I. INTRODUCTION
The Consumer Financial Protection Bureau (CFPB) has amended Regulation Z to implement amendments to the Truth in Lending Act (TILA) made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
The final rule implements requirements and restrictions imposed by the Dodd-Frank Act concerning loan originator compensation; qualifications of, and registration or licensing of loan originators; compliance procedures for depository institutions; mandatory arbitration; and the financing of single premium credit insurance.
The final rule also revises or provides additional commentary on Regulation Z’s restrictions on loan originator compensation, including application of these restrictions to prohibitions on dual compensation and compensation based on a term of a transaction or a proxy for a term of a transaction, and to recordkeeping requirements. In addition, the final rule establishes tests for when loan originators can be compensated through certain profits-based compensation arrangements. At this time, the CFPB is not prohibiting payments to and receipt of payments by loan originators when a consumer pays upfront points or fees in the mortgage transaction.
The final rule will apply to transactions that are consummated and for which the creditor or loan originator organization paid compensation on or after January 1, 2014; and the amendments pertaining to contributions to or benefits under designated tax-advantage plans for individual loan originators will apply to transactions for which the creditor or loan originator organization paid compensation on or after January 1, 2014, regardless of when the transactions were consummated or their applications were received.
The final rule is designed primarily to protect consumers by reducing incentives for loan originators to steer consumers into loans with particular terms and by ensuring that loan originators are adequately qualified.
The amendments to Regulation Z § 1026.36(h) Prohibition on Mandatory Arbitration Clauses became effective on June 1, 2013. All other provisions of the final rule became effective on January 10, 2014.
II. LOAN ORIGINATOR
The final rule clarified the definition of “loan originator” for purposes of the compensation and qualification rules.
A loan originator includes any person who receives direct or indirect compensation (salaries, commissions, and any financial or similar incentive, including an annual or periodic bonus and any prizes or merchandise) in connection with an extension of credit. The previous standard that included any person who in expectation of compensation “arranges, negotiates, or otherwise obtains an extension of credit for another person” has been replaced with a laundry list. The term “loan originator” now includes anyone who directly or indirectly expects a monetary gain or compensation for performing any of the following activities:
Producing branch managers are generally deemed “loan originators” since they perform the duties listed above. The final rule provides that some producing branch managers may receive profit-based compensation under the exceptions for “Profit Sharing Plans” set forth below at paragraph IV.D.2.
The final rule also expressly includes in the definition of a loan originator any person referring a consumer to any person who participates in the origination process as a loan originator. The commentary to the final rule provides that the term “referring” includes any oral or written action directed to a consumer that can affirmatively influence the consumer to select a particular loan originator or creditor to obtain an extension of credit when the consumer will pay for such credit.
However, the rule sets forth an exception from the “referral” rule for persons who provide loan originator or creditor contact information as employees of a creditor or loan originator. Such information must be provided to the consumer in response to the consumer’s request, provided that the employee does not discuss particular transaction terms and does not refer the consumer, based on the employee’s assessment of the consumer’s financial characteristics, to a particular loan originator or creditor seeking to originate particular transactions to consumers with those financial characteristics.
The term loan originator does not include:
Generally, persons who do not discuss credit terms with the consumer will not be considered loan originators. Such persons include loan processors, underwriters, and other individuals who evaluate the quality of a credit but do not communicate decisions to the consumer, or a person who sets general credit terms available from the creditor provided that the loan originator communicates the information.
While generally any person, including a loan originator employee would be acting as a loan originator if he or she refers consumers to a particular creditor by providing an application from that creditor, the CFPB does not believe that a loan originator or creditor employee should be considered a loan originator for simply providing an application from the loan originator or creditor entity for which he or she works. In such a case, provided that the person does not assist the consumer in completing the application or otherwise influence his or her decision, the person is performing an administrative task on behalf of the entity for which he or she works.
III. SCOPE OF COVERAGE
The final rule amends the rules relating to compensation for loan originators under the Truth in Lending Act (Regulation Z). Section 1026.36 of Regulation Z applies to all closed-end consumer credit transactions secured by a consumer’s principal dwelling. This section of the regulation will apply to closed-end consumer credit transactions secured by a dwelling. Home equity lines of credit secured by a consumer’s principal dwelling are exempted from the final rule, except they must comply with the single-premium credit and the arbitration clause requirements discussed below.
