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Mortgage Loan Originator Compensation – the Current Interpretation
The Secure and Fair Enforcement for Mortgage Licensing Act (S.A.F.E. Act) of 2008 was effective on October 1, 2010. The Act is intended to protect consumers from unfair, abusive, or deceptive practices to prohibit certain compensation payments to Mortgage Loan Originators and prohibit steering of customers based on compensation considerations. Upon the effective date, financial institutions were required to develop policies and procedures for compliance with the act. Most institutions have a good understanding of the requirements for determining who the MLOs within their organizations are and the registration requirements; however, the definition of “compensation” for these lenders has been open for interpretation and a bit confusing.
On February 12, 2012, staff from the FDIC’s Division of Depositor and Consumer Protection (DCP) hosted a national banker teleconference to review and discuss Regulation Z’s (Truth in Lending) Mortgage Loan Originator Compensation Rule and its impact on a bank’s ability to compensate their MLOs based on the terms and conditions of a loan, including compensation based on the bank’s profitability.
Under the Act, “compensation” is defined as: salaries, commissions, processing fees assessed by loan originators or any financial or similar incentive. It also includes an annual or periodic bonus, which may include awards of merchandise, services, trips or other prizes.
The compensation rules prohibits an MLO to be paid from steering a borrower to a more “lucrative” program wherein the MLO will receive added compensation than if the borrower chooses another program. It also prohibits the MLO from receiving compensation from more than one party in the transaction such as from the institution the MLO works for and a third party or direct payment to the MLO from the borrower. In addition, an MLO cannot receive compensation based on the terms or conditions of the loan. Compensation cannot be based on the interest rate, annual percentage rate, loan-to-value ratio, the existence of a prepayment penalty or a proxy for terms and conditions.
The terms interest rate, annual percentage rate, loan-to-value ratio, and the existence of a prepayment penalty are easily identifiable and understood. However, the last element “proxy” for terms and conditions is one that requires additional attention.
The definition of proxy is credit score and debt to income ratios and/or compensation based on profits and profitability of the bank. Herein lies the problem for most financial institutions. If the financial institution has a profit-sharing or profitability plan, 401k contributions based on profits, set income goals for MLOs within the financial institution, ESOP plans or a retirement plan contributions based on profits in which employees of the institution participate, then these plans may be in violation of the Act for MLO compensation.
If the “profits” of residential mortgage loans the institution holds or mortgage loan operations are included in the total profits for which the profit-sharing plan is based, the Federal Deposit Insurance Corporation (FDIC) and Federal Reserve Board (FRB) interpret these compensation arrangements to be impermissible because the income is derived from loan terms and conditions.
Banks are strongly encouraged to review their compensation plans and ensure there are no prohibited elements incorporated into the plan that may include not only the terms and conditions of a loan, but also the bank’s overall profitability.
It is also recommended that financial institutions seek counsel in reviewing and establishing the compensation plan for MLOs to comply with the S.A.F.E Act and to ensure the compensation plan does not violate the Employee Retirement Income Security Act (ERISA).