RESPA— the Real Estate Settlement Procedures Act— assures transparency during real estate settlements. As a federal law, it prevents predatory settlements, mandating that mortgage lenders, brokers and other loan servicers offer full transparency to borrowers, avoid kickbacks and excessive referral fees and set escrow account guidelines.
Some of the significant provisions of the law include:
- RESPA affects all parties involved in residential real estate sales. It applies to transactions involving one to four family units financed with a federal mortgage loan. People subject to the law include homeowners, business entrepreneurs, mortgage brokers, bank loan originators, builders and developers, title firms, home warranty providers, lawyers, real estate brokers and agents.
- RESPA’s goal is to prevent “bait-and-switch" settlement tactics, including kickbacks, veiled costs, excessive referral and service fees and unfair escrow policies.
- You can find the law’s full text in Title 12, Chapter 27, of the United States Code, 12 U.S.C. §§ 2601-2617.
- RESPA mandates disclosures at four points in the settlement transaction, starting with the loan application.
- Law violators are subject to fines and penalties, potentially including imprisonment in severe cases.
- The law allows exceptions to encourage collaboration between real estate agents and brokers and related service firms, including those that do cooperative marketing.
Congress passed RESPA in 1974. The law entered the books in June 1975. Since then, Congress has modified the law, creating confusion in the industry about how it currently works. For example, the law originally fell under the purview of the Department of Housing and Urban Development (HUD). However, in 2011, Congress passed the Dodd-Frank Act. As a result, enforcement power moved to the new Consumer Financial Protection Bureau (CFPB). Today, RESPA applies to all loans or settlements involving residential real estate of one to four family units only.
Lenders must make settlement disclosures and provide related documents to borrowers at four stages of the home-buying or -selling transaction:
At loan application– When a potential borrower asks for a mortgage application, the loan originator must provide a Special Information Booklet at the time of application or within three days. The loan provider must provide the booklet to borrowers in all transactions except for refinancing, subordinate liens or reverse mortgages. The booklet should include the following items:
- Overview and details of closing costs
- Explanation of the RESPA settlement form and a sample form
- Overview and details of escrow accounts
- Explanation of the settlement providers’ borrowers may select
- Discussion of abusive practices borrowers may experience during the settlement transaction
Loan companies must also give borrowers a Good Faith Estimate (GFE) form. This document should display the total costs a borrower will face after the loan goes through. The GFE must contain the following items, among others:
- Origination fees, including application and processing costs
- Cost estimates for appraisals, attorney services, credit reports, surveys or flood certificates
- Title search and insurance premiums
- Accrued interest
- Deposits into escrow accounts
- Insurance costs
Loan companies must also give borrowers a Mortgaging Service Disclosure Statement. This document details whether the lender plans to service the loan or transfer it to another entity. The document must also offer guidance on complaint filing.
Before settlement– Lenders must provide the following information before closing:
- Affiliated Business Arrangement (ABA) form– It must inform the borrower if a broker or real estate agent has a financial interest in any firm (for example, a mortgage financer or title insurance provider) to whom it has referred a borrower. Note: RESPA restricts lenders from requiring borrowers to use a specific provider, with some exceptions.
- HUD-1 Settlement Statement– Lists fees borrower and seller must pay at closing.
At Settlement– Lenders must give borrowers the following items at the closing:
- HUD-1 Settlement Statement– This includes precise settlement costs.
- Initial Escrow Statement– This shows estimated insurance costs, taxes and other charges the escrow account must pay during the first year, in addition to the monthly escrow payment.
After Settlement– Lenders must give the following items to borrows after the closing:
- Annual Escrow Statement– It must summarize payments, escrow shortages or surpluses and actions required, including the outstanding balance. The loan provider must provide this form to the borrower annually for as long as the loan continues.
- Servicing Transfer Statement– A required document when a lender sells, transfers or reassigns a borrower’s loan to another service provider.
All real estate professionals and lenders should understand RESPA rules and regulations. Violating the law may result in penalties and even jail time, depending on the severity of the transgression. In 2019, CFPB increased penalties for RESPA lawbreakers, further stressing the need to stay up to date about the law. Real-world RESPA hot spots include:
Providing Gifts for Referrals– Section 8 prohibits real estate agents or brokers from giving or receiving fees, kickbacks or items of “value” in return for referrals. Examples of this violation include:
- Entering customers who provide referrals into a giveaway contest
- Trading or accepting marketing services in exchange for referrals
- A broker accepting an all-expenses-paid vacation from a title firm representative
- A broker hosting periodic meals or social events for agents to solicit referrals
Inflating or Splitting Fees– Section 8 also outlaws adding fees for no reason or inflating the cost of standard items. Loan providers can only charge fees when they complete and document actual work. Moreover, costs must be appropriate and consistent with fair market value. For example, billing an administrative service fee for a standard broker package is not legal under Section 8.
Inflating Standard Service Costs– In addition to making fee splitting and markups illegal, RESPA forbids raising standard service fees. Loan providers must only charge borrowers the actual costs for third-party services. Adding an extra amount to boost profit margins is illegal.
Using Shell Entities to Obscure Funds– Loan companies may create shell companies (those with no office or employees) to manage another company’s money, assets or transactions. However, directing payments through a shell company violates RESPA’s anti-kickback provisions. A real estate company that uses shell accounts to charge borrowers more violates RESPA.
Exceptions and Allowed Activities
Referral arrangements are possible under certain conditions. These include:
- Promotional and educational opportunities– Service providers may attend events to promote their firms. However, they must only be there to promote their own companies and use clearly labeled marketing tools.
- Actual goods and services provided– Firms must pay only a fair market value for goods and services. For example, a real estate company must only rent conference rooms to brokers for the standard cost. Overpayment might be a kickback under RESPA.
- Affiliated business arrangements– Services that are disclosed correctly during the settlement process won’t violate the law.
- Shared marketing– Service providers can share marketing costs, as long as they are split fairly between parties.
Remaining in RESPA compliance takes time and effort. Making mistakes in good faith won’t necessarily prevent you from getting in legal hot water. A better approach: Thoroughly familiarize yourself with the letter of the law. If you need clarification of what a provision means, get legal advice. Good luck!