Thursday, September 5, 2013

Broker v. Lender: The Drive to Mini-Correspondent - Rational Response or Over-Reaction?

The question over Broker Compensation causing loans to be classified as HPML has caused some disruption in the business. It is at the heart of a movement driving current mortgage brokers to adopt the lender business model by becoming "mini-correspondents" to avoid adverse selection. The question posed: Is this a real cause or imagined? If it is real, is it worth the correspondent risk for brokers?

The Issue

On the face of it, the confluence of two rules does appear to create a problem. The first rule - The Truth-in-Lending Higher Priced Mortgage Loan rule (HPML) - requires that loans exceeding a certain interest rate have a number of consumer protections. The interest rate trigger which drives this provision involves calculating the Annual Percentage Rate (APR) which takes into account upfront and monthly lender fees. This calculation is compared to the Average Prime Offered Rate (APOR) which is a WEEKLY index compiled by Freddie Mac in what's known as the Primary Mortgage Market Survey. The rule considers any loan exceeding this calculation by 1.5% a Higher Priced Mortgage Loan requiring extra due diligence and disclosure. To this point all mortgage industry participants must play by the same rules. The conflict occurs when the Truth-in-Lending Originator Compensation Rule is considered.

The second rule creates the problem. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) initiated reforms to the Truth-in-Lending Act, known as the Anti-Steering Rule (LO Comp). This rule constrained loan originator compensation to 3% of the loan amount.
The possibility of triggering Higher Priced Mortgage Loan requirements is exaggerated on mortgage broker originated transactions potentially limiting borrower choice.
In reality, a very small sliver of loans could create a comparative disadvantage. To start with, only those in which the loan starts out as marginally HPML triggered could be an issue. This is the case when you have PMI, MIP or a lot of overlays. In these cases, lenders will run a nearly equal risk of triggering HPML requirements. Once you do have this higher APR present, then you must more carefully measure the transaction. Only then do you have to consider the magnitude of the broker's compensation and its effect on APR - the larger the broker's compensation, the more likely to trigger HPML relative to the same lender's transaction.

Consequences - Limited Choices for Consumers = Higher Costs

For consumers, the compliance risk associated with HPML means fewer lenders willingly offer these loans. Brokers, who can provide alternatives and drive down costs, may be selected out of comparison if the transaction falls into the narrow range of transactions that would be considered HPML if originated by a broker but not by a lender.

In this case you can see how, with a higher APR to start with, the liklihood of triggering HPML requirements is exacerbated by the inclusion of the originator's compensation.  This inclusion exaggerates the APR of the broker originated transaction, which could limit borrower choices in seeking home financing, ultimately costing consumers more.  

But how much of an injury is this?

Take a rational view of the HPML requirements and you realize these already exist in the non-HPML world. Most lenders require escrows, particularly on loans with MIP or PMI, which are the loans most likely to be HPML. We always have to give borrowers copies of appraisals. We already consider ability to repay on all transactions. The limitations on loan types - no prepayment penalties, negative amortization or balloons, are already considered for most of the industry's loans. How is a broker limited if a loan should be categorized as HPML? The truth: the broker doesn't experience a negative impact.

Most of the consequences of tagging a mortgage as HPML have already been incorporated into other requirements - ability to repay, Qualified Mortgage, Appraisal Independence.

The Rush to Correspondent

As a mortgage service provider, there are legitimate reasons to elevate your business to correspondent:

  • An investor offering a specialty product ONLY through correspondent channel 
  • The ability to control generating closing documents locally and improve service delivery 

But when measured against the substantial risks correspondents take, is it really worth it simply to avoid this one small regulatory wrinkle? The NAMB has provided a great TWO PAGE overview of the risks associated with small firms taking on correspondent responsibilities.

  • Repurchase risk 
  • Audit risk 
  • Compliance risk 
  • Liquidity risk 

Slow Down There Big Fella! 

