I. Background

In 1974 Congress enacted the Real Estate Settlement Procedures Act ("RESPA") to change the settlement process for residential real estate to require "more effective advance disclosure to home buyers and sellers of settlement costs" and to eliminate "kickbacks or referral fees that tend to increase unnecessarily the costs of certain settlement services" (12 U.S.C. 2601).

The Department of Housing and Urban Development ("HUD") is responsible for enforcing RESPA.

The RESPA statute is implemented and interpreted by HUD's "Regulation X" (24 CFR 3500) and HUD policy statements (see, for example, RESPA Statement of Policy 1999-1). Because the statute, regulations, and HUD policy are constantly evolving, it is important to keep up to date on the latest developments. One useful source of information is HUD's RESPA web page.

For additional guidance on RESPA's meaning and coverage, HUD has provided some fact scenarios with comments (Appendix B to 24 CFR 3500) and answers to frequently asked RESPA questions.

Scope. RESPA covers transactions involving a "federally related mortgage loan", which includes most loans secured by a lien (first or subordinate position) on residential property. This includes: home purchase loans, refinances, lender approved assumptions, property improvement loans, equity lines of credit, and reverse mortgages. (See 12 U.S.C. 2602; 24 CFR 3500.2).

The following are the kinds of transactions not covered by RESPA: an all cash sale, a sale where the individual home seller takes back the mortgage, a rental property transaction or other business purpose transaction. (See 12 U.S.C. 2606; 24 CFR 3500.5).

III. Kickbacks and referral fees under RESPA

A. General rules prohibiting.

Section 8 of RESPA (12 U.S.C. 2607) prohibits anyone from giving or accepting any fee, kickback, or other thing of value in connection with an agreement or understanding that business will be referred to any person (see 12 U.S.C. 2607(a); 24 CFR 3500.14). Section 8 also prohibits anyone from giving or accepting any portion, split, or percentage of any charge made or received for rendering a settlement service other than for services actually performed (see 12 U.S.C. 2607(b); 24 CFR 3500.14).

B. General rules permitting compensation for settlement services.

However, RESPA also provides that Section 8 should not be construed as prohibiting "the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or services actually performed." (12 U.S.C. 2607(c)(2); see also 12 U.S.C. 2607(c); 24 CFR 3500.14).

1. Mortgage brokers / settlement service providers. Section 8 of RESPA applies to compensation paid to "mortgage brokers" and "settlement service providers." Under "Regulation X", a "mortgage broker" is defined as a person (not an employee or exclusive agent of a lender) who brings a borrower and lender together to obtain a federally related mortgage loan, and who renders services as described in the definition of "settlement services" in this section.(24 CFR 3500.2).

Although it is not required by the RESPA statute or regulations, HUD policy states that a mortgage broker "should provide the consumer with information about the broker's services and compensation, and agreement by the consumer to the arrangement should occur as early as possible in the process." (Statement of Policy 1999-1, paragraph II.E.). HUD has provided a sample form for this purpose. (HUD-1-B (html); HUD-1-B (PDF reader required)). The National Association of Mortgage Brokers has also provided such a form.

2. Affiliated business arrangement. Section 8 of RESPA also applies to compensation paid to someone in an "affiliated business arrangement" which is defined as an arrangement in which (A) a person who is in a position to refer business incident to or a part of a real estate settlement service involving a federally related mortgage loan, or an associate of such person, has either an affiliate relationship with or a direct or beneficial ownership interest of more than 1 percent in a provider of settlement services; and (B) either of such persons directly or indirectly refers such business to that provider or affirmatively influences the selection of that provider; (12 U.S.C. 2602(7)).

The term "associate" in the definition above means one who has one or more of the following relationships with a person in a position to refer settlement business: (A) a spouse, parent, or child of such person; (B) a corporation or business entity that controls, is controlled by, or is under common control with such person; (C) an employer, officer, director, partner, franchisor, or franchisee of such person; or (D) anyone who has an agreement, arrangement, or understanding, with such person, the purpose or substantial effect of which is to enable the person in a position to refer settlement business to benefit financially from the referrals of such business. (12 U.S.C. 2602(8)).

When a settlement service provider in an "affiliated business arrangement" refers a consumer to another provider, the referring provider must give the consumer (at or prior to the time of the referral) an Affiliated Business Arrangement Disclosure, describing the business arrangement between the two providers and giving an estimate of the second provider's chargers (the referring party may not require the consumer to use the particular provider being referred except where a lender refers a borrower to an attorney, credit reporting agency, or real estate appraiser who represents the lender's interest in the transaction) (see 12 U.S.C. 2602(7); 24 CFR 3500.15; Affiliate Business Arrangement Disclosure Statement Format).

