In landmark decisions that could end a long-standing legal controversy in the home mortgage market, a federal appellate court has thrown out three major class action suits over "yield spread premiums" paid by lenders to mortgage brokers.

Yield-spread premiums are payments made by a lender to a broker in exchange for the broker delivering a mortgage carrying a rate higher than the "par" rate offered by the lender. Sometimes the higher note rate is understood and agreed to by the home buyer as part of an arrangement to lower closing costs, as in so-called "zero-cost" loan transactions.

But in other instances, home buyers or refinancers are unaware that their broker is pocketing extra money for convincing them to accept the higher rate. In dozens of cases filed in federal courts over the past two years, class action attorneys charged lenders across the country with violations of federal law over the yield-spread premiums they paid to brokers. Most of the cases alleged that the payments represented illegal kickbacks with no additional services rendered to borrowers. Mortgage banking industry experts have estimated the aggregate exposure of lenders in these cases to be in excess of $100 billion, in the event courts sided with the consumer plaintiffs in every decision.

Last week (September 18) the 11th U.S. Circuit Court of Appeals ruled in the industry’s favor in cases involving First Union Mortgage Corp., BankAmerica Corp. and Irwin Mortgage Corp. All the rulings embraced the U.S. Department of Housing and Urban Development’s (HUD’s) October 2001 "Statement of Policy" on yield-spread premiums as the key legal guidance for courts dealing with the subject. The decisions also said federal courts in general should give "deference" to HUD’s views on the subject as carrying the full force of law.

In its 2001 policy statement, HUD said that yield-spread premiums are not illegal referral fees per se. Instead, said HUD, courts must examine each loan transaction individually to determine whether goods and services were provided by the broker to justify the fee. Then the courts must evaluate whether the "total compensation paid to the broker is reasonably related" to the total value of the goods or services provided.

The tests set up by HUD requiring individual analyses effectively preclude certification of mass class action complaints, which require common sets of facts applicable to all members of the class. HUD’s policy allows individual borrowers to sue lenders or brokers in connection with yield-spread fees. But class action trial attorneys, who usually work on a contingency-fee basis, are not likely to pursue their cases.

Plaintiffs in the 11th circuit cases and elsewhere have asked courts to ignore HUD’s 2001 policy statement. But last week’s decisions represent a huge setback for them. Courts in other judicial circuits around the country are now likely to cite the 11th circuit decisions as precedent, and deny or reverse other class action certifications on yield-spread premiums.

In Heimmermann v. First Union Mortgage Corp., the 11th circuit appellate court put it bluntly: "We...conclude hat the rule announced (by HUD in 2001) can, in effect, overrule" the holdings of earlier district court decisions certifying class action. The most prominent of these is known as Culpepper v. Irwin Mortgage Corp.

Lawyers representing bankers cheered the decisions by the 11th circuit last week. Michael J. Agoglia of Morrison & Foerster in San Francisco, a leading attorney representing lenders in yield-spread class action defenses, called them a "sword in the heart" of the opposition.. Consumer representatives, on the other hand, said the rulings will make it more difficult to protect unsuspecting home buyers and refinancers--especially seniors and minorities--from being charged excess fees and rates.

Published: September 23, 2002

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consmer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.