For brokers the APOR/APR issue seems to be problematic, but the broker starts at a lower APR then adds fees. How likely are you to trigger HPML on most transactions that you wouldn't trigger if you were a lender? Small chance - you have same overlays/MI, etc. It is not worth taking on correspondent risk to avoid the relatively rare occasion when a broker transaction would carry an APR so much higher than a lender transaction to trigger HPML. Plus, borrower paid transactions are excluded from this entire debate. Plus, what really happens when a loan becomes HPML? You can't have prepays balloons or negam, you have to qualify, and you have to give the borrower a copy of the appraisal, right? WE DO THAT ANYWAY!

Tell me if I'm wrong. The furor is causing a lot of disruption among small brokers. Much of this concern has been caused by wholesalers who want to differentiate their service offering, so have stirred the pot over this debate.  Warehouse lenders have also chimed in on the importance of having a warehouse line.

Holy Secondary Conflict, Batman!

There are bigger problems with the HPML rule. APOR is set once a week. We have seen major fluctuations in pricing to the upside, and when this happens simple market movement can cause EVERY LOAN IN YOUR PIPELINE to be HPML. Maybe the day is here where we simply assume each loan will be HPML, and move forward from there. We are doing it anyway.

Additional Resources

Bankers Online HPML Checklist - You can document that you determined whether a loan was HPML or not, and then what you did to comply. 


  1. The debate over the Mini-Corr as some sort of panacea continues... Rob Chrisman opining in Mortgage Daily

  2. There have been some great points in response to this article.

    1.) Nothing prevents a broker with a mini-corr arrangement from brokering to another investor. Many banks also broker loans. But there is pressure to use the mini-corr line for a propensity of the business, if the purpose of the arrangement is to avoid disclosing fees or other aspects of the broker regulatory construct, right? I mean, if the reason for going mini-corr was to maximize revenue, as opposed to providing the best deal for the borrower on a transparent basis, would you broker a loan if it meant that you couldn't charge as much? Maybe if it was the only way you could get the loan approved.

    2.) One commenter said that the fact that you may encounter a buy-back doesn't mean that you will actually incur that loss. True. You can mitigate secondary market losses: we have a policy and procedure for this as well:

    But the time spent on loss mitigation can really take away from the amount of time you spend on your business. Brokers need to be aware of the fact that, just because you can mitigate a risk, this does not mean that the risk doesn't exist.

    Actually, the point is simply that the broker mini-corr model doesn't necessarily provide the benefits it is being sold as. The point is not that warehouse lending /correspondent lending does not provide a tremendous value. And "mini-correspondent" provides a step up for the emerging banker. But there is limited utility for the mini-correspondent model.

    Defining mini-correspondent: 1.) captive warehouse line - funding most or all loans for sale to the warehouse lender 2.) no delegated lending approval - pre-approved loans only 3.) may or may not include drawing docs. Loan funds on broker's warehouse line and is purchased from warehouse line 7-14 days after funding.

    The specific reason brokers want this mechanism is to avoid the disclosure of the broker fee and the ability to collect additional fees above the 3% limit allowed for brokered transactions. In addition, there is a minor advantage is avoiding adverse selection for loans which may become HPML. Most of the brokers I have surveyed aren't getting anywhere near 3 points on a loan. Would you recommend mini corr to them?

  3. I am most concerned with what fee's will be backed out of the 3% fee cap and thus what revenue will remain and if said revenue will be sustainable for my business and my personal income requirements. I have not seen any information on what fees will be backed out so if anyone here knows I would welcome the contact.

    1. Larry - one of my favorite pages on the internet:

      All the rules are here. BUT for QM and Comp read here:

      Beginning on Page 38. The key difference - and my next newsletter addresses this, is the difference between those fees included in the APR (everything related to the loan) and those considered in the HPML calculation - limited to actual fees you receive - not pass throughs - for your 3%.

      So if you are a broker your 3% is ONLY WHAT YOU KEEP. You don't have to worry about MIP or your wholesaler's underwriting fee, etc., etc. Title charges, too, are excluded UNLESS you own the title company