RESPA stands for the Real Estate Settlement Procedures Act of 1974. The law was created to help protect consumers from predatory lending practices in residential real estate transactions.
If the jargon seems overwhelming, don’t worry. We’ll walk through exactly what protections the law offers you, how it has been updated over the years and how it gets enforced.
RESPA is designed to protect borrowers from situations that may arise during the mortgage loan process. It requires lenders to disclose necessary financial information so consumers can make an informed home-buying decision. It also eliminates kickbacks and limits the use of escrow accounts.
RESPA applies to home loans made for residential properties designed to accommodate one to four families. These loans include most home purchase loans as well as home equity lines of credit (HELOCs), mortgage refinances and home improvement loans.
Below is an overview of protections RESPA affords borrowers:
Collectively with the Truth in Lending Act (TILA), mortgage lenders who wish to offer government-issued or government-backed loans must comply with the TILA-RESPA Integrated Disclosure, or TRID, rule.
A core component of RESPA is prohibiting or limiting lenders from engaging in certain actions. We’ll go through them in more detail below.
To illustrate why kickbacks and unearned fees are prohibited, we’ll use a hypothetical example.
Imagine a real estate agent helping a prospective buyer find their dream home. Once they find the right property, the real estate agent recommends a mortgage loan provider to their client. In return for bringing them business, the mortgage loan provider pays the real estate agent.
In this example, the home buyer could have found a better deal by using another lender. They also didn’t know the real estate agent was making money by bringing them to this particular lender. U.S. lawmakers enacted RESPA to fight exactly this type of collusion against home buyers.
One important caveat here is a legal exemption exists for real estate brokers and real estate agents to still recommend services. They just need to follow additional federal regulations when doing so, like making necessary disclosures to the client.
RESPA allows lenders and loan servicing providers to collect funds to pay property taxes, homeowners insurance and escrow account costs. However, it limits the amount lenders and providers can add to these accounts.
Lenders can require payments equaling 1/12th of total annual disbursements and require a 2-month cushion of these payments. Escrow account overage balances must be returned to the borrower after all annual disbursements are made.
Violations could lead to borrower lawsuits or escrow account refund requirements.
Real estate developers and builders often have relationships with title companies to handle bulk title insurance transactions in new home developments. In some cases, attorneys for sellers have financial relationships with title insurance companies and seek to direct buyers to use their services.
As a rule, if a seller compels a potential buyer to use a title insurance company and will not let the sale go forward unless the buyer complies, they’ve violated RESPA. However, if sellers agree to pay for title insurance on behalf of the buyer, they’ll comply with RESPA as long as they don’t add the cost back elsewhere in the transaction.