CBA Publications >> CBA Regulatory Compliance Bulletin >> Vol 2001 No. 14 November 7, 2001

Vol 2001 No. 14 November 7, 2001

HUD Reiterates Position On Yield Spread Premiums

This article was prepared for CBA by Janet Bonnefin, member of the CBA Regulatory Compliance Committee and principal with the firm, Aldrich & Bonnefin.

The Department of Housing and Urban Development (HUD) has issued a new Statement of Policy 2001-1 (2001 Policy Statement) (66 F.R. 53052) which reiterates and clarifies its previous position with respect to payments of yield spread premiums and overcharges in connection with loans covered under the Real Estate Settlement Procedures Act (RESPA). According to HUD, the 2001 Policy Statement contains no new significant interpretations of RESPA. Rather, it is intended to clarify HUD's interpretation of Section 8 of RESPA as set out in its March 1999 Statement of Policy 1999-1 (the 1999 Policy Statement) by addressing issues raised by two recent court decisions. That said, there appears to be a significant new development regarding a lender's ability to charge a "review" fee in connection with reviewing another settlement service provider's services.

Scope

Section 8 of RESPA provides two basic prohibitions against the payments of kickbacks and unearned fees. In general, Section 8(a) of RESPA prohibits any person from giving and any person from accepting "any fee, kickback or thing of value pursuant to an agreement or understanding, oral or otherwise" for the referral of business in any RESPA-covered transaction. 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."

Background

Lender payments to mortgage brokers continue to be challenged in the courts. The 1999 Policy Statement was actually produced as a result of various legal claims. Many of the claims assert that payments of "yield spread premiums," where compensation reflects the difference between the lender's par (or market) rate and the actual interest rate agreed to by the borrower, violate the anti-kickback provisions of RESPA Section 8(a). On another front, courts have reviewed the issue of charging unearned fees in violation of Section 8(b). Two highly publicized cases address these two matters: Culpepper v. Inland Mortg. Corp., 132 F.3d 692 (11th Cir.1998), as modified, 144 F.3d 717 (11th Cir. 1998); and Echevarria v. Chicago Title & Trust Co., 256 F.3d 623 (7th Cir. 2001).

Culpepper. The Culpepper case was the first of several class actions concerning the legality of yield spread premiums to reach the federal appeals court level. Through a mortgage broker (Premiere Mortgage Company) the Culpeppers obtained a loan that was placed with Inland Mortgage Corporation. While the loan was table-funded, the real source of funding was a contemporaneous advance from Inland, with Premiere immediately assigning the loan to Inland.

The loan was priced at 7.5%. However, Inland's par rate on comparable loans was only 7.25%, creating a yield spread premium of 1.675 points (or $1,263.61). Had Premiere closed the loan at the par rate of 7.25%, Inland would have paid a premium of only one-eighth one point or $97.20. When the loan closed, the borrowers paid Premiere a one point loan fee of $760.50 directly, in addition to the yield spread premium received from Inland.

The court held that table funding, while permissible, is not a bona fide secondary market transaction. Because Inland funded the transaction, it was deemed to be the owner of the loan. Inland attempted to argue that Premiere's right to direct the disposition of the loan was a valuable attribute of ownership, but the court saw this as essentially another way of characterizing a payment for a referral. The court's initial opinion suggested that a yield spread premium was per se illegal. However, in a clarifying opinion, the court held that Inland had not proven that the yield spread premium was paid for goods or services, which RESPA would have permitted, thus it would have to prove this at trial.

In further developments, the Court of Appeals for the Eleventh Circuit has upheld the district court's class certification of the case. Culpepper v. Irwin Mortgage Corp., 253 F.3d 1324 (11th Cir. 2001) (Culpepper II). The district 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 the services, if any, the broker performed.

Echevarria. In Echevarria, the Court of Appeals for the Seventh Circuit concluded that unearned fees must be passed from one settlement provider to another in order for the fees to violate Section 8(b). Based on this conclusion, the court held that a settlement service provider did not violate Section 8(b) when it added an overcharge to another provider's fees and retained the additional charge without providing any additional goods, facilities or services. In that case, the title company pocketed the difference between the recording fee it charged the borrower and the lower amount actually charged by the county recorder's office. Other courts have also held that two or more parties must split or share a fee in order for a violation of Section 8(b) to occur. Still other courts have stated that a single provider can violate Section 8(b).

