Conflicting Stances on Loan Markups

Question: The U.S. 7th Circuit Court of Appeals recently ruled that it is legal for lenders to make a profit on third-party services sold to borrowers, such as appraisals and credit reports. In contrast, the Department of Housing and Urban Development has always said that markups were illegal if there were no services provided in connection with them. Who is right, and if the court ruling stands, how can borrowers protect themselves against excessive charges?

Answer: I’m with the court on this one. HUD’s rule was essentially unenforceable and was widely violated before the recent court decision. Having unenforceable laws on the books that are routinely violated does not protect the borrower and undermines respect for the law.

There is a case for prohibiting markups in this market. Loan providers are not restricted in their ability to charge directly for their services.

The list of fees that loan providers charge is bewilderingly long. Markups aren’t needed to assure that loan providers are adequately compensated, and they create one more layer of complexity for consumers.

If I were mortgage czar, I would prohibit all markups and limit loan providers to two fees: one expressed as a percentage of the loan (“points”) and one expressed in dollars (“total fees”).

This would greatly simplify life for borrowers without in any way restricting the ability of loan providers to charge for their services.

In the world that exists, however, it is better to permit markups. The alternative to permitting markups is not my ideal rule but an actual HUD rule that allows markups if additional services are provided but prohibits them otherwise. Though the HUD rule may appear fair, it is not, because it is not enforceable except very selectively, which is unfair. The vast majority of loan providers know they are beyond HUD’s reach.

Violations of the HUD rule were pervasive before the recent court decision. Hence, the problem that markups on third-party services pose for borrowers will be little different than before the recent court decision.

What does a borrower do to protect against unjustified markups? Let me begin with what not to do.

Another columnist advises borrowers: “Don’t be asleep at settlement; demand to know why you’re being charged $60 for a credit report instead of much less and take a hard look at other fees if they seem high.”

If the borrower doesn’t wake up until settlement, he might as well go back to sleep for all the power he will have to affect the outcome. To expect that a borrower will be able to talk down fees at settlement because they “seem high” is unrealistic. The lender will have ready explanations for every charge, and the borrower’s clout in protesting them is zilch.

For example, the loan provider can explain that the $60 charge for the credit report includes the lender’s cost to extract the critical information from the report and analyze it. That will end the discussion and the charge will remain.

A borrower who awakens prior to closing may have more success. If the deal is a refinancing, the borrower can threaten to walk from the deal. If it is a home purchase and a real estate agent recommended the lender, the borrower can enlist the agent to intervene with the lender.

Another not-so-great idea is for borrowers to order their own services. Loan providers will strongly resist it, for good reason. They know they will have to instruct the borrower how to do it and then monitor the results, which takes more of their time than if they did it themselves. Loan providers expect to be compensated for their time, so if you demand more of it in order to reduce their fees on third-party services, they will look to make it up elsewhere.

The fact is that markups on third-party services, when they occur, are the smallest part of a loan provider’s compensation. It makes no sense to try to save $150 on the appraisal if it costs you the equivalent of $500 elsewhere in the deal.

Borrowers should be concerned with the total, not one part of the total. In my next column, I’ll outline strategies for dealing with markups that don’t lose sight of the total picture.

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Jack Guttentag is a syndicated columnist and professor of finance emeritus at the Wharton School of the University of Pennsylvania. Questions or comments can be left at www.mtgprofessor.com.

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Distributed by Inman News Features.