Charging Fees for Outside Services Higher Than Costs;
Fees to Employees of Affiliates; Reduced Costs to Builder Borrowers -
- We have recently received several questions regarding interpretation of Section 8 of the Real Estate Settlement Procedures Act ("RESPA"). In addition, the FDIC has issued a new Financial Institution Letter ("FIL"), "Practices Which May Result in Potential Violations of Section 8 of the Real Estate Settlement Procedures Act". FIL-103-99 (November 17, 1999). Given the continuing confusion in this area, we thought an examination of several different fact situations might be helpful. Mortgage Broker Fees
- The relevant prohibitions in Section 8 read as follows:
"(a) No person shall give and no person shall accept any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business incident to or a part of a real estate settlement service involving a federally related mortgage loan shall be referred to any person.
"(b) No person shall give and no person shall accept any portion, split, or percentage of any charge made or received for the rendering of a real estate settlement service in connection with a transaction involving a federally related mortgage loan other than for services actually performed." 12 USC 2607(a) and (b).
- Section 8 then goes on to state that the RESPA is not intended to prohibit the payment of fees to attorneys, title companies, or agents for service actually performed, the payment of a bona fide salary or compensation to a person for goods or products actually furnished or services actually performed in the making of a loan, and payments pursuant to cooperative brokerage and referral arrangements or agreements between real estate agents and brokers. Nor is RESPA intended to prohibit controlled business arrangements (common ownership existing between the lender and providers of settlement services) so long as certain disclosures are made and the borrower is not required to use the affiliated provider for settlement services. 12 USC 2607(c).
- Penalties for violation of Section 8 of RESPA are rather stiff. Violations are punishable by a fine of not more than $10,000 or a prison term of up to one year, or both. In addition, violators are liable for damages in a civil suit up to three times the amount of any charge paid for the settlement service. 12 USC 2607(d)(1) and (2).
- Of course, it is often not that easy to determine whether a fee, kickback or a "thing of value" has been given for referral to a provider of a settlement service. Nor is it easy to determine whether payment to a settlement service provider is for services actually performed. Accordingly, HUD has issued a series of confusing and often arbitrary explanations attempting to clarify when a Section 8 violation has occurred. The latest of these, HUD Statement of Policy 1999-1, was discussed in News 99-2 (5/3/99), p 8.
- The following fact situation illustrates the confusion in this area.
EXAMPLE: Anywhere National Bank institutes a mortgage lending program offered to clients of area mortgage brokers, real estate brokers, attorneys, and accountants. Each broker, attorney, and accountant (the "Participants") pays Bank an annual fee of $2,500 to be included in the program. Bank advertises the program and publishes a list of Participants. Each Participant will explain the mortgage program offered by Bank, assemble the financial records of each applicant, complete either a loan application or a similar worksheet on each applicant, analyze the applicant's income and debt to determine the maximum mortgage amount for which the applicant is likely to qualify, generally advise the applicant on the loan origination process, and maintain contact with the applicant and the Bank to facilitate processing of the application and to gather any additional information that might be needed. Participants charge applicants a fee for their services which is paid at closing. Bank does not set the fee paid by the Participants nor does Bank receive any portion of that fee.
- It is clear that the Participants in the example are providing "settlement services". A "settlement service" includes any service provided in connection with a real estate settlement, including the origination of a federally related mortgage loan including the taking of loan applications. 12 USC 2602(3). Regulation X states "settlement service" means any service provided in connection with a "prospective or actual settlement" including:
"(1) origination of a federally related mortgage loan (including, but not limited to, the taking of loan applications, obtaining verifications and appraisals, and other loan-processing and origination services, and communicating with the borrower and lender);
"(2) rendering of services by a mortgage broker (including counseling, taking of applications, obtaining verifications and appraisals, and other loan processing and origination services, and communicating with the borrower and the lender)." 24 CFR 3500.2(b).
It is also clear the Participants in our example are "mortgage brokers". The term "mortgage broker" is defined by Regulation X as:
"*** a person (not an employee or exclusive agent of the lender) who brings a borrower and lender together to obtain a federally related mortgage loan, and who renders services as described in the definition of 'settlement services' in this section." 24 CFR 3500.2(b).
- To violate the RESPA Section 8(a) prohibition against fees, kickbacks, or things of value and the equivalent Regulation X, Section 3500.14, three elements must be present. First, there must be a payment or giving of a thing of value. Second, the payment must be paramount to an agreement to refer business. Third, a referral must occur.
- In the example, two payments are involved. The first, the $2,500 annual fee, is paid by the Participant to the Bank for the right to be included in the program. The second, a fee set by each Participant, is paid by the borrower to the Participant for the Participant's services. Both are clearly payments of "things of value".
