New Broker Payment and Anti-Steering Rules Effective April 1
March 7, 2011
Last September the Federal Reserve Board issued final rules pursuant to the Truth in Lending Act restricting residential mortgage originator compensation. While the rule had been proposed in 2009, its provisions mirror the originator compensation and anti-steering provisions in Title XIV of the Dodd-Frank Act.
However the Board states that this final rule does not implement the Dodd-Frank Act; those rules are still forthcoming. This final rule (hereafter, the “Rule”) applies to closed-end consumer loans secured by a dwelling or real property that includes a dwelling (not limited to just principal dwelling) without regard to price or lien position. It does not cover home equity lines of credit extended under open-end credit plans or to timeshare plans. It also does not apply to transactions between creditors and secondary market purchasers to which consumers are not direct parties.
The Rule prohibits any person from paying a loan originator a fee in connection with a covered transaction that is based on a term or condition of the transaction except the amount of the loan; prohibits any person from paying an originator in connection with a transaction if the consumer pays the originator directly; and it prohibits an originator from steering a consumer to obtain a loan that produces greater compensation to the originator under certain circumstances.
Loan Originator. The term “loan originator” is 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 is intended to encompass both natural persons and mortgage broker companies. An employee of the creditor could be an originator (such as if the employee is compensated based on the rate of the loan), but managers, administrative staff, and similar individuals who are employed by a creditor or loan originator but who do not arrange, negotiate, or obtain a loan for a consumer, and whose compensation is not based on whether a particular loan is originated, are not loan originators . A person who is deemed to be a loan originator in a covered transaction will not also be deemed the creditor .
A loan originator includes the “creditor” in a table funded transaction where another person provides the funds and then receives immediate assignment . If, in contrast, a person closes a loan in its own name and, for example, draws on a bona fide warehouse line of credit to fund it, it is deemed the creditor and not the loan originator in the transaction. Neither the Rule nor comments define what a bona fide warehouse line of credit is.
The term loan originator does not apply to a loan servicer who modifies an existing loan on behalf of the current owner of the loan . The restrictions set forth in the Rule do not apply if a modification of an existing obligation’s terms does not constitute a refinancing .
Mortgage Broker. “Mortgage broker” is defined as any loan originator that is not an employee of the creditor and includes both the company and its employees who perform the functions of a loan originator .
Compensation. The term “compensation” includes salaries, bonuses, commissions, awards of merchandise, services, trips, and any financial or similar incentive. Compensation includes any upcharges for third-party services, but not bona fide and reasonable overcharges that the originator retains .
Prohibited Compensation That Varies By Terms and Conditions
It is prohibited for a loan originator to receive (or any person to pay to an originator) compensation that is based on the terms or conditions of the transaction except for the loan amount . Thus, compensation that varies based on the interest rate, loan-to-value ratio, or the existence of a prepayment penalty is prohibited . Compensation that is based on the loan amount is permitted only if it is based on a “fixed percentage” of the credit extended, except that the compensation may be subject to a minimum or maximum dollar amount . The latter provision is intended to prevent disincentives for creditors from making small loans. For example, a creditor may offer a loan originator one percent of the amount of each loan but not less than $1,000 or greater than $5,000 for each loan. But a creditor may not offer a loan originator one percent of the loan amount for loans of $300,000 or more and two percent of the loan amount for loans between $200,000 and $300,000 .
Comment 36(d)(1)-5 cites the following example: Originator compensation may not be selectively lowered to respond to competition from lower-rate competitors, or adjusted depending on the result of negotiated terms that differ from standard terms. However, Comment 36(d)(1)-6 provides that compensation may be adjusted periodically (such as for reasons based on loan performance, transaction volume, and market conditions) if it does not result in payments that vary with the terms or conditions of a transaction.
Compensation also cannot be based on a factor that is a proxy for a term or condition. For example, a consumer’s credit score or debt-to-income ratio, while not a term or condition of a transaction, cannot be the basis of an originator’s compensation . However, the Board emphasizes that the Rule does not prohibit risk-based pricing as long as the loan originator’s compensation does not vary based on the transaction’s terms or conditions or on proxy factors.
