Legislative Committee Real Estate Finance (information only)
This material is for discussion purposes only and has not been approved by the Legislative Committee, Real Estate Finance Committee, Executive Committee or the Board of Directors
Issue: Should C.A.R. sponsor a change in the regulation of mortgage loan brokers?
Options: 1. Sponsor or support legislation to create a separate license for mortgage loan origination and brokerage; in a regulator other than DRE (most likely Department of Corporations);
2. Sponsor or support legislation to create an additional level of license, or a license endorsement, that would be required to engage in mortgage activity;
3. Prohibit a real estate licensee from acting as both the mortgage broker and sales agent in a single transaction.
4. Sponsor or support increased regulation of lending-related functions within the existing license structure.
5. Do Nothing. Continue to resist any change to the existing license and continue to collaborate with mortgage broker groups to create private sector certification or other recognition for “mortgage originators” or mortgage brokers.
Status/Summary: As the lending function has become increasingly complicated, and increasingly the subject of disputes, calls for more supervision or separation of the lending function from the restof real estate license have increased. Legislative pressure for reform continues to increase, aggravated by fears of increased defaults among non-traditional mortgages. SB 385 will empower DRE to regulate licensees making “non-traditional” loans. C.A.R. has usually resisted any specialization or "compartmentalization" of the very broad authority of the real estate license, but has not resisted "functional" regulation that did not seem to be heading toward a special license.
C.A.R. has historically had a strong policy position in favor of a single real estate license, and opposed attempts to create internal specializations within the license. C.A.R. has beenconcerned that if one area of “specialty licensing” is accepted, other specialty practitioners (e.g. property managers, commercial sales, new homes, re-sales etc.) will follow. C.A.R. has instead supported private sector certifications or endorsements like GRI (Graduate of the Real Estate Institute) or membership in an affiliate organization.
California is nearly unique in that almost every other state requires mortgage brokers to obtain aseparate license – only Alabama exempts real estate brokers from the mortgage broker license requirement that would otherwise apply. In many states the license requirements are not burdensome, but the activity is not within the scope of the real estate license.
Mortgage brokerage has created considerable debate about its function within the real estate license. Most recently, concerns have been raised in two main areas:
First, licensees that attempt to handle both the mortgage portion of a transaction and the sale portion of the transaction are accused of fouling up one portion or the other, or of "poaching" on another licensee's client relationship or legitimate role in the transaction. Examples often involve a lender attempting to use loan pre-qualification to continue to control a client relationship or attempting to exact unearned commissions in an out of area transaction.
Second, legislators and regulators voice concern that there has not been sufficient supervision or regulation of mortgage brokers who have arranged many of the non-traditional loans (e.g. "option ARMs") that are expected to contribute to rising delinquency rates in the near future. Indeed, Department of Real Estate claims not to be able to tell even which of its 530,000 licensees are in the business, and cannot regulate their underwriting (as opposed to brokerage) practices. SB 385 contains language responding to DRE by clarifying that the department has authority over the “making” of loans as well as brokerage, and allowing it to require licensees to report if they go “into the business” of lending their own funds.Exploring Possible Responses
1. Sponsor or support legislation to create a separate license for mortgage origination and brokerage. This option would involve the creation ofa new license with the same mortgage-related authority as currently exists within the real estate license. The license would be regulated within Department of Corporations (DOC), which now regulates Residential Mortgage Lenders (RMLs) and Finance Lenders (CFLs). The proposal would effectively transplant the mortgage brokerage function out of DRE and into DOC. If a real estate firm wished to handle mortgage activities, even on its own transactions, it could seek a DOClicense for a mortgage company as is currently done with independent escrow companies.
This option would require a change in the scope of practice of the real estate license, but not create a specialty license. Mortgage broker/mortgage banker groups may be divided on this approach - all of them like the idea of a separation from other licensees, they may not all like separation from DRE. Should this function be moved to the other regulator (DOC)?
A brief survey of other states reveals that only two other states do not have separate regulation of mortgage loan brokers. One state (Alaska) does not regulate the function at all; the other (Arkansas) hasthe regulation within their real estate license like California.
2. Sponsor or support legislation to create an additional level of license or license endorsement that would be required to engage in mortgage activity. This option would change the scope of the general real estate license and require additional education, audit costs and other regulation within DRE. This option would create an "add on" license option within DRE, but it is unclear how much additional education or cost would be required. Does it make sense to require mortgage originators to get a real estate broker's license before they can get a mortgage license? Should some provision be made to allow real estate brokers to facilitate the buying and selling of notes by private investors or in situations where the notes are not originated by the broker or are not related to purchase money?
