Mortgage Companies Continue To Violate Compensation Guidelines

It is prohibited to pay a loan originator differently depending on the product type.

In the 2022 Spring issue of Supervisory Highlights, the CFPB emphasized LO compensation violations among supervised mortgage entities. According to the report, examiners found that certain lenders’ compensation agreements provided for different compensation arrangements depending on product types. According to The LO Comp Rule, this is clearly not allowed. Consider the 2021 Summer issue of Supervisory Highlights with an identical violation, it’s still happening and unfortunately not a rare occurrence. This is addressed in the Small Entity Compliance Guide as well.

In fact, one example from the compliance guide involved a company paying more basis points on loans during months when LOs closed a certain percentage of loans that conformed to Fannie Mae guidelines. Another example of a violation identified a company paying different amounts for bond loans created by a state’s Housing Finance Agency.

I am already hearing the future arguments coming from brokers and other mortgage business owners. I’ve had many conversations with them over the years to the present day. I understand it is frustrating, but The LO Comp Rule was established primarily to prevent steering, which means directing originators through financial incentives to certain products. If companies pay differently based on product types, it encourages and promotes steering.

As a footnote to the above-mentioned violations, the term “product,” used generally in the industry as a loan, is not as clearly defined as you might expect. However, the CFPB has written at other times that the word product, “generally refers to various combinations of features such as the type of interest rate and the form of amortization.” (2013 Loan Originator Compensation Rule, 78 Fed. Reg. 11279, 11284.)

Profit-Based Pay and Overrides are Prohibited

The LO Comp Rule prohibits most profit-based compensation plans. It does allow for companies to pay a bonus of up to 10 percent of the total compensation to the loan originator. It also allows for profit-based payments to a designated tax-advantaged plan, like a 401(k). There is also an exception to a manager who less-frequently originates loans (less than 10 loans in a rolling 12-month period).

One of the most frequent questions I receive relates to loan originators who are interested in recruiting other loan officers, in order to generate overrides on their loans. This may be possible, but it’s an area that is NOT clearly defined in the rule and if done incorrectly, could result in clear violations of profits-based compensation. There is a risk factor that mortgage companies need to consider in this scenario, is the profit worth the risk of violations. I would strongly err on the side of caution.

When All Else Fails, Run a Proxy Test

Remember that pay cannot vary based on the transaction term of a loan. The LO Comp Rule provides a two-step proxy test to determine if a payment method was a proxy for a transaction term.

The first step in the test is to determine whether the “factor consistently varies with a transaction term or terms over a significant number of transactions.” 12 CFR 1026.36(d)(1)(i).

The second step is to determine if “the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction.” Ibid.

If you can answer in the affirmative to BOTH scenarios, payments to MLO’s in this way would be a violation of compensation law.

The Seven Safe Compensation Methods.

Business owners don’t have to be discouraged, there is some good news here! The CFPB has provided seven permissible payment methods that can be mixed and matched to generate a creative payment plan that helps the company’s balance sheet. The list is not comprehensive, so loan originators can be paid outside of these seven ways, but keep in mind that mixing and matching these seven options will keep you compliant.

The following makes up the safe list (which can also be found in the Small Entity Compliance Guide on page 43):

1. Compensation based on the loan originator’s overall dollar volume (total dollar amount of credit extended or total number of transactions originated) delivered to the creditor.
2. Compensation based on the long-term performance of the originator’s loans.
3. An hourly pay rate based on the actual number of hours worked.
4. Compensation based on loans made to new customers versus loans to existing customers.
5. Compensation based on payments that are fixed in advance for every loan the originator arranges for the creditor. (For example, $600 for every credit transaction arranged for the creditor, or $1,000 for the first 1,000 credit transactions arranged, and then $500 for each additional credit transaction arranged.)
6. Compensation based on the percentage of the loan originator’s applications that close.
7. Compensation based on the quality of the loan originator’s loans filed (for example, accuracy and completeness of the loan documentation) and submitted to the creditor.

If you are considering a compensation plan that goes beyond the seven safe methods outlined above, I highly recommend discussing the ideas with someone familiar with LO Compensation guidelines and other federal labor laws to ensure you are protected. It will save you in the long run to get it right from the start to avoid a lengthy struggle with a violation later.

Creative compensation options for business owners IS an option in today’s market. With careful steps taken, you can navigate the violations and secure new profits for your company. Protecting those hard-earned profits and investing in a compliant LO compensation structure should be your top priority. It’s possible, it really is.