortgage loan from a mortgage broker, as well as from mortgage bankers, lenders or other loan originators, and would better protect borrowers from unnecessary surprise charges at settlement. It would:

(1) Include an interest rate quote in the form of the mortgage loan's note rate and APR, and notification of any prepayment penalties, to assist the borrower in shopping among mortgages;

(2) Disclose subtotals of major categories of settlement costs (including, for example, loan origination costs and title services) to borrowers to eliminate the proliferation of fees by individual settlement service providers, and to allow borrowers to focus on and compare major fees; and

(3) Provide additional shopping information for borrowers that would provide a breakdown of lender and broker origination charges, title insurance and title agent charges, and inform the borrower of lender required and selected services and those third party services that can be shopped for by the borrower.

The proposed rule would further improve the existing disclosure scheme, by amending Regulation X to establish new rules for the provision of the GFE which would: (1) Clarify the basic information needed in an “application” to obtain a GFE; (2) limit fees paid by borrowers for the GFE, if any, to the amounts necessary to provide the GFE itself and exclude amounts used to defray later appraisal or underwriting charges, in order to facilitate shopping with GFEs; (3) require that loan originators not exceed the amounts reported on the GFE regarding their total compensation, lender required and selected third party services, and government charges through settlement (absent unforeseeable and extraordinary circumstances); (4) require that loan originators comply with upper limits or “tolerances” for specified major settlement charge categories so they do not exceed those stated on the GFE by more than 10%; and (5) clarify that loan originators can make arrangements with third party settlement service providers to lower prices for their customers, provided that these prices and any charges are reflected accurately on the GFE and are not “marked up” or “up charged.”

Third, the proposed rule would remove regulatory barriers to allow packages of settlement services and mortgage loans to be made available to borrowers. These transactions would be even simpler and more transparent for borrowers, and would allow market forces, borrower shopping, and competition to further reduce the costs of settlement services to better achieve the purposes of the statute.

To accomplish this objective, HUD would establish a carefully circumscribed safe harbor under RESPA for “Guaranteed Mortgage Package” (GMP) transactions. Any entity (a lender, broker, other settlement service provider, or other entity), hereinafter a “packager,” may qualify for the safe harbor as long as it offers a GMP. The packager must offer the GMP to a borrower following his or her submission of application information, but before the borrower's payment of any fee to the packager. The GMP must include: (1) A guaranteed package price for a comprehensive package of loan origination and virtually all other settlement services required by the lender to close the mortgage (including without limitation, all application, origination and underwriting services, the appraisal, pest inspection, flood review, title services and insurance, and any other lender required services except hazard insurance,

per diem

interest, and escrow deposits); (2) a mortgage loan with an interest rate guarantee, whether when the “Guaranteed Mortgage Package Agreement” (GMPA) is given or subject to change (prior to borrower lock-in) only pursuant to market changes evident from an observable and verifiable index or other appropriate data or means; and (3) a contract offer in the form of a GMPA to guarantee the price for settlement services and the mortgage interest rate through settlement, if the offer is accepted by the borrower. Additionally, in order to ensure that the borrower receives the settlement package of services and the mortgage loan, the proposed rule would require that the packager sign the GMPA agreeing to provide the Guaranteed Mortgage Package at the Guaranteed Mortgage Package price and that non-lender packagers have a lender sign the

GMPA after borrower acceptance agreeing to provide the loan included in the Guaranteed Mortgage Package.

The GMPA would describe the package as “including all services required by the lender to close the mortgage” but would not itemize the specific services to be provided. The packager would, however, be required to inform the borrower if certain items of interest to the borrower are anticipated to be excluded from the package, specifically lender's title insurance, pest inspections, and a property appraisal. Additionally, where the packager anticipates obtaining a pest inspection, appraisal, or credit report, the packager must disclose that information on Attachment A-1 and make such documents available at the borrower's request. The HUD-1 would list the services ultimately provided, but not the charges for specific services. HUD is requesting comments on whether this approach satisfies, or whether alternative approaches should be developed, to ensure that consumers' rights under TILA and HOEPA are protected while facilitating packaging.

The Secretary is exercising the exemption authority under Section 8(c)(5) and Section 19 of RESPA to establish this Guaranteed Mortgage Packaging safe harbor for those Guaranteed Mortgage Package transactions that meet the requirements set forth in this rule. The Secretary has determined that the establishment of this carefully circumscribed safe harbor is necessary to allow this class of transactions to be available to consumers and to achieve the purposes of the Act. The Secretary has concluded that the availability of these packages to consumers at single guaranteed prices with an interest rate guarantee will simplify consumers' shopping for mortgages and allow them to gain the benefit of an active competitive marketplace in which market forces produce lower settlement costs. For the same reasons, the Secretary has determined that payments among packagers and participating settlement service providers and the earnings of packager in Guaranteed Mortgage Packages, as set forth in this rule, shall not be construed as prohibited under Section 8 of RESPA as long as the requirements in this rule are satisfied. Pursuant to Section 8(c)(5) the Secretary has undertaken the necessary consultation with other agency heads as required prior to promulgating this exemption.

The safe harbor from Section 8 will permit the packager to charge for services within the package and will permit payments to, or exchanges of other things of value between entities participating in the package. Section 8 would, however, continue to prohibit any payments for the referral of business, kickbacks, splits of fees and unearned fees between the packager and any of the entities participating in the package on the one hand and entities outside of the package on the other. Under the safe harbor, packagers would provide the GMPA in lieu of a GFE. HUD regards such provision of a GMPA as fully, indeed more than, satisfying the requirements of Section 5 of RESPA that borrowers receive a Good Faith Estimate of the amount of charges for settlement services the borrower is likely to incur. HUD believes that the GMPA, by providing a Guaranteed Mortgage Package price encompassing virtually all settlement charges, along with a limited number of itemized charges, including owner's title insurance, also more than satisfies the requirements of Section 4 of RESPA. Nevertheless, as long as the requirements of the safe harbor are satisfied, HUD is also prepared to exercise the exemption authority under Section 19 to create a safe harbor for packagers from the requirements of Sections 4 and 5 of RESPA, if it deems such an exemption necessary.

The safe harbor is proposed to be available only where the transaction does not result in a high cost loan as that term is defined in the Home Ownership Equity Protection Act, 15 U.S.C.1601(Supp II 1996). The safe harbor also may not be available to mortgages that exceed other limits, or include other features identified through this rulemaking, resulting in unreasonable settlement charges or loan terms inimical to the purposes of RESPA.

The proposed rule's new regulatory requirements will apply to first and second lien transactions, purchase money loans, and refinances. Home equity transactions are addressed in § 3500.7(f), under current RESPA regulation. At Question 26 the Department invites comments on this issue.

The Department also is inviting comments specifically on whether, and to what extent modification of the existing HUD-1/1A Settlement Statement and Instructions, found at 24 CFR part 3500, Appendix A, is necessary to make it comparable to the new GFE. HUD also announces that it plans to revise the Special Information Booklet concerning settlement costs consistent with the final rule, and to develop new booklets for refinance and junior lien transactions.

In this proposed rule at Appendix C and F, the Department is publishing for comment new proposed required formats for the Good Faith Estimate (GFE) and new GMPA. HUD believes that the content of the material in these proposed forms gives the consumer the information needed to shop for loan products and to assist them during the settlement process. HUD recognizes that in order for these forms to be useful shopping tools, they must be consumer friendly. The Department seeks public comment on these proposed forms In addition, the Department will arrange focus groups during the comment period to elicit comments on how to make the material in the new proposed forms as consumer friendly as possible including considering, among other things, how the new proposed forms are best compared by consumers to the HUD-1 and what revisions, if any, to the HUD-1 would be most helpful.

In addition, the Department will facilitate the provision of web based information to consumers on settlement costs and pursue other efforts to ensure that RESPA regulation encourages technological advances to facilitate competition, and lower costs and prices to consumers. Beyond this rulemaking, the Department is examining possible changes to its rules to facilitate electronic mortgage transactions consistent with the Electronic Signatures in Global and National Commerce Act, Public Law 106-229. The Department will also undertake efforts with Federal and State regulators and others to better address technological changes to lower costs.

Additionally, the Department plans to finalize the 1997 Section 6 transfer of servicing proposed rule; however, in the meantime the Section 6 language in the statute may be provided in conjunction with the GFE. Separate from this rulemaking, the Secretary is increasing the resources dedicated to enforcing and regulating RESPA.

Following the background materials, this proposal includes a description of today's proposed rule, specific questions for public comment, and proposed rule language. Public comment on this proposal will be important to formulating a final rule that is consistent with RESPA's purpose, workable in the marketplace, and best serves the financing needs of America's families.

II. General Background

A. Legal Authority

The Department is proposing this rule in accordance with 5 U.S.C. 552, Sections 19 and 8(c)(5) of the Real Estate

Settlement Procedures Act of 1974 (12 U.S.C. 2617).

RESPA Overview

In 1974, Congress enacted the Real Estate Settlement Procedures Act (Pub. L. 93-533, 88 Stat. 1724, 12 U.S.C. 2601

et seq.

) after finding that “significant reforms in the real estate settlement process are needed to ensure that borrowers throughout the Nation are provided with greater and more timely information on the nature and costs of the settlement process and are protected from the unnecessarily high settlement charges that have developed in some areas of the country.”

Id.

RESPA's stated purpose is to “effect certain changes in the settlement process for residential real estate that will result:

(1) In more effective advance disclosure to home buyers and sellers of settlement costs;

(2) In the elimination of kickbacks or referral fees that tend to increase unnecessarily the costs of certain settlement services;

(3) In a reduction in the amounts home buyers are required to place in escrow accounts established to ensure the payment of real estate taxes and insurance; and

(4) In significant reform and modernization of the local record keeping of land title information.” Id.

RESPA's requirements apply to transactions involving “settlement services” for “federally related mortgage loans.” Under the statute the term “settlement services” includes any service provided in connection with a real estate settlement.

The term “federally related mortgage loan” is broadly defined to encompass virtually all purchase money and refinance mortgages.

Section 4(a) of RESPA requires the Secretary to develop and prescribe “a standard form for the statement of settlement costs which shall be used * * * as the standard real estate settlement form in all transactions in the United States which involve federally related mortgage loans.” The rule further requires that the form “conspicuously and clearly itemize all charges imposed upon the borrower and all charges imposed upon the seller in connection with the settlement. * * *” Section 5 requires the Secretary to prescribe a Special Information Booklet for borrowers. Section 5(c) requires that a Good Faith Estimate (GFE) be provided at or within 3 days of loan application, authorizes the Secretary to prescribe the contents of the GFE, and requires that the GFE state “the amount or range of charges for specific settlement services the borrower is likely to incur in connection with the settlement as prescribed by the Secretary.” Notice of transfer of servicing language was added to RESPA at Section 6 in 1990 and amended most recently in 1996, and requires notification to borrowers at the time of application for the mortgage, and during the life of the loan, of whether the servicing of the loan may be or has been assigned, sold, or transferred.

These services include, but are not limited to, “title searches, title examinations, the provision of title certificates, title insurance, services rendered by an attorney, the preparation of documents, property surveys, the rendering of credit reports or appraisals, pest and fungus inspections, services rendered by a real estate agent or broker, the origination of a federally related mortgage loan (including, but not limited to, the taking of loan applications, loan processing, and the underwriting and funding of loans), and the handling of the processing, and closing of settlement.” 12 U.S.C. 2602(3).

Specifically, the term covers mortgages “secured by a first or subordinate lien on residential real property (including individual units of condominium and cooperatives) designed principally for the occupancy of one to four families”; mortgages made “in whole or in part by any lender the deposits or accounts of which are insured by the Federal Government or is made in whole or in part by any lender which is regulated by any agency of the Federal Government” or “insured, guaranteed, supplemented or assisted in any way by HUD or any officer or agency of the Federal Government,” intended to be sold to Fannie Mae, Ginnie Mae, Freddie Mac or an institution from which it will be purchased by Freddie Mac, or is made in whole or in part by any loan originator, among other things, “who makes or invests in residential real estate loans aggregating more than $1,000,000.00 per year.” 12 U.S.C. 2602(3).

Section 8(a) prohibits any person from giving and any person from accepting “any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise,” that real estate settlement service business shall be referred to any person. 12 U.S.C. 2607(a). Section 8(b) prohibits anyone from giving or accepting “any portion, split, or percentage of any charge made or received” for the rendering of a real estate settlement service “other than for services actually performed.” 12 U.S.C. 2607(b). Section 8(c) of RESPA provides, in part, that “[n]othing in [Section 8] shall be construed as prohibiting * * * (2) the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed.” * * * or “(5) such other payments or classes of payments or other transfers as are specified in regulations prescribed by the Secretary, after consultation 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.” 12 U.S.C. 2607(c)(2).

The Federal Home Loan Bank Board (FHLBB) was abolished Effective October 8, 1989, by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, (Pub. L. 101-73). Its successor agency, the Office of Thrift Supervision, Department of the Treasury, assumed the FHLBB's regulatory functions.

Section 9 forbids any seller of property from requiring buyers to purchase title insurance covering the property from any particular title company as a condition of sale. Section 10 limits the amounts that lenders or servicers may require borrowers to deposit in escrow accounts, and requires that borrowers be provided with both initial and annual escrow account statements. Section 12 prohibits lenders and loan servicers from imposing any fee or charge on any other person for the preparation and submission of the Settlement Statement, the escrow account statements required under Section 10(c), or any disclosures required by the Truth in Lending Act.

