WORD ON THE STREET: Just a few years ago, our country went through the greatest financial crisis since the Great Depression. One of the reasons for the collapse was that mortgage borrowers were steered toward high-cost and risky loans they had no real chance of paying back. Lenders did that because it made them more money. The higher the interest rate on the loan or the more the consumer paid in up-front charges, the more the loan originator profited.
Mortgage loan originators perform a variety of valuable services for compensation. They can take mortgage applications from consumers seeking to buy or refinance a home.Â They can also assist consumers in obtaining or applying for a mortgage loan. They can also offer or negotiate the terms of the loan.
Loan originators include mortgage brokers and loan officers. The Dodd-Frank Act placed certain restrictions on their qualifications and compensation. When the Consumer Financial Protection Bureau inherited the authority to implement these restrictions, we realized that the goal was to bring greater accountability to the mortgage market.
To inform our policymaking, we received input from banks, other lenders, mortgage brokers, trade associations, consumer groups, nonprofits, and other government stakeholders. We also convened a small business review panel for input. We heard a great deal about the problems that the new loan originator compensation rules were intended to address.
These rules set qualification standards for different types of loan originators. The rules require them to meet certain character and fitness requirements, be vetted for felony convictions, and receive periodic training. Consumers deserve to have confidence that loan originators are ethical and knowledgeable.
Congress also specified that loan originators should be motivated by proper incentives. So we are building on rules issued earlier by the Federal Reserve, and applying what we heard from industry and consumers across the country. Our new rules close loopholes to help ensure that loan originator compensation may not be based on the terms of the mortgage transaction. At the same time, they spell out compensation practices that are legitimate and permissible.
These rules recognize that people tend to do what they get paid to do. By removing financial incentives for originators to push borrowers toward risky loans, we are ensuring that the mortgage market will be more stable and sustainable, and consumers will be better protected.
These rules prohibit compensation that is based on the loan terms. A broker or loan officer cannot get paid more by directing the consumer toward a loan with a higher interest rate, a prepayment penalty or higher fees. And the loan originator cannot get paid more for directing the consumer to buy an additional product like title insurance from the lender's affiliate.Â
The rules also ban ‘dual compensation,’ where the broker gets paid by both the consumer and the creditor. In the run-up to the financial crisis, consumers often may have assumed that their loan originator was looking out for their best interests when that was not so.
Now, we recognize that even when the loan originator is working in the consumer's interest, pricing is still an extremely complex process. It involves a series of trade-offs for both the consumer and the lender between up-front and long-term payments. The amounts that consumers pay in up-front fees and charges to the creditor, broker or affiliates often can affect their interest rate. The consumer may choose to pay more money up front through discount points, origination points or origination fees, or instead may choose to pay a higher interest rate, which determines monthly payments.
Determining the appropriate trade-off between payments now and payments later requires consumers to have a clear sense of their own current resources and expected future income. Consumers also have to project how long they expect to stay in the home and in the particular loan.
If the consumer plans to stay in the home for many years without refinancing, then paying points to obtain a lower rate may make sense, if the consumer has the money available. But if the consumer expects to move or refinance within a few years, then agreeing to pay a higher rate to reduce the out-of-pocket expenses at closing may make sense, if the consumer can handle the higher monthly payments. By choosing this option, the consumer may save more up front than he or she will pay in increased monthly payments.
In August 2012, the bureau proposed a rule requiring mortgage loan originators to offer a loan without any up-front origination charges whenever they were offering a loan with up-front origination charges. Based on the comments received, we have decided not to finalize this part of the proposal. Once our new mortgage rules take effect, we will study how they are affecting consumer understanding and decision-making about up-front origination charges, and we will consider further how to protect consumers in this area.
Fundamentally, these rules are about protecting people from predatory lending practices. By adopting the loan originator compensation rule, we are enhancing the efficiency of the mortgage market and working in the best interest of the American consumer.
Richard Cordray is director of the Consumer Financial Protection Bureau. This article is adapted and edited from prepared remarks delivered during a Jan. 18 press call. The original text is online.