IV. PROHIBITED PAYMENTS
A. Compensation Based on a Term of a Transaction or Proxy for a Term of a Transaction
Regulation Z already prohibits basing a loan originator’s compensation on “any of the transaction’s terms or conditions.”
The final rule expands the prohibition of payments to include compensation based on a term, or proxy of a term, of a single transaction, or the terms of multiple transactions by a loan originator or group of loan originators. Whether compensation is “based on” a term is an objective test. Generally, if compensation would have been different if the term of transaction had been different, then it is a “prohibited payment.”
A notable difference from the existing rule is the inclusion of a specific prohibition against compensation based on “multiple transactions.” This means bonuses to loan officers based on the overall profitability of the bank’s loan portfolio is generally prohibited unless it falls into an exception. Extra precaution should be taken when paying a discretionary bonus to loan officers based on overall profits. Bonuses based on individual loan volume, however, are still authorized.
The final rule generally prohibits loan originator compensation based upon the profitability of a transaction or a pool of transactions.
B. Term of a Transaction
The final rule defines “term of a transaction” to mean “any right or obligation of the parties to a credit transaction.” This means, for example, that a mortgage broker cannot receive compensation based on the interest rate of a loan or on the fact that the loan officer steered a consumer to purchase required title insurance from an affiliate of the broker, since the consumer is obligated to pay interest and the required title insurance in connection with the loan.
A “credit transaction” is defined by the final rule to be the operative acts and written and oral agreement that, together, create the consumer’s right to defer payment of debt or to incur debt and defer its payment.
Under the definition of “term of a transaction,” the word “term” includes:
a) The rights and obligations memorialized in a promissory note or other credit contract, as well as the security interest created by a mortgage, deed of trust, or other security instrument, and in any document incorporated by referencing the note, contract, or security instrument;
b) The payment of any loan originator or creditor fees or charges for the credit, or for a product or service provided by the loan originator or creditor related to the extension of that credit, imposed on the consumer, including any fees or charges financed through the interest rate; and
c) The payment of any fees or charges imposed on the consumer, including any fees or charges financed through the interest rate, for any product or service required to be obtained or performed as a condition of the extension of credit. (Fees and charges described above are only a “term of a transaction” if those fees or charges are required to be disclosed in the Good Faith Estimate, the HUD-1 or HUD-1A, or in any subsequent integrated disclosures that CFPB may promulgate.)
The amount of credit extended is not a term, so long as compensation is based on a percentage of the loan amount, and can be subject to a maximum or minimum dollar amount. The definition includes any terms included in the note, security agreement, mortgage, contract or any other document connected with the extension of credit, and any fees imposed on the consumer for products or services provided or required by the creditor related to the extension of credit disclosed in the GFE and HUD. The definition includes, but is not limited to:
Factors upon which a loan officer can be compensated include, but are not limited to:
C. Proxy for a Term of a Transaction
The final rule prohibits compensation based on a “proxy” for a term of a transaction.
The rule also further clarifies the definition of a proxy to focus on whether: (1) The factor consistently varies with a transaction term over a significant number of transactions; and (2) the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction.
For example, suppose a loan officer is compensated more for a loan sold to the secondary market than one held in-house, but only loans that have a variable rate are sold in the secondary market. The factor (secondary market loan) is a proxy for a term (variable rate) for which the loan officer has the ability to add, drop, or change. Thus, such a compensation structure would be prohibited.
The final rule generally prohibits loan originator compensation from being reduced to offset the cost of a change in transaction terms (often called a “pricing concession”). However, the final rule allows loan originators to reduce their compensation to defray certain unexpected increases in estimated settlement costs, as long as the estimate provided to the customer was consistent with the best information reasonably available. The exception includes compensation decreases due to unforeseen tolerance violations, but does not permit reductions to compensation in order to bear the cost of a pricing concession in connection with (a) matching a competitor’s credit terms; (b) clerical errors; (c) attempts to avoid triggering high-cost laws; (d) failure to follow creditor’s policies and procedures; or (e) attempts to prevent disparate impact issued under Fair Lending Laws.
