As a result of the Dodd-Frank bill the following procedure was instituted to replace an old procedure under the auspices of consumer protection. The old procedure definitely needed some revisions because it gave incentives to lenders for charging a higher rate. This practice led to abuse by some lenders by rewarding them for offering the mortgage that paid the most yield spread to the lender and not what was in the consumer’s best interest.
The new practice eliminates most of this procedure and requires each lender to choose how much they will make, as a percentage of the loan amount on every transaction in advance. This “profit” is factored in as part of the rate you are quoted essentially replacing the loan origination fee and some of the other “junk” fees that lenders used to charge.
Sounds like a good plan and in general, it is, with a couple very glaring exceptions. The lender can no longer lay three different rates in front of you and let you offset most or all of your closing costs by choosing a slightly higher rate. If you know you are not staying in a home for more than a couple of years, it may be better to have a slightly higher rate and less out of pocket whereas if you plan to stay long term, rate may be more important than upfront cost.
In the event that the lender receives more than the quoted “profit”, because of the difference in rates at the time they were quoted versus the time the loan was actually locked, the lender has basically two options. They can pass the credit on to the borrower at the time of disclosure only or in what seems to be the most un-American thing ever, they can place the unused funds in a reserve account. This account, commonly referred to as a “flex” account, can be used for any OTHER borrower the lender chooses. It can also be used for the original borrower if they incur unexpected charges such as a relock fee or an appraisal review fee but not in a dollar for dollar fashion and at the discretion of the fund manager. In fairness, this fund is closely monitored, but it still allows the lender to give a very sweet deal to a borrower of their choice at the expense of other borrowers. The fund cannot be converted to “profit” for the lender but it would seem easy enough to build in profit on another loan and then credit from the “flex” account to essentially convert the “flex” account into profit. Although I have ranted before about clauses in this bill, such as paying more for an appraisal now and getting less service because almost half of the appraisal fee now goes to a mandated appraisal management company, this seems especially unfair and prone to abuse. Funds generated from your loan, going to assist another borrower without your knowledge or consent. UN-AMERICAN!