Regulation Z prohibits basing a mortgage loan originator’s compensation on any of the transaction’s terms or conditions or on a proxy for any terms or conditions. In complying with this rule, institutions found it challenging to determine what constituted a proxy for a loan term, particularly because of limited guidance on this issue. New loan originator compensation rules take effect January 10, 2014; these rules clarify existing regulations and commentary regarding compensation, including what constitutes a proxy for a loan term. In this update, we summarize the most relevant features of the new rules for community bank compensation practices based on banker questions and examinations.
What is a transaction term? In the new rule, terms of the transaction are defined as any right or obligation of the parties to a credit transaction, excluding the loan amount, but including
- The interest rate,
- Fees, and
- Charges for services required as a condition of the credit.
For example, a mortgage loan originator cannot receive compensation based on the loan’s interest rate. Likewise, an originator cannot receive compensation for steering a borrower to purchase title insurance from an affiliate. In both cases, the borrower is obligated to pay both interest and title insurance as conditions of the loan.
What is a proxy for a transaction term? According to the final rule’s definition, a proxy (1) consistently varies with a loan term over a significant number of transactions and (2) can be added, dropped, or changed by the loan originator during origination. Many banks have asked if the rule prohibits profit-sharing payments to mortgage originators. The new rule clarifies that banks can use mortgage-related business profits to make contributions to certain tax-advantaged retirement plans such as a 401(k) or a Simple Employee Pension. Banks can also use mortgage-related profits to pay bonuses involving an individual loan originator with 10 or fewer originations or when the payments do not exceed 10 percent of the loan originator’s total compensation. However, banks cannot compensate mortgage loan originators based on the terms of their transactions or on their transactions’ contribution to profits.
What additional compensation is acceptable? The new rule continues to permit mortgage loan originator compensation based on criteria other than the terms of the transaction. Banks can continue to compensate originators if the borrower is a new customer as well as on the quality of the loan files, the long-term performance of the loans, and the percentage of consummated applications. Banks can also continue basing compensation solely on loan volume, but should strongly consider the safety and soundness implications of this practice.
