As Charlie Gasparino remarked in horror on his program a couple of months ago,
“this [new bill] will change the entire financial landscape of America.”
SYNOPSIS of this article…
The Loan Officer Compensation Rule is a product of Dodd-Frank (Wall Street Financial Reform Act) and is administered by the Federal Reserve. It purports to protect consumers by fixing loan originator’s compensation.
But, in doing so, it actually tends to
1) drive prices up by creating upward pressure on fees and relative interest rates,
2) marginalize (and therefore eliminate) even more mortgage professionals from the market by limiting their compensation,
3) introduce a disturbing and regulatory burden throughout the lending industry.
It will be more difficult for the average consumer to find a mortgage professional who has been around and is stable. There will be fewer industry workers competing for borrowers’ loans.
All in all, it’s just one more reason why you need to rely on The Mortgage Institute to solve issues at the intersection of divorce and mortgage finance.
If you think that you will not be affected, think again. And, think about the effect of Dodd-Frank on you and divorcing clients. Consumers (homeowners and borrowers) are harmed by this legislation and no measurable benefit accrues to the market, to home-owners, to borrowers, to industry workers, really to anyone. There does seem to be a windfall to the big banks which are not harmed by rules like the one I discuss today, the Loan Officer Compensation Rule. In fact, the banks’ coffers are enriched while the front line loan originators are made to pay.
You just should know that these regulations and laws creep up on everyone, often without warning and in areas that are out of sight. Being aware of them will make you a better lawyer, a more informed professional and a wiser negotiator.
The Loan Officer Compensation Rule is required by Dodd-Frank and enforced by the Federal Reserve. It specifies and limits how loan originators are paid.
I will not defend originators, of which I am one, other than to say that like all professionals they are capable of performing outstanding services or committing crimes or anything in between. Very few commit crimes and when they do and are caught, they pay severe penalties. One’s disdain for originators (or opinion of any sort) should be tempered with knowledge and not the misinformation that is so prevalent in the press today.
Hopefully, your general impression of loan originators will be positive due to my influence upon you. I perform a value-added service by bringing solutions to divorce negotiations. But, I do it by using mortgage financing and that is how I am paid. And that brings me to the real effect upon financing for your divorcing clients. I am less able, not more, to devote energies and resources to this value-added service (the Divorce-Mortgage Specialty) because more and more of my time, monies and energies are devoted to regulatory compliance, none of which has brought any value to the consumer, your client. Moreover, such regulations that I am bound to enact are actually increasing costs to your borrowing clients.
But, I’m getting ahead of myself.
The Loan Officer Compensation Rule essentially requires that originators be paid a level amount (as a percentage against the loan amount) on all loans. In other words, if my compensation is set at 1%, I must be paid $3,000 for a $300,000 loan and only $600 for a $60,000 loan. No matter that the actual work required for the $60,000 may be (and often is) twice or more times the work required for the $300,000 loan. No matter that my $60,000 customer would gladly pay me 5 points (between fees and Yield Spread Premium via the interest rate) to originate and close her loan. No matter that no originator can stay in business making $600 in compensation on loans (which is a BEFORE-expenses compensation by the way). No matter that I would happily make .5% for the $400,000 loan which is often the case so that I might remain competitive in the market. The amount of compensation must be a pre-set percentage of future loan amounts – even though I have no idea exactly what those loan amounts might be.
One can immediately see all sorts of problems with this pricing structure. What about the originator who does mostly small loan amounts? She would set her pricing so that she would receive compensation at a higher percentage, say 4%. But, when she gets a call to originate a $400,000 loan, while she would be happy to make $16,000 (for closing this loan - $400,000 X 4%) such a quote would easily be outbid by another originator who “specialized” in larger loan amounts and had priced his large loans so as to make only, let’s say, 1%.
Then, the reverse happens. The large-loan specialist has set his percentage at 1% so that he can be competitive with these large loans. But, he gets a call to close a $75,000 loan. Click. He cannot do it. It’s not worth his time. So, the consumer loses. The originators lose. And loans find an originator who has PRE-priced her loans and is therefore unable to compete for any and every customer.
A short course in Economics 101 is in order here: Competition is what drives prices down and consumers get better deals. Regulations drive costs (and therefore prices) up and consumers get less choice and worse deals than they otherwise would get.
The LO Compensation Rule completely subverts normal market pricing pressures. In fact, it has introduced an upward pressure on prices (rates and fees). Here’s how. There is an accommodation for a re-set in the compensation structure for each originator. The bank can reevaluate the originator’s performance (or amount of fees they have earned for the bank) and adjust that originator’s compensation to reflect their production. But, the Federal Reserve has refused to specify how often this could be done except to say that it cannot be done frequently but only infrequently. How’s that for a regulator’s bait?
