Leveling the playing field on closing costs

The government shutdown and the debt limit have dominated the headlines, but a behind-the-scenes fight over federal mortgage policy has been brewing, and it could affect buyers’ choices the next time they apply for a home loan.

The issue concerns differing rules for different types of mortgage sources. Some mortgage brokerage firms have begun advertising that they offer substantial credits to their customers — often in the $2,000 to $5,000 range per loan, but sometimes more than $10,000 — that can be used to defray borrowers’ closing costs. A survey of 164 member firms of the National Association of Mortgage Brokers found that these companies provided more than $69 million in closing-cost credits to clients last year, and are on track to pay out the same or more this year. The group estimates that brokers nationwide rebated upward of $2 billion in 2012.

To illustrate: Charles Berryman, a departmental chairman at Louisiana State University, closed on a $295,900 mortgage to purchase a home earlier this year. It carried a 3 percent fixed rate for 15 years. Essential Mortgage Co., a large brokerage firm in his area, credited him $3,500 to defray his closing costs. In an interview, Berryman said he had shopped at two competing banks before making his choice. They offered the same attractive 3 percent fixed rate, he said, but no credits.

The availability and size of the closing-cost money sealed the deal for him, he said. Plus, “it really surprised me,” he added, that one mortgage company could offer such a sweetener while competitors apparently would not or could not.

Though no one explained it to him at the time, there was an important reason for the difference. The brokerage firm, Essential Mortgage, was required by federal rules to rebate the money to Berryman. The two competing banks were not.

This is because under regulations issued by the Federal Reserve, brokers — who do not lend their own money but can shop among multiple creditors on behalf of borrowers — must disclose all their fees upfront to applicants. They are not permitted to earn any more than the disclosed amounts even if the funding source they choose for a buyer at a specific interest rate will pay them a premium for the loan. When brokers do receive premiums, the extra money must be credited to the borrower. The rules are an outgrowth of abuses during the mortgage-boom years, when some brokers steered unsuspecting customers to higher-cost loans in order to fatten fees for themselves.

Banks that lend their own money, by contrast, are under no such requirements on premiums. They have the option to offer an applicant a credit — or not — in connection with a given interest rate. In Berryman’s case, for example, the two banks he shopped quoted identical 3 percent rates even though they may have had the flexibility to sweeten the pot with a closing-cost credit. Like most mortgage customers, Berryman was not aware that they might have some flexibility, and never asked. The brokerage firm that he ultimately selected, on the other hand, actively advertises its credits and makes them a selling point with potential clients.

So where’s the controversy, and what should mortgage shoppers do with this information? Here’s the issue: Brokers complain that they are treated unequally under current rules — they are forced to rebate money, thereby limiting their potential income on transactions, while competitors are not. Plus, they worry that new “qualified mortgage” rules scheduled to take effect in January that set a limit on total allowable fees in home loans will only make matters worse. They have protested to federal regulators and are pushing for Congressional legislation that would change the rules, but so far have been unsuccessful.

What should mortgage applicants take away from all this? Most important, when they shop among competing banks and mortgage companies, they shouldn’t focus solely on interest rates. They should ask about the possibility of credits toward closing costs. If a lender is quoting the “posted” rate at the time of the inquiry, there may be credits toward closing expenses available at that rate or at another rate. Homebuyers should review the full range of rate scenarios, fees, monthly payments and cash needed to close with the loan officer.

Like professor Berryman, they just might be surprised.

Ken Harney is a syndicated columnist.