On January 20, 2013, the Consumer Financial Protection Bureau (CFPB) issued final regulations implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) provisions concerning loan originator qualification requirements and compensation practices. According to the CFPB, prior to the mortgage crisis, training and qualification standards for loan originators varied widely, and compensation was often designed in a way to give loan originators incentives to steer consumers into more expensive loans. Consumers also frequently paid loan originators (brokers) an upfront fee thinking the broker was there to obtain the best possible loan for the consumer without realizing that the lender was also paying commissions or a yield spread to the originator that increased with the interest rate or other terms.
Congress passed the Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act) in 2008 requiring loan originators to be licensed or registered and to pass background checks and meet other requirements. In 2011, the Fed amended Regulation Z to prohibit payment of compensation to loan originators based on any of the terms or conditions of a loan. Dodd-Frank expanded on those prior efforts to strengthen loan originator qualifications and regulate compensation practices, and the CFPB issued its new rules to implement the Dodd-Frank provisions and to revise and clarify the existing regulations and commentary on compensation. The rules also implement Dodd-Frank provisions prohibiting use of mandatory arbitration agreements and financing single premium credit insurance in connection with mortgage loans. The final rule revises Regulation Z and the changes are summarized below.
Prohibition against compensation based on a loan term or a proxy for a loan term. Reg. Z already prohibits compensation based on “any of the transaction’s terms or conditions.” Dodd-Frank codified this existing prohibition. The final rule implements the Dodd-Frank provisions and clarifies the scope of the rule in several ways.
The final rule defines “a term of a transaction” as “any right or obligation of the parties to a credit transaction.” This means, for example, that a loan originator employee cannot receive compensation based on the interest rate of a loan or on the fact that the loan originator steered a consumer to purchase required title insurance from an affiliate of the lender, since the consumer is obligated to pay interest and the required title insurance is in connection with the loan. The rule generally prohibits compensation to mortgage loan originators based on a term of an individual transaction, the terms of multiple transactions by an individual loan originator, or the terms of multiple transactions by multiple loan originators. Compensation may still be based on loan volume and, with certain limitations, on loan amount.
The final rule also prohibits compensation based on any “proxy” for a term of a transaction and clarifies the definition of a proxy to focus on whether: (1) the factor consistently varies with a transaction term over a significant number of transactions; and (2) the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction. The basic question is whether or not the compensation of the loan originator would be different if any term of the transaction were different.
The final rule generally prohibits loan originator compensation from being reduced to offset the cost of a change in transaction terms (often called a “pricing concession”). For example, an originator could not agree to give up part of his or her compensation in order to provide a credit to the consumer to pay a portion of the consumer’s closing costs. However, the final rule does allow a loan originator to reduce his compensation to defray certain unexpected increases in estimated settlement costs. For example, a bank’s compensation plan for its mortgage loan originators could include a deduction from the originator’s compensation to pay all or part of the amount needed to cure a RESPA disclosure tolerance violation.
To prevent providing incentives to steer or “up- charge” consumers on their loans, the final rule generally prohibits compensation based on the profitability of a transaction or a pool of transactions or overall profitability of a department or organization that includes profits from covered mortgage loans. However, the final rule makes exceptions to this prohibition for contributions to certain kinds of retirement, profit- sharing and bonus plans.
Contributions to a “designated tax-advantaged plan” may be made based on profitability of mortgage-related business activity. A “designated tax-advantaged plan” is basically any IRS qualified defined benefit or defined contribution plan and includes a 401(k), employee annuity plan, simple retirement account, simplified employee pension, or eligible deferred compensation plan, all as defined in specified sections of the Internal Revenue Code. Bonuses and contributions to other non-deferred incentive plans may be made based on mortgage business profits provided that the amount of the bonus or contribution paid to an individual loan originator is not based, directly or indirectly, on the terms of that individual originator’s loan transactions and, either, the bonus or contribution does not exceed 10% of the individual’s total compensation for the same period (including the bonus payment), or the individual was a loan originator for 10 or fewer transactions during the preceding 12 months. The 10% cap on bonus payments only applies to payments based on profits from mortgage-related business. So, to the extent a bank can allocate revenues and expenses between its covered mortgage-related business activity (keeping in mind that the rule applies to all consumer closed- end dwelling secured loans) and its other lines of business, then, bonus payments may be based on profitability of other types of business without regard to the 10% cap. Managers who engage in limited loan origination may fall within the exception for 10 or fewer transactions allowing them to receive bonus payments based on overall bank or branch profitability, including mortgage- related profits. These changes provide much needed clarifications with respect to retirement plan contributions and incentive/bonus plan payments.
