Federal Reserve bans lenders from paying bonuses to brokers for higher-interest-rate loans
It’s about time something like this took away these incentives which were often not disclosed to the borrowers. It is my humble opinion one of the major reason why we had the sub-prime and the Option ARM mess was primarily due to this practice: paying loan brokers a bonus for steering their clients into high risk loans which they knew would not benefit their clients. This was the classic case of agency going awry: the agent was looking out for his own interest to the detriment of his client. A serious conflict of interest.
My philosophy is simple: always know how people get paid to determine their motivation. My commission structure is written out in our listing contract; there is no room for undisclosed bonuses. My clients know exactly how I get paid, so they know my motivation from the start. Imagine if I got a huge bonus from the buyer’s lender if I chose their offer over another and steered my clients into accepting their offer, which was a less than favorable offer because I was influenced by said bonus. Would this be a conflict of interest and would the client have taken my advice if they knew of this secret bonus?
How did the Realtor Associations avoid this type of conflict of interest? By the use of the Agency Relationship Disclosure document(CAR form AD). This document laid out exactly the contractual obligation of the agent vis a vis his client. It states, I owe my sellers or my buyers (depending on whom I represent): “A Fiduciary duty of utmost care, integrity, honesty and loyalty in dealings with the Seller.” (or buyer, if I represent the buyer).
What does Fiduciary duty mean? According to dictionary.com fiduciary duty is:
“the legal duty of a fiduciary to act in the best interests of the beneficiary”
Best interest of the beneficiary, or my client. I have to put my client’s interest over my own. Hence, even if I were to be offered a secret bonus, I could not take said bonus if it would not be in the best interest of my client. Naturally, I could accept such a bonus if I revealed it to my client and they still thought said bonus would be in their best interest.
I am not saying all Realtors are angels, but because they had to sign these disclosures which contractually obligated them, it removed any temptations. The same can be said of loan brokers; I am not accusing all loan brokers of this despicable practice, I’m sure most didn’t engage in such practices. However, because there was no mandatory requirement for the use of such instrument as the Agency Relationship Disclosure, it made it tempting for those brokers who may have decided enriching themselves was more important than looking out for the best interests of their clients.
To control the practice of such steering, the Federal Reserve chose to simply remove the temptation by banning the practice of paying such bonuses all together. One way or another, the borrower’s best interest will now be better protected and that is a good thing.
