Unethical or Illegal? Dual Agency/Dual Capacity, Double Compensation in Loan Origination

Updated 1/6/2025

It seems obvious, but the fact that an originator might represent someone else's interests in a transaction creates an inherent conflict of interest. The real estate agent works for the seller, and the loan officer owes his fiduciary responsibility to the borrower. Conflict occurs when the loan originator can receive compensation elsewhere in a transaction besides the mortgage, such as:

• real estate commission
• insurance sale
• title/closing/escrow transaction
• appraisal/valuation
• financial services
• accounting

The question at issue: whether it's merely unethical to "double-dip" or illegal and prohibited? The answer lies in the location of the property. If your state prohibits dual agency or has rules against dual compensation, then it's illegal. 

Since acting as a real estate agent (where you represent the seller) and a loan officer (where you represent the buyer) is a conflict, you should not allow both. However, it may be acceptable for you to have a business where you actively sell real estate as a licensed real estate agent and separately originate loans as a licensed mortgage loan originator. There is no conflict if you recuse yourself from participating in the transaction. 

Loan Originator Compensation Rules

In a conundrum for "true" buyer brokerage (where the buyer pays the agent's commission), dual agency cannot exist due to the requirement that the borrower cannot pay the loan originator anything outside of the commission on the loan. If you recuses yourself from the fee, it appears this would be acceptable. 

Is it acceptable to Have a Real Estate License?

Mortgage originators with a real estate license sometimes find it easier to generate business because their experience in real estate adds professional credibility to real estate agent referral sources. However, this does not mean the mortgage company or bank finds this acceptable. The POTENTIAL for conflict creates enough possible risk to lead the mortgage company to create a hiring policy that prohibits this arrangement unless the license is affirmatively inactive. 

This stems from the fact many secondary market contracts and loan purchase eligibility warranties often cite the requirement for no conflict of interest in the loans sold or purchased. The mere existence of a conflict can require a lender to repurchase a loan, regardless of whether there was a negative outcome. 

FHA Allows it - USDA Does NOT

Recently, FHA clarified that it WOULD allow non-credit (not underwriters, valuations, quality control, etc.) related parties to act as both agents and loan originators. However, on 3/31/23, USDA clarified this was a conflict of interest and specifically DISALLOWED this. 

Dual agency in Real Estate Transactions Prohibited

Eight states have made dual agency in real estate illegal: Alaska, Colorado (although dual capacity for LO is allowed), Florida, Kansas (allowed for broker), Maryland (Prohibited from receiving finder's fee -aka broker fee), Texas (Dual Capacity For LO allowed), Wyoming, and Vermont. Dual Agency refers to the real estate agent representing both the seller AND the buyer. This is one indicator that, regardless of role, a loan originator who is also a real estate agent could run afoul of this. Some states allow what is known as "Dual Capacity."

Real Estate Rules Where Undisclosed Dual Capacity is a Violation

Massachusetts, Massachusetts, also does not allow acting as a real estate attorney and a broker on the same transaction. 

States that may specifically disallow Dual Capacity

North Dakota	Not Allowed	Examiner - Ownership okay, but cannot be agent and MLO on same transaction
Illinois	Not Allowed (must be separate)	https://idfpr.illinois.gov/faq/bre/mlofaq.html#faq-5caniholdamlolicenseandrealestatesalespersonlicensesimultaneously-faq
Louisiana	Not Allowed	La. Rev. Stat. §6:1090(I)
Utah	Not Allowed	Prohibited per 61-2c-301 (1)(i)
RI	Not Allowed	Commentor

Maryland - No "double dipping"

States that do not specifically disallow Real Estate Agents and Originators to Receive Commissions on Both Transactions - known as "Dual Capacity."

Arizona (Mortgage Broker License)

California (DRE Licensed)

Colorado - With Proper Disclosure

Connecticut

District of Columbia - With Proper Disclosure

Kansas - If properly disclosed

Michigan (MI DFI) - Must use AfBA disclosure

Nebraska

Nevada

New York

North Carolina (maybe) - Strong advisory against it because of possible RESPA/TILA violations

Ohio - with proper disclosure as of 6/24 

Texas - With proper disclosure

Virginia

Washington - Required Language in Disclosure 

We will add it to this list, or you can send your citations as we collect more information.

Regulatory Guidance - Appraiser Independence Rule (AIR) Violation Minefield

The most frequently overlooked problem with this arrangement is the possible influence of the appraiser. The real estate agent (particularly the listing agent) meets the appraiser at the inspection of the property and has a vested interest in obtaining the highest possible value to support the sales price. The company could be liable for undue appraiser influence if the agent is also a loan originator. The lending company can put guardrails in place, but there is no such fail-safe for real estate agents. 

Affiliated Business Arrangement Disclosure

Many states have their own language for Dual Authority, but RESPA rules require that the relationship be disclosed using the Affiliated Business Arrangement Disclosure (AfBA). Further, there should be a prominent disclosure that the customer receives services and pays fees to the same individuals for multiple services. 

This is also true if the agency owns a part of the lender, or any related settlement service. 

Unless it's Specifically Codified - Best Practices Dictate "Don't Do It."

