Part I: THE SETTLEMENT PROCESS: A DESCRIPTIVE OVERVIEW

Part 1 of this study presents an overview of the settlement process and it is divided into six sections:

Each section describes one service in relation to the entire settlement process, specifies the providers of the service, and discusses the overall characteristics of the markets within which the services are sold. Geographic variation in the nature of the services, in how they are provided, and in who provides them is also discussed.

The sections are arranged so that they roughly follow the progression of services needed by home buyers. In finding a home, the home buyer consults a real estate broker, who helps him locate a residence suitable to his needs and desires. Once a house is located, a mortgage is usually necessary. Many of the closing costs which this study analyzed are borne by the consumer because the lender needs assurances that the risk of the mortgage is minimal. One of these costs is private mortgage insurance, which protects the lender against some portion of the loss if a foreclosure occurs on a house with a low down payment.

Title assurance protects both the lender and the buyer in case the title to the property is not absolutely free and clear of encumbrances. There are two basic forms of title assurance, the attorney opinion and title insurance. Often the lender decides who the actual provider of the assurance will be.

The last section describes the provision of settlement and escrow services, as well as the preparation of documents. Often attorneys provide these services. However, because of the simple and routine nature of the work, title insurance companies, brokers, and lenders perform these services in some areas.

A detailed discussion of pricing for these services and of the individual settlement service markets is provided in Part 2.

I. INTRODUCTION TO THE STUDY

The Real Estate Settlement Procedures Act (RESPA) was passed in 1974 and amended in 1975. It was enacted in response to concern on the part of Congress that settlement costs were excessive due to inefficient markets, insufficient consumer information, and anticompetitive behavior on the part of some providers. These perceptions were strengthened by a congressionally mandated study completed in 1972.1 This study reported such conditions and practices as:

The original version of RESPA, passed in 1974, attempted to deal with these and other potential issues in the settlement industry through a number of provisions. Most importantly, the Act:

The purpose of these provisions was to eliminate certain practices which were felt to be anticompetitive, such as the use of kickbacks and referral fees, and to substantially increase the availability of information to consumers. Congress felt that increased information would promote consumer shopping, which in turn would stimulate competition among service providers.

Once enacted, the 1974 Act appeared to impose substantial burdens on providers, particularly upon lenders who were affected more than other providers by the advance disclosure requirements. As a result, amendments to

1 HUD/VA Report on Mortgage Settlement Costs, January 1972.

the Act were promulgated in the Real Estate Settlement Procedures Act of 1975, now in effect. This revision limited lender responsibility for advance disclosure of settlement costs to the provision of good faith estimates, with ranges allowed rather than specific costs. The Act also required that the person conducting settlement make the Uniform Settlement Statement (HUD-1) available to borrowers at least one day prior to closing.

A provision of the original Act that was retained in the amendment requires the Secretary of the Department of Housing and Urban Development (HUD) to report to Congress as to whether further federal legislation regarding settlement procedures is required. Specifically, RESPA requires:

Section 14. (a) The Secretary...after such study,
investigations, and hearings...as he deems appro-
priate, shall...report to Congress on whether, in
view of the implementation of the provisions of
this Act imposing certain requirements and pro-
hibiting certain practices in connection with real
estate settlements, there is any necessity for fur-
ther legislation in this area.

(b) - if the Secretary concludes that there is
necessity for further legislation, he shall report
to the Congress on the specific practices or prob-
lems that should be the subject of such legislation
and the corrective measures that need be taken.1.

It is in fulfillment of this mandate that the present study has been undertaken.

In this chapter, the Introduction to the Study, we present overviews of real estate settlement in the context of RESPA and the methodology we employed in conducting this study. Specifically, we discuss: (1) real estate settlement; (2) the legislative history of RESPA; (3) the purpose and research objectives of the current study; and (4) our methodology.

REAL ESTATE SETTLEMENT

This section discusses the purpose and dimensions of residential real estate settlement and the conditions that prompted the passage of RESPA.

Purpose Of Settlement

"Settlement" refers to the transfer of ownership of real property from seller to buyer. That is, it is the formal process by which ownership of real property passes from seller to buyer. Settlement is commonly perceived

1

The Real Estate Settlement Procedures Act of 1974, 12 USC 2601.

as the end of the home buying process, the time when title to the property is conveyed from seller to buyer. For the purposes of this study, we use "settlement" to refer to the sequence of interrelated activities that begins with a consumer's decision to sell or buy a home and ends with the actual transfer of title.

We limit ourselves in this study to settlement relating to one-to fourunit residential real estate financed through: (1) a lender federally regulated or insured, or (2) a loan insured, guaranteed, supplemented, or assisted by the U.S. government. That is, we limit ourselves to settlement in the

context of RESPA.

While the function of settlement is to effect the transfer of ownership, a major purpose of most settlement services is protection; that is, to protect the lender, seller, and buyer against events or circumstances that may lead to financial loss and to ensure that the actual exchange between buyer and seller is the same as the expected exchange. For example, title search and title insurance are to protect the lender's and buyer's equity in the house and property in the case of unforeseen or undiscovered defects or encumbrances in the title. On the other hand, there are costs associated with settlement, and these costs may be considerable, even relative to the purchase price of the property. This potential conflict leads to three questions:

RESPA attempts to address these questions by providing more complete and more timely information about settlement procedures and costs to consumers of settlement services and by prohibiting certain noncompetitive practices such as kickbacks and unearned fees.

Better consumer information and restrictions on providers are intended to promote greater competition in the provision of settlement services. It is argued that this, in turn, encourages the provision of necessary services at fair prices. Indeed, the basic purpose of RESPA is described as: "...to

1

Reasonable cost is defined as that which approximates the lowest possible cost of providing the settlement service, including a market rate of return (profit).