This article digests the rules for how loan originators may be compensated, including compensation paid directly by the borrower and compensation paid by loan originating organizations.
Loan originator abuse during the Millennium Boom prompted regulators to impose new rules for loan originator compensation. Since 2011, stricter rules have been in place surrounding how loan originators are compensated following a revamp of the Truth-in-Lending Act (TILA).
The Consumer Financial Protection Bureau (CFPB) is responsible for regulating and enforcing TILA. As part of its mandate, the CFPB provides guidance (and a watchful eye) over loan originator compensation rules.
Before we get to the heart of the matter, we need to examine:
- who is bound by the loan originator compensation rules; and
- what qualifies as compensation.
Who needs to follow loan originator compensation rules?
The easy answer is: loan originators need to follow loan originator compensation rules! But who qualifies as a proper “loan originator” under TILA?
A loan originator is a person who, for compensation or other monetary gain, arranges, negotiates or otherwise obtains funding for a personal-use loan for another person. [12 Code of Federal Regulations §1026.36(a)(1)(i)]
The following real estate participants need to follow TILA loan originator compensation rules:
- mortgage brokers — loan originators who are not employees of a lender;
- employees of a lender who provide the services of a loan originator;
- warehouse lenders; and
- any lender who makes loans using funds which it does not own (such as from borrower deposits). [12 CFR 1026.36(a)(1)]
These loan originator compensation rules do not apply to:
- lenders who make loans using their own funds;
- a person who performs only administrative or clerical tasks for a loan originator;
- an employee of a manufactured home retailer (as long as they do not take an application for credit or advise consumers on credit terms);
- a person who only performs real estate brokerage activities (unless they are also compensated by a loan originator); and
- loan services or their employees (as long as they do not offer or negotiate a transaction that constitutes a refinance). [12 CFR 1026.36(a)(1)(i)]
This leaves an important question — are carryback sellers considered loan originators?
In California, carryback sellers are not considered loan originators. That is because — unless they charge a fee to originate a loan (which carryback sellers rarely, if ever, do here in California) — they do not need to be a licensed loan originator.
What is considered “compensation?”
For loan originator compensation rules, compensation includes:
- annual or periodic bonuses;
- awards of merchandise, services or trips; and
- any compensation collected that is retained by the loan originator. [Official interpretation of 12 CFR 1026.36(a)-5]
Further, these rules apply regardless of how a fee is named. Thus, there is no getting around the rules by sneaking in compensation under random “miscellaneous” charges.
However, any fees the borrower pays for bona fide third-party charges are not considered compensation.
For example, an appraisal or title insurance fee are not considered compensation — unless the loan originator intentionally marks-up the price of these services or keeps the difference. This practice is called upcharging.
In some cases, the loan originator reasonably estimates the cost of a third-party service, but the third-party fee comes in below the estimate. The difference between the estimate and actual charge is not considered upcharging or compensation since the original estimate was reasonable. [Official Interpretation of 12 CFR §1026.36(a)-5(v)]
How may a loan originator be compensated?
There are two categories of loan originators, and which category you fall under determines how you may be compensated. These are:
- individual loan originators—natural persons who meet the definition of a loan originator; and
- loan originator organizations—loan originators that are anything other than a natural person. [12 CFR 1026.36(a)(1)(ii), (iii)]
In addition to payments for loan origination services, an individual loan originator may receive compensation in the form of:
- stock plans; and
- tax-deferred retirement plans.
