The fourth and last of the final regulations coming from the Consumer Financial Protection Bureau under the Dodd-Frank Wall Street Reform and Financial Protection Act was released Friday afternoon.  This rule addresses the causes of what CFPB Director Richard Cordray said was one of the reasons for the collapse of the mortgage industry, the steering of consumers to high-priced loans.

It was common for at least a portion of the compensation paid to loan officers and mortgage originators to be tied to their success in writing specific types of loans.  These loans were usually those that were most profitable for the lenders and thus more expensive for the borrowers.  Thus the loan officers were being compensated for steering consumers toward the loans that were probably the most costly and possibly the least suitable for them.

After the collapse the Federal Reserve took steps to change the model under which loan officers, originators, and brokers were compensated.  Richard Cordray, Director of CFPB, said that the rules released today, mandated by the Dodd Frank Wall Street Reform and Consumer Protection Act build on those developed by the Fed.

"Before the financial crisis," Cordray said, "many mortgage borrowers were steered towards risky and high-cost loans because it meant more money for the loan originator.  These rules will hold loan originators more accountable by banning the incentives that led so many of them to direct consumers toward disaster."

The rule has undergone several iterations and periods of public comment.  One notable change in the final rule from the most recent version released last August is that originators are no longer required to provide a consumer with a no-fee or flat loan quote when they quote a loan with fees.  This was intended to give consumers a concrete way to compare the cost advantages or disadvantages of paying upfront fees or costs.  Cordray said numerous public comments convinced CFPB that the flat price example would merely be confusing to consumers.

The new rule prohibits steering incentives.  A loan officer or broker cannot be paid more if the consumer takes a loan with a higher interest rate, a prepayment penalty, or higher fees.  Nor can the LO be paid for convincing the consumer to buy additional services from the lender, broker, or an affiliate such as title insurance or mortgage life insurance.  The loan officer or broker can be compensated by way of other models such as on the number or size of loans or the aggregate dollar volume of loans written within a stated time period. 

The rule also prohibits the loan officer or broker from being paid by both the consumer and another person such as the creditor, i.e. dual compensation.  CFPB said that in the run-up to the mortgage crisis consumers often incorrectly assumed that because they were paying their loan originators they were looking out for the consumer's interest.  However, the Final Rule issued today includes an exception "to allow mortgage brokers to pay their employees or contractors commissions, although the commissions cannot be based on the terms of loans they originate"

While the Dodd-Frank act prohibits consumers from paying upfront points or fees on the same loan where the originator is compensated by someone other than the consumer,  it also authorizes the CFPB to waive or make exceptions to the prohibition.  Such a waiver was proposed in order to facilitate consumer shopping and preserve consumer choice.  Although the proposal wasn't finalized today, the CFPB decided to issue a COMPLETE EXEMPTION to the ban on upfront fees.  

In the meantime, the bureau says it will be scrutinizing "several crucial issues relating to the proposal’s design, operation, and possible effects in a mortgage market undergoing regulatory overhaul. The Bureau is planning consumer testing and other research to understand how new Dodd-Frank Act requirements affect consumers’ understanding of and choices with respect to points and fees, so that the Bureau can determine whether further regulation is appropriate to facilitate consumer shopping and enhanced decision-making while protecting access to credit."

The rule also sets uniform standards for qualifying and screening loan originators.  Under current rules loan originators have different sets of qualifying standards depending on whether they work for a bank, thrift, mortgage brokerage, or nonprofit organization. The new rule provides a more level playing field so consumers can be confident that originators are ethical and knowledgeable. The final rules generally require:

  • That loan originators meet character, fitness, and financial responsibility reviews;
  • That they be screened for felony convictions; and,
  • That they are required to undertake training to ensure they have the knowledge about the rules governing the types of loans they originate.

Mandatory arbitration of disputes involving mortgage and home equity loans are generally prohibited by the new rule as is the practice of increasing loan amounts to cover credit insurance premiums.  These two sections of the law will take effect in June 2013 while the balance of the rule will go into effect in January 2014.

In a press conference accompanying the release of the new rule senior CFPB staff said they will be doing baseline reviews of the effects of the new rules over the next year and will be working with the affected parties to implement them, watching closely as they are implemented, and following up with stakeholders.  They will also be watching the interaction of rules issued by CFPB and those issued by other regulatory agencies.

The final rules will be available on Sunday, January 20 at: