Loan Officer Compensation Reform

QUESTION 

We are a Mini-Correspondent located in the Northwest. We mostly originate QM loans. When we do non-QM loans, we broker them. We've been in business for almost twenty years, and there are eight of us. All our compensation comes from the originating. 

I am interested in all the talk about how Congress plans to change the LO compensation regulations. Frankly, what I've read is complicated. I want to know what issues are involved. And, I want to know how Congress is planning to deal with those issues. 

My mortgage broker organization has put out some information about their position. And the lenders' organization has taken a position. But I am not sure what all the complaining is about. I'm not saying that some change is not needed. I just can't figure out what the change is supposed to be.

 My question is, what reforms are they trying to make to the LO compensation rule? 

SOLUTION 

Loan Officer Compensation Policy 

RESPONSE 

The arguments and proposals for loan officer compensation reform are somewhat complicated. So, trying to navigate their implications can be daunting. The Community Home Lenders of America (CHLA) recently released a white paper advocating for reforms to the loan originator (LO) compensation rule, specifically calling for Congress to narrow the scope of the current regulations.[i] The CHLA argues that the current rules, designed to prevent predatory lending practices, have unintended consequences that harm consumers and stifle competition within the mortgage industry. 

I'll provide you with some of the positions outlined in the CHLA's white paper. We are tracking these suggested reforms, as we do virtually all other federal and state regulatory compliance matters that affect banks and non-banks involved in residential mortgage loan origination and servicing. When appropriate, we will issue updates and alerts through our newsletters. 

I will outline the reform issues by outlining some of the main concerns, the proposed reforms, and the actions suggested to effectuate change. My outline contains sections and subsections to reduce the complexity of the subject issues. In the last section, I will delve a bit deeper. Keep in mind, though, there is considerable complexity, and my explication is not meant to be comprehensive. 

The CHLA's Main Concerns 

The CHLA has expressed several concerns. The following four, in broad strokes, are perhaps the main concerns. 

Harm to Consumers 

The CHLA argues that the current LO compensation rules, which restrict how much lenders can pay their loan originators, can effectively prevent lenders from matching competitors' offers and potentially result in borrowers missing out on better deals. 

Stifled Competition 

The CHLA claims that these rules create an uneven playing field, where brokers can offer more flexible compensation structures than retail lenders, hindering competition and limiting borrower choices. 

Unintended Consequences 

The CHLA contends that the rigid regulations discourage loan officers from working with borrowers over extended periods and make it less attractive for lenders to offer loans through State Housing Finance Agency (HFA) bond programs, which are crucial for low-income and minority borrowers. 

Focus on Inter-Firm Compensation 

The CHLA suggests that the original intent of the Dodd-Frank Act's LO compensation rule was to address yield spread premiums between firms, not to restrict compensation within a lender's own organization. 

the CHLA's Proposed Reforms 

Allow Matching Competitor Offers 

The CHLA proposes allowing lenders to reduce compensation to their loan originator employees to match a competing offer for the same borrower.

Fee Splitting Violations

QUESTION 

We were cited for two RESPA violations. The first thing we supposedly had was an undisclosed referral arrangement. But in our view, there was no increase in our charges, so we do not believe we did something wrong. 

The other violation was about fee splitting. I became a mortgage broker a year ago. I am not a compliance person, and I don’t even know what that is, but based on the banking department’s letter, it means we had an arrangement with a company to split the fees on a mortgage loan. Now, I disagree about us even having such an arrangement, let alone splitting any fees. I now have to prove it to the banking department. 

I need to know more. I want to understand how these violations could cause such a big response from the banking department. I have other questions, but these are the two that matter most to me. I contacted your Brokers Compliance Group to discuss everything. 

Did we actually violate RESPA if there was no increase in our charges? 

Are there exemptions to the prohibitions on referral fees and fee splitting? 

COMPLIANCE SOLUTIONS 

Brokers Compliance Group 

Policies and Procedures 

ANSWER 

RESPA (Real Estate Settlement Procedures Act) refers to a “thing of value” as including, but not limited to, any payment, advance, funds, loan, service, or other consideration.[i] To broaden this concept, a “thing of value” includes, without limitation, monies, things, discounts, salaries, commissions, fees, duplicative payments of a charge, stock, dividends, distributions of partnership profits, franchise royalties, credits representing monies that may be paid at a future date, the opportunity to participate in a money-making program, retained or increased earnings, increased equity in a parent or subsidiary entity, special bank deposits or accounts, special or unusual banking terms, services of all types at special or fee rates, sales or rentals at special prices or rates, lease or rental payments based in whole or in part on the amount of business referred, trips and payment of another person’s expenses, or reduction in credit against an existing obligation. My firm has come across many types of “thing of value” arrangements at one time or another. You get the point! 