Section 19 of RESPA specifically authorizes the Secretary “to prescribe such rules and regulations, * * * and to grant such reasonable exemptions for classes of transactions * * *, as may be necessary to achieve the purposes of [RESPA].”

B. Background

HUD's RESPA Rules

In 1975, HUD promulgated its first set of RESPA rules including limited disclosure requirements. Real Estate Settlement Procedures and Cost, 40 F.R. 22448 (1975). These rules included a requirement that the HUD-1 form be given to borrowers within seven days of a loan commitment, with the provision that estimates were permitted for those items the lender could not accurately provide cost information for at the time of loan commitment. Congress amended the RESPA statute in 1976 and included a requirement that borrowers be provided with a Good Faith Estimate along with the special information booklet at, or within 3 days of a loan application. Following these amendments, HUD promulgated rules in 1977 that included a suggested format for the GFE and requirements for its provision to borrowers at or within 3 days of application, as well as a Uniform Settlement Statement, designated as the HUD-1, to itemize settlement charges to borrowers in every settlement involving a federally related mortgage loan where there is a borrower

and a seller, along with instructions and requirements for its use.

On November 2, 1992, HUD amended its rules to implement the 1984 amendments to RESPA establishing a “controlled business exemption” (now known as an “affiliated business exemption”), a controlled (now known as an “affiliated”) business disclosure to be provided at the time of a referral, and a disclosure of required providers to accompany the GFE. 57 FR 49600. The 1992 amendments also made other significant additions and changes, including defining the term mortgage broker,

and applying disclosure requirements to mortgage brokers, as more fully discussed below. In 1994, at 59 FR 6506, HUD amended its rules to conform with the 1992 amendments to the law covering refinancings and junior lien transactions. At that time, HUD promulgated a new disclosure form, the HUD-1A, for use in refinancing and subordinate loan transactions where there is no seller. While the 1992 and 1994 amendments necessitated additional disclosures, the formats of the GFE and HUD-1, and the disclosure requirements, have remained substantially unchanged since they were originally established in 1977.

HUD's RESPA rules, found at 24 CFR part 3500 (Regulation X), currently define a “mortgage broker” to be “a person (not an employee or exclusive agent of a lender) who brings a borrower and lender together to obtain a federally-related mortgage loan, and who renders services” as described in the rule (24 CFR 3500.2(b)).

Contents of Good Faith Estimate and the HUD-1

HUD's RESPA rules require that lenders and mortgage brokers who are not exclusive agents of lenders provide a GFE to all applicants for federally related mortgage loans, and contain a suggested format in Appendix C to 24 CFR part 3500. The suggested GFE format lists twenty common settlement services and provides spaces for the charges for such services. The instructions indicate that any other possible services and charges should also be listed.

The GFE provides a place for the “amount of or range” of each charge that the borrower is likely to incur in connection with the settlement. Between the name and amount of each charge is a reference to where the same charge will be disclosed on the HUD-1 or HUD 1-A at settlement. If the lender requires the use of particular settlement service provider(s) and requires the borrower to pay for any portion of such provider's services, the rules require that the GFE state: that the use of the provider is required and that the estimate is based on the selected provider's price; the provider's name, address and telephone, and the nature of any relationship between the provider and the lender.

The current GFE does not identify the particular items that the borrower may shop for after he has selected a lender or broker, such as a title or settlement agent, title insurance, and a pest inspector.

Specifically, the GFE format lists the loan origination fee, loan discount fee, appraisal fee, credit report, inspection fee, mortgage broker fee, CLO access fee, tax related service fee, interest at “dollars” per day, mortgage insurance premium, hazard insurance premium, reserves, settlement fee, abstract or title search, document preparation fees, attorney's fee, title insurance, recording fees, city/county tax stamps, state tax, survey, pest inspection and the form provides space for additional fees that may be added.

24 CFR 3500.7(e)(3). Except for a provider that is the lender's chosen attorney, credit reporting agency, or appraiser, if the lender is in an affiliated business relationship with the provider (see § 3500.15), the lender may not require the use of that provider.

The HUD-1, described in detail in Appendix A of HUD's RESPA rules, discloses the charges at settlement in major groupings or series. The left hand column on the front of the HUD-1 summarizes the borrower's transaction, listing the cash due at settlement from the borrower, as a result of the gross amounts due less any amounts paid by or on behalf of the borrower prior to settlement. This part of the HUD-1 lists credits to the borrower as well as the total settlement charges due from line 1400 on the back of the form. The right hand column on the front of the HUD-1 summarizes the seller's transaction, listing the total amount due to the seller as the gross amount due to the seller adjusted for items such as settlement charges to the seller and the payoff(s) of any mortgages, and any other items due from seller (such as taxes), to arrive at a total amount due seller.

The 700 series of the HUD-1 lists real estate broker commissions; the 800 series lists origination fees and certain third party settlement services payable in connection with the loan; the 900 series lists items required by the lender to be paid in advance; the 1000 series lists reserves deposited with lender; the 1100 series lists all title related charges; the 1200 series lists government charges; the 1300 series lists any additional settlement charges; and line 1400 discloses the total settlement charges.

The current GFE and HUD-1/1A forms require a listing of the settlement charge for each service, which appears to have led to an increasing proliferation of enumerated services by individual settlement service providers (e.g., loan originators, title agents, etc.) and an artificial separation and inflation of the total charges of certain settlement service providers resulting in higher total costs to borrowers than a more consolidated list would provide. For example, the current requirements encourage loan originators to charge for several separate “services”— origination, document preparation, document review. Similarly, title service providers are required to separate their charges into “abstract,” “document preparation,” “attorney's fees,” and other charges. Moreover, neither the GFE nor the HUD-1 specify the total amount of fees that each major recipient receives and retains, including the lender, the broker, and the title agent. It is reported that some originators charge “junk” fees for “services” to increase profits by filling in as many blank lines on the form as possible. It also has been reported that some originators compete on rate and points when giving quotes and then charge a variety of additional fees to increase their profits.

Provision of the Good Faith Estimate

The RESPA rules require that the loan originator must provide the GFE either by delivering it or placing it in the mail to the borrower not later than three business days after a loan application

is received or prepared. In practice, loan originators frequently insist on the borrower's completion of a full application form and payment of a significant fee to cover the costs of an appraisal and credit check before a GFE is provided. Therefore, by the time that the borrower receives a GFE he or she has typically already selected a particular loan originator, and paid substantial fees, and is highly unlikely to shop further for another loan originator. In addition, because the GFE is not generally provided until the borrower applies for a loan, the form does not provide borrowers with sufficient opportunity to focus on and compare the full costs of the originator and other major recipients of fees, nor does it indicate clearly other individual settlement services including title services that the borrower may shop for. Borrowers must shop on their own without the aid of a GFE.

The rules define an “application” as the submission of a borrower's financial information in anticipation of a credit decision involving a federally related loan on a specific property. 24 CFR 3500.2(b).

Current Definition of “Good Faith”

HUD's RESPA rules currently require that a GFE must be made in good faith, bear a “reasonable relationship” to the charge the borrower is likely to be

required to pay at settlement, and “be based upon experience in the locality of the mortgaged property.” 24 CFR 3500.7(c)(2). The rules, however, do not establish any bright lines or tolerances to assure that there is, in fact, a reasonable relationship between these estimates and final costs at settlement. Although the rules do require additional disclosure where the lender requires the use of a particular provider, stating that the lender must “make its estimate based upon the lender's knowledge of the amounts charged by the provider,” the rules do not establish any bright lines for the loan originator with respect to their estimates of these or other third party charges, or even with respect to their own charges. Id.

Under HUD's rules, charges on the Good Faith Estimate are to be disclosed as “a dollar amount or range of each charge” which will be listed in section L of the HUD-1 or HUD-1A. Frequently, borrowers report to HUD that brokers' or lenders' own charges at settlement include one or more additional fees that were not disclosed on the GFE, or that the charges for particular services rendered by or for the loan originator substantially exceed the estimated amounts. RESPA contains no sanctions for inaccurate or incomplete GFEs, or even for outright failure to provide a GFE. Bank and other regulators do enforce these requirements with respect to regulated institutions, although other originators are not subject to such enforcement.

While the current rules need improvement, they are not entirely without standards. They do require estimates to be in good faith and tell the borrower what charges he or she is likely to incur at settlement based on the originator's experience. For example, on July 5, 2002, HUD issued a letter to the State of Washington that indicated that a range of charges of 0-$15,000 on a GFE for points did not meet these requirements.

Use and Provision of the HUD-1, HUD-1A

Settlement agents are required to use the HUD-1 in every settlement transaction involving a federally related mortgage loan in which there is a borrower and a seller.

The settlement agent is required to complete the HUD-1 in accordance with the instructions at Appendix A to HUD's RESPA rules and to deliver a completed HUD-1 (or HUD-1A where applicable) at or before the settlement to the borrower, the seller (if applicable), and the lender (if the lender is not the settlement agent) or their agents. 24 CFR 3500.8(a). RESPA and HUD's RESPA rules permit the borrower to inspect, a day before settlement, the HUD-1 or HUD-1A containing those items that are known to the settlement agent at the time of the inspection. 24 CFR 3500.10.

16 Under current rules, where there is a borrower and no seller, such as in a refinance or a subordinate lien loan, the HUD-1 may be utilized using the borrower's side of the HUD-1 statement, or the HUD-1A may be used as an alternative.

Mortgage Brokers

In the discussion of mortgage brokers in the background section of this preamble, the term is being used in a broader sense than the proposed amended HUD definition, and the way the term is used throughout the rest of the proposed rule. In this section when referring to mortgage brokers the term also includes those individuals who are the real source of funds through a warehouse line of credit or otherwise.

At the time RESPA was enacted, single-family mortgages were mainly originated and held by savings and loans, commercial banks, and mortgage bankers. During the 1980's and 1990's, the rise of secondary mortgage market financing resulted in the emergence of new retail entities, notably mortgage brokers, to compete with traditional mortgage originators, lending institutions, and mortgage bankers. Today, mortgage brokers are estimated to originate more than 60% of the nation's mortgages.

Mortgage brokers essentially provide retail lending services, including counseling borrowers on loan products, collecting application information, ordering required reports and documents, and otherwise gathering data required to complete the loan package and mortgage transaction. As retailers, brokers also provide the borrower and lender with goods and facilities such as reports, equipment, and office space to carry out retail functions.

The amount of work mortgage brokers provide in particular transactions depends, in part, on the level of difficulty involved in qualifying applicants for particular loan programs. Differences in credit ratings, employment status, levels of debt, assets, and experience frequently translate into varying degrees of effort required to originate a loan. Also, mortgage brokers may be required to perform different components of origination services (i.e., underwriting) pursuant to specific agreements with individual wholesale lenders.

HUD Statement of Policy-1999-1 Regarding Lender Payments to Mortgage Brokers provided a list of compensable loan origination services originally developed by HUD in a response to an inquiry from the Independent Bankers Association of America (IBAA), which HUD considers relevant in evaluating mortgage broker services. In analyzing each transaction to determine if services are performed by mortgage brokers, HUD stated that it believes the 1999 Statement of Policy should be used as a guide. As stated there, the IBAA list is not exhaustive, and while technology is changing the process of performing settlement services, HUD believes that the list is still a generally accurate description of settlement services.

The terms “wholesale lender” or “funding lender” are used throughout the document to mean a lender who does not originate the mortgage loan but provides funds for the loan and may purchase the loan.

Mortgage brokers have various means of obtaining funding for the loans they originate. Some mortgage brokers close mortgage loans in their own name but, at the time of settlement, transfer the loan to a lender that simultaneously advances funds for the loan. Immediately after the loan is consummated, the mortgage broker delivers the loan package to that lender, including the promissory note, mortgage, evidence of insurance, and all rights in the loan that the mortgage broker held. This type of transaction is known in the lending industry, and defined in HUD's regulations, as “table funding.”

Some mortgage brokers function purely as intermediaries between borrowers and lending sources. They originate loans by providing loan processing and arranging for the provision of funds by lenders. Loans which they originate are closed in the names of the funding lenders.

Other mortgage brokers originate loans that are closed in the mortgage brokers' names, fund the loans temporarily using their own funds or a warehouse line of credit, and sell the loans after settlement. These transactions by mortgage brokers are treated similarly to loans made by mortgage bankers, and other lenders, and hence any compensation received by the mortgage broker, as a result of the bona fide transfer of a loan obligation in the secondary market, is not subject to Section 8 of RESPA due to the “secondary market transaction” exemption. 24 CFR 3500.5(b)(7).

Mortgage Broker Functions and Compensation

Since the advent of mortgage brokers in the mid-1980s, there has been confusion among borrowers concerning the mortgage broker's functions and fees,—i.e., whether brokers do or do not shop on the borrower's behalf, as well as how they are paid and how much they are paid, and by whom.

Some mortgage brokers indicate to borrowers that they will, in essence, act as their agent to shop for the best mortgage loan for them.

Other brokers state that they work with a number of funding sources to provide loans, and

will arrange a favorable loan with one of them for their borrower. Whether brokers serve as the borrower's agent as a strict legal matter, the fact is that many brokers are perceived by borrowers as shopping on their behalf for the best loan to meet the borrower's needs. This perception frequently deters borrowers from shopping themselves for the loan originator and mortgage product that best meets their needs.

