If the new Federal Reserve Compensation Rule were ever the subject of a Hollywood movie--which it won't be--the most appropriate title I can think of would be "10 Things I Hate About You." Now that our industry is only about 5 weeks away from implementation of the new rule, we are starting to receive some training on how loans will be done in the new world of lending as defined by the Federal Reserve. I sat through my first conference call this morning on the how to comply with the new rules, and I now have more questions than I did before I started.
When the Federal Reserve Compensation Rule was finalized last August, many of us predicted that the rule spelled the end of the mortgage broker industry. Since that time, a number of industry participants have assured us that such predictions are alarmist--mortgage brokers will continue to be a vital part of loan origination and we can emerge from the wreckage of the last three years stronger than ever. The reassurances of these "experts" are so comforting that they are easy to believe. But having completed this preliminary training, I can give you three reasons that the Fed Rule will be the end of the mortgage broker industry.
1. The Rule is tilted completely in favor of banks and larger correspondent lenders, so much so that it destroys any concept of competition. Remember that the rule states that no loan originator can be compensated by both the lender and the the borrower. That original wording led brokers like me to believe that our compensation would be coming from the consumer. However, last week the Federal Reserve issued a clarification on this point. Under the new clarified version of the rule, the borrower can compensate the loan originator only if he is salaried (or as some companies interpret the rule if he is a sole proprietor with no loan officers working for him.) Small broker shops cannot afford to salary their loan officers. In fact, the mortgage broker industry has been successful because it revolved around commissioned sales people. But in this new world, the loan officers must be salaried in order for the consumer to pay the fees.
It turns out that there are several benefits to the consumer being able to pay the fees. For one thing, if the borrower is charged an origination fee, the originator can reduce the fee in order to correct problems with the good faith estimate, or to pay fees that were not quoted properly. None of that is possible if the lender pays the loan originator.
According to the Fed Rule, the loan originator cannot be paid on the terms of the loan. However, if the bank or lender is selling a closed loan, the bank or origination company can be paid on the service release premium (which is the same as the yield spread premium). They can keep that money--they just can't pay it to the loan originator. The loan originator has to receive a set amount of compensation from each borrower; if the borrower is paying the loan origination fee, the percentage of fee must be exactly the same for all borrowers. So a salaried originator working for a bank can charge a 1% origination fee to the consumer and the bank can keep the spread on the sale of the money. Isn't that basically the way it works now?
But for the independent mortgage broker the change is huge. A mortgage broker who cannot salary his loan officers or who is not set up as a sole proprietor cannot receive any compensation from the consumer. He must set up a payment agreement with each of his lenders. That agreement cannot be renegotiated for a set period of time, such as quarterly. And since all compensation must come from the lender, it must be charged to the consumer in the form of a higher interest rate, but since the percentage of compensation is the same on all loans, the interest rate is increased proportionately the same for all loans.
Lender-paid compensation cannot be reduced for any reason. The originator cannot use it to lower the consumer's costs or to correct any discrepancies on the good faith estimate. The good faith estimate allows only a 10% tolerance for third party fees. For example, I recently did a good faith estimate for a long-time borrower of mine who recently moved to Dallas, Texas. The contract says that she has to pay for her survey. Since I do the majority of my work in El Paso, Texas, where surveys cost $216.50, I looked on line for a surveyor in Dallas. I found a company that looked professional and appeared to service the Arlington area where she is moving, and I used that company for my written provider list. Since the costs for home inspections were quite a lot more than they are in El Paso, I surmised that a survey might also be more, and since I know that the house she is buying has a comparatively large lot, I estimated her survey fee at $400.00. After I sent the estimate to the borrower, I asked her about ordering the survey, and she said that her agent had recommended that the title company order it. Interestingly, when the survey arrived from the title company a few days later, the company was the same one that I had quoted on my provider list and the actual survey cost was $390.00.
But what if I had quoted the El Paso fee of $216.50? In that case I would have been responsible for paying any amount over a 10% increase against what I quoted. In a world of lender-paid compensation, which is the only type of compensation that I can legally receive under the new guidelines, I am not allowed to pay for these kinds of corrections. And legally, my borrower is not allowed to pay for them either. So the lender has to pay for the corrections, and to do that they have to set up a special fund to pay for items such as lock extensions, missed tolerances, etc. Whether or not they use that fund to pay for one of my specific missed tolerances will be determined by my overall performance with them, including number of closed loans, quality of loans, etc.
Most of the time corrections to the good faith estimate can be avoided simply by double checking all of the fees carefully ahead of time, but what about lock extensions? Missed closing dates can be unavoidable even when the originator does all of the components of his job properly. Take my borrower in Arlington again. At the end of January, she requested that I do her loan for her in Arlington. I sent her a loan package to sign, which she sent back around February 3rd. Since her husband is salaried and they have excellent credit, I was able to complete all of my due diligence and get her underwriting approval back before February 11--she told me when she asked me to do the loan that she wanted to close February 24. However, her closing on her home in Arlington is conditional upon her selling her home in El Paso, and her buyer has not closed yet. Originally, her buyer was supposed on February 14; that closing has now been delayed until February 25. I can extend her lock, which expires March 3, for three days free but then the lender starts charging. Under normal circumstances, a broker will lower his fees to cover a lock extension for a long time customer so that everyone walks away happy. But what if we were in the new world of lender-paid compensation and she refused to pay for the lock extension since the circumstances that will cause it are beyond her control? I would not have the option of paying for it, and if the lender determined that they were not going to pay for it, the deal would be dead. The only way to prevent this type of situation is to require longer lock periods to start with. And that is what we will have to see--lock periods that are 45 days or longer will probably become standard for brokered deals.
Now the problem with that is that in a competitive situation, the brokered loan now has a much higher interest rate. Remember that the salaried originator working for a bank can charge a 1% origination fee and he can still pay for items like lock extensions. Since he can charge the borrower directly, all of his fee is not priced into the interest rate, so he can afford to offer a shorter lock at a lower interest rate which is going to help him capture that deal in the first place. The independent broker has to figure out how set his initial compensation that he is getting from the lender at a percentage that will allow him to keep the doors open while still allowing him to compete. And since the compensation cannot be changed for a set period of time--we all assume that the period will be quarterly--he has to try to predict the future interest rates to figure out where to price himself. Then, when we add in factors such as longer lock periods in a rising interest rate environment where we are today combined with rising fees imposed by Fannie and Freddie, the broker has probably priced himself out of the market.
Tomorrow, I will examine the second reason that the Fed Rule will kill the mortgage brokers.
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