Under California law a mortgage broker has a fiduciary duty to a borrower. A mortgage lender does not. To many, this might seem one of those picky distinctions that is of little consequence in the real world. I don't know about the picky part, but, from a case decided earlier this year (Smith v. Home Loan Funding, California Second District Court of Appeal), we learn that the real world consequences can be pretty significant.

In 2006, Tonya Smith contacted Anthony Baden in response to an advertisement she had received from Home Loan Funding (HLF). Baden worked as a loan officer for HLF. Smith wanted to obtain a $40,000 home equity line of credit (HELOC) on her home that already was encumbered by a first and second mortgage. Smith told her he could "shop the loan", and, she said, she "believed he would provide her with the best loan."

Subsequently, Baden told Smith that he had shopped the loan and that she did not qualify for a HELOC because her credit scores were too low. Instead, he suggested that she refinance with a new first trust deed. Eventually she did this, and received from HLF a $700,000 first trust deed with a variable interest rate. The loan contained a margin of 3.85 percent over the indexed interest rate.

Later, at trial, an expert witness testified that "the commission available to HLF for the sale of the loan on the secondary market was greatly enhanced by the inclusion of both a prepayment penalty and a heavily marked-up margin." The expert testified that a 3.85 margin was "astronomical". "He said Smith would have qualified for a loan with a 2.2 percent margin without a prepayment penalty."

Smith sued Baden and HLF.

"The trial court found that Baden and HLF acted as loan brokers and breached their fiduciary duty to Smith. It found Baden misrepresented both the terms and the ultimate advisability of the loan" Among other things the court awarded damages based on the difference between the 3.85 margin contained in the loan and the margin for which Smith was qualified. "The court calculated the difference over the 30-year life of the loan as $252,000. The court discounted that amount to its present value of $72,187.17"

HLF appealed. It argued a variety of points, including the claim that "…the court cannot find it breached its contract to act as a mortgage broker when the loan documents themselves identify HLF as the lender." The court of appeal was decidedly unimpressed. "…that HLF ultimately persuaded Smith to accept one of its loans, hardly negates that HLF undertook to act as Smith's broker. Instead, it is evidence of HLF's and Baden's self-dealing at the expense of Smith."

Much -- though certainly not all -- of today's real estate debacle is a result of the fact that a multitude of mortgage brokers put their own interests considerably ahead of those of their borrowers. The case of Smith v. HLF is a pointed reminder that brokers who do that are not only unethical, but also they bear some considerable liability.

Published: August 16, 2011

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Bob Hunt is a former director of the National Association of Realtors and is author of the recently published book, "Real Estate the Ethical Way." A graduate of Princeton with a master's degree from UCLA in philosophy, Hunt has served as a U.S. Marine, Realtor association president in South Orange County, and director of the California Association of Realtors, and is an award-winning Realtor. Contact Bob at .