Broker Pay Rules Forcing Banks to Play the 'Bad Cop'

As new restrictions on mortgage broker compensation kick in, lenders are realizing — sadly — they will have to police their brokers.

The pay rule has caused so much rancor for other reasons that two broker trade groups were still hoping for a temporary restraining order to stop the changes from taking effect Friday. (A judge had not granted the request at a hearing late Tuesday.)

But little attention has been paid to the added risks for banks and wholesale lenders of buyback requests if loans they fund do not comply with the Federal Reserve's new broker pay rules. Banks and wholesalers face higher compliance and technology costs because they now have to structure and track broker compensation plans.

"The government has put the onus on us, the lender," said Joe Amoroso, the national sales director at Real Estate Mortgage Network, Inc. "If the loan was originated and [it] violated compensation laws, then I'm on the hook for it. We may very well find ourselves in a situation where on every loan we originate, we have to request the broker compensation package, and where banks may want to know how the loan officer got paid on that loan."

Kevin Marconi, the chief operating officer at United Fidelity Funding, a wholesale and retail lender in Kansas City, Mo., said he is making his brokers sign an attestation that they are being paid according to the new rule.

He wants those assurances because his firm may be required to buy back loans from investors if they turn out to have been made in violation of the broker pay rules.

"It's all on our shoulders that the compensation was paid properly," Marconi said. For example, the rule allows brokers to be paid either by the lender or the borrower, but not both. "If there is dual compensation on a loan, it is technically out of compliance — it could be pushed back to us by a mortgage insurer, Fannie Mae or Freddie Mac."

After months of figuring out how to structure their pay plans, most banks and wholesale lenders have chosen to let mortgage brokerages pick from a range of options that vary by state or geographic region.

U.S. Bancorp, for example, has told brokers to pick a specific pay plan ranging from 1.25% to 2.5% of the loan amount at quarter-point increments. Wells Fargo & Co. has five pay plans that vary by state ranging from 1% to 3% per loan, also in quarter-point increments.

Now instead of brokers receiving a single rate sheet from a lender, each brokerage will pick its compensation and the lender will issue it one of a variety of rate sheets.

"From a lender standpoint, it becomes more complicated to manage," said Andrew Soss, founder and branch director of Stewart & Soss Mortgage, a San Jose, Calif., mortgage bank. "From a broker standpoint, it becomes simpler because you take all the pricing flexibility off your plate."

Brokerages likely will pick a monthly or quarterly pay plan, depending on the lender. They also will have to determine how to compensate individual brokers and loan officers according to the pay plan they choose. The level of compensation selected by brokers will determine their competitiveness — both with consumers and with recruitment.

The rule will force brokerages to parse the competitive advantage of receiving higher pay on each loan, which helps them retain good salespeople, or lower interest rates that would allow them to attract more borrowers and, therefore, volume.

"It's a delicate balance between what you make in profit and the amount you need to pay loan officers to be competitive," Soss said.

For brokers, the biggest change will involve adjusting to life without receiving a yield spread premium, a form of hidden compensation paid as a rebate by lenders that the Fed found was confusing to borrowers and gave brokers a perverse incentive to steer borrowers to more expensive loans.

Some brokers say the rule will unfairly hurt first-time homebuyers and borrowers with dings to their credit who typically relied on brokers using some of the yield spread premium to fund a loan's closing costs.

"Ask any broker if they've had to contribute to the buyer's closing costs, and 100% will say they have," said John Frangoulis, president of Realty Financial Network Inc., a Walnut Creek, Calif., mortgage brokerage. "It's the borrowers not served by the big banks, the ones we have to work with to fix their credit, that will be hurt."

The new pay rule prohibits brokers and loan officers from being paid according to the interest rate or any term or condition of the loan. It also prohibits brokers from "steering" a consumer to a lender offering less favorable terms in order to increase the broker's compensation.

Most of the largest lenders have capped the amount a broker can earn at 3% of the loan amount, because of state laws and provisions of the Dodd-Frank Act that limit compensation on loans deemed "high cost" to that level, lenders said.

Because of those caps, brokers will likely prefer to be paid by the borrower — if the borrower agrees to do so.

Marconi said he thinks borrowers will end up paying most broker commissions because brokers offer something the big banks do not: They can close a loan in 30 days or less, a critical issue for borrowers whose deposits on a home are at risk if the loan does not close on time.

"Would you rather buy a pair of shoes from Target or a pair of shoes from Prada?" Marconi said. "They are both shoes. They will both last the same time and do the job. It is the perceived value, though," that the borrower is paying for.

Others say borrowers are unwilling to pay thousands of dollars out of pocket at the closing table for a broker's commission even if it can be financed over the life of the loan.

Matthew Pineda, president of Castle & Cooke Mortgage LLC in Salt Lake City, said high-producing, high-paid brokers face an immediate pay cut because of the caps on lender-paid compensation.

"The top tier just got squeezed because of compensation reform," Pineda said.

Still, the rule allows brokerages to vary compensation within each broker shop according to the experience, quality and volume of loans produced, so some brokers may simply get paid bonuses at a later date, for factors not tied to the terms of a loan such as loan quality or pull-through rates.

The pay rule also provides a safe harbor from the anti-steering provision if brokers give borrowers three loan offers: a loan with the lowest interest rate for which the consumer qualifies; one with the lowest points and origination fees; and the lowest rate for a loan with no risky features such as a prepayment penalty, negative amortization, or a balloon payment in the first seven years.

Matt Ostrander, CEO of Parkside Lending LLC, a San Francisco wholesale lender, said the rule ignores such important features as "high-touch service" or "faster turn times" that are the strong suit of smaller mortgage bankers.

"The law creates a situation where the only thing that gives you a safe harbor is price. Customer service means nothing," Ostrander said. "What this law does in a nutshell is, it basically makes it a lot more difficult for disadvantaged borrowers to get loans."

Some brokerages may take a safe route by selecting the same pay — say 2.5% per loan — from every lender they work with.

Having a one-size-fits-all pay plan will make accounting easier and would ensure that pay "did not have any influence on the loan product," Amoroso said.

He compared the pay change to the Federal Housing Administration's elimination of the "mini-Eagle" designation for brokers. Instead of the Department of Housing and Urban Development tracking brokers, now the lenders who fund FHA loans through brokers are responsible for the tracking.

Another consequence of the anti-steering provision is that brokerages may end up doing business with fewer wholesale lenders. Operationally it may be too cumbersome for banks and wholesalers to implement, monitor and review so many pay plans.

"There's more technology and more costs, and bigger lenders can absorb that easier than the smaller guys, which have to purchase new technology to catch up," said Craig Doriot, founder and chief technology officer of the pricing engine firm LoanSifter Inc. in Appleton, Wis.