Loan Originator Compensation: New Rules

On January 24, 2013, as the last of the Final Rules of the Consumer Financial Protection Bureau (CFPB) rolled out, I offered an outline of all of them, entitled "CFPB's Gang of Seven (Final Rules)".

I listed them in order of issuance, as follows:

1. Ability-to-Repay (ATR)
2. High-Cost Mortgage (HCM)
3. Escrow
4. Servicing
5. Appraisals for High-Risk Mortgages
6. Copies of Appraisals
7. Mortgage Loan Originator Compensation

Having come through the last two months responding to numerous questions about these Final Rules, I have been able to cobble together some of the most salient questions, regulatory features, and concerns that our clients have expressed about them. And when I have spoken to the media types, it seems that they also have a set of questions and interests that are not being fully addressed in the current dialogue. Of abiding interest is the change relating to loan originator compensation.

With that in mind, I want to provide a brief outline of some loan originator compensation issues, offering additional details garnered from two months in the trenches working through these regulatory issues on behalf of our clients. From time to time, I will have more to discuss about many regulatory changes anticipated in 2013 and 2014. I am going to conduct this review topic by topic, rather than just as specific regulations subject to a final rulemaking. 

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IN THIS ARTICLE

Terms and Conditions
Retirement Plans
Factors and Proxies
Dual Compensation
Non-loan Originations Services
Points and Fees
Loan Originator Qualifications
Mandatory Arbitration Clause
Single Premium Insurance
Record Retention Requirements

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Terms and Conditions

By now, there is nary a residential mortgage lender or originator that does not know that, under Regulation Z, loan originator compensation is prohibited from being based upon the terms and conditions of a mortgage loan transaction.

The CFPB has provided new nomenclature for the terminology "transaction terms and conditions," without much changing the prohibition and certain exceptions to the standing rule. The new terminology is "term of a transaction," but now with the clarified meaning that term of a transaction means to include "any right or obligation of the parties to a credit transaction."

The usual cast of regulatory prohibitions continue in force. For instance, loan originator compensation is still prohibited from being based on such things as the interest rate of a loan, or upon the inclusion of additional fees or charges for products or services provided by other parties to the transaction. 

And the usual cast of regulatory identifiers of a term of a transaction continue in force. Thus, fees or charges are a term of the transaction if they must be disclosed in the Good Faith Estimate (GFE) or HUD-1 or HUD-1A Settlement Statement (HUD-1). That obviously means to include loan originator or creditor fees or charges for the credit transaction or for a product or service provided by the loan originator or creditor that is related to the extension of credit; and it also means those fees or charges of other parties for any product or service required by the lender as a condition of the extension of credit. Keep in mind, however, that just because a fee or charge is stated on the HUD-1 does not in itself make the fee or charge a term of the transaction.

One rather controversial area involves the off-setting of compensation due to increased costs. The standing rule has provided that loan originator compensation is prohibited from being reduced in response to a change in the transaction terms. This has caused lenders all manner of frustration, not to mention loss of revenues and diminished profits. Yet, the new rule would allow compensation to be reduced in order to offset unexpected increases to estimated settlement costs, otherwise known as "unforeseen circumstances." What is a circumstance that is unforeseen? The imagination reels! But since the CFPB has offered no formal guidance to delineate very specifically what may or may not be an unexpected event, the lender must be extremely careful not to enter these dark waters too briskly.

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Retirement Plans

Profits may be used toward contributions to tax advantaged retirement plans. The important feature is to ensure that such contributions are not be based on the terms of the individual loan originator’s transactions. Non-deferred, profit based compensation plans - such as bonus pools and profit-sharing plans - is permissible. However, any such payments (1) must ensure that compensation is not directly or indirectly based on the terms of the individual loan originator’s transactions, and (2) either the compensation under the plan does not exceed 10 percent of the loan originator’s total compensation for the applicable period or the loan originator was an originator for no more than 10 transactions during the preceding 12 months. 

