The White House’s Focus on Closing Costs:  Long Overdue and Worth the Fight (Part 2)

Introduction

The high level of closing costs has been placed onto housing policy’s front burner by two recent events. First, President Biden recently highlighted that “anti-competitive” closing costs are worsening the already strained levels of homeownership affordability, specifically calling out title insurance.¹  Second, the National Association of Realtors (NAR) was recently found liable in a class-action lawsuit for undermining price competition to maintain the long-standing 5 to 6 percent brokerage commission, the single largest closing cost. 

In Part 1 of this series, it was estimated that total closing costs for both buyer and seller accounted for at least 7 to 11 percent of the purchase price of a typical home, surpassing the average 6 to 7 percent down payment made by first-time homebuyers (FTHBs). Specifically, it was estimated that normal price competition could reduce brokerage commissions by up to half and title insurance by up to 90 percent.  This means reducing such costs could materially improve affordability.²  

Part 2 of this analysis discusses a wider range of closing costs, finding that there is an unusual concentration of closing-related transactions – of which brokerage and title insurance are just two – where prices are unnecessarily high due to the suppression of normal price competition.

This paper examines this unusual concentration to determine its root cause.  Surprisingly, the issue is not simply that price competition in closing-related products has been subverted, as this was historically common in many industries.  Nor is it a lack of reform proposals to re-establish price competition. Rather, the root cause has been the long-running blocking of reforms to reinstate price competition in housing and mortgage markets, which contrasts with other industries where such reforms have instead been successfully implemented in past decades.  This blocking has been enabled by extensive political advocacy and lobbying, especially aimed at elected members of Congress and state legislatures, and stands out for how effective it has been.

Fortunately, there is evidence that the decades-long track record of such blocking being so effective may finally be coming to an end.  The upside would be that closing costs overall could decrease by at least one-third, and potentially even by half.  This could significantly increase affordability, especially for FTHBs, and make housing transactions generally more cost-effective for both buyers and sellers. 

Related historic background

Efforts to subvert price competition have long been endemic to commercial activities.³ In the modern era, U.S. antitrust doctrine, reacting to the “trusts” of the late 1800s, focused on protecting competition mainly by seeking to have many firms competing rather than just a few (or one), without much regard for the specific impact on consumers.  As a result, “[l]andmark rulings protecting competitors at the expense of consumers were pervasive throughout the 1960s.”⁴ 

Starting nearly half a century ago, antitrust law in the U.S. evolved to become based upon “the consumer welfare standard,” where the impact on the price and quality of goods and services as experienced by the purchaser was paramount.  This shift took several decades to roll out across the broader U.S. economy.  For example, the securities brokerage industry in 1975 was barred from setting prices as a cartel, as it long had; airline fares were deregulated by the government in 1978; and bank deposit interest rates underwent complete deregulation in phases from the mid-1970s to the mid-1980s.⁵ 

However, for home purchase closing costs, the lack of proper price competition did not similarly disappear in the 1970s and 1980s.  This was despite many attempts at reforms to restore it, in some cases going back decades.⁶   What is extraordinary is how unsuccessful such efforts have been, seemingly leaving price subversion in place in the housing and mortgage markets far longer than in other industries. 

Four closing cost examples

I chose four examples of closing-related transactions to illustrate why closing costs have a reputation for being at “anti-competitive” levels. In the first three – brokerage commissions, title insurance, and credit reports – I demonstrate how price competition subversion came about and how lobbying and advocacy successfully blocked needed market reforms. The fourth example, appraisal costs, is the exception that seems to prove the rule – it shows how a lack of lobbying and advocacy power has allowed reforms to be implemented. It’s important to acknowledge that lobbying and advocacy efforts are often not transparent, and so we can at times only get glimpses of them happening.  

          Brokerage commissions.  A history of the price competitiveness of real estate brokerage commissions⁷ indicates that the NAR⁸ was working to set commission rates on a national basis as early as 1939, while the Department of Justice (DOJ) won its first anti-trust lawsuit against the NAR back in 1950.  However, after each setback, the NAR responded by coming up with a new or modified way to maintain its long-standing subversion of price competition, which has proven a successful strategy ever since.  Thus, the decades-long cat and mouse game between the NAR and the DOJ – and also the Federal Trade Commission (FTC) – has largely been ineffective in establishing normal price competition.⁹

With the recently announced anti-trust settlement, will the NAR once again figure out how to technically adhere to the settlement agreement while developing a new method to undermine price competition?  Certainly, the NAR seems inclined to do so, as they continue to deny any wrongdoing or anti-consumer behavior, and instead blame the media for “spreading misinformation and half-truths” that paint them as obstructing fair competition.¹⁰  This “deny and strongly advocate” strategy is common in the housing industry. The NAR is very well positioned to pursue such a strategy:  it is the second-highest spender among industry associations,¹¹ and has an impressive 1.5 million members – almost one percent of the entire U.S. labor force of 168 million. This translates into considerable clout in Congress and state legislatures.  Perhaps for this reason, the DOJ is currently intervening to strengthen the terms of the recent class-action settlement. 

