Naples Daily News August 8, 2004
Raymond Bowie: RESPA: Silent partner to home buyers and sellers

By RAYMOND J. BOWIE, Special to the Daily News
August 8, 2004

Home buyers and sellers have a "silent partner" accompanying them in most real estate transactions, but he's so silent, they seldom know he is there. Buyers and sellers who do recognize him, however, have a powerful ally on their side in securing independent, lower-cost settlement services.

This silent partner's name is RESPA, an acronym for a federal law known as the Real Estate Settlement Procedures Act. RESPA governs how settlement services are provided to buyers and sellers in the 87 percent of all residential real estate transactions financed with "federally-related mortgages." Passed by Congress in 1974, the idea behind RESPA is that buyers and sellers should be free to choose their own settlement service providers - such as real estate brokers, lenders, attorneys, inspectors, closing and title agents - without being improperly influenced by other settlement service providers.

RESPA is very broad as to the types of activities it covers, specifically including real estate brokerage, all aspects of mortgage lending, mortgage brokerage, title and closing services, attorney's services, credit reports, appraisals, property inspections, property insurance, surveys, and any other services a buyer or seller is required to pay for in a residential real estate closing. RESPA calls all these activities "settlement services," and the parties who perform these services are called "settlement service providers."

The abuse targeted by RESPA is compensated referrals, which occur when a buyer or seller is referred by one settlement service provider to another provider who pays the first provider for the referral.

RESPA prohibits compensated referrals on grounds that they may limit competition, drive up the cost of settlement services, and restrict the right of buyers and sellers to choose providers best representing their own interests. For example, if the seller's real estate broker is paid a referral fee by a title company to steer the buyer there for his closing, other closing agents may not be able to compete for that buyer's business; the buyer may wind up paying higher closing fees to cover the cost of the title company's paying a referral fee to the broker; and the title company may owe greater loyalties to the seller or his broker than to the buyer.

RESPA covers the vast majority of the nation's residential real estate closings. It applies to all closings on residential properties of up to four family units financed by a "federally related mortgage" - defined as any mortgage made by a lender regulated by or insured by the federal government, or sold or serviced on the secondary mortgage market to institutions like "Fannie Mae" or "Freddie Mac". Included are construction loans if the loan is to be converted to permanent financing, or if the loan finances the purchase of a new home by the initial buyer.

As a general proposition, RESPA is violated by any of the following types of schemes: First, any time one settlement service provider requires a buyer or seller to pay for and use the services of another provider; second, any time one provider gives or receives a kickback or any "thing of value" from another provider as part of an agreement to refer settlement business; and third, where any settlement service provider pays unearned or excessive fees to another provider who does not provide actual, fairly valued services.

RESPA also bans home sellers from requiring buyers to buy their title insurance from any particular title company or to pay the seller for providing title insurance to the buyer. It is allowable for the seller to pick the title insurer only if the seller, rather than the buyer, pays for the buyer's title insurance policy without passing the cost on to the buyer. While for many reasons it is not a wise practice, it is, in fact, customary in many areas of the country, including in some parts of Florida, for the seller to pay for and provide the title insurance to the buyer - a practice entirely legal under RESPA.

Problems may, however, arise under RESPA with certain closing practices prevalent in new home sales contracts used by many builders. In the Naples area, many builders require in their sales contracts that new home buyers must use the builder's attorney or title company for their closing and pay a "closing fee" - usually equal to 1.5 percent of the property's sales price - for the closing services and title insurance provided to the buyer. This builder contract clause may be subject to challenge under RESPA if the buyer is getting a federally-related mortgage to finance the home's purchase.

In that situation, the builder will likely be violating RESPA if he charges the buyer a fee tied directly or indirectly to the required use of the builder's designated closing agent, or if the builder otherwise either rewards the buyer for using the builder's title insurer or penalizes the buyer for choosing another title insurer. In the case of such a violation, the buyer may recover from the builder a civil penalty under RESPA equal to an amount three times all the title insurance charges paid by the buyer. Further, title insurers who kickback anything of value to a builder or other home seller in exchange for requiring a buyer's use of their title services may incur RESPA's criminal penalties of a $10,000 fine per incident and imprisonment for up to one year.

Buyers aware of their rights under RESPA may, if they are getting a mortgage, use the law's clout to negotiate with builders to delete the "closing fee/required use" clauses from new home sales contracts. Doing so allows the buyer to preserve the important prerogative to select his own closing agent and title insurer to represent him in the purchase of new construction.

In recent years, RESPA's blanket prohibition on compensated referrals has been somewhat loosened by regulations of the U.S. Department of Housing and Urban Development (HUD), the agency that administers RESPA. These liberalized HUD regulations came about as a result of lobbying by Realtor and mortgage industry groups seeking to offer various different settlement services to the customers in a single package, a movement called "one-stop shopping."

Increasingly, buyers and sellers may now encounter real estate brokers, mortgage lenders and title insurance companies offering "affiliated business arrangements" with other settlement service providers to whom buyers and sellers are referred and for which compensation is paid. Under HUD regulations, these arrangements are lawful provided certain strict requirements are met.

First, the compensation paid by one service provider to the other cannot be based on the amount of referrals made or the dollar volume of the referrals. Rather, the first provider is required to have a bona fide ownership interest - called an "affiliate relationship" - in the second provider receiving the referral. Any profits paid to the first provider must only be in the form of a return on the first provider's ownership interest in the second provider, proportionate to the first provider's actual investment in the second.

Second, the settlement provider receiving referrals from an affiliated provider cannot be a sham operation totally run by and dependent upon business from its affiliate. A proper affiliated business must be independently capitalized, staffed and operated, and actually itself perform the settlement services for which it charges.

And lastly, any buyer or seller referred by any settlement service provider to an affiliate must receive a written "affiliated business arrangement disclosure." This disclosure must inform the buyer or seller of the nature of the affiliation between the providers and the shared ownership interests, an estimate of the referred provider's charges, and notice that the buyer or seller is not required to use the services of the referred provider and is free to choose another provider.

Affiliated business arrangements are becoming ever more prevalent. Real estate brokers are regularly setting up mortgage and title insurance affiliates, and sometimes property insurance, home inspection, and home services affiliates as well. Many mortgage companies have title agency affiliations. And the Financial Services Modernization Act allows commercial banks to own title agencies and insurance agencies as bank subsidiaries.

For this reason, buyers and sellers need to take seriously the notice as to their rights provided in any affiliated business arrangement disclosure they receive. They should indeed shop around and compare prices between the referred settlement service provider and other providers.

And a buyer or seller should always ask whether a settlement service provider affiliated with another entity is truly going to be representing him best as his agent or fiduciary.

RESPA is intricately involved in almost all residential real estate transactions financed by institutional lenders, from contract to closing. As a silent partner, this federal law sits, usually quietly and unnoticed, at the closing table next to every buyer and seller in such transactions, protecting their rights to choose their own settlement service providers, hopefully at lower cost and with better service than if someone else did the choosing.

Raymond J. Bowie is a Naples area attorney and civil-law notary, board certified in real estate law, who has practiced law for 24 years in Florida, Virginia and New York, specializing in real estate transactions, representing buyers and sellers in contracts, closings, title insurance, tax-deferred exchanges, land trusts and financing. He is also a licensed real estate broker, mortgage broker, association manager and real estate instructor. Bowie invites real estate-related questions or suggestions for columns to be addressed to him, c/o Real Estate Editor, Naples Daily News, 1075 Central Avenue, Naples, Fla. 34102.