Definition of “loan originator. The rule clarifies the definition of “loan originator” for purposes of the compensation and qualification rules, including exclusions for certain employees of manufactured home retailers, servicers, seller financers, and real estate brokers; management, clerical, and administrative staff; and loan processors, underwriters, and closers. Existing Reg. Z defines the term “loan originator” as any person who for compensation or gain, or expectation of compensation or gain, “arranges, negotiates or otherwise obtains an extension of consumer credit for another person.” The new rule expands on that definition and defines the term as any person who for direct or indirect compensation or other monetary gain, or in expectation thereof, “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 new rule also makes a distinction between an “individual loan originator,” which is a natural person, and a “loan originator organization,” which is any loan originator that is other than a natural person. So, a bank will be a loan originator organization and its loan originator employees will be individual loan originators. This distinction comes into play in connection with several requirements of the new rule. ‘
With respect to managers, administrative, and clerical staff, the revised commentary provides examples of the types of activities those persons may engage in without becoming a loan originator. For example, simply handing out an application form, accepting a completed form, providing general information in response to customer questions, providing loan originator contact information, discussing other credit products and services, or providing general guidance on qualifications or criteria without discussing or assessing the consumer’s specific circumstances or discussing particular credit terms available from the creditor does not make an employee a loan originator. Backroom loan processors and personnel involved in underwriting, credit approval and loan pricing are not loan originators provided that communications with the consumer about things such as underwriting decisions, specific credit terms, a specific offer of credit, a counter-offer, approval conditions and any negotiations about terms takes place through a loan originator.
Because the definition of loan originator includes any person who 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, a person who engages in any of those activities is covered even if most of their duties are unrelated to loan origination. As a result, managers who only occasionally engage in loan origination activity (so called “producing managers”) are covered. Servicers and servicer employees, including those who deal with consumers on loan modifications, are excluded, as are realtors and certain others. The rule includes a somewhat complicated exemption for certain types of seller financing following the language of Dodd-Frank.
While the revised definition of “loan originator” is similar in many respects to the definition of “mortgage loan originator” contained in the SAFE Act and regulations, lenders should take note that the Reg. Z definition is actually broader. Under Reg. Z, a person is a loan originator if he or she “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.” Doing any one of those things makes a person a loan originator. Under the SAFE Act and regulations, a person is generally considered to be a mortgage loan originator if he or she takes a residential mortgage loan application and offers or negotiates terms of a residential mortgage loan. As a result, coverage of the compensation and qualification rules could extend beyond those originators in the bank who are required to be registered as a mortgage loan originator in the national registry. That may present a compliance challenge and could require some analysis of job descriptions and responsibilities.
Prohibition against dual compensation. Reg. Z already prohibits a loan originator who receives compensation directly from a consumer from receiving compensation from any other person in connection with the same mortgage loan. Dodd- Frank codifies this prohibition, and the final rule implements this restriction but provides an exception clarifying that mortgage brokers receiving compensation from the consumer directly may pay commissions to their employees or contractors, although the commissions cannot be based on the terms of the loans that they originate.
No prohibition on upfront points and fees. Section 1403 of Dodd-Frank generally prohibits payment by consumers of upfront points or fees on transactions in which the loan originator compensation is paid by a person other than the consumer (which would apply to transactions where the lender pays its own employee originators as well as to payments by a creditor to a mortgage broker). However, Dodd-Frank also authorized the CFPB to waive or create exemptions from the prohibition on upfront points and fees if it determines that would be in the interest of consumers and in the public interest. In its original proposal, the CFPB proposed to waive the ban and allow creditors to charge upfront points and fees on a mortgage loan, so long as they also offered to the consumer a “no points and fees” alternative. The CFPB decided not to adopt the proposed rule and, instead, issued a complete exemption to the prohibition on upfront points and fees. The CFPB’s stated reasons were the risk of consumer confusion and possible impact on the availability of credit in light of the major regulatory overhaul of the mortgage market that is underway. The CFPB intends to study the issue further, conduct consumer testing and other research, and, then, decide whether further regulation is appropriate.
Loan originator qualifications. Dodd-Frank imposes a duty on individual loan officers, mortgage brokers, and creditors to be “qualified” and, when applicable, registered or licensed to the extent required under State and Federal law. The final rule imposes duties on loan originator organizations to make sure that their individual loan originators are licensed or registered as applicable under the SAFE Act and other applicable law. For banks and other employers whose employees are not required to be licensed (including all depository institutions, their subsidiaries, and bona fide non-profits), the rule also requires them to: (1) ensure that their loan originator employees meet character, fitness, and criminal background standards similar to existing SAFE Act licensing standards; and (2) provide training to their loan originator employees that is appropriate and consistent with those employees’ origination activities.