D. Exceptions
1. Retirement Plans
The final rule permits certain retirement plans to be based on the terms of multiple loan originators’ transactions. Specifically, the funds can be used for contributions to or benefits under certain designated tax-advantaged retirement plans, such as 401(k) plans and certain pension plans. As a result, a loan officer can receive a compensation in the form of a contribution to a defined contribution plan (i.e., 401k) or defined benefit plan (i.e., pension plan), designated as a tax-advantaged plan, that is based on the terms of multiple transactions by multiple individual loan originators. This exception does not permit contributions to a defined contribution plan based on that individual loan originator’s transactions.
2. Profit Sharing Plans
In certain circumstances, a loan officer may also receive non-deferred profits-based compensation (bonus pools, profit pools, bonus plans, and profit-sharing plans, etc.). While normally the profits of a bank’s mortgage portfolio, and thus the bank itself, are indirectly based on the terms of multiple transactions, the loan officer may still receive the compensation, provided that:
a. The compensation under the profit sharing plan does not exceed 10% of the individual loan originator’s total compensation over the time in which the non-deferred profits-based compensation plan is paid; or
b. The loan originator originated 10 or fewer transactions subject to this section during the 12-month period preceding the date of the compensation determination.
Compensation based on non-mortgage-related business profits are not counted toward the “10% Rule.” For example, there is no restriction on compensation based on the profits of the bank’s deposit department (based on reasonable accounting standards).
V. PROHIBITION AGAINST DUAL COMPENSATION
Regulation Z already provides that where a loan originator receives compensation directly from a consumer in connection with a mortgage loan, no loan originator may receive compensation from another person in connection with the same transaction.
Under the final rule, a loan originator may not receive compensation, directly or indirectly, from any person other than the consumer or the loan originator organization for which they work.
However, the final rule provides an exception to allow mortgage brokers to pay their employees or contractors commissions, although the commissions cannot be based on the terms of the loans they originate.
VI. ANTI-STEERING PROVISIONS
The final rule adopts the proposal that 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. A loan originator is deemed to comply with the anti-steering prohibition if the consumer is presented with, and able to choose from, loan options that provide (1) the lowest interest rate; (2) no risky features, such as a prepayment penalty, negative amortization, or a balloon payment in the first seven years; and (3) the lowest total dollar amount for origination points or fees and discount points.
The final rule applies to loan originators, which are defined to include mortgage brokers, including mortgage broker companies that close loans in their own names in table-funded transactions, and employees of creditors that originate loans (e.g., loan officers). Thus, 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. The final rule covers all transactions secured by a dwelling, but excludes HELOCs extended under open-end credit plans and timeshare transactions.
The final rule will:
o 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);
o The loan options presented to the consumer include the following:
1. the lowest interest rate for which the consumer qualifies;
2. the lowest points and origination fees, and
3. the lowest rate for which the consumer qualifies for a loan with no risky features, which as a prepayment penalty, negative amortization, or a balloon payment, in the first seven years, a demand feature, shared equity, or shared appreciation.
o The loan options presented to the consumer are obtained by the loan originator from a significant number of the creditors with whom the loan originator regularly does business; and
o The loan originator believes in good faith that the consumer likely qualifies for the loan options presented to the consumer. The loan originator need only evaluate loan offers that are available from creditors with whom the loan originator regularly does business.
VII. CONSUMER PAYMENT OF UPFRONT POINTS AND FEES (NOT PROHIBITED)
Section 1403 of the Dodd-Frank Act contains a section that would generally have prohibited consumers from paying upfront points or fees on transactions in which the loan originator compensation is paid by a person other than the consumer (either to the creditor’s own employee or to a mortgage broker).
However, the Dodd-Frank Act also authorizes the CFPB to waive or create exemptions from the prohibition on upfront points and fees if the CFPB determines that doing so would be in the interest of consumers and in the public interest.
