Financial Regulatory Reform: The New Rules on Loan Originator Compensation

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1 Financial Regulatory Reform: The New Rules on Loan Originator Compensation 1

2 Introduction NOTICE: This information is not intended to be used as legal advice to any person or entity. The information contained in this presentation has been compiled from various public sources. Please consult your counsel for additional information. 2

3 Introduction What is the Final Rule? On August 16, 2010, the federal Reserve Board issued a final rule to address loan originator compensation practices 75 Fed. Reg. 185 (Sept. 24, 2010) The Federal Reserve Board (FRB) has announced an amendment to Regulation Z, the implementing regulation for the Truth in Lending Act (TILA), regarding loan originator compensation (the Final rule). The Final Rule, effective for all loan applications received on or after April 1, 2011, regulates mortgage originator compensation and prohibits steering for all mortgage loan originators, in an effort to protect borrowers from unfamiliar lending and abusive compensation practices Effective date: April 1 st,

4 Introduction Goals of the new rule Protect mortgage borrowers from unfair, abusive, or deceptive lending practices; and Help ensure that consumers can choose from loan options that include the lowest interest rate and lowest amount of points and origination fees 4

5 Introduction What transactions are covered by the new rule? All closed-end consumer credit transactions secured by first of subordinate liens on a dwelling that are subject to TILA Includes closed-end reverse mortgage transactions All owner occupancies (first and second homes) All lien positions What transactions are not covered by the new rule? Open-end loans (ie: HELOCs) Timeshares Loan modifications not rising to level of refinance under Reg. Z Loans secured by real property that do not a dwelling (ie: vacant land) Loans not covered by TILA (ie: business purpose loans, such as a loan secured by a home purchased for use as a rental property) 5

6 Introduction Three main prohibitions in the new rule: Compensation based on loan terms or conditions: Loan originators may not receive compensation that is based on loan terms or conditions, other than loan amount Compensation from multiple sources: Loan originators may not receive compensation from the lender or other parties if the loan originator is receiving compensation directly from consumer Steering: Loan originators are prohibited form directing or steering a consumer to accept a mortgage loan that is not in the consumer s interest to increase the loan originator s compensation 6

7 Prohibition #1 Loan Terms 7

8 Prohibition #1 Loan terms or conditions: No loan originator shall receive and no personal shall pay a loan originator directly or indirectly, compensation based on any of the loan terms or conditions What is a loan term or condition? No express definition, but examples provided: Interest rate Annual percentage rate LTV ratio Prepayment penalty A factor that,, while not itself a loan term or condition, serves as a proxy for a loan term or condition (e.g. credit score or DTI ratio) On express exclusion also provided: Loan amount (when the loan originator s compensation is based on a fixed percentage of the loan amount) 8

9 Prohibition #1 Loan terms or conditions example: Practice Tip: credit score or DTI ratio is a proxy for a loan term or condition when either of these factors results in different interest rates for the same loan to different consumers, and the loan originator s compensation from the same creditor for these loans varies in whole or in part based on either of these factors Practice Example: Consumer A and Consumer B receive loans from the same loan originator and creditor. Consumer A has a credit score of 650, and Consumer B has a credit score of 800 Consumer A s loan has a 7% interest rate, and Consumer B s loan has a 6.5% interest rate because of the consumer s difference in credit score The creditor pays the loan originator $1,500 in compensation for Consumer A s loan and $1,000 in compensation for Consumer B s loan. NOT PERMITTED because the creditor varies compensation payments in whole or in part with a proxy for a loan term or condition (i.e. the consumers credit scores reflect difference in interest rate) 9

10 Prohibition #2 Compensation From Multiple Sources 10

11 Prohibition #2 Brokers cannot collect compensation from both the borrower and the lender. On a level basis, the broker will be required to designate at the time of application the compensation method; Borrower-paid or Lender-paid The broker may choose which method works best for their respective business model. However, once the compensation method is selected, it may not change for that transaction For purposes of loan originator compensation, seller contributions are considered paid by the consumer. 11