          Title insurance.  Title insurance was not historically common in many home purchase transactions, as the buyer’s attorney’s search to ensure a clean title gave buyers and lenders enough assurance to proceed with a closing.  What helped turn it into a standard feature of closings was the development of the secondary mortgage market, which started in 1938 with Fannie Mae’s creation.  Lacking first-hand knowledge of the borrower or the property, a secondary mortgage lender had a priority interest in ensuring a clean title via title insurance. Requiring such “belt and suspenders”¹² assurance is now standard for virtually all lenders, especially since the borrower pays for the insurance. 

As documented in the Government Accountability Office (GAO) study referenced in Part 1, homebuyers will almost always defer to a third party involved in the purchase transaction to select a title insurer.  With competition based upon increasing costs to provide economic incentives to those third parties – known as “reverse competition” – such third-party selection leads to higher prices.¹³ 

Unsurprisingly, the title insurance industry today is a fierce defender of third-party selection. Despite some reforms, loopholes have allowed reverse competition to continue through today. The industry has a reputation of engaging in aggressive advocacy and political influencing whenever a threat to the existing third-party selection business model arises.¹⁴   

The newest threat to high title insurance prices is now coming from the Biden administration.  Specifically, the Federal Housing Finance Agency (FHFA), the regulator and conservator of Fannie Mae and Freddie Mac (F&F), has a proposed pilot program that would skip the requirement for title insurance in certain cases, and the Consumer Financial Protection Bureau (CFPB) has announced it might go as far as barring consumers from paying for lender’s title insurance, looking for lenders to pay instead.¹⁵        

          Credit reports. The government agencies that dominate mortgage finance¹⁶ currently require a credit report from each of the three major credit reporting bureaus,¹⁷ known as a “tri-merge” report.¹⁸  This requirement was historically used to support their decision whether or not to purchase or insure a particular mortgage. Unfortunately, this has inadvertently resulted in a non-competitive “captive” market, as all three bureaus know they will always get the business.

Interestingly, this unanticipated consequence of creating a captive market was not apparently historically exploited by the credit bureaus or FICO to charge high prices.  The cost of a tri-merge credit report, paid by the borrower, would, on average, cost about $50 per borrower or $100 for a couple.¹⁹  As this is not a high cost, there has been little policy focus on credit report costs. 

But this has now changed.  Recently, there has been a significant increase in the cost of credit reports, with complaints about the costs doubling, tripling, or more.²⁰ This has caught the attention of policymakers.  The FHFA just proposed that F&F only require two reports, i.e., a bi-merge, so that mortgage applicants could save on fees. Then, the CFPB announced it is investigating these costs and has even referred to them as “price gouging.”²¹ 

In response to the FHFA’s bi-merge proposal, the three national credit bureaus unsurprisingly began to aggressively lobby and advocate to stop a change.  This includes citing their own research to claim²² that this will make credit less available to homeowners and riskier to F&F, directly contradicting the FHFA’s own findings.²³  There has even been legislation proposed in Congress to legally require the tri-merge report,²⁴ overriding the FHFA’s proposed reform.  Industry lobbying and advocacy are now also focused on the CFPB in response to its public announcement of an investigation. 

          Appraisals.  It has been conventional for some time for lenders to require an official appraisal before finalizing a mortgage. This usually costs around $500²⁵ and is typically paid by the homebuyer at closing.  Historically, it was common for a bank to make a mortgage to a local customer it knew on a local property it also knew, without always requiring an official appraisal.  However, with the rise of the secondary market in mortgages, official appraisals became a formal requirement. 

Unusually, the industry’s regulator, the Appraisal Foundation, was established by the industry itself and then, in 1989, designated by Congress as its regulator.  The CFPB has recently commented on the industry’s unhealthy influence over it.²⁶  One role of the Appraisal Foundation, for example, is to control “entry into the appraisal profession by setting qualifications for becoming an appraiser…”²⁷  This appears to have the impact, whether intended or not, of restricting the supply of appraisers, which directly leads to higher prices.

In addition, the appraisal industry developed in recent decades a reputation of being slow and not always acceptably accurate – thus generally impeding the mortgage-making process.²⁸  Consequently, there has been a growing belief within the industry that it was ripe for disruption.  As a result, during the COVID pandemic, some banks and F&F broke with the requirement for an appraisal by a certified appraiser on all of their loans and began to work with “AVM” (automated valuation model) appraisals instead.  Today, post-COVID, the disruption continues as routine loans are increasingly “appraised” by such AVMs integrated with a property inspection, resulting in a faster and cheaper valuation that lenders find accurate enough to rely upon.

Naturally, the appraisal industry has fought such disruption.  However, appraisers are different from the other groups discussed herein:  they are not numerous (estimated at just 78,000 nationally), working mainly as smaller, local providers – and thus not collectively wealthy enough to support a large lobbying and advocacy budget.  Additionally, they are not represented by a single industry association to maximize clout, but by several.²⁹  This “exception to the rule” shows how reforms for greater efficiency can be implemented if the politics are kept at bay. 

