Politics & MoneyMortgagePulse

[Pulse] We need to make LO comp work for everyone. Here’s how

This is what I think the CFPB should do to fix LO Comp Rule problems

The Consumer Financial Protection Bureau has been reviewing mortgage regulations issued to implement Dodd-Frank, with a goal of revisiting areas that need tweaks or modifications. The Loan Originator Compensation Rule should be on that list.

Congress enacted LO Comp to eliminate the subprime practice of financial incentives for brokers to steer borrowers to more costly loans – and to prevent discrimination against less savvy borrowers by requiring loan originator compensation to be the same for all the borrowers an LO serves. 

There are many in the mortgage industry who argue that the entire rule should be scrapped. But such a move would potentially re-open the door to the bad practices of the subprime era, and the divisive debate over this would likely be doomed to failure.

However, the strict application of the law through the LO Comp Rule the CFPB promulgated has unquestionably hurt consumers in some important ways. Therefore, the CFPB could use its existing authority to tweak its LO Comp Rule to fix certain problems, while retaining core consumer protections.

That is the approach promoted in a letter I wrote with other members of the Community Home Lenders Association that was sent to the CFPB in April.

This approach starts by laying out criteria that should govern any changes to the LO Comp Rule:

(1) The CFPB should have statutory authority to make the changes.

(2) Consumers would benefit from the changes.

(3) The changes would not open up loopholes to re-create financial incentives for loan steering.

(4) The changes should have a bright-line test to facilitate compliance and enforcement.

First, we should start with low-hanging fruit. It may be hard to believe, but because of LO Comp, when an individual loan originator makes an error in underwriting, the lender that employs them is prohibited from holding the LO financially responsible for the cost of that error. This deters accountability; the CFPB should act to allow the loan originator to bear the costs of their errors.

The second change is designed to make it easier for mortgage lenders to use state Housing Finance Agency loan programs, which are designed for first-time homebuyers.  

The trade group that represents HFAs – the National Council of State Housing Agencies – pointed out in a letter a year ago that HFA loans can be more costly – and therefore, less profitable – than other mortgage loans.

However, without the ability for the lender to pass some of these added costs along to the loan originator, a lender may be financially incapable of making these loans. Therefore, the CFPB should allow a different (but uniform) compensation amount for all HFA deals than for other types of loans.

The third potential change – highlighted in an industry letter from last September – would be to allow reduced loan originator compensation in order to allow a more competitive scenario when there is “demonstrable price competition.”

This one is trickier. Some would argue that broadly allowing this whenever a lender can make a claim of price competition would simply open the door to allowing pricing discrimination between more and less sophisticated borrowers or enable discrimination based on income or race.

On the other hand, I can say from experience that there is a legitimate frustration when, all too often, a loan originator works with and helps a borrower for some extended period of time, only to lose a deal to a competitor when the borrower price shops the deal at the last minute. 

Having invested time and effort with a borrower, the LO wants to do the loan and keep the borrower as a long-term client. However, the inflexibility of the LO Comp Rule prevents a loan originator from cutting their share of the deal in order to enable the lender to match the loan quote. 

Therefore, my April CFPB letter lays out a targeted approach to allow this, while preserving essential protections of LO Comp. It only allows a reduction in LO compensation when the lender has worked with the borrower for some time and made a loan offer – and is subsequently asked by the borrower to match a price quote they receive shopping around the loan. Further, these facts must be fully documented.

This will not satisfy those who want to junk the LO Comp Rule – and possibly not even those who argue for broad-based flexibility to vary compensation whenever there is demonstrable price competition. But it does address a common frustration faced by loan originators. Moreover, the proposal is narrow and targeted, so it does not open the door to anti-consumer practices. 

I encourage other lenders and trade groups to rally round this targeted approach to make the LO comp rule work for lenders and consumers alike.

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