Sources

“Required Disclosures by State - American Mortgage Network.” American Mortgage Network - Funding The American Dream, 22 Nov. 2022, https://www.amnetmtg.com/required-disclosures-by-state.

The problem with the flip flop - Anti- Steering and Loan Originator Comp

Broker companies are creating compensation plans with flexibility for lowering the compensation of broker loan originators by switching from lender paid to borrower paid. It appears legal, by taking the Safe Harbor of "borrower's best interests" to allow pricing discretion and reduced commission to loan originators. However, this changing commission is based on loan terms (or proxy) because it results from the change of fees. Seen this way, the practice is prohibited under the anti-steering rules. Why? Because if you can reduce pricing by switching, you can achieve the inverse, too. 

This is precisely what is happening today; loan originators go to the prospect with one price based on lender-paid fixed compensation plans. Then the prospect comes back with a competing offer and the loan originator now tries to beat it. Since it's impractical to change pricing under LO comp rules under lender paid on a case-by-case basis, they switch the pricing to borrower paid where there is flexibility to reduce the charges. Now, the compensation is in the hands of the broker-company, not the wholesale lender. This is done under the auspices of "borrower's best interests" Safe Harbor. 

It should be clear that, unless you have a loan amount-based compensation plan, the temptation to flip a borrower from Borrower Paid to Lender Paid and INCREASE commission is inherent in the "flip to borrower paid" structure. 

I think any regulator will see this as flying in the face of the LO Comp/Anti-steering rule because it gives the LO pricing power with discretion to decrease his or her commission. The argument goes; it benefits the borrower - which is a SAFE Harbor. The main flaw in this thinking is that it doesn't consider that the inverse is also true; a loan originator could switch from borrower paid to lender paid at a higher commission. In a word - steering. 

Perhaps the fact that compensation is capped at a QM level of 2.75 points as a maximum commission provides a sense of no variable compensation. 

I am not sure why this has escaped scrutiny for so long. We tell our customers that we recommend a flat commission rate based on loan amounts, not a percentage of the of the fee, to avoid the appearance of steering.

The problem for the industry is that the good actors who lead with their best price in compliance are having their production poached by participants who allow loan originators to adjust pricing to "get the deal." While that seems to benefit the customer by creating a competitive market, remember that the whole idea of the rule was to regulate this practice because the pricing was opaque to the consumer. The consumer has minimal knowledge of the market, rates, and pricing, while loan originators are very knowledgeable and are extremely motivated to increase their income.  

The Proliferation of 1099's, Flat Fee agreements - A Warning

I've just survived a hurricane. In the resulting re-building process, I've learned one thing definitively; many people say that they can fix your problem - just give them a "deposit." In fact, that's a pretty good way to ensure you'll never hear from them again. 

I see the same thing in the loan officer compensation wars currently evolving. No compliance officer or attorney worth his or her salt will authorize a non-compliant compensation plan because the risks so far outweigh any temporary benefits. However, as margins and business shrinks companies are adopting risky plans because they're likely to be out of business when the bill comes due. Unfortunately, this drives the entire market in the same direction. 

When arranging compensation plans in a way that allows the company to capture a flat fee is fine. Charging a flat fee (subject to QM cost limits) to a customer is also fine. Charging a loan originator a monthly desk rental or other fee is also fine. However, netting costs from a loan officer's comp is a problem. You cannot withhold fees from an agreed-upon commission. 

Independent contractors | Washington Department of Revenue

To be considered compliant with the "Anti-Steering Rules" you must set flat commission rates from your wholesalers across the board so the loan originator cannot increase his or her income by steering the customer to a particular product or lender. 

A common trend today involves the adjustment or reduction of a loan originator's compensation because the customer changed to/from borrower-paid compensation. You should only do this in conjunction with a "best interests" scenario, not as a matter of course. We do not know that Federal regulators will accept this as a standard practice for reducing a customer's price. 

Independent Contractors, Again

We get the question about whether a specific state will always accept loan originators paid via 1099. You must know that a state does not necessarily regulate this, though it may take a position. For example, Texas, North Carolina, and CA DFPI do mandate that loan originators must be employees, not contractors. States regulate licensing and business practices, so even though you may see a tacit acceptance of originators as 1099 contractors, this is an internal decision for each company. 

To understand the consequences of 1099 contractors, understand that the IRS and the US Department of Labor define the issue of employee status. Can a loan originator really be a contractor if you control certain elements of their business? For instance, you really should require a loan originator to use your technology (laptops, phones, and networks) to avoid exposing your customers to cyber risks. If a contractor must use your equipment, are they really a contractor? In another instance of controlling the work environment, you must license a remote location or approve the use of remote access. Does this create an employee relationship? If you are offering employee benefits, such as health care, it's likely you are an employer.

For these reasons and others, any reputable compliance consultant or attorney who knows the rules will NOT recommend 1099 employment agreements. I KNOW THAT EVERYONE IS DOING IT. 

Furthermore, regulators have paid surprisingly little attention to this matter. In the end, what may drive your decision relative to 1099 or W-2 is the possible re-classification of your company's contractors as employees in an audit. The penalties are enormous - unpaid taxes, plus a 100% penalty, plus interest. 

