The year 2019 will bring big changes to the financial services industry. Kathy Kraninger’s recent confirmation as Director of the Consumer Financial Protection Bureau understandably raises hopes that that this year will see a rebalancing of the key mortgage regulations to expand credit availability and maintain key protections for consumers, while lessening burdens on industry. The MBA has outlined many such changes in our responses to the Bureau’s requests for information or RFIs. That exercise also made clear that changes to the LO Comp rule should be the Bureau’s top priority this year.
Loan Originator Compensation (LO Comp)
The original impetus for the LO Comp rule was to protect consumers from steering. In the current regulatory environment, the harm associated with steering—borrowers agreeing to a loan they do not understand and cannot repay—is less likely. The LO Comp rule obviously plays a part in this, but so does the other regulatory actions adopted following the passage of the Dodd-Frank Act. After more than five years under the rule, it is clear that certain limited changes should be made to retain core consumer protections while enabling a more competitive and transparent market.
The LO Comp rule, while well-intentioned in conception, is causing serious problems for industry and consumers because of its overly-strict prohibitions on adjusting compensation, and the amorphous definition of what constitutes a “proxy” for a loan’s terms or conditions. These harms are felt when borrowers are unable to obtain lower interest rates from their lender of choice when shopping for a mortgage, or when lenders are unable to hold loan officers accountable for errors in the origination process. Consumers are also harmed when lenders limit their participation in special programs designed to serve first-time and low- to moderate-income borrowers. Three important changes could address these problems:
Change One: The Bureau should allow loan originators to voluntarily lower their compensation in response to demonstrable competition in order to pass along the savings to the consumer.
The Bureau’s rule provides that a loan originator’s compensation may not be increased or decreased once loan terms have been offered to a consumer. This provision is designed to eliminate financial incentives for a loan officer to steer a consumer to a higher interest rate or a higher-cost loan.
However, the rule as implemented has the effect of prohibiting reductions in compensation that could otherwise be passed along to the consumer in the form of a lower-priced, more affordable loan. This also has the effect of reducing the consumer benefit that comes from shopping across multiple lenders in order to negotiate the best interest rates and other terms.
Currently, in such situations, a lender must decide between lowering the interest rate, fees, or discount points to meet the competition (and thus possibly originating an unprofitable loan with the fixed loan originator compensation), or declining to compete with other loan offers. The requirement to pay the loan originator full compensation for a discounted loan creates a strong economic disincentive for lenders to match interest rates. For the consumer, the result is a more expensive loan or the inconvenience and expense of switching lenders in the midst of the process. This anti-competitive feature impedes loan shopping and discourages price competition. Clearly this is contradictory to the stated aims of the Bureau’s Know Before You Owe/RESPA-TILA Integrated Disclosure rulemaking, which seeks to encourage shopping and empower the consumer to negotiate.
To address this unintended outcome, we urge the Bureau to amend the rule to permit lenders to respond to demonstrable price competition with other lenders by allowing the loan originator to voluntarily reduce his or her compensation in order to pass along the savings to the consumer. This change would significantly enhance competition in the marketplace, helping lenders to compete for more loans, while also benefiting consumers who may receive a lower interest rate or lower-cost loan offer.
Change Two: The Bureau should allow lenders to reduce a loan originator’s compensation when the originator makes an error.
The LO Comp rule currently prevents companies from holding their employees financially accountable for losses that result from mistakes or intentional noncompliance with company policy when they make an error on a particular loan. As it stands, a loan originator who is responsible for an error may not bear the cost of that mistake when the loan is originated. This result runs directly contrary to the central premise of the Dodd-Frank Act amendments to TILA that led to the LO Comp rule, compensation is the most effective way to incentivize loan originator behavior.
The inability to tie compensation to the quality of a loan originator’s work on a given loan severely restricts the creditor’s ability to manage its employees and disincentivize future errors. Effectively, the creditor is left with two extreme options in response to the mistake: fire the loan originator, or pay them full commission despite the error. This binary choice does not serve the interests of consumers, creditors, or loan originators. Ultimately, greater accountability on the part of loan originators will incentivize them to reduce errors and consistently comply with regulatory requirements and company policy, leading to a safer and more transparent market for consumers.
Change Three: Lenders should be allowed to alter loan compensation in order to offer loans made under state and local housing finance agency (HFA) programs.
TILA now states that “no mortgage originator shall receive from any person and no person shall pay to a mortgage originator, directly or indirectly, compensation that varies based on the terms of the loan (other than the amount of the principal).” The LO Comp Rule broadly prohibits compensation based on loan terms or proxies for loan terms, while providing a short list of expressly permissible compensation factors. In practice, this requirement is understood to forbid varying compensation for different loan types or products, including loans made under housing finance agency (HFA) programs.
However, the assistance provided through these programs is not without costs. The robust underwriting, tax law-related paperwork, yield restrictions, and other program requirements make HFA loans more expensive to produce. HFAs also frequently cap lender compensation at levels below what a lender typically receives on a non-HFA loan. Covering these expenses is particularly difficult given that many HFA programs include limits on the interest rates, permissible compensation, and other fees that may be charged to borrowers. In the past, lenders would address this challenge by paying loan originators a smaller commission for an HFA loan than for a non-HFA loan. The inability to do so today reduces the ability of companies to offer HFA loans, particularly when producing these loans results in a loss. HFAs report that some lenders have left their programs and others have limited the volume of their participation. The Bureau should address this dilemma through an exemption in the LO Comp rule for HFA loans.
These loans encourage homeownership in a responsible and well-regulated manner. HFA programs provide participants with much-needed access to credit, along with housing counseling and financial education. HFA loans and partnerships with HFAs are important tools to ensure increased access to credit through Fannie Mae and Freddie Mac under the conservatorship of the Federal Housing Finance Agency. HFA programs are particularly important for first-time homebuyers and low- to moderate-income (“LMI”) families who are often underserved and encounter difficulty gaining access to credit elsewhere. In 2016, the latest year for which comprehensive data is available, the median borrower income for all HFA program loans was $49,598, 14 percent below the national median income for the year.
The inability to reduce loan originator compensation to offset HFA production costs under the current LO Comp Rule harms consumers by reducing the availability of these vital programs. Companies that wish to offer these loans do so at a loss. This has the effect of limiting the number of loans they can make and thereby reducing competition, and raising prices, for loans in LMI communities. The Bureau should address this by creating an exemption or alternative path to compliance loans made under local bond or HFA programs.
The rule’s rigidity makes HFA loans less available to consumers in LMI communities, a perverse result given that the rule was intended in part to protect LMI consumers from being steered into expensive loans with higher rates or fees. These unintended consequences need to be addressed. Similarly, CFPB has exempted loans directly originated by HFAs from the High-Cost mortgage rule and classified all HFAs as “small servicers” under its mortgage servicing rule, regardless of the size of their servicing portfolios.
The LO Comp Rule remains a top priority for MBA going into 2019. Industry and consumers would be better served if targeted changes were considered after five years of experience with the rule. We hope that Director Kraninger considers doing so at the beginning of her tenure.