Should Markups on Third Party Settlement Services Be Legal?
December 17, 2001, Revised August 10, 2009

“The Federal appellate court in the 7th circuit recently ruled that it is legal for lenders to make a profit on third party services sold to borrowers, such as appraisals and credit reports. In contrast, HUD has always said that markups were illegal if there were no services provided in connection with them. Who is right, and if the court ruling stands, how can borrowers protect themselves against excessive charges?”

I’m with the court on this one. HUD’s rule is essentially unenforceable and was widely violated before the recent court decision. Having unenforceable laws on the books that are routinely violated does not protect the borrower, and undermines respect for the law.

There is a case for prohibiting markups in this market. Loan providers are not restricted in their ability to charge directly for their services. Indeed, the list of fees that one or another loan provider charges is bewilderingly long. Markups aren’t needed to assure that loan providers are adequately compensated, and create one more layer of complexity for consumers.

Indeed, if I were mortgage czar rather than professor, I would prohibit all markups, and limit loan providers to two fees: one expressed as a percent of the loan (“points”), and one expressed in dollars (“total fees”). This would drastically simplify life for borrowers without in any way restricting the ability of loan providers to charge for their services.

In the world that exists, however, it is better to permit markups. The alternative to permitting markups is not my ideal rule but an actual HUD rule that allows markups if additional services are provided but prohibits them otherwise. While the HUD rule may appear fair, it is not because it is not enforceable -- except very selectively, which is unfair. The vast majority of loan providers know they are beyond HUD’s reach.

Violations of the HUD rule were pervasive before the recent court decision. Hence, the problem that markups on third party services pose for borrowers will be little different in the future than it was before the recent court decision.
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