Loan Originator Compensation & the New Underwriting Rules Joseph M. Kolar & Jonathan W. Cannon BuckleySandler LLP Washington, DC Experienced Specialized

Loan Originator Compensation &the New Underwriting Rules

Joseph M. Kolar &Jonathan W. Cannon

BuckleySandler LLPWashington, DC

Experienced

Specialized

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Overview

Mortgage Originator Compensation Restrictions under Dodd-Frank and the Federal Reserve Board’s Final Rule

New Underwriting Standards and the Qualified Mortgage Exception

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Mortgage Originator Compensation - Overview

Dodd-Frank provisions (Section 1403 of Title XIV, creating new Section 129B(c) of TILA) are illuminated by recent Federal Reserve Board (“FRB”) final rule

FRB rule is effective for all applications received by the creditor after April 1, 2011

FRB intends to implement Dodd-Frank provisions in future rulemaking, but acknowledges similarity of provisions

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Both Dodd-Frank and FRB rule prohibit payments to a loan originator that vary based on the terms of the loan, other than loan amount

Both Dodd-Frank and FRB rule allow loan originators to receive payment from a person other than the consumer only if the originator does not receive compensation directly from the consumer

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Dodd-Frank has additional restriction not in FRB rule: If loan originator receives compensation from someone other than the consumer, the consumer must not make any upfront payment to the lender for points or fees other than bona fide third party charges. FRB will address this restriction in a subsequent rulemaking.

FRB Rule prohibits loan originator from steering consumers to loans not in their interest because it will result in greater compensation for the loan originator, but FRB rule adopts a safe harbor.

Dodd-Frank requires further regulations on “anti-steering.”

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Mortgage Originator Compensation

Under Dodd-Frank - “Mortgage originator” is defined as: Any person who, for direct or indirect compensation or gain, or in

the expectation of direct or indirect compensation or gain– Takes a residential loan application (residential loan

excludes HELOCs); Assists a consumer in obtaining or applying to obtain a

residential mortgage loanIncludes, among other things, advising on loan terms

(including rates, fees, and other costs), preparing loan packages, or collecting info on behalf of borrower; or

Offers or negotiates terms of a residential mortgage loan. Includes persons who represent to the public that they

can do the foregoing. Does not include servicers (as defined in RESPA),

including those offering modifications to borrowers in default.

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Under FRB Rule – “Loan Originator” defined as: A person who, for compensation or other monetary gain, or in expectation

of compensation or other monetary gain – arranges, negotiates, or otherwise obtains an extension of

consumer credit for another person. Includes the employee of the creditor as well as employee of a

mortgage broker. Does not include the creditor, unless table funding occurs

(where creditor does not provide the funds for the transaction). Does not include managers, administrative staff, and similar

individuals who are employed by a creditor or loan originator who do not arrange, negotiate, or otherwise obtain an extension of credit for a consumer AND whose compensation is not based on whether any particular loan is originated.

Under FRB Rule – “Mortgage Broker” defined as Loan Originator who is not an employee of the creditor.

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Restrictions on Loan Originator Comp in Dodd-Frank

Dodd-Frank prohibits any mortgage originator from receiving (and prohibits any person from paying to a mortgage originator, directly or indirectly) compensation that varies based on the loan terms, other than loan amount.

Dodd-Frank further prohibits a mortgage originator from receiving from any person other than the consumer (and prohibits any person who knows or has reason to know that the consumer has or will directly compensate the loan originator from paying to the loan originator) any origination fee or charge, except bona fide third party charges not retained by the creditor, mortgage originator, or an affiliate of the creditor or mortgage originator (but see the exception).

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Restrictions on Loan Originator Comp in Dodd-Frank

EXCEPTION: A mortgage originator may receive from a person other the consumer (and a person other than the consumer may pay a mortgage originator) an origination fee or charge IF:

The mortgage originator does not receive any compensation directly from the consumer; and

The consumer does not make an upfront payment of discount points, origination points, or fees, however denominated (other than bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or originator). The FRB may by rule waive or provide exemptions to this

limitation if such is in consumers’ or the public’s interest.

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Finally, Dodd-Frank provides a “Rule of Construction” that the foregoing language shall not be construed as:

Permitting any yield spread premium or other comp that would permit the total amount of direct or indirect comp from all sources permitted to a mortgage originator to vary based on the loan terms, other than loan amount;

Limiting or affecting the amount of comp received by a creditor upon the sale of a consummated loan to a subsequent purchaser;

Restricting a consumer’s ability to finance, at the option of the consumer, including through principal or rate, any origination fees or costs permitted under this provision, or the mortgage originator’s right to receive such fees or costs (including compensation) from any person, SO LONG AS

no person other than the consumer may pay fees to the originator if the consumer directly compensates the originator or if the consumer pays upfront discount points, origination points, or fees other than bona third party charges not retained by the creditor, the originator, or an affiliate of either (the FRB may waive this restriction if in the consumers’ or public interest), and

such fees or costs do not vary based on the terms of the loan (other than the loan amount) or the consumer’s decision about whether to finance such fees or costs; or

Prohibiting incentive payments to a mortgage originator based on the number of residential loans originated within a specified period of time.