By the way, the term “payment” is effectively synonymous with the giving or receiving of any “thing of value” and does not require a transfer of money.[ii] 

If you have a particular arrangement for referrals, and you are not sure if the arrangement violates RESPA, contact a competent compliance professional to discuss your plans. 

With respect to your view that there was no increase in the charge, therefore, there should be no violation of RESPA, you are 100% wrong. The fact that the transfer of a thing of value does not result in an increase in any charge made by the entity giving the thing of value is irrelevant in determining whether the act is prohibited.[iii] 

The answer about exemptions[iv] to the referral and fee splitting prohibitions is both specifically outlined in RESPA with examples. I will provide a brief outline here; however, a compliance evaluation should be undertaken to ensure any plan based on an exemption is thoroughly vetted by a compliance professional. 

The RESPA specifically provides seven exemptions to referral and fee splitting prohibitions. 

The RESPA exemptions are: 

1.   A payment to an attorney at law for services actually rendered; 

2.   A payment by a title company to its duly appointed agent for services actually performed in the issuance of a policy of title insurance; 

3.   A payment by a lender to its duly appointed agent or contractor for services actually performed in the origination, processing, or funding of a loan; 

4.   A payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed; 

5.   A payment pursuant to cooperative brokerage and referral arrangements or agreements between real estate agents and real estate brokers;[v] 

6.   Normal promotional and educational activities that are not conditioned on the referral of business and that do not involve the defraying of expenses that otherwise would be incurred by persons in a position to refer settlement services or business incident thereto; or 

7.  An employer’s payment to its own employees for any referral activities. 

I would argue that each of these examples requires significant explication by a compliance professional who has core competency in interpreting and applying the requirements of RESPA and Regulation X. 

There has been some confusion about different versions of exemptions for payments to employees. The exemptions from the referral fee and fee splitting prohibitions are contained in Regulation X, the implementing regulation of RESPA.[vi] The Code of Federal Regulations includes an Effective Date Note[vii] that sets forth a second version of the same version with different provisions regarding payments to employees. Congress prohibited the Department of Housing and Urban Development (HUD) from implementing the revised version until July 31, 2007, and it required HUD to provide advance public notice if it ever intended to implement the different provisions. But, HUD has never acted to implement the revised version. 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

________________________

[i] 12 USC § 2602(2)
[ii] 12 CFR 3500.14(d)
[iii] 12 CFR § 3500.14(g)(2)
[iv] 12 CFR 3500.14(g)(1)
[v] The statutory exemption refers only to fee divisions within real estate brokerage arrangements when all parties are acting in a real estate brokerage capacity and has no applicability to any fee arrangements between real estate brokers and mortgage brokers or between mortgage brokers.
[vi] Regulation X § 3500.14(g)(3)
[vii] 12 CFR § 3500.14(g), Effective Date Note

Online Group’s S.A.F.E Act Violations

QUESTION
In our recent examination, the banking department cited us for S.A.F.E. Act violations. The worst offenders were in our online group. 

The way we’re set up, the online loan officers separate between those who take an application and those who just answer phones and direct the applicants to loan officers. 

It became a licensing issue based on the definition of “taking an application” and whether anyone who spoke to the applicant was licensed in the property’s state. 

Some of the things we now have to do are install a call recording service, monitor all the calls, additional training, quarterly review of all loan officer licenses, complete description of the “hand-off” procedures, and compliance with the S.A.F.E. Act’s definition of originating mortgage loans. 

The biggest problem we face is defining what the banking department calls “mortgage loan originator activities.” We want to revamp the online group, beginning with a new definition. 

What are “mortgage loan originator activities” according to the S.A.F.E. Act?

ANSWER
There are several aspects of your inquiry leading up to the question itself. I have repeatedly said that a financial institution should not go online unless it has the appropriate policies and procedures in place. It appears that your company did exactly what I have argued against doing! I understand the need to get into online sales, but it should not be at the expense of courting regulatory violations. 

If you had come to us to build an online platform, we would have had you work with our checklist and document review that guide you in establishing an online sales group. We would be interacting every step of the way until you launch the platform. 

Such requirements would include not only the items you mention but also many more features that standardize and stabilize the interaction with consumers and ensure federal and, where applicable, state banking law compliance. 

Our firm already has the policies and procedures to conform to your business model. There are several necessary policy documents. But that’s just one feature of the build. 

You need periodic call calibration. Call calibration, which we offer, is an oversight process to monitor, rate, and report on call compliance by listening to recorded calls. Ideally, this should be done by a compliance professional. 

There are numerous disclosure requirements, both oral and written. 

And the threat of being trapped in a licensing violation is real. We have worked with clients that fell into multistate licensing violations and paid millions of dollars in civil monetary penalties. When you say “hand-off procedures,” I say be careful! 

