The Senate has passed an amendment to the Wall Street Reform bill that would ban loan originators from accepting compensation based on placing a consumer in a higher interest rate loan or a loan with less favorable terms.  The amendment also requires lenders to underwrite loans to assure a homeowner’s ability to repay the loan.

As you can imagine, loan originators everywhere are outraged.

Imagine not being able to earn extra compensation for selling a higher rate loan! Imagine making sure that homeowners can repay their loans! 

Wait a minute. Isn’t that the world we currently live in right now?

The horror we’re leaving behind if this amendment becomes law was the predatory lending frat parties of 2006.  From what I can tell, most (not all) of that is behind us. What are we really losing with the passage of the Merkley-Klobuchar Amendment?

Mortgage brokers have to disclose all yield spread premium earned as fee income on line 1 of the new Good Faith Estimate.  They will not be losing anything new.  It can be argued that mortgage brokers should have lost the ability to earn yield spread premium because it was horribly misused not by “an unsavory few” but by the vast majority of mortgage broker LOs all across the United States.  For the few LOs who had no problems honestly explaining their full compensation, the change to the new GFE was not seamless but certainly not painful.

Brokers might be fearful that consumers will no longer be able to select a “no cost” refinance.  First of all: THERE IS NO SUCH THING AS A NO COST REFI.  There are costs. Instead, the homeowner is selecting to amortize the costs over the term of the loan instead of coming to the table with cash to pay for the cost to refinance into a lower interest rate loan.   The way I interpret the spirt of the amendment, consumers can still elect to use yield spread premium (YSP) as a credit back from the lender, to cover their closing costs….but broker LOs are prohibited from helping themselves to any leftover YSP as compensation.  This is true today and it would still be true under the amendment. 

Mortgage loan originators who work under a consumer loan company license (They say, “I’m a mortgage banker, I’m a correspondent lender”) or LOs who work at a depository bank can still, at least today, earn hidden compensation called “overage” by selling a higher interest rate than what the homeowner could have received.  Think of it as a retail markup. These LOs may or may not choose to show the consumer the wholesale rate sheet.  This is just the same as yield spread premium but consumer loan company and bank LOs do not have to disclose their overage to the consumer.

The Merkley Klo-bu amendment aims right at the practice of earning “overage” and scores a bullseye.

Someone has been educating the Senators about how to create a level playing field and it’s not me. I’m too busy trying to recover from this delightful carpal tunnel surgery on my right wrist.  I wish you could see me try to eat a bowl of Cracklin’ Oat Bran with my left hand. As it is, I shouldn’t be typing this but don’t tell Dr. McCallister.  For me this short blog post IS taking it easy.

Brokers have been asking for a level playing field. Well the Merkley-Klobuchar amendment creates just that.  Instead of hidden compensation, the way loan originators are paid will transform. We will most likely revert back to a 1 percent loan origination fee.

Here are some new ideas. 

How about we pay loan originators based on customer satisfaction surveys. We’ll call it the Redfin model.  After the transaction is complete, clients would rate a loan originator based on how well they explained the loan program choices and how close the HUD 1 fees matched the initial GFE.  How about we pay loan originators based on the number of hours spent doing origination functions on each loan, and the hourly wage would be set by the employer based on a loan originator’s experience, education, and….loan performance.

That’s another idea. Why not base LO compensation on low default rates? 

Take a look at the national default rate of FHA loans.  You can sort by state, county, company name and so forth.  What the hell is going on at these companies with high FHA default rates?  I’ll bet any of us can find out by simply having a casual water cooler conversation with loan originators at any firm in your city.  Everyone knows which loan originators are scamming the FHA system.  Can we please get rid of these LOs? The only reason they still have a job is because it takes FHA 4 years to hunt them down and between now and then, their bosses can make hundreds of thousands of dollars sending FHA these dog loans and then simply close up shop, pay the fine and move on to another firm. 

The Merkley-can-we-just-drop-the-second-name amendment might just do us all a favor and make it a good business decision for firms to get rid of the people who are sending fradulent, high default loans to FHA.

Now I know we’re going to get some clever LOs to point out that it’s not their fault that a homeowner got laid off or a homeowner decides to walk away from the loan when their 3.5% FHA loan goes negative equity this fall.  Okay fine. I see you two whiny shoulder shrugs and raise you two underwriting screw tightens.  After this amendment passes, underwriting guidelines are going to tighten up fast and lenders will definitely want homebuyers to put more money down.  Both will not give 100 percent assurance that a homebuyer will not default, however, it will be better than the loans we’re currently making. I’m hearing lenders are still making FHA loans where the back end ratio can be 50%.  Today’s FHA loans will not end well.

Loan originators, the best way to assure the future of your industry is to fully disclose ALL compensation to your clients, no matter where you work, and if you can’t justify your compensation, it’s too high so you’d better start re-learning how to create value for your clients or pretty soon you won’t be needed.

A client just called me this week and said a lender called American Interbanc is telling consumers they don’t charge a loan origination fee because they don’t have any loan originators.  I sent then an email requesting to interview someone from American Interbanc but so far they’re being shy.  Well I hope any regulator reading this schedules them for an audit real soon because someone is doing the job described in the SAFE Act as “loan origination” and if they want to slough off the work to their unlicensed processors, well then this is one company to watch. We should watch to see if this is a business model for the future or if it’s a business model that we’ll be reading about in a State Consent Order or HUD Audit. 

I happen to believe loan originators are valuable.  The most valuable LOs I meet today are the ones who have already learned how to clearly communicate their value to their clients.  The Merkley amendment has a good chance at passing.  LOs: Imagine a world where your compensation is much lower than it is today. Many will leave the industry. Many will stay and do more loans for the other’s clients.  You will have to work harder for your compensation but the ones who will choose to stay already love the industry so much it doesn’t feel like work.