(This is Part 2 of a two-part series. Read Part 1, "Transparency is king in U.K. mortgage system.")
Last week I noted that the pricing of mortgage broker services in the United Kingdom was much more transparent than in the United States. As a result, the U.K. system provides no leeway for brokers to price opportunistically, meaning to vary the price according to what the borrower can be persuaded to pay. In the U.S., however, opportunistic pricing is pervasive and average broker fees are much higher.
The regulation of mortgage brokers also is very different. In the U.K., a series of sweeping changes beginning in 1997 placed most financial regulation under a new Financial Services Authority (FSA). FSA is an independent nongovernmental body but it is answerable to the Treasury and ultimately to the Parliament.
In 2004, the FSA took over regulation of the mortgage sector, including mortgage brokers. Mortgage brokers in the U.K. are thus subject to one set of rules, and borrowers know where to go to register a complaint. All FSA rules described below apply to loan officer employees of lenders as well as to brokers.
In the U.S., brokers have to obtain separate licenses for every state in which they want to do business, and are subject to a different set of rules in every state. A new initiative to create a nationwide licensing system would streamline the process of applying for licenses, and ultimately create a national database of mortgage brokers and loan officers, which could be accessed by borrowers. We are years away from that, however, and even when it materializes, every state will retain its licensing authority.
Note: Brokers are subject to a few provisions of the federal Truth in Lending Act and the Real Estate Settlement Procedures Act, both of which soon may be tightened.
In the U.K., FSA has ruled that every broker and loan officer must pass a competency exam. According to Richard Hobson who was a broker in the U.K. and took the exam, it was far more difficult than the one he had to take to be licensed in the state of Washington. And that state is one of the few that require an exam.
The FSA has three sets of disclosure rules. At their first meeting, the broker gives the borrower an Initial Disclosure Document (IDD). The IDD indicates whether the broker has access to mortgages from all lenders in the market, only some lenders or only one lender. It also provides complete information on the broker’s fee — including amount, when payable, and how it relates to lender fees paid to the broker. If the broker also sells insurance — a common practice in the U.K. — the same information is required for the insurance transaction.
There is no counterpart to the IDD in the U.S. However, proposals from both HUD and the Federal Reserve would require fuller disclosure of broker fees.
The second set of U.K. disclosure rules applies after the broker, in consultation with the borrower, has identified one loan program that appears to meet the borrower’s needs. This is called a Key Facts Illustration (KFI), and it is a kind of an amalgam of the Good Faith Estimate and the Truth in Lending disclosure documents in the U.S. The KFI is a little better because it is only one document, has as much useful information, and less useless information.
The third disclosure, which has no counterpart in the U.S., is the Mortgage Record of Suitability, or MROS, which has two major parts. The first is a statement of the borrower’s circumstances that bear on the mortgage selection. It includes how the borrower intends to use the loan proceeds, and what features of the loan the borrower views as most important.
The second part of the MROS is the broker’s comment about all major features of the recommended loan, and why the broker is recommending it. This includes the broker’s statement regarding why the loan is affordable to the borrower, now and in the future.
One consequence of the FSA rules is a heavy compliance burden, which makes it difficult to operate as a one-person firm. Most brokers belong to larger firms that can provide compliance as well as other types of support.
An article I wrote last year argues that making brokers and loan officers responsible for determining mortgage suitability was not workable because most of them were transaction-oriented and strongly averse to providing any information that might jeopardize a deal. But Richard Hobson argues that brokers in the U.K. are relationship-oriented and view borrowers as potential clients for life. He is a firm believer in the U.K. system, and is using the model in his Seattle, Wash., business.
Why is a relationship as opposed to a transaction orientation much more common in the U.K.? I plan to write about this as soon as I understand it better.
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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