In some states, for example North Carolina, mortgage brokers may be held to have an agency relationship or a legal responsibility to the borrower.

Mortgage brokers receive compensation for their services by various methods. A broker may be paid directly by the borrower, indirectly by the lender or wholesale lender who purchases the mortgage loan, or through a combination of both. Brokers may charge borrowers directly at or before settlement for loan origination as well as for other services including the application, document preparation and document review. In some cases, broker origination charges may be denominated as an origination fee and sometimes as an “origination point” (one point equals 1% of the loan amount), while other fees for named services (e.g., application fees, document preparation fees, processing fee, etc.) are charged as separate cost items on the GFE.

Some brokers receive both percentage based fees and fees for named services.

Mortgage broker fees are not always described in the same terms. Sometimes mortgage brokers fees are expressed in straight dollar amounts and sometimes as “points.” “Points” are charges based on a percentage of the borrower's loan. Points therefore have a dollar equivalent to the borrower.

Where brokers receive a payment for compensation from someone other than the borrower, most commonly the lender, it is called indirect compensation. Such indirect compensation from lenders is ordinarily based upon an above market interest rate on the loan entered into by the broker with the borrower. This type of compensation is often referred to as a “yield spread premium,” (YSP) though it sometimes shows up under a different label, e.g. servicing release premium.

The use of a YSP can reduce up front settlement costs to a borrower by building these costs into the borrower's interest rate and monthly payments over the life of the borrower's loan. In issuing RESPA Policy Statement 2001-1, discussed in greater detail below, HUD stated that borrowers should continue to have the choice of paying their total settlement costs up-front or using the yield spread premium payment as a credit to pay all or part of these costs. Consumer advocates assert, however, that all too frequently brokers place the borrower in an above par rate loan without the borrower's knowledge, provide the borrower with little or no benefit in the form of reduced up front costs, and use the YSP payment solely or primarily as a means of increasing their total compensation.

Current Broker Disclosure Requirements

Under HUD's current rules, where mortgage brokers originate and table fund loans or act as intermediaries, they are required to disclose their direct charges and any indirect payments to be made to them on the GFE, and deliver or mail it to the borrower no later than 3 days after loan application. 24 CFR 3500.7(a)-(c). Such disclosure must also be provided to borrowers, as a final figure, at settlement on the HUD-1 and HUD-1A settlement statement. 24 CFR 3500.8. In table funded and intermediary transactions, direct broker fees are treated like the fees of other settlement service providers, such as title agents, attorneys, appraisers, etc, whose fees are disbursed at or before settlement. However, HUD's current rules require that on the GFE and HUD-1, lender-paid (indirect) mortgage broker fees are to be shown as “Paid Outside of Closing” (P.O.C.), listed outside the columns, and excluded from the computation of borrower's total settlement costs. 24 CFR 3500.7(a)(2). This approach does not assure that YSPs are understood and credited to the borrower to reduce up front settlement costs.

Disclosure of Fees by Lenders

Lenders are also compensated by borrowers through various methods. When lenders originate mortgage loans, they may charge borrowers directly at or before settlement for loan origination as well as for other services including the application, document preparation and document review. In some cases, lender origination charges may be denominated as an origination fee and sometimes as an “origination point” (one point equals 1% of the loan amount), while other fees for named services (e.g., application fees, document preparation fees, processing fee, etc.) are charged as separate cost items on the GFE.

Lenders' fees are not always described in the same terms. Sometimes lenders' fees are expressed in straight dollar amounts and sometimes as “points.” “Points” may be used to describe “origination fees” or “discount points” and both types of points may be charged in the same transaction. “Points” are just percentage amounts of the borrowers loans, and these “points,” just like any other terms used to describe fees to loan originators, have a dollar equivalent to the borrower.

Lenders may also require “discount points” from the borrower for the stated purpose of lowering the interest rate of the loan. It is unclear to what extent discount points represent the present value of the difference between the par mortgage interest rate and the rate on the loan on one hand, or provide additional compensation to lenders on the other.

The functional equivalent of a yield spread premium may also be present in loans originated by lenders. Lenders routinely offer loans with low or no up front costs required at settlement. They can do so just like brokers do by charging higher interest rates for these loans and then recouping the costs by selling the loans into the secondary market for a premium representing the difference between the interest rate on the loan and the par, or wholesale market interest rate. Alternatively, the lender can hold the loan and earn the above market return in exchange for any lender paid settlement costs.

HUD's current rules require lenders to disclose only direct fees paid to them by borrowers including origination fees or “origination points” as well as other direct fees for named services and discount points. However, neither the current GFE, nor the HUD-1, provides totals of all charges paid to the lender. The rules also do not require lenders to disclose indirect fees earned in secondary market transactions from the sale of borrowers' loans. This is because the compensation earned from the bona fide transfer of the loan obligation in the secondary market is exempt from HUD's RESPA rules. HUD's RESPA rules provide “[i]n determining what constitutes a bona fide transfer HUD will consider the real source of funding and the real interest of the funding lender.” 24 CFR 3500.5(b)(7). HUD's rules explicitly provide, however, that table-funded mortgage broker transactions are not secondary market transactions. Lender sales into the secondary market are considered secondary market transactions.

Legality of Mortgage Broker Fees

Over the last decade, there has been persistent litigation concerning the legality of indirect fees to mortgage brokers. More than 150 lawsuits have been brought since the mid-1990s seeking class action certification, based in whole or in part on the theory that the indirect fees paid by lenders to mortgage brokers are fees for the referral of business in violation of section 8 of RESPA.

See e.g.,

Mentecki

Saxon Mortgage,

No. 96-1629-A, slip op. (E.D. Va. Jan. 10, 1997). The court held initially that indirect fees to mortgage brokers in the form of “yield spread premiums” violated section 8(a) of RESPA as referral fees. However, subsequently, in an order and opinion dated July 11, 1997, the Court refused to certify the class.

Culpepper

Inland Mortgage Corp.,

953 F.Supp. 367 (N.D. Ala. 1997). The court held that a payment for a loan above market was permissible under section 8(c) of RESPA as payment for a “good.”

Barbosa

Target Mortgage,

No. 94-1938, U.S.D.C., Southern District of Florida;

Martinez

Weyerhauser Mortgage,

No. 94-160, U.S.D.C., Southern District of Florida;

Monoz

Crossland Mortgage Company,

Civil Action No. 96-12260, U.S.D.C. for the District of Massachusetts. These last two Federal district courts concluded that yield spread premiums (or differentials) were not per se violations of RESPA and therefore refused to certify class actions on this issue.

HUD's RESPA rules, amended in 1992 to require disclosure of indirect fees to mortgage brokers, did not explicitly take a position on whether yield spread premiums or any other named class of back-funded or indirect fees paid by lenders to brokers are per se legal or illegal. See Illustrations of Requirements of RESPA, Fact Situations 5 and 12 in Appendix B to 24 CFR part 3500. The rule specifically listed “servicing release premiums” and “yield spread premiums” as fees required to be itemized on the HUD-1/1A Settlement Statement. Accordingly, while the rule specifically acknowledged the existence of such fees and provided illustrations of how they are to be reflected on HUD disclosure forms, HUD took the position that the rule does not create a presumption of per se legality or illegality.

Between 1992 and 1999, HUD provided various interpretations and other issuances under its RESPA rules stating the Department's position that the legality of a payment to a mortgage broker does not depend on the name of the particular fee. Rather, HUD has consistently advised that the issue under RESPA is whether the total compensation to a mortgage broker is reasonably related to the total value of the goods or facilities actually furnished or services actually performed. If the compensation, or a portion thereof, is not reasonably related to the goods or facilities actually furnished or the services actually performed, there is a compensated referral or an unearned fee in violation of Section 8(a) or 8(b) of RESPA, whether the compensation results from a direct or indirect payment or a combination thereof.

In 1995, as a result of concerns that the requirement that mortgage brokers disclose indirect fees placed mortgage brokers on an unequal footing with other mortgage loan providers, and that information on indirect fees was confusing to borrowers, HUD issued a proposed rule to obtain the public's views on the disclosure and legality of broker fees. 60 FR 47650 (September 13, 1995). At that time, plaintiff borrowers began initiating class action lawsuits claiming that payments to mortgage brokers by lenders were per se illegal. Shortly afterwards, HUD embarked on a negotiated rulemaking on these subjects. See notices published on October 25, 1995 (60 FR 54794) and December 8, 1995 (60 FR 63008).

The 1995-1996 negotiated rulemaking on mortgage broker fees did not result in a final rule. It did, however, result in a clear consensus by rulemaking participants that borrowers were confused about the functions of mortgage brokers and the amounts and sources of their fees. See Report on Negotiated Rulemaking on Mortgage Broker Disclosure—Final Report, A.L.J. Alan W. Heifetz, (July 19, 1996). This confusion may translate into borrowers failing to compare services and fees, thereby paying unnecessarily high settlement costs. Most of the rulemaking participants, except for the representative of the mortgage brokerage industry and one consumer advocate, agreed on a regulatory framework that would create a pre-application agreement between a borrower and a broker fully disclosing the broker's function and compensation, in return for a limited “safe harbor” for transactions where these contracts were entered into. In 1997, HUD issued a proposed rule on mortgage broker fees that would have established a safe harbor for brokers who contractually commit to borrowers regarding their total compensation, along the lines agreed to by the majority in the negotiated rulemaking. The proposed rule also provided that during the rulemaking process, a ceiling on the amount of fees eligible for the safe harbor would be established to protect against predatory lending. The rule was strongly opposed by the mortgage brokerage industry and other segments of the mortgage industry. HUD did not finalize the 1997 rule and efforts to do so were soon eclipsed by HUD's effort to clarify its position on the legality of mortgage broker fees under existing law.

1999 Statement of Policy on Lender Payments to Mortgage Brokers

In 1998, in the Conference Report on HUD's 1999 Appropriations Act, Congress directed HUD to clarify its position on the legality of mortgage broker fees and to work with industry, Federal agencies, consumer groups, and other interested parties on a statement of policy on the subject. The Report also stated that Congress never intended payments by lenders for goods or facilities actually furnished or for services actually performed to violate Section 8(a) or (b) of RESPA.

On March 1, 1999, in response to Congress's directive, HUD issued RESPA Statement of Policy 1999-1 Regarding Lender Payments to Mortgage Brokers, following extensive discussions with industry, consumer groups, and essential agreement among them on the interpretation embodied in the Statement. The Statement said that, in applying Section 8 and HUD's regulations to lender payments to mortgage brokers, HUD did not consider such payments to be legal or illegal per se. The Statement said that the “fees in cases and classes of transactions are illegal if they violate the prohibitions of Section 8 of RESPA.” 64 FR 10084.

The Statement established a two-part test to determine the legality of lender payments to mortgage brokers under RESPA which requires that: (1) Goods or facilities must actually be furnished or services actually performed for the compensation paid; and (2) payments must be reasonably related to the value of the goods or facilities that were actually furnished or services that were actually performed. In applying this test, HUD stated that total compensation should be scrutinized to assure that it is reasonably related to goods, facilities, or services furnished or performed to determine whether it is legal under RESPA.

The 1999 Statement of Policy also said, “[t]he Department considers that higher interest rates alone cannot justify higher total fees to mortgage brokers. All fees will be scrutinized as part of total compensation to determine that total compensation is reasonably related to the goods or facilities actually furnished or services actually performed.” 64 FR 10084.

As a Statement of Policy, the 1999 Statement interpreted HUD's existing rules. Nonetheless, beyond these rules, the Statement emphasized the importance of disclosing brokerage fees, including yield spread premiums, to borrowers as early as possible in the borrower's process of shopping for a mortgage. See 64 FR at 10087.

The 1999 Statement said:

There is no requirement under existing law that consumers be fully informed of the broker's services and compensation prior to the GFE. Nevertheless, HUD believes that the broker should provide the consumer with information about the broker's services and compensation, and agreement by the consumer to the arrangement should occur as early as possible in the process. 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. 64 FR at 10087.

Post 1999-1 Statement of Policy Circuit Court Decision

After HUD issued its 1999 Statement of Policy, most Federal District courts held that yield spread premium payments from lenders to mortgage brokers are legal provided that such payments meet the test for legality articulated in the 1999 Statement of Policy and otherwise comport with RESPA. However, in

Culpepper

Irwin Mortgage Corp.,

253 F.3d 1324 (11th Cir. 2001), the U.S. Court of Appeals for the Eleventh Circuit upheld class certification in a case alleging that yield spread premiums violated Section 8 of RESPA where the defendant lender, pursuant to a prior understanding with mortgage brokers, paid yield spread premiums to brokers based on the lender's use of a rate sheet and the brokers' delivery of above par interest rate loans, without the lender knowing whether, or to what extent, the brokers had performed services. The court concluded that a jury could find that yield spread premiums were illegal kickbacks or referral fees under RESPA where the lender's payments were based exclusively on interest rate differentials reflected on rate sheets, and the lender had no knowledge of what services, if any, the brokers had performed. The court also said that HUD's 1999 Statement of Policy was ambiguous.