And, most important, you need to understand what constitutes “mortgage loan originator activities” as defined by the S.A.F.E. Act (“Act”),[i] whose implementing Regulation H describes specific requirements for S.A.F.E. Act-compliant state mortgage loan originator licenses and the Nationwide Mortgage Licensing System and Registry.[ii] 

To answer your question, I will treat three fundamental elements that constitute mortgage loan originator activities. The three components are (1) taking an application, (2) offering or negotiating loan terms, and (3) compensation or gain for rendering such services. 

These are not all the possible scenarios but about as comprehensive as I can provide in the space available for this article. If you want more information, please get in touch with me HERE. 

I will base my response on an appendix to the Act.[iii] This appendix is best understood as providing possible examples to aid in understanding activities that would cause an individual to fall within or outside the definition of a mortgage loan originator. Even then, they illustrate only the issue described and do not illustrate any other issues that may arise. 

Let’s begin by describing a residential mortgage loan as any loan primarily for personal, family, or household use that is secured by a mortgage, deed of trust, or other equivalent consensual security interest on a dwelling[iv] or residential real estate upon which is constructed or intended to be constructed a dwelling.[v] 

And, broadly, a loan application is a request, in any form, for an offer (or a response to a solicitation of an offer) of residential mortgage loan terms, and the information about the borrower or prospective borrower that is customary or necessary in a decision on whether to make such an offer. I know this language seems legalistic – and I guess I can’t help myself! – but in this case, every single word counts. Read it again! 

Taking an Application 

The act of taking a residential mortgage loan application means receipt by an individual for the purpose of facilitating a decision whether to extend an offer of loan terms to a borrower or prospective borrower.[vi]

Here are some examples of taking or not taking an application. 

An individual “takes a residential mortgage loan application” even if the individual: 

·    Has received the borrower or prospective borrower’s request or information indirectly, which means an individual takes an application whether they receive it “directly or indirectly” from the borrower or prospective borrower.[vii] It also means that an individual who offers or negotiates residential mortgage loan terms for compensation or gain cannot avoid licensing requirements simply by having another person physically receive the application from the prospective borrower and then pass the application to the individual; 

·    Is not responsible for verifying information. The fact that an individual who takes application information from a borrower or prospective borrower is not responsible for verifying that information – for example, the individual is a mortgage broker who collects and sends that information to a lender – does not mean that the individual is not taking an application; 

·    Only inputs the information into an online application or other automated system; or 

·    Is not involved in the approval of the loan, including determining whether the consumer qualifies for the loan. Similar to an individual who is not responsible for verification, an individual can still “take a residential mortgage loan application” even if they are not ultimately responsible for approving the loan. For instance, a mortgage broker can take a residential mortgage loan application even though it is passed on to a lender to decide whether the borrower qualifies for the loan and the ultimate loan approval. 

An individual does not take a loan application merely because the individual performs any of the following actions: 

·    Receives a loan application through the mail and forwards it, without review, to loan approval personnel. The Bureau interpreted the term “takes a residential mortgage loan application” to exclude an individual whose only role with respect to the application is physically handling a completed application form or transmitting a completed form to a lender on behalf of a borrower or prospective borrower.[viii] 

·    Assists a borrower or prospective borrower who is filling out an application by explaining the contents of the application and where particular borrower information is to be provided on the application; 

·    Generally describes for a borrower or prospective borrower the loan application process without a discussion of particular loan products; or 

·    In response to an inquiry regarding a prequalified offer that a borrower or prospective borrower has received from a lender, collects only basic identifying information about the borrower or prospective borrower on behalf of that lender. 

Offering or Negotiating Terms of a Loan 

The following examples illustrate when an individual offers or negotiates terms of a loan[ix] and, conversely, what does not constitute an offering or negotiating terms of a loan: 

Offering or negotiating the terms of a loan includes: 

·    Presenting for consideration by a borrower or prospective borrower particular loan terms, whether verbally, in writing, or otherwise, even if:

o   Further verification of information is necessary;

o   The offer is conditional;

o   Other individuals must complete the loan process;

o   The individual lacks authority to negotiate the interest rate or other loan terms; or

o   The individual lacks the authority to bind the person that is the source of the prospective financing. 

·    Communicating directly or indirectly with a borrower or prospective borrower to reach a mutual understanding about prospective residential mortgage loan terms, including responding to a borrower or prospective borrower’s request for a different rate or different fees on a pending loan application by presenting to the borrower or prospective borrower a revised loan offer, even if a mutual understanding is not subsequently achieved. 