Loan originators may receive a bonus out of a bonus or profit pool or other mortgage profits-based plan as long as:
- the contribution does not exceed 10% of the individual loan originator’s total compensation at the time the contribution is made; or
- the individual loan originator has originated ten or fewer transactions during the preceding 12-months. [12 CFR 1026.36(d)(1)(iv)(B)]
Loan originators cannot accept compensation or payment of any kind (including those mentioned above) based on:
- the terms or conditions of a transaction;
- the terms of multiple transactions by the loan originator; or
- the terms of multiple transactions by multiple loan originators. [12 CFR 1026.36(d)(1)(i)]
Terms or conditions of a transaction include any factor which varies with the terms of the transaction over which the loan originator has control. For example, terms or conditions include but are not limited to the:
- interest rate;
- existence of a prepayment penalty;
- annual percentage rate (APR); and
- loan-to-value ratio (LTV). [12 CFR 1026.36(d); Official Interpretation of 12 CFR 12 CFR §1026.36(d)(1)]
The loan amount is not considered a term or condition of the transaction for these purposes — as long as the compensation is based purely on a fixed percentage of the loan amount. In other words, the loan originator is not compensated at a higher percentage rate when the loan amount if higher, and vice-versa. [12 CFR §1026.36(d)(1)(ii)]
Examples of variances which may impact loan originator compensation include:
- the loan originator’s overall dollar volume delivered to the lender;
- the long-term performance of a loan originator’s loans;
- hourly pay for the actual number of hours worked;
- whether the borrower is a new or existing customer;
- a payment fixed in advance for the volume of loans originated (e.g., $1,000 for the first 100 loans originated by the loan originator and $1,500 for all additional loans);
- the share of closed loans compared to loan applications submitted over time; and
- the accuracy and completeness of submitted loan files. [Official Interpretation of 12 CFR 1026.36(d)(1)-2(i)]
Who may compensate a loan originator?
The loan originator of a consumer credit transaction secured by a dwelling may accept compensation directly from the borrower.
However, if they accept any compensation from the borrower, they are prohibited from receiving compensation from any other person or entity in relation to the loan.
Further, any party aware of the direct borrower compensation may not pay the loan originator any compensation in relation to the loan. [12 CFR §1026.36(d)(2)(i)(A)]
Additionally, if the loan originator receives compensation from the borrower directly, neither the mortgage broker who employs the loan originator nor any other employee of the mortgage broker may receive compensation from the lender in connection with the same loan. [Official Interpretation of 12 CFR §1026.36(d)(2)(i)-1]
Direct payments from the borrower include payments made out of the loan proceeds.
However, points paid on a loan by the borrower to the lender (out of which the lender pays the loan originator) are not considered direct payments. In such cases, the lender is considered to have paid the loan originator, and the loan originator is prohibited from receiving additional payments from the borrower. [12 CFR §1026.36(d)(2)(i)(B)]
A loan originator organization that receives compensation from the borrower can split the compensation with an individual loan originator. This allows a brokerage to pay its employed loan originators. However, in such a case, both the loan originator organization and the individual loan originator are prohibited from receiving compensation from any other source, e.g., the lender. [12 CFR §1026.36(d)(2)(i)(C)]
What about non-loan origination fees?
Consider a loan originator organization that offers title insurance services in addition to their loan origination services.
The organization may receive payment from the borrower for loan origination services — they may also receive payment for title insurance services as long as compensation is not determined or adjusted based on the borrower’s use of the non-loan origination services.
For example, the loan originator organization may not charge borrowers a 1% fee when they buy title insurance from the loan originator — but a 2% fee if the borrower buys title insurance from a third-party title insurance provider. [Official Interpretation of 12 CFR §1026.36(a)(-5(iv)]
Further, since all payments made to individual loan originators are considered compensation, the individual loan originator may not receive an additional fee when their employing loan originator organization sells title insurance services to the borrower. [Official Interpretation of 12 CFR §1026.36(a)-5(iv)]
I scrolled to the bottom — can you summarize things for me?
The most important takeaway about loan originator compensation rules is this: loan originators may not be compensated based on the terms or conditions of the loan.
This helps dissuade loan originators from steering borrowers into loans that are ultimately against their best interest, but may provide greater profits to the lender.
Most loan originators are paid based on a salary plus commission amount for each loan originated. Other types of compensation include:
- salaries; and
Loan originators may be compensated directly by the borrower, but only if they do not receive any other compensation from another source in relation to the loan.
Further, the borrower may pay the loan originator organization, which may then distribute compensation to individual loan originators.
Third-party service fees are usually not considered compensation, unless the loan originator upcharges these service fees.