Here's what one state is doing to mandate that brokers keep clients' best interests in mind

John Long, attorney, John Long Law

As published in Scotsman Guide's Residential Edition, June 2008.

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 brokers:

• 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 transaction;
• 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 after consideration.

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.

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