12 Prohibition #2 Borrower-Paid Highlights Amount of compensation is negotiated between you and your borrowers Borrowers may use credits from the interest rate chosen to pay for third party fees, but such credits may not be used to cover any amount of the Borrower-Paid Broker compensation Brokers can lower compensation, pay for tolerance violations or offer credits towards third party costs Borrowers may pay discount points to reduce their interest rate 12

13 Prohibition #2 Lender-Paid Highlights 100% of the Broker s compensation must be paid by Majestic Home Loan. For purposes of the Final Rule, Yield Spread Premiums will always be considered Lender-paid. Compensation must match exactly to Broker s schedule of fees on file with company Borrowers may also use credits from the interest rate chosen to pay for third party fees Borrowers may pay discount points to reduce the interest rate Broker may not reduce commission to pay for tolerance violations, credit third party fees or offer other concessions 13

14 Prohibition #2 Borrower-Paid vs Lender-Paid Comparison Borrower-Paid Lender-Paid Source of Compensation All broker compensation paid by the borrower at closing with their own funds or with the proceeds of the loan All broker compensation paid by Majestic Home Loan through interest rate yield Amount of Compensation Loan Officer Compensation Premium Pricing Credit Broker negotiates broker origination fee and processing fee directly with the borrower Hourly wage or salary only Any premium pricing credit must be credited to the borrower and may only be used to pay third party closing costs and any Majestic Home Loan lender fee. *May not be used to pay any origination charge. Broker will choose their compensation margin in which they wish to operate; subject to change during a 5 day review period every 30 days Subject to agreement between broker company and loan officer Any premium pricing credit must be credited to the borrower and may be used to pay third party closing costs, broker fees and any Majestic Home Loan fee Steering Provision Not Applicable Title and Settlement Services Concessions Tolerance cures are deducted from compensation. Broker credits allowed. No broker credits. Origination may not be reduced at any time during the transaction. 14

15 Prohibition #2 Lender-Paid Compensation The following shows a sample rate sheet and the proper disclosure of lender-paid compensation on the GFE. For this example, the loan amount is $200,000. The rate selected is 4.750% for a 30 day lock and the above par pricing to the consumer is 1.134% or $2,268 Lender-Paid Broker Compensation is at a 2% margin; Lender fee = $795*; Title and settlement services = $3,000. Rate Lender Paid Scenario Agency 30 Year Fixed+ 30 day NOTE: The borrower credit can be used to pay all fees in Box 1 including broker compensation *Lender Fee can vary by state. GFE Section Amount Calculation Block 1 $4,795 Lender-Paid 2% broker comp. + Lender Underwriting Fee Block 2 $2,268 Discount paid by borrower Block A $7,063 Block 1 + Block 2 Block B $3,000 Title and Settlement Services Total Fees Paid by Borrower Total Broker Compensation $10,063 Block A + Block B $4,000 Broker Fee 15

16 Prohibition #2 Borrower-Paid Compensation The following shows a sample rate sheet and the proper disclosure of borrower-paid compensation on the GFE. For this example, the loan amount is $200,000. The rate selected is 4.750% for a 30 day lock and the above par pricing to the consumer is.866% or $1,732. Negotiated Broker Fee = $3,500; Broker Processing Fee = $500; Lender Fee = $795*; Title and Settlement Services = $3,000. Borrower-Paid Scenario Agency 30 Year Fixed+ Rate 30 day GFE Section Amount Calculation Block 1 $4,795 Block 2 ($1,732) Block A $3,063 Block 1 + Block 2 Broker Fee + Broker Processing Fee + Lender Underwriting Fee Credit to borrower of.866% for an interest rate of 4.750% Block B $3,000 Title and Settlement Services NOTE: The borrower credit can be used to pay all fees in Box 1 including broker compensation *Lender Fee can vary by state. Total Fees Paid by Borrower Total Broker Compensation $6,063 Block A + Block B $4,000 Broker Fee + Broker Processing Fee 16

