RateWatch #257 - Culpepper v Irwin Mortgage
June 30, 2001
by Dick Lepre

What's Happening

Last week I said, "A Fed easing this coming week will send bond prices down and rates up. Lock now!". The Fed eased and rates shot up on Friday.

Culpepper v Irwin Mortgage

Recently the U.S 11th Circuit Court of Appeals made a ruling, which, unless reversed, will have a dramatic effect of the mortgage business.

When I come to work each day I have a series of rate sheets from various lenders. Looking at only a 30-year fixed rate conforming loan from one lender and only at the pricing for a 30-day lock, I might see a column such as this:

Rate Price
6.500 2.5 
6.625 2.125 
6.75  1.25 
6.875  0.625 
7.00  .25 
7.125  -.125 
7.375  -1.125
7.5  -1.375 
7.625  -1.75 

The prices without minus signs are costs.  The prices with minus signs are rebates or "yield spread premiums". The above are the wholesale prices.  If you want me to get you a 6.5% 30-year
fixed it will cost me 2.5 points.  I add one point and charge you 3.5 points.  My experience is that no one wants such a loan. Borrowers are looking almost exclusively for no point loans.  If you wanted a no point loan I would quote you the 7.375% and make the 1.125 points. 

The problem is that someone saw these "yield spread premiums" (YSPs) and said "Hey wait,  lenders are giving fees to brokers for bringing them borrowers at higher rates."  This statement is true. Mortgage lending is a "you pay me now or you pay me later" proposition.  The more you pay in points, the lower your rate and payment.  The less you pay up front - the higher your rate is.
This is a basic economic concept.

Culpepper is a class action suit.  The Appeals Court in its recent ruling affirmed certification of the class.  The class literally includes:

[a]ll persons who, from April 11, 1995, until this class is certified, [June 22, 1999], inclusive, obtained an FHA mortgage loan that was funded by Irwin Mortgage Corporation wherein the broker was paid a loan origination fee of 1% or more and wherein Irwin paid a "yield spread premium" to a mortgage broker.

(Note that while this ruling pertains only to FHA loans made by one company it opens the gate to suits on all loans that used YSPs.)

You can find the court's ruling at:

The heart of the courts ruling is section 8 of RESPA (Real Estate Settlement Procedures Act) which:

"prohibits both the giving and acceptance of "any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business incident to or a part of a real estate
settlement service . . . shall be referred to any person."

The finding of the original court was that YSP's were prohibited referral fees (or that a jury might so find) because they depended on the value of the referral (higher rate = higher rebates).

After the original court's finding Congress requested HUD to "clarify" its position concerning the legality of YSP's.  HUD stated that YSP's are not illegal per se but can nonetheless be illegal.  (This next little bit is - I think - the heart of the matter.) HUD tests the legality of YSP's in two steps.  The first step is "whether goods or facilities were actually furnished or services were actually performed for the compensation paid."  HUD muddied the issue by stating "The fact that...
services have been actually performed by the mortgage broker does not by itself make the payment legal." The second part of the test is "whether the payments are reasonably related to the value of the goods or facilities that were actually furnished or services that were actually performed."

The appeals court sides with the plaintiffs and concluded that YSP's are referral fees and not compensation for services rendered and that the second step - the reasonableness of compensation is irrelevant.

What's Wrong With This Picture?

The court seems to be totally unfamiliar with both the mortgage business and the wishes of the borrowers.  Borrowers want no point loans.  They understand that no point loans are at higher rate than loans with points. YSP's are not referral fees.  They are the only available mechanism
for providing the broker with the same compensation on a no point loan that he would have received on a one-point loan.  If brokers made more on loans with YSP's than loans without YSP's then the court's conclusion might have some merit.

The conclusion of this court leaves only two possibilities:
1) mortgage brokers are supposed to get folks no points loans and do so with no compensation or 2) no points loan will vanish and borrowers will need to pay points on all mortgages.  Choice one ain't gonna happen.  Choice two creates the absurdity of abridging consumers the right to get, for example, no cost loans when rates drop.  The court's ruling has, then, the effect of being completely anti-borrower and increasing the value of present mortgage pools by making it difficult or impossible to refinance them. It is inane to believe that the intent of HUD was to screw borrowers to the benefit of investors in Mortgage Backed Securities.  Sadly, this is the conclusion that the appeals court reached.

The Solution

There are only three possible resolutions to this. 
1) This ruling will be overturned by SCOTUS - not a likely scenario at this stage ;
2) no point loans are going to disappear or
3) HUD will need to clarify for this court its position with regard to YSP's.  No one believes that
there is a legislativesolution available.  Getting Congress to act is politically inexpedient.

HUD can merely clarify that YSP's give brokers no more compensation than they would receive on loans with points.  They are, in fact, not referral fees. They serve only the purpose of providing the borrower with what is desired - low cost loans.

The path that is being pursued by the mortgage lobby is going to HUD and getting them to indicate that YSP's are - in almost all cases - not referral fees.  This would "pull the rug out" from under the class action suit and require that each borrower who felt aggrieved would have to demonstrate that, in his case, a referral fee has been paid.


Part of the problem is, I think, semantic.  The mortgage industry should not have used the term "yield spread premium".  That makes it sound like the broker is making "a premium" on this loan rater than a loan with points.  An expression such as "low cost bonus" might be construed as being more consumer friendly.

Some Non Sequiturs

The court's ruling leads to some illogical conclusions.  If I, as a broker, am getting you a no point loan and taking a YSP from the lender as my fair compensation and becoming a felon thereby, why can a person who works for a direct lender receive the identical compensation for doing the exact same work and delivering the exact same loan to the exact same borrowers?

The mortgage industry exists in its present form and size because of the ability of the secondary market to securitize pools of mortgages.  The YSP pricing starts at the top.  It is set by FNMA and FHLMC.  Mortgage brokers and lenders serve to connect individual with investors.  Should
FNMAC and FHLMC be held liable for offering "premium pricing"?  

Intent of RESPA

Presumably, the intent of RESPA was to eliminate "referral fees" because the borrower, in some way paid for them.  It is also intended to promote competition.  For example, escrow companies are unable to offer reduced escrow fees to some people to get their business because this is a
"referral fee".  Yield Spread Premiums are merely an extension of the "you pay me now or you pay me later" nature of the pricing seen above. The sole intent is to provide no point loans to the consumer.  Lower cost now, higher payment later.  The details of this are spelled out on the disclosures that consumers are given.

Political Reality

HUD must be approached by the mortgage industry with the proposition that the present administration can clean up this mess with a clarification that the previous murky HUD ruling has been misconstrued by the appeals court and led to a consumer-unfriendly conclusion. 

Allowing this ruling to stand and allowing an untold number of class action suits to go forward will have a devastating effect on the mortgage industry and serve to eliminate what is the consumer's
"loan of choice". It will also prevent people who do not have enough money from becoming homeowners by forcing the to accrue the money to pay the points out of their own pockets.

This case is a perfect example of what goes wrong with our system of justice when judges divest themselves of any semblance of common sense and protection of the common good and reduce justice to the crafting of words on paper with insufficient regard for the real-world workings behind those words.  This is a topic which is forever discussed in legal circles:  are judges supposed to figure out what is the intent behind the law or mereley interpret the letter of the law? 

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