Offering or negotiating terms of a loan does not include any of the following activities: 

·    Providing general explanations or descriptions in response to consumer queries, such as explaining loan terminology (i.e., debt-to-income ratio) or lending policies (i.e., the loan-to-value ratio policy of the lender), or describing product-related services; 

·    Arranging the loan closing or other aspects of the loan process, including by communicating with a borrower or prospective borrower about those arrangements, provided that any communication that includes a discussion about loan terms only verifies terms already agreed to by the borrower or prospective borrower; 

·    Providing a borrower or prospective borrower with information unrelated to loan terms, such as the best days of the month for scheduling loan closings at the bank; 

·    Making an underwriting decision about whether the borrower or prospective borrower qualifies for a loan; 

·    Explaining or describing the steps that a borrower or prospective borrower would need to take to obtain a loan offer, including providing general guidance about qualifications or criteria that would need to be met that is not specific to that borrower or prospective borrower’s circumstances; 

·    Communicating on behalf of a mortgage loan originator that a written offer has been sent to a borrower or prospective borrower without providing any details of that offer; or 

·    Offering or negotiating loan terms solely through a third-party licensed loan originator, so long as the non-licensed individual does not represent to the public that they can or will perform covered activities and does not communicate with the borrower or potential borrower. 

Examples:

-    A seller who provides financing to a purchaser of a dwelling owned by that seller where the offer and negotiation of loan terms with the borrower or prospective borrower are conducted exclusively by a third-party licensed loan originator.

-    An individual who works solely for a lender, when the individual offers loan terms exclusively to third-party licensed loan originators and not to borrowers or potential borrowers. 

Compensation or Gain 

An individual acts “for compensation or gain”[x] if the individual receives or expects to receive, in connection with the individual’s activities, anything of value, including, but not limited to, payment of a salary, bonus, or commission. 

Note: The concept “anything of value” is interpreted broadly and is not limited only to payments contingent upon the closing of a loan. 

An individual does not act “for compensation or gain” if the individual acts as a volunteer without receiving or expecting to receive anything of value in connection with the individual’s activities. 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group
_____________________________
[i] 12 CFR Part 1008 – S.A.F.E. Mortgage Licensing Act – State Compliance and Bureau Registration System (Regulation H)
[ii] Regulation H was issued by the Consumer Financial Protection Bureau to implement the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, title V of the Housing and Economic Recovery Act of 2008 (S.A.F.E. Act) (Pub. L. 110-289, 122 Stat. 2654, 12 U.S.C. 5101 et seq.)
[iii] See Appendix A to Part 1008
[iv] As defined in section 103(w) of the Truth in Lending Act
[v] Ibid, as defined
[vi] See § 1008.103(c)(1)
[vii] Ibid
[viii] This interpretation is consistent with the definition of “loan originator” in section 1503(3) of the S.A.F.E. Act.
[ix] See § 1008.103(c)(2)
[x] See § 1008.103(c)(2)(ii)

Sham Employment

QUESTION
We are the CEO and General Counsel of a regional mortgage banker. We decided to write you about an administrative action that has been taken against us by our state banking department.

The issue involves employer-employee compensation. The banking department claims that we are engaged in “sham employment” in violation of RESPA. We do not want to describe the alleged violation here. 

However, we would like to know some history and context related to “sham employment.” We have already contacted your firm to conduct a risk assessment of our employment practices. 

What is “sham employment?”

ANSWER
To say this area of the Real Estate Settlement Procedures Act (RESPA) is complicated would be an understatement. Thank you for contacting us to assist you. If you or anyone else would like to discuss this subject, please feel free to contact me HERE.

Right from the start, issues involving employer-employee compensation have proved to be one of the more controversial areas covered by RESPA. 

You can go back to HUD’s decision in 1996 to withdraw the employer-employee exemption the Department had promulgated only four years earlier,[i] followed by HUD’s Congressionally mandated postponement of the effective date of the withdrawal.[ii] 

As a result, the 1992 exemption, which states that Section 8 of RESPA does not prohibit an employer’s payment to its own employees for any referral services, remains in effect. That section of the RESPA statute specifically lists several practices that do not violate the statute. 

The statute provides: 

Nothing in this section shall be construed as prohibiting (1) the payment of a fee … (C) by a lender to its duly appointed agent for services actually performed in the making of a loan, (2) the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed … 

The foregoing subsections support the payment of fees by employers to their employees.

In December 2011, when the CFPB republished Regulation X as its own regulation, it removed the unimplemented provisions of the 1996 rule that had remained part of HUD’s Regulation X. Accordingly, Regulation X, RESPA’s implementing regulation, currently allows an employer to pay its own employees for any referral activity. For the most part, this is all most mortgage professionals usually need to know about employer-employee compensation in the context of “sham employment.” 

In place of the 1992 exemption, HUD adopted but then postponed the effective date, and then the CFPB permanently eliminated it, providing two additional limited exemptions for payments: 

1. One for employer payments to managerial employees.[iii] 

2. Another for payments to employees who do not perform settlement services.[iv] 

The proposed 1996 revision also would have added a third exemption to clarify that payments made to an employer’s own bona fide employee for generating business for that employer are permissible.[v] 

HUD’s May 9, 1997, proposal,[vi] which the Department withdrew on February 13, 2001,[vii] would have added a new “like-provider” exemption to RESPA’s Section 8 prohibition against kickbacks and unearned fees. (I will not treat the 1996 amendments and the proposed “like-provider” exemption in this response.)