Examples of Allowable Compensation. It is not prohibited for compensation to be based on:
- the total dollar amount of credit extended or total number of loans over a certain period;
- the long-term performance of the originator’s loans;
- an hourly rate of pay to compensate the originator for the actual number of hours worked;
- whether the consumer is an existing customer of the creditor or a new customer;
- payment that is fixed in advance for every loan arranged for the creditor;
- the percentage of applications submitted by the loan originator to the creditor that results in consummated transactions;
- the quality of the loan originator’s loan files;
- a legitimate business expense, such as fixed overhead costs; or
- compensation that is based on the amount of credit extended .
A creditor may also offer a higher interest rate that allows a consumer to finance the originator’s compensation that the consumer would otherwise be required to pay. Similarly, a creditor may charge a lower rate if the consumer pays more of the costs directly .
Payments to a loan originator made out of loan proceeds are considered compensation received directly from the consumer. Payments derived from an increased interest rate are not considered received from the consumer, nor are points paid by the consumer to the creditor whether paid in cash or out of the loan proceeds. If the consumer pays origination points to the creditor and the creditor compensates the loan originator, the loan originator may not also receive compensation directly from the consumer . The comments also note that a yield spread premium characterized under RESPA as a “credit” to be applied to reduce the consumer’s settlement charges is nevertheless not considered to be received by the loan originator directly from the consumer .
These provisions make it prudent for creditors to closely monitor broker activities to ensure no upcharges or reductions in broker compensation, and that all sources of broker compensation—especially if charged to borrowers—are known.
For purposes of the prohibition against varying compensation, the term “affiliates” is treated as a single “person.” Thus if the originator may deliver loans to either of two subsidiaries of the same company, they must compensate the originator in the same manner .
Consumer Payment Rule
If a loan originator is paid directly by a consumer, the originator may not be paid by any other person, and any person who knows or has reason to know of such payment may not pay the originator with respect to the transaction . Thus as a practical matter, a person must ensure that a consumer is not paying the originator directly before promising to pay the originator in a covered transaction. However, when a consumer pays the originator directly, the prohibition against varying compensation based on the terms and conditions of the transaction does not apply . Direct compensation paid by a consumer is not limited to “origination fees,” “broker fees,” or similarly labeled charges, but may include any payment by the consumer that is retained by the originator.
It is prohibited for a loan originator to “steer” a consumer to complete a transaction based on the fact that the originator will receive more compensation from the creditor compared to other transactions that the originator offered or could have offered, unless the completed transaction is in the consumer’s interest . Little guidance is offered as to what is or is not in a consumer’s interest. “Steering” means advising, counseling, or otherwise influencing a consumer to accept a transaction. For such actions to constitute steering, the consumer must actually consummate the transaction .
In determining whether a consummated transaction is in the consumer’s interest, the transaction must be compared to other possible loan offers available through the originator (i.e., could be obtained from a creditor with which the originator regularly does business), if any, for which the consumer was likely to qualify at the time the transaction was offered. The originator need not consider loans available from other creditors with which it does not regularly do business. Note however that a loan need not actually be offered by a creditor to be a possible loan offer; it need only be an offer that the creditor likely would extend if an application were received based on the creditor’s current credit standards, rate sheets or other credit terms communicated to the originator. An originator is not required to inform the consumer about a loan that the originator believes in good faith the consumer is not likely to qualify for .
The anti-steering provision does not require an originator to direct a consumer to the transaction that will result in a creditor paying the least amount of compensation. Comment 36(e)(1)-2ii states that the originator may direct the consumer to a transaction that will result in more creditor-paid compensation if the terms and conditions of other possible offers available through the originator for which the consumer likely qualifies are the same.
If an originator who is an employee of the creditor is not compensated based on a transaction’s terms or conditions, then that satisfies the anti-steering restriction as well, but not if he or she acts as a broker by forwarding an application to another creditor for compensation by the other creditor .
The following is an example cited in Comment 36(e)(1)-3: An originator violates the anti-steering restriction where the originatoar determines that a consumer likely qualifies for a loan with a 7 percent fixed rate from one creditor but directs the consumer to a loan from another creditor with a 7.5 percent fixed rate and for which the originator receives more compensation. However, there is no violation if the higher rate loan is in the consumer’s interest, such as if the lower rate loan has a prepayment penalty or requires higher up-front charges. In practice, however, it would be difficult to compare the relative benefit to a consumer between a higher rate and the absence of certain terms, and this will be one of the challenges that will face originators and creditors.
