The Federal Reserve Board announced its final rule on Aug. 26, 2010 (published in the Federal Register on Sept. 24, 2010) regarding the loan originator compensation components of a proposed rule published in August 2009.
Since that announcement, only 25 days after President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law, the industry has been abuzz with speculation about how the Board will implement the rule, how the rule relates to Dodd-Frank and what it will actually mean to loan originator compensation and how to interpret some of its less obvious requirements.
Much has been written and talked about with respect to what it will really mean. The one thing that is clear is that there is almost nothing clear, especially regarding how lenders may interpret what the rule means regarding how they will deal with compensating mortgage brokers.
What is unambiguous in the rule?
• A loan originator may be an individual or a company.
• A mortgage company that funds a loan using its own funds (borrowed or otherwise) is not a loan originator.
• The rule prohibits anyone other than the borrower from compensating the loan originator based on the loan’s terms and conditions except for the loan amount which is not considered a term or condition of the loan.
• Creditor-paid compensation retained by the originator may not vary based on the transaction’s terms or conditions.
What may be misunderstood about the rule?
• How the Board’s definition of originator can affect the decisions lenders make with respect to their current compensation practices.
• The impact of the simple fact that consumers virtually never pay loan originators directly. That consumers pay companies, companies pay loan originators and lenders pay companies.
• To a large degree as it relates to mortgage brokers, lenders will be able to conduct “business as usual” on and after April 1, 2011 if they decide to do so.
So, if lenders can approach the change largely as business as usual, what is all the confusion about how lenders have to change their process all about?
The fact of the matter is that come April 1, 2011 and in the context of the Board’s final rule published Sept. 24, 2010 if the industry decides to do so, it can, for the most part maintain a compensation status quo. It will simply take deciding to do so, then doing it.
Let’s look at some material aspects of the rule (quoted text is from the final rule):
First, the “final rule prohibits payments to loan originators, which includes mortgage brokers and loan officers, based on the terms or conditions of the transaction other than the amount of credit extended.”
Second, the final rule defines a loan originator as an individual or a company.
Third, the rule establishes that the term creditor, for the purposes of the rule only and not other aspects of the Truth in Lending Act does not include a person (or company) that uses its own (or borrowed) funds in a transaction. The rule defines table funding as closing in your name but without using your own funds.
Fourth, direct consumer payments to a loan originator are excluded from the prohibition regarding compensation based on a loan’s terms and conditions.
Fifth, “the final rule further prohibits any person other than the consumer from paying compensation to a loan originator in a transaction where the consumer pays the loan originator directly.”
The rule also addresses “steering” and a variety of safe harbor activities that prove the loan originator has not steered the consumer “to loans based on the fact that the originator will receive additional compensation, when that loan may not be in the consumer’s interest.” The prohibition on steering is beyond the scope of this article but it is a very interesting and complex part of the Board’s new rule and requires attention by everyone who is affected by this rule.
As everyone with access to the Internet or a subscription to any mortgage-related publication knows, the industry is reeling with concern about how the lenders will respond to this rule. And, from what I can tell the lenders are no less confused and no less concerned about how to respond.
So, the purpose of this brief article is to plant the seed of an alternative that I hope the lenders will take to heart and consider. That seed is the idea that except for formalizing internal compensation programs with their employed originators, lenders should be able to continue to do business with the wholesale distribution channel with virtually no (or very limited) change to today’s processes.
How is that possible?
The Board has actually provided the mechanism in its definitions and in the restrictions it has imposed and to some degree, coincidentally the January 2010 HUD changes to the good-faith estimate began the compensation transition for many before anyone even really thought about it.
Let’s use the Board’s own example of an allowable originator compensation plan as a starting point.
The Board makes it clear that an originator (we’ll focus here on the individual, not a company; more on the company in a minute) may be paid using a fixed percentage rate and may combine that with a minimum and/or maximum amount. So, each employee can be paid on their own personal plan.
Next, it is important to consider that the consumer pays the company, not the individual. So the individual originator must never be paid based on the terms and conditions of the loan. Further, this means the mortgage company is always paid by the consumer unless the deal is paid totally by the lender based on rate.
As an example, the originator’s compensation plan is a $2,000 minimum and a $10,000 maximum with 1.5% on all loans between those allowed limits. The borrower is obtaining a refinance for $200,000. In this example, the rate, selected transparently by the borrower being allowed access to the originators pricing matrix, pays 0.5% or in this case $1,000.
Now for the detail that allows the lenders to continue to do business as usual without having to develop some intricate alternative mechanisms to do business with their wholesale partners. The rule is very specific in stating “compensation for this purpose (where “this purpose” means a payment from both the consumer and another party”) includes any payment by the consumer that is retained by the loan originator.” Since the company is paid by the consumer in this example and because the company does not retain the credit for the rate paid by the lender and since the individual originator is paid based on his/her arrangement with the company; the rule has been satisfied and the lender did not have to change anything about how it does business with the mortgage company.
At worst the company has to develop a formal compensation process and while the GFE should be adequate proof about the consumer retaining the benefit, the company may want to develop a one-page document that states that it did not retain any of the money transferred as a result of the rate. Nothing in the rule precludes either the lender or the mortgage company from being paid fees as well.
The purpose of this brief article is not to visit all the combinations or permutations that may attend to the complexities of this new rule, but rather to reach the lending community in hopes that the wholesale lenders who are evaluating their options under the new rule will consider this interpretation during their process. Obviously there are other scenarios, but the key is for lenders and mortgage companies to consider the implications of individual, company, consumer and retained by during the process of adapting to this new rule.
Bill Kidwell is president of Impact Mortgage Management Advocacy & Advisory Group, Lakewood, Colo.
