LO Comp. and distinguishing between Refinance and Purchase
Some thoughts on the issue of complying with the Loan Originator Compensation Rule when it makes good business sense to pay an originator less for refinances than purchases. **
Maybe we should call the Wednesday compliance newsletter "Short Stories in Compliance." So ... here is a short story in compliance! I visit the head of lending at a bank, one of our clients. Here's a colloquy of what happened next ...
Client: Ben, we're concerned with loan officers churning their own portfolios. We're concerned they aren't incentivized enough to go out and get new business. I want them out talking to realtors and going out to lunch with divorce attorneys! But, I don't want to "pull a Castle & Cooke" and violate the CFPB's LO Compensation Rule. Ben, is it okay if I pay a higher BP for purchases than I do for refinances?
Me: No, you shouldn't do that. I'm sorry.
Client: Well, I may have to do it just to make a living!
Me: Well, in the immortal words of Clint Eastwood, "Dying ain't much of a living, boy."
We get paid to provide the right answers. But sometimes the highest value we can provide is by asking the right questions. So the next chapter in this book, I would say to this head of lending, "Why don't you do this instead?"
Here's a summary of our response to the original question:
Short Answer
No.
Medium Answer ("Goldilocks")
It probably shouldn't be a violation, but to avoid a technical violation, you'll have to justify with individualized efforts and documentation. That's not worth it because there is a better way of structuring LO Comp. to accomplish the same goal. Instead of a distinction between refis and purchases, instead pay a higher BP for "new" business.
Full Answer: Proxy Analysis
Determining whether a compensation plan violates LO Comp. is a 2- step process
Is compensation based on a "term"? If yes, then this violates the Rule.
If not based on a term, is it nonetheless based on a "proxy" for a term? If yes, then this also violates the Rule.
So let's apply this process to the purchase vs. refinance question.
#1) No, the fact that the loan is a purchase or refinance is not a "term" of the transaction. Let's go to step two.
#2) This is called the "proxy" analysis. We cannot answer this question without digging deep into the specific facts. A proxy is something that, while not a term itself, is something that (a) consistently varies with a term, and (b) the originator can influence.
So get (a) out of the way; this easily passes--many "terms" will vary with the purchase/refi distinction, such as closing costs.
The key here is with (b) (you need both (a) and (b) to have a "proxy.") Initially, many of us expected the purchase vs. refi distinction to fail
(b) and thus be permitted by the LO Comp Rule. We figured, "an LO doesn't have any control over whether a borrower refis or purchases! That's ridiculous!" Well, the regulators disagree. Both the FDIC and CFPB have said, essentially, that while an LO might not be able to influence the decision, they are reserving the right to check for themselves depending on the unique facts and circumstances of each case. In other words, while this probably isn't a "proxy" to make your LO Compensation plan illegal, you have to prove that it is in each individual case.
So, are you going to train LO's not to discuss the pros/cons of refinancing to build an addition versus moving to a new home or buying a second? And are you going to document this and be prepared to prove to the regulators that your LO's are not influencing this decision?
No, probably not. That's the point.
But don't feel bad, because there's a better way to do it anyway. Provide incentives for "new" business instead. This is perfectly safe under the LO Comp Rule, and accomplishes close to the same objectives as the purchase/refi distinction. Pay an increased BP for loans to "new" customers and limit the risks of LOs just churning their own portfolios. So if you're asking our advice, this would be it. Just take the safe road. Of course, some may disagree, and these rules are still evolving. If it changes we will let you know!
In other news:
Don't forget about the new Mass. Flood law that takes effect tomorrow. Here are some FAQs from the Division of Banks that might help you. Down at the bottom there is a link to a sample form to comply with this (didn't want you to miss it!)
Not anything surprising (that I saw anyway), but just so you're informed, the CFPB's most recent LO Comp. enforcement action (against Franklin Loan Co. for $730,000) can be found here. I don't think this is the type of thing New England mortgage bankers are getting involved in.
Just because pre-payment penalties are stigmatized (and almost eliminated now), don't forget that you may still be able to recover recoupment costs. What are those? They're third party fees, and you can get them back if a borrower pays off early, even if a pre-payment penalty is impermissible. Especially important if you're rolling out a no-closing cost product.
Potential Changes to Newsletter - We're planning to add a section to this newsletter called Compliance Question of the Week, where we research and answer a specific compliance question every week from one of our readers. This is our way of encouraging more comments and questions. So send them in and we'll knock 'em down! We're also considering offering a video or podcast version of the newsletter. While we consider these changes, we would very much appreciate any of your insights.
I can't wake up tomorrow and be more intelligent. Certainly not a better dancer (as my best man so thoughtfully pointed out in his speech at my wedding). But one thing you can control is attitude. That's why leaders focus heavily on improving it (strong leaders often ignore issues they can't control). Anyone can wake up in the morning with a positive attitude to share with colleagues and employees. Kind of a "touchy feely" point, Ben? Not realistic, Ben? Just do your work, Ben? Well, I think this idea has practical value ... here's a concrete example. Compare the attitudes of two leaders I've dealt with in the last year in the context of discussing the new mortgage regulations with the Lending Department.
Leader A says sarcastically, "I'm glad I'm not responsible for this ... good luck to you all! Bet you're regretting your choice of profession now! Haha!"
Leader B says to the team, "Hey, if it were easy, none of us would have jobs!" (And by the way, a very happy birthday to Leader B!)
No doubt the lending department prefers more of Leader B's "smooth seas don't require a skilled sailor" mentality. Where would you rather work?
There are plenty examples of how an attitude is passed along through a "domino effect." Here's one I learned as a lawyer: The Judge's wife jabs him over breakfast- "Aren't you getting a little heavy? Are you sure you wouldn't prefer egg whites?" The Judge takes it out on a lawyer in court- "They must have lowered the standard of entry into this profession. Is your client really paying you for this?" The lawyer then passes it along to her law clerk- "There are a million people out there like you, can't you do any better than this?" And so on and so on ... Can you imagine how the story would change if this had started differently?
"I want them to fall in love with the process, not the prize."
- Kevin Ollie, UCONN's mens basketball coach
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