17 Prohibition #2 How to complete the GFE Block A The following shows a sample GFE and what fields need to be completed. Block 1 Broker Fee + Broker Processing Fee + Lender Underwriting Fee or Lender-Paid Broker Comp + Lender Underwriting Fee Block 2 Credit to Borrower of.866% for an interest rate of 4.750% or Discount paid by borrower. Block A Block 1 + Block 2 17

18 Prohibition #2 How to complete the GFE Block B The following shows a sample GFE and what fields need to be completed. Block B Total Title and Settlement Fees Total Fees for Consumer Block A + Block B 18

19 Prohibition #3 Steering 19

20 Prohibition #3 How does the rule prohibit steering Loan originators are prohibited from directing or steering a consumer to a dwelling-secured loan based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator offered or could have offered, unless the consummated transaction is in the consumer s interest. Directing or steering = advising, counseling, or otherwise influencing a consumer to accept a particular dwelling-secured loan Transaction must be closed 20

21 Prohibition #3 What does it mean to be in the consumer s interest? The transaction must be compared to other possible loan offers available through the originator (if any) for which the consumer was likely to qualify at the time of the transaction Possible loan offer = an offer that the creditor likely would extend upon receiving an application from the consumer (ie; offer does not need to actually be extended) Available = loan could be obtained from a creditor with which the loan originator regularly does business Likely to qualify = based on a creditor s standards and credit terms at the time of the transaction Good faith belief Based on information reasonably available May rely on information provided by consumer, even if subsequently determined to be inaccurate Loan originator not expected to know all aspects of creditor s underwriting criteria (only pricing and other information creditors routinely communicate to loan originators, such as rate sheets and minimum credit scroes) 21

22 Prohibition #3 Three ways to satisfy the prohibition: 1. Creditor Employees: Loan originator employees of creditors complying with the provisions of the rule prohibiting compensation based on loan terms and conditions in originating loans for their creditoremployers (ie; loan not brokered to another creditor) are deemed to comply with the steering prohibitions - Employee loan originators must comply with either 2 or 3 below when brokering a loan to another creditor. 2. Safe Harbor: Satisfy the Safe Harbor requirements 3. Least amount of Compensation: The loan originator reviews possible loan offers available from a significant number of creditors with which the originator regularly does business and directs consumer to the transaction that will result in the least amount of creditor-paid compensation to the loan originator. 22

23 Prohibition #3 Significant number of creditors = 3 or more creditors with whom loan originator regularly does business If loan originator regularly does business fewer than 3 creditors, loan originator is deemed to comply by obtaining offers from all creditors with whom it regularly does business Regularly does business = a loan originator regularly does business with a creditor if: There is a written agreement between the originator and the creditor governing the originator s submission of mortgage loan applications to the creditor; The creditor has extended credit secured by a dwelling to 1 or more consumers during the current or previous calendar month based on an application submitted by the loan originator; or The creditor has extended credit secured by a dwelling 25 or more times during the previous 12 calendar months based on applications submitted by the loan originator. For this purpose, the previous 12 calendar months begin with the calendar month that precedes the month in which the loan originator accepted the consumer s application 23

24 Prohibition #3 How is the Safe Harbor satisfied? 1. Consumer must be presented with loan options from a minimum number of 3 creditors with whom the loan originator regularly does business, that includes: A loan with the lowest interest rate; A loan with the lowest interest rate with no risky features (e.g. negative amortization, prepayment penalty, interest-only payments, balloon payment within first 7 years, demand feature, shared equity, shared appreciation); and A loan with the lowest total dollar amount for origination points or fees and discount points 2. If more than 3 loan options are presented for each type of transaction, loan originator should highlight the three loan options which meets the above criteria; and Less than 3 loan options for each type of transaction may be presented if the option(s) presented satisfy the above criteria (e.g., 1 loan meets all the requirements) 3. Loan originator believes in good faith that the consumer likely qualifies for the loan options presented 24