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Loan Originator Comp in Dodd-Frank: What Does It Mean?

First, it is clear that mortgage originator compensation may never be based on the terms of the loan, other than loan amount. The meaning of the phrase “terms of the loan” is illustrated in the FRB rule (see below)

Second, if the consumer directly compensates the mortgage originator, no one other than the consumer, including the creditor, may compensate the loan originator.

Third, the consumer may continue to buy up or buy down the rate with discount points, so long as no one but the consumer compensates the mortgage originator. This restriction is subject to a waiver if found not to be in consumers’ or the public’s interest.

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Restrictions on Loan Originator Comp in FRB Rule

Like the Dodd-Frank provisions, the FRB rule prohibits any compensation to the loan originator based on the loan terms.

But this restriction does not apply if only the consumer directly compensates the loan originator (in which case no one other than the consumer may compensate the loan originator).

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The FRB Rule and the Commentary accompanying the Rule add these further clarifications:

Compensation includes salaries, commissions, and any financial or similar incentive provided to a loan originator that is based on any of the terms or conditions of the loan originator’s transactions.

Compensation to a loan originator may be based on a fixed percentage of the loan amount, and may be subject to a minimum or maximum dollar amount, so long as the minimum or maximum dollar amounts do not vary with each transaction.

A creditor may not offer “tiered percentages” of compensation, such as 1% of principal for loans of $300,000 or more, 2% of principal for loans between $200,000 and $300,000, and 3% of principal for loans below $200,000.

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In addition to terms such as interest rate, annual percentage rate, loan-to-value ratio, or the existence of a prepayment penalty, the rule prohibits basing loan originator compensation on a factor that serves as a proxy for loan terms and conditions. Credit score could serve as a proxy if it determines the interest rate.

Compensation (i) for long-term performance of the originator’s loans, (ii) based on an hourly rate for number of hours worked by the originator, (iii) based on whether the consumer is a new customer, (iv) based on a fixed flat fee for each loan, (v) based on the originator’s pull-through rate (percentage of applications that result in closed loans), (vi) based on the quality of the loan files, or (vii) based on a legitimate business expense, such as fixed overhead costs, is not compensation based on the loan’s terms.

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Once a creditor offers to extend a loan with specified terms (such as the rate and points), the amount of the originator’s compensation for that loan is not subject to change (increase or decrease) based on whether different loan terms are negotiated.

Payment by a consumer of lender’s points that are then used by the lender to pay the loan originator are not considered payments received directly from the consumer.

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Unlike Dodd-Frank, the FRB rule does not prohibit compensation to a loan originator from a person other than the consumer where the consumer pays discount points or origination points or fees to the lender. That provision will be addressed in future rulemaking.

The FRB rule does, however, adopt an anti-steering provision that prohibits a loan originator from directing a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator offered or could have offered to the consumer, unless the consummated transaction is in the consumer’s interest.

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Safe Harbor Regarding Steering. The anti-steering provision is not violated if the loan originator presents the following loan options for the type of transaction in which the consumer expressed an interest (there are three “types of transactions” – fixed rate mortgage, ARM, or reverse mortgage):

The loan originator must obtain loan options from a significant number of the creditors with which the originator regularly does business (this number is 3 or more, unless the originator does not deal with that many creditors)

The loan originator must present:

The loan with the lowest rate The loan with the lowest rate without neg am, a prepayment penalty,

interest-only payments, a balloon payment in the first 7 years, a demand feature, shared equity, or in the case of a reverse mortgage, a loan without a prepayment penalty, or shared equity or shared appreciation; and

The loan with the lowest total dollar amount for origination points or fees and discount points

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Safe Harbor Regarding Steering (continued)

The loan originator must have a good faith belief that the consumer likely qualifies for the options presented

For each type of transaction, if the originator presents more than three loans, the ones satisfying the criteria above must be highlighted

Fewer than three loans can be presented if the loans presented satisfy the criteria described above

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Under the FRB rule, if the consumer directly compensates the mortgage originator, no one other than the consumer, including the creditor, may compensate the loan originator.

The rule and Commentary make clarifications to this rule.

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The Rule and the Commentary make the following clarifications:

The restriction applicable to loans where the consumer compensates the loan originator relates only to payments, such as commissions, that are specific to, and paid solely in connection with, the transaction. Thus, payments by a mortgage broker company to an employee in the form of a salary or hourly wage, which is not tied to a specific transaction, do not violate this provision even if the consumer directly pays a loan originator a fee in connection with a specific credit transaction.

But, if any loan originator receives compensation directly from the consumer in connection with a specific transaction, neither the mortgage broker company nor an employee of the mortgage broker company can receive compensation from the creditor in connection with that particular credit transaction.

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The Rule and the Commentary make the following clarifications:

Affiliates are treated as a single person, so if a holding company has two mortgage lenders, and a loan originator may deliver loans to both lenders, they must compensate the loan originator in the same manner.