HUD proposed amending Regulation X[viii] to add an exemption that would allow payments by an employer to its own bona fide employees for the referral of settlement service business to an affiliated settlement service provider, provided that the referred settlement service business is the same category of settlement service as provided by the employer of the employee making the referral, the employee makes the affiliated business arrangement disclosure[ix], and the employee making the referral does not perform any other category of settlement service in the same transaction.

Thus, here is the current situation with respect to your question about “sham employment,” specifically, the variety of developments regarding payments by an employer to its employees. Under RESPA, an employer may pay its own employees for any settlement service, including referrals to affiliates. A company may pay the employees of another company only reasonable compensation for settlement services actually rendered.

HUD has made clear, both in its regulatory guidance and its enforcement actions,[x] that it regards “sham employment” or “bogus employee” arrangements as RESPA violations. There is no reason to believe the CFPB takes a different position on this issue.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group

________________________

[i] 12 CFR 1024.14(g)(1)(vii), originally adopted by 57 Fed. Reg. 49600 (November 2, 1996) and republished by the CFPB, 76 Fed. Reg. 78978 (December 20, 2011)
[ii] Section 2103(b) of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (Title II of the Omnibus Consolidated Appropriations Act, 1997, Pub. L. 104-208), signed by President Clinton on September 30, 1996; 61 Fed. Reg. 58,472 (11/15/96)
[iii] Withdrawn Regulation X Section 3500.14(g)(1)(viii)
[iv] Withdrawn Regulation X Section 3500.14(g)(1)(ix)
[v] Withdrawn Regulation X Section 3500.14(g)(1)(vii)
[vi] 62 Fed. Reg. 25,740 (May 9, 1997)
[vii] 66 Fed. Reg. 25,478, at 25,497 (5/14/01). HUD withdrew the proposal following the January 20, 2001, issuance of a “Regulatory Review Plan” by the new Bush administration’s White House Chief of Staff, Andrew H. Card, Jr. HUD pointed out in its semiannual regulatory agenda that “Withdrawal of a rule does not necessarily mean that HUD will not proceed with the rulemaking. Withdrawal allows the new HUD Administration to further assess the subject matter and determine whether rulemaking for this subject matter is appropriate.”
[viii] Section 3500.14(g)(1)
[ix] As provided in 12 CFR 1024.15
[x] For instance, see the Znet Financial settlement (September 17, 2003). HUD found that Znet paid ReMax of Atlanta real estate agents as "employees" even though the agents performed little or no work for the lender. These agents were, therefore, sham “employees" who did little or no work for referral fees. Investigators found the agents performed little or no origination work other than filling out loan application forms.

Transitioning Loan Officer as Employee

QUESTION

A while back Jonathan Foxx discussed the transitioning of loan officers. He wrote about how to handle the licensing issues so that new loan officers can get to work. The questioner asked about transferring loan officers from their bank registration to become licensed loan officers. My question also deals with transitioning. Is a transitioning loan officer an employee?

ANSWER

Click Transitioning Loan Officer Licensing to read the post we published on November 7, 2019. I continue to see employers struggling with the issue of how best to effectuate the transitioning of a loan officer.

Indeed, it was in November 2019 that the CFPB issued an interpretive rule to construe an ambiguity regarding certain non-licensed loan originators. The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (EGRRCP Act) made it easier for loan originators to move from one employer to another, by giving a registered or state-licensed loan originator temporary authority to act as a loan originator in a different state if he or she:

• Has not had an application for a loan originator license denied or a loan originator license revoked or suspended;
• Has not been subjected to or served with a cease and desist order;
• Has not been convicted of a misdemeanor or felony that would preclude licensing in the new state;
• Has submitted an application to be a state-licensed loan originator in the new state; and,
• If applicable, was registered in the NMLSR as a loan originator during the 1-year period preceding the filing of the new application.

The statute separately addresses registered loan originators and state-licensed loan originators.

Regulation Z imposes training requirements on loan originator organizations for “each of its individual loan originator employees who

• is not required to be licensed, and
• is not licensed as a loan originator….”

This language, which the CFPB adopted before the EGRRCP Act existed, is ambiguous regarding whether the individual loan originators it references include loan originators with temporary authority under the EGRRCP Act. Accordingly, on November 19, 2019, the CFPB adopted an interpretive rule to address the ambiguity.

In its interpretive rule, the CFPB took the position that, although the language is ambiguous, the Bureau believes the most appropriate interpretation of Regulation Z is that the regulation does not refer to a loan originator with temporary authority under the EGRRCP Act, because a loan originator with temporary authority does not satisfy the first condition in Regulation Z § 1026.36(f)(3)—“is not required to be licensed.”