You CAN withhold taxes and mark the employee's W-2 as "Statutory Employee" which will allow them to deduct their business expenses on Schedule C. Or have the employee get licensed as an LLC, or even as a Sole Prop, and pay the LLC directly. 

Mortgage News Digest: Can I pay a Loan Originator by 1099?

There is a sample Loan Originator Agreement in the folder you got with your 2-0 Compliance Module. You can also copy it here:

Loan Originator Compensation Plan Template - Mortgage Manuals

Audit Season: Loan Officer Comp Plans vs Loan Officer Employment Agreements

Questions Persist on the Meaning of "Employment Agreement" or "Compensation Plan"

With the onset of annual audit season, we have noticed a large increase in the number of requests we get for compensation plans and loan officer agreements. We need to set the record straight on some definitions so that you have clarity on what is required and what the regulator is requesting.

First, there are two different things at play. 

• The need to establish the arrangement between the loan originator and the company as to employment. This item is referred to as an employment agreement. 
• The need to establish the pay rate for the originator is referred to as a compensation plan
• These two items are exclusive of each other, although an agreement may refer to a compensation plan. 

Employment Agreements are NOT Compensation Plans

Employment agreements define job duties, the terms of employment, and how employment will terminate. In other words - this is your job; do these things and don't do other things. If you do things we say not to do, we can terminate you. This is how we'll wrap matters up if you separate from the company voluntarily or involuntarily. 

One of the difficulties we face in providing compliance services is that we often get asked for advice. Largely, advice on compliance relates to understanding what regulatory rulemaking means. This is not interpretation or advice, it simply is a translation of the rules into a more easily understood or practical application. Employment agreements, on the other hand, are contracts. In order to draft a contract for a third party you need to be authorized to practice law: an attorney or lawyer. A compliance company should not provide this service. Instead, you should seek the advice of a competent advisor familiar with the employment laws of a state. 

When we provide this free sample loan originator employment agreement, we are actually calling it a comp plan, because it forms part of the comp plan. You may copy the text and use it as a model for drafting an agreement yourself. 

That said, we have some general, common-sense guidance for the creation of employment agreements:

1.) Separate compensation plans from the employment agreement by attaching the compensation plan as an exhibit which is SUBJECT TO CHANGE AT ANY TIME.

2.) An Employment Agreement states the general minimum job requirements of the position. You can augment that by having a very detailed job description such as that in our Loan Originator, Loan Processor, Loan Closer or Underwriting policies and procedures. 

Compensation Plans are NOT Legal Agreements

A compensation plan simply states the rate of pay for various services. In the case of the current regulatory scheme, we have to be aware of anti-steering rules. A compliant compensation plan defines how compensation to loan originators happens in a way that does not violate the anti-steering rules. 

Elements of a Compensation Plan

• Loans Subject to the Rule
• Definition of a Loan Originator
• Exclusions from the LO Comp Rule
• Dual Compensation, Upfront Points and Fees
• Proxies for Loan Terms
• Non-Loan-Term Items
• Profits-Based Compensation
• Pick-A-Pay Plans
• Pooled Compensation
• Compensation for LOs that Work as a Team
• Pricing Concessions
• Point Banks
• Competition for LOs
• SAFE Act Requirements
• Anti-Steering Provisions/Safe Harbor
• Record Retention
• QMs and Double Counting
• LO Qualifications
• Written Policies and Procedures
• Non-Cash Compensation Incentives
• Splitting Comp Between LOs
• Bonuses and Retirement Plans
• Bonuses Based on Volume
• Non-Producing Managers and Sales Executives

Our Compliance Module provides a policy and procedure that addresses all of these issues. 

North Carolina Mortgage Licensing and Examinations - What have we learned?

It should surprise no one that NCCOB - the nation's FIRST state regulator to initiate anti-predatory lending laws, and one of the first to initiate robust pre-licensing training, AND was a leader in pre-Dodd-Frank regulation - has now taken the flag as one of the most detail-oriented examiners. 

Expect an initial examination within the first 12 months of licensing. Existing licensees who have never been examined should expect one, and this normally coincides with a complaint or other inconsistency.

For those licensed in the state, NCCOB (North Carolina Commissioner of Banks) has clearly and transparently posted its expectations. Yet over and over we see brokers and lenders alike responding with surprise to examination findings and questionnaires. When we review the findings to help licensees comply we aren't surprised, just a little disappointed at what some might call willful blindness.

We have a great deal of respect for the rational approach that the regulator has taken. Nothing in the findings represent anything that brokers or lenders shouldn't be responsible for. If anything, our concern is that these problems exist elsewhere and propagate because of a lack of oversight.

Broker Fee Agreements

It's illegal to collect a fee without the customer's explicit agreement. These files show missing or incorrect broker fee agreements, or incorrectly completed lender financing agreements. The common response or argument is that the LE or CD provides the customer's tacit agreement. However, it's usually too late at that point; the information on the LE/CD should come from the financing or broker agreement.

For our customers, we devote a section of our quality control plan for correct completion and retention of financing or fee agreements.

BSA/Anti-Money Laundering Plans

We sell both stand-alone anti-money laundering plans, or better yet, QC (Quality Control) plans that identify the full set of FinCEN (FINancial Crimes Enforcement Network) identified Red Flags. Our BSA/AML (Bank Secrecy Act/Anti-Money Laundering) plans use these to identify potential SARs (Suspicious Activity Reports) for reporting.

