Loan originators see dark at end of Reg. Z tunnel

“Unfair practices” involving mortgage brokers and loan originators are targeted in a part of the Truth in Lending act slated to begin April 1, but the rule’s effect could turn the world of the broker around, and not in a good way, according to those in the loan industry.

The Z Loan Originator Compensation and Steering 12 CFR 226 rule – more commonly called Reg. Z – implements the Truth In Lending Act passed by Congress in 2008 by strengthening consumer protections. Reg. Z changes the way mortgage brokers, or any person or company that arranges a mortgage for a client, are compensated.

Traditionally, mortgage brokers were paid directly by the home buyer. The practice of lenders providing additional compensation to brokers who brought them high-interest loans is relatively new. Borrowers weren’t always aware of this part of the transaction and that it led to higher loan costs for them.

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Under Reg. Z, payments to brokers linked to loan interest rates – called yield-spread premiums -will be a thing of the past. Mortgage brokers’ opportunities to make money may be reduced as banks and mortgage lenders will only be able to pay commissions tied to the mortgage loan amount.

Reg. Z was designed to protect borrowers by “prohibiting compensation to a loan originator, paid by any person other than consumer, that is based on loan’s terms or conditions. (The) amount of credit extended (loan amount) is not deemed to be a term or condition provided it’s a fixed percentage,” according to the Federal Reserve System.

On March 8 and 9, the National Association of Independent Housing Professionals and the National Association of Mortgage Brokers filed separate lawsuits to stop the law from going into effect. In part, the suits claim that Reg. Z will cause “a competitive disadvantage and will stifle competition,” and “mortgage brokers are already losing their life blood, their loan officers … ultimately the mortgage broker industry will become extinct.”

On March 11, the Federal Reserve Board combined the lawsuits; on March 31, a stay was granted by the U.S. Court of Appeals, delaying implementation of the rule at least until a hearing on April 5, the day the Business Report went to press.

Bad for borrowers

Kathleen Day of the Center for Responsible Lending said that practices such as yield-spread premiums were bad for all borrowers. It paid people to steer borrowers, and not just borrowers with shaky credit, into higher-than-market-rate loans. She cited a 2005 study by a San Francisco research firm called First American Loan Performance that found over half of the borrowers with good enough credit to qualify for conventional loans instead wound up with subprime mortgages that were then packaged into securities for sale to investors. The study looked at more than $2.5 trillion in subprime loans.

“(Before Reg. Z), brokers had a fundamental interest to act against the best interest of the borrower,” Day said. “It was a bad product. You can put lipstick on a pig – the pig here is yield-spread premiums – but it’s still a pig.”

The NAIHP and NAMB aren’t the only ones unhappy with Reg. Z. Gene Gustafson, Fort Collins branch manager for imortgage, is not a fan.

“The rule undercuts the free market,” he said. “It will turn the world of the mortgage broker around. I’ve competed with them all of my career, but I think you let the market decide. (Reg. Z) gives way too much power to the Feds. If there is a compensation tsar, who has the knowledge to say what (the compensation) should be?”

While Cornerstone Mortgage is making plans to deal with the changes, Executive Vice President Julie Piepho characterizes Reg. Z as unnecessary. “Why do we have to protect borrowers?” she asked. “We don’t protect them over a car or refrigerator (purchase). This is one of the first industries where Congress has tried to regulate compensation. There isn’t regulation over others.”

That may be so, said Day of the Center for Responsible Lending. However, “no other industry has so many subsidies, or FDIC insurance, or called ‘too big to fail.’ As soon as you put taxpayers on the hook, taxpayers have a seat at the table.”

Market adjustment

How will the market adjust? Piepho said that many businesses will go ahead and change compensation structures. However, “if everyone makes compensation neutral there will be no increase in rates for consumers. We’re trying to keep compensation neutral.”

There might be fewer loan officers. “We’ve already seen a decrease in the licensing of loan officers,” she said.

Gustafson said that we may see an exodus of loan officers from business to business because “whoever figures out how to adjust into the most advantageous way (to compensate loan originators) will get a lot of people coming to their company.”

Mick Occhiato, branch manager and a mortgage banker for 1st City Mortgage Group, a division of Megastar Financial, the largest locally owned mortgage company in Colorado, has yet another take on the future with Reg. Z.

“In short, I believe the big banks will benefit from this new rule and the consumer will end up paying much more in closing costs and in higher interest rates. Luckily, our company has always been very transparent with our loan officers so we will not be affected like many mortgage companies,” he said.