The CFPB has issued a complete exemption to the prohibition on upfront points and fees pursuant to its exemption authority under section 1403.
VIII. LOAN ORIGINATOR QUALIFICATIONS AND IDENTIFIER REQUIREMENTS
The Dodd-Frank Act imposes a duty on individual loan officers, mortgage brokers, and creditors to be “qualified” and, when applicable, registered or licensed to the extent required under state and federal law. The final rule imposes duties on loan originator organizations to make sure that their individual loan originators are licensed or registered as applicable under the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act) and other applicable law.
For loan originator employers whose employees are not required to be licensed, including depository institutions, the rule requires them to: (1) ensure their loan originator employees meet character, fitness, and criminal background standards similar to existing SAFE Act licensing standards; and (2) provide training to their loan originator employees that is appropriate and consistent with those loan originators’ origination activities. The final rule contains special provisions with respect to criminal background checks and the circumstances in which a criminal conviction is disqualifying, and with respect to situations in which a credit check on a loan originator is required.
There is no exception under the final rule for construction or temporary financing. If the collateral is a dwelling, the loan officer must be registered.
In order to comply with this section, a loan originator organization must:
i) A criminal background check through the NMLSR or law enforcement agency or commercial service;
ii) A credit report;
iii) Information from the NMLSR about any administrative, civil, or criminal findings or, if not registered under the NMLSR, from the individual loan originator;
i) Has not been convicted of, or pleaded guilty or nolo contendere to, a felony in the past seven years, or, in the case of a felony involving fraud, dishonesty, a breach of trust, or money laundering, at any time;
ii) Has demonstrated financial responsibility, character, and general fitness; and
IX. NMLSR ID DISCLOSURE REQUIREMENTS
The final rule also implements a Dodd-Frank Act requirement that loan originators provide their unique identifiers under the Nationwide Mortgage Licensing System and Registry (NMLSR) on loan documents. Accordingly, mortgage brokers, creditors, and individual loan originators who are primarily responsible for a particular origination will be required to list on enumerated loan documents (the credit application; the note or loan contract; and the security agreement) their NMLSR unique identifiers (NMLSR IDs), if any, along with their names.
X. WRITTEN POLICIES AND PROCEDURES
An institution must establish and maintain written policies and procedures to ensure and monitor for compliance with loan originator compensation, loan originator qualification requirements, including the NMLSR ID number on certain loan documents, and the prohibition of steering rules.
XI. TRAINING
Depository institutions must provide periodic training to loan originating employees covering federal and state law requirements pertinent to the originator’s activities. The periodic training must be sufficient in frequency, timing, duration, and content to ensure the individual loan originator has the knowledge of state and federal legal requirements that apply to the individual loan originator’s loan origination activities.
The training must take into consideration the particular responsibilities of the individual loan originator and the nature and complexity of the mortgage loans with which the individual loan originator works. Individual originators are not required to receive training on requirements that apply to types of mortgage loans that the originator does not originate, or on subjects in which the individual loan originator already has the necessary knowledge and skill.
XII. PROHIBITION ON MANDATORY ARBITRATION CLAUSES (EFFECTIVE DATE JUNE 1, 2013)
The final rule also prohibits (a) the inclusion of clauses requiring the consumer to submit disputes concerning a residential mortgage loan or home equity line of credit to binding arbitration and (b) the application or interpretation of provisions of such loans or related agreements so as to bar a consumer from bringing a claim in court in connection with any alleged violation of federal law. These prohibitions do not prevent the creditor and consumer, after a dispute is arisen, to agree to settle or use arbitration on other non-judicial procedures.
XIII. PROHIBITION ON SINGLE PREMIUM CREDIT INSURANCE FINANCING
The final rule prohibits a creditor from financing the premium for credit insurance in connection with a consumer credit transaction secured by a dwelling. It is important to note that the prohibition does not apply to credit insurance for which premiums or fees are calculated and paid in full on a monthly basis.
The prohibition applies to credit life, credit disability, credit unemployment, or credit property insurance, or any other accident, loss-of-income, life, or health insurance, or any payments directly or indirectly for any debt cancellation or suspension agreement or contract.