This approach is directly contrary to historic policy against specialization, but is not a great extension of the special rules that already apply to "threshold" brokers under Business and Professions 10232(b). It is similar to past proposals from some mortgage broker groups to create a "mortgage originator" license.
Should there be special license requirements for real estate licensees that engage in mortgage activities?
3. Prohibit a real estate licensee from acting as both the mortgage broker and sales agent in a single transaction. This option narrowly addresses two potential abuses:
- The situation in which a lender develops a relationship with a purchaser through pre-qualification and then attempts to leverage that relationship into a share of the sales transaction; and,
- The perceived conflict created by the loan originator’s obligation to ensure that the loan application is accurate and adequately underwritten, and his or her desire as the buyer’s agent to ensure that both borrower and property qualify, even though the agent may know additional relevant information.
Thisoption does not run afoul of specialty license concerns, but it does restrict agents’ access to multiple profit centers in a transaction. Do the concerns about the dual role merit the restriction? Should the same rule apply if the loan will occur through a separate entity such as a Department of Corporations licensed lender, even if the lender is under common ownership?
4. Sponsor or support increased regulation of lending-related functions within the existing license structure. Legislation that will clarify that DRE can regulate a real estate licensee’s loan underwriting practices (the making, as opposed to brokering, of a loan) is already moving in the Senate. This option would enable DRE to require licensees to notify the department when they engage in enough loans to be “in the business” of mortgages, and allow the department to focus additional resources on this higher risk segment of the industry. Unlike other lenders, mortgage brokers are not subject to regularly scheduled audits by the regulatory authority, and are not charged for costs of audit, even if a violation is found.
Should mortgage brokers be treated more like other lenders? Should all loan originators acting under the real estate license have to report to DRE? Under existing law (B&P 10232) only a limited number of “threshold” brokers report to DRE that theyare in the “business” and supply minimal information.
5. Do Nothing. Continue existing policy to resist any change to the existing license and continue to collaborate with mortgage broker groups to create private sector certification or other recognition for “mortgage originators” or mortgage brokers. Existing policy would not necessarily require opposition to increased enforcement, but would result in opposition to the creation of two (or more) classes of broker.
Historic Policy.C.A.R. has historically fought to preserve the flexibility of a licensee to shift between various functions (e.g. residential re-sale to mortgage finance to commercial investment) as markets change and as licensees’ preferences change. Perhaps the ultimate contrast to this flexibility is the Contractors State License Board that separately regulates an enormous number of specialty activities.
Preserving flexibility has been politically expensive. Over the years a great deal of attention has been focused upon mortgage brokers’ involvement in so-called predatory lending schemes. There has beenconcern voiced that C.A.R. has had to “carry the water” for a relatively small number of mortgage broker entities that could not otherwise defend themselves from onerous legislation or regulation. In the most recent C.A.R. internal poll, between 2 and 3 percent of members indicated that they were involved in mortgage brokerage. DRE estimates about twice that number with about 20,000 (out of about 530,000 total) licensees engaged in mortgage brokerage, although reporting isvoluntary.
Expense comes in real dollar costs as well. For example, DRE devotes about half of its audit resources to licensees active in mortgage brokerage, and this relatively small class of licensees reportedly accounts for about half of the payments out of the real estate recovery fund.
Should C.A.R. consider specialty recognition and/or enforcement within the real estate license for mortgage brokerage?
Mortgage Bankers and RMLs (Residential Mortgage Lenders).The RML is a relatively new license within the Department of Corporations for full-time lenders financing residential transactions. In the mid-1990s the California Mortgage Bankers Association was involved in a major confrontation with DRE and C.A.R. over the application of real estate license rules to mortgage bankers which are organized in a corporate format instead with individual licenses. The dispute was ultimately resolved by creating a new type of license within the Department of Corporations, and now most mortgage bankers have acquired such a license. While mortgage bankers loan “their own funds” to finance real estate transactions, they can engage in limited brokerage functions (under the same rules as a real estate broker) pursuant to the authority of the RML license.
It appears that most full time DRE licensed mortgage brokers areeither acting as the de facto loan origination sales force of a mortgage banker, or acting as a residential lender themselves but not large enough to meet the requirements for RML licensing.
Department of Corporations also licenses and regulates other types of corporate lenders (CFLs) and independent escrow companies.
Should C.A.R. consider legislatively moving the mortgage brokerage function into a new Department of Corporations license?
Should C.A.R. consider sponsoring legislation to separately license mortgage brokerage?