Following Culpepper,

representatives of the mortgage industry urged HUD to issue a clarification to the 1999 Statement of Policy to make clear that the lenders could make payments to brokers through rate sheets and that, to properly apply the 1999 test, all payments must be examined, not simply the payment from the lender, to determine if the broker's total compensation is reasonable. These representatives said that if the Culpepper interpretation prevailed, without further guidance from HUD, the industry could no longer offer yield spread premiums as an option to borrowers to lower their up front settlement costs.

In this proposed rule Culpepper refers to

Culpepper

Irwin Mortgage Corp.,

253 F.3d 1324 (11th Cir. 2001). There were earlier reported decisions in this same litigation.

Representatives of the mortgage industry, including representatives of the Mortgage Bankers Association and the National Association of Mortgage Brokers, assured the Department that following a clarification by HUD, they also would support a HUD rule requiring improved fee disclosure.

Letter to Secretary Martinez, Submitted by America's Community Bankers, American Banking Association, Consumer Mortgage Coalition, and Mortgage Bankers Association of America (December 27, 2001); National Association of Mortgage Brokers, Position Paper: Prospective HUD Rulemaking Concerning Mortgage Originator Disclosure, Correspondence to the Department (December 4th, 2001).

Statement of Policy 2001-1

On October 17, 2001, the Department issued 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). The 2001 Policy Statement reiterated and clarified the test articulated in the 1999 Statement of Policy that where compensable services are performed, application of both parts of the HUD test is required before a determination can be made regarding the legality of a lender payment to a mortgage broker. 66 FR 53052, 53054-55. The 2001 Statement also said:

[n]either 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 solely upon the fact that the lender pays the broker a yield spread premium that is based upon a rate sheet, or because the lender does not have specific knowledge of what services the broker has performed. 66 FR 53052, 53055.

The 2001 Statement of Policy also interpreted HUD's existing rules then further detailed what HUD regards as meaningful disclosure of mortgage broker fees to borrowers:

In HUD's view, meaningful disclosure includes many types of information: What services a mortgage broker will perform, the amount of the broker's total compensation for performing those services (including any yield spread premium paid by the lender), and whether or not the broker has an agency or fiduciary relationship with the borrower. The disclosure should also make the borrower aware that he or she may pay higher up front costs for a mortgage with a lower interest rate, or conversely pay a higher interest rate in return for lower up front costs, and should identify the specific trade-off between the amount of the increase in the borrower's monthly payment (and also the increase in the interest rate) and the amount by which up front costs are reduced. HUD believes that disclosure of this information, and written acknowledgment by the borrower that he or she has received the information, should be provided early in the transaction. Such disclosure facilitates comparison shopping by the borrower, to choose the best combination of up front costs and mortgage terms from his or her individual standpoint. HUD regards full disclosure and written acknowledgment by the borrower, at the earliest possible time, as a best practice. 66 FR 53056.

The 2001 Policy Statement also specifically acknowledged the utility to borrowers of treating and reporting all interest rate based lender payments as monies belonging to the borrower. The Policy Statement endorsed this approach, stating:

[I]t has been suggested to the Department that the yield spread premium should be reported as a credit to the borrower in the “200” series, among the “Amounts Paid by or in Behalf of Borrowers.” The homebuyer or homeowner could then see that the yield spread premium is reducing closing costs, and also see the extent of the reduction.

HUD believes that improved early disclosure regarding mortgage broker compensation and the entry of yield spread premiums as credits to borrowers on the GFE and the HUD-1 settlement statement are both useful and complementary forms of disclosure. The Department believes that used together these methods of disclosure offer greater assurance that lender payments to mortgage brokers serve borrowers' best interests. 66 FR 53056.

C. HUD's Commitment to Mortgage Reform

The HUD-Federal Reserve Report

Since the mid-1990s, HUD has been examining ways to improve the mortgage process for borrowers to lower settlement costs.

In June of 1998, in response to a Congressional directive in Section 2101 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (Pub. L. 104-208, 110 Stat. 3009), HUD and the Board of Governors of the Federal Reserve (“the Board”) issued a joint report on reforming RESPA. The HUD-Federal Reserve Report. The Report called for legislative changes to reform both laws. The Report did not attempt to differentiate where changes could be made under existing law pursuant to the Board's and HUD's existing regulatory authorities from areas where new legislation was required. Subsequently, the Board has exercised its regulatory authority under TILA to effectuate certain of the Report's recommendations. See 66 FR 65604, December 20, 2001.

HUD and others have considered proposals to permit lenders to package settlement services almost from the time the law was enacted. Senator Proxmire introduced S. 2775 which would have required lenders to bear certain settlement costs with the view that the lenders have the sophistication and bargaining power to keep costs down.

Major Findings of the Report

The HUD-Federal Reserve Report posed and addressed several questions involving the disclosure scheme under both RESPA and TILA, and both HUD

and the Board recommended in part

that:

The Report also concluded that the APR and finance charge disclosures under TILA should be retained and improved to include all costs required by the creditor to get the credit and that additional substantive protections should be added to TILA.

• Loan originators be required to provide firmer quotes for settlement costs disclosed under RESPA; and

• The timing of RESPA and TILA disclosures to borrowers be advanced, so that borrowers receive them earlier and use them to shop.

In order to achieve firmer cost information, both agencies also recommended that lenders and other providers be given the choice of:

• Offering a “packaging” or a guaranteed cost approach; or

• Providing a GFE where estimated costs would be subject to tolerances, to improve the current disclosure scheme by reducing the instances in which consumers may incur additional costs at closing.

Both agencies recommended an exemption from Section 8 to facilitate packaging. HUD also said that to receive the exemption, both the settlement costs and the interest rate on a mortgage should be guaranteed.

Timing of Disclosures

The Report observed that in home secured transactions, the borrower currently receives TILA or RESPA disclosures at several different times. Borrowers receive generic information such as HUD's Special Information Booklet at the time of application. Additionally, for residential mortgage transactions, lenders and brokers provide through mailing or delivery within 3 days after application, specific information including the GFE and the initial TILA disclosure disclosing the finance charge and the “APR” or “annual percentage rate” for the mortgage. TILA § 128(b)(2); Reg. Z § 226.19(a). TILA may require additional new disclosures for home-purchase loans if early disclosures have become inaccurate. See TILA 128(b) and Reg. Z § 226.17(b). A settlement agent gives final disclosures on the HUD-1 at settlement based on information provided by the lender.

Both agencies recommended that the disclosure process could be improved for industry if the timing requirements for disclosures were made more consistent between RESPA and TILA

and it would be improved for borrowers if disclosures were given when they would be most useful. In the Report, HUD recommended that generic information, e.g., HUD's Special Information Booklet, be given when the borrower first contacts settlement service providers, including loan originators and real estate agents. Both HUD and the Board also recommended that borrowers be given initial disclosures, including firm information about settlement costs, interest rates and points as early in the shopping process as possible so that they can shop and make informed choices. The HUD-Federal Reserve Report at 41. Although HUD and the Board differed somewhat in their approaches, both indicated that advances in technology and market competition promised to provide borrowers better information at or near the time of application. HUD said that it supported requiring that estimated costs disclosures be provided earlier than three days after application—ideally at first contact with lenders. HUD indicated, however, that while it seeks early disclosures, it recognizes that sometimes there will be a trade-off between having an early disclosure and ensuring that a disclosure is firm and complete enough to allow borrowers to shop and protect against increases in costs. In such cases, HUD recommended that timing requirements be flexible to allow enough time to provide guaranteed information.

Under current TILA rules, Regulation Z, the TILA disclosure may be given simultaneously along with the GFE, TILA § 128 (b); Reg. Z § 226.17(b).

Moreover, in the interest of promoting shopping, HUD recommended that borrowers not be required to pay a significant fee to the loan originator prior to receiving initial cost information. Id. at 42.

Providing Firmer Cost Disclosures

In arriving at the recommendation that cost disclosures must be firmer, the Report observed that borrowers reported many instances in which the costs disclosed on the GFE were significantly lower than those actually charged at settlement or that costs were completely left out of the GFE. The HUD-Federal Reserve Report at 20. The Report noted that more reliable settlement cost information could promote shopping. Id. at 32. In recommending that the choice of providing “guaranteed cost packages” or a more reliable GFE subject to tolerances be offered, the agencies stated that a dual system would create an opportunity for the market to test whether guaranteed cost arrangements offer more economical and efficient means for consumers to obtain mortgage loans.

Packages/Guaranteed Costs

Under the packaging or guaranteed cost approach envisioned in the Report, the lender or other packager would set a lump-sum price for settlement costs and would be held to that figure from the time the package is agreed to through settlement. Most charges for services that the borrower currently pays at settlement for origination, title work and insurance, credit report, appraisal, document review, inspection, up front mortgage insurance, pest inspection and flood review, etc., would be included in the package.

Government charges associated with filing a mortgage or release that can be determined easily also would be included. The Report suggested that any costs excluded from the guaranteed settlement costs would be disclosed as either “other required costs” or as “optional costs.” “Other required costs” would include charges such as per diem interest, which fit the definition of those costs that the borrower will have to pay at settlement, but the amount of which the packager cannot be readily determined at the time the package is provided to the borrower.

The Report suggested, however, that there are means for per diem interest to be included in the package; lenders could be required to state a maximum amount

based on thirty days (a full month) or to disclose the daily interest to allow borrowers to calculate the actual amount as the date of settlement becomes certain. The Report also suggested that mortgage insurance should be included in the package price even though it is difficult to calculate until final underwriting.

In developing the Report, the agencies considered whether services should be itemized within the package. Some entities claim that for there to be true competition, borrowers must be able to know what is included in each package to compare. These entities point out that borrowers generally like to know what services are included in packages and that without itemization lenders may choose to forego many services for their packages while insisting that nonlenders have more expansive packages, making borrower information and competition impossible. On the other hand, it was observed that a requirement for full itemization of services might lead some packagers to create longer lists, ultimately confusing borrowers and hindering their evaluation of different loans. Also, lenders pointed out that services are performed in large measure to protect their security and when the initial disclosure is provided they may not know what is needed in each case. The Board and HUD concluded that in packages, lenders could disclose the guaranteed amount for settlement costs without any elaboration on the early disclosure, and subsequently provide a list of services actually performed on the final settlement disclosure. Alternatively, lenders could provide a list of services that might be performed on the early disclosure with an explanation, if appropriate, that all items may not be performed, and then indicate on the settlement statement the services actually performed. The Report also observed that disclosing the cost of each service also could present problems, particularly where lenders or other packagers enter into volume-based contracts. The HUD-Federal Reserve Report at 25-26.

Charges for per diem or “odd days” interest, which floats along with the interest rate, cover the time between the date of settlement and the date regular monthly interest starts accruing. As an illustration, if a loan closes on January 15 and the first monthly payment (due on March 1) begins to accrue interest on February 1, interest for the days between January 15 and February 1 is generally required to be paid at settlement as per diem interest. Some lenders do not collect per diem interest at settlement but add the amount to the first monthly payment.

According to the Report “optional costs” would include charges that depend on whether the borrower chooses to purchase the service, and on the level of service chosen. The HUD-Federal Reserve Report at 27-28. Examples include owner's title insurance and optional hazard insurance chosen by the borrower.

The Report observed that packagers would arrive at their package prices based on their experience or, more likely, enter into volume-based contracts with affiliated and other settlement service providers for those goods and services required by lenders to close a loan. Id. at 23.

Support for Packaging

Many of the nation's largest mortgage lenders and their representatives expressed support for a “packaging” approach. They said that borrowers rarely shop for individual settlement services, and also that borrowers are more interested in the overall price of their mortgage loan than the prices of individual settlement services, and that borrowers would shop for mortgages if all they needed to compare was a single guaranteed price for all the settlement services needed to close the loan. Advocates of packaging said that by packaging services, discounts that would be secured by lenders under these arrangements will be passed on to borrowers. Through this dynamic and by making it easier for borrowers to shop, costs would be lowered.

For example, a packager could contract to have XYZ Appraisal Company complete all its appraisals for a given period for $300 each rather than the $350 the company normally charges for a standard appraisal. The packager could rely on that discounted contract price in pricing the package of guaranteed costs to the borrower. With their own costs negotiated in advance, packagers could disclose the cost for the entire package early in the borrower's mortgage shopping process with certainty, and the borrower then could compare different vendors' packages.

In the development of the Report, entities other than lenders, including real estate firms and affinity groups, also expressed some interest in packaging. These entities asserted that if packaging was restricted only to lenders, competition would be unnecessarily restricted and borrowers could be deprived of lower prices. Some industry representatives voiced the fear that large lenders will make it difficult for non-lenders to develop any packages other than those the lenders themselves retail, by refusing to participate in other entities' packages.

On the other hand, lenders asserted that since settlement services are largely required to protect the lender's security, lenders should not have to accept unconditionally any other settlement service providers' settlement packages. In the HUD-Federal Reserve Report HUD recommended that any entity should be permitted to package as long as it can provide a Guaranteed Mortgage Package and a mortgage loan at a guaranteed interest rate.

Nonlenders also suggested that to provide a level playing field, the services in the package should be itemized.

