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Do brokers work for the buyer?

In a class action settlement with potential impact on borrowers in every state, a major mortgage company has agreed to refund to consumers undisclosed fees it paid loan brokers to bring in customers at higher than its standard rates.

The refunds and penalties, estimated at $2.25-million, will go to homeowners who allegedly were charged excessive rates and fees on their mortgages.

The case involves approximately 300 loans made in Virginia by Georgia-based Fleet Financial Inc. The settlement is particularly significant, legal experts say, because it focuses on a practice that has been widespread throughout the industry for years: the payment of "yield-spread premiums" or "overages" to brokers when borrowers lock in or sign contracts at rates or terms that exceed what the lender would otherwise be willing to deliver.

A broker delivering a loan at 9} percent and two points, for example, might receive a premium payment from a lender buying the loan if the prevailing rate in the market was 9\ percent and two points. A point is equal to 1 percent of the loan amount. Mortgage lenders and brokers confirm the existence of the practice and defend it vigorously as an integral part of the economics of their business.

The Fleet settlement also opens the door to further legal challenges to mortgage brokers on the grounds that they breach their fiduciary duties to customers when they pocket overages. Under some interpretations of common law, mortgage brokers could be construed as having the primary duty to their clients of obtaining the most favorable terms and rates available.

If a broker receives extra compensation from a lending institution for bringing in clients at higher than the best available rates, then those clients may have the right to sue, according to David Rubinstein, one of the lead counsels for the plaintiffs in the Fleet case. Rubinstein is executive director of the Virginia Poverty Law Center and member of a collaborative group of private sector and legal aid attorneys who filed the suit.

Leaders of the mortgage brokerage industry predict the Oct. 20 settlement could trigger a wave of suits in the coming months based on the fiduciary duty argument.

"I think it's a terrible outcome," said Michael J. Hoogendyk, a broker based in Phoenix and the immediate past executive vice president of the National Association of Mortgage Brokers.

"We should be able to operate at arm's length from either side and not owe (common law) fiduciary duties to either side."

The loans involved in the Fleet case were made to Virginia borrowers during the late 1980s and early 1990s. The borrowers generally had some minor problems in their credit histories and therefore were unlikely to obtain mortgage financing from local banks.

Instead they sought mortgage money through three Virginia-based mortgage brokerage firms that could access national lenders like Fleet, who specialize in "non-conforming" loans. The note rates on the mortgages were in the mid to upper teens, high in today's rate environment but not extreme for applicants with sub-par credit during that period of time.

What the suit attacked, however, were not only the rates but the undisclosed fees the local brokers were paid by Fleet for bringing in clients at these rates and terms.

For example, one couple borrowed $63,500 at 19{ percent and was charged a total of $6,399.74 in brokerage fees _ roughly 10 percent of the principal amount of the loan. Of those fees, $1,270 was disclosed to the borrowers as a brokerage charge, another $635 was disclosed as a "service fee," and $1,270 was listed as "discount points." The largest single piece of compensation, however, according to the suit, was an undisclosed $3,224 yield-spread premium paid to the broker for closing the deal at 19{ percent.

Other loans detailed in the class action suit carried total broker compensation of five and six times the amount of brokerage fees disclosed in federal truth-in-lending and settlement documents. One $29,000 loan carried an 18{ percent note rate but $4,293 in total payments to the broker, 15 percent of the mortgage amount. Part of the compensation was an undisclosed premium of $730 for selling the borrowers a mortgage credit life insurance policy.

What should consumers conclude from the Fleet class action settlement? Several points to keep in mind: First, under federal regulations issued in December 1992, mortgage brokers must disclose to borrowers rate premium fees and other compensation. Second, any borrower seeking mortgage financing should look hard at the fees and shop for the package of rates, fees and services that is most advantageous.

Finally, as lawyers on both sides of this issue admit, the jury is still out as to whether loan brokers owe fiduciary duties to you. Probably the most useful fact to keep in mind is that brokers themselves don't think that they have a fiduciary relationship with you. Most of them genuinely want to help you obtain financing, but they don't think of their connection with you as that of doctor to patient.