Fredric J. Gooch
General Counsel – VP Compliance
New loan originator compensation rules enacted by the Federal Reserve Board go into effect on April 1, 2011. The final rules were released by the Federal Reserve Board on August 16, 2010 and are designed to protect mortgage borrowers from unfair, abusive, or deceptive lending practices the Fed determined could arise under the current loan originator compensation standards. The new rules affect a vast number of parties including mortgage brokers and their employees and mortgage loan officers employed by depository institutions and other lenders.
The main focus of these new rules is to prohibit loan originator compensation based on the terms or conditions of the transaction (other than the amount of credit extended). The new rule also prohibits steering, a practice where a loan originator may influence a borrower to accept a loan with terms that are not in their best interest but results in higher compensation to a loan originator. The new rules apply to all closed end transactions secured by a dwelling where the creditor receives a loan application on or after April 1, 2011.
The rule covers all “consumer credit transactions secured by a dwelling.” This includes all owner occupancies including first and second homes, all first and subordinate liens, all loan types including reverse mortgages and bridge loans. It does not apply to Home Equity Lines of Credit, timeshare transactions, vacant land or other transactions that are not covered by TILA.
The rule applies to “originators” defined as: a person who for compensation or other monetary gain, or in expectation of compensation or other monetary gain, arranges, negotiates, or otherwise obtains an extension of consumer credit for another person. The term “loan originator” includes an employee of the creditor if the employee meets this definition. The term “loan originator” includes the creditor only if the creditor does not provide the funds for the transaction at consummation out of the creditor’s own resources, including drawing on a bona fide warehouse line of credit, or out of deposits held by the creditor. The rule defines a mortgage broker, for the purposes of the new rule only, as “any loan originator that is not an employee of the creditor.” This definition has broad reach including individual brokers, broker companies and employees of creditors. It only applies to creditors themselves if the transaction is table funded as opposed to a bona fide warehouse line of credit. It does not apply to servicers or to managers or administrative staff.
The rule prohibits payments to loan originators based on transaction terms or conditions. It places restrictions on both the payers and receivers of compensation as it states that “no loan originator shall receive and no person shall pay to a loan originator, directly or indirectly, compensation in an amount that is based on any of the transactions terms and conditions.” The regulation expressly exempts compensation based on a fixed amount of the credit extended to the borrower and states that compensation based on a fixed amount of the credit extended may be subject to a minimum or maximum dollar amount.
The new rule also places restrictions on the ways a loan originator can receive compensation. It states that if a loan originator receives compensation directly from a consumer, then the loan originator is prohibited from receiving compensation, directly or indirectly, from any other person other than the consumer in connection with the loan. It also prohibits any person who knows or has reason to know of borrower-paid compensation to a loan originator from paying any compensation to a loan originator, directly or indirectly, in connection with the transaction.
Prohibition on Steering
The practice commonly referred to as steering is also prohibited in the new regulation. Steering refers to the practice of directing a consumer to a loan product based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator could have offered to the consumer. There is a carve-out in the rule for transactions that happen to be more expensive to the borrower but are also in the borrower’s “best interest.”
The rule provides for safe harbor protection against steering claims if the originator provides the consumer with different loan options from which to choose. The originator must provide options for each type of transaction that the borrower expresses an interest in obtaining, i.e. fixed loans or adjustable rate loans. For each option presented the loan originator must present the customer with loan options that include: (1) the loan with the lowest interest rate; (2) the loan with the lowest interest rate without any risky features, such as: negative amortization, prepayment penalties, interest only payments, balloon payments in the first seven years, a demand feature or shared appreciation (for reverse mortgages it must be a loan without a prepayment penalty, shared appreciation or shared equity); (3) the loan with the lowest total dollar amount for origination points or fees and discount points.
The loan options must be from a significant number of creditors that the originator regularly does business with and the originator must have a good faith belief that the consumer is likely to qualify for each of the loan options presented. The loan originator may present fewer than three loan options if the loans that are presented meet all the other criteria set forth above.
DocuTech Helps Keep You Compliant
DocuTech will be making a couple of system changes within its ConformX product to help users comply with the new loan originator compensation rule. First, DocuTech currently has a systems setting that allows the user to choose whether to have the yield spread premium amount in line 802 automatically added to line 801. For loans with an application date after April 1, 2011, users will be prompted whether to elimintate this functionality and they will have to send the broker compensation in a blank 800 series line and assign it as a Block 1 charge. The existing YSP amount imported from the system of record will continue to populate in line 802 to meet RESPA requirements.
DocuTech will also be providing an anti-steering loan options disclosure to help originators achieve safe harbor protection form steering allegations. The disclosure will display up to three loan options that meet the requirements set forth in this article for a fixed loan and/or an ARM loans based on customer interest. As this form will require many prompts to fill out the data sets, customers will have the form and the prompts added to their process upon request. For more information on how this new rule will affect your document drawing process contact your DocuTech customer support specialist.