Consumer advocates also supported packaging, but asserted that any packages must include a loan with an interest rate guarantee to be useful to borrowers. Although consumer advocacy groups believed that guaranteeing settlement costs has value, they noted that these costs are a small portion of the overall cost of a mortgage loan. Advocates said that unless borrowers also receive a firm commitment on the interest rate and any applicable points they cannot truly comparison shop. Without such a firm commitment, consumer advocates said some lenders may provide the borrower with a guaranteed settlement cost quote and then increase the interest rate to offset any savings offered to the borrower on the settlement costs. These lenders would then realize additional profits based on the mortgage's pricing. These advocates expressed the fear that unwary borrowers will be lured into particular loan products by inexpensive or below-market settlement cost packages and then find themselves in higher rate loans that more than offset any purported cost savings. The HUD-Federal Reserve Report at 22.

Lender representatives expressed varying views on guaranteeing rates as part of a specific package. Some lenders stated that underwriting is costly and time-intensive and that mortgage brokers and other retail originators cannot provide guaranteed rates that bind lenders early in the mortgage loan process. Other industry representatives asserted, however, that requiring lenders to provide guaranteed rates along with guaranteed settlement costs is viable. Many of today's mortgage originators provide firm rate information to shoppers early in the process based on nearly instantly available credit information, without any assurance that the borrower will go forward with the transaction and the originator will receive compensation.

Section 8 Exemption for Packaging

Lenders' representatives asserted at the time of the Report that an exemption from RESPA's Section 8 prohibitions is necessary for packaging to work. These representatives pointed out that Section 8 prohibits volume-based discounts between settlement service providers, since they fear such arrangements would be viewed as compensated referral arrangements in violation of the statute. Also, while Section 8 prohibits kickbacks, compensated referrals, and unearned fees, the statute provides no bright line on how to determine when a payment has been earned for goods or services (which is permissible under RESPA) or is compensation for a referral, or is an unearned fee (which are illegal and subject to criminal sanctions and civil action under Section 8). Moreover, RESPA prohibits requiring the use of an affiliated settlement service provider except in limited circumstances,

which can be an additional impediment to packaging services. Proponents of packaging further asserted that because of Section 8's prohibitions and questions about how they apply, lenders and others do not currently package. These proponents said that were an exemption granted and packaging of services prevalent, borrowers would benefit more from the resulting lower costs than they do from RESPA's current Section 8 prohibitions. The HUD-Federal Reserve Report at 30. Consumer groups generally also supported an exemption for packaging, as long as packagers are required to guarantee both settlement costs and interest rates.

Generally, under Section 8(c)(4) of RESPA an entity may refer business to an affiliate as long as the affiliate arrangement is disclosed, there is no required use, and the only return to the entity making the referral is a return on capital.

Members of the settlement services industry other than large lenders, however, including small lenders and title companies, expressed strong concern about and, in some cases, outright opposition to an exemption from Section 8 to encourage packaging. They said that only lenders would offer packages and that the lenders would squeeze out savings from small providers and then retain these savings in the form of higher profits, without passing them on to borrowers. Small settlement service providers also said that the only way they could remain competitive would be by offering packages themselves, and they expressed serious concern about their ability to do so. They further asserted

that borrowers do in fact already shop for settlement services, that prices for these services are currently competitive, and that lifting Section 8 restrictions will harm rather than help borrowers because any savings from packaging will not be passed on to borrowers and fewer providers will be available to compete. Id. at 22.

During the development of the HUD-Federal Reserve Report the agencies noted that technology is enabling the provision of earlier, firmer, settlement cost information. Id. at 39. Moreover, during the development of the Report, HUD became aware of promising proposals that were advanced by consumer advocates and some industry representatives where lenders, after obtaining credit reports, would provide borrowers guaranteed rate and point information.

This guarantee would be subject to appropriate conditions such as market changes in the cost of money (where the rate and points are not locked), and verification of the value of the collateral and the borrower's creditworthiness. HUD supported these and similar efforts because it regards the full costs of obtaining a loan—including settlement costs, interest rate, and points—as the information that is essential to assist borrowers in shopping for a mortgage loan.

At the time of the Report some consumer and industry groups discussed the possibility that borrowers could pay credit repositories the costs of and arrange the provision of credit information to lenders to expedite the process and to avoid significant fees.

HUD concluded that an exemption should be provided for packaging to facilitate earlier comparison shopping by borrowers, greater competition among mortgage lenders and others, and guaranteed prices to borrowers from the time the borrower applies for a mortgage through settlement. The Board recommended an exemption to improve the consumer's ability to shop effectively and to allow competition to reduce the cost of financing a home. To encourage packaging, HUD recommended that a Section 8 exemption should be made available to loan originators and others who: (1) Offer borrowers a comprehensive package of settlement services needed to close a loan; (2) provide borrowers with a simple prescribed disclosure that gives the guaranteed maximum price for the package of services through settlement; and (3) disclose the rate offered to the borrower for the loan, with a guarantee that the rate will not increase, subject to prescribed conditions.

The Report suggested that fees paid and arrangements within packages would be exempt from Section 8. Fees for referrals to or from the packager of settlement services to or from those outside the package would continue to be subject to Section 8. For example a real estate agent could not receive a fee for referring a borrower to a packager. Entities that do not meet the requirements of the exemption would be subject to Section 8. The HUD-Federal Reserve Report at 33.

A More Reliable GFE

As an alternative to packaging, both the Board and HUD also recommended making disclosures firmer under the current practice, by requiring a more reliable GFE, subject to tolerances. The HUD-Federal Reserve Report at 31.

The Report suggested that tolerances could be based on a percentage of the total estimated costs; if the actual costs at settlement exceeded the sum of the estimated costs and the amount of the tolerance, the loan originator would generally be held liable. Alternatively, the tolerance could apply only to certain categories of costs such as those within the loan originator's control. The Report said that charges imposed directly by the loan originator would have to be accurate. On the other hand, an increase in costs resulting from a borrower's choice would not count against the loan originator in determining whether the total costs exceeded the tolerance. The HUD-Federal Reserve Report at 31.

The HUD-Treasury Report

Early in 2000, HUD, in cooperation with the Department of the Treasury, reviewed the problem of predatory mortgage lending. Following five hearings in New York, Chicago, Atlanta, Los Angeles and Baltimore, in June, HUD and the Treasury issued a major report on the subject of predatory mortgage lending. The Report, entitled “Curbing Predatory Home Mortgage Lending” (HUD-Treasury Report), detailed predatory or abusive lending practices in connection with higher cost loans in the mortgage market. In addition, among numerous recommendations to address predatory lending, the Report reiterated support for RESPA/TILA reform along the lines recommended in the HUD-Federal Reserve Report.

The HUD-Treasury Report stated: “that borrowers need firm information early in the loan process so that they can compare the products of one settlement service provider with another. If borrowers receive firm information but it comes too late in the loan process, they will not have the opportunity to shop. Moreover, if the information is available but the borrower must pay a significant fee to obtain it, borrowers may be disinclined to seek comparable information from multiple sources.

See

HUD-Treasury Report, 2000 at 66.

The HUD-Treasury Report pointed out that unscrupulous mortgage brokers “may receive compensation as a result of inflated upfront charges paid by borrowers and indirect fees paid by lenders * * *. Brokers and lenders may also structure charges so that they are less transparent to the borrower, through the use of mechanisms such as yield spread premiums, which may disguise the true cost of credit.” HUD-Treasury Report, 2000, at 80.

III. This Proposed Rule

With the above background in mind, today's rule proposes a new framework for borrower disclosures under RESPA that would:

1. Address the issue of mortgage broker compensation, specifically the problem of lender payments to mortgage brokers, by fundamentally changing the way in which such lender payments in brokered mortgage transactions are recorded and reported to borrowers;

2. Significantly improve HUD's Good Faith Estimate (GFE) settlement cost disclosure, and amend HUD's related RESPA regulations, to make the GFE firmer and more usable, to facilitate shopping for mortgages, and to avoid unexpected charges to borrowers at settlement; and

3. Remove regulatory barriers to allow guaranteed packages of settlement services and mortgages to be made available to borrowers, to make borrower shopping for mortgages easier and further reduce settlement costs. A description of each of these aspects of the rule follows.

A. Addressing Mortgage Broker Compensation and Lender Payments to Brokers

The proposed rule would fundamentally change the way in which information on the mortgage broker's functions and charges are reported in the Good Faith Estimate as described below.

1. Describing the Loan Originator's Function

Under this proposed rule, the new GFE at Section I would require that mortgage brokers and all other loan originators describe their services. The proposed form does not ask that only brokers provide this description because the description of other originators' services is equally useful to borrowers. The GFE would advise that the loan originator performs origination services by arranging funding from one or more

sources for the borrower. It also advises that the originator does not shop for nor offer loans from all mortgage funding sources and the originator cannot guarantee the lowest price or best terms available in the market. The GFE makes clear that the borrower should compare the prices on the form and shop for the loan originator, mortgage product, and settlement services that best meet the borrower's needs.

The rule would require that this information be provided on the GFE to effectuate the GFE's purpose of providing borrowers with settlement cost information and avoiding confusion particularly with respect to the role of mortgage brokers. This language seeks to disabuse borrowers of the notion that brokers or other loan originators are their agents, and therefore are automatically shopping for them, a notion that can prevent their own shopping. This new provision will be coupled with increased education through the Settlement Cost Booklet and other means to help borrowers.

2. Explaining to the Borrower the Option of Paying Settlement Costs through the Use of Lender Payments Based on Higher Interest Rate

The new GFE, at Section IV, would clearly show borrowers the effect of alternative interest rates and their effect on monthly payments and cash needed for settlement. The GFE would inform borrowers that they have the options to pay settlement costs: (1) Through cash payments at settlement, (2) by borrowing additional funds to pay settlement costs, (3) by paying settlement costs through a higher interest rate and higher monthly payment, or (4) by lowering the interest rate and monthly payment by paying discount points. These options are available in loans from originators other than brokers. The Department in both the 1999 and 2001 Policy Statements on Mortgage Broker Fees especially called for the provision of this information to borrowers by brokers in brokered loans.

The provision of this information on the form will help borrowers understand their options for paying settlement costs and decide whether to use any lender payments to the borrower, discussed in (4) below, to help defray some costs or all of their settlement costs, including but not limited to the mortgage broker's charges.

3. Disclosing the Loan Originators' Charges—Including the Mortgage Broker's and Lender's Total Charges to Borrowers

HUD's current rules require that the broker's direct charges be disclosed on the GFE while all indirect payments including yield spread premiums are disclosed separately as “Paid Outside of Closing” (P.O.C.).

The existing disclosure requirements and instructions do not make clear to the borrower the broker's total charges so that the borrower can focus on them, shop among brokers, or negotiate these total costs with the broker. Instead, because of the way indirect broker compensation is currently disclosed, many borrowers conclude incorrectly that such indirect payments have no effect on their loan costs.

HUD's existing RESPA regulations do not provide explicit guidance on where to place a yield spread premium on the GFE, nor is there any express reference to such indirect payments on the GFE format. The regulations do suggest generally, however, that Appendix A Instructions for the HUD-1 should be followed in completing the GFE. See 24 CFR 3500.7(c)(1). As described above, these Instructions state that a mortgage broker's fee is to be disclosed on one of the blank lines in the 800 series. A corresponding line appears on HUD's current suggested GFE format (Appendix C to Regulation X) for listing such fees. HUD's instructions, however, do not require that the amount to be reported in the 800 series for mortgage broker fees must include yield spread premiums. To the contrary, HUD's Appendix A Instructions advise that yield spread premiums and other lender payments to mortgage brokers should be disclosed on the HUD-1 as payments by the lender to the broker that are “paid outside of closing” (“P.O.C.”), and expressly state that such amounts should not be shown in the borrower's column. 24 CFR part 3500, Appendix A.

HUD's Settlement Cost Booklet is also not helpful. It suggests, incorrectly, that yield spread premiums are not costs to the borrower. It will be revised.

Section III A of the GFE, as proposed, would disclose to the borrower as a consolidated figure the total origination charges of the mortgage broker and the lender. (The zero tolerance applies to the total origination charges of the mortgage broker and the lender rather than any split between them.) Additionally, on Attachment A-1 there would be a breakdown of the origination charges into the total charges, respectively, of the broker and of the lender. This approach of providing total origination charges initially is taken to assist borrowers in comparing total origination charges of brokered loans to loans originated by lenders. At the same time, it ensures that the borrower knows the broker's and lender's charges. For mortgage brokers, these charges shall include all charges from the borrower that are paid to the mortgage broker for the transaction. For lenders, these charges shall include all or any portion of direct charges from the borrower that the lender receives for the transaction, other than discount points reported in line III B (2). Under the secondary market exemption, any additional fees realized by a lender from a bona fide transfer of a loan is not required to be disclosed under HUD's RESPA regulations. See 24 CFR 3500.5 (b)(7).

4. Requiring That in Brokered Transactions Lender Payments to the Borrower and Borrower Payments to the Lender Be More Appropriately Reported

A major provision of this rule is the requirement that in all loans originated by mortgage brokers, any payments from a lender based on a borrower's transaction, other than a payment to the broker for the par value of the loan, including payments based upon an above par interest rate on the loan (including payments formerly denominated as yield spread premium), be reported on the GFE (and the HUD-1/1A Settlement Statement) as a lender payment to the borrower. Additionally, the rule would require that any borrower payments to reduce the interest rate (discount points) in brokered loans must equal the discount points paid to the lender, and be reported as such on the GFE (and HUD-1/1A) as a borrower payment to the lender. These changes would require mortgage brokers to disclose the maximum amount of compensation they could receive from a transaction, by including the amount in the “origination charges” block of the GFE, and indicating the amount of the lender payment to borrower that would be received at the interest rate quoted, if any. Mortgage brokers would be unable to increase their compensation without the borrower's knowledge, by placing the borrower in an above par loan and receiving a payment from the lender (yield spread premiums), or by retaining any part of any borrower payment intended to reduce the loan rate (discount points).

