Question: If one of loan officer needs to price a loan lower than what our company normally requires in order for the officer to be eligible for compensation, could an “internal referral” of the loan be made to a non-commissioned loan officer/manager who then pays the originating loan officer a referral fee? For example, John Smith has a deal in which he is competing with a local credit union offering a 4.5% rate. But to be paid his 2% commission under the company’s compensation rules, Smith has to offer the client a rate of 4.75%. Could the loan be “referred internally” to a non-commissioned manager who then gives the borrower the 4.5% rate to be competitive, and pays the LO a flat referral fee?
Regulation X, the implementing regulation for the Real Estate Settlement Procedures Act (“RESPA”) does authorize payment of compensation for certain “internal referrals.” Thus, as an exception to the anti-kickback provisions of RESPA Section 8, Regulation X [12 CFR §1024.14(g)(iv) and (vii)] specifically authorizes:
“(iv) A payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed;” and
“(vii) An employer's payment to its own employees for any referral activities.” (Emphasis added.)
However, Regulation X is not the only regulation to consider. In that regard, for at least two (2) reasons, I believe this arrangement, as you describe it, would probably violate the Loan Officer Compensation Rules in Regulation Z, the implementing regulation of the Truth in Lending Act:
First, the loan officer’s compensation appears to be based on term of the loan, or a proxy for such a term. In that regard, Regulation Z provides at 12 C.F.R. §1026.36(d)(1) that:
(i) Except as provided in paragraph (d)(1)(iii) or (iv) of this section, in connection with a consumer credit transaction secured by a dwelling, no loan originator shall receive and no person shall pay to a loan originator, directly or indirectly, compensation in an amount that is based on a term of a transaction, the terms of multiple transactions by an individual loan originator, or the terms of multiple transactions by multiple individual loan originators. If a loan originator's compensation is based in whole or in part on a factor that is a proxy for a term of a transaction, the loan originator's compensation is based on a term of a transaction. A factor that is not itself a term of a transaction is a proxy for a term of the transaction if the factor consistently varies with that term over a significant number of transactions, and the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction.” (Emphasis added.)
Under Section 1026.36(d)(ii) of Regulation Z, “[t]he amount of credit extended is not a term of a transaction or a proxy for a term of a transaction, provided that compensation received by or paid to a loan originator, directly or indirectly, is based on a fixed percentage of the amount of credit extended…” (Emphasis added.) However, the interest rate most assuredly is a term of the transaction. And the so-called “referral fee” is actually compensation to the loan officer, the amount of which is indeed based on a term of the transaction or a proxy for a term; i.e., the interest rate. As you have described it, the loan officer is paid the referral fee only when the interest rate to the borrower is adjusted below what is normally required by the company for the loan officer to earn a commission.
Second, the arrangement at least appears to violate (or encourage violation of) the “anti-steering” provisions of the Loan Officer Compensation Rules in Regulation Z. In that regard, the loan officer operating under the proposed arrangement would be dis-incentivized to make an “internal referral” of loans at the lower interest rate since the flat referral fee would presumably be less than the amount of compensation the loan officer would ordinarily receive under his or her regular compensation formula if the loan were made at the higher interest rate. The applicable provisions of Regulation Z [12 C.F.R. §1026.36(e)] read as follows:
“(1) General. In connection with a consumer credit transaction secured by a dwelling, a loan originator shall not direct or “steer” a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator offered or could have offered to the consumer, unless the consummated transaction is in the consumer's interest.” (Emphasis added.)
Here, it is difficult to see how the consummated transaction would be “in the consumer’s interest” since the loan interest rate would be higher than what the consumer would have to pay under the referral fee arrangement. In that regard,
Section 1026.36(e) goes on to state:
“(2) Permissible transactions. A transaction does not violate paragraph (e)(1) of this section if the consumer is presented with loan options that meet the conditions in paragraph (e)(3) of this section for each type of transaction in which the consumer expressed an interest. For purposes of paragraph (e) of this section, the term “type of transaction” refers to whether:
(i) A loan has an annual percentage rate that cannot increase after consummation;
(ii) A loan has an annual percentage rate that may increase after consummation; or
(iii) A loan is a reverse mortgage.
(3) Loan options presented. A transaction satisfies paragraph (e)(2) of this section only if the loan originator presents the loan options required by that paragraph and all of the following conditions are met:
(i) The loan originator must obtain loan options from a significant number of the creditors with which the originator regularly does business and, for each type of transaction in which the consumer expressed an interest, must present the consumer with loan options that include:
(A) The loan with the lowest interest rate;
(B) The loan with the lowest interest rate 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; and
(C) The loan with the lowest total dollar amount of discount points, origination points or origination fees (or, if two or more loans have the same total dollar amount of discount points, origination points or origination fees, the loan with the lowest interest rate that has the lowest total dollar amount of discount points, origination points or origination fees).
(ii) The loan originator must have a good faith belief that the options presented to the consumer pursuant to paragraph (e)(3)(i) of this section are loans for which the consumer likely qualifies.
(iii) 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 paragraph (e)(3)(i) of this section.” (Emphasis added.)
Here, there is no indication that the terms of the above “options” exception have been satisfied. Accordingly, I would not recommend this suggested method of loan officer compensation.
Michael Pfeifer is Director/Legal & Regulatory Compliance for Lenders Compliance Group & Servicers Compliance Group.