On January 1, 2010,
a redesigned Good Faith Estimate (GFE) will become effective, making
mortgage loan shopping a little easier for borrowers.
The GFE is a
disclosure of information about a mortgage transaction that lenders and
mortgage brokers must provide within 3 business days of receiving an
application. The existing GFE, which has been around for at least 30
years, is so bad that the bar for improvement is extremely low. The new
GFE clears the bar by a comfortable margin, though it is far from
perfect.
Clearer Presentation of Critical Mortgage Features
The existing GFE,
along with the Truth in Lending (TIL) disclosure that the borrower
receives at the same time, are so poorly designed that borrowers who are
distracted and feel under pressure when they are exposed to disclosure
documents often miss critically important information. This could be
that the interest rate on their loan can increase, that the balance can
increase, that their loan has a balloon payment, or that it has a
prepayment penalty. With the new GFE, it will be very difficult for a
borrower to miss these features because they are prominently displayed
on page 1 in a nice summary table.
Clearer Presentation of Lender Charges
The existing GFE
provides an open-ended listing of all settlement charges, without
distinguishing charges of the lender and those of third parties. This
format encourages lenders to invent new charges, and since all the
figures are “estimates” subject to change, to escalate charges as loans
move to closing. The format also encourages borrowers to question individual
lender charges – what they mean and whether they are fairly priced –
while neglecting the only number that matters, which is the total of all
such charges. Trying to negotiate individual charges is a costly
distraction for borrowers, but the existing GFE encourages it. In
contrast, the new GFE does not even show a total of the
individual lender charges!
The new GFE makes a
clear distinction between lender charges and third party charges. Lender charges consist of just
two items: Points that are paid to reduce the interest rate, and the
total of all other charges, referred to as the Origination Charge. The
Origination Charge cannot change at closing. The sum of the points and
Origination Charge is the Adjusted Origination Charges.
Clearer Presentation of Broker Charges
On brokered loans,
the Origination Charge includes any fee paid the broker by the lender,
called the “yield spread premium”, or YSP. The YSP is shown as an
upfront credit to the borrower (negative points) granted in exchange for
a higher rate. (This is on the second line under item 2). This allows the borrower to see how much of the
Origination Charge she is paying indirectly through a higher rate.
Obfuscation of the Distinction Between Broker and Lender
An unfortunate consequence of the new GFE is that it obfuscates the distinction between brokers and lenders. In order to avoid disclosing YSP, brokers are flocking to join pseudo lender organizations that change their legal status from independent contractor to employee of a lender. They may keep their name and operate in the same way, but instead of delivering documents to a lender who funds the loan, the lender gives them a credit line that enables them to fund the loan themselves, delivering it to the lender 48 hours later.
This creates a problem for the borrower who wants to retain a broker as her agent to shop for a loan, at a fee specified in advance. If the loan provider she retains is legally a broker, then the borrower can check the agreed-upon fee against what is shown on the GFE. But if the loan provider is in fact a pseudo lender who does not have to report YSP, the borrower has no way to confirm the fee.
Borrowers who want an agency-type relationship with their broker should select a broker who belongs to the Upfront Mortgage Brokers Association (see www.upfrontmortgagebrokers.org.) If any of their members operate legally as lenders, they are nonetheless obliged to disclose their YSP equivalent to the borrower.
Little Improvement in Clarifying the Lender’s Price Commitment
While the new GFE
does freeze the Origination Charge, it does not commit the lender to the
rate and points shown on the GFE until they are locked by the lender.
The new GFE is little better than the old one in helping borrowers
understand how and when the lender is committed.
The new GFE tries
to convey this to the borrower by having the lender disclose on the GFE
how long the rate and points in the GFE are good. If the loan has been
locked when the borrower receives the GFE, the GFE will show the lock
period, usually 30 to 60 days. But if the loan is not locked when the
borrower receives the GFE, and if the GFE has been sent by overnight or
slower mail, the terms in the GFE have lapsed when the borrower receives
it because mortgage prices are reset every day. It is not clear how the
lender will answer the question of how long the rate and points in the
GFE are good if they have already expired. .
It is possible that
lenders will try to avoid this problem by delivering the GFE on the day
the terms in the GFE are set. In such event, the GFE could read that the
terms are good until the end of the same day. This would require an
on-line or other method of rapid communication.
Lenders may be
encouraged to lock loans as soon as possible by recent changes in Truth
in Lending regulations. If the APR at closing is more than .125% higher
than the APR in the disclosure documents, the new regulations require
lenders to issue a new set of documents.
Disclosure of Third Party Settlement Costs
Third party
settlement charges are charges for services that lenders require
borrowers to purchase. They have always been over-priced because the
lender has usually selected the service provider and the borrower has
paid the tab. This results in “reverse competition”, where service
providers compete for the favor of lenders, which raises their costs and
prices.
The obvious, simple
and direct remedy is to require that lenders themselves purchase all
third party services they require borrowers to have. Lenders would pass
the cost on to borrowers in the mortgage price, but it would be far
smaller than it is now because lenders are informed buyers who would buy
in bulk and drive down prices. It is the same reason why car buyers pay
less for tires when the tires are purchased by the manufacturer and
included in the price of the car.
Instead of doing
the obvious, Congress declared that fees paid by service providers for
the referral of business were illegal, as if this would encourage
service providers to reduce prices. It hasn’t.
In the new GFE that
became effective January 1, HUD tries another tack. It requires lenders
to distinguish third party charges of service providers that the lender
selects, and charges of providers selected by the borrower. Charges in
the first group cannot be more than 10% higher at closing than the
estimate shown on the GFE. There is no such limit applicable to the
charges of service providers selected by the borrower.
The 10% limit on
price increases will eliminate the practice of “low-balling” these
charges, which some lenders did as a way to entice borrowers who shopped
total settlement costs. But it will not reduce these charges. The
explicit recognition of the two categories of charges may induce more
borrowers to shop, and more service providers to market directly to
borrowers. Over the years, this could put some downward pressure on
prices. This is about the best HUD could do, since it does not have the
legal authority to require lenders to purchase all third party services
themselves.