What is RESPA?
Once upon a time, even if you were fortunate enough to find your dream home and lock in a great mortgage rate, you still had to worry about one last detail: the very fairness of the transaction you were engaging in.
For many years, the rights of borrowers were discreetly trampled on by certain mortgage lenders whose transparency and truthfulness were less than 100%. In other words, because settlement laws were lax, manipulation was not uncommon in the industry. As a result, customers sometimes ended up with the short end of the stick, unsuspectingly paying more for some services and being steered toward unnecessary escrow payments, for example.
To level the playing field, regulators began proposing new laws. The Real Estate Settlement Procedures Act (RESPA) was one such piece of legislation designed to address these issues and protect borrowers.
In this article, we’ll dive into what RESPA is, why it was necessary and the best ways to ensure your mortgage lending experience is not only affordable, but professionally executed to the full letter of the law.
History of RESPA
While the housing market saw a huge boost in post-WW2 America with the creation of Fannie Mae, Freddie Mac and the modern mortgage system, as the decades clipped by and new lenders entered the arena, it became clear that some were more scrupulous than others. These practices were not necessarily overtly encouraged or endorsed, but within some lending environments this activity was allowed to persist—at the expense of the borrower.
Congress first passed the Truth in Lending Act (TILA) in 1968 as a way to mandate full disclosure around terms and conditions of mortgage agreements. It was a bold piece of legislation, a game-changer really, but for all its accolades it failed to address the full scope of the problem, namely the kickbacks and referral fees that often inflated the costs of mortgages.
In a determined effort to fully protect borrowers, the The Real Estate Settlement Procedures Act (RESPA) was signed into law in 1974 and activated on June 20, 1975. RESPA legislation pertains to all federally related mortgage loans* and was designed to cover the majority of mortgage purchase loans, assumptions,** refinances, property improvement loans, reverse mortgages and home equity lines of credit. In the subsequent decades, it’s been expanded and amended several times, but the primary mission has remained the same.
Key elements of RESPA
There were three core elements to the original RESPA legislation that were transformative in creating necessary transparency within the lending sector for federally related mortgage loans:
- Settlement disclosures: Lenders, mortgage brokers, or servicers of home loans would now be required to provide borrowers with relevant and timely disclosures regarding the nature and costs of the real estate settlement process.
- Kickbacks: For years, loan officers had been paying kickbacks as finder’s fees for identifying suitable mortgage applicants. This fee was often unwittingly passed on to the borrower.
- Escrow: Historically, many loan officers were asking borrowers to open premature or unnecessary escrow accounts, depriving them of much-needed cash reserves when they needed it most.
RESPA: Protection and education
It’s important to note that RESPA was enacted not just to regulate the industry and prevent banks and other lenders from pursuing unfair practices, but also to educate the consumer. Most borrowers had no idea what kinds of shenanigans were actually going on behind the scenes affecting closing costs and inflating their mortgage. RESPA changed all that; it threw into relief the illicit practice of certain lenders and simplified the mortgage process while providing transparency.
Part of this educational process was a mandate that all residential mortgage lenders would need to itemize charges so borrowers could clearly see every cost and every service. These disclosures were required for all aspects of the real estate transaction including settlement services, consumer protection laws and any other relevant information such as business connections between closing service agents and any other party connected to the settlement process. Shady business practices—such as undisclosed kickbacks— are a lot harder to get away with when everything is written down and borrowers have an opportunity to say to their loan officer, “Hey, what’s this charge?”
When we say “settlement service” or “settlement process” this merely means anything pertaining to the closing of the real estate transaction, including provision of a title certificate, title insurance, attorney services, property survey, home appraisal, loan origination fees and services related to mortgage processing. For a full list go to the CFPB website.
Escrow and title insurance
RESPA strictly regulates the use of escrow accounts. Pre-legislation, loan servicers often demanded that borrowers provide excessively large escrow accounts to ensure sufficient funds were on hand to pay homeowner’s insurance and relevant taxes. RESPA introduced fairness into the process. It also restricted sellers from requiring borrowers select particular title insurance companies.
What is TRID?
