Loan originators face compensation crackdown

New rules take aim at loan pricing, yield spread premiums

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Feb. 16, 2011

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New rules take aim at loan pricing, yield spread premiums

Jack Guttentag
Inman News™

Come April 1, a new set of rules governing the compensation of loan originators comes into play. Loan originators are mortgage brokers, and loan officers (LOs) working for brokers or lenders. They are the individuals who borrowers deal with; they take the loan application and shepherd the borrower through the process.

I wrote about the new rules when they were first announced in 2009, but a current rereading indicates that I didn't get to the bottom of it at that time. This week, I decided to take another look with the help of a "Compliance Guide" recently issued by the Fed, which helps clarify both what the Fed is looking for and where it is muddled.

Defining lenders and brokers

The rules hit brokers and lenders differently, so it is important to know the difference. Lenders are entities that close loans with their own or borrowed funds, and either hold them in their portfolios or sell them in the secondary market. Brokers deliver loan packages to lenders who close and fund the loans.

Some firms close loans in their own name and immediately sell them to the lender who provides the funding, a process called "table-funding." They are defined as brokers.

The new core rule

The core rule that will come into play on April 1 "prohibits a creditor or any other person from paying, directly or indirectly, compensation to a mortgage broker or any other loan originator that is based on a mortgage transaction's terms or conditions, except the amount of credit extended."

The purpose of the rule is to eliminate any incentive for originators to select loans that carry larger payments to the originator.

Understanding how this will work, or how it might not, requires an understanding of how originators are compensated and how mortgage price information is provided to them.

The rule as it applies to lenders

LOs working for lenders receive retail prices for all loan products, and are paid a commission that is included in the price. For example, on a 30-year fixed-rate mortgage, the LO's price sheet might show 4.875 percent at 1 point, 5 percent at zero points, and 5.25 percent at -1 point, which is a rebate from the lender.

The LO might be paid a commission of 0.7 percent of the loan, which means that he makes more on larger loans. This has long been customary and is permitted by the new rules.

What is not permitted under the new rules is for the LO to sell the customer the 5.25 percent loan and be rewarded by the lender with a larger commission. This has long been the practice in mortgage banking, with the higher price referred to as the "overage."

The new rules don't make overages illegal, but since LOs can't be rewarded for them, they might as well be illegal. The result will be an important and much overdue change in industry practice. Some lenders, in anticipation of the new rules, have already eliminated overages.

A potential evasion by lenders

However, the rule is consistent with a lender response that would leave borrowers no better off, and perhaps worse off. Suppose a lender has an LO, "Smith," who is a major producer and expects compensation of 1 percent, and another LO, "Jones," who is a neophyte willing to accept 0.5 percent.

The lender in such case could provide Smith with a set of retail prices that are 0.5 percent higher than those provided to Jones. The compensation of both LOs would be independent of the prices they offer borrowers, and therefore in compliance with the rules.

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