Loan Origination Compensation Rules – Do they hit the mark?

February 3, 2011   Posted in Uncategorized

Effective April 1, 2011, the Federal Reserve Board is implementing the “final” rules for loan officer compensation and steering. (follow this link for further information) Having spent time reviewing the rule and its implementation, I have some thoughts.  No one can disagree with the importance of regulation prohibiting unfair, abusive or deceptive mortgage lending practices. The question is how to achieve these goals. I believe that these loan originator compensation regulations create a number of undesirable and unintended consequences for lenders and consumers. Let me identify a few.

Consumers will be prohibited, on a practical basis, from negotiating price with lenders. Because compensation to loan originators must remain constant, loan originators will be prohibited from reducing their commissions on specific loans to meet competitive conditions. The net effect of this will be that a consumer will be prompted to obtain their mortgage from a second lender rather than negotiate better pricing with their first lender. Think of the consequence of this prohibition being applied to the automobile industry. Consumers would be prohibited from negotiating a better deal with an auto dealer and have to go from one dealer to another in order to achieve their best deal. I don’t believe consumers will appreciate this frustrating “serial shopping” requirement.  This is one unintended consequence of the new regulation.

Loan products that require more work on the part of loan originators and lenders are likely to be deemphasized or ignored. Loan originators can only receive a fixed commission percent based on loan amount, without regard to loan type or any other factors. This means that the more complex loans such as first-time home buyer loans, low-to-moderate income loans and other type of products that require more work are more likely to be ignored. Loan originators will pursue the loans which are easiest to do and not focus on loans that take double the time to complete.  Consumers lose out under this scenario.

I estimate that the cost of implementation for small to mid-size lenders will range between $50 and $150 per loan for the first year. Significant legal, management, regulatory, disclosure, technology, training, monitoring, process workflow, audit and other expenses make this a costly regulation to implement.

Now, here’s the kicker.  The Federal Reserve Board intends on implementing this regulation on April 1, 2011.  Meanwhile, the Dodd-Frank Wall Street Reform and Protection Act also includes provisions for loan officer compensation changes.   The Board plans to create a second round of rules to further revise loan officer compensation.  This means that lenders will be required to pay twice to implement loan officer commission rules.

What about the new disclosure requirement?  I’m not convinced that the simplistic “safe harbor” provision will provide consumers with the best loan choices.  Providing “lowest rate,” “lowest points and fee,” and “lowest interest rate” for a “safe mortgage” options is not the same as providing consumers with the best loan recommendations for their circumstances.  Selecting the “best loan” for a consumer is not always as simple as the three “lowest” options.

I’m not persuaded, given the regulation’s complexity, that the “one and done” rulemaking process will produce a regulation that does no harm to consumers, lenders and loan originators.  It’s essential that the Board issue FAQs to lenders answering the multitude of questions that have arisen to clarify how lenders should implement the regulation. I believe it would be appropriate to delay the implementation date until the Federal Reserve Bank issues FAQs and examines closely the unintended consequences and negative effects of the regulation as currently written.

Should the regulation be implemented on April 1st as is? Should it be delayed and modified to eliminate known problems and issues?  Should it be delayed until a single officer compensation regulation be implemented that includes the Dodd-Frank Act? What do you think?

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About Jim Jones

James D. Jones, a national speaker for 16 years, has presented to financial services and mortgage audiences for organizations of all sizes.More >

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