Pay Attention to the New Rules for Mortgage Originators Beginning April 1st
Amending the Truth in Lending Act’s Regulation Z
Originally passed in 1968, the Truth in Lending Act (“TILA”) is a federal law which promotes the informed use of consumer credit by requiring disclosures to consumers about the terms and costs of their loans. Major new changes to this law go into effect on April 1st, so that all loan applications from that date onward will be affected.
TILA is implemented by the Federal Reserve Board's Regulation Z (12 CFR Part 226), which prohibits specific acts and practices in connection with an extension of credit secured by a consumer's home. The Loan Originator Compensation Amendment to Regulation Z (“LOCA”), which goes into effect on April 1, 2011, applies to mortgage brokers and the companies that employ them, as well as mortgage loan officers employed by banks and other lenders.
Regulation Z prohibits certain practices relating to payments made to compensate mortgage brokers and other loan originators. The goal of LOCA is to protect consumers in the mortgage market from unfair practices involving compensation paid to loan originators. The major form of abuse is known as “steering”, where consumers are “steered” to a lender offering less favorable terms in order to increase the loan originator's compensation.
LOCA provides a safe harbor to facilitate compliance. The safe harbor is met if the consumer is presented with loan offers for each type of transaction in which the consumer expresses an interest (that is, a fixed rate loan, adjustable rate loan, or a reverse mortgage); and the loan options presented to the consumer include:
(a) the loan with the lowest interest rate for which the consumer qualifies;
(b) the loan with the lowest total dollar amount for origination points or fees, and discount points, and
(c) the loan with the lowest rate for which the consumer qualifies for a loan without negative amortization, a prepayment penalty, interest-only payments, a balloon payment in the first 7 years of the life of the loan, a demand feature, shared equity, or shared appreciation; or, in the case of a reverse mortgage, a loan without a prepayment penalty, or shared equity or shared appreciation.
To be within the safe harbor, the loan originator must obtain loan options from a significant number of the creditors with which the originator regularly does business. The loan originator can present fewer than three loans and satisfy the safe harbor, if the loan(s) presented to the consumer otherwise meet the criteria in the rule.
The loan originator must have a good faith belief that the options presented to the consumer are loans for which the consumer likely qualifies. For each type of transaction, if the originator presents to the consumer more than three loans, the originator must highlight the loans that satisfy the criteria specified in the rule.
For purposes of these rules, loan originators are defined to include mortgage brokers, who may be natural persons or mortgage broker companies. This includes companies that close loans in their own names but use “table-funding” from a third party lender. The term loan originator also includes employees of banks and employees of mortgage brokers that originate loans (i.e., loan officers).
Banks and mortgage companies 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.
The 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.
A loan originator's compensation can neither be increased nor decreased based on the loan terms or conditions. When the creditor offers to extend a loan with specified terms and conditions (such as rate and points), the amount of the originator's compensation for that transaction is not subject to change, based on either an increase or a decrease in the consumer's loan cost or any other change in the loan terms.
Under LOCA, the amount of credit extended is deemed not to be a transaction term or condition of the loan for purposes of the prohibition, provided the compensation payments to loan originators are based on a fixed percentage of the amount of credit extended. However, such compensation may be subject to a minimum or maximum dollar amount. The minimum or maximum amount may not vary with each credit transaction.
Creditors may use other compensation methods to provide adequate compensation for smaller loans, such as basing compensation on an hourly rate, or on the number of loans originated in a given time period.
Increased Yield Spread Premiums Can Be Used to Cover Closing Costs
An originator that increases the consumer's interest rate to generate a larger yield spread premium can apply the excess creditor payment to third-party closing costs and thereby reduce the amount of consumer funds needed to cover upfront fees. Thus, the rule does not prohibit creditors or loan originators from using the interest rate to cover upfront closing costs, as long as any creditor-paid compensation retained by the originator does not vary based on the transaction's terms or conditions.
Reager & Adler, PC has handled thousands of consumer real estate transactions through its independent title company, Midstate Abstract Company of Camp Hill. To be sure that your mortgage originator is in compliance with LOCA, the next time you purchase or refinance your home, be sure to use our services for your closing. An attorney is assigned to your file, conducts the closing, and is available at any time to answer your questions about issues like the one discussed in this article.