There were many fingers of blame when the housing market collapsed, but one was pointed squarely at the mortgage industry -- mortgage brokers in particular.
As part of it attempt to reform the industry, the U.S. Federal Reserve drafted new compensation rules for mortgage brokers, and those new rules go into effect April 1. The basic aspect of the new rule requires consumers getting a mortgage through a broker must be offered the lowest possible rate and fees for which they qualify.
The Fed's new rules is known as the Loan Originator Compensation amendment to Regulation Z. Regulation Z prohibits certain practices relating to payments made to compensate mortgage brokers and other loan originators. The goal of the amendments is to protect consumers in the mortgage market from unfair practices involving compensation paid to loan originators, according to the Fed.
In the middle of the transaction
Mortgage brokers are loan originators who market their lending services directly to consumers, except they have no money to actually pay the loans. They arrange with a bank or mortgage lender to actually provide the funds. They are in the middle of the transaction, earning commissions and fees from the entity that actually makes the loan.
During the housing boom, some mortgage brokers steered customers to loans that were the most lucrative for them, and might not have been in the best interests of the consumer.
The new prohibitions related to mortgage originator compensation and steering apply to closed-end consumer loans secured by a home or real property that includes a dwelling. The rule does not apply to open-end home equity lines of credit (HELOCs) or time-share transactions. It also does not apply to loans secured by real property if the property does not include a dwelling.
Definition of loan originator
"For purposes of these rules, loan originators are defined to include mortgage brokers, who may be natural persons or mortgage broker companies," the Fed said in an explanation of the new rule. "This includes companies that close loans in their own names but use table-funding from a third party. The term loan originator also includes employees of creditors and employees of mortgage brokers that originate loans."
Creditors are excluded from the definition of a loan originator when they do not use table funding, whether they are a depository institution or a non-depository mortgage company, but employees of such entities are loan originators.
Table funding is an option that allows brokers approved for Wholesale Traditional Lending to originate, process and close loans in their name. But at the time of settlement, the loan is transferred to the lender. And the lender simultaneously advances funds for the loan.
The new rule prohibits a creditor or any other person from paying, directly or indirectly, compensation to a mortgage broker or any other loan originator that is based on a mortgage transaction's terms or conditions, except the amount of credit extended. The rule also prohibits any person from paying compensation to a loan originator for a particular transaction if the consumer pays the loan originator's compensation directly.
The rule also prohibits a loan originator from steering a consumer to consummate a loan that provides the loan originator with greater compensation, as compared to other transactions the loan originator offered or could have offered to the consumer, unless the loan is in the consumer's interest. The rule provides a safe harbor to facilitate compliance with the prohibition on steering.
Creditors who compensate loan originators must retain records to evidence compliance with Regulation Z for at least two years after a mortgage transaction is consummated.
Compliance with these rules is mandatory beginning on April 1, 2011. the House Financial Services Committee has said that it will examine how these rules will be implemented, and what effect they will have on consumers. Mike Anderson, a spokesman for the National Association of Mortgage Brokers, says the effect of the new rule will be higher costs for consumers and lower compensation for independent mortgage brokers.