In our initial article announcing our top 10 considerations for financial institutions in 2016, which can be found here, our seventh consideration was loan originator compensation. This is just one of a few areas the CFPB has specifically identified for supervision and enforcement in 2016. While the compensation rules that changed how mortgage loan originators are paid were promulgated by the Federal Reserve in 2010, and reinforced by the CFPB in 2013, these rules continue to create issues for financial institutions trying to attract and retain talented loan originators.
Generally, the loan originator compensation (LO Comp) rules prohibit a loan originator from receiving (and no person may pay a loan originator), directly or indirectly, compensation based on a term or condition of a mortgage loan transaction. Within the rules are a number of definitions that need to be fleshed out in a compliance review. For example, the definitions of “loan originator,” “compensation,” and “term of a transaction” are critical to the analysis of any compensation plan or structure.
Most significantly, Regulation Z, which implements the Truth in Lending Act, defines a “loan originator” as:
“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, 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 through advertising or other means of communication represents to the public that such person can or will perform any of these activities.”1
After a loan originator is identified, based on the activities performed, the next inquiry is the definition of “compensation” and whether such compensation is based on the “terms of the transaction.” Generally, “compensation” is interpreted broadly and includes “salaries, commissions and any financial or similar incentive,” such as “annual or periodic bonuses, and awards of merchandise, services, trips or similar prizes.”2 Additionally, a “term of a transaction” is defined as “any right or obligation of the parties to a credit transaction” and includes, for example, the interest rate, loan-to-value ratio, or prepayment penalty associated with the transaction.
To make matters even more complicated, the LO Comp rule also prohibits any compensation that is based on a factor that is a proxy for a term or condition of the loan transaction. Such “proxies” are factors which consistently vary with the term or terms of a transaction over a significant number of transactions, and which the loan originator has ability, directly or indirectly, to manipulate when originating the transaction. This analysis can be particularly complex and fraught with uncertainty.
However, amidst all the complication there do appear to be a number of permissible methods of compensating loan originators. These compensation methods include, but may not be limited to, payments based on: a fixed percentage of the loan amount; the overall dollar or unit volume of transactions; the long-term performance of the loan; an hourly rate of pay for actual hours worked; whether the borrower is a new or existing customer; and the quality of loan files.
Going forward, loan originator compensation will continue to be an area of heightened scrutiny and risk for mortgage originators. The CFPB, and the prudential banking regulators, expect to see comprehensive policies regarding loan originator compensation practices, as well as compliant compensation structures, and, as such, financial institutions are well advised to conduct periodic reviews of such policies, procedures and compensation structures organization-wide, amend them as necessary and conduct reasonable monitoring of actual compensation practices.