Here’s what one state is doing to mandate that brokers keep clients’ best interests in mind
The federal government and several states are proposing
stricter mortgage-industry regulation. Some of these proposals focus on
creating a fiduciary duty for mortgage brokers toward their clients. Some also
propose increased criminal penalties for brokers who commit fraud or knowingly
mislead borrowers and expand or clarify disclosure requirements.
On the national level, for instance, Congress is considering a number of proposals to increase broker legislation. The proposed laws include increasing continuing-education requirements, creating a national mortgage-broker database and instituting national licensing, among other things.
And as state mortgage regulations get stricter, Washington
state is taking the lead. Two bills that take effect this month -- state Senate
Bill No. 6381 and substitute state House Bill No. 2770 -- will change the
manner in which mortgage brokers in the state do business dramatically. Through
them, the state has implemented new requirements for brokers to act in the best
interests of their clients and to ensure that they recommend the “right loans”
for the “right borrowers.”
Brokers in Washington state, as well as those keeping an eye
on regulations nationwide, would be wise to understand the changes, which
affect the mortgage-broker industry greatly. Here’s what you should know about
what the new regulations mean and how brokers can stay in compliance.
Creation of fiduciary duties
The most dramatic change for Washington-state mortgage
brokers comes from state Senate Bill No. 6381. It establishes a fiduciary
obligation to borrowers, fundamentally changing the relationship between
brokers and borrowers.
This means that a mortgage transaction is no longer an
arm’s-length transaction to protect brokers in case of litigation. Instead,
brokers must take measures to ensure that borrowers understand the loan they
receive, all the associated expenses and whether it is the best loan available
for them, given their credit score and prudent underwriting standards.
This change dramatically impacts the manner in which brokers
must do business for regulatory and civil-liability reasons. Before the
creation of a fiduciary duty, borrowers were responsible for investigating the
loan and essentially for protecting their own interests independently of the
broker. Now, brokers are obligated to protect borrowers.
This impact is especially burdensome in the context of civil
litigation. Basically, with a fiduciary duty, the burden of proof in a trial
shifts to the broker. That is, borrowers need only accuse, and brokers must
demonstrate that the accusation is untrue. Previously, borrowers would have to
demonstrate the validity of their accusation.
Other highlights of the new law’s requirements mandate that
- Must act in borrowers’ best interests with the utmost good
faith and fair dealing toward them;
- Must disclose any and all interests to borrowers that are
used to facilitate their request. That is, brokers must explain and determine
that borrowers understand how everyone in the process benefits from the
- Must disclose to borrowers all material facts known to the
broker that might reasonably affect their rights, interest or ability to
receive the intended benefit; and
- Must not steer or direct borrowers to accept a loan with a
less-favorable risk grade than the grade they would qualify for under prudent
underwriting standards. This is permitted, however, if borrowers are offered
loan products within the risk category and choose the higher-risk-grade product
Disclosures, policies and penalties
The state’s substitute House Bill No. 2770 makes a number of
provisions of which brokers should be aware.
A major provision requires brokers to provide borrowers with
a new and separate written disclosure within three days of receipt of a loan
application. Brokers also must update that disclosure if there are any material
changes in the loan or costs before closing.
All subsequent disclosures must be made within three days of
the change or closing, whichever is sooner.
The new disclosure’s form and content will be determined by
the state’s Department of Financial Institutions (DFI), which will adopt a rule
that complies with the new law. As of press time, the rulemaking timeline has
yet to be determined.
The new law has mandated the disclosure’s minimum
requirements, however. First, the disclosure must be in plain language that is
reasonable and understandable to borrowers without the help of third-party
resources. It also must state:
- Fees and discount points on the loan;
- Interest rates of the loan;
- All broker fees;
- Yield-spread premiums (YSPs) stated in a dollar amount;
- Whether there is a prepayment penalty;
- Whether property taxes and insurance are to be escrowed;
- Whether the loan payments will adjust at the fully indexed
- Whether there is a price added or premium charged for loans
based on reduced documentation.
Another provision of this bill requires Washington-state
mortgage brokers to comply with internal policies and procedures set forth in
the “Interagency Guidance Nontraditional Mortgage Product Risks” and the
“Statement on Subprime Mortgage Lending,” which were created by a group of
federal-government regulatory agencies -- the Conference of State Bank
Supervisors, the American Association of Residential Mortgage Regulators and
the National Association of Consumer Credit Administrators.
