Bonuses to Loan Brokers Scrutinized

WASHINGTON —  A little-known reward for brokers who arrange home loans at high interest rates is drawing scrutiny from law enforcement authorities, who say these bonuses can cost unwitting homeowners thousands of dollars over time.

Lenders pay the bonuses to independent brokers who sign up borrowers for mortgages at higher interest rates than they qualify for. With these brokers now writing an estimated 60% of home loans in the U.S., regulators are concerned that many people are being steered into higher-rate loans without being aware of the higher costs.

“With the growing role of mortgage brokers, my office and attorneys general around the country have focused increased attention on these lending arrangements,” California Atty. Gen. Bill Lockyer said in a statement to The Times. “We will be monitoring the market to ensure abuses do not occur.”

The bonus -- typically worth thousands of dollars -- is included in most loans written by independent brokers, some industry experts say, and may be especially prevalent in costlier mortgages that brokers arrange for borrowers with weak credit.

In some cases, customers knowingly accept the higher rates. Homeowners who plan to sell or refinance in a year or two, for example, can often save money by taking a higher-interest loan and lowering their upfront closing costs.

But homeowners who settle on a higher rate and plan on staying put can spend thousands of additional dollars over time. Consumer advocates and regulators say this trade-off is often not understood by borrowers. They also caution that brokers may not always make clear that they are rewarded by the lender for loans with higher interest rates.

Kimberly Marumoto said she used a broker to get a mortgage for her Hermosa Beach home and learned later -- from her accountant -- that she could have qualified for a lower interest rate.

“It’s almost like if you went to the store, and the store didn’t tell you you could actually get this item for 20% off,” said Marumoto, who sells bedding and table linens. “This whole home loan business thing is very daunting to a first-time buyer.”

Lockyer is part of a nationwide task force of prosecutors that in January announced a $325-million settlement by Orange-based Ameriquest Mortgage Co. for alleged deceptive lending practices. Under that agreement, Ameriquest’s loan agents cannot profit from bumping customers into loans at higher rates than they qualify for.

A leader of the task force said that the practices of independent brokers -- who now write an estimated 60% of home loans -- is an emerging focus, although no cases are imminent. Up to now, investigators have concentrated on retail lenders, such as Ameriquest, that deal with customers directly.

“We want to look at it because it may constitute a deceptive practice,” said Iowa Atty. Gen. Tom Miller, who led the Ameriquest case. “Consumers are paying more than the fair market price of their loan.”

The payments to brokers are known in the industry as yield spread premiums. The terms vary by company but generally work the same way.

Say a consumer qualifies for a $400,000 loan at a 6.75% annual interest rate and an upfront fee of 1 percentage point, or $4,000. If that same borrower agrees to take the loan at 7%, a lender might reward the broker with a bonus of half a percentage point, or $2,000.

The $2,000 is the yield spread premium. The “spread” reflects the difference between the lower interest rate that the borrower could qualify for and the higher interest rate that he or she actually paid. The “premium” is the reward paid to the broker.

Although buying a home is a typical family’s biggest financial commitment, “here’s a major component of it that folks are clueless about,” said Michael D. Calhoun, general counsel of the Center for Responsible Lending. “This obscurity and confusion has been a huge boon to those brokers who want to overreach.”

The National Assn. of Mortgage Brokers does not keep statistics on the prevalence of such payments. But a Harvard study concluded that they were paid in 85% to 90% of broker-arranged loans and averaged $1,850 in the late 1990s. With the escalation in housing prices and the size of mortgages, those average payments are probably higher today.

A 2002 analysis by the U.S. Department of Housing and Urban Development has suggested that the payments amount to about half of brokers’ income, with the rest coming from other commissions and fees.

Brokers fiercely defend the incentives. Higher interest rates may enable borrowers to finance closing costs and pay less upfront, they point out, in return for accepting higher monthly payments. In those cases, federal officials and courts have said the payments are legal compensation to brokers, who have the ability to guide consumers through many loan choices.

The premiums “are not inherently bad or evil,” said Tom Pool, an assistant commissioner and spokesman with the California Department of Real Estate. “They’re in response to a need of the market.”

Brokers also take exception to consumer advocates’ complaint that they often guide naive borrowers into costlier loans, without apprising them of their choices, to pocket the fee from lenders.

The realities of the marketplace, said Harry H. Dinham, president-elect of the National Assn. of Mortgage Brokers, leave brokers no choice but to treat consumers fairly. “In my experience in this business, they’re shopping” for the cheapest loan. “You have to do the best you can to get them the best deal you can provide, and work from there.”

Brokers are supposed to disclose such payments on a “good faith estimate” form, which borrowers get after they apply for a loan, as well as on the settlement statement at the time of the loan’s closing.

But the premium is not explained on the forms and often is not even labeled. It may appear as a footnote or an abbreviation or be included in a category such as broker compensation that occupies one line in a pile of loan papers.

Said Lockyer: “We strongly recommend that consumers buying a home, refinancing a loan or taking out a second mortgage take the time to ask brokers questions, including whether they get any kickback or payment from the financial institution for placing the loan with them. Consumers also should comparison shop and consult with trusted advisors before signing on the dotted line.”

In a reaction to the complexities of buying a home, a small group that has dubbed itself Upfront Mortgage Brokers charges customers a flat fee agreed on at the beginning of the loan process and emphasizes clear disclosure.

“There are people who say, ‘I only charged the guy 1 point.’ But no you didn’t. You’re getting 2 points more through the yield spread premium,” said Randy Johnson, owner of Independence Mortgage Co. in Newport Beach and author of “How to Save Thousands of Dollars on Your Home Mortgage.”

Consumer advocates have long challenged the payment as an illegal kickback. “I never met a consumer who knew what it is,” said Ira Rheingold, general counsel with the National Assn. of Consumer Advocates. “I never had a client who knew they were paying a higher interest rate because of that charge.”

The U.S. Department of Housing and Urban Development has long held that the payments were legal if reasonably tied to services a broker had performed for the borrower. In 2001, HUD also said their legitimacy could be determined only on a case-by-case basis, a declaration that was accepted by courts and had the effect of derailing class-action lawsuits challenging the bonuses.

The housing agency currently is mulling over whether to offer new proposals affecting real estate purchases, including changes in disclosure requirements for the broker payments.

The National Assn. of Mortgage Brokers contends that brokers should not have to disclose the payment at all in part because lenders who don’t use brokers are not required to do so. Mortgage bankers who make loans without brokers often sell them for a profit in the financial markets, earning larger premiums for loans with higher interest rates. HUD, however, lacks the authority to regulate those transactions.

“We feel like everybody should have to disclose a yield spread premium or nobody should because of the confusion it causes the consumer,” Dinham said.

Still, many in the lending industry agree that clearer disclosure requirements would help the public.

“There’s a growing consensus that the yield spread premium is an issue that needs to be dealt with,” said Howard B. Glaser, a former deputy general counsel at HUD who is now counsel to the National Alliance of Independent Mortgage Bankers.

“It’s confusing to consumers and can cost them a lot of money if they don’t know what they’re getting into,” he added. “Most players in the industry would agree that it’s time to reform the disclosure of the yield spread premium.”