Whatever the choice, the entity involved must ensure that payments do not include bonuses, awards, trips, or other 'incentive' products or services.

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Factors and Proxies

Although the standing rule provides that loan originator compensation may not be dependent upon a factor that is a “proxy” for what would otherwise be considered a term of a loan transaction, there is clarification now that a factor is a term of a loan transaction “proxy” if it meets these two criteria: (1) the factor varies with a transaction term over a significant number of transactions, and (2) the loan originator, directly or indirectly, has the ability to add, reduce, or change the factor when originating the loan or credit.

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Next Up, Reverse Mortgages!

In a June 28, 2012 Report to Congress, the Consumer Financial Protection Bureau (the CFPB or the Bureau) published its study of reverse mortgage transactions. This study was required by Section 1076 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

The Report surmised that reverse mortgages are not being used as Congress originally intended, because, rather than provide income for borrowers during retirement, reverse mortgages are being provided to consumers at younger ages, thereby increasing the risk that these borrowers will go broke later in life. The study found that almost half of reverse mortgage borrowers in fiscal year 2011 were younger than 70 years of age.

Furthermore, the Report concluded that 70% of reverse mortgage borrowers withdrew all the available funds at once in lump-sum payments, which the CFPB claims can be squandered quickly, leaving borrowers with the potential to face foreclosure due to the reduced ability to pay property taxes. According to the study, nearly 10% of reverse mortgagors (as of February 2012) were at risk of foreclosure.

In its 231 page Report, the CFPB stated the following "emerging concerns":

1. Reverse mortgages are complex products and difficult for consumers to understand.

2. Reverse mortgage borrowers are using the loans in different ways than in the past, which increase risks to consumers.

3. Product features, market dynamics, and industry practices also create risks for consumers.

4. Counseling, while designed to help consumers understand the risks associated with reverse mortgages, needs improvement in order to be able to meet these challenges.

5. Some risks to consumers appear to have been adequately addressed by regulation, but remain a matter for supervision and enforcement, while other risks still require regulatory attention.

The study identified four major topics "where additional research would help determine if additional consumer education or regulatory action is needed."

Those topics are:

(a) Factors influencing consumer decisions;
(b) consumer use of reverse mortgage proceeds;
(c) the longer-term outcomes of reverse mortgages; and
(d) the differences in market dynamics and business practices among the broker, correspondent, and retail channels.

On July 2, 2012, the CFPB began the process of investigating the consumer use of reverse mortgages. This procedure begins with a Notice and Request for Information. In effect, that CFPB now seeks comment and information from the public on the aforementioned topics.

In this review of reverse mortgages, the CFPB will undertake, among other things, to identify any practice as unfair, deceptive, or abusive, and may provide for an integrated disclosure standard and model disclosures. Additionally, it will seek detailed information from the public on the factors that influence reverse mortgage consumers' decision-making, consumers' use of reverse mortgage loan proceeds, longer-term consumer outcomes of a decision to obtain a reverse mortgage, and differences in market dynamics and business practices among the broker, correspondent, and retail channels for reverse mortgages.

In this article, I will outline the scope of information that the CFPB is seeking from the public, including consumers, housing counselors, financial institutions, and others, regarding consumer use of reverse mortgages and consumer experiences during the reverse mortgage shopping process.*

Factors Influencing Consumer Decisions

The CFPB asks the following questions regarding the factors that influence consumer decisions:

1. What factors are most important to consumers in deciding whether to get a reverse mortgage?

2. What factors are most important to consumers in choosing among products? Among other things, comments could address the choice between fixed-rate, lump-sum reverse mortgages and adjustable-rate, line-of-credit or monthly disbursement reverse mortgages.

3. What factors are most important to consumers in choosing among potential lenders?

Consumer Use of Reverse Mortgage Proceeds

4. Nearly 75% of recent reverse mortgage consumers took out all of their available funds upfront in a lump sum.
   

a. What do consumers do with these funds?
b. Where do consumers place loan money that they do not use immediately? (i.e., in a savings account, an investment account, a certificate of deposit (CD), et cetera).

