The world’s financial systems teetered on the brink of collapse for the last several years. In large part, this is due to the excesses and greed of major financial institutions. Coupled with a dearth of oversight by federal watchdogs, fortunes have vanished and Joe Average daily finds himself struggling to make ends meet. In response to this crisis, Congress passed the Restoring American Financial Stability Act of 2010, commonly called the Financial Reform Bill. In November of 2009, Speaker of the House Nancy Pelosi (D-CA) said, “. . . the party is over. Never again will the reckless behavior [of] a few threaten the fiscal stability of our people. . . .” She also said the legislation would “. . . inject transparency and accountability into our financial system.” Will the Financial Reform Bill truly achieve its objectives, or will it cause more problems? What effect will these reforms have on the mortgage industry?
The effect on the Yield Spread Premium (YSP) is central to this discussion. The YSP is the money (or rebate) paid to a mortgage broker for negotiating a higher interest rate on a loan in exchange for lower upfront costs (e.g., origination fees or discount points). There is nothing intrinsically wrong with this practice. For many borrowers it represents the only way they can get a loan. The problem is that many lenders (both institutional and mortgage brokers) take advantage of the borrower by unreasonably increasing their profit margin on a loan.
The Financial Reform Bill adds new disclosure requirements so that the borrower will know in advance the true costs of the loan. Unfortunately, there are inconsistencies in the legislation (i.e., loopholes) that put mortgage brokers at a disadvantage against institutional lenders (e.g., banks). First, the institutional lenders do not have to disclose their YSP. Second, if a lender funds a loan and then sells it after closing, that lender is not required to disclose the YSP. effectively giving them “hidden” profits. Mortgage brokers, however, must make full disclosure in writing, even when they have purchased the loan from an institution. This gives the institutional lender an unfair advantage over the mortgage broker. To reiterate, no fair-minded person is against disclosure requirements so long as there is a level playing field and all lending entities must follow the same rules.
Aside from the fact that institutional lenders can “hide” true costs from a borrower, particularly when they sell the servicing rights to another lender, there is another onus working against mortgage brokers. Since the YSP must be disclosed on the “good faith estimate,” this encourages broader loan shopping. The mortgage brokers will have to invest time (and expense) in deals they will have little chance of closing, because borrowers who have agreed to a deal can effectively walk out of the closing process anywhere along the way if they think they have found a better deal.
Because some mortgage brokers abuse the system, all are being punished (while banking institutions are not particularly affected). Yes, the YSP is a great source of income–by some measures bringing in at least $16,000,000,000 per year. Nevertheless, it is also an avenue for underfunded borrowers (people who can make their monthly mortgage payments, but lack the upfront monies to afford the loan) to buy a home.
The Financial Reform Bill has many positive elements. It increases oversight of the financial and banking industry. It addresses the problem of “too big to fail” (although the largest banks may become even more powerful). It gives shareholders more say in the compensation of company executives. It places a cap on credit card fees and regulates that industry more assiduously. However, its effect on mortgage brokers, particularly as it unevenly regulates disclosure of the Yield Spread Premium regulations, may hurt the consumers it was meant to protect.