That is, to point a fine point on it, a loan originator with temporary authority is not an “individual loan originator employee … who is not required to be licensed….” He or she is an employee who is required to be licensed, although the employee can act as a loan originator while seeking the required license.

The CFPB issued its interpretation as an interpretive rule to further ensure that TILA § 130(f) offers a safe harbor to loan originator organizations that act in conformity with the interpretive rule. [84 FR 63791 (Nov. 19, 2019)] The Bureau plans to incorporate the interpretive rule into Regulation Z.

Jonathan Foxx
Chairman & Managing Director
Lenders Compliance Group

Individual Loan Originator Compensation and Borrower Paid Transactions

QUESTION

As a mortgage broker, our company pays the loan originator the same, irrespective of whether it is a lender paid or borrower paid transaction. However, we are hearing that we may be able to pay the loan originator differently on borrower paid transactions, which would allow us to be more competitive. So, can we vary compensation based upon lender paid versus borrower paid?

ANSWER

A conservative approach is that you cannot vary individual loan originator compensation based upon whether it is borrower paid or lender paid. However, in reliance on commentary to Regulation Z, some brokers and lenders are assuming a more aggressive approach and permitting an individual loan originator’s compensation on borrower paid loans to be based on the amount of compensation paid directly by the consumer to the brokerage company. For example, the individual loan originator earns 200 bps on lender paid transactions and 70% of compensation received by broker on borrower paid. To date, we have not seen any commentary from a regulator saying this practice is not permissible.  However, you need to check with your lenders as some will not permit a variation in compensation based upon borrower paid or lender paid.  

Here are some citations to consider.

12 CFR 1026.36(d)(2)(i)(C)

If a loan originator organization receives compensation directly from a consumer in connection with a transaction, the loan originator organization may pay compensation to an individual loan originator, and the individual loan originator may receive compensation from the loan originator organization, subject to paragraph (d)(1) of this section.

Official Commentary 36(d)(1)-2 [emphasis added]

“2. Compensation that is or is not based on a term of a transaction or a proxy for a term of a transaction. Section 1026.36(d)(1) does not prohibit compensating a loan originator differently on different transactions, provided the difference is not based on a term of a transaction or a proxy for a term of a transaction. The rule prohibits compensation to a loan originator for a transaction based on, among other things, that transaction's interest rate, annual percentage rate, collateral type (e.g., condominium, cooperative, detached home, or manufactured housing), or the existence of a prepayment penalty. The rule also prohibits compensation to a loan originator that is based on any factor that is a proxy for a term of a transaction. Compensation paid to a loan originator organization directly by a consumer in a transaction is not prohibited by §1026.36(d)(1) simply because that compensation itself is a term of the transaction. Nonetheless, that compensation may not be based on any other term of the transaction or a proxy for any other term of the transaction. In addition, in a transaction where a loan originator organization is paid compensation directly by a consumer, compensation paid by the loan originator organization to individual loan originators is not prohibited by §1026.36(d)(1) simply because it is based on the amount of compensation paid directly by the consumer to the loan originator organization but the compensation to the individual loan originator may not be based on any other term of the transaction or proxy for any other term of the transaction.”

Joyce Wilkins Pollison, Esq.

Director/Legal and Regulatory Compliance

Executive Director / Lenders Compliance Group

Loan Officer Compensation and Internal Referral Fees

QUESTION

If one of loan officer needs to price a loan lower than what our company normally requires in order for the officer to be eligible for compensation, could an “internal referral” of the loan be made to a non-commissioned loan officer/manager who then pays the originating loan officer a referral fee?  For example, John Smith has a deal in which he is competing with a local credit union offering a 4.5% rate. But to be paid his 2% commission under the company’s compensation rules, Smith has to offer the client a rate of 4.75%. Could the loan be “referred internally” to a non-commissioned manager who then gives the borrower the 4.5% rate to be competitive, and pays the LO a flat referral fee?

ANSWER

Regulation X, the implementing regulation for the Real Estate Settlement Procedures Act (“RESPA”) does authorize payment of compensation for certain “internal referrals.” Thus, as an exception to the anti-kickback provisions of RESPA Section 8, Regulation X [12 CFR §1024.14(g)(iv) and (vii)] specifically authorizes:  

“(iv) A payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed;” and 

“(vii) An employer's payment to its own employees for any referral activities.” (Emphasis added.)

