Last week, the Federal Reserve Board announced rules aimed at protecting consumers from what many consumer advocates considered abusive lending practices. In connection with its release of the new rules, the Fed stated that the rules will help “prevent loan originators from increasing their own compensation by raising the consumers’ loan costs.” The new rules apply to closed-end loans secured by a consumer’s dwelling. The rules specifically target loan originator compensation and are effective April 1, 2011. The rules will most certainly change the way mortgage originators and lenders do business.
Yield Spread Premiums
The main focus of the new rules is the ban of yield spread premiums. During the housing boom, it became common practice for many lenders to pay loan originators a higher compensation if a borrower accepted a loan with an interest rate higher than that required by the lender for borrowers of similar creditworthiness. This “yield spread premium” is banned under the new rules as a loan originator may no longer receive compensation that is based on the interest rate or other loan terms, such as increased points paid by the borrower at closing. The rules do not, however, prohibit the common practice of loan originators receiving compensation based on the percentage of the loan amount.
Steering and Safe Harbor
The rules also seek to prevent a mortgage originator from steering a borrower to a mortgage loan that may not be in the borrower’s interest in order to increase its own compensation. Fortunately, the rules provide a “safer harbor” to help lenders comply with the anti-steering rule. To meet the safe harbor requirements, a lender must present the borrower with options for all loan products in which the borrower expresses an interest (for example, fixed rate and adjustable rate loans). Also, the options presented to the borrower must include (i) the lowest interest rate for which the borrower qualifies, (ii) the lowest points and origination fees, and (iii) the lowest rate for which the borrower qualifies for a loan with no “risky” features such as a balloon payment in the first seven years or a prepayment penalty.
The new rules were in the works long before the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (CFPA). It should be noted that the CFPA contains provisions similar to the ban on yield spread premiums contained in the new rules, but the CFPA addresses a number of other loan origination issues not targeted by the rules released last week. As such, the rules announced by the Fed last week are likely only the tip of the iceberg of the reform that is to affect loan origination practices in the months and years to come.