Question for discussion: In Washington State, can Loan Officers operate within the framework of a Fiduciary duty to their clients when the lending industry is structured with incentives that may be in conflict with the new standard?
Jane Kim of the Wall Street Journal wrote an excellent article in this past weekend’s issue regarding Wall Street brokers (selling investments) being placed under Fiduciary standards in dealing with customers.
Currently, Wall Street brokers are held to what is termed “suitability standard,” which is a more lenient standard than that of a fiduciary. In contrast, Registered Investment Advisers have operated for a long time under the more stringent “fiduciary” standard—a legal standard that compelled them to act in the best interests of customers. The proposed higher standard forces disclosure of potential conflicts of interest (i.e., if they make more money off of an investment offered vs. others) and promotes recommendations of investments that may be less costly to the consumer and more tax-efficient.
While Wall Street struggles with reform as part of its regulatory overhaul, the mortgage industry has also implemented reform by introducing a similar “fiduciary standard” for mortgage brokers and loan officers. Prior to this reform in the mortgage industry, those who originated loans had no obligation to work in the best interest of their customers.
“In most states, mortgage loan originators still have no fiduciary obligation to work on behalf of their client’s best interests. The state of California mandated fiduciary duties for only mortgage brokers even during the height of the real estate bubble and Washington State added fiduciary duties for mortgage brokers and loan originators in 2008 but this still leaves consumer loan company loan officers (LO’s) and bank loan officers with more of a salesperson’s status. I’m sure there are some LOs who work at a bank, credit union, or consumer loan company (they like to say “mortgage banker” or “correspondent lender”
because it sounds better) who do regularly look after their clients’ best interests but this is just mere subjectivism.”
– Jillayne Schlicke, Founder of the National Assn. of Mortgage Fiduciaries
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Much of today’s economic problems are directly associated with lending-gone-wild. Countless cases of fraud both locally and throughout the country have been exposed resulting in massive losses for lenders and consumers, even those caught innocently in its wake.
One of the questions unanswered: How can the mortgage community effectively work the way a fiduciary standard is intended when the current lending structure is one in which incentives provided to the loan originators seem to undermine their ability to work in the best interest of their client?
For example, if you have two perfectly credit worthy borrowers, gainfully employed and with similar financial resources that are purchasing a home, it is common that you can have one borrower obtain a loan interest rate at about 1/4 to 1/2 percent less than that of the other borrower. Sometimes the spread may be larger. Why? It may have to do with incentives commonly called yield spread premiums or rebates from the lender paid directly to the mortgage broker/loan officer for originating the loan at a specific interest rate. This is retail lending. There was nothing wrong with this system when it operated under the prior “salesperson” framework where a Fiduciary duty was absent. Today, the Washington State licensed loan originators, working under a Fiduciary standard with the incentives at hand, may have an inherent conflict that didn’t exist before. I find this terribly ironic.
A loan sold to the consumer at 5.0% interest rate may provide a payout/rebate to the loan originator of only .125% (1/8th of one percent) of the loan amount but a loan sold to the consumer at 5.25% may bump that paid incentive to the loan originator up to .5% (1/2 of one percent) of the loan amount (note: the rebates are earned fees over and above the commonly standard 1% fee charged). If the interest rate is sold at 5.5%, the incentive provided for the loan originator may be even greater. The checks and balances to this scenario is that consumers shop and therefore a loan officer must compete in fees and rate or they will have little chance of making the loan. In addition, there is no way of knowing what rate will be offered to the consumer at loan application including any rebate back to the loan originator until the loan program and rate is locked. Rates can and do change daily and even several times within the day.
“During the bubble run up and predatory lending days, loan originators would routinely lowball their Good Faith Estimates or simply not disclose this rebate existed. At closing the consumer would see the higher fees but have no time to object.” – Jillayne Schlicke
What is the solution?
It could be that a loan originator could guarantee their rate and fees (subject to restrictions and conditions) on the new Good Faith Estimate or GFE (coming this January 2010) that has been recently overhauled by HUD to provide a clearer understanding of the fees and loan program that is being offered. There has been push-back resistance of this new Good Faith Estimate by the lending industry, and some of it for arguably good reason. According to Jillayne Schlicke, the National Association of Mortgage Brokers (NAMB) has lost this round to influence a change in the newly proposed GFE.
Many in the lending industry have elected to avoid the disclosure of yield spread premiums (shown on a Settlement Statement) by working at a company that is licensed as a consumer loan company or by working at a bank. In other cases, the loan officer may work under a correspondent lending company or other similarly structured business model. Under these business models the loan is originated and closed in the name of the lending firm where the loan officer works and shortly after closing (almost simultaneously) the loan is sold to an investor such as Wells Fargo or Chase Bank. This business structure avoids disclosure of any rebates or yield spread premiums and, if the loan was brokered and not closed in the name of the correspondent or consumer loan company name, the awkward situation when a consumer may ask (while signing their closing papers) what the separate figure or YSP disclosure is on their Settlement Statement.
Working within a framework of a “Fiduciary Standard” is not an easy task because of so many competing interests, potential conflicts of interest and regulatory standards that may or may not be practical in all situations. Jane Kim, in the article she writes in this weekend’s edition of the Wall Street Journal summed up the problem facing Wall Street brokers well:
“Trying to define what constitutes a fiduciary duty is like trying to define the duty to not commit fraud—any application of it depends on the client’s particular facts and circumstances.”
On January 1st of 2010 (the date that HUD begins requiring use of the newly updated Good Faith Estimate document), it could be new era when a loan officer says to their client, “I charge “x” amount to make your loan and when I lock your rate if there is a rebate or yield spread premium excess beyond what I charge in aggregate, you will receive the benefit of that money in the form of a credit or partial credit to reduce your closing costs. We won’t know that that amount is until your loan is locked. I don’t control what those rates and rebates offered will be. The ability for you to float your lock and play the market may also work in your favor and also work against you if rates rise. Together we will communicate to make sure we obtain the very best terms for you.” That would foster long-term business relationships like no other.
To conclude, I don’t think there has to be over-concern in the lending community with regards to the new Good Faith Estimate and properly disclosing earned fees. From my perspective, a lot of the uproar and concern by the mortgage broker community is energy misplaced. Consumers have no qualms about paying for services provided they know what to expect and can appropriately budget for their expenses if they are informed in a transparent way. Since late 2003, when our escrow office opened, there have been only a select few cases where clients have chosen not to close a loan because of confusion over fees or under disclosed matters that have come to light after receiving their Settlement Statement. I would argue that in those few cases, had the consumer been communicated with properly and all earned fees were explained in a manner that made sense, the loans would have closed and everyone would have been happy, including the escrow and title firms that are paid only if a loan closes. There is nothing more frustrating for title firms and escrow companies closing transactions than to have a client across the table walk away because of rates, fees or “unknowns” that take the consumer by surprise.
(thanks goes to Jillayne Schlicke for collaborating with me and editing this post)