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Restrictions on Loan Originator Comp in FRB Rule: What Does it Mean?

The FRB rule provides clearer guidance on loan originator compensation restrictions than the Dodd-Frank provisions, but it doesn’t address the most problematic of the Dodd-Frank provisions (the prohibition on paying a loan originator compensation if the consumer pays any upfront discount points or origination points or fees, presumably to the creditor).

The FRB rule does provide clarity on what compensation is and is not “based on the loan terms.”

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Restrictions on Loan Originator Comp in FRB Rule: What Does it Mean?

FRB rule also provides guidance on the permissibility of non commission-based salaries to employees even where the consumer pays the loan originator directly. However, its treatment of managers as loan originators based on the fact that their compensation is based on whether the loan is made, even if they do not perform loan originator functions, raises concerns.

Finally, the FRB rule provides guidance on the new anti-steering provision, but additional questions remain, including how a mortgage broker is to determine whether a consumer likely qualifies for a loan for the purposes of the safe harbor.

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Mortgage Underwriting Reforms

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Under Dodd-Frank, the creditor must make a reasonable and good faith determination that the consumer has a reasonable ability to repay the loan

Determination must be based on verified and documented information

Determination must take into account loan, taxes, insurance (including MI), and assessments

Creditor must combine payments if more than one loan

“Nonstandard loans” must be assessed using a fixed, fully indexed rate and a fully amortizing repayment schedule.

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The ability to repay determination must include a consideration of the following:

credit history current income expected income current obligations DTI or the residual income employment status other financial resources other than equity in the

dwelling

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Income Verification: Income or assets (including expected income or assets) must be verified by reviewing the following:

W-2 tax returns payroll receipts financial institution records, or other reasonably reliable third-party documents

Consideration of income history must include IRS tax transcripts (or other method subject to rulemaking).

Seasonal or irregular income, including income from a small business, may be considered.

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Federal departments or agencies may exempt refinancings under a streamlined refinancing from the income verification requirement as long as the following conditions are met:

No 30-day or greater delinquency No increase in principal (except for fees allowed by agency) Total points and fees do not exceed 3% of loan amount Interest rate is lower (unless refinancing from an ARM to fixed;

then subject to agency guidelines) Refinancing is subject to payment schedule that fully amortizes

loan No balloon payment Both the loan being refinanced and the refinancing satisfy all

requirements of the department or agency

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Qualified Mortgage Exception

Any creditor (and any assignee subject to liability) may presume that the residential mortgage loan has met the ability to repay requirements if the loan is a “qualified mortgage”

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“Qualified mortgage” means any residential mortgage loan that meets the following criteria:

payments do not increase principal balance or defer payment of principal

loan does not contain a balloon payment (except in limited circumstances)

income and financial resources are verified and documented underwriting process is based on fully amortizing payments

including taxes, insurance, and assessments for ARMs, underwriting is based on the maximum rate permitted

under the loan during the first five years the loan complies with guidelines or regulations (to be established)

regarding DTI or other methods of analyzing ability to pay total points and fees (defined below; includes fees paid to

affiliates) do not exceed three percent of the total loan amount loan term is thirty years or less

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“Qualified mortgage” further provisions:

Reverse mortgages may be considered QMs if they satisfy standards set forth in regulations

Regulations must be issued to adjust points and fees criteria for small loans

Regulations may adjust QM safe harbor if changes are necessary to ensure the extension of “responsible, affordable mortgage credit”

HUD, VA, Ag., Rural Housing must define their own QM Rural and underserved areas will have special rules Prepayment are substantially restricted for QMs and

prohibited for non-QMs

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“Points and fees” (which must not exceed 3% of loan amt. for a QM) generally include

Fees and charges paid to the mortgage originator, lender, or affiliate of lender or MO

All compensation paid directly or indirectly by a consumer or creditor to a mortgage originator from any source, including MO in a table-funded transaction

Credit insurance premiums paid at closing Maximum prepayment penalties

Points and fees do not include bona fide third-party fees paid to non-affiliates

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“Points and fees” (which must not exceed 3% of loan amt. for a QM) do not include the following:

Up to and including 2 bona fide discount points, but only if the interest rate from which the mortgage's interest rate will be discounted does not exceed by more than 1 percentage point the average prime offer rate; or

Up to and including 1 bona fide discount point, but only if the interest rate from which the mortgage's interest rate will be discounted does not exceed by more than 2 percentage points the average prime offer rate.

The amount of the interest rate reduction purchased must be reasonably consistent with established industry norms and practices for secondary mortgage market transactions.

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For further information:

Joseph M. Kolar

BuckleySandler LLP

1250 24th Street, NW

Suite 700

Washington, DC 20037

[email protected]

202-349-8020

Jonathan W. Cannon

BuckleySandler LLP

1250 24th Street, NW

Suite 700

Washington, DC 20037

[email protected]

202-349-8063

Documents

Loan Originator Compensation & the New Underwriting Rules Joseph M. Kolar & Jonathan W. Cannon BuckleySandler LLP Washington, DC Experienced Specialized