1999 Policy Statement

HUD's 1999 Policy Statement provided guidance on the legality of payments by lenders to mortgage brokers under RESPA. HUD stated that yield spread premiums or any other class of payments from lenders to mortgage brokers are not per se illegal, but noted that is not to imply that they are legal in individual cases or classes of transactions. The 1999 Policy Statement established a two-part test that is applied to two common transactions in which mortgage brokers are not viewed as the real source of funds.

The first pertains to intermediary transactions where the broker acts solely as an intermediary and the loan is closed in the name of the ultimate lender. The second is table-funded transactions where the broker closes the loan in its own name but there is a simultaneous advance of funds by the lender and the broker assigns the loan to that lender. The two part test involves determining: (1) whether goods or facilities were actually furnished or services were actually performed for the compensation paid and; (2) whether the payments are reasonably related to the value of the goods or facilities that were actually furnished or services that were actually performed.

Part One of HUD's Test. Under part one of the test, HUD indicated that in determining whether a yield spread premium was for goods, facilities or services it is necessary to look at each transaction individually, including examining all of the goods or facilities provided or services performed by the mortgage broker in the transaction. The 1999 Statement contains a list of compensable loan origination services originally developed by HUD in 1995 in response to a letter from the Independent Bankers Association of America (IBAA), and which HUD considers relevant in evaluating mortgage broker services. In its IBAA letter, HUD noted that the list was not exhaustive but that it generally would be satisfied that sufficient origination work was performed to justify compensation if it found that, in addition to taking the loan application, the mortgage broker performed at least five additional services from the list.

Part Two of HUD's Test. Under the second part of the test, the total compensation received by the mortgage broker must be examined to determine that it reasonably relates to the total set of goods or facilities actually furnished or services performed. In analyzing whether a particular payment or fee bears a reasonable relationship to the value of the goods or facilities actually furnished or services actually performed, HUD indicated that it will consider price structures and practices in similar transactions and in similar markets. The 1999 Policy Statement emphasized that higher interest rates, by themselves, cannot justify higher broker fees. All fees will be scrutinized as part of total compensation to determine that the total compensation is reasonably related to the goods or facilities actually furnished or services actually performed. HUD also indicated that the mortgage loan itself is not a "good" provided by the broker that the lender may pay for based on the difference between its yield and the market yield.

Disclosures. The 1999 Policy Statement also reiterated the current RESPA requirement that brokers disclose estimated direct and indirect fees on the Good Faith Estimate (GFE) and at closing on the HUD-1 settlement statement. Lender payments must be shown as "Paid Outside of Closing" (P.O.C.), and are not computed in arriving at totals. Code-like abbreviations, such as "YSP to DBG, POC," are discouraged because they may be confusing or hard to understand and inadequately identify the nature of the payment of yield spread premiums. On the other hand, HUD noted that a fee would be appropriately disclosed as "Mortgage broker fee from lender to XYZ Corporation (P.O.C.)." HUD acknowledged that RESPA requires no disclosure of broker services and compensation prior to the GFE, but encourages brokers to provide such information as early as possible.

Statement of Policy 2001-1

HUD's 2001 Policy Statement is being issued in response to conflicting court decisions. The district court in Culpepper II described HUD's 1999 Policy Statement as "ambiguous." Similarly, the Court of Appeals for the Seventh Circuit rendered its conclusion in Echevarria"absent a formal commitment by HUD to an opposing position . . .." As a result, HUD has indicated that it is obligated to clarify its position.

Yield Spread Premiums. In the 2001 Policy Statement, HUD restates its position with respect to yield spread premiums. That is, while yield spread premiums are not per se illegal, that does not imply that they are legal in individual cases or classes of transactions. According to the 2001 Policy Statement, where compensable services are performed both parts of the HUD test outlined in 1999 Policy Statement must be applied before a determination can be made regarding the legality of a lender's payment to the mortgage broker.

