Question & Answer
Question: In our effort to review our entire loan portfolio for flood insurance compliance, we have identified a vendor who will certify our entire portfolio at a very low cost if we retain that vendor to conduct flood hazard searches for loan applications for the next four years. The certifications on future applications would be for the life of the loan and priced at $22.50. Our examiner told us that it would be a violation of RESPA. Is this correct, and if so, is there any legal way to negotiate a price savings on portfolio searches?
Answer: You have put your finger on a real problem. HUD is in the process of reviewing this issue and has hinted - strongly - that it believes that the agreement would violate RESPA.
The rationale for HUD's view is that the flood search is a referral of a settlement service. Arrangements such as you describe involve two steps that concern HUD. First, the low price on the portfolio review constitutes a thing of value. The bank, not the consumer, would get the benefit of the discounted service.
Second, future customers would be locked in to the specific service provider at the price set in the agreement between the bank and the vendor. Should prices fall, the consumer would be forced to pay above market rates for the service with no compensating benefit.
We believe that HUD would be over-reaching to take the position that such an arrangement is illegal. First, the position would be contrary to the views HUD published when issuing the final regulation in 1992. In that document, HUD emphasized that fees should be based on fair market value. Fees and services should be market based and fairly priced. The other core test is whether the customer gets value for the fee. For example, the customer should get prompt and accurate performance of the service. Using HUD's '92 rationale, the question should be: is there a market reason for this pricing structure. Ironically, it is another regulation, Flood, that creates that market reason.
Second, carried to its logical (or illogical) extreme, HUD's proposed position on pricing would make any contacts relating to settlement services illegal. Lenders would be forced to shop for settlement services for each loan as the loan was being processed to ensure that each customer gets fair market value.
The reality is that arrangements such as this can give all parties some value. In particular, both the consumer and the bank benefit from this pricing structure. These arrangements are not necessarily corrupt. After all, when you make business loans for products or services, you look for the existence of this kind of ongoing contract.
We are also concerned that the threatened HUD position ignores the legal requirement that banks monitor changes in flood zones and take steps to ensure that required flood insurance is maintained for the life of the loan. These regulatory requirements give the bank a strong business interest in identifying an accurate and cost-effective vendor to perform flood certification. Because potentially enormous liability can result from compliance failures, the bank should identify the best vendor to do the job. The bank must look to the future relationship because it is highly desirable that the vendor will stay in the flood certification business for the life of the loan.
HUD's expected position may actually be contrary to the purposes of RESPA. One of the statutory purposes is to protect consumers from high costs that result from arrangements and kickbacks that unfairly benefit parties to the process and directly or indirectly increase the cost paid by the customer. Ironically, one of the goals of this flood service agreement is to reduce costs. Since these are costs which the customer pays, keeping them down is desirable.
Tip: If you choose to use such an arrangement with a vendor, we recommend that you take several steps to protect yourself. These steps are designed to refute the concerns that would be raised under RESPA. First, keep the contract as open-ended as possible. Retain the bank's ability to terminate the contract for cause and for reasons which relate to the RESPA concerns. In particular, changes in service quality, and in the cost of services should be reasons that would enable the bank to cancel the contract.
Second, include in your agreement a provision that if the vendor's price for life of loan searches charged to any other lender drops below the price in your contract, the rate charged to the bank will be reduced to match that lowest price.
Finally, regularly obtain information about the price of your vendor's competitors and document this. You will need to be able to show that the service is at market rate, i.e. a fair price for the service performed and that there is no harm to the customer.
Copyright © 1996 Compliance Action. Originally appeared in Compliance Action, Vol. 1, No. 7, 4/96
First published on 04/01/1996