In order to understand all the whining taking place by loan originators (LOs) about compensation limits under the Dodd Frank Wall Street Reform Act as well as the Federal Reserve Board that go into effect in 2011, it’s important to lay down some background for consumers.

During the predatory lending days (which I like to fantasize about as being in the past) some loan originators would frequently mis-use the government mandated disclosure forms to deceive consumers as to the amount of compensation earned on a typical mortgage loan.  LO fee income was put on the wrong line, left of the forms altogether, bait-and-switch was a common practice, and there are ample cases of flat out mortgage fraud to last us a lifetime.  It is no longer a matter of IF it was done.  Evidence of loan originators making six figures a year income with no training, no high school diploma, and no experience  attracted more of the same “get rich quick” mentality.  It happened in communities all over the United States by loan originators who worked at all different types of institutions: depository banks, non-depository lenders, consumer loan companies and mortgage brokerage firms.  Because it happened is one of the logical reasons and there are others, why LO compensation limits will be put into place.

For consumers reading this blog post, it is important to understand the three main ways mortgage companies are regulated. A loan originator can work for a retail depository bank that accepts checking and savings deposits, an LO can work at a non-depository mortgage lender which has the ability to fund their own loans but does not offer retail banking, and a loan originator can work under a mortgage broker.  A broker does not have the ability to fund their own loans. For a fee, a broker “finds” the mortgage money on behalf of the consumer.  To make things slightly more complex, a loan originator working for a bank or lender might also be able to broker a loan out to another lender.  There are other ways to originate such as working at a credit union, an insurance company, etc., but the three main ways, broker, banker, or lender are historically the most common.

Loan originators are compensated in many ways.  LOs can earn a percentage of the loan amount, LOs can charge extra fees such as an administration fee, application fee, processing fee, and so forth, and take some or all of those extra fees as income.  In Jan of 2010 changes in the federal law RESPA requires all compensation that inures to the benefit of the loan originator to be shown on line 1 of the Good Faith Estimate. This includes compensation to a loan originator who works for a mortgage broker as well as a loan originator who works for a non-depository mortgage lender and also a loan originator who works for a retail depository bank.  Everyone’s compensation is now shown on line 1 of the Good Faith Estimate. The federal government’s intentions with this change to RESPA was to help consumers shop for the lowest cost loan.

During the predatory lending days, many LOs put their fee income on all different lines of the Good Faith Estimate (GFE) and consumers were unable to compare costs.  Some predatory lenders simply left fees off of the GFE to make the consumer believe they were the lowest cost choice only to have the fees re-appear at closing (definitely a violation of many state laws because consumers are not given a chance to question the suddenly higher fees.) 

There is no question that many LOs who worked under the mortgage broker system enjoyed earning lots of extra compensation by charging the consumer a little bit (or a lot) higher interest rate than what the consumer could have received.  This extra fee income is called Yield Spread Premium. This is similar to when a retail store marks up the cost of goods or services from its wholesale price.  The difference between wholesale and retail markup might be pure profit but it also might cover costs.  There’s nothing wrong with a mortgage broker charging a higher rate for services rendered….provided the extra compensation income is disclosed to the consumer.  MANY predatory lenders simply decided not to disclose their extra fee income!  Yield spread premium income wasn’t on the GFE at all or it was disclosed in a way that was in violation of state and federal law. Why? I suppose we could argue that all day but for the most part, LOs who blatantly violated YSP disclosure rules did so because…they could.  We had too many LOs, too many loans being written, too much money being made by everyone, too many funding lenders teaching LOs how to earn lots of money this way and not enough regulatory oversight.  Predatory lending was happening all across the spectrum, not jut on the mortgage broker side, from as early as 1999, the first year I really took notice of the problem.  The brokers were the first ones to really get shot down for their extra YSP compensation when GFEs and HUD 1 closing statements were scrutinized in the courtroom.  Fast forward to 2010 and today instead of LOs up-selling interest rates and helping themselves to extra compensation, all LO compensation must show on line 1 of the GFE. So they can still do it, provided it’s disclosed to the consumer.