Most people don't read them.

Otherwise, they would know that they include:

• A SAR Reporting Workflow
• A Compliance Officer (You have to put the person's name where it says "Insert Compliance Officer here")
• Initial and Periodic Training (We give this away here, or provide a checklist to ensure you have taken AML specific training as part of your Continuing Education)
• Both FinCEN and Industry Specific Red Flags

When we see a finding related to "deficient AML plans" these all fall under that category.

Missing Documents in Audit Files

Inexcusably, many files reflect missing exhibits or data reflected in reporting doesn't match loan files. THIS IS JOB ONE of a quality control plan! Time spent retrieving documents from investors, closing agents or even borrowers represents lost loan production time; wouldn't you rather spend time originating than chasing old loan file exhibits? 

This is the reason our QC Plan has a closed loan checklist. Click to download NCCOB's version here. We find it interesting that the checklist they provide bears some resemblance to the one in your plan:

1099's - Beware EVERYONE

We recently wrote an article on 1099 compensation of originators. NCCOB takes the position that originators are employees. Unless you follow the recommendations in our article, expect an issue with 1099 payments. Further, BRANCH MANAGERS ARE EMPLOYEES by definition; you can't be a contract manager. No Branch Manager 1099s. Also, you can't have branches in homes.

Contract Processors and other unlicensed entities

As above, compensating 3rd parties for work normally done by employees, such as processing, should automatically prompt you to require licensing of that individual or service.

Can I pay a Loan Originator by 1099?

As we roll into tax season, we return again and again to the topic of originator compensation; it remains the most ambiguous topic in compliance. Varying comp, broker company compensation, borrower-paid or lender-paid, all represent areas of confusion. But nothing confounds more, with multiple layers of regulations, than whether you can pay a loan originator as a contractor by 1099.

Conflicting Interests

Ironically, originators WANT this, while other industries experience the opposite with employees decrying the "gig economy" and its loss of employment benefits. But mortgage brokers want to minimize costs and payroll taxes represent a high margin expense. Originators also may benefit from treatment as self-employed with a much wider latitude to expense business development costs than employees. 

On the other side, state and Federal governments have taken aim at the contract labor movement because of the loss in payroll taxes. The IRS has taken steps to formalize the delineation between formal W-2 employees and 1099 contractors.

https://www.irs.gov/pub/irs-pdf/p1779.pdf

The IRS guidelines basically say, “If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.” The IRS focuses on three main areas when determining employment status:

• How much control the employer has over the worker’s behavior and work results. (Who controls training, where and when the person works, what equipment they use?)
• How much control does the employer have on finances? (Does the employer have primary control over the person’s profit or loss?)
• What is the relationship between parties? (Does the worker receive benefits and is it a long-term relationship?)

Here is the 20-point checklist from the IRS, which may be used as guidelines in determining if a worker can be legally paid as a contractor:

• Must the individual take instructions from your management staff regarding when, where, and how work is to be done?
• Does the individual receive training from your company?
• Is the success or continuation of your business somewhat dependent on the type of service provided by the individual?
• Must the individual personally perform the contracted services?
• Have you hired, supervised, or paid individuals to assist the worker in completing the project stated in the contract?
• Is there a continuing relationship between your company and the individual?
• Must the individual work set hours?
• Is the individual required to work full time at your company?
• Is the work performed on company premises?
• Is the individual required to follow a set sequence or routine in the performance of his work?
• Must the individual give you reports regarding his/her work?
• Is the individual paid by the hour, week, or month?
• Do you reimburse the individual for business/travel expenses? 
• Do you supply the individual with needed tools or materials?
• Have you made a significant investment in facilities used by the individual to perform services?
• Is the individual free from suffering a loss or realizing a profit based on his work?
• Does the individual only perform services for your company?
• Does the individual limit the availability of his services to the general public?
• Do you have the right to discharge the individual?
• May the individual terminate his services at any time?

Further, fair labor laws stipulate minimum wages, safe working conditions, and benefits. 

https://www.dol.gov/sites/dolgov/files/WHD/legacy/files/misclassification-facts.pdf

Draw a Bright Line

We may never get closure on this matter; too many variable circumstances exist for a regulator to draw a definitive line. This exposes the mortgage industry to individual legal or regulatory actions such as those we have already seen; lawsuits for minimum wage claims and licensing censure for incorrect classification of marketers as contractors. 

There's Only ONE Legitimate Solution

In our estimation, the ONLY legitimate solution lies in having the employee/contractor affirmatively claiming self-employment. For mortgage brokers, this means licensing as a company as well as an individual. In other words, instead of just an MU-4, the loan originator will also file an MU-1 and MU-2 in his or her natural name. In this way, the mortgage originator can insist on payment as a contractor with no risk to the employer for misclassification or wage-hour claims.

The state, then, will ensure that there is an EXCLUSIVE agreement between the company and the loan originator firm, that will ensure that all business gets conducted through the company, and not through multiple other firms. In other words, you are an exclusive wholesaler for the loan originator. 

In Virginia, there is an exclusive loan brokerage agreement. 

