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Proposed Far-Reaching RESPA/TILA Changes Could Adversely Impact Settlement System

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July/August 1998 - Volume 77, Number 4

By Ann vom Eigen
ALTA® Legislative Counsel

ALTA® is beginning a concentrated effort to convince Congress, federal agencies and consumer organizations that far-reaching changes in RESPA and Truth-in-Lending as proposed by HUD and the Federal Reserve are a misdirected approach toward improving the quality and delivery of residential real estate settlement services.

At the heart of this controversy are proposals from HUD and the Federal Reserve that, if enacted, could dramatically change the present system for delivering settlement services and slash the price for title insurance and other related charges to a point where acceptable quality is threatened.

Receiving close attention from ALTA® in particular are statutory changes recommended by the agencies for new alternative federal mortgage disclosures, and for a new exemption from RESPA’s Section 8 anti-kickback provisions, all for the stated purpose of promoting consumer shopping and lowering the cost of settlement services.

The exemption would be designed to encourage so called "packaging" of settlement services by creditors and others, such as Realtors or title companies, who can put together a bundle of services needed to close a mortgage loan. At HUD and the Federal Reserve, the operative assumption is that advertising this bundle or "package" of settlement costs will bring pressure to lower the charges - - and that the proposed Section 8 exemption would allow lenders and others who "package" the services to seek volume discounts from those who provide them.

ALTA® believes that "packaging" is already occurring without the anti-kickback exception. In the title industry, the proposed Section 8 exemption would be seen as likely to drive down the price of title services - - but at a considerable detriment to home buyers and others who invest in real property.

These recommendations from HUD and the Federal Reserve reached Capitol Hill early in July, as a response to a Congressional directive for the agencies to seek simplification in improving mortgage disclosures required for consumers under the two major statutes regulating them - - RESPA and Truth-in-Lending. As this article heads for press, it already is late in the current session of Congress, with both Senate and House targeted for October adjournment and reconvening set for late January.

Both the Senate and House Banking Committees have heard testimony from HUD and the Federal Reserve, and may hear from affected industries and groups later this year. No legislation has been introduced to date, and Chairman Lauch Faircloth (R-NC) of the Senate Housing/Financial Institutions Subcommittee pointed out at his July hearings on the proposal that it will take time to assess the recommendations. That suggests a window remains for educating Congress and the agencies concerning their misperceptions about the title industry and the impact the reform proposal is likely to have on the real estate economy.

Genesis of the Proposal

The reform proposal first was raised by a creditor interest group - - ironically named the Consumer Mortgage Coalition - - composed of five of the largest national mortgage lenders (Bank of America, Citibank, etc.). The proposal surfaced in a Mortgage Reform Working Group, in which ALTA® has been participating, at public forums organized by the Federal Reserve Board and the Department of Housing and Urban Development, and at several ALTA® meetings.

ALTA® President Malcolm S. Morris, president and CEO of Stewart Title, presented the Association’s perspective on RESPA /TILA Reform at Fannie Mae’s National Advisory Council meeting, a body on which he serves as ALTA® president. As he reported to the ALTA® Government Affairs Committee at the Associations’s 1998 Mid-Year Convention, Art Ringwold, the Bank of America representative on the Fannie Mae Council, at that meeting stated the twofold purpose of this proposal - - to reduce lender liability under these disclosure schemes and to obtain volume discounts in settlement services. The new disclosure system and regulatory scheme initially proposed by this group, parts of which are recommended in the Federal Reserve and HUD report, would effectively create a new mortgage product advertised by large national lenders - - a guaranteed loan settlement cost - - and would negate gains that ALTA® members have achieved in reaching the market and the consumer through technology. As the ALTA® president pointed out, these national lenders have developed the proposals to obtain a reduction in title service prices, while increasing their own, and are seeking to lock in the point of contact with the consumer of real estate closing services to the lender.

HUD and the Federal Reserve, to a lesser extent, have endorsed the proposals because lender groups have contended that "packaging" would lower settlement costs for consumers. HUD Secretary Andrew Cuomo in transmitting the report to Congress, announced that it would save consumers millions annually in settlement costs.

