By Brian Chappelle
RISMEDIA, November 3, 2010—On August 16, 2010, the Federal Reserve Board (the Fed) published its final rule on loan originator compensation. The rule amends Regulation Z and is effective for applications taken on or after April 1, 2011. The cornerstone of this rule is to preclude loan originators (retail loan officers and mortgage brokers) from having any financial interest in the terms or conditions of the loan (e.g. interest rate or product type) or “a factor that is a proxy for a transaction’s terms or conditions.”
The rule, in effect, decouples the mortgage lender’s compensation arrangement with the loan originator from the lender’s negotiation of the transaction’s terms or conditions with the consumer. The loan originator can assist/facilitate this negotiation, but can no longer have any financial incentive based on a term or condition of the loan (or “proxy”). Said another way, the lender’s compensation of the loan originator must be pre-determined and fixed for any particular loan, while the lender’s negotiation with the consumer about the terms or conditions can vary as the lender deems necessary in light of market conditions.
There are three main points to the Fed’s final rule:
1. Creditors (mortgage lenders) are prohibited “from paying compensation to a loan originator based on the terms or conditions of the credit transaction, other than the amount of credit extended.” The only exception to this rule is for payments that consumers make directly to a loan originator.
• A “term or condition” includes interest rate, APR, loan-to-value ratio or the existence of a pre-payment penalty.
• A “term or condition” does not include mortgage amount. As long as the percentage is fixed and does not vary with the loan amount, the loan originator can be paid based on the size of the loan. Additionally, compensation is not considered a “term or condition” if it is based on total volume, long-term performance, hourly pay based on actual hours worked, customer status, or several other items.
2. Prohibits compensation based on a factor that is a proxy for a transaction’s terms or conditions. While the “Board believes credit scores or similar indications of credit risk, such as DTI, are not terms or conditions,” the Fed also states that “the Board recognizes that they (credit scores and indications of credit risk) can serve as proxies for a transaction’s terms or conditions.” The Fed provided an example of such a situation which is paraphrased below:
• Consumer A having a credit score of 650 obtains an interest rate of 7% and consumer B with a credit score of 800 obtains an interest rate of 6½%. If the loan originator compensation varied “in whole or in part” based on credit score (e.g. the originator received $1,500 in consumer A’s transaction and $1,000 in consumer B’s), “the originator’s compensation would be based on a transaction’s terms or conditions.”
3. Loan originators are not permitted to “steer” borrowers to products that are not in their interest. The steering prohibition applies to transactions in which retail originators “broker out” loans.
While the Federal Reserve’s final rule on loan originator compensation makes sweeping changes to the way loan officers and mortgage brokers can be paid, it is important to note the following:
• The rule “does not set a cap on the amount of compensation that a loan originator may receive.”
• The rule does not limit the interest rate or discount points that a mortgage lender (creditor) can charge the borrower.
• The rule does not apply to payments received by the creditor (lender) when selling the loan in the secondary market (servicing release premiums).
• The rule is applicable to all loan originators (retail loan officers and mortgage brokers).
In summary, the final rule represents a paradigm shift in how loan originators will be compensated. It is also more restrictive than the proposed rule. With the introduction of the “proxy” concept in the final rule, the Fed makes clear that the use of substitute factors for loan terms or conditions to circumvent the intent of the rule is not permissible.
Brian Chappelle is a consultant for the National Association of REALTORS®.
For more information on this rule and detailed Q&A’s, visit http://www.realtor.org.