5. Some reverse mortgage consumers use reverse mortgage loan funds to refinance a traditional mortgage or home equity loan/line of credit.
   

a. What proportion of consumers are using reverse mortgage loan funds to refinance a traditional mortgage or home equity loan/line of credit?
b. What proportion of the loan funds are typically spent on paying off an existing mortgage?
c. Do consumers using a reverse mortgage to refinance an existing mortgage typically consider other options first (e.g. moving to a different home or a traditional refinancing)? If not, why not? If so, what factors lead them to choose a reverse mortgage instead?
   

6. Some reverse mortgage consumers use reverse mortgage loan funds to consolidate non-housing debts.
   

a. What proportion of borrowers use reverse mortgage loan funds to
consolidate non-housing debts?
b. What proportion of the loan funds are typically spent on consolidating non-housing debts?
c. What types of non-housing debts are typically consolidated (i.e., credit card, auto, medical-related debt, et cetera)?

CFPB's Flatland Fee

Kicked in the gut by a "flat fee" proposal, the already winded mortgage industry seems to be barely able to catch its breath from the CFPB's recent lurching toward yet another vaguely expected and somewhat ill-defined nostrum.*

The pattern replays itself time and again: first the news, followed by the rulemaking proposal, which is then given a brief period for public acquiescence or remonstrance; and then inevitably the final rule, which is much like the initial proposal. Early on, industry associations issue a Call to Action!

Alas, when the Federal Register publishes the effective compliance date, everybody falls in line and scrambles to adjust. Sometimes, a few organizations even threaten litigation, though, when tried, litigating has not thus far brought about much satisfaction.

Exactly what is this Flat Fee debacle?

Let's take a peek at this flatland mystery.

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IN THIS ARTICLE

DAY OF RECKONING

FLATLAND FEE

YET ANOTHER COMMITTEE

OVERVIEW AND QUESTIONNAIRE

BEFORE AND AFTER

CREDITOR-PAID COMPENSATION - BEFORE AND AFTER

CONSUMER-PAID COMPENSATION - BEFORE AND AFTER

BROKERAGE-PAID COMPENSATION - BEFORE AND AFTER

BRIEF DISCUSSION

RECAPITULATION

LIBRARY

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DAY OF RECKONING

On the day that the CFPB announced the Flat Fee - along with a wish list of other proposals - the New York Times explained the CFPB's position in this way:

"Bureau officials said that the rules, which were released Wednesday ahead of formal introduction this summer, would ban mortgage companies from charging origination fees that vary with the amount of the loan.

Those fees are sometimes referred to as origination points and are disclosed in a blizzard of documents and fees that most home buyers face at closing. But they can easily be confused with the upfront discount points that borrowers often pay to secure a lower interest rate."

The May 9, 2012 article came accoutered with Richard Cordray's observation that "Mortgages today often come with so many different types of fees and points that it can be hard to compare offers ... We want to bring greater transparency to the market so consumers can clearly see their options and choose the loan that is right for them."

It is not as if we did not see this coming. We did! At least those of us compliance nerds, wonkishly spending time around our own wonkish types, rubbing elbows with regulators, lobbyists, agencies officials, congressional staff, industry associations, and everything in between.

Still, keeping it real, even when we know that something unpleasant is coming, nevertheless a sense of disbelief is often provoked when the day of reckoning finally arrives.  

The Flat Fee, which I shall henceforth call the Flatland Fee, has now emerged from its gestational limbo.

FLATLAND FEE

In its announcement of May 9, 2012, wearisomely titled in the manner of a 17th century dogmatic text "CONSUMER FINANCIAL PROTECTION BUREAU CONSIDERS RULES TO SIMPLIFY MORTGAGE POINTS AND FEES - Rules Would Bring Greater Transparency to the Mortgage Market" (caps in the original), the CFPB stated that its recipe for "transparency" is to:

"Ban Origination Charges that Vary with the Size of the Loan:

Brokerage firms and creditors would no longer be allowed to charge origination fees that vary with the size of the loan. These 'origination points' are easily confused with discount points. Instead, under the rules the CFPB is considering, brokerage firms and creditors would be allowed to charge only flat origination fees."