Through these changes in reporting requirements, HUD believes that virtually all disputes regarding broker compensation in table-funded transactions and intermediary transactions involving yield spread premiums will be resolved. All mortgage broker compensation will be reported as direct compensation in the origination block of the GFE, maximum broker compensation will be clear and brokers will have no incentive to seek out lenders paying the largest yield spread. They will, instead, be motivated to find the best loan product they can for the borrower.

In requiring this methodology for reporting lender payments and discount points, it is important to note what the Department has not done. HUD has not taken away from borrowers the ability to select a higher rate loan in order to pay settlement costs (including, where the

borrower so chooses, broker compensation), or to pay additional sums at settlement in order to lower their interest rate and monthly payments. HUD has long recognized that these financing tools provide flexibility and have value to borrowers in specific circumstances. The Department emphasized this point most recently in Statement of Policy 2001-1. HUD's proposed rule, therefore, preserves these options, but seeks to the maximum extent possible within the Department's statutory and regulatory framework, to eliminate the possibility of abuse in the application of these financing tools, by ensuring that the full value of selecting either option is known and redounds to the borrower.

The Department acknowledges that the proposed rule results in different treatment of compensation in loans originated by lenders and those originated by mortgage brokers. This is not because the Department believes that the latter are necessarily more suspect or susceptible of abuse than the former. It results simply from the fact that the reporting of total lender compensation cannot be meaningfully regulated under RESPA, while total broker compensation can be regulated. This is so for both legal and practical reasons; first, as indicated above, lenders enjoy a secondary market exemption from RESPA Section 8 scrutiny, meaning that under HUD's regulations any compensation derived from the sale of a loan in the secondary market by a lender is outside RESPA's purview. Second, were there no such exemption, measuring indirect lender compensation (compensation derived from the loan rate) would be very difficult. A lender may retain the loan in its portfolio for the life of the loan, or sell it long after the settlement. Payments from lenders to borrowers in brokered loans, however, based on the lenders' rate sheets or otherwise, as well as discount points paid to lenders, are capable of quantification down to the last penny.

Currently, as indicated in the background, the GFE requires disclosure of the lender payment to the borrower (formerly the “yield spread premium”) as a charge that is “POC” or “paid outside of closing,” which has been a cause of confusion for borrowers. The form as proposed would now require that the lender payment be disclosed immediately after the origination charges. HUD believes that this new location for the disclosure of the lender payment will cure any confusion and clearly tell borrowers how much their mortgage broker is earning from the transaction. Furthermore in order to avoid borrower confusion about the mortgage brokers' charges as compared to other loan originators' charges and the impact of a lender payment, the proposed rule would require that immediately following disclosure of the lender payment the form will show the net loan origination charge due from the borrower. It is this number that HUD intends the borrower to focus on and HUD seeks to achieve this by highlighting that total on the form, so that the borrower understands that the payment is applied as a credit to reduce the borrower's total origination charges. HUD believes that this approach ensures clearer disclosure of all relevant broker fees and lender payments while avoiding disadvantaging brokers. With the understanding provided by the form the borrower can compare his or her net origination charges loan-to-loan, originator-to-originator.

B. Significantly Improved Good Faith Estimate (GFE)

As described in the Background, under RESPA and its implementing regulations, loan originators must provide the GFE either by delivering the GFE or by placing it in the mail to the loan applicant, not later than 3 business days after an application is received or prepared.

Frequently, a GFE is provided only after the borrower pays a significant fee or fees. The current suggested GFE calls for a listing of charges that may itself lead to a proliferation of charges. Moreover, there are few standards for loan originators to follow in calculating estimated costs, which allows the GFE to be unreliable.

For these reasons, the GFE is generally not a useful shopping tool to compare the charges of loan originators, other settlement service providers, or loan products. The GFE, and its attendant rules, also do not effectively prevent surprise costs at settlement.

The rule indicates that the GFE must be given within 3 days of the time an application is received or prepared to accommodate those instances where originators prepare applications for borrowers.

See note 13, infra.

Today's rule would make the GFE firmer and more usable, to facilitate borrower shopping for mortgages by making the mortgage transaction more transparent, and to prevent unexpected charges to the borrower at settlement. In order to improve the GFE HUD has concluded that establishment of a new required GFE format is necessary.

The rule therefore would establish a new, more informative, required GFE format to be provided to borrowers by loan originators in all RESPA covered transactions and new requirements for its provision. HUD believes that the content of the material in these proposed forms gives the consumer the information needed to shop for loan products and to assist them during the settlement process. HUD recognizes that in order for these forms to be useful shopping tools, they must be consumer friendly. The Department seeks public comment on these forms. In addition, the Department will arrange focus groups during the comment period to elicit comments on how to make the material in the new proposed forms as consumer friendly as possible, including considering how the new proposed forms are best compared by consumers to the HUD-1 and what revisions, if any, to the HUD-1 would be most helpful.

1. The New GFE

The proposed format for the new GFE and Instructions for completing it appear as Appendix C to this rule. The proposed form is intended for use in all federally related mortgage transactions. In addition to the changes to the GFE described in A above, the new required GFE format would:

a. Provide the Interest Rate and Costs for the Loan the Borrower Seeks

The current requirements for the GFE do not require the inclusion of an interest rate. Nonetheless, borrowers shop for mortgages based on the interest rate as well as settlement costs, and the inclusion of this information would be useful to borrowers. Accordingly, the new GFE, in Section II, would list the note rate, Annual Percentage Rate (APR), and loan amount for the loan that the GFE is based on. Any mortgage insurance premium included in the APR would be separately disclosed in Section II. Section V would contain information on interest rates and adjustments to adjustable rate mortgages and applicable prepayment penalties and balloon payments. In Section III, the GFE would include a disclaimer indicating that unless the borrower locks at this time, the interest rate may change.

b. Simplify and Consolidate Major Categories on the GFE

As detailed in the Background section, under current RESPA rules, the GFE simply lists estimated charges or ranges of charges for settlement services. There is no requirement for grouping or subtotaling charges to the same recipients. The costs listed on the GFE include loan originator/lender-retained charges, such as loan origination and underwriting charges; charges by third parties for lender required services, such as appraisal, title and title

insurance fees; state and local charges imposed at settlement, such as recording fees or city/county stamps; and amounts the borrower is required to put into an escrow account, or reserves, for items such as property taxes or hazard insurance. At settlement, borrowers receive a second RESPA disclosure—the Uniform Settlement Statement (the HUD-1/1A)—that enumerates the final costs associated with both the loan and, if applicable, the purchase transaction.

As proposed, the revised GFE, in Section III, would group and consolidate all fees and charges into major settlement cost categories, with a single total amount estimated for each category. This approach would reduce any incentive for loan originators and others to establish a myriad of “junk fees” and provide them in a long list, in order to increase their profits. Loan originators would be required to include all fees they receive in their total, including all points and origination charges. The interest rate dependent payment would include all fees formerly to the mortgage broker from the lender as well as any such fees in the future.

In addition to the loan originator charges and the interest rate dependent payment, the major cost categories on the revised GFE would be: (1) Lender required and selected third party services; (2) title charges and title insurance premiums; (3) shoppable lender required third party services; (4) state and local government charges; (5) escrow/reserves (for taxes and insurance); (6) hazard insurance; (7) per diem interest; and (8) optional owner's title insurance. The proposed form then would include a final total of all settlement charges so the borrower can focus on the total costs to properly compare offers.

c. Identifies Shoppable and Required Services

The GFE in Section III E, would aid shopping after application by requiring loan originators to separately identify those third party settlement services that are loan originator selected and required and those that the borrower may shop for independently.

This provision will enable borrowers to shop for major services to the extent possible, even after the borrower has selected a loan originator. As described above, HUD's current rules at 24 CFR 3500.7(e) requires lenders to list on the GFE the particular providers of settlement services that they require their customers to use.

Attachment A-1 to the proposed form will list those “Required Use” providers while also identifying the services that are required, but which borrowers can shop for providers on their own. Additionally, the rule proposes to ease the “Required Use” disclosure requirement, by only requiring the loan originator to state the service, the name of the provider, and the cost estimate. The Department proposes to forego the requirement that this listing also include the lender's relationship to the required provider.

Lender required, lender selected third party services are to include items such as flood certification services and mortgage insurance, to the extent an upfront premium is charged.

HUD's RESPA regulations contain certain restrictions on Affiliated Business Arrangements. See 24 CFR 3500.15. Section 9 of RESPA also prohibits sellers of property from requiring, directly or indirectly, the buyer to purchase title insurance from any particular title company.

Attachment A-1 will, as noted, also include the breakdown of the origination charges into lender and broker charges so that borrowers can better understand the respective lender and broker charges, and where possible even negotiate lower costs. In a similar vein, Attachment A-1 also breaks out title agent services and title insurance into separate subtotals for the actual title insurance versus compensation to the title agent. Title agents routinely receive direct payments from borrowers for their services as well as commissions from the insurance premium for the sale of insurance. The title agent subtotal will add up these costs so that the borrower can compare, and possibly negotiate, these charges.

2. New GFE Requirements

To improve the existing disclosure scheme, this proposed rule would amend Regulation X to establish new rules for the GFE including the following:

a. Clarifying the Application Requirements

Under the proposed rule, the GFE would be delivered or mailed at or within 3 days of application. The proposed rule, however, would only require a borrower to provide basic credit information and a property address in verbal, written or computerized form, but before the payment of any significant fee to the loan originator in order to receive a GFE. The GFE would be conditioned on the borrower's credit approval following final underwriting and appraisal of the property to be secured by the mortgage.

To carry out this approach, the rule proposes to first clarify the definition of the term application, in HUD's RESPA rules at 24 CFR 3500.2(b). The new definition of application would make clear, in accordance with informal HUD advice, that an application is deemed to exist whenever a prospective borrower provides a loan originator sufficient information (typically a social security number, a property address, basic employment information, the borrower's information on the house price or a best estimate on the value of the property, and the mortgage loan needed), whether verbally, in writing or computer generated, to enable the loan originator to make a preliminary credit decision concerning the borrower so that the originator can provide a GFE. See HUD Old Informal Opinion (March 27, 1980) and HUD Old Informal Opinion (October 15, 1982). HUD proposes this new definition to facilitate the provision of GFEs in response to virtually any type of request for a GFE, in order to give the borrower the necessary information for shopping. Under current rules, an application is the “submission of a borrower's financial information, in anticipation of a credit decision whether written or computer generated relating to a federally related loan” identifying a specific property. The proposed rule would explicitly broaden the definition to cover verbal and other requests as long as these requests contain sufficient information for the originator to provide a GFE. HUD also will consider comments on whether it should provide a brief form for the application.

Under RESPA, a “Good Faith Estimate” is to be provided with a settlement cost booklet by a lender to each person “from whom it receives or for whom it prepares a written application.” 12 U.S.C. 2604(d). Because an originator begins the process of preparing an application on behalf of the borrower when the borrower submits application information, the borrower's information itself need not be provided in writing.

RESPA's time limits for delivery of the GFE would run from the point that an originator receives “an application.” While the statute allows the loan originator to mail or deliver the GFE 3 days after application, it is likely that the originator will provide the GFE as quickly after the borrower's request as possible.

HUD recognizes that the proposed rule's change of the definition of application, and the requirement that

GFE be provided to prospective borrowers early in the shopping process, frequently before they select a loan originator, may have implications for the content and delivery of required disclosures under the Truth in Lending Act (TILA). Question 28 specifically seeks comments on how HUD's proposed GFE changes impact other federal disclosure requirements, and invites suggestions on ways to consolidate or coordinate existing statutory disclosure requirements.

As indicated in the background section, supra, during the development of the HUD/Fed Report, HUD became aware of proposals where borrowers would arrange and pay for credit reports to loan originators of their selection. HUD supports these efforts as a way to lessen the burden on the originator's customers of paying the costs of those who are shopping.

