License to deal: Industry regulations pertaining to mortgage brokers

Mortgage brokers have been the primary points of interaction between customers and the mortgage industry during the last 25 years. There have been allegations against certain brokers of fraud, forging loan documentation, and misrepresenting the interests of their customers. The efficiency of the existing industry regulation is called into question by the claims. Although licensing might be a means of addressing these quality-related problems, this type of regulation can unintentionally raise costs or limit market access, especially for groups who are already at a disadvantage. This article looks at the benefits and drawbacks of licensing, outlines other regulatory strategies, and offers cautious suggestions as it waits for more research.

The evolution of the industry and the emergence of mortgage brokers

The mortgage sector shifted from federally regulated banks and savings and loans to more specialized venues in the 1980s due to interest rate instability, significant bank failures, and breakthroughs in the capital market and information technology. Currently, third-party mortgage brokers handle around two thirds of all mortgage loan transactions. They link customers to mortgage banks’ products and give them the information they need to complete the application process. Upon approval and funding of an application, the mortgage bank takes on full responsibility for the transaction. In addition to selling the mortgage to a securitizer—a company that purchases mortgages from mortgage banks, bundles them, and offers them as securities to investors—the mortgage bank may choose to provide direct loan servicing or transfer servicing.1./ 2.

Significant advantages have been linked to this industrial shift. Between 1993 and 2001, the rise in house purchase loans to low-income borrowers was 80.4 percent, whereas the growth in home purchase lending as a whole was much lower at 48 percent. According to some study, mortgage brokers explicitly assist clients in obtaining better loan conditions.3/ The market became more flexible and therefore complex as a result of the industry’s increasing sophistication, particularly in the form of subprime mortgages. Many previously rejected high-risk candidates found the extra freedom to be quite helpful.

The rationale behind regulation

Regrettably, dishonest mortgage brokers now have more opportunities to take advantage of clients due to the increased complexity of the mortgage market. The mortgage broker benefits financially from this practice, known as “predatory lending,” while the borrower frequently suffers grave repercussions. Predatory lending is thought to cost $9 billion annually,4 which raises the possibility that more stringent regulation or other forms of governmental intervention may be required. Occupational licensing is one increasingly common regulation strategy that may have both favorable and unfavorable consequences on consumers. (For further information on the rise of occupational licensing, see the sidebar below.)

Benefits and drawbacks of licensing

Occupational licensing might help customers by enhancing the standard of the mortgage broker sector through ease of enforcement, gatekeeping, and behavioral modifications. By filtering out incompetents and deterring impatient scammers, forcing mortgage brokers to pay fees, finish educational programs, and pass licensing exams helps keep certain undesirable components out of the business. This practice is known as “gate keeping.” Moreover, licensing may alter the conduct of individuals who do decide to work in the field. Formal rules of conduct or mandatory instructional programs may encourage or empower brokers to act in a more morally upright manner. Lastly, standards of behavior and licensing may facilitate enforcement. Licensing boards would investigate complaints and revoke licenses through their own processes, as opposed to using the legal system for prosecution. Theoretically, licensing offers a rapid, simple, and cost-effective means of discouraging undesirable actors from operating./5

But the same steps used to raise quality may also result in higher costs, which tend to lessen industry competitiveness. It’s conceivable that customers will pay more as a result of these increases in costs. The whole cost of a business’s licensing and broker education may go up rapidly in places where the loan originators and the firm must be licensed. In Wisconsin, for instance, the cost of a license and exam is $400 per person.7/ The expenses of continuing education are also high; a course on exam preparation with a textbook can go up to $430.8/ The company may pay the same fees to each broker many times if it operates in different states. The supply of brokers may be reduced by these expenses, causing some businesses to lay off employees or shut. The entry barriers into the field may be particularly high for low-income persons looking to start small brokerage businesses.

Policymakers must carefully weigh the costs of entrance restrictions and reduced competition against the possible quality advantages when drafting public policy on occupational licensing. A difficult balance may need to be struck because there hasn’t been much of an apparent impact of occupational licensing on objective quality outcomes in a number of occupations.9/

Two important queries

Apart from examining the crucial cost-benefit ratio, legislators who are contemplating an occupational licensing program for mortgage brokers also need to tackle two crucial and pragmatic queries: that needs to be licensed, the company alone or all of the loan originators that work for the company? And which tier of government has the means to administer the licensing?

State rules differ with respect to who should be licensed.10/ Only 28 states have granted the company a license. This policy’s general justification is that businesses can be held accountable for the deeds of persons inside their own ranks, hence businesses will use internal rules and guidelines that abide by local, state, and federal laws to police their workforce. Additionally, businesses are wealthier and less mobile than individuals, which makes it simpler to enforce license revocation and pursue damages when needed. Apart from formal licensing, several of these 28 states impose extra requirements on employment brokers, such independent contractor license, registration, or ongoing education. Further, eighteen states license brokerage businesses as well as the individual brokers they hire.11/ 12/ In theory, this strategy keeps dishonest people from switching to other companies.

In response to the second important query, states already enforce licensing laws. However, there are sporadic proposals for federal law. Federal licensing might streamline rules and reduce cost increases by enforcing uniformity, as many major businesses operate in numerous states and are subject to a variety of restrictions that raise their business expenses. But the notion of uniformity enforced by the federal government begs the question of whether states would be able to modify rules and licensing requirements to suit their own needs. A coalition of state regulators is aiming for a nationwide cooperative licensing system that would encourage efficiency and make it simpler to detect and penalize fraudulent activity in the mortgage business, striking a balance between the advantages of uniformity and state creativity. (For further details, see the sidebar below.)