Why the housing industry has been so successful in blocking reforms

For decades, the housing and mortgage industries have distinguished themselves by successfully resisting reforms to re-establish price competition.  By contrast, most other industries – which, of course, also fought government reforms to do the same – lost their battles, often decades ago. There seem to be three reasons for this exceptionalism. 

One, housing is among the most potent political issues because it is both large and ubiquitous:  it is usually the largest part of every family’s monthly budget, while the industry is also a big employer³⁰ in every single congressional district and state. Thus, housing is extremely relevant to almost every member of Congress or state legislature. This is enhanced by housing’s economic impact: it is the second largest sector of the economy, and mortgages are also one of the biggest asset classes in U.S. financial markets (e.g., F&F alone today have $7.5 trillion of assets).  This substantial base of wealth provides ample resources for funding campaign donations or other political support at generous levels.

This means that representatives of a housing-related industry have significant influence when they approach members of Congress or state legislatures. These government officials are motivated to at least listen and consider how the issue will impact important interest groups “back home.”

Two, as several government officials told me, issues related to subverted price competition in housing and mortgage markets generally have little, if any, impact on election voting outcomes.  This is because the issues and proposed corrections are usually very technical and behind-the-scenes in nature.³¹ Thus, since members of Congress or state legislatures are almost always fundraising for the next election cycle, likely significant campaign contributions and support from a housing interest group too often outweigh what might otherwise be viewed as good public policy.

And three, members of Congress are very aware of the fact that nearly two-thirds of families are homeowners, with the equity in their homes typically representing their largest source of net worth.  This creates a bias against making changes, such as supporting reform proposals, that could have the unintended consequence of potentially reducing home values or increasing mortgage costs, as such impacts carry a significant risk of costing votes. Naturally, those opposing reform often exploit these fears.

This means all the ingredients are there for housing interest groups to engage in “deny and strongly advocate” tactics effectively enough to win the day.  The historic track record of blocked reforms is thus understandable from a political perspective.³²   

Light at the end of the tunnel?

Four recent events indicate that the decades-long blocking of reforms to re-establish full price competition in housing and mortgage markets may no longer work quite so well going forward. 

          Private class-action lawsuits as an alternative path for reform.  The recent class-action lawsuit seems to have been successful – at least so far – in attacking the NAR’s efforts to subvert price competition.   The lawsuit resulted in the issue being addressed through discovery, depositions, and a trial, far from the arena of political lobbying and advocacy.  One can envision that class-action litigators will increasingly start focusing on housing-related issues, such as possibly taking on the pricing of title insurance. 

          It is now about housing affordability. President Biden’s rebranding of the high level of closing costs as an affordability issue – rather than a hard-to-understand technical one – at a time when housing is so expensive has made it more challenging for members of Congress and state legislatures to support an interest group fighting reform.  In other words, vote totals in the next election are now visibly in play.  The administration also may have turned closing costs into a partisan issue, making it difficult for many members of Congress and state legislatures to support efforts to block reform.   

          The FHFA and the White House can together better resist reforms being blocked.  The FHFA, from its founding in 2008 to 2021, was an independent regulator.  Thus, while in theory it could enact many reforms on its own, in reality it often didn’t have the political clout in Congress to counter industry lobbying.³³  However, the FHFA lost its independence in 2021 and is now under the control of the White House.  Thus, as long as the presidential administration is supportive of proposed reforms, their combined congressional clout is much greater (as is now happening with title insurance, for example). 

          The CFPB enters the picture.  The CFPB, created to have a singular regulatory focus on protecting consumers of financial products, has tremendous authority to ban various practices.  It also lost its regulatory independence, allowing for better coordination with the FHFA and the White House to use even more levers to enact reforms.  As described earlier, the CFPB has already announced initiatives to investigate housing, specifically mentioning credit reporting as well as “junk fees,” for which it has seemingly expanded its definition to include fees for which “there is little competition.”³⁴

Altogether, these changes will hopefully create a significantly different political playing field, increasing the likelihood of reforms to reduce closing costs no longer being blocked.

Conclusion

Ending the ability of housing and mortgage industry groups to block reforms designed to restore normal price competition will create several public policy benefits.  One, it will lead to a more efficient home purchase marketplace, which will benefit all buyers and sellers by significantly reducing closing costs.  More specifically, reforms to just brokerage and title insurance are anticipated to reduce closing costs by up to a third from the previously estimated level of at least 7 to 11 percent.³⁵   If other closing-related products are considered, it is conceivable that closing costs could even be cut by almost half. Such changes would significantly improve homeownership affordability, especially for the FTHBs who so often struggle to save for a down payment.

In short, homebuyers and sellers have simply been paying inflated closing costs for far too long.  Given today’s extreme affordability crisis, it’s crucial that reforms to restore full-price competition be implemented as soon as possible.