The rule proposes that GFE estimates would be valid for a minimum of 30 days from when the document is delivered or mailed to the borrower. This is proposed in light of the tolerances to avoid committing originators indefinitely. Within the 30 days the borrower must agree to go forward and pay any additional money required to complete the underwriting process. If the borrower fails to accept the offer within 30 days, the borrower would need to return to the loan originator to request the originator to provide a new GFE or ratify the previous one. Commenters are asked in Question 5 below whether this is an appropriate time period for the GFE.

b. Facilitating Shopping With the GFE

As stated above, to achieve the purposes of the Act, the proposed rule would limit fees paid by the borrower for the GFE, if any, to the amounts necessary for the originator to provide the GFE itself. The fee could not include amounts to defray later appraisal or underwriting costs. This approach would both facilitate shopping and reduce the possibility that fees for the GFE are unearned, in violation of RESPA's proscription against such fees. While HUD recognizes that there may be costs attendant to obtaining credit information from third parties and evaluating that information manually and/or electronically, the provision of the GFE does not today, and would not in the future, necessitate full underwriting and appraisal. These steps come afterwards, and under the approach in this proposal, GFEs explicitly would be given subject to underwriting and appraisal. Therefore, any charge at the time of application should be limited only to those costs that result directly from providing the GFE. This is not to say that all loan originators would be expected to charge for GFEs. HUD would prefer that originators not impose any charge for a GFE, since providing a GFE before the payment of any fee will further facilitate shopping. HUD believes it would be reasonable for loan originators to treat shoppers for mortgages in much the same way other retailers treat shoppers, where the price of the product includes marketing expenses and purchasers pay the costs incurred to serve shoppers who do not purchase the goods or services. Such an approach would better serve the purposes of the statute.

c. Providing an Accurate GFE

As described in the background section, Regulation X currently defines “Good faith estimate” as “an estimate, prepared in accordance with Section 5 of RESPA, of charges that a borrower is likely to incur in connection with a settlement.” Pursuant to 24 CFR 3500.7(c) of Regulation X, loan originators are required to state on the GFE the dollar amount or range of charges that the borrower will normally pay at or before settlement based upon common practice in the locality of the mortgaged property. While the rules require that the estimate be made in “good faith” and “bear a reasonable relationship” to the charges the borrower is likely to incur at settlement, there is no further explication of what a “Good Faith Estimate” demands, either with respect to the loan originator's own charges/compensation, or with regard to lender required third party charges and other settlement costs.

Three decades of experience has shown that too often the estimates appearing on GFEs are significantly lower than the amount ultimately charged at settlement, are not made in good faith (

e.g.

, a range of $0-$10,000), and do not provide meaningful guidance on the costs borrowers ultimately will face at settlement. The Department recognizes that, occasionally, unforeseeable circumstances can and do drive up costs in particular transactions. HUD believes, however, that in most cases loan originators have the ability to estimate final settlement costs with great accuracy. The loan originator's own fee/compensation, which is entirely within the originator's control, can be stated with certainty, absent unforeseeable and extraordinary circumstances. Moreover, most third party costs such as appraisal charges, pest inspection fees, and tax/flood reviews, are fixed, and others, such as upfront mortgage insurance premiums, and title services and insurance, typically only vary depending on the value of the property or the loan amount. State and local recording charges, stamps, taxes are also generally well known to loan originators or, where necessary, can readily be calculated based on the loan amount or estimated precisely, on a pro rata basis, based on a projected settlement date.

HUD also believes that recent advances in technology and telecommunications in loan processing make the routine provision of accurate estimates of third party costs both easier and cheaper.

Notwithstanding, the GFE has too often failed to represent an accurate estimate of final settlement costs for a number of reasons. The absence of more precise regulatory standards for measuring accuracy has not helped ensure greater accuracy and reliability. Beyond that, some originators appear to purposely underestimate settlement costs as a means of inducing prospective borrowers to use their services, or as a way to obfuscate the amounts they plan to receive later in the final mortgage transaction. In too many cases, charges that never appeared on the GFE materialize at settlement. Such “junk fees” typically result in additional compensation for the originator and/or third party settlement service providers.

In light of these considerations, HUD believes that in order for the GFE to serve its intended purpose, which is to apprise prospective borrowers of the charges they are likely to incur at settlement, new standards must be established under existing law to better define “good faith” and the standards applicable to the GFE.

Accordingly, the proposed rule would make a number of specific changes to GFE requirements.

Differing editions of Black's Law Dictionary have defined “good faith” as “a state of mind consisting in * * * honesty in belief or purpose * * * [and faithfulness to one's duty or obligation,” and “freedom from knowledge of circumstances which ought to put the holder upon inquiry” as well as “absence of all information, notice, or benefit or belief of facts which render [a transaction unconscientious.” Inherent in these definitions is the concept that where a party makes an estimate in good faith they will take into account all relevant information available to them, and will exercise reasonable care in ascertaining and evaluating such information before providing such an estimate.

First, the rule would prohibit loan originators from exceeding the charges stated on the GFE for their own services, lender required and lender selected third party services, and government charges at settlement absent “unforeseeable and extraordinary circumstances” beyond the loan originator's control such as acts of God, war, disaster, or any other emergency, making it impossible or impractical to perform.

Second, the rule would establish an upper limit, or 10% “tolerance,” so that actual charges at settlement for shoppable lender required third party services, borrower selected title services and insurance, and reserves/escrow, cannot vary by more than 10% of the estimates of those fees and charges

stated on the GFE absent unforeseeable and extraordinary circumstances. The 10% tolerance applies to all lender selected third party services, and to third party services from providers who have been suggested to the borrower by the loan originator. It does not apply to third party services from providers selected by the borrower independently of the originator's recommendation.

The inclusion of these tolerances will assure that borrowers can either find prices within the estimates in the marketplace or return to the lender who will identify sources that will honor those prices. However, if the borrower chooses to purchase a more expensive service than is available or than the lender can provide, the lender will not be held to have exceeded the tolerance. The 10% level for tolerances has been selected to inject discipline into estimates while providing a margin for legitimate error based on market changes. Commenters are asked to provide their views on whether this is or is not the appropriate tolerance level, tolerance, and why.

Third, the rule would include redisclosure requirements triggered by changed circumstances. Specifically, if, after full underwriting, a loan originator selected by a borrower to obtain a mortgage loan determines that the prospective borrower does not qualify for the loan product identified in a previously provided GFE, the loan originator shall inform the borrower that the loan originator does not offer loan products meeting the borrower's needs or credit status. Alternatively if the loan originator does offer other products meeting the borrower's circumstances, the loan originator must so inform the borrower and the borrower may request a new GFE. Furthermore, when, after receiving a GFE, a borrower selects a loan originator to obtain a mortgage loan and qualifies for the loan product identified, but elects not to lock-in the interest rate and the interest rate dependent payment quoted on the GFE, the loan originator shall provide the borrower with an amended GFE at such time as the borrower does lock the rate and the interest rate dependent payment if either has changed from that quoted on the original GFE. The amended GFE shall identify those cost categories that have changed as a result of the change in the interest rate. In no case may an amended GFE include increases in cost categories which are not dependent on the interest rate (Section III. B.).

By limiting the extent to which final settlement charges can exceed GFE estimates, the Department intends to render the GFE a much firmer, more reliable, and meaningful disclosure for borrowers. If the cost at settlement exceeds the amount reported on the Good Faith Estimate, absent unforeseeable and extraordinary circumstances, the borrower may withdraw the application and receive a full refund of all loan-related fees. Such circumstances would have to be documented in writing by the loan originator and such documentation retained by the loan originator. These circumstances may be further defined in HUD's final regulations, and comments are requested in response to Question 2 below on both the definition of unforeseeable and extraordinary circumstances, and borrower rights where there is noncompliance with GFE requirements. Concurrent with finalization of this rule, HUD also will establish procedures for closely scrutinizing loan originators that fail to meet these new GFE requirements for possible Section 8 violations.

d. Negotiating Discounts From Third Party Settlement Service Providers

The establishment of tolerances under the proposal will require that loan originators actively follow the market prices for settlement services in their communities. HUD recognizes that the new GFE's tighter requirements on estimated third party charges may cause many loan originators not already doing so to seek to establish pricing arrangements with specific third party settlement service providers in advance, in order both to ensure they are able to meet the tolerances and to ensure lower prices for their customers. As part of negotiations for such arrangements, many originators, particularly those with a substantial volume of business, may seek prices from third party providers that are lower than those providers offer on a retail basis. However, because Section 8 of RESPA broadly prohibits providing a “thing of value,” which is specifically defined to include discounts, in exchange for the referral of business, many loan originators have been reluctant to openly seek such pricing benefits, even where any such discount in the price is passed on to the borrower. HUD believes that the fundamental purpose of RESPA is to lower settlement costs to borrowers, and it is therefore contrary to the law's objectives to interpret the anti-referral fee provisions of Section 8 to prohibit one settlement service provider from using its market power to negotiate discounted prices, as long as the entire discounted price negotiated by the originator is charged to the borrower and reported as part of the total charge within Sections III(C) through (J) as appropriate. The proposed rule amends Regulation X to make this clear. HUD also solicits comments on this issue in Question 4 below.

e. Revising the HUD-1/1A and Appendix A Instructions

Consistent with the proposed rule's new approach to the reporting of lender payments to borrowers, the proposal would require that on the HUD-1 all such payments be reflected in the borrower's column, in the applicable series (e.g., 800 series for payments to mortgage brokers; 1300 series for payments to other third party settlement service providers). However, inasmuch as there is no place for identifying and reporting credits on the HUD-1 A, in any transaction where there is such payment, the rule requires that the HUD-1 must be used. The proposed rule's revisions to the Appendix A instructions for the HUD-1 appear immediately following the proposed amendments to Regulation X.

Also, the proposed new GFE, while reducing the number of cost items reported on the face page, and consolidating the presentation to the borrower of important cost information, is not readily comparable to either the HUD-1 or HUD-1A form, which the borrower will receive at settlement. This is because certain cost items on the GFE are currently reported in numbered sections of the HUD1/1A forms not corresponding to their GFE counterparts. Thus, for example, while the proposed GFE clearly distinguishes between those settlement costs attributable to the loan originator(s) (section A. on the new GFE) and other lender required third party settlement services (sections C. and E. on the new GFE), the HUD-1/1A forms combine loan originator costs and some third party costs under the same heading (“Items Payable in Connection with the Loan”) and numbered section (800). The HUD1/1-A forms include credit report fees, appraisal fees, mortgage insurance application fees, and inspection fees in this category. Other third party services, such as pest inspection fees, permit fee, and surveys are separately reported on the HUD-1/1A (1300). In addition, the new GFE identifies as separate major cost categories some items reported, in whole or in part, under the same heading on the HUD-1/1A. For example, the new GFE lists hazard insurance and per diem interest as separate categories. However, on the HUD-1/1A, where hazard insurance premiums are paid in advance they are reported, along with other items such as per diem interest and pre-paid mortgage insurance premiums, in section 900, “Items Required by Lender to be Paid in

Advance.” Moreover, where a portion of the hazard insurance premium is required to be escrowed, that amount is reported on the HUD-1/1A in section 1000, along with other escrow items, as “Reserves Deposited With Lender.”

As proposed, the new GFE would consolidate certain charges into lump sum categories (e.g. lender required third party services). The Department has made only minor changes to the HUD-1 instructions, to assist the borrower in comparing the new GFE to the HUD-1. The Department took this approach because the HUD-1 is well accepted as a listing of settlement service charges by industry and consumers alike and HUD is reluctant to change the form unnecessarily. However, there is a risk that if the forms are not clearly comparable, lenders could deviate from the prices given in the GFE or GMPA and the borrower would not realize the deviations. Modifications could be made to the HUD-1 so that the fee categories on the new GFE would correspond to similar groupings on the HUD-1 and the two documents could be more easily compared. HUD invites comments in Question 9 below on whether or not the HUD-1 should be modified. HUD plans to use focus groups to ensure that the proposed forms are consumer friendly including considering, among other things, how the new proposed forms are best compared by consumers to the HUD-1 and what revisions, if any, to the HUD-1 would be most helpful.

For purposes of TILA, the packager must list the finance charges needed to calculate the APR on an addendum to the HUD-1 or HUD-1A and HUD invites comments in Question 20 on this issue. The proposed rule seeks comment on whether there should be further modifications to the HUD-1/1A forms so that they more accurately correspond to the new GFE. However, the Department believes that, in the absence of further changes to the HUD-1/1A forms, borrowers can be assisted in comparing the two disclosures, and, to that end, the new GFE identifies, next to each GFE category, where on the current HUD-1/1A the corresponding cost information is to be found. As the preceding discussion makes clear, this necessitates identifying more than one HUD-1/1A section number next to some GFE categories.

Specifically, the new GFE contains the following cross-references to the HUD-1/1A for each GFE category: A. Origination Fees, 800; C. Lender Required/SelectedThird Party Services, 800, 900, 1000, 1300; D. Title Services/Insurance, 1100; E. Lender Required/Shoppable Third Party Services, 800, 900, 1000, 1300; F. Government Charges—Taxes, 1000, 1200; G. Reserves/Escrow, 1000; H. Per Diem Interest, 900; I. Hazard Insurance, 900, 1000; J. Optional Owner's Title, 1100.

3. Section 6 Transfer of Servicing Language

In 1990, Congress amended RESPA to include a disclosure, which informs borrowers that their loan or the servicing of their loan, may be sold. 12 U.S.C. 2605, Public Law 93-533 section 6 (November 28, 1990). In 1997, HUD proposed a rule to implement the amended statute. Many comments were received and the rule was never finalized. 62 FR 25740. The Department plans to finalize the 1997 proposed rule shortly. However, in the meantime, the Section 6 language in the statute may be provided in conjunction with the GFE instead of the language currently indicated in § 3500.21 and Appendix MS-1.

C. Remove Regulatory Barriers To Allow Guaranteed Packages of Settlement Services and Mortgages To Be Made Available to Borrowers

1. A New Safe Harbor for Guaranteed Mortgage Packages (GMP) Created Through HUD's Exemption Authority

Consistent with its earlier recommendations in the HUD-Federal Reserve Report, described in the background section of this rule, the Department believes that the most effective means of simplifying the process of obtaining a mortgage, promoting competition to lower costs and facilitating shopping is to offer borrowers Guaranteed Mortgage Packages containing a lump sum price for all loan originator and governmental required settlement costs associated with obtaining a mortgage combined with an interest rate guarantee for the loan. The Department believes that such packages offer borrowers the possibility of lower prices through innovation by packagers, the pricing discipline involved in arranging packages, and competition among packagers.