The agencies jointly recommend:

    • Revising the APR disclosure required under Truth in Lending to better reflect the overall cost of credit by defining the finance charge to include cost the consumer is required to pay to obtain the loan
    • Requiring more firm settlement cost disclosures under RESPA through either guaranteed closing costs, or a revised good faith estimate, on which penalties would be imposed if estimates exceed a tolerance
    • Revising and streamlining the timing requirements under TILA and RESPA to provide consumers with cost information earlier in the mortgage process, and
    • Adding substantive protections to protect consumers against abusive lending practices.

This article focuses on the two agency proposals that most directly affect the title industry. First, under current disclosures, fees for title insurance, search, and examination, and many of the other services that the industry receives from either sellers or buyers, now are rolled into the "amount financed" disclosure under Truth in Lending. Under the new proposal, these charges would now be rolled into a different disclosure term, the finance charge. While this disclosure provision appears innocuous, it has a significant practical implication. The tolerance - - the amount by which the finance charge may be exceeded - - was adjusted in 1995 so that mischaracterization of minimal fees would not encourage class action litigaton. Neverthess, it can still be exceeded.

Consequently, if material TILA disclosures are not delivered or deemed to be inaccurate (because actual charges exceed the original disclosure), the consumers’ right to rescind can be exercised up to three years. A lender may well see his lien on the property disappear - - the most extreme remedy for failure to comply with a disclosure, and an extremely powerful hammer on the creditor community. It is this enormous potential liability which has been driving lender’s interest in the issue. This remedy has had a dramatic financial effect on the creditor community, as class actions can be filed for up to three years past the time the loan is originated.

The Federal Reserve and HUD recommend in the report that the finance charge be defined to include "the cost the consumer is required to pay to get the credit." Title services and other "ancillary services" and closing fees could well be reflected in the finance charge. Further, additional services which can vary substantially based on the transaction, such as pest inspection and home warranty inspection, might conceivably be included. Consequently, if this new disclosure provision were enacted, there might well be pressure from creditors on closers to find a way to limit costs at settlement in order to stay within the tolerance. Taken to a logical end, could this mean money out of the closer’s pocket to make up any shortfall to stay within the tolerance? Alternatively, would the closer have to cut service?

The second major change affecting the title industry described in the report has even more significant implications. The Board and HUD have proposed that settlement costs, now reflected in the "good faith estimate," be disclosed in two alternative ways to ensure better accuracy - - either as part of a guaranteed loan closing cost which would be exempt from Section 8, or under a revised good faith estimate, which would be subject to an accuracy standard (not detailed in the report )and penalties. The question is, what is the potential tradeoff between these two disclosures, and the potential market effects?

Under the proposed new guaranteed loan closing cost approach, creditors or others "packaging" settlement services would be granted an exemption from the anti-kickback provisions of RESPA to guarantee specific lender required settlement costs. In order to obtain the exemption, a "packager" must:

    • Offer consumers a comprehensive package of the settlement services needed to close a loan,
    • Provide the consumer with a simple prescribed disclosure that gives the guaranteed maximum price for the package of services through closing, and
    • Disclose the rate and points offered to the consumer for the loan, with a guarantee that the rate and points will not increase, subject to prescribed conditions.

According to many of the nation’s largest creditors, consumers do not shop for these settlement services, and are more interested in a "set" certain price. These creditors also have argued that consumers would be more likely to shop if they only had to compare a single price for "required" services. The Federal Reserve Board and HUD have not addressed the possibility that the services "required" by different lenders could vary, so the guaranteed package of services could contain quite different services. According to the agencies, creditors would enter into volume based contracts with affiliated and other settlement service providers for services such as appraisals, title insurance, credit reports, or "lender required" attorney fees, and "package" all the services needed for the loan. The agencies state that "by doing so," they can obtain volume discounts that could be passed on to consumers. Under current law, these "discounts" could be considered violations of the anti-kickback provisions of RESPA.

The agencies envision a package of settlement services that would include all charges for creditor performed services, and third party fees for such items as surveys, appraisals, credit reports and mortgage broker services. Mortgage filing and recording fees might also be included. However, points and per diem interest, and other services which vary, e.g., hazard insurance, and other "optional services," might be excluded.

The report notes that a guaranteed close scheme raises two significant issues, which ALTA® agrees are significant concerns. Namely, should closing costs be itemized, and should consumers be allowed to substitute service providers?

Itemization is not required, according to the report, because "the creditor may engage in average cost pricing, and if services were itemized, and then not ultimately used, consumers responsible for paying that guaranteed settlement cost might be irate, believing that, where services are not provided, that they are paying for services that were not received."