However, Regulation X is not the only regulation to consider.  In that regard, for at least two (2) reasons, I believe this arrangement, as you describe it, would probably violate the Loan Officer Compensation Rules in Regulation Z, the implementing regulation of the Truth in Lending Act:

First, the loan officer’s compensation appears to be based on term of the loan, or a proxy for such a term.  In that regard, Regulation Z provides at 12 C.F.R. §1026.36(d)(1) that:

 (i) Except as provided in paragraph (d)(1)(iii) or (iv) of this section, in connection with a consumer credit transaction secured by a dwelling, no loan originator shall receive and no person shall pay to a loan originator, directly or indirectly, compensation in an amount that is based on a term of a transaction, the terms of multiple transactions by an individual loan originator, or the terms of multiple transactions by multiple individual loan originators. If a loan originator's compensation is based in whole or in part on a factor that is a proxy for a term of a transaction, the loan originator's compensation is based on a term of a transaction. A factor that is not itself a term of a transaction is a proxy for a term of the transaction if the factor consistently varies with that term over a significant number of transactions, and the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction.” (Emphasis added.)

Under Section 1026.36(d)(ii) of Regulation Z, “[t]he amount of credit extended is not a term of a transaction or a proxy for a term of a transaction, provided that compensation received by or paid to a loan originator, directly or indirectly, is based on a fixed percentage of the amount of credit extended…” (Emphasis added.) However, the interest rate most assuredly is a term of the transaction. And the so-called “referral fee” is actually compensation to the loan officer, the amount of which is indeed based on a term of the transaction or a proxy for a term; i.e., the interest rate. As you have described it, the loan officer is paid the referral fee only when the interest rate to the borrower is adjusted below what is normally required by the company for the loan officer to earn a commission. 

Second, the arrangement at least appears to violate (or encourage violation of) the “anti-steering” provisions of the Loan Officer Compensation Rules in Regulation Z. In that regard, the loan officer operating under the proposed arrangement would be dis-incentivized to make an “internal referral” of loans at the lower interest rate since the flat referral fee would presumably be less than the amount of compensation the loan officer would ordinarily receive under his or her regular compensation formula if the loan were made at the higher interest rate. The applicable provisions of Regulation Z [12 C.F.R. §1026.36(e)] read as follows:   

 “(1) General. In connection with a consumer credit transaction secured by a dwelling, a loan originator shall not direct or “steer” a consumer to consummate a transaction 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 to the consumer, unless the consummated transaction is in the consumer's interest.” (Emphasis added.)

Here, it is difficult to see how the consummated transaction would be “in the consumer’s interest” since the loan interest rate would be higher than what the consumer would have to pay under the referral fee arrangement. In that regard, Section 1026.36(e) goes on to state:

“(2) Permissible transactions. A transaction does not violate paragraph (e)(1) of this section if the consumer is presented with loan options that meet the conditions in paragraph (e)(3) of this section for each type of transaction in which the consumer expressed an interest. For purposes of paragraph (e) of this section, the term “type of transaction” refers to whether:

(i) A loan has an annual percentage rate that cannot increase after consummation;

(ii) A loan has an annual percentage rate that may increase after consummation; or

(iii) A loan is a reverse mortgage.

(3) Loan options presented. A transaction satisfies paragraph (e)(2) of this section only if the loan originator presents the loan options required by that paragraph and all of the following conditions are met:

(i) The loan originator must obtain loan options from a significant number of the creditors with which the originator regularly does business and, for each type of transaction in which the consumer expressed an interest, must present the consumer with loan options that include:

(A) The loan with the lowest interest rate;

(B) The loan with the lowest interest rate without negative amortization, a prepayment penalty, interest-only payments, a balloon payment in the first 7 years of the life 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

(C) The loan with the lowest total dollar amount of discount points, origination points or origination fees (or, if two or more loans have the same total dollar amount of discount points, origination points or origination fees, the loan with the lowest interest rate that has the lowest total dollar amount of discount points, origination points or origination fees).

(ii) The loan originator must have a good faith belief that the options presented to the consumer pursuant to paragraph (e)(3)(i) of this section are loans for which the consumer likely qualifies.

(iii) For each type of transaction, if the originator presents to the consumer more than three loans, the originator must highlight the loans that satisfy the criteria specified in paragraph (e)(3)(i) of this section.” (Emphasis added.)

Here, there is no indication that the terms of the above “options” exception have been satisfied. Accordingly, I would not recommend this suggested method of loan officer compensation.

Michael Pfeifer

Director/Legal & Regulatory Compliance

Lenders Compliance Group &

Servicers Compliance Group

Bonus for Loan Officer’s Recruitment of New Loan Officer

QUESTION

If one of my loan officers recruits a new loan officer for us, is it legal to bonus the existing loan officer ten (10) basis points for each of the loans that the new loan officer brings in?

ANSWER

This is an interesting question because the bonus compensation is linked to new loans brought in by another loan officer. This raises questions regarding compliance with anti-kickback provisions of Section 8 of the Real Estate Settlement Procedures Act (RESPA), and the Loan Officer Compensation rules of the Truth in Lending Act (TILA).