There is an exception to the prohibition for credit unemployment insurance if the following criteria are met:
The CFPB has clarified and revised three aspects of the rules implementing the Dodd-Frank Act prohibition on creditors financing credit insurance premiums in connection with certain consumer credit transactions secured by a dwelling. The CFPB has added new sections of the final rule to clarify (a) what constitutes financing of such premiums by a creditor; (b) when credit insurance premiums are considered to be calculated and paid on a monthly basis for purposes of the statutory exclusion from the prohibition for certain credit insurance premium calculation and payment arrangements; and (c) when including the credit insurance premium or fee in the amount owed violates the rule.
The CFPB has provided further clarification regarding the exclusion from the prohibition of financing credit insurance premiums or fees that are “calculated and paid in full on a monthly basis.” Under the final rule, “financing” occurs when a creditor treats a credit insurance premium as an amount owed and provides a consumer the right to defer payment of that obligation. The CFPB has also clarified that granting the consumer this right to defer payment only constitutes financing if it provides the consumer the right to defer payment of the premiums or fees “beyond the period in which they are due.” Accordingly, a creditor will not be considered to have financed a credit insurance premium if, upon the close of the month, the consumer has failed to make the premium or fee payment, but the creditor does not incorporate that amount into the amount owed by the consumer. However, if the creditor treats the premium as an addition to the consumer’s debt, such as by communicating to the consumer that the consumer must pay it to satisfy the consumer’s obligations under the loan or by charging interest on the premium, the creditor will be considered to have financed the premium in violation of the prohibition.
Likewise, charging level premiums each month is permitted as long as there is no deferral of payment. (A level premium or fee arrangement involves the monthly payment of the same amount on a debt protection or credit insurance product over the life of the loan, instead of using a “declining balance” method.) The rule concludes that “the important distinction regarding whether or not the premium is considered to be financed hinges on whether the creditor treats the premium as a debt obligation due and then defers a right pay.”
A. Grace Periods.
Grace periods on monthly debt protection fees or credit insurance premiums are permitted as long as the creditor “does not advance the amount of money necessary to meet the monthly credit insurance payment on the consumer’s behalf and then require that the consumer pay the creditor.”
B. Adding Premium or Fees to a Monthly Balance.
An interpretive comment was added by the final rule to clarify that adding a single lump sum premium credit insurance premium or debt protection fee to a loan balance at closing (a “single premium” product) is comparable to adding a monthly credit insurance premium or debt protection fee to an outstanding loan balance at the end of each month. However, if the monthly credit insurance premium or debt protection fee is only added to the monthly amount due for billing purposes and does not actually result in a debt obligation that the consumer must pay (i.e. the monthly credit insurance premium or debt protection fee is not added to the outstanding loan balance), then the product would not be considered “financed” and would be permitted.
C. Charging Interest on Credit Insurance Premiums or Debt Protection Fees Raises Consumer Protection Concerns.
Although the CFPB acknowledges in the final rule that charging interest on premiums or fees before they are due does not constitute financing, the Bureau flagged this as an area of “potential concern” that might not “comply with other Federal or State requirements.” The agency said it “intends to monitor this practice in the future and may address this issue at another time, whether by rulemaking or other means.” The CFPB encouraged companies engaged in this practice to refund any interest charges on credit insurance premiums and debt protection fees that are incurred before payment is due.
XIV. RECORD RETENTION REQUIREMENTS
The final rule also extends existing recordkeeping requirements concerning loan originator compensation so they apply to both creditors and mortgage brokers for three years. A creditor needs to retain the records of compensation it pays to a loan originator, and the compensation agreement that governs those payments, for three years after the date of payment. A loan originator organization must maintain the records of all compensation it receives from a creditor, a consumer, or another person; all compensation it pays to any individual loan originator; and the compensation agreement that governs such payments, for three years after the date of each receipt or payment.
Records are sufficient to evidence payment and receipt of compensation if they demonstrate the following:
a) The nature and amount of the compensation;
b) That the compensation was paid, and by whom;
c) That the compensation was received, and by whom; and
d) When the payment and receipt of compensation occurred.