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 firstname.lastname@example.org. 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.