From Mortgage Daily
A final rule on loan originator compensation aims to eliminate incentives for originators to steer borrowers into high-cost loans.
Prior to the subprime mortgage meltdown in 2007, mortgage brokers and loan officers were encouraged by subprime lenders to forego low-rate options for their clients that yielded smaller commissions and instead push prospects into higher-cost subprime products that paid big yield-spread premiums.
While many originators behaved responsibly and put borrowers into the lowest cost programs, some succumbed to the incentives and opted to put prime borrowers into subprime loans.
Provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act were designed to eliminate such incentives.
The Consumer Financial Protection Bureau Friday released final rules that implement the Dodd-Frank provisions. The rules, which were originally proposed in August 2012, revise Regulation Z to implement amendments to the Truth in Lending Act.
Compensation that varies with the loan terms is prohibited by the rules. This means that originators cannot earn more because they convince a customer to take a mortgage with a higher interest rate, a prepayment penalty or higher fees. Also prohibited is compensation paid for steering the borrower to a lender-affiliated title company.
“To prevent evasion, the final rule prohibits compensation based on a ‘proxy’ for a term of a transaction,” the CFPB explained. “The rule also further clarifies the definition of a proxy to focus on whether: (1) the factor consistently varies with a transaction term over a significant number of transactions; and (2) the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction.”
While originators are generally prohibited from reducing their compensation to offset the cost of a change in transaction terms, the final rule allows originators to reduce compensation to defray some unexpected increases in estimated settlement costs.
The final rule, however, does allow business profits to be used to make contributions to certain tax-advantaged retirement plans like 401(k) plans. It also authorizes bonuses and contributions to other plans that don’t exceed 10 percent of an individual originator’s total compensation.
Originators are prohibited from being paid by both the borrower and other parties like creditors, though mortgage brokers are allowed to pay commissions to employees or contractors as long as the commissions are not based on loan terms.
While the Dodd-Frank act generally prohibits originators from collecting up-front points or fees from the consumer while also being paid by another party, the CFPB elected to exercise its authority to completely exempt the prohibition while it scrutinizes the proposal’s design, operation and possible effects in a mortgage market undergoing regulatory overhaul.
In response to public comments from the mortgage industry, consumer groups and other government stakeholders, the CFPB abandoned a proposal to require that originators provide borrowers prospects with an option that has no up-front discount points or origination fees. Among those that had opposed the provision was the National Association of Federal Credit Unions.
“Once the new set of Dodd-Frank rules that the bureau is implementing take effect, the bureau will evaluate how those rules are affecting consumers’ understanding of up-front charges and the decisions consumers make,” the bureau stated.
In order to level the playing field between bank and non-bank originators, both types of originators will be required to meet character, fitness and financial responsibility reviews. In addition, both types of originators will be required to undergo criminal background checks for felony convictions and completed training about mortgage rules.
The rule clarifies that certain employees of manufactured home retailers, servicers and seller financers are excluded from the definition of a loan originator. Also excluded are real estate brokers; management, clerical and administrative staff; and loan processors, underwriters and closers.
On mortgages and home-equity loans, mandatory arbitration of disputes are generally prohibited under the new rules. In addition, the practice of increasing loan amounts to cover credit insurance premiums is also not allowed.
The rules go into effect in January 2014, though the prohibition against mandatory arbitration and credit insurance financing takes effect in June 2013.
“The CFPB plans to work with creditors and mortgage originators to ensure a smooth transition to implementation,” the announcement said. “To help with compliance, the CFPB will, among other things, be publishing implementation guides, and, in coordination with other agencies, be releasing materials that help creditors and originators understand supervisory expectations.”