Under the final Federal Reserve Board’s loan originator (LO) compensation rule, effective April 1, 2011, an LO may not receive compensation based on the interest rate or loan terms. This will prevent LOs from increasing their own compensation by raising the consumers’ rate. LOs can continue to receive compensation based on a percentage of the loan amount and consumers can continue to select a loan where loan costs are paid for via a higher rate. The final rule prohibits an LO who receives compensation directly from the consumer from also receiving compensation from the lender or another party.

The final rule also prohibits LOs from steering a consumer to accept a mortgage loan that is not in the consumer’s interest in order to increase the LO’s compensation.

Though a lawsuit has been filed to stop the changes from going into effect, there has been legal research conducted by the FRB over the course of many years.

The FRB’s research found that consumers do not understand the various ways LOs can be compensated such as yield spread premiums (YSPs), overages, and so forth, so they cannot effectively negotiate their fees. Yes, some LOs spend many hours educating their borrowers but this is not true for all LOs.

YSPs and overages create a conflict of interest between the loan originator and consumer. For consumers to be able to make an educated choice, they would have to know the lowest rate the creditor would have accepted, and determine that the offered rate is higher than the lowest rate available. The consumer also would need to understand the dollar amount of the YSP to figure out what portion will be applied as a credit against their loan fees and what portion is being kept by the LO as additional compensation. Currently, mortgage broker LOs must do this, but LOs who work for non-depository lenders or depository banks are not required to disclose their overage.

LOs argue that consumers ought to read their loan docs and take personal responsibility for negotiating a good deal on their mortgage yet facts related to LO compensation are hidden from consumers when working with depository banks and non-depository lenders.

The FRB’s experience with consumer testing showed that mortgage disclosures are inadequate for the average random consumer to be able to understand the complex mechanisms of YSPs when working with mortgage broker LOs. Consumers in these tests did not understand YSPs and how they create an incentive for loan originators to increase their compensation.

For example, an LO may charge the consumer an LO fee but this may lead the consumer to believe that the LO will act in the best interest of the consumer. The FRB says: 

“This may lead reasonable consumers erroneously to believe that loan originators are working on their behalf, and are under a legal or ethical obligation to help them obtain the most favorable loan terms and conditions.”

Consumers may regard loan originators as ‘‘trusted advisors’’ or ‘‘hired experts,’’ and consequently rely on originator’s advice. Consumers who regard loan originators in this manner are far less likely to shop or negotiate to assure themselves that they are being offered competitive mortgage terms. Even for consumers who shop, the lack of transparency in originator compensation arrangements makes it unlikely that consumers will avoid yield spread premiums that unnecessarily increase the cost of their loan.

Consumers generally lack expertise in complex mortgage transactions because they engage in such mortgage transactions infrequently. Their reliance on loan originators is reasonable in light of originators’ greater experience and professional training in the area, the belief that originators are working on their behalf, and the apparent ineffectiveness of disclosures to dispel that belief.

The FRB believes that where loan originators have the capacity to control their own compensation based on the terms or conditions offered to consumers, the incentive to provide consumers with a higher interest rate or other less favorable terms exists. When this unfair practice occurs, it results in direct economic harm to consumers whether the loan originator is a mortgage broker or employed as a loan officer for a bank, credit union, or community bank.”

Mortgage broker LOs have been forced to show all their compensation on line 1 of the GFE since Jan 2010. Mortgage Broker LOs will have very little difficulty in making the transition on April 1st. LOs who work for a non-depository lender or depository bank who are currently earning overage by selling the consumer a higher rate will need to make the ostensibly painful transition to full transparency.

* LOs who argue that consumers should take more responsibility for their mortgage loan ought welcome the FRB rule.

* LOs who argue that predatory lending was bad for consumers and bad for the mortgage industry should support the FRB rule. 

* Mortgage broker trade groups who have been screaming for a “level playing field” should celebrate the FRB rule and reconsider wasting membership dollars on a lawsuit.

Remember, the FRB rule does not limit LO compensation. Instead the FRB is imposing LO compensation prohibitions. The three percent rule on compensation will come later, with the Dodd-Frank Act.

The two doods from TBWS have put out  a series of entertainment videos that ought be taken with a grain of salt. Mike Anderson from Louisiana posted a youtube video meant to incite Realtors to earmark political action donations to fight off this new rule by telling viewers Realtor commissions might be next! And after that….used car salesmen and all commision salespeople. “This is a David v. Goliath story! Unprecidented! This is America, people.  We need donations now!”  Oh please. What a sorry-ass way to use fear to manipulate. 

Rhonda Porter, whom I highly respect, says the FRB rule is bad for consumers because an LO would not be able to lower his/her commission to help pull a transaction together.  The problem with all this talk of “this is bad for the consumer” is that nobody seems to have taken the time to read WHY the FRB rule was strutured this way. 

The FRB says the reason why LOs will not be able to lower their fees if needed is because LOs bring their own subjective decisions into which customers are able to receive this “I’m going to help you by lowering my commission” gift, and which customers would not be offered this same gift. The Rule aims for fairness and takes the subjective decision out of the hands of loan originators.   Maybe if I wear a button-down shirt and wave my hands around and video tape myself talking like a TBWS dood I’d get heard: Federal regulators don’t trust LOs.  I know this sounds harsh, LOs but the industry did this to themselves.  And don’t even get me started on the argument that all the predatory lenders are gone.  I. Think. Not. They’re still around, laying low doing loan mods, short sale negotiating or predatory mortgage litigation scams waiting until the market turns.

Yes, I know the FRB Rule means banks and lenders will increase their rates to make up for the increase in their own cost of doing business.  Yes, I know the big banks will be able to keep their profits.  Oooo, I iz so scarrrred of the evewl banksters.  To that I say, don’t like it? Then go open a bank.  This is still America and last time I checked you can still start a business anytime you’d like.  And besides, the last time I checked the banks are still funding the loans you’re making LOs, so stop talking out of both sides of your butt.  If bankers are the devil, then perhaps you could find someone else to fund your loans. Let me know how that works out.

The Federal Reserve Board Rule prohibitions on loan originator compensation attack predatory lending.  Consumers will receive more protection and for that consumers will have to make a trade: Rates and fees will be higher.  Count me in favor of the new FRB rule.  Four years ago I outlined solutions to the subprime lending crisis:  “Let’s stop dancing around the ambiguous behavior we call “predatory lending” and define it”The FRB rule does just that.

Mortgage loan originators who embrace the new FRB Rule and can make the transition to this new consumer-protection wave of legislation heading our way will survive and thrive.  Yes, even mortgage brokers will survive just fine. The FRB Rule is a speck of dust compared to what’s coming our way with The Dodd-Frank Act.