Rules change on how brokers, lenders negotiate credit terms

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By Mike Scott
Legal News

The turmoil that adversely impacted the mortgage and housing market has forced a legal change in how brokers and loan officers can negotiate credit terms, according to an area attorney who is an expert on compliance issues.

The Federal Reserve Board (FRB) created a loan originator compensation rule late last year designed to stop loan officers and mortgage brokers from negotiating credit terms. This is a significant change to how real estate funding is handled and is requiring the work of area real estate lawyers to help loan officers better understand their requirements.

This rule does not end loan officer commissions or lender paid broker fees, and it will not eliminate brokered loans. But it does add a new layer of guidelines, said Howard Lax, a partner and real estate lawyer with Lipson, Neilson, Cole, Seltzer & Garin in Bloomfield Hills.

“A lender that has a wholesale (third party) origination program (and) accepts loan applications from mortgage brokers has to review and modify its broker agreements,” Lax said. “With these changes under the loan originator compensation rule, there are a number of issues that I counsel lenders on and various agreements that need to be drafted.”

The FRB announced final rules last August to protect mortgage borrowers from unfair, abusive, or deceptive lending practices that can arise from loan originator compensation practices. The new rules apply to mortgage brokers and the companies that employ them, as well as mortgage loan officers employed by depository institutions and other lenders.

Every mortgage company, bank, and every other financial institution that originates residential mortgage loans has to review and perhaps modify its loan officer compensation formulas and other terms of its loan officer employment contracts, Lax said. He and other lawyers in the field counsel lenders on proper compensation programs, and draft loan officer employment agreements.

There are three main points to the Federal Reserve Board’s final rule, Lax said. First is that mortgage lenders are prohibited from paying compensation to a loan originator based on the terms or conditions of the credit transaction, other than the amount of credit extended. The only exception to this rule is for payments that consumers make directly to a loan originator.

Second is that compensation based on a factor that is a proxy for a transaction’s terms or conditions is prohibited. Finally, loan originators are not permitted to “steer” borrowers to products that are not in their interest. The steering prohibition applies to transactions in which retail originators “broker out” loans.

Lenders commonly will pay loan originators more compensation if the borrower accepts an interest rate higher than the rate required by the lender, Lax said. Under the final rule, however, a loan originator may not receive compensation that is based on the interest rate or other loan terms.

“Ideally this will prevent loan originators from increasing their own compensation by raising the consumers’ loan costs, such as by increasing the interest rate or points,” Lax said.

Loan originators can continue to receive compensation that is based on a percentage of the loan amount, which is a common practice.
“The new rule seeks to ensure that consumers who agree to pay the originator directly do not also pay the originator indirectly through a higher interest rate, thereby paying more in total compensation than they realize,” Lax said.

It also prohibits loan originators from directing or “steering” a consumer to accept a mortgage loan that is not in the consumer’s interest in order to increase the originator’s compensation. The rule will preserve consumer choice by ensuring that consumers can choose from loan options that include the loan with the lowest rate and the loan with the least amount of points and origination fees, rather than the loans that maximize the originator’s compensation.

Every financial institution that buys mortgage loans has a legal team in place to review and modify its due diligence procedures and record keeping protocols, according to Lax.

“There are a significant number of compliance issues that need to be addressed (by lenders),” Lax said.
One of the benefits to consumers is that there is less incentive for loan officers to sell pricey mortgages to buyers Lax said. It won’t eliminate the need for consumers to shop for the best credit terms since there are no requirements for lenders to offer the lowest rate.

“The loan officer, mortgage broker and lender are not fiduciaries,” Lax said.

This rule was written in an effort to stop predatory lending practices, according to an FRB press release. It first conducted hearings in 2006 and identified situations where loan officers convinced borrowers that they had to pay more for credit or they had to take a subprime loan rather than a lower cost prime loan, due to problems with their credit.

This assumption turned out to be false, and loan officers and brokers originated far too many subprime loans simply to be paid more, necessitating the change.
“The formulas that approximate prior earnings are often complex, and require consultation with human resources professionals and legal counsel to ensure that no facet of the plan overlooks some indirect connection with profits generated through variable loan terms,” Lax said.

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