New regulations will soon restrict a common way of compensating residential mortgage brokers and loan officers.
However, those sales representatives still have to be paid somehow, and far more may change than simply commission structures.
Mortgage lenders are mulling over how to comply with the Federal Reserve's compensation restrictions that take effect April 1. The rule will all but ban yield-spread premiums, which are paid to the broker or loan officer for originating a loan with a higher interest rate (sometimes in exchange for lower up-front settlement costs).
Alternatives under consideration range from paying sales representatives a flat fee per loan to charging the borrower higher up-front fees to cover the commission for the loan officer or broker.
"You can still pay the loan officer just as much as you did before, it's just the manner in which you do it," said A.W. Pickel, the president and chief executive of LeaderOne Financial, an Overland Park, Kan., mortgage lender.
The Fed rule is similar to provisions of the Dodd-Frank Act, which call for an outright ban on yield-spread premiums but allow regulators to make exceptions. Over time, the Fed, or its forthcoming Consumer Financial Protection Bureau (CFPB), is expected to resolve any discrepancies.
To make mortgage costs more transparent, the Fed rule will let lenders pay yield-spread premiums only in cases where the borrower is not paying an origination or other fee to the lender. In practice, such cases are unlikely, since the lender typically charges borrowers some form of origination fee.
Several experts say the new rule will radically change the way brokers and some loan officers are paid.
"This is going to present a challenge for all lenders," said Phillip Schulman, a partner at the law firm K&L Gates. "The question is how do you incentivize loan officers and mortgage brokers when you can't pay them the old-fashioned way?"
Small brokers may be forced to quit the business if they only earn 1% of the loan amount, which may not be enough to cover their own costs. Both brokers and retail loan officers may end up joining mortgage banks and correspondent lenders that pay a salary, a commission or any other incentive based on factors other than the interest rate or loan terms. Correspondent lenders said they may take secondary market profits and use that gain-on-sale income to pay loan officers, particularly high producers that currently earn 4% or more per loan.
Lawyers say regulators have been nudging big banks to eliminate points and fees, and push more costs into the interest rate.
Yet some lenders say the Fed rule limiting yield-spread premiums could have the opposite effect and result in borrowers being charged up to two percentage points in origination charges or up-front fees, compared with about 1 point these days.
Several experts say that once they are no longer paying commissions tied to the interest rate, large banks and originators could reap a windfall — they will pocket most of what they had previously paid to loan officers and brokers on top of (potentially higher) points and fees collected from the borrower and secondary market gains from the sale of loans.
Complicating the issue are provisions of the Dodd-Frank Act that limit compensation on high-cost loans to 3% of the total loan amount, though such provisions will not be in effect until after the CFPB is up and running, which could take a year.
"It's going to be very, very difficult for people to make big, big chunks of cash and income, based on the two rules," said Joseph Lynyak, a partner at the law firm Venable.
Consumer advocates have long tried to eliminate yield-spread premiums. Several unsuccessful class actions in the 1990s alleged that such payments violated the Real Estate Settlement Procedures Act for being "unearned fees" that were not related to a service.
In 2008, several large lenders reduced the cap on the total compensation brokers could receive to 4% of the loan amount.
Richard Andreano, a partner at the law firm Patton Boggs LLP, said the Fed rule, when combined with the compensation provisions of Dodd-Frank, would put lenders in a Catch-22.
"If they tell the lender they can pay the broker but can't collect anything in points and fees from the borrower, then they have to throw everything into the rate," Andreano said. But if they do build broker compensation into the rate, they could get burned later: Loans with higher rates tend to prepay faster, lowering the value of mortgage servicing rights and raising the risk that a lender may not make enough money from a loan to cover the cost of originating it.
"Consumers weren't expecting to get loans with no costs associated with them and there is a trade-off between how much you pay up front and the rate," Andreano said.
Still, Dodd-Frank allows for exceptions and the restrictions on yield-spread premiums could be changed by the CFPB, he said.
Other lenders said the rules do not go far enough.
"The government is smelling the coffee but it needs to go further by eliminating incentives that go 180 degrees against finding the client the right loan," said Anthony Hsieh, the founder and CEO of loanDepot.com, an Irvine, Calif., online lender. Hsieh, whose loan officers are paid on salary, said the mortgage industry needs to imitate the real estate agent model by paying a flat fee for service or a percentage of each transaction.
Regulators "stopped short of the magic formula, which is a fixed fee for services," Hsieh said. "They're going in the right direction but coming up short."
The benefit of a fixed fee, he said, is that "if there is a static margin, the consumer will always be getting the market rate," he said. "Otherwise it is completely confusing to the consumer."
Roy DeLoach, the CEO of the National Association of Mortgage Brokers, said the broker business model may survive even if brokers are paid a flat rate. "It all depends on what the market will bear," DeLoach said. "If what the lender pays stays where it is today at 2.5% to 3%, that's fine, but if it moves lower then there will be a problem."
Some lenders are tying loan officer pay to performance measures such as volume or the pull-through rate of loans that ultimately get funded. Such changes are unpopular among sales representatives — as is the Fed rule.
"The goal [of regulators] was to prevent the unscrupulous loan officer from being able to upsell," by raising the interest rate to get a higher commission, Pickel said. "Now there are a lot of very angry loan officers because they may have their income cut."