Judge Rules Some Loan Fees Illegal

In a case with potentially huge significance for home loan borrowers and lenders, a federal judge has ruled that certain fees routinely paid to mortgage brokers nationwide constitute illegal kickbacks prohibited by federal law, even if disclosed to the consumer.

The ruling by Judge Albert V. Bryan Jr. of the U.S. District Court in Alexandria, Va., has shocked the mortgage industry because it challenges the legality of one of the most commonplace forms of compensation in home lending: fees paid to local mortgage brokers by the large lenders who buy their loans.

The fees carry various names--overages, yield-spread premiums, servicing release premiums and back-end points, among others. They represent payment to the broker for originating a mortgage at an interest rate that is higher than the lending institution’s lowest posted “wholesale” rate. Typically they are in addition to the regular fees charged by the broker and paid by the borrower for the broker’s loan origination services.

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Brokers argue that the extra fees are legitimate and necessary compensation for the implicit branch office or retailing function they provide for major lenders. They save the lender overhead by taking on staffing and other expenses the lender otherwise would have to pay to conduct business.

Critics charge, however, that the payments are simply camouflaged referral fees for signing unsuspecting mortgage customers at higher rates than the lowest available. A broker who charges applicants a brokerage fee and persuades them to sign up for a rate that is half a percentage point higher than necessary shouldn’t be paid $1,000 to $2,000 by the lender for doing so, they argue.

The widespread existence of these fees has triggered a wave of class-action suits against brokers and large wholesale lenders in the last year. Bryan’s Jan. 10 ruling in a case involving Virginia-based Crestar Mortgage Corp. and Saxon Mortgage Inc. is the first to flatly declare that such fees are illegal and constitute “a bad deal” for consumers.

“By their very nature,” wrote Bryan, “yield-spread premiums are not compensation for services actually performed by the broker. The reality of the transaction is that the broker benefits by payment of the premiums, the lender benefits by obtaining a higher than par [interest rate] and the borrower pays.”

Bryan’s opinion said yield-spread premiums violate the anti-kickback provisions of the federal Real Estate Settlement Procedures Act. His sharply worded 15-page ruling came in response to a motion by Crestar Mortgage and Saxon Mortgage to dismiss a class-action suit filed against them by two Maryland couples.

The ruling has sent shock waves rippling through the mortgage industry. Some major lenders said it would cause them to reassess whether they want to continue doing business through local mortgage brokers. Paul Reid, immediate past president of the Mortgage Bankers Assn. of America and CEO of American Home Funding of Richmond, Va., said the ruling “highlights the need for the consumer to do a lot of shopping” and to ask for disclosure of fees before deciding on a particular broker or lender.

Saiyid T. Naqvi, president and CEO of PNC Mortgage Corp., a major lender based in Vernon Hills, Ill., said the ruling “is going to have very significant impacts,” not only on the mortgage business but on consumers as well.

“What it tells the consumer,” Naqvi said, “is to recognize the advantages of dealing directly with a lender versus dealing through an intermediary,” whose interest may not always be to secure the lowest rate. PNC Mortgage abandoned a $1 billion-per-year wholesale business it ran through a network of local brokers 16 months ago, according to Naqvi, in part because of concerns that “the end pricing to the borrower wasn’t always the best.”

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What’s the bottom line for loan applicants and shoppers in the wake of the new ruling? First, the legal issue is far from settled. The Bryan ruling didn’t decide the case as a whole. Nor does it indicate how other federal judges--or federal regulators--will rule on the controversial fees. Mortgage brokers believe that their fees are legal and fair and predict they will win in court or in Congress.

Second, remember this rule: When you shop, ask for the full menu of interest rates and fees. Generally the lower the fees, the higher the rate and the lower the rate, the higher the fees. Your job is to spot the best-priced combination available through either brokers or retail lenders.

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Distributed by the Washington Post Writers Group.