- Skipping for the moment to the third test, that a referral must occur, Regulation X defines "referral" as:
"(1) A referral includes any oral or written action directed to a person which has the effect of affirmatively influencing the selection by any person of a provider of a settlement service or business incident to or part of a settlement service when such person will pay for such settlement service or business incident thereto or pay a charge attributable in whole or in part to such settlement service or business." 24 CFR 3500.14(f)(1).
- In our example, both the Bank and the Participants are providing settlement services. The Participants will be "affirmatively influencing" the selection of the Bank by explaining the Bank's mortgage program to clients and by assisting the clients in the application process, including the taking of applications. In addition, the taking of any action by the Bank affirmatively influencing applicants toward any or all of the Participants, such as listing the Participants in advertising the program, will be considered a referral.
- The second test of Section 8(a) is whether the payment or giving of the thing of value is pursuant to an agreement to refer business. Old HUD Opinion Letter No. 130, April 24, 1986, involved exactly the Plan in our example. In ruling that the $2,500 fee paid Bank by the Participants was not a violation of Section 8(a), HUD stated:
"*** No question of a violation of Section 8(a) is reached by the payment of the enrollment fee by a Participant to the lender, for the obvious reason that the payment goes in the wrong direction. The payment, therefore, cannot be considered in any way compensation by the lender for a referral. Instead, it is a payment by the Participant to secure the benefits of the Program for customers and potential customers of the Participant. Nothing in RESPA casts doubt upon the validity of a payment made for such a benefit. I also note that the enrollment fee is not based upon 'referrals' in any case; it is a fixed fee which will not vary based upon actual volume of activity."
- With regard to the fee paid the Participants by borrowers, HUD stated:
"Neither is any question of violation of Section 8(a) raised by the payment of a fee to the Participant by a borrower. We have previously held that the payment of a fee by the borrower to the broker, as a result of a direct arrangement between the mortgage broker and the borrower and not as a result of any requirement imposed by the lender, is outside the prohibitions of Section 8(a) *** These holdings are applicable to payments by borrowers to Participants under the Program." HUD Old Opinion Letter No. 130, April 24, 1986.
- In opining on the legality of the $2,500 enrollment fee under Section 8(b), HUD stated:
"We also find no potential violation of the fee-sharing prohibitions of Section 8(b) of RESPA (12 U.S.C. 2607(b)). Assuming, for purposes of this opinion, that the activities of the Participant constitute the 'rendering of a real estate settlement service' within the meaning of Section 8(b), it is not reasonable to view the enrollment fee paid to the lender as a 'split' of the fees paid to Participants by borrowers. As indicated above, the enrollment fee is fixed, not contingent either in obligation or amount on the receipt of compensation by Participants from borrowers. Further, the enrollment fee, as also stated above, is a payment to secure the benefits of the Program for the customers of the Participant, and therefore may be considered payment 'for services actually performed' within the meaning of Section 8(b). See 24 CFR 3500.14(e)." Old HUD Informal Opinion Letter 130, April 24, 1986.
- Letter 130 did not specifically give any rationale for the legality of the fee paid by the borrower to the Participant under 8(b). HUD obviously considered these payment for actual services performed, because the Letter called for them to be disclosed in both the Good Faith Estimate and the HUD-1 Uniform Settlement Statement. The Letter suggested the fee be listed on one of the blank lines on the 800 Series of the HUD-1 (and reflected consistently in the Good Faith Estimate) and marked, if appropriate, "paid outside of closing". The Letter also suggested the following notice be added to the Good Faith Estimate:
"NOTICE: A mortgage broker fee in the amount of $............ is listed in the above estimate (Line ...................)
on the basis of information furnished by (Participant).........................................................
Pursuant to the Consumer, Agency and Fee Agreement you have signed, this fee will be paid directly to the (Participant) ....................................
and is not imposed by or paid to the (Lender).............................................."
Old HUD Informal Opinion Letter 130.
- HUD has withdrawn all informal counsel's opinions and staff interpretations issued prior to November 2, 1992. 24 CFR 3500.4(c). Accordingly, Letter No. 130 is no longer determinative. Nevertheless, it does give some guidance as to HUD's thinking in the area. No new HUD Informal Opinions have been issued that address a fact situation similar to that presented in our example. However, HUD has opined that paying to be on a list of prospective settlement service providers would be permissible so long as payments for appearing on such lists are not contingent on referrals received. In that case, providers had paid a flat fee for their price and rate information to be included in brochures directed to prospective purchasers. New HUD Informal Opinion 3, September 1, 1993.
- However, the issuance of HUD Statement of Policy 1999-1 (March 1, 1999) casts new doubt upon the legality of arrangements similar to that given in our example. That Statement covers the legality of payments by lenders to mortgage brokers under both Sections 8(a) and 8(b) of RESPA.