I’ll let you guess what the attorneys are telling their client banks about how to determine “infrequency.” Well, no I won’t let you guess. The lawyers are telling the banks to only reevaluate and make adjustments no less frequently than every year. Loan originators would be happy with every month as that would effectively allow them to be paid as they always have – monthly and in precise proportion to what they have earned, the fees they have generated. The truth is, while banks and lenders have taken a stab at what is “infrequent” it is still too soon to see how all of it will shake out. The rule began in April and there have really been only 2 or 3 pay cycles since the rule took effect (depending on what date loans were originated). So banks don’t know how often they will be adjusting pay structures and they certainly do not know what the regulators will say when they come in and tell banks “sorry, but that is not infrequent enough.”
They really do deserve a 10% approval rating! Dodd, Frank and the congress that voted for it, that is; not the banks, lawyers and originators.
Back to how this creates upward pressure on prices. If you are a loan originator and understand that your new compensation is based no longer on the fees you can earn on each loan but upon the fees (as a percentage of loan amounts) on the loans you have already closed in the past, how would you “price” your loans now and going forward? Well, for one thing, if you are doing an $800,000 loan, you certainly do not want to price it so as to make only .250% (which would yield you $2,000) because that means that when you are closing an $80,000 loan in the future you would only make $200. It doesn’t work in reverse (pricing low now in anticipation of future large loan amounts) because no one knows the future and, as any wise business advisor would tell you, one can certainly not make projections based on rosy and overly optimistic predictions. Also, to price a small loan amount lower now in anticipation of larger loan amounts in the future doesn’t put enough money in the originator’s pocket right now. She might not survive to see that fictitious larger loan amount in the future.
Another way that the rule creates upward pressure on prices is because, since banks must pay their originator’s a fixed percentage and because they cannot OVER-pay them, they therefore must UNDER-pay them. So, if an originator wishes to stay even compared to what she has been making on her loans, she will need to charge a bit more to the customer (through fees or through the rate) to do so.
Still another factor that creates upward pressure on prices is the age old factor of regulatory burdens. Every time new regulations are introduced in virtually any industry, the consumer pays more for the product being regulated. Why? It’s simple. It increases the cost of doing business which is then passed on to the consumer. In our bank (a relatively small slice of the financial industry), our VP over mortgage lending spent countless hours and considerable monies trying to understand the new regulation. Then, other managers had to spend additional and countless hours designing complicated formulas for pay – for each loan officer in their company. And this now must happen on an “infrequent” basis. Imagine 100 loan officers whose pay structure must be constantly reevaluated and for whom the bank must now prepare customizable pay packages.
This is the proverbial tip of the iceberg. The regulatory requirements on banks and mortgage professionals are now getting to be gargantuan.
If you are in a heavily regulated industry, you know exactly what I mean. If not, you need a good example.
Let’s say you work at a lawyer’s office as a paralegal. The state imposes extra paper work that you must file with the state every week and it takes an average of 8 hours to do this paper work. You can hire someone else to do this work for you; all of it except 2 hours’ worth which the government says that you alone must perform. You cannot do it on “company time” and you cannot be paid extra for it. You can come in on Saturdays – EVERY Saturday whether you are on vacation or not – and simply increase your work load by 20% while keeping your pay exactly the same. Or you can take money out of your pocket and pay someone else to do all but ¼ of it which you must continue to do. Or, you hear another lawyer is hiring paralegals and she has agreed to let you spend Fridays doing your regulatory work (or will hire an assistant to do it for you – even better) except for the 2 hours’ work you must do for yourself and the new attorney will allow you to do this on “company time.”
All things being equal, this new attorney must raise her fees (the part that reflects her cost of doing business) by more than 20%. (It never just costs the boss the mere salary of her new employee. There are always additional taxes and regulatory costs involved with new hires not to mention the simple internal costs of extra furniture, space to be rented, supplies to be purchased, insurance to be paid, ad infinitum).
And don’t forget, the paralegal’s boss just lost at least 5% productivity from the paralegal. He or she must commit 2 hours of company time (5% of a 40 hour work week). At some point, people are stretched too thin or costs continue to rise to accommodate the increased burdens.
So, how does all of this affect divorcing clients? It makes shopping for loans very difficult. It really makes it impossible to shop for the best deal because the first quality in a lender-originator should be that they understand divorce and financing issues related to it. It’s unfair for me to say this because I am still the only Divorce-Mortgage Specialist in Texas and maybe one of only a handful in the country. My mother says that I am, hands-down, the best in any case. So it doesn’t matter how many others there are. The key here, of course, is to find a way to get certain transactions closed at any rate or price. Even so, the borrowing landscape is more confusing and its costs are more complicated and obscure.
And a new disturbing trend – the disappearance of mortgage brokers and originators – does not bode well for the consumer. There will simply be less choice. The bright spot is that only the strong survive. The down side is that the strong are not always the best, they are just strong. In theory, and we shall see if it works out in practice, the bad originators are weeded out of the industry, leaving a higher quality and more stable field of mortgage professionals to service consumers.
The solution is really to rely upon tried and true wisdom – find a competent lending professional whom you trust and who understands your problems and issues and is able to solve them. The service is beyond worthwhile. It is critical to a closed transaction and a final resolution to your cases.
Of course, that's me - Noel Cookman - at 972-724-2881 or firstname.lastname@example.org.
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