The CFPB rules issued January 20, 2013, make substantial changes to Reg. Z in order to implement the Dodd-Frank provisions concerning loan originator compensation. However, the final rules do more than just that. They include loan originator qualifications, expand recordkeeping requirements, prohibit use of mandatory arbitration and the financing of single premium credit insurance and require the use of NMLRS unique identifier numbers on loan documents. The prohibitions on use of mandatory arbitration and financing single premium credit insurance become effective June 1, 2013, and the remaining rules become effective January 10, 2014. In this article, we will review each of the new requirements.
Definition of Loan Originator. The rule revises the definition of the term “loan originator” for purposes of the compensation and qualification rules. Currently, Reg. Z defines “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 the definition to cover any person who for direct or indirect compensation or other monetary gain, or in expectation thereof, does any of the following: takes an application, offers, arranges or assists a consumer in obtaining or applying to obtain, negotiates, or otherwise obtains or makes an extension of consumer credit for another person; or advertises or holds themselves out to the public as being able or willing to perform any of these activities. There are exclusions for licensed real estate brokers, certain seller financers and their employees, manufactured home retailers and their employees, loan servicers including loan workout staff when modifying an existing loan, loan underwriters and processors and managers, administrative and clerical staff provided they are not actually engaging in loan originator activity.
It is expected that the CFPB and other bank regulators will interpret this definition broadly and include persons engaging in referral activity within the definition. However, the rule does list examples of the types of activity that will not make a person a loan originator. These include: simply handing out application forms, accepting completed forms, providing general information in response to customer questions, providing loan originator contact information, discussing other credit products and services unrelated to home loans, or providing broad and general guidance on qualifications or criteria without discussing or assessing the consumer’s specific situation or circumstances or discussing particular credit terms available from the creditor. Backroom loan processors and personnel involved in underwriting, credit approval and loan pricing are not loan originators provided that all 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. Managers and others who only occasionally engage in originator type activity will still be covered.
Note that the definition of “loan originator” under Reg. Z is a little broader than the definition of “mortgage loan originator” in the SAFE Act and its regulations. Under revised 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, or holds themselves out to the public as being willing to do so. Engaging in any one of those activities 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. That distinction could be important as we discuss the loan originator qualification requirements below. It is also important to note that the coverage of the compensation and qualification rules may possibly extend to persons who technically may not be required to be registered as a mortgage loan originator in the national registry.
Compensation. Dodd-Frank codified the existing prohibition in Reg. Z prohibiting loan originator compensation based on the terms or conditions of the loan transaction. Revised Reg. Z continues that prohibition and clarifies the scope and application of the rule.
The final rule prohibits compensation based on any of the mortgage loan transaction’s terms or conditions, including any factor that might serve as a proxy for a loan term or conditions. A “term of a transaction” is defined as any right or obligation of the parties to a credit transaction. Things like the interest rate, maturity, or type of loan would all be terms of the transaction. Other things might be a little more subtle. For example, paying compensation to an originator for referring the borrower to an affiliate of the lender to buy title insurance would be prohibited. The principal amount of the loan is not considered to be a term of the transaction provided that any compensation based on loan amount is based on a fixed percentage.
A proxy for a term of a transaction is any factor that: (i) consistently varies with a transaction term over a significant number of transactions, and (ii) the loan originator has the ability, directly or indirectly, to add, drop, or change. Credit score might be one example as the interest rate or other terms of the loan may vary based on credit score or credit quality. The basic question is whether or not the compensation of the loan originator would be different if any term of the transaction were different.
Loan originator compensation may not be reduced to offset the cost of a change in transaction terms. For example, an originator could not grant a pricing concession by giving up part of his or her commission to pay a portion of the consumer’s closing costs. However, the final rule does allow oan originator compensation to be reduced to cover unexpected increases in estimated settlement costs. For example, a bank’s loan originator compensation plan could include a deduction from the originator’s compensation to pay the amount needed to cure a RESPA disclosure tolerance violation.
The rule generally prohibits loan originator compensation 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. As a result, compensation based on profitability of a pool of loan transactions or a department or branch that includes mortgage loan profits would be prohibited. However, the final rule includes two important exceptions to this prohibition.
First, contributions to any IRS qualified defined benefit or defined contribution plan are excluded. So, contributions to things like a 401(k), employee annuity plan, simple retirement account, simplified employee pension, or eligible deferred compensation plan, if they fall within certain specified sections of the Internal Revenue Code, would be permissible. The second exception allows payment of bonuses and contributions based on mortgage business profits to other non- deferred bonus and incentive plans if the amount paid to an individual loan originator is not based, directly or indirectly, on the terms of that originator’s loan transactions and either of the two following conditions are met: (i) the payment does not exceed 10% of that individual’s total compensation, including the bonus payment, for the same period, or (ii) the person was a loan originator for 10 or fewer transactions during the preceding 12 months. Also, the 10% cap only applies to payments based on profits from mortgage-related business, meaning compensation based on profits from other areas could be paid in addition to the 10% cap related to mortgage activity. This could be important in compensation plans for branch, department or other managers. Managers who engage in limited loan origination activity for 10 or fewer transactions may receive bonus payments based on overall bank or branch profitability that includes mortgage-related profits. For managers that engage in more than 10 transactions, the bank may be able to come up with a plan that allocates revenues and expenses between its mortgage-related business activity and its other lines of business so that any bonus payments based on profitability of other types of business would not be subject to the 10% cap.