An originator is not in violation even if the originator does receive relatively more compensation for the completed transaction regardless of the consumer’s best interest if the consumer is presented with the loan options discussed below for each “type” of loan that the consumer is interested in, the three types being fixed rate loans, variable rate loans, and reverse mortgage loans . To qualify under this exception, the originator is required to obtain loan options from a “significant number” of the creditors with which the originator regularly does business . Comment 36(e)(3)-1 provides that a significant number is three or more creditors.
An originator is deemed to regularly do business with a creditor if: (i) there is a written agreement governing the originator’s submission of applications to the creditor; (ii) the creditor has extended credit secured by a dwelling to at least one consumer during the current or previous calendar month based on an application submitted by loan originator; or (iii) the creditor has extended credit secured by a dwelling at least 25 times during the previous 12 calendar months based on applications submitted by the originator .
The options presented must be ones that the originator has a good faith belief the consumer likely qualifies for. This requirement likely means that the originator would have to pre-qualify the borrower based on information in the application and credit reports, as compared against the creditors’ rate and credit score criteria.
For each type of requested transaction, the consumer must be given options that include the loan with: (A) the lowest interest rate; (B) the lowest interest rate without negative amortization, a prepayment penalty, interest-only payments, a balloon payment in the first seven years of the loan, a demand feature, shared equity, or shared appreciation, or in the case of a reverse mortgage, a loan without a prepayment penalty, or shared equity or shared appreciation; and © the lowest total dollar amount for origination points or fees and discount points. With respect to each type of transaction if the originator presents more than three loans, he or she must “highlight” the loans that satisfy the above criteria .
The anti-steering restriction is not necessarily violated even if the originator presents fewer than three loans (presumably per type of transaction) if the options that are presented do satisfy the criteria listed in A-C above. However, presenting more than four loan options for each type of transaction would not likely be helpful to the consumer .
In determining the lowest interest rate, for loans that have an initial rate that is fixed for at least five years, the initial rate that would be in effect at consummation is used. Where the initial rate is not fixed for at least five years, (i) if the interest rate varies based on an index the fully-indexed rate is used without regard to any initial discount or premium, and (ii) for a step-rate loan, the highest rate that would apply during the first five years is used .
In determining the transactions for which the consumer likely qualifies the originator may rely on information provided by the consumer even if later determined to be inaccurate. The originator is not expected to know all aspects of each creditor’s underwriting criteria, but is expected to be apprised of pricing or other information that is routinely communicated by creditors .
Record retention. For each covered transaction, a creditor is required to maintain records for two years of the compensation provided to the originator and the compensation agreement in effect on the date the interest rate was set for the transaction.
The Rule applies to transactions for which the creditor receives an application on or after April 1, 2011. This is a link to the Rule.
- 12 CFR 226.36(a)(1) and Comments 36(a)-1.i-iv.
- Comment 36(a)-4.
- Comment 36(a)-3.
- Comment 36(a)-1.ii.
- Comment 36(a)-1.iii.
- 12 CFR 226.36(a)(2) and Comment 36(a)-2.
- Comment 36(d)(1)-1.
- 12 CFR 226.36(d).
- See Comment 36(d)(1)-2.
- 12 CFR 226.36(d)(1)(ii).
- See Comments 36(d)(1)-9.i.-ii.
- Comment 36(d)(1)-2.
- Comment 36(d)(1)-3.
- Comment 36(d)(1)-4.
- Comment 36.(d)(1)-7.
- Comment 36(d)(2)-2.
- Comment 36(d)(3)-1.
- 12 CFR 226.36(d)(2).
- 12 CFR 226.36(d)(1)(iii).
- 12 CFR 226.36(e).
- Comment 36(e)(1)-1.
- Comment 36(e)(1)-2.i.
- Comment 36(e)(1)-2.ii.
- 12 CFR 226.36(e)(2).
- Comment 36(e)(3).
- Comment 36(e)(3)-2.
- 12 CFR 226.36(e)(3).
- Comment 36(e)(2)-2.
- Comment 36(e)(3)-3.
- Comment 36(e)(3)-4.
The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.
© This CBA Regulatory Compliance Bulletin is copyrighted by the California Bankers Association, and may not be reproduced or distributed without the prior written consent of CBA.