With respect to character, fitness and background standards, the revised rule requires a loan originator organization to obtain three basic things about each of its individual loan originators: a criminal background check, information about any administrative, civil or criminal findings, and a credit report. For mortgage loan originators who are registered or licensed in the national registry, the requirement for a criminal background check and collection of information about administrative, civil or criminal findings will have been satisfied through the licensing or registration process. Banks and others employing loan originators will need to obtain credit reports on individual loan originators hired after January 10, 2014, but it is not clear whether it will be necessary to obtain a credit report on licensed or registered originators hired before that date.
For any person who is a “loan originator” under Reg. Z, but is not registered or licensed as a “mortgage loan originator” in the national registry, it will be necessary for the employer to conduct its own assessment of whether the person meets equivalent standards. That means the employer must obtain a criminal background check through a law enforcement agency or commercial service and obtain information about administrative, civil or criminal findings directly from the individual, as well as obtain a credit report, before the person can act as a loan originator.
The final rule contains special provisions with respect to criminal background checks and the circumstances in which a criminal conviction is disqualifying. Generally, any person who has been convicted or pleaded guilty or nolo contendere to a felony during the previous 7 years, or in the case of a felony involving an act of fraud, dishonesty, a breach of trust, or money laundering, at any time, is ineligible to serve as a loan originator.
In its original proposal, the CFPB had considered imposing on non-licensed loan originators (including registered loan originator employees of banks) the same types of pre-licensing and continuing education requirements that apply to State licensed mortgage loan originators. In the final rule, the CFPB only included a general requirement that loan originators receive periodic training covering State and Federal law requirements that apply to the person’s loan origination activities.
NMLSR identifier requirements. The final rule also implements a Dodd-Frank requirement that loan originators provide their unique identifiers under the Nationwide Mortgage Licensing System and Registry (NMLSR) on loan documents. Accordingly, the name and NMLSR ID, if one, of the loan originator organization and the name and NMLSR ID of the individual loan originator employee that is primarily responsible for a particular origination must be listed on the credit application, note, and the mortgage or deed of trust.
Prohibition on mandatory arbitration. The final rule contains language implementing a Dodd- Frank provision which prohibits use of mandatory arbitration clauses and agreements in connection with any consumer credit transaction secured by a dwelling (including any home equity line of credit secured by the consumer’s principal dwelling). It does not prohibit a voluntary agreement to arbitrate a dispute once the dispute has arisen. The rule also prohibits the application or interpretation of any of provision in any such loan or credit contract in a manner that would waive, or bar a consumer from bringing, a claim in court for damages or other relief in connection with any alleged violation of Federal law.
Single premium credit insurance. The rule implements a Dodd-Frank provision which prohibits the financing of any premiums or fees for credit insurance (including credit life, disability, unemployment or credit property insurance, and debt cancellation/debt suspension contracts) in connection with a consumer credit transaction secured by a dwelling (including any home equity line of credit secured by the consumer’s principal dwelling), but allows credit insurance to be paid for on a monthly basis.
Policies and procedures. The rule includes a requirement that all depository institutions must establish and maintain written policies and procedures reasonably designed to ensure and monitor compliance of the depository institution, its employees, its subsidiaries and the employees of its subsidiaries with the rules on loan originator compensation, prohibited steering, loan originator qualifications, and use of the NMLSR identifiers. The policies and procedures must be appropriate to the size, nature, complexity and scope of the mortgage lending activities of the institution and its subsidiaries.
Recordkeeping. The final rule also extends existing recordkeeping requirements concerning loan originator compensation so that they apply to both creditors and mortgage brokers for three years. A creditor must maintain records of all compensation it pays to a loan originator and any compensation agreement that governs those payments for at least 3 years after the payment. A loan originator organization must maintain records of all compensation it received from a creditor, a consumer or another person, and all compensation it pays to any individual loan originator and any related compensation agreement, for at least 3 years.
Effective dates; Implementation. The prohibitions against use of mandatory arbitration and financing credit insurance premiums become effective June 1, 2013. The remaining parts of the rule are effective on January 10, 2014. To a large extent, this rulemaking is an expansion and clarification of the existing rules on loan originator compensation. It may be necessary for a bank to give some additional consideration to identifying all persons who may be a loan originator under Reg. Z. It will be necessary to revise existing policies and procedures to take the rule changes into account, revise loan forms and procedures to add NMLSR identifiers and remove any mandatory arbitration clauses or provision for financing credit insurance, and, possibly, to revisit compensation and bonus plans for loan originators and their managers.