But Everyone's Doing It

Yes. We hear of this all the time. The fact that other companies pay via 1099, and even advertise it,  does not mean you've missed something. Structures like this take advantage of the ambiguity in the rules, hoping to "fly below the radar" of lax oversight. Many states don't validate compensation plans by drilling down into W-2 employees versus contract employees. It's likely that this is what you are seeing. You take a chance when offering non-standard plans. 

Exceptions

• HUD requires that lenders participating in its programs affirmatively eschew conflicts of interest created by outside employment. Lenders offering FHA financing must compensate employees by W-2. 

You Cannot EVER Pay a Branch Manager as 1099

This is a contradiction in terms. A manager, by definition, is an employee responsible for ensuring employees perform their duties according to company policy. 

SAFE Act Update

Transitional Licensing Update - We updated the SAFE Act Licensing Policy to iterate the requirements of Transitional Licensing for LOs. Remember that you MUST have an existing license to transition. Registration does not count. Also, the company has to be licensed before you can transition to the company.

Licensing Processors - It should be obvious that processors or other employees don't need to be licensed. It should be equally obvious that processors who aren't employees MUST be licensed. Among other things, besides a license, that your contract processor must have:

• Processing Policies and Procedures
• Information Security
• Fair Lending
• Anti-Money Laundering
• Anti-Predatory Lending

Consult your Vendor Management plan.

Small Commissions, High Costs, No Interest - At the Heart of the First-Time Buyer Problem

No reward for taking on small loans with lots of “headaches”

NAR study shows, after tax incentive expired, first time

homeownership plunged. (NAR 2014)

Theories abound over the causes for first-time and start-up buyers' lack of participation in the housing market. Analysts point to too much student debt, constricted underwriting, and housing prices outpacing affordability. Sociologists say people prefer to rent. The NAR study, which identifies the decline, refutes these propositions. Commonly cited theories ignore the reality of the current mortgage production landscape. Loan officers and mortgage companies have a negative incentive to make loans to a large segment of the first time buyer population. Entry level loans require far more work than other applications. Smaller loan sizes mean smaller revenues for lenders and smaller commissions for loan officers. A look at how regulatory price controls, fee caps and tiered pricing prohibitions affect income and profitability explain the real problem.

Originator Compensation Caps - Another Example of Price Control Failure

Basic economic principles dictate that price controls distort markets and create disincentives. When the Carter administration implemented price controls on consumer goods in an attempt to mitigate the effects of inflation, the supplies of milk predictably dried up. When New York City implemented rent controls to limit the rate of rent growth, the supply of existing rental housing constricted. This same principle goes into effect when the maximum fee on a mortgage loan doesn't cover the structural costs of production.

Fair Hourly Wage Comparison - Originator Compensation 

While many mortgage loan originators strive to earn six figure incomes, earnings at that level normally accrue only to top producers or those fortunate enough to originate in areas of high loan balances. According to the Bureau of Labor Statistics, the 2012 Median Pay for mortgage loan officer was $59,820 per year or $28.76 per hour. Loan officers normally receive commissions, not a salary, so they make business decisions about how to maximize the value of their time.  First time home buyers require much more work than move-up/experienced borrowers.

Figure 1: This shows the amount of time a loan officer spends to originate a first time buyer loan compared to the time spent working with an experienced borrower.  Even if the hours get attributed differently, no loan officer would argue that a first time borrower is LESS work. 

Due to the extra number of hours spent sourcing and processing loans to entry-level or first time borrowers, loan officers have an incentive to avoid these loans and focus on larger loans to more sophisticated and well-qualified borrowers.  Figure 1 reflects the rationale for avoiding loans to first time buyers.  The reward is comparatively low for the amount of work.

The fixed cost nature of the mortgage business makes these loans unprofitable for mortgage brokerage companies, but particularly for mortgage lenders whose fixed infrastructure costs and compliance costs tend to be much higher.  Figure 2 shows that for a $100,000 loan, with a 3% fee structure, these loans actually lose money for the firms.  (Per loan cost basis varies dependent on loan volumes - higher loan volumes bring per loan costs down, but low volumes drive per loan cost up.)

Figure 2: Commission income and loan profitability for small loans decreases markedly. Cost source: Broker - cost Analysis; Lender  (Finklestein 2014) 

The current regulatory system creates massive disincentive for loan originators who work for lenders, because their compensation cannot vary as a result of loan features. In Figure 2, a loan originator who makes an industry standard commission of 60 basis points, working on a ends up with an hourly compensation rate of $12 an hour on small loans for first time buyers.  This, by itself, can explain the structural problems related to stimulating the housing market.

The inflexibility created by Loan Originator Compensation Rule and Anti-Steering Rules, prevents lenders and brokers from adjusting loan pricing to offset the cost of making small loans. These rules impact the compensation of loan officers who work for lenders even more dramatically than brokers, so when you add the higher time investment required for first time buyers, loan officers working for lenders have the greatest disincentive to make these loans. Lenders account for 89% of all mortgage production (Bancroft 2014)

HPML Impact on Small Loans Aggravates Supply Constriction

The Higher Priced Mortgage Loan (HPML) Rule further restricts loans that exceed rate thresholds by increasing lender liability, documentation requirements, scrutiny of appraisals, and limiting the flexibility of underwriting. Many loans with small down payments already trigger the HPML thresholds by virtue of the mortgage insurance costs. The rule's thresholds further limit the fees that a lender can charge to offset the cost of originating smaller loans.

