New rules from the *CFPB will dramatically affect the ability of
all borrowers to obtain mortgages. This post will analyze and expose the
devastating effects of a second rule – the 3% rule.
The “We-Didn’t-Think-This-One-Through-Just-Ask-Texas-Mortgage-Originators” 3%
Rule
The bureau’s general guideline reads
No excess upfront points and fees: A Qualified Mortgage
limits points and fees including those used to compensate loan originators,
such as loan officers and brokers. When lenders tack on excessive points and
fees to the origination costs, consumers end up paying a lot more than planned.
The last
post began with “Richard Cordray of the CFPB declares ‘All American borrowers are stupid
and we have to save them.’" Of course, he didn’t say it exactly
that way but the proposed rules effectively say it. [That's him on the right. Don't be fooled - I'm sure no head of a bureau created by Dodd-Frank could possibly be a political activist. Ignore the Barack Obama poster in front of him.]
One of those
rules that will allegedly protect consumers is the 3% Rule.
The 3% Rule is a cap on closing costs. It
requires that closing costs cannot exceed 3% of the loan amount. (There is some
variance for loan amount less than $100,000). Also, the bureau has only vaguely
specified what fees might be exempt from this accounting. It has, however,
signaled that the loan officer compensation will be counted against this fee
cap. While a CFPB bulletin in January 2013 stated that
The Bureau has decided not to finalize the proposal
[something about LO compensation] at this time, however, because of concerns
that it would have created consumer confusion and other negative outcomes. The
Bureau has decided instead to issue a complete exemption to the prohibition on
upfront points and fees pursuant to its exemption authority under section 1403
while it scrutinizes several crucial issues relating to the proposal’s design,
operation, and possible effects in a mortgage market undergoing regulatory
overhaul.
A **bulletin
released in April of this year indicates the full implementation to include
Loan Officer Compensation in the 3% limitation on closing costs.
To those
outside the industry, this may appear confusing at worst and falsely helpful at
best. Let me give you 5 facts that will help clarify:
1.
Costs are not the same as prices. The many costs that comprise
“closing costs” are insensitive to government regulations. Appraisers, for
example, do not lower their fees because some agency requires that the total
fees not exceed a certain amount. Neither do the gas stations (from which they
purchase the fuel to power their vehicles) lower the price of their product as
the appraisers travel to the properties to perform their inspections. While
prices are capped by government, costs cannot be so easily controlled.
2. Loan Officer Compensation is not the same as the origination fee, the processing fee or other fees listed as going to the lender.
3. Loan Officers are most frequently paid not only from any “origination fee” but from the yield paid by the investor-lender which funds the loan. Think about those things that are almost a thing-of-the-past, the “no closing cost” loan. With no closing costs, including no origination fee, how do you think anyone was paid. They were paid by the investor who purchased the loan which was made at a higher than “par rate” which paid a specific percentage of the loan amount.
4. These yields can go as high as 7%-8% but are often “eaten up” in other costs. (More on that later; but, they are called LLPA’s Loan Level Pricing Adjustments . . . another way for Fannie and Freddie to collect fees).
5. Loan officers typically make .7% - 2% as a commission on their loans per their contract with their employing lender. Many economic factors affect this commission structure, not the least of which is the market in which the loan officer works. That is, the loan officer who serves a market of mostly $80,000 mortgages and makes 2% on her loans will work just as hard and diligently as the loan officer who serves a market of mostly $400,000 mortgages making only .7% on his loans, yet she will net less real dollar for the same number of loans closed as her counterpart in the higher dollar market.
Price
controls never work to the benefit of consumers. The proposed 3% limit on closing
costs cannot fare any better than any other price controls. And because the
proposal also includes restrictions upon the wages of the mortgage
professionals, it’s quite possibly unconstitutional, not to mention insane. But
whether it’s insane, illegal or just pure nonsense, one thing is inescapable –
it’s still harmful to the consumer. Wage and price controls have never inured
to the benefit of the consumers. They always – without exception – produce
shortages (a lack of available credit) and diminished quality (a lack of
service and ultimately a lack of access to credit). In the case of mortgages,
the shortage is simply running out of dollars (allowed by law) available to pay
the fixed costs.
A
fixed percentage unfairly discriminates against borrowers with lower loan
amounts. By
placing limits on closing costs AS A PERCENTAGE OF A LOAN AMOUNT, the CFPB
effectively denies the “do-ability” of loan amounts below certain thresholds.
This should be obvious. But, obvious it is not. So, let me illustrate. Nearly
all closing “costs” are fixed. If they are not fixed they are certainly not
subject to percentages. For example, the costs to have attorneys draw up the
loan documents is about $350. Doc prep attorneys charge this amount whether the
loan amount is $100,000 or $500,000. That means that – AS A PERCENTAGE OF THE
LOAN AMOUNT – doc prep fees range (in this illustration) from .35% to .07%. In
the latter case, there doesn’t seem to be a problem. But, in the former we only
have 2.65% left to go and we are just getting started with one of the minimal
fees. Underwriting and related fees typically range from $900 to $1600. Again,
for an average set of underwriting costs of $1250, that’s 1.25% for a loan
amount of $100,000 but only .25% of the $500,000 loan amount. It should take an
Einstein to see that fixed loan costs quickly amount to more than 3% of loan
amounts of $100,000 or so.