3. Computer Loan Origination systems. By HUD policy, RESPA also applies to compensation for services provided in connection with Computer Loan Origination systems (CLOs). Under the policy, a CLO is defined as a computer system that is used by or on behalf of a consumer to facilitate a consumer's choice among alternative products or settlement service providers in connection with a particular RESPA-covered real estate transaction. Such a computer system: (1) may provide information concerning products or services; (2) may pre-qualify a prospective borrower; (3) may provide consumers with an opportunity to select ancillary settlement services; (4) may provide prospective borrowers with information regarding the rates and terms of loan products for a particular property in order for the borrower to choose a loan product; (5) may collect and transmit information concerning the borrower, the property, and other information on a mortgage loan application for evaluation by a lender or lenders; (6) may provide loan origination, processing, and underwriting services, including but not limited to, the taking of loan applications, obtaining verifications and appraisals, and communicating with the borrower and lender; and (7) may make a funding decision.

(HUD Statement of Policy 1996-1: Computer Loan Origination Systems (CLOs)).

The HUD policy adds that this definition "is not meant to be restrictive or exhaustive" but "merely attempts to describe existing practices of service providers." HUD acknowledges that, "with the use of technology evolving so rapidly . . . it is difficult for the Department [HUD] to provide guidance on future unspecified practices in the abstract." (Statement of Policy 1996-1).

The HUD policy concludes: "To the extent that a CLO performs 'settlement services', it is a settlement service provider." (Statement of Policy 1996-1).

4. Definition of "settlement service". Regulation X defines "settlement service" as:

any service provided in connection with a prospective or actual settlement, including, but not limited to, any one or more of the following:
(1) Origination of a federally related mortgage loan (including, but not limited to, the taking of loan applications, loan processing, and the underwriting and funding of such loans);
(2) Rendering of services by a mortgage broker (including counseling, taking of applications, obtaining verifications and appraisals, and other loan processing and origination services, and communicating with the borrower and lender);
(3) Provision of any services related to the origination, processing or funding of a federally related mortgage loan;
(4) Provision of title services, including title searches, title examinations, abstract preparation, insurability determinations, and the issuance of title commitments and title insurance policies;
(5) Rendering of services by an attorney;
(6) Preparation of documents, including notarization, delivery, and recordation;
(7) Rendering of credit reports and appraisals;
(8) Rendering of inspections, including inspections required by applicable law or any inspections required by the sales contract or mortgage documents prior to transfer of title;
(9) Conducting of settlement by a settlement agent and any related services;
(10) Provision of services involving mortgage insurance;
(11) Provision of services involving hazard, flood, or other casualty insurance or homeowner's warranties;
(12) Provision of services involving mortgage life, disability, or similar insurance designed to pay a mortgage loan upon disability or death of a borrower, but only if such insurance is required by the lender as a condition of the loan;
(13) Provision of services involving real property taxes or any other assessments or charges on the real property;
(14) Rendering of services by a real estate agent or real estate broker; and
(15) Provision of any other services for which a settlement service provider requires a borrower or seller to pay.

(24 CFR 3500.2).

Regulation X also provides that "if the payment of a thing of value bears no reasonable relationship to the market value of the goods or services provided, then the excess is not for services or goods actually performed or provided." (24 CFR 3500.14(g)(2)).

5. HUD's 1999 RESPA Policy Statement. In a 1999 Policy Statement, HUD stated its position on the legality of payments by lenders to mortgage brokers under RESPA and Regulation X:

In determining whether a payment from a lender to a mortgage broker is permissible under Section 8 of RESPA, the first question is whether goods or facilities were actually furnished or services were actually performed for the compensation paid. . . . The second question 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.

(Statement of Policy 1999-1, paragraph II.A.; emphasis added).

a. Payments must be for goods, facilities, or services actually provided. To help determine whether compensable services are performed, HUD referred to its letter to the Independent Bankers Association of America, dated February 14, 1995 (IBAA letter). In that letter, HUD identified the following services normally performed in the origination of a loan:
(a) Taking information from the borrower and filling out the application;
(b) Analyzing the prospective borrower's income and debt and pre-qualifying the prospective borrower to determine the maximum mortgage that the prospective borrower can afford;
(c) Educating the prospective borrower in the home buying and financing process, advising the borrower about the different types of loan products available, and demonstrating how closing costs and monthly payments could vary under each product;
(d) Collecting financial information (tax returns, bank statements) and other related documents that are part of the application process;
(e) Initiating/ordering VOEs (verifications of employment) and VODs (verifications of deposit);
(f) Initiating/ordering requests for mortgage and other loan verifications;
(g) Initiating/ordering appraisals;
(h) Initiating/ordering inspections or engineering reports;
(i) Providing disclosures (truth in lending, good faith estimate, others) to the borrower;
(j) Assisting the borrower in understanding and clearing credit problems;
(k) Maintaining regular contact with the borrower, realtors, lender, between application and closing to appraise them of the status of the application and gather any additional information as needed;
(l) Ordering legal documents;
(m) Determining whether the property was located in a flood zone or ordering such service; and
(n) Participating in the loan closing.

(Statement of Policy 1999-1, paragraph II.C.).

