HR 1728: Proof That This Congress Is In the Pockets of Big Banks

I said a few days ago that Banks hate the concept of mortgage brokers, because without brokers, they could jack up their margin per loan. Here's what they're doing about it: Introducing a bill into Congress making it impossible for mortgage brokers to do exactly what the banks themselves do.

You can track HR 1728 here.

Text of HR 1728. Most of it is redundant, iterating other things already done. One that isn't, however, is found in Section 103, subsections 1, 2 and 4

'(1) IN GENERAL- For any mortgage loan, the total amount of direct and indirect compensation from all sources permitted to a mortgage originator may not vary based on the terms of the loan (other than the amount of the principal).

This means that they are not permitting differing compensation to an originator based upon the tradeoff between rate and cost of real estate loans. Defensible, in and of itself. But not in conjunction with other parts of this section.

'(2) RESTRUCTURING OF FINANCING ORIGINATION FEE-

'(A) IN GENERAL- For any mortgage loan, a mortgage originator may not arrange for a consumer to finance through rate any origination fee or cost except bona fide third party settlement charges not retained by the creditor or mortgage originator.

'(B) EXCEPTION- Notwithstanding paragraph subparagraph (A), a mortgage originator may arrange for a consumer to finance through rate an origination fee or cost if--

'(i) the mortgage originator does not receive any other compensation from the consumer except the compensation that is financed through rate; and

'(ii) the mortgage is a qualified mortgage.

This removes the ability of a broker to allow consumers the choice or paying the origination fee via yield spread. I've explained yield spread more than once. It can be thought of a "negative discount" because that's exactly what it is: Something the banks voluntarily pay brokers in order to get those brokers to bring them loans at that rate of interest. It is rooted in the secondary market for loans, and what that secondary market pays for such loans. If the secondary market won't pay a premium (i.e. more than face value of the note) for such loans, I've never heard of a single lender offering any yield spread on such loans. In fact, there's usually a difference of about 1.5 points between secondary market premium and yield spread, with yield spread being the lesser of the two. So if it's a $400,000 loan with a yield spread, that lender is making about $6000, over and above what they pay the broker - just for the act of funding that loan long enough to sell it on the secondary market. This premium has nothing to do with whatever interest the consumer may be charged - it's a strictly cash bonus earned by being an intermediary middleman between the broker and the secondary market. Many loans with secondary market premium bonuses are still charged discount by lenders. In short, this section prohibits brokers from simply sharing in the premiums earned by bankers on the secondary market.

Furthermore, there is absolutely nothing compelling lenders to offer yield spread in the first place for any loan. It is purely voluntary on their part. They do it because otherwise brokers will shop other lenders for their clients requesting loans in that current cost range. Since this happens to be the vast majority of all mortgage loans I have experience with, this will have no effect other than the restriction of consumer choice on the most popular loan choices, forcing them to go to direct lenders, prohibiting brokers from competing effectively. This is in the consumer interest how?

The answer is that it isn't. It's in the big direct lender's interests, because it would enable them to jack up their profit margin per loan.

The exception might be taken as allowing yield spread to be used to finance origination, except for the following in subsection 4

'(4) RULES OF CONSTRUCTION- No provision of this subsection shall be construed as--

'(A) permitting yield spread premiums or other similar incentive compensation;

'(B) affecting the mechanism for providing the total amount of direct and indirect compensation permitted to a mortgage originator;

'(C) limiting or affecting the amount of compensation received by a creditor upon the sale of a consummated loan to a subsequent purchaser;

'(D) restricting a consumer's ability to finance, including through principal, any origination fees or costs permitted under this subsection, or the mortgage originator's ability to receive such fees or costs (including compensation) from any person, so long as such fees or costs were fully and clearly disclosed to the consumer earlier in the application process as required by 129B(b)(1)(C)(i) and do not vary based on the terms of the loan (other than the amount of the principal) or the consumer's decision about whether to finance such fees or costs; or

'(E) prohibiting incentive payments to a mortgage originator based on the number of residential mortgage loans originated within a specified period of time.'.

The last sentence should be known as the "encouraging unethical mortgage originators clause" but it's that first sentence that's the real killer. It flatly prohibits yield spread, something that the lender's lobby has been after for years. Individual lenders pay yield spread because they make more money by encouraging brokers to place the loans with them (as I said, about 1.5 points per loan), while the industry as a whole has been looking for a way to ban it because if no lenders are legally allowed to pay yield spread, they will make even more money per loan, not to mention cut down on the competitive advantage brokers have by economizing.

I wrote in Yield Spread is a Beneficial Tool That Can Be Misused that yield spread is not a cost paid by consumers, and it isn't. It's a premium paid by banks so they can make more more money (roughly $1.50 per hundred dollars loaned) by doing a higher volume of loans. By having yield spread available as an option, consumers have the option of not increasing their loan balance, or not increasing it by so much. You can't do reduced cost loans, let alone zero cost loans, without yield spread.

Here's an example to illustrate: Suppose you have a $400,0000 loan at 7.5%, and rates drop (as they have currently). However, you're also planning to sell in a year or two. So you don't want to spend a huge amount of money you'll never recover before you sell the property on refinancing your property. Along comes a broker who says, "Instead of refinancing you at 4.5% with a point of discount and a point of origination, costing you $8000 extra on your loan balance, suppose I refinance you at 5.25% with no discount and no origination. I make what I need to via yield spread, and it only costs you about $2000 on your balance to refinance. You save 2.25% every year in interest cost, or $9000, so if you go a year and a half, that's $13,500 you save in interest charges, less $2000 on up front cost, giving you a net of $11,500 in your pocket a year and a half from now." Wouldn't you say "yes" to that? It is completely logical and to your benefit to do so. But HR 1728 would remove that option by prohibiting the payment of yield spread. The only people to benefit by this are the lenders who keep you in higher interest rate loans.

I personally work through a correspondent lender. We don't get yield spread (unless we choose to work as brokers instead) because correspondent lenders fund in our own name - thereby getting most of the secondary market premium that the big lenders get. HR 1728 would probably be a good thing for me, personally, at least in the short term by putting brokers out of business. But I have learned the hard way that anytime consumer choice is adversely impacted, I will pay for it later. Yeah, they're only coming for brokers and I'm not a broker. But then what happens next? Easy: Once true brokers are out of business, they figure out a way to kill correspondent lenders. Instead, I choose to help brokers, even though I haven't got a personal stake in it - yet. Furthermore, it seems rather spurious to villainize a process that is a much smaller piece of precisely the way the big lenders themselves do business.

Stand up and be counted as in favor of permitting yield spread. The only people who benefit from banning it are major lenders and corrupt politicians engaged in paying them back for campaign contributions and personal favors (Yes, I'm looking at you Barney Frank (D - Malfeasance), and Chris Dodd (D - Corruption), too.)

Caveat Emptor