Market Turmoil Over Mortgage Rebates
July 7, 2003, Reviewed August 29, 2007
"I recently refinanced into a 30-year fixed-rate loan with no cost to me except the broker’s fee of $1500. The broker insisted, as a condition of the loan, that I agree to pay a penalty of $4500 if I refinance the loan within 6 months. I read the note and it does not contain a prepayment penalty. I never heard of a prepayment penalty imposed by a broker. Afterwards, I discovered that the broker was paid $4500 by the lender. Is the $4500 connected to the prepayment penalty?"
Yes. Under a policy adopted by your lender, the broker must return the $4500 rebate received from the lender if you repay the loan within 6 months.
The broker is using the prepayment penalty in an attempt to shift the burden to you. I am not a lawyer, but I doubt that the penalty is enforceable. The broker probably knows this, but is hoping that it will deter you from refinancing again soon.
You took a rebate loan in the midst of the current refinancing frenzy, and found yourself in the middle of a conflict between mortgage brokers and the wholesale lenders who fund their loans. The conflict is about rebates.
Rebates are negative points on high interest rate loans. Points are an upfront payment expressed as a percent of the loan amount. One point is 1% of the loan amount due the lender. Negative 1 point is 1% of the loan amount due from the lender.
For example, a lender might offer a 30-year fixed-rate mortgage at 5.00% with 1 point, 5.25% with zero points, 5.50% with –1 point, 5.75% with –2 points, and 6.25 % with –3 points. The last three are rebate loans.
The lender who pays 3 points for a 6.25% loan assumes he will have the loan at least 40 months. It takes that long for the higher rate to cover the rebate. If a rebate loan is paid off in 3 months, the lender takes a big hit.
In the past, I have written about brokers who enlist borrowers in a scam where they share the largest rebate the lender offers, then refinance every two-three months, each time with a different lender. (See The Dual Loan Scam). This practice irritates lenders but in normal markets it isn’t sufficiently widespread to affect their bottom line significantly. Most borrowers with rebate loans hold them long enough for the lender to recover the rebates.
However, in a market in which rates drop a notch, and then shortly thereafter drop again, which has been the pattern in 2003, the trickle of very short-lived rebate loans becomes a flood. The flood is initiated not by larcenous brokers but by borrowers exercising their free-market right to lower their rates. Lenders don’t want to stop offering rebate loans, which are a major part of their business, but they have been anxious to stop the losses that engulf them each time market rates drop.
So some of them have decided to shift the burden to their brokers. Their general rule is that if a rebate loan from a broker is paid off within 6 months, the broker must reimburse the lender for the rebate. In the case of at least one large lender, repayment is required even if the broker has nothing to do with the subsequent refinance, and even if the early payoff results from sale of the mortgaged property!
The broker in your case does not deserve a lot of sympathy, since you paid for but never agreed to the rebate he collected from the lender. In many other cases, however, the rebate is shared with the borrower, and making the broker responsible for the entire amount is patently unfair.
Upfront Mortgage Brokers (UMBs) credit the entire rebate to the borrower, who can use it to pay the agreed-upon broker fee, to reduce settlement costs, or both. For example, the broker might retain half of a 3-point rebate as his fee and credit the other half against the borrower’s settlement costs. To require reimbursement of the entire 3 points from the broker is an obscenity.
In 2002, HUD proposed a regulation that would require lenders to credit rebates to borrowers. Borrowers would have to specifically authorize the payment of a rebate to a broker, eliminating overcharges arising from borrower ignorance. This regulation would also eliminate lender rules that require brokers to reimburse lenders for rebates on loans that pay off early. If the rebate is credited to the borrower, there is no way the lender can get it back from the broker.
"I recently refinanced into a 30-year fixed-rate loan with no cost to me except the broker’s fee of $1500. The broker insisted, as a condition of the loan, that I agree to pay a penalty of $4500 if I refinance the loan within 6 months. I read the note and it does not contain a prepayment penalty. I never heard of a prepayment penalty imposed by a broker. Afterwards, I discovered that the broker was paid $4500 by the lender. Is the $4500 connected to the prepayment penalty?"
Yes. Under a policy adopted by your lender, the broker must return the $4500 rebate received from the lender if you repay the loan within 6 months.
Prepayment Penalty Imposed by a Broker
The broker is using the prepayment penalty in an attempt to shift the burden to you. I am not a lawyer, but I doubt that the penalty is enforceable. The broker probably knows this, but is hoping that it will deter you from refinancing again soon.
Conflict Over Rebates During a Refinancing Boom
You took a rebate loan in the midst of the current refinancing frenzy, and found yourself in the middle of a conflict between mortgage brokers and the wholesale lenders who fund their loans. The conflict is about rebates.
Rebates are negative points on high interest rate loans. Points are an upfront payment expressed as a percent of the loan amount. One point is 1% of the loan amount due the lender. Negative 1 point is 1% of the loan amount due from the lender.
For example, a lender might offer a 30-year fixed-rate mortgage at 5.00% with 1 point, 5.25% with zero points, 5.50% with –1 point, 5.75% with –2 points, and 6.25 % with –3 points. The last three are rebate loans.
The lender who pays 3 points for a 6.25% loan assumes he will have the loan at least 40 months. It takes that long for the higher rate to cover the rebate. If a rebate loan is paid off in 3 months, the lender takes a big hit.
In the past, I have written about brokers who enlist borrowers in a scam where they share the largest rebate the lender offers, then refinance every two-three months, each time with a different lender. (See The Dual Loan Scam). This practice irritates lenders but in normal markets it isn’t sufficiently widespread to affect their bottom line significantly. Most borrowers with rebate loans hold them long enough for the lender to recover the rebates.
However, in a market in which rates drop a notch, and then shortly thereafter drop again, which has been the pattern in 2003, the trickle of very short-lived rebate loans becomes a flood. The flood is initiated not by larcenous brokers but by borrowers exercising their free-market right to lower their rates. Lenders don’t want to stop offering rebate loans, which are a major part of their business, but they have been anxious to stop the losses that engulf them each time market rates drop.
So some of them have decided to shift the burden to their brokers. Their general rule is that if a rebate loan from a broker is paid off within 6 months, the broker must reimburse the lender for the rebate. In the case of at least one large lender, repayment is required even if the broker has nothing to do with the subsequent refinance, and even if the early payoff results from sale of the mortgaged property!
Forcing Repayment by the Broker Is Unfair if the Broker Did Not Receive All the Rebate
The broker in your case does not deserve a lot of sympathy, since you paid for but never agreed to the rebate he collected from the lender. In many other cases, however, the rebate is shared with the borrower, and making the broker responsible for the entire amount is patently unfair.
Upfront Mortgage Brokers (UMBs) credit the entire rebate to the borrower, who can use it to pay the agreed-upon broker fee, to reduce settlement costs, or both. For example, the broker might retain half of a 3-point rebate as his fee and credit the other half against the borrower’s settlement costs. To require reimbursement of the entire 3 points from the broker is an obscenity.
In 2002, HUD proposed a regulation that would require lenders to credit rebates to borrowers. Borrowers would have to specifically authorize the payment of a rebate to a broker, eliminating overcharges arising from borrower ignorance. This regulation would also eliminate lender rules that require brokers to reimburse lenders for rebates on loans that pay off early. If the rebate is credited to the borrower, there is no way the lender can get it back from the broker.