Conclusion - Eliminating Price Controls May Represent Only Solution

Figure 3: While the percentage of buyers purchasing new

homes has declined, the percentage of buyers purchasing

new homes has increased.  This shows builders have adapted

to the new environment.

An extemporaneous loan officer survey reveals that loan officers will only pursue small loans to first time buyers when a referral source specifically requests it. In this situation, these small loans originated at a loss ride for free on the company's profits from larger loans.  This model forces lenders to take the same approach as hospitals who accept patients without insurance. We have to treat you, but we aren't happy about it.

Examining several examples of home builders who specialize in building product for the first time buyer shows they have developed their lending systems to specifically accommodate this model, and rationalize the loan production losses with the profits on the home sale. Figure 3 shows how the the creativity and natural balance in a market where businesses innovate to overcome problems. Builders can focus on a particular segment and design a business model that meets a particular need.  However, the market as a whole cannot overcome a set of regulatory rules designed to affect the entire market.

This ironic situation, where the regulatory structure actually hurts the population it intended to protect, hurts the markets which need financing the most.  The real estate markets which have failed to recover from the 2008 crash exhibit a large percentage of loans impacted by this effect. The constriction on financing exacerbates the slowness of the recovery.

While the issue requires further data analysis, common sense supports this hypothesis. Only loan fee de-regulation will reverse the declining share of first time buyers in the market. Without this, the housing market's regulatory structural defect will prevent any broad, long term resurgence in real estate.

Author:  Thomas Morgan

Citations
Bancroft, John.  Mortgage Brokers Gained Market Share in Second Quarter, At Least on GSE Loans. Inside Mortgage Finance. July 10, 2014
Berndt, Antje, Hollifield, Burton and Sand, Patrik. What Broker Charges Reveal about Mortgage Credit Risk, SEC http://www.sec.gov/divisions/riskfin/seminar/berndt091312.pdf. June 2012
Finklestein, Brad. Companies began to increase compliance staff to deal with the new rules and that helped to increase the net cost to originate to $5,171 per loan in the fourth quarter from $4,573 in the third quarter. National Mortgage News, April 2014.
Lautz, Jessica. 2014 Profile of Buyers and Sellers. National Association of REALTORS®, October 30, 2014
National Association of Homebuilders, Housing Market Survey 2012

Bulletin: CFPB Does Not Want Table Funders Masquerading as Correspondents

The CFPB has provided the guidance it will use in determining whether correspondents are table-funders or conducting bona-fide secondary marketing transactions:

Does the correspondent have:

• the net worth to be a warehouse banker
• underwriting staff
• multiple investors to sell closed loans to
• arrangements where it brokers but also funds with an investor/wholesaler
• multiple lines of credit
• the ability to sell loans to whomever it chooses vs. captive line
• understanding of compliance risks associated with funding
• rigorous approval by warehouse lender

Basically, are you really a lender, or are you a glorified table-funder?  The CFPB guidelines for determining this have been tempered with the idea that a company may be transitioning to correspondent, but that this may not be an artifice for circumventing Dodd-Frank rules re: compensation, disclosure.

http://files.consumerfinance.gov/f/201407_cfpb_guidance_mini-correspondent-lenders.pdf

Not to Say "We Told You So" But...

Link to LinkedIn Discussion Regarding this

Sample Ability to Repay Policy

With the degree to which the Qualified Mortgage and Ability to Repay rules have affected the outlook for the mortgage industry, it comes as a surprise that an "Ability to Repay" policy does not represent a bulky and expansive document.  What should it say?  Something fairly simple and straightforward. As with many policies the devil is in the details.  Saying you will comply is a policy.  What is the PROCEDURE for complying?  HOW will you comply? THAT is an effective policy.

Sadly, regulators and investors focus their interest in seeing the policy as opposed to the procedure used to effect the policy.

Here is a sample Ability to Repay POLICY:

2.37 Ability to Repay

For any consumer credit transaction secured by a dwelling, Company Name must ensure that the borrower has the ability to repay the transaction.  Failure to do so could allow the borrower to challenge the validity of the loan.  Some transactions are exempt from Qualified Mortgage Ability to Repay requirements, however, even with loans which are exempt from a rebuttal presumption of repayment ability, we will strive to only make loans which the borrower can repay..

Exempt Transactions

• HELOCs
• Timeshares
• Bridge Loans
• Construction/Construction Perm
• Reverse Mortgages

In addition, some transactions receive an automatic “presumption” of compliance

• Eligible for purchase by Federal National Mortgage Association (FNMA) or Federal Home Loan Mortgage Corporation (FHLMC) (until sunset provision)
• Insured by the Federal Housing Administration
• Eligible for Guarantee by the USDA
• Guaranteed by the US Department of Veterans Affairs
• Originated by or for, or Approved for purchase by any state Housing Finance Agency (HFA)
• Has been found eligible as evidenced by a written letter or certificate from a Department of Housing and Urban Development counseling agency that there is a reasonable expectation of repayment

On all other cases we will follow our normal “full documentation” methods of verifying customer information and qualifying the borrower.  Rather than list all documentation which we could potentially require, we refer you to our checklist of documents that we do require for all applicants, as applicable to their situation.  (See Complete Application Checklist and Pre-Underwriting Document Review Checklist which are updated regularly to reflect changing circumstances and requirements.)

