Q. Last month you made an observation that mortgage lending brokerage services were apt to be more expensive and less competitive as of April 1, 2011. Would you please elaborate?

You said that you would have more to say about this situation this month.

A. First off, let me state why the New Comp Rule was devised. Its purpose was to protect consumers from unfair, abusive, or deceptive practices that might arise from compensation agreements. In other words, in days gone by, a broker
might have charged a 1% origination fee and received a half percent from the borrower and a half percent from the lender (rebate). Nothing wrong with that. But some brokers or loan officers (LOs) charged a one-percent origination fee and got 2 percent in rebate from the lender. Even though it was disclosed on the Mortgage Loan Disclosure Statement, the GFE and the Fees Worksheet, the Federal Reserve Board (FRB) said that many borrowers did not understand this and the borrowers failed to realize that they could have gotten a lower interest rate if the broker or LO had not received a 1 or 2 point rebate. So that this would no longer be confusing to borrowers, the FRB ruled that compensation paid to brokers or loan officers could only come from one source not both: either borrower paid compensation or lender paid compensation (rebate). I have no problem with this as it was purportedly done to give the consumer a fairer shake. Unfortunately, the solution that the FRB came up with was ill-conceived and poorly drafted because it has the net effect of making the cost of loans more expensive and added more needless paperwork for loan officers which no one will ever read and the reason I wrote last month that "the road to Hell is paved with good intentions".

Now, the only persons that are allowed to do borrower paid compensation loans (conceivably those with the lowest interest rates) are mortgage brokers who also own mortgage companies. As of April 6th, mortgage brokers [who don't own brokerages probably comprise 90% of loan originators (LOs)] are only allowed to do loans with lender paid compensation, unless they are paid hourly or are salaried. The reason that this leaves most mortgage brokers out in the cold is because nearly all of us are independent contractors that receive 1099s, not employees who receive W-2s. Broker/owners prefer to "contract" with mortgage brokers this way because they do not have to pay them whether they close a loan or not. Nor do they do have to offer them health insurance or deal with the bookkeeping of withholding: FICA, SDI, workmen's comp and so forth that are part of a salaried employee's payroll deductions. The reason that it harms consumers is that lender paid compensation is
approximately 0.375% higher in rate as compared to borrower paid compensation. Depending on the program and the lender, the spread rate is about 0.60% higher.

Another reason that the consumer is poorly served is because about the only loan officers that are paid a salary or compensated hourly are typically, the least knowledgeable, are not licensed and work under a lender's Department of Corporations (DOC) license. Not all states require mortgage brokers to be licensed, although California certainly does. There are two licensing options available to those wishing to operate as a loan officer: Mortgage brokers are licensed and operate under the jurisdiction of the Department of Real Estate, whereas a California Finance Lender (CFL) is under the aegis of the Department of Corporations. Mortgage brokers under the DRE are required to pass the same exam as real estate sales agents. Naturally, just because someone is licensed, it doesn't make them good. But, licensed mortgage brokers have a fiduciary relationship to their clients involving a high degree of trust, fidelity, integrity and confidence. Whereas a loan officer working under a California Finance Lender's license may be doing many of the same things that a mortgage broker or banker does but is not required to be licensed and the courts have held that CFL brokers do not have a fiduciary duty to their borrowers.

Many loan officers get their training on-the-job and/or are new to the profession. So it should come as no surprise that there is a significant percentage out there that know very little or whom are out of touch with market events. I've been in office meetings in which the loan officers didn't know what the Prime Rate was currently fixed at. I've also witnessed cases of loan agents not knowing how to process a loan, read a rate sheet or understand what causes mortgage rates to move. I have seen other instances of mortgage brokers possessing astonishing little knowledge of lenders programs, guidelines and rates, but succeeded because they were "eye candy" for
male real estate agents. These individuals relied almost wholly on the lenders' reps to put their deals together and their processors to keep them stuck together. Not surprisingly, their closings were erratic and full of surprises. Thus, there are conceivably individuals working for "mortgage mills" under a corporation's license out there doing loans that were flipping hamburgers last week.

