For
Release: February
27, 2004
FTC
Releases Staff Report on Mortgage Broker Compensation Disclosures
On October 28, 2002, the Federal Trade
Commission staff submitted comments to the Department of Housing
and Urban Development (HUD) on its July 2002 Real Estate Settlement
Procedures Act (RESPA) reform proposal. The FTC staff generally
supported the RESPA reform proposal, including rules that
would permit the packaging of settlement services; make the
Good Faith Estimate disclosure form more understandable and
easier to use for consumers; and increase the certainty of
settlement cost estimates given to consumers. The FTC staff
raised concerns, however, about the requirement that mortgage
brokers (but not other mortgage providers) must disclose certain
types of compensation.
The FTC’s Bureau of Economics today
released a staff report titled “The Effect of Mortgage
Broker Compensation Disclosures on Consumers and Competition:
A Controlled Experiment.” The report presents the results
of a study that examines the mortgage broker compensation
disclosure proposed by HUD, as well as two alternative versions.
The study finds that the disclosures are likely to confuse
consumers, cause a significant number of consumers to choose
loans that are more expensive than the available alternatives,
and create a substantial consumer bias against broker loans,
even when the broker loans cost the same or less than direct
lender loans.
The study notes that a major part of mortgage
broker compensation, and the focus of the proposed disclosure,
is any yield spread premium (YSP) paid by the lender for a
loan originated at an above-par (premium) interest rate. The
YSP reflects the additional value to the lender of a loan
originated at the higher interest rate. Lenders making loans
directly to consumers may charge the same interest rate and
earn the same compensation as a mortgage broker but would
not be required to make the same disclosure under the proposed
policy.
The study examines the disclosures in a
controlled experiment with more than 500 recent mortgage customers.
Participants were shown cost information about two hypothetical
mortgage loans and asked to identify which loan was less expensive
and which loan they would choose if they were shopping for
a mortgage. Participants were divided into five groups. A
broker compensation disclosure was included in the cost information
shown to three of the groups, with the format and wording
of the disclosure varying across the groups. In each of the
groups, one loan was treated as a broker loan and one as a
direct lender loan. The broker loan disclosed a YSP amount
but the direct lender loan did not, following the policy proposed
by HUD. A broker compensation disclosure was not included
in the cost information shown to the other two groups.
In the two groups shown cost information
without a broker compensation disclosure, about 90 percent
of the respondents in each group correctly identified the
less expensive loan, and 85 percent and 94 percent identified
the less expensive loan as the one they would choose if they
were shopping for a mortgage. Only 3 percent of the respondents
in one of the groups identified the more expensive loan as
the one they would choose if shopping. Others said they would
choose either, neither, or did not know.
In contrast, in the three groups shown
cost information that included a broker compensation disclosure,
only 63 percent to 72 percent of the respondents correctly
identified the less expensive loan, and only 60 percent to
70 percent identified the less expensive loan as the one they
would choose if they were shopping for a mortgage; 16 percent
to 27 percent identified the more expensive loan as the one
they would choose if shopping. The study concludes that the
consumer confusion and mistaken loan choices arising from
the compensation disclosure are likely to increase mortgage
costs for many consumers.
The study also included tests in which
both loans cost the same. In the two groups shown cost information
without a broker compensation disclosure, 95 percent and 99
percent of the respondents correctly recognized that both
loans cost the same, and 78 percent and 83 percent said they
would choose “either loan, both cost the same”
if they were shopping for a mortgage. The few respondents
who chose one of the two loans split fairly evenly between
the two.
In contrast, in the three groups shown
cost information that included a broker compensation disclosure,
40 percent to 50 percent of the respondents mistakenly believed
that one loan was less expensive than the other, and of these,
75 percent to 90 percent believed that the direct lender loan
(that did not disclose a YSP) was less expensive than the
broker loan (that did disclose a YSP). Similar results, with
an even larger bias against the broker loan, were found when
these respondents were asked which loan they would choose
if shopping for a mortgage. The study concludes that the bias
against broker loans arising from the asymmetric compensation
disclosure may harm competition in the mortgage market and
result in higher mortgage costs for consumers.
The study concludes that a better way to
help consumers obtain less expensive mortgages would be to
encourage and facilitate comparison shopping on loan costs.
This approach is incorporated in other components of HUD’s
RESPA reform proposal and would be far more beneficial for
consumers. Implementation of these policies, along with appropriate
refinements to ensure that consumers easily understand the
disclosures, would provide benefits to consumers without the
adverse effects that are likely to arise from the compensation
disclosure.
Copies
of the report are available on the FTC’s Web site at
www.ftc.gov
and also from the FTC’s Bureau of Economics at 202-326-2361,
or requests can be e-mailed to troundtree@ftc.gov.
The FTC works for the consumer to prevent fraudulent, deceptive
and unfair business practices in the marketplace and to provide
information to help consumers spot, stop and avoid them. To
file a complaint, or to get free information on any of 150
consumer topics, call toll-free, 1-877-FTC-HELP (1-877-382-4357),
or use the complaint form at http://www.ftc.gov.
The FTC enters Internet, telemarketing, identity theft and
other fraud-related complaints into Consumer Sentinel, a secure,
online database available to hundreds of civil and criminal
law enforcement agencies in the U.S. and abroad.
*The report’s authors are James M.
Lacko and Janis K. Pappalardo of the FTC’s Bureau of
Economics. The views expressed in the report are those of
the authors and do not necessarily represent the views of
the Federal Trade Commission or any individual Commissioner.
MEDIA CONTACT:
Jennifer Schwartzman
Office of Public Affairs
202-326-2674 or jschwartzman@ftc.gov
STAFF CONTACT:
Pauline M. Ippolito
Bureau of Economics
202-326-3477 or pippolito@ftc.gov
(http://www.ftc.gov/opa/2004/01/mortgagerpt.htm)
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