The following sections of our operating policies and procedures thoroughly identify the process for complying with “Ability to Repay.” We believe it is not enough to meet the letter of the law, but to fully implement procedures that allow us to ensure compliance.  These operating procedures are incorporated by reference.

Origination Policies and Procedures

• Loan Qualification/Pre-Qualification Process – we qualify all borrowers based on their ability to repay
• Complete Application Process – identifies ALL potential documentation needed to substantiate a borrower’s ability to repay
• Borrower Checklist of Required Documentation – Allows the borrower to identify all documentation required for qualification and verification of ability to repay
• Points and Fees – identifies our points and fees structures for the purposes of calculating maximum allowable fees.

Processing Policies and Procedures

• Pre-Underwriting Review Process – loan processing is the second stage of loan level ability to repay evaluation. Processing completes the Pre-underwriting review checklist to ensure all documentation to substantiate the borrower’s ability to repay is included in the loan file prior to underwriting evaluation.  Items identified as missing or incomplete are forwarded to the borrower and lender staff prior to proceeding.

Underwriting Policies and Procedures

• Qualified Mortgage Guidelines – Underwriting maintains guidelines and credit policy for reviewing all loans, including the evaluation of whether a loan meets qualified mortgage requirements or not. In the event that a loan is not a qualified mortgage, underwriters will still establish the borrower's ability to repay.  
• Credit Policy for Non-Qualified Mortgages – We and our investors and purchasers of loans determine whether, and under what conditions, loans which do not meet Qualified Mortgage Guidelines will be available and how they are underwritten. 

Quality Control

• Production Quality Control Process – The Audit Process reinforces the production quality control process be re-reviewing a sampling of loans to ensure that appropriate documentation and qualification calculations are retained in loan files

Secondary Marketing

The determination of whether a loan is a qualified mortgage falls initially on secondary marketing when the loan is registered and priced.  Loan Level Price Adjustments and net pricing is presented on a daily basis. As a loan is identified as a non-QM mortgage, secondary marketing must establish that there is a market for the loan, or that the loan will be held in portfolio as non-salable.  Non-salable loans must STILL document ability to repay pursuant to standard practice. 

Determining Ability to Repay – Appendix Q

Property Collateral Not Primary Method of Repayment

Company Name will not rely primarily on the sale or refinance of the collateral in determining the borrower’s ability to repay the offered loan.

Calculation of Ability to Repay

In order to ascertain ability to repay we will always utilize industry standard ratio or residual income calculations:

• Interest Rate - Fixed Rate or Fully Indexed Rate for a maximum amortization period of 30 years.
• All debts, including housing expenses and liabilities, will be included in the calculation as required by Appendix Q of the Ability to Repay rule.

Changed Circumstances

If a borrower’s ability to repay changes, based on updated and revised information, the loan will be re-evaluated to ensure the borrower is still able to maintain ability to repay.

Second Level of Review

As with all credit decisions, should the borrower be deemed ineligible, or unable to repay the loan, the decision will be reviewed by a 2nd level credit review to examine if there are any reasonable alternatives to assist the borrower in obtaining financing.

The Policy Quandary

One problem that remains endemic to process management: listing a few eligible items, and then adding the phrase "...and any other items as may be required" or "but not limited to..."  Do we really think that that there are items that could be presented that we have never seen before?  Why not have a comprehensive list of checklist items?

A POLICY is not a PROCEDURE

This is what we try and reinforce in our discussions.  Don't write a policy just to meet a regulatory need.  Make sure you integrate the way you will comply within the policy.  If you, as a manager or employee, cannot see the clear execution of a policy within the day-to-day activity, then your policy likely requires you to do something that you are not currently doing.  Which is a recipe for non-compliance.

Broker v. Lender: Lender's Perspective - Trying to Make Sense of QM Pricing Model

The Qualified Mortgage (QM) points and fees and Higher Priced Mortgage Loan rule (HPML) threshold calculation looks like an MC Escher drawing where you go around an infinite staircase.  While brokers face QM comp issues, lenders have an even more daunting challenge: trying to calculate allowable discount points, LLPAs, MI, and LO Comp, and still keep loans below HPML thresholds.  In anticipation of the January, 2014 QM and Loan Originator Compensation Rule (LO Comp) implementation dates, the industry as a whole struggles to make sense of the regulatory scheme.

Lenders face even greater challenges with the conundrums and complexities of the rule in its implementation. The HPML adds wrinkles to the equation.  Even with a clear understanding, a practical solution to meeting both a borrower's financing needs and maximizing lender compensation may represent two incompatible objectives.

The Objective:  A Qualified Mortgage

Remember, the whole point behind this set of pricing exercises is to limit lender liability.  QM removes the borrower's ability to pursue a claim that the lender did not consider his or her ability to repay under the Qualified Mortgage Ability to Repay Rule (ATR).  As long as the loan meets Appendix Q requirements a court necessarily might dismiss the action. However, with an HPML, the lender loses rebuttal presumption exposing himself to risk if a borrower chooses legal recourse to challenge the mortgage.  Even if all other elements of ATR fall into line, the lender still takes risk when exceeding HPML thresholds because of the borrower's right to challenge.  Of course, the lender can still rebut the borrower's assertion but must prove ATR conclusively. (** See Blog Comment Below - attorneys may find a way around rebuttal presumption.)

