Co-Author: Peter G. Sotiropoulos
Part II: Questions and Answers about Lender-Paid Compensation
Question 1: May a brokerage company contract for different compensation arrangements with different lenders?
Yes, as long as the company pays its mortgage originators in a certain way. Pursuant to Dodd-Frank, Title XIV, Section 1403, “for any residential mortgage loan, no mortgage originator shall receive from any person and no person shall pay to a mortgage originator, directly or indirectly, compensation that varies based on the terms of the loan (other than the amount of the principal).”
This provision, known as the “Prohibition on Steering Incentives,” is a central part of Dodd-Frank. The purpose of the provision, as its name indicates, is to eliminate any incentive for a mortgage originator to “steer” a consumer toward a specific type of loan. It accomplishes this goal by mandating that mortgage originators shall not be compensated differently for mortgage loans with different terms (higher interest rates, for example). The amount of the principal is the only loan term that may affect mortgage originator compensation.
A brokerage company is not required to have uniform contracts with all of its lenders as long as the lack of uniformity does not incentivize mortgage originators to steer consumers to one lender over another. In other words, a brokerage company may negotiate different compensation packages with different lenders provided that the company sets up a system to compensate its mortgage originators identically, regardless of which lender is used for the loan.
Consider a brokerage company that has separate contracts and fee arrangements with three different lenders: A, B, and C. Lender A pays the company 2% of the loan amount, lender B pays the company 3% of the loan amount, and lender C pays the company 4% of the loan amount. The legality of this system depends upon on the way the company compensates its mortgage originators:
- If the company pays its mortgage originators a fixed percentage of the loan amount (140 basis points, for example), mortgage originators would be paid the same (140 basis points) regardless of whether the loan was with lender A, lender B, or lender C. This would not be prohibited by Section 1403 because it does not provide any steering incentives for the mortgage originators.
- However, if the company pays its mortgage originators a percentage of what the company is paid from the lender, mortgage originators would earn different commissions depending on which lender they used. For example, assume the company pays its mortgage originators 50% of the company’s revenue from each loan. A mortgage originator would earn a 2% commission from a loan with lender C (who pays 4% to the company), but only a 1% commission from a loan with lender A (who pays 2% to the company). This arrangement is prohibited by Section 1403 because it provides mortgage originators with the incentive to steer consumers to loans with lender C.
Question 2: May a brokerage company pay its mortgage originators a percentage of what the company is paid on each loan?
Yes, as long as the company is compensated the same by each lender. Again, the operative rule is Section 1403, which states, “for any residential mortgage loan, no mortgage originator shall receive from any person and no person shall pay to a mortgage originator, directly or indirectly, compensation that varies based on the terms of the loan (other than the amount of the principal).”
If a brokerage company has the same compensation arrangement with all of its lenders, the company can pay its mortgage originators a percentage commission of the company’s payment from the lender. This is because, under these parameters, a mortgage originator would not be incentivized to steer consumers to one loan over another.
Assume, for example, that a brokerage company pays its mortgage originators 50% of what the company earns from the lender on each loan. Also, assume the company has three different lenders: A, B, and C. The legality of this arrangement depends on the company’s compensation arrangement with its lenders:
- If the company is paid 2% of the loan amount by lender A, 3% of the loan amount by lender B, and 4% of the loan amount by lender C, a mortgage originator working for the company would earn different commissions from deals with each lender (1% on a loan from A, 1.5% on a loan from B, and 2% on a loan from C). Therefore, this arrangement is impermissible under Dodd-Frank.
- However, if lenders A, B, and C each pay the company 2% of the loan amount, a mortgage originator would receive the same 1% commission on a loan from any of the lenders. Therefore, he would have no incentive to steer a consumer toward a specific lender. Consequently, this arrangement is permissible under Dodd-Frank.
As you can see, there are two basic options for a company to comply with Section 1403. First, a company could standardize its contracts with lenders (as seen here). Or, second, a company could standardize payments to its mortgage originators (as seen in question 1). Regardless of which option a mortgage company chooses, the important point is that mortgage originators must be compensated the same for all loans of the same amount.
Question 3: If a brokerage company is compensated at different rates by its lenders, can the company pay its owners 100% of the money it receives from lenders?
No. The same restrictions that govern loan officer employees of a brokerage company apply to owners of the company when they are acting as mortgage originators.
The restrictions found in Section 1403, discussed above, apply to all “mortgage originators.” According to Section 1401 of Dodd-Frank, the term “mortgage originators” generally includes anyone who, for “direct or indirect compensation or gain, or in the expectation of direct or indirect compensation or gain:
- (i) takes a residential mortgage loan application;
- (ii) assists a consumer in obtaining or applying to obtain a residential mortgage loan; or
- (iii) offers or negotiates terms of a residential mortgage loan. . .”
Therefore, company owners are subject to the 1403 rules when they are negotiating residential mortgage loans or otherwise serving as “mortgage originators.”If each lender compensates a company differently, the company may not pay its owners a percentage of the company’s profit from each deal. To avoid this problem, the company may choose to compensate its owners at a standard rate (140 basis points of the loan amount, for example). Profits of the mortgage brokerage company may be distributed based upon the bona fide percentage of ownership of each owner.
Part I of this article provides a brief overview of the new regulations.