But this is only half the story. There are now a new thicket of Federal Reserve regulations that involve Anti-Steering and Safe-Harbor rules whereby a loan originator has to document that of all the lenders they represent, who offer a specific program, the one chosen must have the lowest interest rate and fees, regardless of extenuating factors like service, timeliness and the likelihood of the client receiving an approval. To get around this paperwork snowstorm, many brokers are limiting their choices to only one lender for each program. So, if they have 10 lenders that do FHAs, they will only sign up with one lender for FHA programs. Again, this is not in the borrower's best interest because in doing my weekly surveys of various lenders, I have found that no one lender consistently has the best pricing for a variety of programs. Those that had great rates on FHAs or conventional loans will have much less attractive pricing a month or two down the road. What the new regulations do is effectively act in restraint of trade.

To complicate matters further, the FRB deemed that loan originators working for mortgage brokerages have a specific compensation tier for various lenders. In other words, your broker/owner picks a compensation tier that ranges anywhere from 1% to 3.5%. All LOs working for that broker have to abide by the compensation tier chosen by the broker. The compensation tiers may vary from lender to lender. But should your brokerage's compensation tier be 1.75%, you can NOT do a loan for say 1.5% instead, even if you are willing to forego that portion of your commission. Again, this makes it more costly for the consumer. Rates are no longer negotiable; they are dictated by the mortgage brokerage or the mortgage bank.

If this weren't daunting enough, imagine what one is to do with respect to the Anti-Steering and Safe Harbor rules in cases where differing lock periods and various rebates intersect with different compensation tiers. Some lenders have lock periods of 12, 15, 21, 25, & 30 day locks. Now, let's suppose you must receive a rebate of 1.5 % from lender A, 1.75% from lender B, 2% from lender C. But lender A is offering a 25-day lock on a 30 yr. fixed rate loan with a borrower credit (lender paid rebate) of 1.75% @ an interest rate of 5.25%, Lender B offers a 2% credit for 30 days @ 5.25%, and lender C offers a 2% credit for 21 days @ 5.25%. Which one is the least expensive? Remember a loan originator is required to offer the loan with the lowest rate and fees for a lender under their brokerage's compensation plan. Imagine if the rates were not the same, two were at 5.125%, and one at 5.25%. It becomes positively mind-boggling. Mortgage bankers are exempted from this since their rates, programs and credits are the only ones they have and therefore the only ones they must show.

Other segments of the market that are apt to feel the impact are the very small loans and those that are very large. For example, if I am required to go with a 2% lender paid compensation agreement for a particular lender and my borrower wants a $100,000 loan, the most my firm can make on this loan is $2,000. Also with lender paid compensation there can be no charge for a processing fee. So, if one deducts say $600 for processing, that leaves $1400, and then there is a $100 deduction for Errors and Omission insurance that one has to charge against the commission which now leaves $1300 to be split between the owner of the mortgage company and the loan originator for what may be 30 to 45-days of work or 100 to 150 hours of work. At these prices one is working at minimum wage levels, so the easiest thing to do is to turn down the loan and opt to work on larger loans because the work on a $100,000 loan is about the same as on a $500,000 loan, but the latter pays 5X more. Net result, the public is under-served on smaller loans under these regulations.

A borrower wishing to obtain a loan for $1 million may feel even more aggrieved because prior to the implementation of these rules they might reasonably expect to pay an origination fee of 1% (or $10,000), but if because the brokerage has a 2% compensation tier among its various lenders, then the cheapest that it could be done for by that brokerage would be $20,000 (2%). Chances are the LO would lose that loan to another brokerage with a 1.5% compensation tier. But even so, the borrower is now paying 50% more in fee under the new regulations.

The only loan originators that are not apt to be bothered by this are those that are currently working for minimum wage and possess only marginal competence, those that are unaware of the new rules because they haven't done a loan in some time and those that are broker/owners. So, you can see that the new regulations have some inherently serious flaws. If this weren't maddening enough, different lenders have chosen to interpret these regulations differently. One would think that such a mandate would have a uniform application, but evidently not. Lastly, I've spoken with 8 different lenders about the newly mandated regulations and they are now scrambling to provide loan originators with more options to circumvent the regulations because borrowers and loan officers are bridling at the new regulations. Lenders are making certain concessions because they have seen their submissions dry up. This craziness is just the thing that the housing market needs as we enter the summer selling season.

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