Regulation Z and Loan Originator Compensation

Issue/Inquiry

The Bank pays its Mortgage Loan Officers (“MLO”) a flat commission rate on all traditional first lien mortgage applications. The Bank inquires as to whether it would be allowed to pay a different commission rate on the following loan products:

• First lien residential mortgage with a term shorter than 24 months (i.e., bridge loan or construction loan, typically interest only payment structure)
• Land/Lot loans
• Home Equity Lines of Credit (“HELOC”) (first lien or subordinate lien)
• Second (or third) lien closed end mortgage

For example, could the Bank pay MLOs a flat commission of 70 bps for closed-end first lien residential mortgages, but 35 bps for closed production on the four loan types described above? Would this meet the requirements of the Dodd-Frank compensation rule?

Response Summary

For closed-end consumer loans secured by a dwelling, if the Bank varied an MLO’s commission for types of loans, it would be doing so on the basis of a term of the transaction, which is prohibited by Regulation Z. This rule, however, does not pertain to HELOCs or consumer closed-end loans secured by real property on which there is not a dwelling.

Response Detail

For closed-end consumer loans secured by a dwelling, Regulation Z prohibits paying a loan originator compensation in an amount that is based on a term of a transaction or a proxy for a term of the transaction. A “term of a transaction” is any right or obligation of any of the parties to a credit transaction. This includes the rights and obligations memorialized in a promissory note or security instrument, such as a mortgage, and the payment of loan originator fees or any other fees charges. 12 CFR §1026.36(d)(1); Official Interpretations, §1026.36(d)(1) – 1.iii.

If the Bank varied compensation by loan types, it would, in effect, be doing so on the term of the loan or the priority of the security, and thus on the basis of a term of the transaction.

When the final rule regarding loan originator restrictions was published by the Federal Reserve Board, the commentary indicated that creditors can encourage originators to make small loans as well as large loans by setting a minimum and maximum payment for each loan if they compensate loan originators a fixed percentage of the amount of credit extended. The Board believed, however, “that allowing compensation to vary with loan type, such as loans eligible for consideration under the CRA, would permit unfair compensation practices to persist in loan programs offered to consumers who may be more vulnerable to such practices.” Federal Register, Vol.75, No. 185, September 24, 2010.

The following would be permissible methods of compensation:

• The loan originator’s overall dollar volume (i.e., total dollar amount of credit extended or total number of transactions originated) delivered to the creditor
• The long-term performance of the originator’s loans
• An hourly rate of pay to compensate the originator for the actual number of hours worked
• A payment fixed in advance for every loan the originator arranges for the creditor (e.g., $600 for every credit transaction arranged for the creditor or $1,000 for the first 1,000 credit transactions arranged and $500 for each additional credit transaction arranged)
• The percentage of applications submitted by the loan originator to the creditor that results in  consummated transactions
• The quality of the loan originator’s loan files (e.g., accuracy and completeness of the loan documentation submitted to the creditor). Official Interpretations, §1026.36(d)(1) – 2.i.

The compensation of the loan originator cannot be based on a factor that is a proxy for a term of the transaction (e.g., if compensation was based on the loans kept in the creditor’s portfolio rather than being sold on the secondary market, and the creditor held in its portfolio only loans that have a fixed interest rate and a five-year term with a final balloon payment, whether a loan is held in the portfolio or not and whether the loan originator receives a higher commission is a proxy for the terms of the transaction). Official Interpretations, §1026.36(d)(1) – 2.ii.A.

The prohibitions related to loan originator compensation and steering apply only to closed-end consumer loans secured by a dwelling or real property that includes a dwelling. The rule does not apply to open-end HELOCs or time-share transactions. It also does not apply to loans secured by real property if the property does not include a dwelling. 12 CFR §1026.36(b). For these types of loans, the Bank could vary the compensation of the MLOs.

This entry was posted on Monday, December 12th, 2016 at 1:34 pm.