There
are many fixed costs in loans. A percentage
limitation does not allow enough flexibility to cover such costs. Other fixed costs include flood
certifications, tax certifications, tax service fees, appraisals (having risen
over 150% in costs since the advent of HVCC and Dodd-Frank), appraisal reviews,
title/escrow fees, title insurance (varying from state to state although 3%
works the same mathematically across the entire universe not to mention across
state boundaries), courier fees. These fees represent individuals or firms who
actually perform work on a loan file. Increasingly they represent people or
firms who perform work that is required by government regulation. For example,
the HVCC (Home Value Code of Conduct) rule (now under Dodd-Frank) created the
need for appraisal management companies which, oddly enough, cannot perform
their tasks for free or out of the goodness of their hearts. Real people
working real hours in need of paying their own mortgages and putting food on
their own table have to perform these tasks. How are these fees to be paid when
an arbitrarily fixed percentage is mandated by a bureaucracy sitting in
Washington, D.C. and does not allow for such costs; and such a fixed percentage
especially is harmful when, because of inflation and government regulations,
these costs actually rise sometimes when home prices are flat or actually
declining.
Texas
has proved that this fixed percentage does not work to the benefit of borrowers. Texas already has this rule (since
about 1998) for equity loans. Because costs cannot exceed 3% of the loan amount
and because THOSE COSTS DO NOT MAGICALLY GO AWAY JUST BECAUSE LEGISLATORS IN
AUSTIN DECLARED THEY WERE UNLAWFUL, they still have to be paid. How are they
paid? Those who know anything about lending understand that the lender must
charge a higher interest rate to recoup the fixed costs in a loan. The higher the
rate - the higher the yield. And since lenders cannot lose money by making
loans, they must find a way to pay for these fees.
This
3% rule will mean higher interest rates for borrowers with lower loan amounts
who already pay higher rates because of rate adjustments for low loan amounts. How does that benefit the
consumer? They pay a higher rate because
a legislator (or in this case, a CFPB staffer) decided that an
arbitrarily-contrived percentage was just enough, above which consumers should
not pay without being “harmed.”
Even
higher rates will not alleviate the shortage that this rule will produce. But, the problem is not solved by
simply charging a higher interest rate. Yields which certain rates produce are
not unlimited. That is, there is a point at which a higher rate not only does
not pay more dollars but actually pays less. In other words, there is a ceiling
limit beyond which a rate will pay no more dollars. What then does a lender do?
How then will this conundrum be resolved? For years now, lenders have published
loan amounts below which they will not lend. The reason is quite clear for
anyone who cares to know the economics of lending and borrowing. Those minimal
loan amounts will necessarily be instituted; if not by the actual lending company,
by the originator.
How
The Inclusion of Loan Officer Compensation Affects The Actual Price and Cost of
a Mortgage
To make matters worse, loan
officer compensation must be included in the 3% limitation. Besides the purely
insane, Marxist nature of such a proposal, let us examine the practical effect
of such a measure. As I have already demonstrated, the fixed costs can hardly
be contained within the 3% limit on $100,000 loans in many cases. So, where now
will loan officer compensation fit in such a scheme? It will fit ONLY IN LARGER
LOAN AMOUNTS. That is also to say that the law of diminishing returns means
that loan originators cannot afford to do loans below certain thresholds. It is
not because they do not want to or because they would be unwilling to make a
little less on one loan than another. The fact is, they would have to work for
free – at certain loan amount thresholds, the originator would make $0 or,
worse, pay a lender for the privilege of doing a loan for a customer.
Such
a rule will produce the same moral hazard that all price controls produce – it will give rise to a black market
whereby loan originators will perform task for favored individuals in exchange
for money or favors that are completely off the grid. The indignation that
politicians, government officials or CFPB staffers may express does nothing to
produce access to credit for consumers.
The wiser and saner route
for equal access to credit, good and fair prices and a robust housing market is
really straightforward – do not institute the wage and price control measures
currently ordered in the 3% closing costs limitations and its corollary
limitation on loan officer compensation.
*The CFPB is the Consumer Finance Protection Bureau created by
Dodd-Frank [Wall Street
Reform and Consumer Protection Act] (2010)
to regulate America’s finance industry. It has unquestioned authority, writes
its own rules and can levy sizeable enough fines to put a medium sized mortgage
company out of business.
**The CFPB bulletins and publications are poorly dated but the URL address above indicates that the publication is most likely from January of 2013. But the readiness guide dated 7/8/2013 (http://files.consumerfinance.gov/f/201307_cfpb_mortgage-implementation-readiness-guide.pdf) has listed the following web-based publication which lays out guidelines for caps on points and fees which are to include Loan Officer Compensation. As you can tell, it is dated in April of this year. http://files.consumerfinance.gov/f/201304_cfpb_compliance-guide_atr-qm-rule.pdf