- Statement of Policy 1999-1 applies to payments by lenders to mortgage brokers. As such, it does not apply to the payment of a fee by a broker to a lender such as the annual fee to be paid by the Participants. That fee would, in our opinion, continue to be legal.
- It might also be argued that Statement of Policy 1999-1 is not relevant to the fee paid the Participant since that fee is paid by the borrower. However, the Statement does not take that narrow a view.
- In determining whether a given fee is legal under RESPA, the Statement uses a two-step test. First, the goods or facilities must actually be furnished or the services actually performed for the compensation paid. Second, the payments must reasonably be related to the value of the goods or facilities being provided or the services being performed. If either test is not met, the payment is considered to be for a referral pursuant to an agreement and thus a violation of Section 8. In applying the test:
"*** HUD believes that total compensation should be scrutinized to assure that it is reasonably related to goods, facilities, or services furnished or performed to determine whether it is legal under RESPA. Total compensation to a broker includes direct origination and other fees paid by the borrower, indirect fees, including those that are derived from the interest rate paid by the borrower, or a combination of some or all. The department considers that higher interest rates alone cannot justify higher total fees to mortgage brokers. All fees will be scrutinized as part of total compensation to determine that total compensation is reasonably related to the goods or facilities actually furnished or services actually performed. HUD believes that total compensation should be carefully considered in relation to price structures and practices in similar transactions and in similar markets." HUD Statement 1999-1, Section A.
- In determining whether payments are for referrals or for services actually performed, HUD has identified the following services normally performed in the origination of a loan:
- taking information from the borrower and filling out the application;
- analyzing the prospective borrower's income and debt and pre-qualifying the prospective borrower to determine the maximum mortgage that the prospective borrower can afford;
- educating the prospective borrower in the home-buying and -financing process, advising the borrower about the different types of loan products available, and demonstrating how closing costs and monthly payments could vary under each product;
- collecting financial information (tax returns, bank statements) and other related documents that are part of the application process;
- initiating/ordering VOEs (verifications of employment) and VODs (verifications of deposit);
- initiating/ordering requests for mortgage and other loan verifications;
- initiating/ordering appraisals;
- initiating/ordering inspections or engineering reports;
- providing disclosures (truth in lending, good faith estimate, others) to the borrower;
- assisting the borrower in understanding and clearing credit problems;
- maintaining regular contact with the borrower, realtors, lender, between application and closing to appraise them of the status of the application and gather any additional information as needed;
- ordering legal documents;
- determining whether the property was located in a flood zone or ordering such service; and
- participating in the loan closing."
- HUD Statement of Policy 1999-1, Section C.
- HUD has stated that it would be satisfied that sufficient origination work had been performed to justify a fee if the agent or contractor took the application information (a., above) and performed at least five additional items from the above list. HUD Statement of Policy 1999-1, Section C. In our example, the Participants are providing settlement services that fall under items b, c, d, j, and k. Normally, if any five are provided, HUD would be satisfied sufficient work had been performed to justify compensation. However, since only "counseling type" services are being performed (designated by HUD as b, c, d, j, and k from the above list) HUD, in order to determine that meaningful counseling rather than steering has taken place, will be satisfied only if the following also occur:
- counseling gave the borrower the opportunity to consider products from at least three different lenders;
- the entity performing the counseling would receive the same compensation regardless of which lender's products were ultimately selected; and
- any payment made for the 'counseling-type' services is reasonably related to the services performed and not based on the amount of loan business referred to a particular lender."
- Emphasis added. HUD Statement of Policy 1999-1, Section C.
- As described, it is doubtful the program in our example meets this test. There is no indication that products of any other lenders other than Bank's will be offered by the Participants. Nor is it clear that Participants will receive the fee from the applicant if the loan does not close or if another lender's product is selected. Nor does the example indicate that the amount of the fee is related to the amount and nature of the services provided rather than the amount of the loan or some other loan characteristic. Under HUD Statement of Policy 1999-1, all three would have to occur for the fee paid by the borrower to the Participant to be legal under Section 8.
- The fact the fee is paid by the borrower rather than the Bank is not determinative of liability under RESPA. Section 8(b) prohibits the payment of any fee for services not actually performed. Further, the Statement, by giving the following example, makes clear that all fees are to be considered:
*** For example, if the lender pays the mortgage broker $600 and the borrower pays the broker $500, the total compensation of $1,100 would be examined to determine whether it is reasonably related to the goods or facilities actually furnished or the services actually performed by the broker." HUD Statement of Policy 1999-1, Section D.Discounting Services Provided on Prior Loans
- Another situation dealing with illegal payment of "things of value" for settlement service providers is illustrated by the following:
EXAMPLE: Bank wishes to enter into a contract with X, a vendor supplying tax payment services on residential real estate loans. X will review all real estate loans in Bank's files to determine real estate taxes that are due, on property secured by loans made by Bank. Bank will send X a check periodically for total amounts due. X will then pay the appropriate taxing authority. As part of X's agreement with Bank, Bank will pay X $75 for each mortgage loan closed after entering into the contract and $1 for each mortgage loan on the books of Bank at the time of the contract.
