On January 20, 2013, the Consumer Financial Protection Bureau (Bureau) released its final rule regarding the loan originator compensation requirements under the Truth in Lending Act (Rule). It followed up by publishing the Rule in the Federal Register on February 15, 2013. Despite the Bureau’s labeling of the Rule, it does more than implement statutorily required loan originator compensation changes. It also clarifies existing loan origination compensation requirements, including those based on prior informal interpretations rather than the plain language of Regulation Z or its commentary. Less obvious from the name of the Rule, it includes loan originator qualification requirements, requires the use of unique identifiers on certain loan documents, prohibits mandatory arbitration provisions and the financing of single-premium credit insurance for covered loans, and extends record keeping requirements. It also addresses the statutory prohibition on upfront points and fees in certain loans. The provisions regarding mandatory arbitration and the financing of single premium credit insurance have a stated effective date of June 1, 2013. The remainder of the Rule has a stated effective date of January 10, 2014.
The Rule revises the definition of the term “loan originator.” The term generally will mean a person, who in the expectation of compensation, does any of the following in connection with a residential mortgage loan: offers, arranges, negotiates, takes an application for, assists a consumer in obtaining or applying for, or otherwise obtains or makes a residential mortgage loan for another person. It will also include a person that advertises that the person can or will perform any of these activities. The Bureau will interpret this definition broadly and, consistent with prior informal interpretations, will include referral activity within the scope of covered loan origination activities. However, the Rule and related commentary provide some clarifications regarding the scope of covered referral activity. For example, covered referral activity will not include, among other things, providing general information in response to inquiries or, if the person is an employee of a creditor or mortgage broker, providing contact information for a loan originator in response to a request, unless the employee does so based on the inquiring person’s financial characteristics or discusses particular loan terms. Additionally, the Rule lists several categories of persons that will not be loan originators, including certain bona fide third-party advisors, certain licensed or registered real estate brokers, certain seller financers, and loan servicers and their employees when modifying or offering to modify an existing loan that is in default or is likely to go into default. It also clarifies when administrative and clerical staff members are not acting as loan originators.
The Rule continues the prohibition on basing loan originator compensation on any of the residential mortgage loan transaction’s terms or conditions, including any factor that is a proxy for a loan term or condition. The terms and conditions will include any right or obligation of the parties to a residential mortgage loan, except the amount of credit extended if the compensation is based on a fixed percentage. The Rule provides clarification regarding what constitutes a proxy. A factor will be a proxy if it consistently varies a term or terms over a significant number of loans and the loan originator has the ability to add, drop, or change the factor.
Consistent with prior informal interpretations of Regulation Z, the Rule clarifies that the prohibition includes not only compensation based on the terms or conditions of a single transaction, but also compensation based on the terms of multiple transactions by a single loan originator or multiple loan originators. Because the prohibition includes the terms or conditions of multiple loans by multiple originators, loan originator compensation cannot be based on the profits of a residential mortgage loan-related business. The Rule adopts this interpretation, but creates two exceptions. First, contributions to or benefits paid from designated tax-advantaged plans are permissible if they are not based on the terms of the individual loan originator’s transactions. Second, payments pursuant to certain non-deferred profits based compensation plans, as set forth in the Rule, could be permissible if they meet additional requirements, such as being limited to 10 percent or less of the loan originator’s total compensation or if the individual was the loan originator for 10 or fewer residential mortgage loans during the 12 months preceding the compensation determination date.
The Rule, similar to current Regulation Z, will generally prohibit reductions to loan originator compensation to offset costs if the terms of a transaction change. The reductions are prohibited because they are based on a term or condition of the transaction. However, the Commentary to the Rule states that reductions to compensation to offset unanticipated increases in certain settlement charges are permitted.
The Rule creates an exception to the Regulation Z prohibition on dual compensation. The Rule will allow a mortgage broker that receives compensation from the consumer to pay its employees or contractors commissions under certain circumstances.
For some, what is not in the Rule may be as important as what is in it. The Dodd-Frank Act would have prohibited certain loan originator compensation if the borrower paid upfront points and fees. For example, the Dodd-Frank Act would have generally prohibited a lender from paying individual loan originators certain commissions and other compensation in connection with a mortgage loan if the borrower paid up front points and fees. The Bureau had proposed creating a partial exemption. The proposal would have allowed a lender to charge up front points and fees and pay commissions and other compensation if the lender offered the borrower an alternative loan that did not include upfront points and fees. Rather than adopt this partial exemption, the Bureau decided to adopt a complete exemption to the statutory ban on upfront points and fees. The Bureau intends to assess the effects of the complete exemption and may take future action, including narrowing the exemption.
The Rule imposes obligations on creditors and mortgage brokers to ensure that the individual loan originators who work for them (i.e., employees, agents, contractors) are licensed or registered under other applicable laws, such as the Secure and Fair Enforcement for Mortgage Licensing Act of 2008. The Rule requires creditors and mortgage brokers that employ individual loan originators who are not required to be licensed or registered to ensure that these loan originator employees meet character, fitness, and background standards and receive training similar to licensed and registered loan originators. The Rule also requires that creditors and mortgage brokers include their unique identifiers and names on certain loan documents. The creditor or broker also must list the name and identifier of the individual loan originator primarily responsible for the origination of the loan.
The Rule prohibits loan terms that require the borrower to submit a dispute about a residential mortgage loan or certain home equity lines of credit (HELOCs) to binding arbitration. Additionally, under the Rule, no agreement relating to a residential mortgage loan or certain HELOCs could be applied to bar a borrower from bringing a court claim regarding an alleged violation of federal law. However, the parties could agree to arbitrate or otherwise settle a claim after a dispute arises.
The Rule prohibits the financing of any premiums for credit insurance in connection with a residential mortgage loan or certain HELOCs, but will permit premiums that are calculated and paid in full on a monthly basis.
The Rule expands recordkeeping requirements regarding loan originator compensation. The recordkeeping requirements apply to loan originator organizations, including both creditors and mortgage brokers. They will be required to keep evidence of compliance for three years. The increased time period will match the longer statute of limitations that will apply to claims for violations of the loan originator compensation requirements.
In conclusion, the Rule could affect several different aspects of a mortgage lender’s or broker’s operations, including hiring, employee training, compensation structures, referral activities, loan forms, litigation budgets, record retention schedules, and other policies and procedures. Going forward, lenders and brokers may be able to revise compensation structures. If they do so, they may need to consider other recently published rules that could affect loan originator compensation (e.g., Ability-to-Repay Rule). Depository institutions will have to provide additional training and background screening. Lenders and brokers will likely need to revise loan documents to provide identification information and revise their record retention schedules and other policies and procedures so that they are able to demonstrate compliance. The Rule is an example of the importance of reviewing not only the regulation but also the commentary and supplementary information. In this case, the Rule does not cover everything that one must know about upcoming loan originator compensation issues, but the commentary and supplementary information as well as the regulation clarify several important points from current Regulation Z’s requirements and cover several other issues on which mortgage lenders and brokers will need to be advised.