Under a Guaranteed Mortgage Package approach packagers would offer a lump-sum price for settlement costs, and an interest rate guarantee at no cost to the borrower until the borrower selects the package. The packager would be held to those figures from the time the package is agreed to through settlement. This approach would allow the borrower to rely on the quoted price and rate and to compare fewer numbers in shopping for the best loan to meet his or her needs. Even with improvements to the current disclosure scheme, including more reliable quotes for major settlement costs under the new GFE (see B(2)(c), above), it will not be as easy for borrowers to shop and compare as it would be if they could simply comparison shop for mortgages based on a few prices as under this proposal.

The Secretary has determined, therefore, that effective packaging of settlement services will depend on packagers negotiating lower costs with third party settlement service providers, and then providing borrowers with an alternative disclosure, the Guaranteed Mortgage Package Agreement (GMPA). This proposal will increase the opportunities for borrowers to shop among packages fostering competition to lower costs further. Under Section 8(c)(5) of the Act, the Secretary is authorized to issue regulations that remove certain payments or classes of payments or other transfers from the Section 8 prohibitions on kickbacks and unearned fees after consultation with designated regulatory agencies. Also, under Section 19 (a) of the Act, the Secretary is authorized to grant reasonable exemptions for classes of transactions as may be necessary to achieve the purposes of the Act. Accordingly, under these authorities, HUD is proposing to establish a carefully circumscribed safe harbor from RESPA's provisions at Section 8 to facilitate the development and marketing of Guaranteed Mortgage Packages.

2. Who May Package

The purpose of the Guaranteed Mortgage Package safe harbor is to stimulate competition and improve the borrower's ability to shop. Under this proposal, entities other than lenders may qualify as packagers for a safe harbor, as long as their packages include a mortgage and otherwise satisfy the requirements of the safe harbor. In this connection, in order to ensure that the borrower receives the settlement package of services and the mortgage loan, the proposed rule would require that the packager sign the GMPA agreeing to provide the Guaranteed Mortgage Package at the Guaranteed Mortgage Package price and that non-lender packagers have a lender sign the GMPA after borrower acceptance agreeing to provide the loan included in the Guaranteed Mortgage Package.

3. Requirements for the Safe Harbor

Packagers that provide the GMP and abide by its terms and the other requirements of this rule, along with any settlement service providers participating in such a package, would receive a safe harbor from scrutiny under Section 8 of RESPA as described below. Specifically, to qualify for the

safe harbor, packagers, within 3 days of borrower's application, would have to offer, without an upfront fee: (1) A guaranteed price for the loan origination and virtually all other lender required settlement services needed to close the mortgage, including without limitation, all application, origination, underwriting, appraisal, pest inspection, flood and tax review, title services and insurance, and any other lender required services, and governmental charges; (2) a mortgage loan with an interest rate guarantee, subject to change (prior to borrower lock-in) resulting only from a change in an observable and verifiable index or based on other appropriate data or means to ensure the guarantee;

and (3) a Guaranteed Mortgage Package Agreement (GMPA) as a prospective contract with the borrower that is binding through settlement containing the maximum settlement costs. The GMP offer would remain open as an offer for a minimum of 30 days from when the document is delivered or mailed to the borrower. The GMPA becomes a binding contractual commitment immediately upon borrower acceptance of the package and payment of a minimal engagement fee, subject only to acceptable final underwriting and property appraisal.

Through this requirement, discussed infra, HUD seeks to ensure that the rate of the loan does not vary after the borrower commits to a packager for reasons other than an increase in the cost of funds. There may be a variety of ways to solve this problem and HUD is seeking comments, in particular, on how to implement an interest rate guarantee.

The guaranteed package also would include up-front costs of mortgage insurance. The cost of mortgage insurance is based on the ratio of the loan amount to the value of the property and is not finally determined with certainty until the lender knows the property value. In the GMP price, the packager shall include any maximum upfront mortgage insurance premium based upon the borrower's estimate of the property value and the amount that needs to be borrowed. The GMPA will inform the borrower that the upfront mortgage insurance premium, if any, may decrease or become unnecessary depending on the final appraised value of the property. The “Other Required Settlement Costs”, discussed immediately below, would include any required reserves for mortgage insurance premiums. Because full underwriting information will not be available to the packager at the time the GMPA is provided, implementation issues are presented. Commenters are invited in Question 21 below to provide their views on how mortgage insurance should be addressed in Guaranteed Mortgage Package Agreements.

Under the proposal, reserves that are escrowed would be disclosed on the GMPA as “Other Required Costs” and subject to a 10% tolerance. The only costs that could be excluded from the guarantee and not subject to any tolerance would be those that fluctuate depending upon the borrower's choice, such as hazard insurance, per diem interest, and optional owner's title insurance. However, the Questions below ask commenters whether these items should also be included in the package at the required minimum amounts with a notation that “optional costs” are the responsibility of the borrower.

The proposal does not require packagers to itemize the services included in the GMPA. HUD believes however, that there are certain settlement services that are of specific interest and value to the borrower such as pest inspection, appraisal and the purchase of lender's title insurance (which may affect the cost of owner's title insurance). Some lenders may choose to forego some or all of these services. Therefore, HUD proposes that if any of these particular services are not anticipated to be included in the GMP, this fact must be disclosed on the GMPA.

Packagers may in GMP transactions provide a GMPA in lieu of the GFE. The revised instructions for the HUD-1/1A require that in Guaranteed Mortgage Packages, the HUD-1/1A must itemize the services provided, but not the specific charges for those services. However, because the amounts of certain individual charges needed to compute the finance charge and the APR under TILA and HOEPA, the packager must list the finance charges needed to calculate the APR on an addendum to the HUD-1 or HUD-1A. At Question 20, commenters are asked to provide their views on whether this approach adequately protects and preserves consumers' rights under TILA and HOEPA while facilitating packaging, and to suggest alternatives, if needed. Entities that do not choose to seek this safe harbor will continue to provide the GFE and HUD-1/1A disclosure scheme, as amended by this rule.

4. Contents of the Guaranteed Mortgage Package Agreement

The premise underpinning packaging is that firm, simple, guaranteed price quotes will enable borrowers to shop for mortgage loans with much greater confidence and certainty. The GMPA starts with a brief description of the function of the packager—what the packager is providing—and a statement that the interest rate on the proposed form, and the settlement costs quotation (if any), represent an offer to the borrower which is open and guaranteed for 30 days from when the document is delivered or mailed to the borrower, and which will immediately become a binding contractual agreement upon borrower acceptance and payment of a minimal engagement fee, subject only to acceptable final underwriting and property appraisal. The opening description also makes clear that any required settlement costs not separately itemized and estimated in Section III of the GMPA are the responsibility of the packager.

Section I of the GMPA provides the interest rate guarantee and APR along with an explanation that the interest rate is guaranteed through settlement if the borrower agrees now to the GMPA and locks-in this rate by a specified date/time. Any mortgage insurance premium included in the APR would be separately disclosed in Section I. It provides that if the borrower does not choose to commit immediately, it is guaranteed that the quoted interest rate will not change except in relation to changes in a specified index rate (or other such appropriate data or means as HUD may determine to assure that changes in the rate are reflective of the cost of funds and not simply to increase the packager's compensation).

Section II of the GMPA states that this package price covers all services, besides those listed in Section III, that are necessary to close the loan. The packager would, however, be required to inform the borrower if certain designated items are not anticipated to be included as part of the package including lender's title insurance, the pest inspection, and appraisal. Under the GMPA, any pest inspection report, credit report, and appraisal would be provided to the borrower upon the borrower's request. (On the HUD-1, borrowers will receive a listing of the specific services provided, but not the specific prices for each service. The total settlement costs will be provided.)

Section III of the GMPA provides a description of “Other Required Settlement Costs” which are outside the package and informs the borrower that reserves/escrow are subject to a 10% upper limit, or tolerance, at settlement absent unforeseeable and extraordinary circumstances. However, the 10% tolerance does not apply to hazard insurance and per diem interest in this category. The GMPA also makes clear that any required settlement cost not specifically identified on the GMPA as

outside a package, and itemized on the GMPA, is included in the guaranteed price quote and is the responsibility of the packager.

Section IV of the GMPA provides the borrower the cost of owner's title insurance, if available. For any package where the packager offers the borrower the option of paying all or part of the stated guaranteed and/or estimated settlement costs through a higher interest rate, that option will be explained in accordance with Section V of the GMPA. Similarly, where a packager offers the borrower the option of lowering the stated guaranteed interest rate by paying additional amounts at settlement, commonly referred to as discount points, that option will also be explained in accordance with Section V of the GMPA.

Section VI provides interest rates and adjustment terms related to adjustable rate mortgages, applicable prepayment penalties, and balloon payments. Section VII of the GMPA must be signed by an authorized agent of the packager and the borrower to become a binding contract for the Guaranteed Mortgage Package at the Guaranteed Mortgage Package price. After acceptance by the borrower, non-lender packagers must ensure that the lender sign the GMPA agreeing to provide the loan included in the Guaranteed Mortgage Package. HUD solicits comments on the issue of lender signatures on the GMPA in Question 18 below. Notwithstanding the basic objective of packaging, which is to dramatically improve the borrower's capacity to comparison shop, different entities may offer two types of packages. Some packagers may offer GMPs in which all settlement costs are included in the interest rate guarantee (in which case no guaranteed settlement cost quote will be provided), while other packagers may quote a guaranteed price for all settlement costs along with a (presumably lower) interest rate guarantee. The Special Information Booklet and other consumer education materials will alert borrowers to compare the combined impact of both settlement cost and interest rate guarantees when shopping among packagers, and will suggest that a borrower might wish to compare the APRs of the two products as well as consider how long the borrower plans to stay in the property; a longer mortgage term may mitigate in favor of a borrower choosing to pay settlement costs through a higher rate.

5. Interest Rate Guarantee

In the rule, HUD is requiring that Guaranteed Mortgage Packages include an interest rate guarantee. HUD's rationale for this requirement is that both the settlement costs and the interest rate need to be firm for borrowers to compare loan products. HUD recognizes, however, that after a borrower requests a GMPA but before locking in a rate, the interest rate on a loan may change based on market forces. Similarly, some borrowers choose to float even after they have committed to an originator, in the hopes that market interest rates will fall. In such instances, HUD believes that in the context of GMPs, it is necessary to assure that when the borrower is ready to lock, the interest rate will only be changed based on observable market changes, or based on other data or appropriate means to ensure the guarantee. One possibility is to have the rate move with an observable and verifiable index. Another is to have a rate publicly available. Whatever the ultimate methodology, it must be easily useable and verifiable by the borrower and the industry. Commenters are asked to address Question 13 concerning the use of an index or a substitute therefore to address this problem.

6. Scope of the Safe Harbor

The Secretary is exercising exemption authority under Section 8(c)(5) and Section 19 of RESPA to establish this carefully circumscribed guaranteed mortgage packaging safe harbor. The Secretary is establishing this safe harbor only for those Guaranteed Mortgage Package transactions that meet the requirements set forth in this rule. The Secretary has determined that the establishment of this safe harbor is necessary to allow this class of transactions— guaranteed packages of settlement services with the protections required under this rule— to be available to consumers to achieve the purposes of the Act. The Secretary has concluded that the availability of these packages to consumers will simplify their shopping for settlement services and allow them to gain the benefit of an active competitive marketplace where market forces lower settlement costs. For the same reasons, the Secretary has determined that payments and pricing arrangements between packagers and participating settlement service providers for Guaranteed Mortgage Packages as set forth in this rule shall not be construed as prohibited under Section 8 of RESPA as long as the requirements in this rule are satisfied. Pursuant to Section 8(c) (5) the Secretary has undertaken the necessary consultation with other agency heads as required prior to promulgating this exemption.

This safe harbor will allow packagers to inject pricing discipline to negotiate firm overall prices for essentially all settlement services and mortgage interest rates with participating settlement service providers. Some GMPs may require the use of affiliated entities, a practice prohibited by Section 8 except in limited circumstances. Other GMPs may involve arrangements between independent providers based on the projected volume of business to be referred. The safe harbor will apply in both of these arrangements. Without this safe harbor, Section 8(a)'s prohibition on referral fees may bar such arrangements and Section 8 (b)'s prohibitions may deter packagers from retaining profits that result from packaging, which could be regarded as unearned. Outside the safe harbor, where loan originators arrange discounted prices that are charged to consumers, HUD is proposing in this rulemaking to clarify that Section 8 is not violated (see above). Because HUD believes that the benefits to borrowers of packaging outweigh any protections offered by Section 8's provisions, the Secretary has concluded that such a carefully circumscribed safe harbor is appropriate, subject to the eligibility conditions set forth in this rule.

Accordingly, pursuant to Section 19, the Secretary has determined that the safe harbor is necessary for these prescribed transactions to achieve the purposes of the Act. Where the requirements are met, the safe harbor from Section 8 will permit payments or other things of value exchanged between a packager and entities participating in the package, and

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