On January 1, 2010, a redesigned Good Faith Estimate (GFE) will become effective, making mortgage loan shopping a little easier for borrowers.
The GFE is a disclosure of information about a mortgage transaction that lenders and mortgage brokers must provide within 3 business days of receiving an application. The existing GFE, which has been around for at least 30 years, is so bad that the bar for improvement is extremely low. The new GFE clears the bar by a comfortable margin, though it is far from perfect.
Clearer Presentation of Critical Mortgage Features
The existing GFE, along with the Truth in Lending (TIL) disclosure that the borrower receives at the same time, are so poorly designed that borrowers who are distracted and feel under pressure when they are exposed to disclosure documents often miss critically important information. This could be that the interest rate on their loan can increase, that the balance can increase, that their loan has a balloon payment, or that it has a prepayment penalty. With the new GFE, it will be very difficult for a borrower to miss these features because they are prominently displayed on page 1 in a nice summary table.
Clearer Presentation of Lender Charges
The existing GFE provides an open-ended listing of all settlement charges, without distinguishing charges of the lender and those of third parties. This format encourages lenders to invent new charges, and since all the figures are “estimates” subject to change, to escalate charges as loans move to closing. The format also encourages borrowers to question individual lender charges – what they mean and whether they are fairly priced – while neglecting the only number that matters, which is the total of all such charges. Trying to negotiate individual charges is a costly distraction for borrowers, but the existing GFE encourages it. In contrast, the new GFE does not even show the individual lender charges!
The new GFE makes a clear distinction between lender charges and third party charges. Lender charges consist of just two items: Points that are paid to reduce the interest rate, and the total of all other charges, referred to as the Origination Charge. The Origination Charge cannot change at closing. The sum of the points and Origination Charge is the Adjusted Origination Charges.
Clearer Presentation of Broker Charges
On brokered loans, the Origination Charge includes any fee paid the broker by the lender, called the “yield spread premium”, or YSP. The YSP is shown as an upfront credit to the borrower (negative points) granted in exchange for a higher rate. (This is on the second line under item 2). This allows the borrower to see how much of the Origination Charge she is paying indirectly through a higher rate. Showing the borrower exactly how much the broker is earning in total on the transaction is useful to any borrower who has retained a mortgage broker and is not shopping alternatives.
It can be misleading, however, if the borrower is comparing one GFE offered by a broker with another GFE offered by a lender because the lender is not obliged to show its YSP equivalent -- its profit on the sale of the loan. The comparison could falsely suggest that the broker is making more on the transaction than the lender. Borrowers making such comparisons should ignore any YSP and focus on the lowest price, which is the combination of the rate and the Adjusted Origination Charge. This provides an unbiased price comparison between direct and brokered loans.
Obfuscation of the Distinction Between Broker and Lender
An unfortunate consequence of the new GFE is that it obfuscates the distinction between brokers and lenders. In order to avoid disclosing YSP, brokers are flocking to join pseudo lender organizations that change their legal status from independent contractor to employee of a lender. They may keep their name and operate in the same way, but instead of delivering documents to a lender who funds the loan, the lender gives them a credit line that enables them to fund the loan themselves, delivering it to the lender 48 hours later.
This creates a problem for the borrower who wants to retain a broker as her agent to shop for a loan, at a fee specified in advance. If the loan provider she retains is legally a broker, then the borrower can check the agreed-upon fee against what is shown on the GFE. But if the loan provider is in fact a pseudo lender who does not have to report YSP, the borrower has no way to confirm the fee.
Borrowers who want an agency-type relationship with their broker should select a broker who belongs to the Upfront Mortgage Brokers Association (see www.upfrontmortgagebrokers.org.) If any of their members operate legally as lenders, they are nonetheless obliged to disclose their YSP equivalent to the borrower.
Little Improvement in Clarifying the Lender’s Price Commitment
While the new GFE does freeze the Origination Charge, it does not commit the lender to the rate and points shown on the GFE until they are locked by the lender. The new GFE is little better than the old one in helping borrowers understand how and when the lender is committed.
The new GFE tries to convey this to the borrower by having the lender disclose on the GFE how long the rate and points in the GFE are good. If the loan has been locked when the borrower receives the GFE, the GFE will show the lock period, usually 30 to 60 days. But if the loan is not locked when the borrower receives the GFE, and if the GFE has been sent by overnight or slower mail, the terms in the GFE have lapsed when the borrower receives it because mortgage prices are reset every day. It is not clear how the lender will answer the question of how long the rate and points in the GFE are good if they have already expired. .
It is possible that lenders will try to avoid this problem by delivering the GFE on the day the terms in the GFE are set. In such event, the GFE could read that the terms are good until the end of the same day. This would require an on-line or other method of rapid communication.
Lenders may be encouraged to lock loans as soon as possible by recent changes in Truth in Lending regulations. If the APR at closing is more than .125% higher than the APR in the disclosure documents, the new regulations require lenders to issue a new set of documents.
Disclosure of Third Party Settlement Costs
Third party settlement charges are charges for services that lenders require borrowers to purchase. They have always been over-priced because the lender has usually selected the service provider and the borrower has paid the tab. This results in “reverse competition”, where service providers compete for the favor of lenders, which raises their costs and prices.
The obvious, simple and direct remedy is to require that lenders themselves purchase all third party services they require borrowers to have. Lenders would pass the cost on to borrowers in the mortgage price, but it would be far smaller than it is now because lenders are informed buyers who would buy in bulk and drive down prices. It is the same reason why car buyers pay less for tires when the tires are purchased by the manufacturer and included in the price of the car.
Instead of doing the obvious, Congress declared that fees paid by service providers for the referral of business were illegal, as if this would encourage service providers to reduce prices. It hasn’t.
In the new GFE that became effective January 1, HUD tries another tack. It requires lenders to distinguish third party charges of service providers that the lender selects, and charges of providers selected by the borrower. Charges in the first group cannot be more than 10% higher at closing than the estimate shown on the GFE. There is no such limit applicable to the charges of service providers selected by the borrower.
The 10% limit on price increases will eliminate the practice of “low-balling” these charges, which some lenders did as a way to entice borrowers who shopped total settlement costs. But it will not reduce these charges. The explicit recognition of the two categories of charges may induce more borrowers to shop, and more service providers to market directly to borrowers. Over the years, this could put some downward pressure on prices. This is about the best HUD could do, since it does not have the legal authority to require lenders to purchase all third party services themselves.