In 2009 and throughout 2010, LOs have fled the mortgage broker model and were recruited to work for the non-depository mortgage lenders (they also like to call themselves mortgage bankers.)  Why? Well one reason is because RESPA exempts a lender with the ability to fund its own loans from disclosing extra compensation (similar to YSP but we call it overage at a mortgage bank) from up-selling a higher rate. LOs who work at a depository bank are also exempt from disclosing this “overage” income.  So how much money are we talking about? It varies from company to company and from lender to lender and is based on a percentage of the loan amount.  One LO tells me that his income could drop as much as 42 percent once the provisions of Dodd-Frank Wall Street Reform come into play in the spring of 2011:

• A loan originator may not receive compensation that is based on the interest rate or other loan terms
• However, loan originators can continue to receive compensation that is based on a percentage of the loan amount
• A loan originator receiving compensation directly from the consumer may not receive additional compensation from the lender or another party
• Loan originators are prohibited from directing or “steering” a consumer to accept a mortgage loan that is not in the consumer’s interest in order to increase the loan originator’s compensation.

This last bullet point eliminates yield spread premium income from LOs who work under a mortgage broker AND ALSO eliminates “overage” income from LOs who work for a retail bank as well as LOs who work for a non-depository lender. This will force all LO compensation onto line 1 of the Good Faith Estimate. 

I recently reviewed a Good Faith Estimate for my cousin who lives in another state.  The LO was charging .50% loan origination fee and $1800 dollars in junk fees: processing fee, underwriting fee, administration fee, application fee showed up on a supplimentary worksheet. In addition, the LO quoted a higher rate than what my cousin could have obtained for that same loan from another lender. Since the lender fell into the catagory of “non-depository lender” that LO was earning even more compensation than what was shown on the GFE.  After LO compensation limits of Wall Street Reform go into effect, all this LO compensation will be forced onto line 1 of the GFE, hopefully giving my cousin and other consumers the ability to shop for the lowest rates and lowest cost loan. 

LOs who argue “customers don’t care about how much I make, they just care about the rate and the payment” are missing the point. Consumers DO CARE about your compensation when it means they will be paying your compensation EVERY SINGLE MONTH in the form of a higher rate and a higher payment.  LOs who have no problems justifying their fee income will survive and thrive.

LOs who argue “the banks are the ones who win with the compensation limits because they can hire “phone officers” to just take a loan application and pay loan processors way less money than a loan originator to finish up the file.” Indeed that is very true having met many of these phone officers already.  Phone officers are completely worthless, which is why I firmly believe there is a place in the future of mortgage lending for mortgage brokers and non-depository mortgage lender originators.  LOs who are able to justify their compensation will survive and thrive.  These are people with 15 or more years of experience who know their loan programs, know state and federal law, and know how to counsel their clients.  LOs who are brand new are going to have a much harder time justifying high fees.  Maybe that’s the way it should be: We separate the men from the boys and the women from the girls.  Just like baby attorneys fresh out of law school make way less per hour than a 20 year courtroom veteran. 

LOs will argue: “No one will originate loans under $100,000 because nobody can earn a living on such low fee income per deal.”  Guess what? I’ve met HUNDREDS of loan originators who will GLADY originate that loan. 

LOs who argue: “People are going to leave the industry because they can’t earn enough money.”  To that Red Forman would say, don’t let the door hit your ass on the way out. 

LOs don’t even have to hold a high school diploma to originate loans.  That should change and will.  Until then the only requirement is to take a measly 20 hour class (that’s two, 10 hour days), pass a national and state exam and not have any felony convictions….over the last 7 years. Yes that’s right a convicted felon can still originate loans unless the felony conviction was a financial-type crime.  This is a VERY low barrier to entry but it has only now been put into place in 2010.  LOs: Your income at entry level should never have been as high as it was.  The government is correcting what the industry refuses to do: Take away the motivation to treat the consumer as an object to maximize your own income.   

The winds of change are blowing in favor of more consumer protection, more reponsibility of disclosure placed onto the loan originator and less wide open territory for LOs to “earn six figures, no experience necessary” which was a common way of recruiting LOs on craigslist during the 00s.  Oh wait, here’s an “earn six figures” ad from today!  The LOs that will survive are the LOs who already work for a mortgage broker!  Mortgage brokers are already disclosing ALL their income on line 1 of the GFE.  A consumer has the most transparency already with mortgage broker LOs.  The LOs that survive and thrive will be those who can transform themselves from salesperson to counselor, who can transform from “helping customers” into serving clients. Treating a person as a client is a radically different mindset. Indeed many LOs never fell into the catagory of “predatory lender.” Those LOs are still around today originating and they will gladly serve the clients of LOs who choose not to make the transition from hidden compensation to full disclosure. 

With Dodd-Frank Wall Street Reform, the government is doing what the mortgage industry has refused to do: transform loan originators from salespeople into something a little bit more than that.  LOs who never engaged in predatory lending behavior don’t have to make any radical changes.  LOs with no problems justifying their compensation will do just fine under Dodd Frank Wall St Reform. They’re already livin’ the dream.