The bonus plan probably does not violate RESPA §8, if both loan officers are W-2 employees, because Regulation X, the implementing regulation for RESPA, specifically permits the following:

“(iv) A payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed;” and 

“(vii) An employer's payment to its own employees for any referral activities.” (Emphasis added.) ^[i]

Also, assuming the bonus compensation is not paid by the consumer, so that the loan officers are not paid “dual compensation” by both the loan originator organization and the consumer in violation of Regulation Z, the implementing regulation for TILA[ii], such a bonus may be permissible under the TILA Loan Officer Compensation rules under certain conditions:

1. The compensation plan does not result in any kind of “steering” of consumers into loans not in their interest in order to increase the loan officer’s compensation. Such “steering” is prohibited under Regulation Z.[iii]

             

2. The compensation is not based on the term of a transaction or the profitability of a transaction or pool of transactions under Section 36(d)(1) of Regulation Z.[iv] In general, this section prohibits compensation based on “profits,” unless profits are from business other than mortgage-related business. However, the Rule adds two exceptions to this general prohibition: (1) mortgage-related business profits can be used to make contributions to certain tax advantaged retirement plans (which does not appear to be the case here); and (2) mortgage-related business profits can be used to pay bonuses and contributions under certain other plans if either the amount paid does not exceed 10% of the individual loan originator’s total compensation or the loan originator acts as an originator on 10 or fewer transactions over the preceding 12 months.[v]  The operative language of Reg. Z is as follows:

“(iv) An individual loan originator may receive, and a person may pay to an individual loan originator, compensation under a non-deferred profits-based compensation plan (i.e., any arrangement for the payment of non-deferred compensation that is determined with reference to the profits of the person from mortgage-related business), provided that:

(A) The compensation paid to an individual loan originator pursuant to this paragraph (d)(1)(iv) is not directly or indirectly based on the terms of that individual loan originator's transactions that are subject to this paragraph (d); and

(B) At least one of the following conditions

 is satisfied:

(1) The compensation paid to an individual loan originator pursuant to this paragraph (d)(1)(iv) does not, in the aggregate, exceed 10 percent of the individual loan originator's total compensation corresponding to the time period for which the compensation under the non-deferred profits-based compensation plan is paid; or

(2) The individual loan originator was a loan originator for ten or fewer transactions subject to this paragraph (d) consummated during the 12-month period preceding the date of the compensation determination.”

Under the scenario you have described, it is also possible that the loan officer may not actually qualify as a “loan originator” on any of the transactions you refer to, if he or she does not engage in any of the activities on any of the subject transactions that are described in the definition of “loan originator” under Regulation Z Section 1026.36(a). In that event the limitations of the Rule would not apply. The applicable definition of “loan originator” is as follows:

“(a)(i) For purposes of this section, the term ‘loan originator’ means a person who, in expectation of direct or indirect compensation or other monetary gain or for direct or indirect compensation or other monetary gain, performs any of the following activities: takes an application, offers, arranges, assists a consumer in obtaining or applying to obtain, negotiates, or otherwise obtains or makes an extension of consumer credit for another person; or through advertising or other means of communication represents to the public that such person can or will perform any of these activities. The term “loan originator” includes an employee, agent, or contractor of the creditor or loan originator organization if the employee, agent, or contractor meets this definition. The term “loan originator” includes a creditor that engages in loan origination activities if the creditor does not finance the transaction at consummation out of the creditor's own resources, including by drawing on a bona fide warehouse line of credit or out of deposits held by the creditor. All creditors that engage in any of the foregoing loan origination activities are loan originators for purposes of paragraphs (f) and (g) of this section. The term does not include:

(A) A person who does not take a consumer credit application or offer or negotiate credit terms available from a creditor, but who performs purely administrative or clerical tasks on behalf of a person who does engage in such activities.” (Emphasis added.)

Since the terms “arranges,” “assists,” and “otherwise obtains” are broad, it is theoretically possible that someone could construe the loan officer’s recruiting activities of another loan officer as falling within those specified activities, but that is not likely. Nevertheless, it is probably safest to assume that the loan officer is an “originator” and to try to comply with the terms of the exception to the L.O. Compensation Rule outlined above.

Michael Pfeifer

Director/Legal & Regulatory Compliance

Lenders Compliance Group &

Servicers Compliance Group

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[i] 12 CFR §1024.14(g)(iv) and (vii)

[ii] 12 CFR §1026.36(d)(2)

[iii] With certain specified exceptions, under 12 CFR 1026.36(e)(1) “[i]n connection with a consumer credit transaction secured by a dwelling, a loan originator shall not direct or “steer” a consumer to consummate a transaction 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 to the consumer, unless the consummated transaction is in the consumer's interest.

[iv] See 12 CFR §1026.36(d)(1)

[v] See Section 1026.36(d)(1)(iii)-(iv)