New rules for loan officer compensation are in full effect today after a federal appeals court lifted an order staying their implementation.
The rules — aimed at eliminating incentives for loan originators to steer borrowers into higher-cost loans — are likely to remain in place pending the outcome of a legal challenge mounted by two groups representing mortgage brokers.
The National Association of Independent Housing Professionals (NAIHP) and the National Association of Mortgage Brokers (NAMB) filed legal challenges of the rules last month in U.S. District Court, claiming the Federal Reserve Board lacked the authority to regulate mortgage brokers and that the rules were "arbitrary and capricious."
Mortgage brokers — who work independently from banks, brokering loans through multiple lenders — maintain that the rules favor loan officers employed by banks, and will drive many of them out of business.
The trial court last week denied NAIHP’s and NAMB’s requests for temporary restraining orders and preliminary injunctions blocking implementation of the rules, saying the groups hadn’t demonstrated they were likely to succeed in their challenge.
Both groups appealed that decision to the U.S. Court of Appeals for the District of Columbia Circuit, which issued an administrative stay of the rules on March 31 — the day before they were scheduled to take effect.
In agreeing to stay implementation of the rules, the appeals court said it was not ruling on the legal merits of the emergency motions filed by mortgage brokers. The appeals court gave attorneys for the Federal Reserve until Monday to respond.
Arguing that the administrative stay should be lifted and a motion for an emergency stay denied, attorneys for the Federal Reserve said in a filing Monday that the trial court "properly concluded that the appellants had not shown that they were likely to prevail" in their arguments.
Claims by mortgage brokers that they will suffer "irreparable harm" must be weighed against the likelihood that delaying implementation of the rules would harm consumers by leaving in place a system that rewards mortgage brokers for putting borrowers in higher-cost loans, Fed attorneys said.
"Each day that the rule’s effective date is postponed is another day consumers will suffer this harm, and their injury, too, is irreparable," attorneys for the government said.
The appeals court on Tuesday ruled that NAIHP and NAMB had not "satisfied the stringent standards required for a stay pending appeal," and dissolved its administrative stay of the rule.
The three-judge appeals court panel also denied an emergency motion to stay implementation of the rule pending appeal, and denied a motion for expedited relief that sought to fast-track the appeal process.
NAMB President Michael D’Alonzo declared the group will continue to argue its case in appeals court, vowing on the group’s Facebook page that "This fight is far from over."
The new rules — an amendment to the Federal Reserve Board’s Regulation Z, which implements the Truth in Lending Act — were published in the Federal Register on Sept. 24.
The rules prohibit loan originators from receiving compensation that’s based on any of a loan’s terms or conditions, except for the amount of the loan.
But mortgage brokers say that one aspect of the rules — governing rebates paid by lenders on higher-interest-rate loans — is targeted specifically at them.
The rebates, known as yield spread premiums, can help borrowers cover closing costs including loan origination fees. But Fed policymakers maintain that yield-spread premiums can also serve as an incentive for mortgage brokers to steer borrowers into high-interest loans.
Mortgage brokers say they are already required to disclose yield-spread premiums to consumers, and that banks earn similar "service release premiums" when they sell higher-interest-rate loans in secondary markets.
But the Fed maintains that consumers are often oblivious of the fact that mortgage brokers receive payments from lenders; they tend to think of mortgage brokers as working on their behalf — a "trusted adviser" who will have their best interest in mind when shopping for the best deal among various lender.
Consumers therefore don’t necessarily understand that mortgage brokers may steer them into a loan that provides the broker with the best compensation, instead of the loan that’s the best deal for the consumer, attorneys for the Fed said in defending the new rules.
That’s especially the case when consumers are also paying loan origination fees themselves, the Fed maintains.
When the consumer is making a direct payment to a loan originator, "the consumer could reasonably expect that making that direct payment would reduce or eliminate the need for the creditor to compensate the originator through a higher interest rate," the Fed maintains.
The solution devised by the Fed in the new loan officer compensation rules is to require mortgage brokers to choose one form of compensation or the other. Mortgage brokers must decide whether they will be paid by lenders (through yield-spread premiums) or by consumers, but cannot receive compensation from both.
Groups representing mortgage brokers say that the rule will give bank loan officers an unfair advantage.
"The Board’s decision to regulate mortgage brokers, while effectively exempting creditors that control 90 percent of the mortgage origination market, was arbitrary and capricious," attorneys for NAIHP and NAMB said in arguing for an emergency stay of the rules.
Mortgage brokers, the groups said Tuesday in an appeals court filing, "provide consumers with disclosures that make clear that they are independent contractors, are not the consumers’ agents, and cannot guarantee the lowest price or best terms available in the market."
Historically, when borrowers are seeking the lowest rate on a loan, mortgage brokers have collected both origination fees paid by consumers and yield-spread premiums from lenders, attorneys for NAMB said in their original March 9 complaint.
Banks’ loan officers offer loans with reduced or no upfront settlement costs in exchange for a higher rate on the borrower’s mortgage, and banks recoup those costs by adding a "service release premium" when they sell mortgages with higher interest rates in the secondary market, NAIHP said in a March 7 complaint.
Attorneys for the Fed acknowledged that while loan officers are also in a position of trust, consumers understand that banks’ loan officers work on behalf of a single lender, and will not help borrowers look for better deals from other lenders.
The rule’s intent was "to prevent a loan originator who works with a variety of lenders from steering a consumer to the lender that will pay the loan originator a higher fee," attorneys for the Fed said.
The fact that a bank lender may charge a high rate for a loan to earn a service release premium "does not present the same problem of a hidden conflict of interest," the Fed maintains. Consumers "would naturally expect that the (bank lender) is not his or her ‘trusted adviser’ in the transaction but is representing its own interest."
According to a report in American Banker, major lenders like Bank of America and Wells Fargo are revamping loan officer compensation to eliminate incentives tied to loan terms, including the interest rate. Banks plan to shift to volume-based incentives that reward loan officers for making more, and bigger loans, American Banker said, citing confidential documents.
The Federal Reserve has suggested that mortgage brokers could make similar changes in the way employees are compensated.