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dodd-frank
How the new Dodd-Frank Loan Officer Compensation Rules will Affect Home Buyers
On April 1, 2011, the new Dodd-Frank Loan Officer Compensation Rules (Reg Z) imposed by the Federal Reserve took effect. The intent of Reg Z is to regulate loan officer compensation and introduce new “anti-steering” provisions. Reg Z changes how all loan originators (not just mortgage brokers) are paid for originating closed-end loans secured by the borrower’s dwelling.
Prohibitions under the Reg Z amendment include:
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Basing loan officer compensation on loan terms or conditions other than loan amount
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Compensation paid from both the consumer and the lender to the loan officer
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Steering the borrower into a loan that is not deemed in their best interest but results in higher compensation to the loan originator
Historically, mortgage brokers and their sponsored originators received compensation from the fees they charged the borrower and from the lender funding the loan (yield spread). The compensation from the lender increased in direct proportion to the magnitude of the interest rate locked. For example, a 30-year 4.75% loan paid the originator less than would the same loan locked at 5.00%. Skilled mortgage originators were able to balance the two income streams to “custom-fit” the loan to the client’s needs. In the case of a rate-sensitive client, the lowest rate could be locked resulting in little or no lender compensation, while the borrower fees adequately paid the originator. Conversely, the cash-strapped first-time buyer could close with a slightly higher rate which allowed for lender compensation to pay the originator while minimizing closing costs to the borrower. Under the new Fed Rule, this art form has been deemed illegal.
The perception was that the yield spread premium was a hidden under-the-table payment that went largely undetected and caused borrowers to be “steered” into high rate programs. On January 1, 2010, Reg Z changes mandated that the yield spread be clearly identified in all loan applications via the Good Faith Estimate and be paid directly to the borrower. Since January 1, 2010 no loan originator has received one cent of yield spread premium. With the imposition of the new Fed Rule, the yield spread premium has, effectively, been taken away from the borrower and returned to the lender.
The Fed Rule mandates that loan originators who select lender-paid compensation for any transaction must be paid no more and no less than a previously selected percentage. This rate (typically 2%-2.5%) is determined through an amended agreement to the brokers/lenders contract. Once the application has been signed by the borrower, no changes to the originator compensation are allowed. When the inevitable unforeseen event (read costly) happens as the loan progresses through underwriting to closing, the increased costs must be paid by the lender. The borrower cannot be charged additional fees (e.g. lock expirations, appraisal reviews etc.) and the originator’s compensation is guaranteed. An effect of this rule is the lenders will have to anticipate these events and incorporate them into their future rate structures. Who suffers? The obvious answer is the consumer.
Conversely, the transaction can be submitted to the lender as a borrower paid loan. Here is where the damage done by the Fed Rule reaches its most insidious depth. Traditionally, the loan revenue would flow to the mortgage broker who would then cut a check to the loan officer for their contractual percentage and fees. The Fed Rule absolutely prohibits the loan officer from being paid by the broker in a lender paid scenario. The loan officer cannot be compensated unless they can collect payment directly from the borrower at closing, which transcends the bounds of professionalism!
Also, loan officers must be paid hourly or salaried and cannot participate in any loan revenue bonus programs. Small mortgage brokers across the country will no longer be able to retain loan officers unless they have been exceptional producers who must be retained with salaries or attractive hourly packages. Many thousands of loan originators inevitably will leave the industry, abandoning their clients to the higher cost and higher rate retail banks.
Lastly, the Fed Rule acts in the favor of the retail banks in another significant manner. When an originator who works as a banker (i.e. the entity funding the loan) the compensation paid by the lender is labeled a service release premium (SRP). This is no different than a yield spread premium; however, it is not regulated in the same manner because the employer of the originator must either sell the loan in the secondary market before collecting the SRP or retain and service it. Therefore, these bankers can designate all loans as borrower paid transactions while continuing to collect the SRP on the backside of the transaction. For bankers and warehouse lenders who close in their own name it’s business as usual.
It is vividly obvious that the vague idea of the inequity of the yield spread premium has been contorted into new regulations. These shortsighted regulations will harm the consumer, force thousands into the unemployment office, and will only serve to line the coffers of the major retail banks.
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