In its 1999 Policy Statement, HUD added that, for "other services to be compensable under RESPA, they should be identifiable and meaningful services akin to those identified" above, "for example, the operation of a computer origination system (CLO) or an automated underwriting system (AUS)." (Statement of Policy 1999-1, paragraph II.C.).

(1) General rule: to justify compensation, settlement service provider must take application and perform five additional services. HUD has articulated that it generally would be satisfied that sufficient origination work was performed to justify compensation if it found that:

The lender's agent or contractor took the application information (under item (a) [in the list above]); and

The lender's agent or contractor performed at least five additional items on the list above.

(Statement of Policy 1999-1, paragraph II.C.).

(2) If only counseling-type services, three additional requirements. HUD added three requirements if the lender's agent or contractor relied on taking the application and performing only "counseling type" services (see (b), (c), (d), (j), and (k) on the list above) to justify a fee:

Counseling gave the borrower the opportunity to consider products from at least three different lenders;

The entity performing the counseling would receive the same compensation regardless of which lender's products were ultimately selected; and

Any payment made for the "counseling-type" services is reasonably related to the services performed and not based on the amount of loan business referred to a particular lender.

(Statement of Policy 1999-1, paragraph II.C.).

(3) Determinative test: relationship of services to total compensation. In its 1999 Policy Statement, HUD cautioned that the IBAA letter responded to a program where a relatively small fee was to be provided for limited services by lenders that were brokering loans. Accordingly, the formulation in the IBAA letter of the number of origination services which may be required to be performed for compensation is not dispositive in analyzing more costly mortgage broker transactions where more comprehensive services are provided [than in the IBAA scenario]. The determinative test under RESPA is the relationship of the services, goods or facilities furnished to the total compensation received by the broker.

(Statement of Policy 1999-1, paragraph II.C.; emphasis added).

b. Compensation must be reasonably related to value of goods, facilities, or services

In its 1999 Policy Statement, HUD wrote:

In analyzing whether a particular payment or fee bears a reasonable relationship to the value of the goods or facilities actually furnished or services actually performed, HUD believes that payments must be commensurate with that amount normally charged for similar services, goods or facilities. This analysis requires careful consideration of fees paid in relation to price structures and practices in similar transactions and in similar markets. If the payment or a portion thereof bears no reasonable relationship to the market value of the goods, facilities or services provided, the excess over the market rate may be used as evidence of a compensated referral or an unearned fee in violation of Section 8(a) or (b) of RESPA. (See 24 CFR 3500.14(g)(2).)

The consumer is ultimately purchasing the total loan and is ultimately paying for all the services needed to create the loan. All compensation to the broker either is paid by the borrower in the form of fees or points, directly or by addition to principal, or is derived from the interest rate of the loan paid by the borrower. Accordingly, in analyzing whether lender payments to mortgage brokers comport with the requirements of Section 8 of RESPA, HUD believes that the totality of the compensation to the mortgage broker for the loan must be examined. For example, if the lender pays the mortgage broker $600 and the borrower pays the mortgage broker $500, the total compensation of $1,100 would be examined to determine whether it is reasonably related to the goods or facilities actually furnished or services actually performed by the broker.

Therefore, in applying this test, HUD believes that total compensation should be scrutinized to assure that it is reasonably related to goods, facilities, or services furnished or performed to determine whether total compensation is legal under RESPA. Total compensation to a broker includes direct origination and other fees paid by the borrower, indirect fees, including those that are derived from the interest rate paid by the borrower, or a combination of some or all. All payments, including payments based upon a percentage of the loan amount, are subject to the reasonableness test defined above. In applying this test, the Department considers that higher interest rates alone cannot justify higher total fees to mortgage brokers. All fees will be scrutinized as part of total compensation to determine that total compensation is reasonably related to the goods or facilities actually furnished or services actually performed.

In so-called "no-cost" loans, borrowers accept a higher interest rate in order to reduce direct fees, and the absence of direct payments to the mortgage broker is made up by higher indirect fees (e.g., yield spread premiums). Higher indirect fees in such arrangements are legal if, and only if, the total compensation is reasonably related to the goods or facilities actually furnished or services actually performed.

In determining whether the compensation paid to a mortgage broker is reasonably related to the goods or facilities actually furnished or services actually performed, HUD will consider all compensation, including any volume-based compensation. In this analysis, there may be no payments merely for referrals of business under Section 8 of RESPA. (See 24 CFR 3500.14.)

Under HUD's rules, when a person in a position to refer settlement service business receives a payment for providing additional settlement services as part of the transaction, such payment must be for services that are actual, necessary and distinct from the primary services provided by the person. (24 CFR 3500.14(g)(3).) While mortgage brokers may receive part of their compensation from a lender, where the lender payment duplicates direct compensation paid by the borrower for goods or facilities actually furnished or services actually performed, Section 8 is violated. In light of the fact that the borrower and the lender may both contribute to some items, HUD believes that it is best to evaluate seemingly duplicative fees by analyzing total compensation under the reasonableness test described above.

(Statement of Policy 1999-1, paragraph II.D.).