(This is Part 2 of a three-part series. Read Part 1, “New mortgage underwriting rules will be tough to enforce.”)

Last week, I criticized the Federal Reserve Board’s proposed rule to prohibit lenders from making loans that were not affordable, and to require lenders to verify the information on which they base loan decisions. These rules are too vague to be enforceable, and it is too late for them to do any good even if they were enforceable.

This week I look at the board’s proposed approach to curbing abuses by mortgage brokers. Timeliness is not an issue here, but doing it right is.

Mortgage brokers abuse borrowers when they collect a rebate from the lender for delivering a high-interest-rate loan without the knowledge of the borrower. I developed the Upfront Mortgage Broker program largely to deal with this problem.

Upfront Mortgage Brokers (UMBs) agree in writing with borrowers to a specified total fee, which includes any payment received by the broker from the lender. The borrower elects how to pay the fee, either in cash at closing or in a rate high enough that the lender will pay a rebate to the broker.

Under the board’s proposal, lenders would be prohibited from making a payment to a broker unless the borrower and broker had agreed in advance on the broker’s total compensation. The obligation imposed on the broker by this rule is thus identical to that imposed on a UMB.

However, the UMB program is voluntary whereas the board would impose the obligation on all brokers, most of whom don’t want it. This makes enforcement a challenge.

The board would impose enforcement responsibility on wholesale lenders. Before paying a rebate to a broker, the lender would have to check the agreement between the broker and the borrower, as well as the HUD1 closing statement, to make sure that the total amount received by the broker does not exceed the amount agreed upon.

Next week: how the board would curb servicing abuses.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

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