25 Prohibition #3 What is not required by the anti-steering provisions? Loan originator is not required to meet the safe harbor requirements Failure to satisfy the safe harbor does not subject the loan originator to any presumption that the loan originator failed to comply with the anti-steering provisions of the rule Loan originator is not required to establish a business relationship with any new creditors Loan originator is not required to inform a consumer about a potential transaction if the originator makes a good faith determination that the consumer is not likely to qualify Loan originator is not required to direct a consumer to the transaction that will result in a creditor paying the least amount of compensation to the originator Practice Tip: What is a creditor s liability for a broker violation of the prohibition on steering? A creditor s liability for a broker s violation with the steering provisions is not addressed under the Rule We strongly recommend that creditors impose a requirement on brokers to deliver a copy of a document evidencing compliance with these provisions (i.e., a borrower-signed document showing that he/she was offered loan options meeting the safe harbor) 25

26 Understanding Compensation 26

27 Understanding Compensation What is compensation? Fees the loan originator retains or keeps, regardless of the label or name given or associated with the fee Salaries, wages, commissions, and any financial or similar incentive, including: Annual or periodic bonuses; and Awards of merchandise, services, trips, or similar prizes What is not compensation? Amounts a broker receives and passes through for bona fide and reasonable third party charges (e.g. title insurance or appraisals) Contract Processing is a bona fide third party charge as long as the fee is paid through escrow/closing agent to a processing entity. 27

28 Understanding Compensation Broker Compensation Examples 1) Mortgage Broker charges a $400 application fee and uses that amount to pay $350 for a property appraisal and $50 for a credit report. Application fee does not constitute LO compensation for the purpose of the rule 2) Mortgage Broker deliberately marks up a third-party fee and retains the difference Mark-up amount retained is LO compensation 3) Mortgage broker is uncertain of the cost of a third-party charge at the time the $400 application fee is charged (ie; mortgage broker chooses from a list of appraisers that usually charge in a range of $300-$400 for a typical appraisal), and later the appraisal fee is determined to come in at $300 (ie; $50 less than expected) Mortgage broker may retain the $50 without it being deemed compensation under the FRB rule 28

29 Understanding Compensation What are permissible compensation methods? Compensation based on: Fixed percentage of the loan amount, where the fixed percentage remains the same for all loans (no tiers based on loan amount). Fixed minimum or maximum dollar amounts permitted. Overall loan volume (i.e. total dollar amount of credit extended or total number of loans originated) delivered to the creditor 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 or new customer Payment that is fixed in advance for every loan the originator arranges for the creditor (e.g. $600 for every loan arranged for the creditor, or $1,000 for the first 1,000 loans arranged and $500 for each additional loan arranged) Percentage of applications submitted by the loan originator to the creditor that result in consummated transactions Quality of the loan originator s loan files (e.g. accuracy and completeness of the loan docs) or Legitimate business expenses, such as fixed overhead costs 29

30 Understanding Compensation Can Broker compensation be revised? If so, when? YES Periodic Revisions A creditor or other person paying a loan originator may periodically revise the loan originator s compensation prospectively, so long as the revised compensation is not based on a loan s terms or conditions. Factors such as loan performance, loan volume, and current market conditions may be reviewed and a loan originator s compensation revised prospectively based on that review. Majestic Home Loan allows one (1) tier change every 30 days. In order to request a tier change, a new Compensation Agreement must be completed and submitted online through the MTrac system. NO Modification of Loan Terms When a creditor offers a loan with specific terms and conditions, and subsequently, different terms or conditions are negotiated for that loan, the loan originator s compensation for that loan may not increase or decrease based on the renegotiated terms and conditions 30

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