In the aftermath of the housing bubble collapse, the mortgage broker industry is a giant target for reform. Regulators and legislators at the state and federal levels are busy implementing a variety of laws and regulations designed to protect consumers and prevent another housing meltdown in the future.

Most of the new actions have a two-fold purpose: to purge the mortgage industry of the exotic mortgages that have caused so much pain to consumers while protecting consumers from the practices of unscrupulous brokers. Among the changes are regulations designed to protect the independence of real estate appraisers and ensure that brokers act in the best interest of consumers, a national licensing system, and funds to compensate consumers wronged by broker and lender fraud. How brokers are compensated is the biggest issue addressed by pending legislation and rules.

Here’s an overview of recently enacted state and federal legislation and regulation of mortgage brokers:

Real Estate Appraiser Independence: During the housing bubble, many home appraisals were, if not outright inflated, at the very least, overly generous. In an effort to promote the independence of mortgage brokers and lessen lender influence on the process, Fannie Mae and Freddie Mac agreed to implement the Home Valuation Code of Conduct. As of the beginning of 2009, all lenders selling mortgages in the secondary market to Fannie or Freddie — virtually all lenders in the country — must abide by these rules, which forbid mortgage brokers from selecting appraisers and prohibit lenders from using appraisal companies they own or control and from using in-house appraisers to conduct initial estimates.

Brokers Must Act in the Interest of Consumers: About a dozen states have passed regulations requiring that brokers act in the best interest of consumers. “If you are going to be a licensed, insured, bonded mortgage broker you are legally required to represent the interests of the borrower,” says Uriah King, a policy associate with the Center for Responsible Lending, a consumer rights non-profit. “Without rules like this, brokers are basically third-party agents that are theoretically getting paid to help borrowers but are disclaiming that responsibility in the fine print and accepting compensation from the lender that may not be in the buyer’s best interest.” States that have promulgated these rules include North Carolina, Ohio, Virginia, Washington, Minnesota and Maine.

National Mortgage Broker Licensing: A law signed by President Bush in 2008 establishes a nationwide mortgage licensing system to be in place by July 30 of this year; states have an additional year to establish a state loan originator licensing and registration system. The system requires all loan originators, including mortgage brokers, to undergo a substantial background check, including fingerprinting, and to take a minimum of 20 hours of continuing education, pass an exam and post either a surety or net worth bond.

Funds to Compensate Defrauded Consumers: Several states have established funds to compensate consumers who have been defrauded by mortgage brokers. In Florida, the Mortgage Guaranteed Trust Fund will make payments to consumers who have obtained a judgment against a mortgage broker or loan originator but are unable to collect from that individual, says Valerie Saunders, president of the Florida Association of Mortgage Brokers. Most state funds operate in a similar fashion.

Compensation Proposals: A number of state and federal proposals for regulation deal with mortgage broker compensation and disclosures of that compensation. A big hot-button issue is the yield-spread premium, which is a rebate paid to a mortgage broker or bank based on the difference between the lowest interest rate available to a consumer and the interest rate at which a consumer’s loan is closed. Jorge Gomez, president of the Illinois Association of Mortgage Brokers, says the yield-spread premium allows consumers to avoid paying up-front fees to mortgage brokers, instead folding them into the loan. “This has been made into something that is bad, when it’s intended to help consumers get a better deal on their mortgages by minimizing their closing costs,” he adds.

But the Center for Responsible Lending’s King maintains that yield-spread premiums are a component of a broken compensation model and should be banned. “For mortgage brokers, their incentive isn’t really to see loans perform in the long run, it is to close as many loans as possible,” he says. “They don’t have any skin in the game. For unethical brokers, there is an additional incentive to extract as much fee income out of each deal. To get to the root of the problem, you have to address the incentives that prompted brokers to steer people to unsuitable products.”