Not Much To Cheer About – Part 1

Under the headline The Mortgage-Closing Nightmare a major newspaper wrote an editorial praising the revisions to the closing process contemplated by the Department of Housing and Urban Development (HUD) and suggested that consumers had something to cheer about.   Those of us who are in the mortgage industry have studied the proposed changes and the people I know are pretty certain that even with the new rules consumers will not be offered the kind of protection they deserve.

I have dealt with 3,000 borrowers in my career and I can confirm that many people are, indeed, confused by the closing process, although hopefully none of my clients thought it was a nightmare. But many others have written me about their transactions, so I have heard plenty of nightmare stories.  

HUD proposes to change the rules to make the process clearer. But, as is usual with our government, I don’t think that their solution will solve the problem. In fact, it may turn out like energy deregulation. It might actually make the situation worse.   If borrowers took a look at the implications of the HUD proposal, they wouldn’t be cheering.

Some of the confusion at closing arises from the fact that getting a loan is a complicated process involving the services of many people, all of whom have a right to reasonable compensation.   When you add up the costs of appraisal, processing, underwriting, funding, settlement, and other miscellaneous services of a loan, the total is typically about $1,700, more for a larger loan. Add title insurance and it’s even more. What would happen if these services were “bundled” into a $1,700 flat fee?     Perhaps it would it make it easier to understand, but it wouldn’t save the consumer money. No.

HUD has stated that the new rules can squeeze $700 out of those costs. First, it is important to understand that not all of these are lender costs. The services of over a half-dozen companies are in that $1,700. These services, appraisals for example, are being provided at a price that is competitively determined by hundreds of players.   Specifically, there is no way that HUD can wave a magic wand and make appraisers or any other provider so much more efficient so they can cut their fees by 40 percent. There is simply not enough “fat” in the process to do those same functions for $1,000.

What that means is that lenders will tell borrowers that the flat fee is $1,000 and will proceed to hide the other costs somewhere else.   This is what is being done now with no-cost loans. They just increase the interest rate to cover them.   Many borrowers will be driven to zero-point loans because those will be the easiest to shop for.   On an average loan, a lender will cover that extra $700 by raising the interest rate by one-eighth or one-quarter of a percent.   The borrower – and HUD ­- thinks that he has saved $700 but he is really paying an extra $200 to $400 per year in interest.   Is that doing the borrower a favor?   Better to pay the $700 and save the added interest cost.

In fact, the Mortgage-Closing Nightmare comes not from the costs but because borrowers got gouged because they chose to do business with an unethical or dishonest mortgage broker or lender who took advantage of them. Honest mortgage brokers and lenders don’t add on last minute fees or pull any other of the shenanigans that the dishonest ones do.   The honest ones have to compete with those who lie, and they, more so even than borrowers, wish that the rules would change so as to make the bad apples compete fairly. The new HUD rules won’t change that.

The bad ones deliberately mislead clients, giving them initial disclosures that they have no intention of meeting. They can do so with impunity, not because of the rules but because of lack of enforcement and the ignorance of borrowers who don’t understand what they are reading and signing.   Obviously, a loan rep who is trying to gouge a client is not going to help his client understand all the paperwork.

This is exacerbated by FannieMae’s and FreddieMac’s rebate pricing, allowing such lenders to get additional compensation through Yield Spread Premiums that are well in excess of the compensation that was originally disclosed to the borrower.   (Those who missed my articles about Yield Spread Premiums should check the website.) HUD misses the point because it is this additional compensation that is the problem, not the standard closing costs.

We’ll discuss the rest of this issue in a following article next week.