Dual compensation. Revised Reg. Z continues the existing prohibition against a loan originator who receives compensation directly from a consumer from also receiving compensation from any other person in connection with the same mortgage loan. The final rule clarifies that mortgage brokers who receive compensation from the consumer directly may compensate broker employees and contractors, although the payments cannot be based on the terms of the loans they originate.
Upfront points and fees. One of the things that, thankfully, did not make it into the rule is the Dodd-Frank prohibition against lenders charging any upfront points or fees on a loan transaction where the loan originator receives any compensation from any person other than the consumer. Dodd-Frank allowed the CFPB to waive or create exemptions from this prohibition if that was in the interests of consumers and the public. The CFPB originally proposed to waive the ban and allow creditors to charge upfront points and fees as long as a no points and fees alternative was offered at the same time. Instead, the CFPB included a complete exemption in the final rule and indicated it would study the issue further.
Loan originator qualifications. Revised Reg. Z makes loan originator organizations responsible for making sure that their individual loan originators are properly qualified and licensed or registered to the extent required under State and Federal law. For depository institutions and their subsidiaries whose employees are exempt from state licensing requirements, this means that the bank or company must: (i) ensure that their loan originator employees meet character, fitness, and criminal background standards similar to existing SAFE Act licensing standards; and (ii) provide training to its loan originator employees that is appropriate and consistent with the employee’s origination activities.
To satisfy the character, fitness and background standards, a loan originator organization must obtain three basic things about each individual loan originators: (i) a criminal background check; (ii) information about any administrative, civil or criminal findings concerning that person; and (iii) a credit report. Licensing or registration and inclusion in the national registry will satisfy the requirement for a criminal background check and collection of information about administrative, civil or criminal findings. Credit reports will need to be obtained on individual loan originators hired after January 10, 2014. The commentary makes it clear that it is not necessary to go back and obtain this information on someone hired before that date who satisfied the applicable statutory or regulatory background standards at the time they were hired (i.e., they are licensed or registered originators).
As we noted above, the definition of “loan originator” under revised Reg. Z is broader than the definition of “mortgage loan originator” under the SAFE Act and regulations. Some states use a broader definition in their loan originator licensing laws as well. To the extent you employ a 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 the employer’s responsibility 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 better course of action may be to make sure that anyone who falls within the broad definition of “loan originator” under Reg. Z is registered in the national registry.
The CFPB had originally proposed to require registered loan originator employees of banks and their subsidiaries to meet the same pre-licensing and continuing education requirements that apply to State licensed mortgage loan originators. Fortunately, the CFPB only included in the final rule a general requirement that loan originators receive periodic training covering State and Federal law requirements that apply to that person’s loan origination activities.
Use of NMLSR identifiers. Revised Reg. Z requires that the name and Nationwide Mortgage Licensing System and Registry (NMLSR) ID number of the loan originator organization and the individual loan originator employee primarily responsible for the particular transaction be shown on the credit application, the note, and the mortgage or deed of trust.
Use of mandatory arbitration. Revised Reg. Z prohibits use of mandatory arbitration clauses and agreements in connection with any dwelling secured consumer credit transaction including any home equity line of credit secured by the consumer’s principal dwelling. It does not prohibit post-dispute voluntary agreements to arbitrate. The rule also prohibits the application or interpretation of any 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 for any alleged violation of Federal law.
Single premium credit insurance. Revised Reg. Z 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. It does not prohibit credit insurance or debt cancellation type products that are paid for on a monthly basis.
Policies and procedures. Revised Reg. Z requires all depository institutions to establish and maintain written policies and procedures reasonably designed to ensure and monitor compliance of the institution, its subsidiaries and their employees with the rules on loan originator compensation, prohibited steering, loan originator qualifications, and use of the NMLSR identifiers. Those 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. Revised Reg. Z extends existing recordkeeping requirements to require creditors and mortgage brokers to retain records reflecting their compliance with the compensation rules for three years. A creditor must maintain records of all compensation it pays to a loan originator, which could include an employee or a loan broker, and any related compensation agreement for at least 3 years after the payment. A loan originator organization, which could include a broker, must maintain records of all compensation it receives from a creditor, a consumer or another person, and all compensation it pays to its individual loan originators and any related compensation agreement, for at least 3 years after the payment.
Implementation. As noted above, 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. While the new rules are in some respects a continuation and clarification of some existing requirements, compliance will require a number of steps. It will be necessary to write new policies and procedures, if they do not already exist, and to review and revise any existing policies and procedures relating to hiring loan originators, their qualifications, background screening, and inclusion in the national registry. Periodic loan originator training should be implemented if it does not already exist, and the requirements for that training should be included in the written policies and procedures. As part of the review process, a bank may want to re-consider whether all employees who may be a loan originator under the revised Reg. Z definition have been identified. Loan applications, note forms, and mortgage or deed of trust forms will need to be revised to add NMLSR identifiers. Those documents and others may need to be revised to remove mandatory arbitration clauses or terms relating to financing credit insurance. Record retention schedules should be reviewed and revised where appropriate. Finally, compensation and bonus plans covering loan originators and managers may need to be reviewed and revised.