Last week I reported favorably on one part of HUD's current reform
proposals. A new and substantially improved good faith estimate (GFE)
would make it easier for borrowers to shop alternative loan providers
(LPs). The proposed GFE along with new rules as to how it must be used
will also eliminate critical weaknesses of the current GFE that
encourage opportunistic pricing -- the practice of charging as much as
you can get away with.
The current GFE is an open-ended list of settlement costs with no
meaningful subtotals, encouraging lenders to invent new charges.
Further, all of the charges on the current GFE are "estimates" subject
to change, the only barrier to abuse being the "good faith" of the LP.
In all too many cases, charges are raised in bad faith and there is
nothing that HUD can do about it.
In the proposed GFE, settlement costs are divided into three
categories. Category one includes all charges by the lender and
mortgage broker, tabbed "Our Service Charge," and government recording
and transfer charges. At settlement, these charges must be the same as
those on the GFE. This rule is completely appropriate regarding
lender's own charges; it is also long overdue. Charges by governmental
entities are another matter, and my experience suggests that these
charges belong in category two, where the LP has a little latitude.
The second category now consists of services provided by third
parties who are selected or identified by the LP. The most important
of these is title insurance. The total of such charges can be as much
as 10 percent higher at settlement than the total shown on the new GFE.
This limit is better than no limit, but it doesn't touch the
dysfunctional system that makes third-party settlement services far
more costly than they should be. I comment on this further below.
The third category consists of services that the borrower has
elected to shop among service providers not selected or identified by
the LP. It includes homeowners insurance, which borrowers typically
purchase on their own, and it can include title insurance if the
borrower solicits title agencies on his own. These charges are not
subject to any limits on price increases. This is a reasonable
To help borrowers police their own transactions, HUD has proposed
to change the HUD-1 closing document so that it corresponds closely
with the new GFE. It will then be easy for borrowers to compare the
final charges on the HUD-1 with those on the GFE. Good idea.
HUD also intends to seek authority to require that the HUD-1 form
be made available three days before closing, rather than one day,
which is the current requirement. Another good idea, but they ought to
include the mortgage note in this requirement. There is no excuse for
forcing borrowers to confront a complicated contract for the first
time at the closing table.
The most disappointing part of the proposed new GFE is that it
leaves untouched the odious network of relationships between loan
providers and third-party service providers, which raise the cost of
these services to borrowers. Mandating that a title charge of $1,000
on the GFE can't be more than $1,100 on the HUD-1 closing document
doesn't accomplish much if the charge ought to be $300.
While it is not possible to know what the charge would be in a
properly functioning competitive market, we do know that the
perversely competitive markets we have now encourage high prices.
Competition is perverse when service providers market not to
purchasers but to the entities who refer the purchasers to them. The
LPs who refer mortgage borrowers to third-party service providers
share in the overcharges -- sometimes legally, sometimes not.
The remedy is well-known and well-tested. It is to require lenders
to pay for all services that they require from borrowers. If lenders
want title protection, they should buy it and pay for it, passing the
cost to borrowers in the rate and points. The cost passed through will
be a small fraction of what borrowers pay now, as lenders are large
and knowledgeable purchasers who can buy in bulk.
This is not a pie-in-the-sky idea. Indeed, since Bank of America
adopted it last year, it can be viewed as an industry "best practice."
Yet HUD, despite its legal mandate to lower settlement costs, ignores
it. If this reflects HUD's concern that they will receive no support,
they are surely mistaken. If it were placed on the table, community
groups would have to support it. How could they not?
To be sure, the mortgage bankers would oppose the idea because
trade groups can't advocate best practices without alienating a major
segment of their membership. But the fact that a leading lender has
adopted it voluntarily and successfully will make it difficult for
them to argue that the market will collapse.
Next week: How broker charges are handled in the new GFE.