Key Points to Loan Originator Compensation Rules

• August 22, 2010
• Marissa Blundell

by Marissa Aquila, Esq.
Bankers Advisory Staff Attorney

On August 16, 2010 the Federal Reserve Board (the Board) promulgated final rules regarding loan originator compensation practices, implementing changes anticipated by the mortgage lending community since the Board’s proposal was released in August of 2009. This rulemaking comes in the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act’s passage (Dodd-Frank) which contains its own provisions related to originator compensation. Recognizing that Dodd-Frank’s Title XIV creates a new Truth-in-Lending Act section similar to its own proposal, the Board has implemented this final rule consistent with the spirit of Dodd-Frank, the exact provisions of which will be the subject of a future rulemaking.

Pursuant to its authority under the Truth-in-Lending Act, the Board has applied these rules to “parties who arrange, negotiate, or obtain an extension of mortgage credit for a consumer in return for compensation or gain,” and to “all closed-end consumer credit transactions secured by a dwelling regardless of price or lien position.”  In doing so, the Board has declared that the benefits to consumers of the prohibitions contained herein outweigh the associated compliance costs, even for smaller entities.

The following are KEY POINTS regarding the new rules, effective April 1, 2011, as well as the Board’s reasoning, which will no doubt be relied upon by proponents and opponents alike as future proposals are considered:

1.   Payments to a loan originator that vary based on the terms of a loan, other than the amount of credit extended, are prohibited.

• The Board found that compensating loan originators based on a loan’s terms or conditions, other than amount of credit extended, is an unfair practice that causes substantial injury to consumers. The Board determined that compensation based on the amount of credit extended is less subject to manipulation by the originator and the Borrower is also protected by underwriting standards.
•  Worth noting is the Board’s acknowledgment that a loan originator may still use the interest rate to cover upfront closing costs, as long as any creditor-paid compensation retained by the originator does not vary based on the transaction terms.

2.   A loan originator may receive payment from a person other than the consumer (i.e. receipt of a yield spread premium (YSP) from a creditor), only if the loan originator does not  receive any compensation directly from a consumer.

• The Board found consumers are generally unaware of the existence of YSPs and are unable to appreciate the incentives such compensation creates.  Moreover, the Board believes that consumers, likely to rely on loan originator advice, pay more than they would otherwise, an unfair practice.

3.   A loan originator is prohibited from steering a consumer to consummate a loan that provides the loan originator with greater compensation as compared to other transactions the loan originator offered or could have offered, unless the loan is in the consumer’s interest.

• The Board deemed this provision necessary to avoid circumvention of the first rule highlighted above, prohibiting payments to loan originators which vary based on the terms of a loan.

4.   The new anti-steering rule includes the following “safe harbor” provision for originators:

• A “safe harbor” will be provided to an originator if the consumer is presented with loan options that provide one of each of the following: 

• a loan with the lowest interest rate
• a loan without any “risky” features such as: prepayment penalties, negative amortization, balloon payment, demand feature, shared equity, etc.
• a loan with the lowest total dollar amount for orig. fee/pts or discount points

• The “safe harbor” is intended to provide a loan originator with clear guidance to ensure that he or she is  able to comply with the anti-steering rule and to be sufficiently flexible to ensure consumers are not unduly restricted from considering various loan options.

The Board anticipates issuing additional compensation-related provisions, such as the additional compensation restrictions contained in Dodd-Frank, in subsequent rulemakings.  One such additional restriction is the prohibition of a payment to a loan originator if the consumer is required to make any upfront payment for points or fees, other than certain bonafide third party charges.

For additional information, including an in depth discussion of permissible forms of compensation, and to view the applicable Federal Reserve Board official staff commentary visit http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20100816d1.pdf

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