Real Estate Settlement
The Real Estate Settlement Procedures Act, (known as "RESPA"), was an Act passed by the United States Congress in 1974.
It was created because various companies associated with the buying and selling of real estate, such as lenders, realtors, and title insurance companies were often engaging in providing undisclosed kickbacks to each other, inflating the costs of real estate transactions and obscuring price competition by facilitating bait and switch tactics.
For example, a lender advertising a home loan might have advertised the loan with a 5% interest rate, but then when one applies for the loan one is told that one must use the lender's affiliated title insurance company and pay $5,000 for the service (whereas the normal rate is $1,000). The title company would then have paid $4,000 to the lender. This was made illegal.
The Act prohibits kickbacks between lenders and third-party settlement service agents in the real estate settlement process (Section 8 of RESPA), requires lenders to provide a good faith estimate for all the approximate costs of a particular loan and finally a HUD-1 (for purchase real estate loans) or a HUD-1A (for refinances of real estate loans) at the closing of the real estate loan. The final HUD-1 or HUD-1A allows the borrower to know specifically the costs of the loan and to whom the fees are being allotted.
Critics say however that various kickbacks still occur. For example, lenders often provide captive insurance to the title insurance companies they work with, which critics say is essentially a kickback mechanism. Others counter that economically the transaction is a zero sum game, where if the kickback were forbidden, a lender would simply charge higher prices. One of the core elements of the debate is the fact that customers overwhelmingly go with the default service providers associated with a lender or a realtor, even though they sign documents explicitly stating that they can choose to use any service provider. Some say that if the profits of the service providers were truly excessive or if the prices of the service were excessively inflated because of illegal or quasi-legal kickbacks, then at some point non affiliated service providers would attempt to target consumers directly with lower prices to entice them to choose the unaffiliated provider.
There have been various proposals to modify the Real Estate Settlement Procedures Act. One proposal is to change the "open architecture" system currently in place, where a customer can choose to use any service provider for each service, to one where the services are bundled, but where the realtor or lender must pay directly for all other costs. Under this system, lenders, who have more buying power and would more savvily seek for the lowest price for the various real estate settlement services.