- Under RESPA, X clearly is providing a "settlement service". At issue is whether the discount given Bank by X for loans currently on the books of Bank constitutes the payment and receipt of a fee or thing of value in return for the referral of settlement service business, and thus a violation of Section 8 of RESPA.
- The FDIC's recently issued FIL-103-99 addresses this practice also:
"Contracts with Third-Party Settlement Service Providers -- Some financial institutions have contracted with third-party settlement service providers for such services as flood hazard determinations, and real estate tax and hazard insurance services. In exchange for performing these services for all loans originated by the institution during the term of the contract, some firms have agreed to perform the services for loans that were on the institution's books before entering into the contract for no additional fee or a substantially reduced fee. HUD has determined that these types of agreements are in violation of Section 8 because they provide a thing of value for the referral of future settlement services." FIL-103-99 (November 17, 1999).
- The FDIC opinion relies on Question 15 of the "Industry FAQs About RESPA" on HUD's website. Question 15 states:
15. Can a flood zone certification company examine a lender's existing loan portfolio for free or at a reduced rate, in exchange for the lender sending the company future business?
No. Flood zone certification is a covered settlement service (24 CFR 3500.2), therefore RESPA would apply to agreements by companies or persons providing portfolio reviews. Providing free or reduced reviews is a thing of value. Providing this service in exchange for referrals of future flood insurance business would violate Section 8(a) of RESPA which provides that '[n]o person shall give and no person shall accept any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business incident to or a part of a real estate settlement service involving a federally related mortgage loan shall be referred to any person.'" "Industry Q&As About RESPA", http://www.hud.gov/fha/sfh/res/resindus.html, Question 15.
- Accordingly, the discount offered Bank by X constitutes the giving of a thing of value for the referral of future settlement services. Such a provision would be a violation of Section 8 of RESPA.Setting Fees Higher Than Actually Paid to Outside Parties
- As noted, it is illegal under Section 8(b) of RESPA to charge a fee for services not actually performed. Consider the following:
EXAMPLE: Anywhere National Bank charges applicants for mortgage loans $25 for a flood hazard determination but pays the firm that provides the determination only $20. Similarly, Bank charges $40 for a credit report but only pays $15 for the report. In addition, Bank charges applicants a $50 appraisal evaluation fee that is passed on to members of a committee of Bank's board of directors who do not actually review appraisals.
- Each of the above fees constitutes a violation of Section 8(b) of RESPA in that they involve fee-splitting with retention by the Bank, or its directors, of fees for services the recipient of the fees did not actually perform. See FIL-103-99 (November 17, 1999), p 2. Accordingly, whenever services are performed by outside parties, fees collected by lenders for those services must not exceed the amount actually paid to the third party providers.Referral Fees From Mortgage Companies To Affiliated Bank Employees
- Consider the following situation:
EXAMPLE: Anywhere National Bank ("Bank") and Anywhere Mortgage Company ("Company") are both subsidiaries of Anywhere Holding Company. Company pays employees of Bank $50 for each referral that results in a loan origination.Regulation X, Section 3500.14(b) specifically prohibits the payment of such fees. That section states:
"*** A business entity (whether or not in an affiliate relationship) may not pay any other business entity or the employees of any other business entity for the referral of settlement service business." 24 CFR 3500.14(b).Reduction of Borrowing Costs to Builders Borrowing From Lender
- Violations of RESPA can occur when the same lender finances both the builder's construction costs and the home buyer's mortgage. Consider the following:
EXAMPLE: Anywhere National Bank finances the construction costs of Builder B and for buyers of B's homes. B refers potential buyers to Bank. Bank reduces B's lien release fees on any loan to a customer referred by B.
- In the above example, Bank is providing a "thing of value" to B in the form of reduced lien release fees. Any reduction in borrowing costs as a result of referrals is a violation of RESPA. FIL-103-99, "Builder Loans".Conclusion
- The area of prohibited referral fees remains confusing. HUD's attempts to clarify the situation in Statement of Policy 1999-1 only resulted in the establishment of some arbitrary rules such as requiring brokers who provide purely counseling services to refer to three or more lenders. The result is a narrowing of the clear meaning of the Section 8(c) statement that RESPA is not to prohibit payment of fees for services actually rendered. In HUD's defense, it has called upon Congress to clarify RESPA. So far, such clarification has not been forthcoming.
- We will keep you apprised of further developments in this area.