I’ve been a lawyer for more than thirty years, and the biggest part of that time was spent at the Federal Trade Commission working on issues relating to credit and rules for consumer protection. I’ve seen a whole bunch of regulations come and go—some good, some bad. Well, on April 1, a really good one was supposed to take effect, until a court put a stop to it. I thought it was an April Fool’s joke.
The new rule I’m talking about was to address a widespread—and, in my view, distasteful—practice that gave financial incentives to loan officers to charge consumers higher interest rates and fees on mortgage loans and to steer consumers to more costly loans, even when better loans were available. The rule was issued by the Federal Reserve Board and implemented provisions of the Dodd-Frank Act, the most sweeping overhaul of financial regulation since the Great Depression.
But it was not to be—not yet, anyway. Just before the rule limiting commissions for loan officers was scheduled to take effect, a court of appeals stepped in and temporarily blocked it.
To anyone who believes that the mortgage pricing business could benefit from more sunshine, the specifics of the rule seem utterly uncontroversial. It would prevent mortgage companies from compensating loan officers and loan brokers based on the interest rate and other terms of the mortgage loan. Consumers shopping for a mortgage loan have generally been unaware that most loan officers and brokers could “negotiate” a higher interest rate on a mortgage than the bank’s regular rate—and earn a bigger commission for hiking the rate or adding unnecessary fees.
Lenders have also sometimes paid higher commissions if they persuaded the consumer to take a more costly loan, such as an interest-only loan, a loan with negative amortization (where the payment does not cover the interest, causing the amount owed to go up, not down, as payments are made), and loans with a penalty for early payment, such as when the borrower finds a better loan. The rule also addressed the practice of brokers charging consumers a commission for arranging the loan, and also receiving a commission from the lender. Consumers who paid a commission understandably thought the broker was looking out for their best interests, when in fact the broker could receive a higher commission from the lender for adding more interest and fees to the consumer’s loan. Under the rule, a broker could be paid by the consumer or by the lender, but not by both.
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Even more disturbing, allowing loan officers to set higher interest rates also can be racially discriminatory. The U.S. Department of Justice has sued mortgage lenders who permit this practice, claiming that the practical result is that African-American and Hispanic borrowers pay more for their mortgage loans than similarly qualified white borrowers. The risk that brokers and loan officers could charge minority borrowers more has caused many banks to put expensive monitoring programs in place just to ensure that the pricing discretion given to brokers and loan officers doesn’t result in higher costs to some racial or ethnic groups.
Image by kynan tait, via Flickr