Decode the loan originator compensation rule — it’s not complicated

When the Consumer Financial Protection Bureau (CFPB) issued its final loan originator compensation rule in 2013, many financial institutions struggled to understand what types of payments they could and could not make to their loan originators.

To this day, the loan originator compensation rule seems complicated. However, by simply defining key terms in the rule and looking at permissible and prohibited payments, we can demystify its complexities and provide clarity on what it means for financial institutions and loan originators.

Loan originator compensation restrictions

The rule restricts compensating loan originators in certain closed-end, dwelling-secured mortgage transactions (covered transactions) — loan originators can’t receive compensation (directly or indirectly) in any amount that’s based on:

• A term of a transaction.
• The terms of multiple transactions by an individual loan originator.
• A proxy for a term of a transaction. 

The rule aims to stop loan originators from trying to push consumers toward specific credit products or features to increase their own compensation, regardless of consumer harm.

You will want to familiarize yourself with the following terms:

• Compensation: Salaries, commissions, bonuses, enhanced periodic payments (e.g., monthly, quarterly or similar threshold-driven awards), awards of merchandise, services, trips or similar prizes and awards of stock, stock options or equity interests.
• Terms of a transaction: Any rights, obligations, fees or charges imposed by the creditor or their affiliate, or for any product or service needed for the credit, as listed on the closing disclosure. Can include interest rate, annual percentage rate, collateral type (e.g., condo, cooperative, detached home or manufactured housing), lien status, prepayment penalty, origination points or fees paid and fees for creditor-required title insurance.
• Proxy: A factor if it consistently varies with that term over a significant number of transactions, which then reflects a connection between the factor and the term, if the loan originator has the ability, directly or indirectly, to add, drop or change the factor when originating the transaction.
• Relevant time period: The time during which the compensation was earned, regardless of when it was paid.

What types of enhanced periodic payments are permissible?

The rule allows a loan originator to receive a fixed payment, determined in advance, for every covered loan the originator arranges for the creditor (in addition to or instead of a straight salary or hourly wage). For example, they might receive $500 for each completed covered transaction, or $750 for the first 500 transactions and $1,000 for each additional transaction completed during the relevant time period. 

The rule also permits loan originators to receive payments based on the amount of credit extended as long as compensation is a fixed percentage of that amount. This fixed percentage can have minimum and/or maximum dollar limits, but those limits can’t change for each credit transaction and the percentage must be based on the total credit amount extended during the relevant time period. 

What payments are prohibited?

The rule bans loan originator payments that may vary with mortgage-related profits.This means compensation can’t be tied to profits calculated from revenue generated from covered transactions. This can include origination fees and interest associated with these transactions, proceeds of secondary market sales or income derived from the servicing of covered transactions. 

Are there any exceptions?

The rule makes a limited exception for certain deferred tax-advantaged plans. It allows loan originators to receive compensation that qualifies for tax-advantaged status and is paid in the form of a defined contribution or defined benefit. Be aware, however, that in defined contribution plans, the contribution amount can’t be directly or indirectly based on the terms of an individual loan originator's transactions. 

There’s also an exception for non-deferred, profits-based compensation plans if the payments are less than 10% of the total compensation paid during the relevant time period. Examples of both are in the “Calculating total compensation” table below.

How is the 10% limit calculated?

To identify the 10% limit amount, begin by calculating the total compensation amount by adding up the total of all wages and tips that were paid during that time, regardless of when those amounts were earned. 

If the loan originator’s compensation is reportable on a W-2, use the amount reportable for Medicare tax purposes in Box 5. If the loan originator is an independent contractor, use the amount of compensation reportable on IRS form 1099-MISC. For a loan originator who receives both W-2 and 1099-MISC income, add both amounts together. 

Here’s where it gets tricky. At the payor’s option, total compensation may also include:

• Contributions made during the relevant time period to any deferred tax-advantaged defined contribution plan.
• Any non-deferred, profits-based compensation such as bonus pools, profit pools, bonus plans and profit-sharing plans earned during the relevant time period.

When calculating the 10% limit without considering non-deferred, profits-based compensation, simply multiply the total amount by 0.10.

When you include non-deferred, profits-based compensation earned during the relevant time period, you must account for this amount in both the numerator and denominator of the total compensation calculation. 

Here’s an example. Let’s say the total compensation before payment of the non-deferred, profits-based compensation plan is $175,000. To get the amount that can be paid without exceeding the 10% limit, divide the base amount by 9. Using 9 as the denominator ensures the amount of the non-deferred, profits-based bonus will yield a 10% total compensation (when added to the base amount).

$175,000/9 = $19,444

Next, calculate the total compensation amount by adding the result of the prior equation — in this case, $19,444 — to the base amount, $175,000. So, for this example:

$175,000 + $19,444 = $194,444

194,444 X 10% = $19,444

Are there any exceptions to the 10% limit? 

Individuals who only occasionally act as loan originators aren’t subject to the 10% cap if they have completed 10 or fewer covered transactions during the 12 months preceding the compensation determination date.

The restriction doesn’t apply to profits derived from business other than mortgage-related profits, as determined with reasonable accounting principles. However, if mortgage-related and non-mortgage-related business profits aren’t separately calculated, the Bureau tells us all profits are to be considered mortgage-related business.

Are there any payment types that are not prohibited or restricted?

Just because a payment is labeled a bonus and is related to mortgage activity doesn’t make it a bonus based on mortgage-related profits. The following payments aren’t prohibited:

• A retention bonus budgeted for in advance
• A performance bonus paid out of a bonus pool set aside at the beginning of the company’s annual accounting period as part of the company’s operating budget

This is true regardless of whether these payments are based on the terms of a transaction or transactions by that individual loan originator. The reason is that they were budgeted for in advance or set aside in advance, so they aren’t considered to be based on the profits of a mortgage-related business and are therefore not prohibited.

What records must be maintained?

To prove compliance with the rule, financial institutions are generally required to maintain sufficient records of all compensation paid to loan originators, along with loan originator compensation agreements, for three years after the date of payment. Failure to maintain sufficient records could be viewed as a violation of the rule.

Can you show me a few examples of what’s allowed and what’s not?

Here are a few examples of permissible and prohibited payment structures:

How Wipfli can help

If you’re still struggling to understand the loan originator compensation rule, Wipfli can help. Our tax advisors and financial services team can help you with everything from tax planning and strategy to accounting and delivering comprehensive solutions to individuals, businesses and nonprofits.