Let me broaden this statement out for you:

The CFPB will allow the consumer a choice of paying discount points in creditor-paid transactions only if: (1) the points actually result in a "minimum reduction" in the interest rate for each point paid; and (2) the lender also offers the option of a no discount point loan. (At this time, the CFPB actually provides no details for the correlation between "minimum reduction" and the interest rate.)

The CFPB would allow a consumer to pay up-front origination fees in creditor-paid transactions only if it is a flat amount that does not vary with the size of the loan (and if it is not compensation to the individual loan originator).
 

According to the CFPB, this proposal is supposed to "preserve consumers' choices while increasing transparency."

YET ANOTHER COMMITTEE

Pursuant to Dodd-Frank the CFPB must convene a small business panel, consisting of consumers and industry representatives, the purpose of which is to determine the effects of new regulations on financial institutions subject to the new requirements.

The CFPB will be sharing with these small businesses an overview of the proposals under consideration and a list of questions for input. After its review, the panel's participants are supposed to provide feedback to the panel on the proposals the CFPB is considering and suggest alternatives. At the conclusion of its review, the panel will issue a report to the CFPB that summarizes this feedback. And, from that point on, the CFPB is expected to consider the panels findings when formulating the proposed rule.

CFPB Offers A View Of Profit Sharing

The CFPB recently announced that it will update the TILA loan originator compensation rule (Rule) in July of 2012. The updated rule may cause some new concerns regarding the implementation of the current Rule or it just may actually provide some sorely needed repairs for issues, strange and otherwise, that have dogged the Rule from the very start.

One issue in particular has been fomenting all along: the FRB's interpretation of the Rule (and the interpretation informally adopted by the FDIC) regarding contributions made to retirement plans on behalf of loan originator employees. The FRB deemed such contributions to be compensation and subject to the restriction that compensation cannot be based on the terms and conditions of the loan transaction. This is because the FRB asserted that profits were considered a proxy for loan terms and conditions.

Recently, the CFPB has weighed into this matter by declaring that employers should be permitted to contribute to "Qualified Plans" out of a profit pool derived from loan originations.

So let's discuss what this all means and if this issue is really resolved! *

IN THIS ARTICLE

Profit Sharing Debacle
Contortions
Bulletin 2012-02
Interpreting the Bulletin
"Heads-Up" Regulating

Profit Sharing Debacle

Contributions to a profit sharing plan pose a significant challenge to mortgage brokers or bankers whose sole source of profitability is from the origination of loans. If the broker only brokers loans, then the income received was already subject to the restriction that it could not be based on the terms and conditions of the credit extended.

Thus, the profit sharing contribution also would not be based on the terms and conditions.

If, on the other hand, a mortgage banker funds the loans with its own money and makes a profit from a true secondary market transaction that is allowed to be dependent on the terms and conditions of the credit extended, it will be much harder to make a profit sharing contribution and effectively assert that the payment is not dependent on the terms and conditions of the credit extended.

For those entities, there might be a need to revise the 401(k) plan to make it a nondiscretionary plan so that such profits play no part in determining whether a contribution is made or the amount of the contribution.

There has been considerable debate on how or whether profit sharing plan contributions may accept compensation. If the contribution is tied to profits, and profits are tied to the origination of loans, a portion of which might be determined by the terms or conditions of the transaction originated, then the FRB asserted that no contribution could be made. This becomes particularly problematic because Employee Retirement Income Security Act (ERISA) rules generally do not allow for contributions to be made for some employees but not for other employees. Thus, this would have the effect of eliminating contributions for all employees.

So here is the debacle: In order for a lender to make the contributions for loan originators without running afoul of the Rule, it is the lender's responsibility to show that the contribution was not based on the terms and conditions of the credits extended.