With respect to mortgage brokerage services, HUD notes in the 2001 Policy Statement that the IBAA list is still a generally accurate description of settlement services. According to HUD, compensation for these services may be paid either by the borrower, the lender or partly by both. However, HUD reiterates that compensable services under part one of the test do not include referrals, or no, nominal or duplicative work. HUD also repeats its position that the total compensation to the broker must be reasonably related to the total value of goods or facilities provided or services performed by the broker. Simply delivering a loan with a higher interest rate is not a compensable service.

HUD went to great pains to justify yield spread premiums as a means of making mortgage loans more affordable to more consumers because they serve to reduce the up-front costs of mortgage loans. HUD did provide, though, that in the case of less scrupulous brokers and lenders, who do not provide a reduction in up-front fees in exchange for a higher interest rate, the total compensation paid to the broker may fail to comply with the second part of the two-part test. This would of course mean that the yield spread premium violates Section 8(a) in such cases.

Disclosures. The 2001 Policy Statement also provides guidance regarding the disclosure of yield spread premiums. Currently, yield spread premiums are to be listed in the "800" series ("Items Payable in Connection with Loan") of the HUD-1 settlement statement given at closing. HUD asserts, however, that the purpose of yield spread premiums is to lower up front costs to borrowers and, therefore, this should be reflected in the disclosure to the borrower. HUD has adopted the suggestion by others that by also disclosing the amount of the yield spread premium in the "200" series ("Amounts Paid by or in Behalf of Borrowers"), borrowers will be able to see that the yield spread premium is reducing closing costs and the extent of that reduction. Thus, lenders may disclose the yield spread premium in both places on the HUD-1 as POC (paid outside of closing).

HUD has indicated in its 2001 Policy Statement that full information provided as early as possible in the shopping process would increase consumer satisfaction and reduce the possibility of misunderstanding. The Policy Statement indicates that "HUD regards full disclosure and written acknowledgment by the borrower, at the earliest possible time, as a best practice." Accordingly, HUD states that in the future, full and early disclosures are factors that it would weigh favorably in exercising its enforcement discretion in cases involving mortgage broker fees. Nevertheless, the 2001 Policy Statement also again makes clear that disclosure alone does not make illegal fees legal under RESPA. HUD states that it will scrutinize all relevant information in making enforcement decisions, including whether transactions evidence practices that may be illegal.

Unearned Fees. The 2001 Policy Statement reiterates HUD's long-standing interpretation of Section 8(b) of RESPA that it is illegal to charge or accept a fee or part of a fee where no service has actually been performed. Section 3500.14 of Regulation X (which implements RESPA) specifies that no person shall give and no person shall accept any portion, split or percentage of any charge made or received for the rendering of a settlement service in connection with a RESPA covered transaction, other than for services actually performed.

HUD notes that because the proscription against "any portion, split, or percentage" of an unearned charge for settlement services is written in the disjunctive, the prohibition is not limited to a split. In HUD's view, the statute forbids paying or accepting any portion or percentage of a settlement service, including up to 100% that is unearned regardless of whether the entire charge is divided or split among more than one person or entity or is retained by a single person. Furthermore, settlement service providers cannot mark-up the cost of another provider's services without providing additional settlement services and those services must be actual, necessary and distinct services in order to justify the charge. HUD specifically notes that some lenders have charged an additional fee merely for "reviewing" another settlement service provider's services. According to HUD, this type of "review" does not constitute an actual, necessary or distinct additional service permissible under Regulation X (emphasis added). Thus, it appears that it is not permissible for a lender to charge an additional fee for, as an example, reviewing a title policy or an appraisal.

HUD continues to interpret Section 8(b) to prohibit all unearned fees, including, but not limited to, cases where: (i) two or more persons split the fee for settlement services, any portion of which is unearned; (ii) one settlement service provider marks-up the cost of the services performed or goods provided by another settlement service provider without providing additional actual, necessary, and distinct services, goods, or facilities to justify the additional charge; or (iii) one service provider charges the consumer a fee where no, nominal, or duplicative work is done, or the fee is in excess of the reasonable value of goods or facilities provided or the services actually performed.