The Real Estate Settlement Procedures Act (“RESPA”) is a series of federal consumer-protection statutes that impose rules upon all of the professions involved in an activity relating to a real estate settlement involving a federally related mortgage loan. The State of Colorado has adopted laws and regulations governing real estate brokers that impose similar rules.
The intent behind these laws is to protect consumers by prohibiting certain abusive practices (e.g. “kickbacks” and “unearned fees”) and by requiring settlement service providers to create transparency through the disclosure of “affiliated business arrangements.” Ultimately, the effect of these laws is to reduce the cost of settlement services by providing full information to consumers and by prohibiting service providers from improperly influencing consumers’ selections.
The purpose of this article is to give readers – especially Colorado real estate brokers – a fundamental understanding of RESPA and two of its most important provisions. As with remedial level coursework, the point of this article is to provide only an introduction to the basic components of RESPA that are most likely impact settlement service providers involved in real estate transactions.
RESPA Rules, Broken Down
I. The Anti-Kickback and Unearned Fee Rules
Section 8 of RESPA prohibits giving or accepting unearned fees as well as kickbacks pursuant to referral agreements in any transaction involving a federally related mortgage loan. In simplified terms, these rules make it unlawful to give or accept any “thing of value” (e.g. a referral fee) where the following elements are met:
- A. The real estate transaction involves a federally related mortgage loan, and
- B. A referral fee is paid as part of an agreement for the referral of business involving a settlement service; or
- C. The payment of an unearned fee is made.
Keep in mind that this seemingly simple rule may become quite complicated when applied in a real-life situation. Regulatory agencies (e.g. the Colorado Real Estate Commission, the Consumer Financial Protection Bureau, etcetera) can be aggressive when interpreting the rules or seeking their application. As a result, readers should exercise caution before concluding that RESPA does not apply to a given transaction or when attempting to avoid its application. Moreover, readers should remember that RESPA and its state law equivalent may not be the only laws regulating referral fees in a given situation. For example, Commission Rules E-18 and E-19 prohibit certain referral fees between brokers, mortgage lenders, and title insurance companies, regardless if the criteria described are met.
Which referral fees are unlawful under RESPA?
An unlawful referral fee (a “kickback” using RESPA’s terminology) can take a variety of forms. In fact, a prohibited referral fee can be any “thing of value,” which includes any payment, advance, loan, service, or other valuable consideration that is paid in exchange for the referral of business. Nearly any quid pro quo (“something for something” in Latin) exchange involving the referral of settlement-service business may be an unlawful referral fee under RESPA. It can take the form of money, objects or things, discounts, salaries, commissions or fees, stock, services of any type at special or free rates, etc. Any “thing of value” qualifies.
Importantly, under this definition, it is inconsequential whether the value flows directly to the source of the referral, or to a third-party as a result of the referral. For example, the payment of a fee in a direct exchange for the referral of business is clearly unlawful under RESPA. Similarly, if made in exchange for the referral of business, a donation of money to charity or a contribution of volunteer hours to a local nonprofit could constitute an unlawful referral fee under RESPA.
What is an “Unearned Fee”?
An unearned fee is the payment of any portion of a commission (or any other amount charged) to a settlement service provider for anything other than services that the settlement service provider actually provides in a real estate transaction. This provision covers a possible gap that is left open under the “kickback” rule, described above. The following example is helpful.
Suppose a real estate broker (who is also a licensed title insurance agent) refers an individual who is purchasing a home to an unaffiliated title company for the purchase of title insurance. If the real estate broker performs no actual title services in connection with the issuance of the title insurance policy, an “unearned fee” would arise if the title company pays the broker a commission on the transaction or if the broker receives a portion of the insurance premiums.
There is an important exception to this unearned fee rule: an unlawful unearned fee or kickback does not arise in the context of payments pursuant to cooperative brokerage or referral arrangements between real estate brokers and brokerages. Other exceptions also exist.
What is a “Settlement Service Provider”?
Per the statutes, a settlement service provider is “any service provided in connection with a real estate settlement.” This rule applies to both prospective and actual real estate transactions, meaning a person can meet the definition if they are actually involved with a current real estate transaction or attempting to become involved in a prospective transaction.