The agencies also note that, if the consumer had the choice to substitute service providers, then it would be necessary to disclose to the consumer which ones could be substituted, and the allocation of the package to that service. While this would, in effect, establish the price of the substitute service, creditors apparently argued successfully that allowing substitution could jeopardize their security interest. However, lenders and others who package would be allowed to charge a "packaging" fee.

The agencies report several negatives associated with the guaranteed loan closing costs, primarily the concern that smaller, unaffiliated institutions and other settlement service providers might not be able to arrange packages and compete in a guaranteed cost environment. However, the agencies believe that allowing these lenders to provide a more accurate good faith estimate would allow them to compete, while still providing the consumer with good faith information.

A Revised Good Faith Estimate

The second alternative to increase consumer certainty would involve a less drastic change to current disclosures. Currently, the good faith estimate cost disclosures must show a reasonable relationship to the actual charges that are incurred, and some creditors are more accurate than others. However, as there is no liability if a creditor is inaccurate, many are smaller than actual settlement costs by a significant amount. Similar to the scheme now provided under TILA, a "more accurate GFE" could be required, where costs could be limited to only certain categories of costs within the lender’s control. For example, if a consumer wanted to substitute a service provider, an increased cost in that service would not count against the creditor’s initial quote. The report does not specify a specific tolerance, but notes that a potential penalty could be set as a flat fee or a percentage difference from the initial to actual costs. While there would be a minimal change from the current system, there would be no relief from Section 8 liability-- a strong disincentive to use this approach.

Potential Consequences

ALTA® can identify three major potential effects of the guaranteed loan closing cost proposal that would alter the service delivery system. It could well affect (1) the price and quality of title services, (2) title industry access to the customer, and, eventually, (3) the service delivery system as it could precipitate an evolution to a few, national service providers of both credit and settlement services. These projections are based on the following assumption. Lenders that "package" guaranteed loan closing costs will undoubtedly, if they obtain an exemption from the anti-kickback provision, seek "volume discounts" in fees and services. These volume discounts will result in less revenue to the title industry, and will lead to pressures to decrease service.

Second, the title industry’s access to the customer has improved to allow more direct marketing. A recent Gallup poll shows that almost 50 percent of consumers now personally shop for such settlement services as owner’s title insurance. Further, the Board, in its "Economic Analysis of Packaging," states that "for particular items within the package, . . . ., for the bank to serve as an intermediary may be less efficient than for the consumer to transact directly with the ancillary service provider." For example, interacting directly with the title insurance providers may be more efficient, particulary because title insurance services are now offered over the Internet, giving consumers low cost access to a wide range of choices.

However, access to consumers may well be effectively denied under this new scheme. Consumers shopping for mortgage credit will actually purchase settlement services in the loan product. Packaging of loan settlement services can limit consumer choice where a consumer believes mortgage credit would be unavailable if the provider’s package was not used, and under the HUD scenario, substitution is prohibited.

"Blind" packages discourage comparison shopping. The report envisions at least one alternative which effectively denies the consumer information about the specific services, providers, and prices that make up the settlement package. Consequently, consumers cannot compare apples to apples.

The national delivery system described above would be more likely to evolve and exacerbate present consolidation in the lending industry. If the more reliable good faith estimate option is not attractive to creditors, the guaranteed loan closing cost could well become just one more part of the mortgage product. Under the proposed regime, substitution of services is impossible. Further, as these national lenders are likely to negotiate national contracts, some type of membership in a national network may be necessary in order to get into the package as all.

Next Steps

Besides the Congressional education effort, where ALTA® will be seeking industry assistance, the Association also will participate in the Mortgage Reform Working Group, where we will continue to raise concerns that will focus on the practical transactional considerations raised by the recommendations made in the report. And ALTA® will continue the task initiated by the members of the Association who participated in the Mid-Year Convention in Washington, D.C., and the many visits that ALTA® Board and Government Affairs Committee members made to the Federal agencies last spring to educate their members of Congress about the problems associated with these recommendations.

We hope we can rely on you to help. This is the beginning of a long legislative process. According to the Congressional Research Service, the research arm of Congress, it takes an average five years for a bill to become a law.

As yet, there is no legislation. We have a long way to go. If you would like to obtain a copy of the report, or locate it on the Federal Reserve Web page, or if you have comments, please contact Ann vom Eigen at 800-787-ALTA.

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