When trying to parse out the various permutations of QM and HPML, it helps to look at specific examples. The biggest concern for many is the effect of the Loan Level Price Adjustments (LLPA) on the cost and rate structure. Since LLPAs are secondary market loan sale eligibility fees, and not specifically profit or pricing gain, it seems unfair, to lenders and borrower alike, to have had them included in the calculation of points and fees. One potential solution: "adjust out" the loan level pricing by adding to the coupon rate - effectively buying out the LLPA upfront cost.  While for brokers the regulatory scheme may simply limit fees and create triggers for HPMLs, for lenders the rules create a minefield of quandaries.

Quandary 1:  What is the price?

To determine whether a loan will trigger HPML and how much discount you can charge to offset LLPAs, you need to work backwards into a price in a calculation similar to borrower pre-qualification.

You may download a copy of this spreadsheet to work on by clicking here.  If you have found another resource, feel free to share it and we will post it on our updates page.

Until you have loan level price adjustments factored in you have no way of knowing the final price of the loan, and no way of knowing whether you can charge an adequate discount to offset the LLPA. Naturally, you can always increase the interest rate, tantamount to buying out the LLPA fees.  But this may be of little comfort if it triggers HPML.

Quandary 2:  Limits to Buy-ups and Prepays?

If the most you can charge, net of compensation, is two discount points (provided you keep your rate within 1% of the Average Prime Offered Rate (APOR)), a higher LTV, lower credit score borrower could potentially price himself out of the lenders rebuttal presumption for QM.  It may not be possible to charge enough fees to cover all of the upfront cost of the LLPAs.  To deal with this the lender may solve this problem by "buying up" the rate to "zero out" or minimize the upfront LLPA.

The problem: The buy-up/buy-down cost formulation has always had an options seller's position built in. From par, buying down the rate with points costs progressively more and buying up the rate yields progressively less.  The more you are out of the money, the less that option is worth (or the more the insurance costs).  You may essentially "run out of rope" as you move up coupon rates to offset the cost.  This is particularly true on ARM loans, which offer a much more restricted rate "buyup".

5.500	103.375
5.375	103.000
5.250	102.625
5.125	102.250
5.000	101.875
4.875	101.500
4.750	101.000
4.625	100.500
4.500	100.000
4.375	99.500
4.250	99.000
4.125	98.500
4.000	98.000
3.875	97.375
3.750	96.750
3.625	96.125
3.500	95.250
3.375	94.375
3.250	93.500

Buy-Up Rate to Reduce LLPA Fees - it gets expensive and you eventually run out of rope.

Quandary 3:  Bought up the rate, now the loan is HPML

Secondary has always experienced the added prepayment risk from loans priced with high yield spreads. The higher the coupon relative to the market, the higher the prepay rate. Lenders offset this risk by adding prepayment penalties.  However, if the coupon is high enough to make the loan an HPML you may not be able to offset with a prepayment penalty because the Higher Priced Mortgage Loan rule prohibits these features.

This calculation shows how compensation, when combined with LLPAs for even moderately priced loans can create HPML Status.  In addition, high LLPAs can create HPML loans by their very nature.  Will the market accept the risk of not having presumptive rebuttal status?

Quandary 4:  You can't get there from here - APOR's artificiality

The regulatory scheme seems to imagine the mortgage market as some sleepy backwater drifting along oblivious to the machinations of global credit markets.  A loan with steep LLPAs already looks like a candidate for triggering HPML status.  The features of the APOR as an index calculation can make avoiding this impossible.

The APOR index looks at last week's data.  Because of this, depending on when an originator looks to lock a loan, APOR's relation to current market can be as much as two weeks old.  In addition, because this survey represents a range of lender pricing we don't know the extent to which the surveyed rate has been impacted by hedging strategies and pricing concessions.  One only needs to look at the rate surveys posted in local daily newspapers to see how bottom fishing originators may skew this data.

Because we confer QM status at the time of lock-in, the APOR index, with market conditions moving as they have in the past year, could potentially create a pipeline of HPMLs for loans with even moderate LLPAs.

Brokering Doesn't Sound so Bad Now...

Considering this complexity, the broker's limit of 3% compensation seems like an attractive option for avoiding issues in the regulatory scheme instead of the inverse.  Again, we ask the question:  Does mini-correspondent solve the broker's problem, or just add a set of additional problems.  For lenders, who carry the risk of liability, the questions are more dire than compensation.

When we overlay the pricing reality against the regulatory construct of QM, it seems clear that many more loans will achieve HPML status than originally conceived.  Will the market for these transactions shut down and add further inertia to a fledgling economic recovery?  Or will lenders accept the risk of no rebuttal presumption and continue make HPMLs.  During the 80's lenders originated 95% LTV loans using qualifying ratios of 25/33.  Certainly, if there is a place for HPMLs, they will have very restrictive guidelines.  

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.

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.

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.