So You've Been Preempted-What Are You Going to Do Now?: Solutions for States Following Federal Preemption of State Predatory Lending Statutes

Brigham Young University Law Review, 2004 by Childs, Christopher R

Because of their extensive involvement in the lending process and the relationship of trust and counseling they often have with their clients, mortgage brokers are also in a unique position that may allow them to take advantage of unwary borrowers. Brokers

may hide disclosures from borrowers, begin work on a borrower's home and then "bait and switch" with new loan terms before the loan is closed, finance fees without borrowers' knowledge, or lead them to believe that they must purchase products such as credit insurance in order to close the loan."

Many third party brokers engage in "aggressive marketing and solicitation tactics" that sometimes "rise to the level of fraud or illegal deception."100

Mortgage brokers engage in such practices because of the real potential for financial gain. The broker compensation system is such that "brokers are paid by borrowers and in many cases, by lenders .... The total from both sources is their gross profit from a transaction."101 While the amount of the borrower-paid portion of the fee is typically ascertainable before or at the closing of the loan, the amount the lender pays to the broker is often paid in the form of a confusing and nontransparent "yield-spread premium," which, in the end, comes out of the borrower's pocket as well. A yield-spread premium-a fee lacked back from the lender to the broker- "is inflated interest on a loan that is used to cover the cost of the broker's fee."102 One study of such premiums determined that, in the prime market,

[brokers] added an average cost of over $1,100 on each transaction in which they were charged. The author found that the most likely explanation for the added cost was not added value, nor added services. Rather, it is a system which lends itself to price discrimination: extra broker-compensation can be extracted from less sophisticated consumers, while it can be waived for the few who are savvy about the complex pricing practices in today's mortgage market.103

Because of the potential of collecting yield-spread premiums from unwary borrowers, some mortgage brokers seek out lenders that serve their own interests by offering the broker the best compensation package rather than looking out for their client's best interests.104

Even when yield-spread premiums are not involved, broker compensation is based upon the amount of the loan. In order to increase fees and commissions, "brokers have an incentive to encourage the borrowers to take out as large a loan as possible."105 "The use of brokers has hastened the growth of subprime lending, given that brokers have placed some borrowers who would otherwise qualify for conventional loans into subprime loans because of the greater broker fees from subprime loans."106 These compensation features cause divided loyalties, since the broker should be looking out for the interests of her client. "As with most other transactions in our increasingly complex society, these borrowers rely on the good faith and honesty of the 'specialist' to help provide full, accurate, and complete information and explanations. Unfortunately, much predatory lending is a function of misplaced trust."107 Although mortgage brokers act in many ways as agents for their clients and stand in relationships of trust with them, the compensation system can lead to unfavorable results for borrowers.108