11/17/08: HUD Issues New Forms to Protect Homebuying Consumers
By Benny L. Kass
Change is now politically correct, and the Department of Housing and Urban Development (HUD) has jumped on the bandwagon. On November 13, 2008, HUD Secretary Steve Preston announced major revisions to the Real Estate Settlement Procedures Act (RESPA), including the requirement that – effective January 1, 2010 – consumers interested in buying a home using a mortgage must be given two completely revised forms: a Good Faith Estimate (GFE) and a settlement statement (called a HUD-1).
RESPA was enacted by Congress back in 1974, based in large part on a series of articles in the Washington Post which disclosed a host of problems involving mortgage lending and real estate settlement practices. The stated purpose of the Act was to help consumers become better shoppers for settlement services and to eliminate the kickbacks and referral fees that unnecessarily increased the costs of closing on your home.
These objectives, while laudable, have not materialized. According to Secretary Preston, “the mortgage crisis was fueled in part by people agreeing to mortgages that they ultimately could not afford. In some cases, people didn't understand or know that their mortgages could result in large payment increases after just two or three years.”
In an effort to ensure that RESPA's goals can be achieved, HUD has issued these two important documents, which mortgage lenders will be required to use for any mortgage loan involving one-to-four family residential properties. No later than three business days after a potential borrower makes a loan application, the lender is required to provide the borrower with a Good Faith Estimate of the projected settlement and closing costs. Unfortunately, as consumers have learned the hard way when they sat down at the settlement table, the information contained in this GFE is only an estimate, and all too often were shocked at the extra (and often expensive) costs for which there was no disclosure.
At settlement, in addition to a host of legal documents that the homebuyer had to sign, they were provided with the HUD-1. This settlement sheet lists the costs of the entire transaction, and is perhaps the most important document involved in the home-buying process. It is important for future tax purposes. When the house is ultimately sold, many of the line items on the HUD-1 can be used to increase the tax basis of the house, so as to avoid any capital gains which might otherwise be owed to the IRS.
Transparency is also politically correct. Over the years, lenders often did not disclose the fees they paid – or received – in order to get the loan closed. According to Secretary Preston, “HUD will require that the compensation lenders pay to mortgage brokers be more fully disclosed. These so-called ‘yield spread premiums' are rarely understood by, or fully disclosed to, borrowers. Consumers deserve to understand this and they need to get credit for essentially paying these premiums.”
What does this mean for the consumer? Armed with information as to how much money the mortgage broker may be receiving from the ultimate lender, the consumer will now have the opportunity to negotiate a better rate. A basic principle in mortgage lending is that one can buy down interest rates by paying points. Typically, one point (i.e. one percent of the loan) can reduce the rate by one-eighth of a percent.
The new Good Faith Estimate, which must be provided to consumers starting January 1, 2010, is three pages long. It is designed to provide basic information – in simple English - so that potential home buyers will have answers to such questions as:
what is the term of the loan?
is the interest rate fixed or can it be changed? And if so, when can this change take place and what is the maximum dollar amount that I will ever have to pay on a monthly basis;
is this a balloon note? That means that although I pay a small amount of money each month to my lender, at the end of a period of time, the entire balance of my mortgage will become due – i.e. it balloons;
if I refinance this mortgage at a later date, will I have to pay a pre-payment penalty? If so, what is the maximum I will have to pay? and
what are the total amount of closing costs that I will have to pay when I go to the settlement?
All of the information contained in the GFE becomes meaningless, however, if the dollars change at the settlement table. At that time, it is usually too late to complain. Your seller is ready, willing and able and expects that you will complete the settlement as required under the real estate sales contract. If you try to back out now, based on the erroneous information previously provided by your lender, you will be in default and the seller could very well try to keep your earnest money deposit and sell the property to someone else. As far as the seller is concerned, your dealings with the mortgage lender are irrelevant to the sales contract you entered into.
To help consumers confirm that the information provided by the lender in the GFE will be what they have to pay at closing, HUD also issued a revised settlement statement. According to Brian Montgomery, FHA Commissioner, “to facilitate comparison between the HUD-1 and the GFE, each designed line on the final HUD-1 will now include a reference to the relevant line from the GFE. Borrowers will now be able to easily compare their estimated and actual costs...”
The new form contains three pages. Settlement attorneys and companies will have to state (on page 3 of the new document) those charges which cannot increase from the time the lender first provided the GFE – such as origination charge, points and transfer tax – as well as charges which may change – such as the daily interest charge or homeowner's insurance.
Perhaps the most significant change in the new HUD-1 is a section entitled “Loan Terms”. This will contain almost the same information which the consumer initially received in the revised GFE when the loan application began. It will make it very easy for the consumer to confirm – at settlement – that what the lender initially promised is being honored.
These two documents are important steps toward the goal of allowing consumers to fully understand – up front – what it will cost them to buy their house. “None of us can lose sight of the fact”, said Commissioner Montgomery, “that millions of Americans simply don't understand all of the fine print of their mortgages and this, in many respects, is at the heart of today's mortgage crisis.”
Congress has sixty days to react to the new RESPA rules, which include the new forms. If no such action is taken, it is hoped that legitimate mortgage lenders will not wait until January 1, 2010, and will begin using the forms just as soon as their computer systems make them available.