Their purpose is to increase regulatory oversight of
nonprime mortgage products, such as interest-only loans, payment-option ARMs,
nonprime ARMs, nonprime extended-amortization products, reduced-documentation
products and simultaneous second-lien loans.
The state’s DFI will adopt rules to implement this
requirement, but it is worthwhile to note what these rules will likely cover.
First, brokers’ internal policies and procedures must be in
writing and must demonstrate that the brokers understand the responsibilities
for covered transactions. In particular, they should cover: consumer contact;
internal controls, monitoring and reporting; and requirements that promotional
materials and other product descriptions provide information about costs,
terms, features and risks that can help consumers select a product.
They also should address the broker’s adherence to the newly
required disclosure form and provide general guidance of the disclosure policy
to consumers, such as clear and balanced information about the relative risks
of products offered.
These policies’ and procedures’ adequacy also will be
measured against the new fiduciary duty.
Finally, the new state House bill also increases the
criminal penalties for violation of certain aspects of the law. Under the
Mortgage Brokers Practices Act, an act violation was a misdemeanor punishable
by as many as 90 days in county jail and/or a $1,000 fine.
Under the new law, however, some of the violations now
subject violators to a class-B felony charge that is punishable by as many as
10 years in state prison and/or a $25,000 fine, as well as civil forfeiture.
Brokers who commit one of the following violations, whether
directly or indirectly, are subject to the new penalties.
- Employing a scheme, device or artifice to defraud or
materially mislead a borrower, lender or any person
- Engaging in any unfair or deceptive practice toward any
person in the lending process
- Obtaining property by fraud or material misrepresentation in
the lending process
- Knowingly making any misstatement, misrepresentation or
omission during the lending process with the knowledge that a lender, borrower
or other party may rely on it
- Using or facilitating the use of any misstatement,
misrepresentation or omission, knowing it to be incorrect, during the lending
process with the intention that the lender, borrower or other party to the
process rely on it
- Receiving anything of value by these violations
This particular change may impact the state’s “Mortgage
Lending Fraud Prosecution Account,” enacted in 2003. Funded by a $1 surcharge
for every deed of trust recorded in Washington state, the account is
administered by the DFI for prosecution of criminal fraud in mortgage lending.
According to the DFI, this fund creates more than $800,000
in annual revenue. Expanding criminal penalties into a class-B felony enhances
the state’s ability to use these funds.
Decoding the rules
The ideas that borrowers must protect themselves and that
“whatever the traffic will bear is permissible” are attitudes of the past in
the mortgage industry. Brokers’ affirmative obligation now is to deliver a loan
product that the borrower understands and that is prudent for that borrower.
When it comes to litigation, it is no longer enough for
mortgage brokers in Washington state to simply produce loan documents that
borrowers signed. Instead, they now must greatly increase their communication
and show the utmost good faith and fair dealing with clients. This includes
ensuring that borrowers understand the loan’s material aspects. Just giving the
information is not enough.
Brokers have the affirmative obligation to offer loan
products appropriate for borrowers’ risk classification and clearly must avoid
excessive loan charges. All communications with consumers -- including
advertisements, oral statements and promotional materials -- also must provide
clear and balanced information about the products’ benefits and risks.
Brokers also should have timely communication that will help
borrowers’ product selection and should not steer them to a particular product
to the exclusion of others. Brokers also must explain costs of
reduced-documentation loans, as well as risks such as payment shock, prepayment
penalties, balloon payments, and lack of escrow for taxes and insurance.
• • •
Controls will become especially important and should include
written policies and procedures that cover criteria for hiring and training
loan personnel; compliance with applicable laws and regulations; consumer
disclosures; and record-keeping.
With their new fiduciary duty, brokers must have practices
and procedures in place that are well-documented and that include regular
It also is important to keep any compliance program in
writing. Documenting borrower communication also is critical. An undocumented
file will be nearly indefensible in light of the new responsibility for brokers
to assure that borrowers understand the loan product, its costs and risks and
that the product they receive is appropriate to their circumstances.
Though some brokers in Washington and nationwide may balk at
these new requirements, it is important to note that ethical business dealings
are key to any industry.
Given the mortgage industry’s recent turmoil, ethical
behavior is essential for turning its image around. These new bills likely set
the stage for doing so.