RESPA and Colorado state law provide a nonexhaustive list of service providers that typically fall within this definition. They include:
- Title insurance and closing companies
- Home inspectors
- Real estate brokers
- Mortgage loan originators and lenders
As before, it can sometimes be difficult to determine whether an individual or entity is a settlement service provider in a real-life transaction. Indeed, any number of other types of service providers might be considered “settlement service providers” depending upon the circumstances. In essence, if someone provides a service in connection with a real estate transaction, they may qualify as a “settlement service provider.” For example, a carpet contractor likely qualifies as a “settlement service provider” if the contractor installs carpet in connection with an actual sale (e.g. to satisfy an Inspection Resolution calling for the installation of new carpet prior to closing). By contrast, if the very same carpet contractor installs carpet without having any involvement with a prospective or actual sale (e.g. by installing carpet following a sale), then the contractor likely does not meet the definition.
The crucial element is that the service provider must have a connection with a prospective or actual real estate settlement.
What is a “Federally Related Mortgage Loan”?
Generally, most residential loans fall within the definition of a “federally related mortgage loan.” The definition excludes extensions of credit made primarily for “business” or “commercial” purposes. By contrast, RESPA applies where credit is secured for “personal, family, or household purposes.” Loans to government agencies are also excluded. However, even a transaction that appears to be a “business” or “commercial” transaction may still fall within the scope of RESPA
II. The Disclosure Rules
Both RESPA and Colorado law place restrictions upon the use of “affiliated business arrangements.” In order to avoid violations, brokers should be able to determine: (A) whether they are engaged in an affiliated business arrangement that requires disclosure; (B) when and to whom such disclosures are made; and (C) the form in which disclosure must be made.
What is an Affiliated Business Arrangement?
In simplified terms, an affiliated business arrangement arises where:
- A. A person or their “associate” has either an “affiliate relationship” with, or a direct ownership interest of more than 1 percent, in a settlement services provider;
- B. The person or their associate directly or indirectly refers business to that provider.
An “associate” is a person or entity with whom the referring party has a special kind of relationship or arrangement defined by statute. The definition includes spouses, parents, and children, as well as certain business entities that have common control features (e.g. a common parent entity, a parent-subsidiary relationship, a partnership, etcetera). Those having certain corporate or employment relationships may also qualify as an “associate” (e.g. employer, director, officer, partner, franchisor/franchisee). Importantly, an “associate” also includes anyone who has an agreement or arrangement that provides a financial benefit to the referring party in exchange for the referral. The term “affiliate relationship” also describes a situation where multiple business entities have common control features. So, as above, an affiliate relationship arises where two companies have a common parent entity, a parent-subsidiary relationship, a partnership, or another form of common control.
Notably, a person does not run afoul of the anti-kickback and unearned fee rules described above if they make a referral of business to an affiliated business and the only “thing of value” received is a return on the person’s ownership interest.
When and to Whom is Disclosure Required?
Colorado real estate brokers must disclose the existence of affiliated business relationships to their customers and to the Colorado Division of Real Estate.
RESPA provides that a person must make appropriate disclosures before the time they make a referral to an affiliated business entity. Colorado law further requires that a person make such disclosure at or before the time a contract to buy and sell real estate is fully executed. Various other requirements apply for different types of settlement service providers such as lenders and attorneys.
Three rules apply to the timing of disclosure to the Colorado Division of Real Estate. First, Division of Real Estate regulations require brokers to make the disclosure of an affiliated business arrangement at the time they form or change the arrangement. Second, Colorado law requires that, at the time the contract to buy and sell is executed by the buyer and seller, the existence of an affiliated business arrangement with the broker or the employing broker shall be disclosed in writing to all parties to the transaction. Third, on an annual basis and upon formation, an employing real estate broker must disclose the existence of all affiliated business arrangements then in existence. Disclosure can be made through the Division of Real Estate website.
What Form must the Disclosure Take?
RESPA and Colorado law each require that settlement service providers provide disclosure in writing and in a format consistent with the Affiliated Business Arrangement Disclosure Statement promulgated by the U.S. Department of Housing and Urban Development (HUD).
The disclosure must describe the nature of the relationship (explaining the ownership or financial interest) between the provider of settlement services and the person making the referral, and it must provide an estimated charge or range of charges generally made by such provider.
Finally, certain requirements are also in place to ensure that the disclosure is sufficiently conspicuous. For example, the disclosure must be presented in writing, on a separate sheet of paper, presented in a clear and conspicuous manner, and in a form that the recipient may keep.
For questions about RESPA, please contact Jon Goodman.