Contortions

I will list just some of the contortions that loan originators have had to deal with thus far, depending on the profit sharing plan:

Plans with matching contributions: There would be no difficulty in showing the amount of the contribution was independent of the terms and conditions of the credit transaction because the amount of the contribution is based on the amount contributed by the employee.

Non-discretionary plans: Where the contributions must be made in a fixed amount irrespective of "profits," there would be a valid case that the amount of the contribution is not based on the terms and conditions of credit extended.

Discretionary non-elective or matching contributions: That are not tied directly to specific profit targets, is a more complicated issue, but could be supported by the point that all employees, mortgage originators or not, receive the same amount. In other words, no originator received compensation tied to the loan terms and conditions because others were compensated equally irrespective of loan terms and conditions.

Discretionary plan tied to specific profit targets: Would likely need to exclude the income from loan originations to avoid a challenge that the payment was based on the terms and conditions.

And, of course, any plan that sets the amount of the contribution based entirely on the income an originator generated would definitely violate the regulation. 

Bulletin 2012-02

Since the CFPB issued its April 2, 2012 CFPB Bulletin 2012-02  (Bulletin) that dealt, in part, with profit sharing, various media outlets and industry associations have applauded it for "clarifying" that the Rule does not ban loan originators from participating in employee stock ownership plans (ESOPs) or 401(k) plans - so-called "Qualified Plans."

One prominent law firm provides the Bulletin's exact text, which states that "employers of loan originators may make contributions to employees' qualified profit sharing, 401(k), and stock ownership plans (qualified plans) out of a profit pool derived from loan originations."

Another highly-respected law firm issued a notice, stating the CFPB "has confirmed that Regulation Z (which implements the Truth in Lending Act) does not prohibit mortgage loan originators from participating in qualified profit-sharing 401(k) or employee stock ownership plans (Qualified Plans)."

The plain reading of the Bulletin's text seems to provide a somewhat more nuanced view!

FRB: Mortgage Rulemaking Chart 2008 - 2011

On Wednesday, we notified you about the testimony given by witnesses in the hearing held by the Insurance, Housing and Community Opportunity Subcommittee (Committee of Financial Services) held a hearing, entitled "Mortgage Origination: the Impact of Recent Changes on Homeowners And Businesses."

The overall purpose of the hearing was to evaluate recent changes to mortgage origination laws, with particular focus on the impact the new laws and regulations have on consumers and credit availability in the mortgage finance markets.

During the hearing, Sandra Braunstein, the FRB's Director of Division of Consumer and Community Affairs, provided written testimony containing a table entitled "Summary of Federal Reserve Board Mortgage Rulemakings - 2008 through 2011."

I have removed the table from the written testimony and featured it separately in our Library. 

MORTGAGE RULEMAKINGS - 2008 THROUGH 2011

FINAL RULES

• Home Ownership and Equity Protection Act (HOEPA): Final Rule
• Mortgage Disclosure Improvement Act, Part I: Final Rule
• Mortgage Disclosure Improvement Act, Part II: Interim Final Rule
• Helping Families Save Their Homes Act - Mortgage Transfer Disclosure: Final Rule
• Loan Originator Compensation: Final Rule
• Dodd-Frank Act - Appraisal Independence: Interim Final Rule
• Dodd-Frank Act - Escrow Account: Final Rule

PROPOSED RULES

• Regulatory Review of Disclosure Rules for Closed-end Mortgages (Phase I)
• Regulatory Review of Disclosure Rules for Home Equity Lines of Credit (HELOCs) (Phase I)
• Regulatory Review of Mortgage Disclosure Rules (Phase II)
• Dodd-Frank Act - Escrow Account Disclosures
• Dodd-Frank Act - Ability to Repay/Qualified Mortgages

LIBRARY

Summary of Federal Reserve Board Mortgage Rulemakings

2008 through 2011 

Statement of Sandra F. Braunstein, Director
Division of Consumer and Community Affairs, Federal Reserve System
Insurance, Housing, and Community Opportunity Subcommittee
(Committee on Financial Services)
July 13, 2011