TRID, or TILA-RESPA Integrated Disclosures, is a set of government guidelines designed to help borrowers better understand their loan before they finalize their agreement. It’s also known as the “Know Before You Owe” disclosure rule. Like much of RESPA proper, it’s a reaction to unscrupulous activity by lenders and creates a common framework from which to analyze mortgage costs prior to the closing process. Key to TRID are the following two disclosures:
- Loan estimate: This is a document that carefully spells out all identifiable mortgage costs and loan terms including principal, interest rate, closing costs, APR and other mortgage features. These costs and terms should match what your mortgage provider has previously indicated, although as your selections change the loan estimate may change, too. In theory, this should put an end to any bait and switch practices or unidentified last-minute charges. The loan estimate also makes it easy to compare costs between different lenders, providing you with an opportunity to find the best deal available.
- Closing disclosure: This takes the loan estimate one step further, detailing all final agreed-upon costs you will be expected to pay as part of your mortgage or refinance. The closing disclosure should resemble the loan estimate; conduct a comparison between documents to be sure. While some charges may change as updated estimates become available (such as tax and insurance costs), you should not be seeing any new charges. If anything seems out of place, this is your opportunity to inquire with your loan officer to ensure full transparency.
Enforcement of RESPA was originally up to the Department of Housing and Urban Development (HUD) but due to the establishment of a new federal office in 2010, it moved under the jurisdiction of the Consumer Financial Protection Bureau (CFPB).
According to the CFPB, plaintiffs have up to one year to bring a lawsuit if they suspect illegal kickbacks or other improprieties during the settlement process. However, there are certain preliminary steps that must be executed before a suit can be filed:
- The borrower must contact their loan servicer in writing, detailing the nature of their issue. This is known as a qualified written request.
- The servicer (lender) is required to respond to the borrower’s complaint in writing within 20 business days of receipt of the complaint.
- The servicer has 60 business days to correct the issue or give a reason for the validity of the account's current status.
- During this time, borrowers should continue to make the required payments until the issue is resolved.
Depending on the severity of the violation, penalties can range from $96 to many thousands of dollars (topping off at $192,768). If you suspect you’re a victim of a RESPA violation, the first thing you need to do is find a reliable real estate lawyer who can navigate you through what can be a complex legal process. Parallel to this, you can file a complaint with the CFPB online and make them aware of the violation.
Although RESPA has been a powerful regulatory tool for over 45 years, it’s not a panacea for all industry ills and there are those who don’t think it goes far enough to protect consumers during the lending process. Take kickbacks, for example. Some critics maintain that lenders provide “captive insurance” to title insurance companies they work with. Their argument is that since most customers will automatically go with the service provider (title company) associated with the lender, the title insurance could be considered a form of kickback for the parent company.
Naturally, while there have been some proposals initiated to address these types of concerns (including making the lender liable for title insurance costs), many industry-leading lenders have simply prioritized clarity throughout the process. For example, mortgage companies that put a premium on transparency use explicit disclosures to detail any possible benefit they might receive if you choose their title services. They also make sure to clearly state that as a borrower you have many options when it comes to obtaining these services and that you are always free to explore the marketplace when looking for the best price.
Despite some criticism, the CFPB continues to look at ways to improve RESPA and protect consumers from any lender who is less than forthcoming or manipulative when it comes to settlement issues.
In a sense, all borrowers should be thankful that home mortgages are federally regulated. This designation has enabled potent legislation to be passed on the national level that has helped bring much-needed transparency to the borrowing process and put an end to deceptive business practices by mortgage lenders.
While many consider TILA the granddaddy of all mortgage legislation, RESPA is equally important. It not only puts a significant cost on transaction settlement violations, but it mandates a complete list of itemized disclosures so that borrowers understand both the services and the fees.
Lenders, too, should feel vindicated when RESPA is mentioned. Along with other key legislation, it provides mortgage professionals with a powerful blueprint to create transparency and provide today’s homebuyers with the reliability and fairness they deserve when shopping for a home.
*RESPA covers loans secured with a mortgage against 1-4 unit residential properties that are guaranteed by a government entity (i.e. Fannie Mae, Freddie Mac, USDA, VA, FHA, and other government entities).
**Assumptions are exempt unless the mortgage instruments require lender approval for the assumption and the lender approves the assumption.